(Unaudited)
1.
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Basis of Presentation and Business Organization
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The accompanying unaudited condensed consolidated financial statements of QSGI INC. (“QSGI” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X under the Securities Exchange Act of 1934. Accordingly they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of the Company’s management, all adjustments (consisting of only normal recurring adjustments) considered necessary to present fairly the financial position, results of operations or cash flows have been made. Certain reclassifications have been made for consistent presentation.
The condensed consolidated statement of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2011. These statements should be read in conjunction with the financial statements and related notes thereto included in the Annual Report of KruseCom for the year ended December 31, 2010 filed on Form 8-K on June 23, 2011 (see “KruseCom Merger” paragraph in Note 1).
On January 31, 2011, the Board of Directors of QSGI, INC. unanimously approved the Third Amended Plan of Reorganization and Disclosure Statement (the “Plan”) to be filed in the United States Bankruptcy Court Southern District of Florida, West Palm Beach Division. This was filed on February 1, 2011.
On February 2, 2011, the United States Bankruptcy Court Southern District of Florida, West Palm Beach Division issued an order approving the Disclosure Statement, setting hearing on confirmation of Plan, setting hearing on fee applications, setting various deadlines, and describing Plan proponent’s obligations.
On March 21, 2011 the United States Bankruptcy Court Southern District of Florida, West Palm Beach Division had a hearing to consider confirmation of the Debtors’ Third Amended Plan of Reorganization (D.E. # 384) under Chapter 11 of the Bankruptcy Code filed by QSGI, INC., QSGI-CCSI, INC. and QUALTECH SERVICES GROUP, INC., and dated February 1, 2011 and confirmed the Plan. The Chapter 11 Plan of Reorganization was confirmed by the US Bankruptcy Court on May 4, 2011 (the “Effective Date”).
Plan of Reorganization
The Plan provides for, among other things, a restructuring of pre-petition debt, as follows (i) distribution of $50,000 and issuance of 10,000,000 common shares in the reorganized debtor for the extinguishment of unsecured indebtedness; (ii) extinguishment of one $10,159,000 unsecured claim in consideration for the confirmation of a Plan of Reorganization; (iii) issuance of 425,000 common shares for the extinguishment of the redeemable convertible preferred stock; (iv) assumption of one $150,000 contingent secured claim bearing interest at 8% per annum and being paid over 8 installments beginning 120 days after confirmation; (v) assumption of note for bankruptcy legal expenses in the amount of $61,673, bearing interest at 8% per annum and being paid over 8 installments beginning 120 days after Plan confirmation; (vi) the right to issue 3,524,000 common shares in exchange for legal services related to the Plan of reorganization; (vii) issuance of 190,000,000 common shares in consideration for the merger of KruseCom; (viii) reservation of 10,000,000 shares to be issued by the reorganized debtor for working capital; (ix) reservation of 2,250,000 shares to be issued by the reorganized debtor to key third parties. All outstanding shares of the Company’s common stock will remain issued and outstanding at and after the Effective Date.
Fresh Start Accounting
The Company, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) ASC 852, adopted fresh-start reporting as of the close of business on May 30, 2011 since the reorganization value of the assets of Predecessor Company immediately before the date of confirmation of the Plan was less than the total of all post petition liabilities and allowed claims, and the holders of the Predecessor Company’s voting shares immediately before confirmation of the Plan received less than 50 percent of the voting shares of the emerging entity. There were no significant operations related to QSGI from May 4, 2011 to May 30, 2011. Accordingly, we used a May 31, 2011 fresh-start date to coincide with KruseCom’s normal financial period close for the month of May. The five-column consolidated statement of financial position as of May 30, 2011, included herein, applies effects of the Plan and fresh-start reporting to the carrying values and classifications of assets or liabilities that were necessary.
Upon adoption of fresh-start reporting, the recorded amounts of assets and liabilities were adjusted to reflect their estimated fair values. Accordingly, the reported historical financial statements of the Predecessor Company prior to the adoption of fresh-start reporting for periods ended on or prior to May 30, 2011 are not comparable to those of the Successor Company. In applying fresh-start accounting, the reorganization value of the entity was allocated to the entity’s assets in conformity with the procedures specified in FASB ASC 805,
Business Combinations.
The reorganization value exceeded the sum of the amounts assigned to assets and liabilities. This excess was recorded as successor company goodwill as of May 31, 2011.
The following five-column consolidated statement of financial position as of May 30, 2011 reflects the implementation of the Plan as if the Plan had been effective on May 30, 2011. Reorganization adjustments have been recorded within the consolidated statement of financial position as of May 30, 2011 to reflect effects of the Plan, including the discharge of liabilities subject to compromise and the adoption of fresh-start reporting in accordance with FASB ASC 852.
KruseCom Merger
Effective June 30, 2011 (the “Merger Date”), the Company merged its operations with KruseCom, LLC (“KruseCom”), a privately-held company headquartered in Palm Beach, FL. KruseCom, was formed as a Florida Limited Liability Company in 2009. KruseCom has not been part of any bankruptcy, receivership or similar proceeding and has not had a material reclassification, merger, consolidation, purchase or sale of a significant amount of assets not in the ordinary course of business. KruseCom’s principal product is data security and compliance (Auditing and Detagging, Erasing of Hard Drive, Tape and Hard Drive Degaussing, Regulatory Compliance Certification and Indemnification, Real time Extranet Reporting, Remarketing and Revenue Sharing and EPA Compliant Recycling, Reverse Logistics, Client-Site Audit and Erasure Solutions). KruseCom has technical facilities in New Jersey, a sales, marketing and business development office in Florida and sales offices in Kentucky and New Hampshire.
As part of QSGI’s plan of reorganization, the Company agreed to merge with KruseCom, whereby QSGI will adopt KruseCom’s operations as its primary business. The members of the KruseCom via a Share Exchange Agreement (the “Exchange Agreement”) transferred 100% of their ownership interest in KruseCom to QSGI on the Merger Date in exchange for 190,00,000 shares of QSGI’s common stock. Under generally accepted accounting principles in the United States of America (“US GAAP”), the share exchange is considered to be a capital transaction in substance, rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by KruseCom for the net monetary assets of QSGI, accompanied by a recapitalization, and is accounted for as a change in capital structure. KruseCom’s shareholders will own the majority of the shares and will exercise significant influence over the operating and financial policies of the consolidated entity. The post reorganization comparative historical financial statements of QSGI and its wholly owned subsidiary will be the historical financial statements of KruseCom accompanied by a recapitalization. References hereafter to the “Company” are intended to be for KruseCom.
The following pro-forma information details the effect of the fresh start accounting along with the KruseCom merger:
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QSGI, Inc
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Preconfirmation
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Adjustments-Confirmation
of Plan and Fresh-Start
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Emerged
Entity
May 30,
2011
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KruseCom, LLC Merger June 30, 2011 (f)
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QSGI Consolidated June 30, 2011
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Current Assets
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Cash and Cash Equivalents
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$
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2,179
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$
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—
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$
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2,179
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$
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240,751
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$
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242,930
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Accounts Receivable
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29,211
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29,211
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Inventory
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244,651
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244,651
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Prepaid expenses and other assets
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75,000
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—
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75,000
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—
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75,000
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Total Current Assets
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77,179
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—
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77,179
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514,613
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591,792
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Long-Term Assets:
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Property, Plant and Equipment, net
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43,833
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43,833
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Goodwill
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—
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1,228,252
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g
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1,228,252
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—
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1,228,252
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Deposits
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11,427
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11,427
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Total Long-Term Assets
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—
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1,228,252
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1,228,252
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55,260
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1,283,512
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TOTAL ASSETS
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$
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77,179
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$
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1,228,252
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$
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1,305,431
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$
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569,873
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$
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1,875,304
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Current Liabilities
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Notes Payable, current portion
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$
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—
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$
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100,928
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d,e
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$
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100,928
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$
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—
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$
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100,928
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Accounts Payable
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—
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—
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—
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178,940
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178,940
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Accrued Expenses and Other Liabilities
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—
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601,531
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a
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601,531
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—
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601,531
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Deferred Taxes
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27,300
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(27,300
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—
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—
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—
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Liabilities Subject to Compromise:
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Accounts Payable
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4,231,668
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(4,231,668
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g
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—
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—
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—
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Accrued Expenses and Other Liabilities
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11,914,983
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(11,914,983
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b,g
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—
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—
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—
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Accrued Payroll
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1,171,773
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(1,171,773
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g
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—
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—
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—
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Total Current Liabilities
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17,345,724
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(16,643,265
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)
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702,459
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178,940
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881,399
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Long-Term Liabilities
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Notes Payable, net of current portion
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—
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110,745
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d,e
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110,745
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100,000
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210,745
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Total Long-Term Liabilities
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—
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110,745
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110,745
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100,000
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210,745
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Redeemable Convertible Preferred Stock
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4,271,472
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(4,271,472
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c
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—
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—
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—
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Stockholders’ Deficit:
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Common Shares-Old (Predecessor Company)
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387,977
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(387,977
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)
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—
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Common Shares-New (Sucessor Company)
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—
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2,004,250
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a,c,f
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2,004,250
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311,727
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h
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2,315,977
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Discount on Common Shares-New
(Sucessor Company)
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—
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(1,535,604
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)
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(1,535,604
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(1,535,604
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Additional paid-in capital-Old (Predecessor
Company)
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16,605,934
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(16,605,934
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b
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—
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—
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—
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Additional paid-in capital-New (Sucessor
Company)
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—
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23,581
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23,581
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52,669
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76,250
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Accumulated Deficit
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(38,533,928
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)
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38,533,928
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—
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(73,463
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)
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(73,463
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Total Stockholders’ Deficit
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(21,540,017
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)
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22,032,244
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492,227
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290,933
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783,160
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TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT
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$
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77,179
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$
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1,228,252
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$
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1,305,431
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$
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569,873
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$
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1,875,304
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Plan of Reorganization
The Plan provides for, among other things, a restructuring of pre-petition debt, as follows:
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a)
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Distribution of $50,000 and issuance of 10,000,000 common shares in the reorganized debtor for the extinguishment of unsecured indebtedness; Amount is comprised of $50,000 pre-petition debt, which was settled as part of the reorganization plan. In addition, amount includes $608,517 of expenses incurred by QSGI in connection with the bankruptcy proceedings, which have been assumed by KruseCom.
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b)
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Extinguishment of one $10,159,000 unsecured claim in consideration for the confirmation of a Plan of Reorganization;
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c)
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Issuance of 425,000 common shares for the extinguishment of the redeemable convertible preferred stock;
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d)
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Assumption of one $150,000 contingent secured claim bearing interest at 8% per annum and being paid over 8 installments beginning 120 days after confirmation;
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e)
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Assumption of note for bankruptcy legal expenses in the amount of $61,673, bearing interest at 8% per annum and being paid over 8 installments beginning 120 days after Plan confirmation;
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f)
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The right to issue 3,524,000 common shares in exchange for legal services related to the Plan of reorganization;
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g)
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Issuance of 190,000,000 common shares in consideration for the merger of KruseCom;
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h)
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Effects of fresh-start accounting;
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i)
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New shares to existing QSGI shareholders.
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2.
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Summary of Significant Accounting Policies
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Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Comprehensive Income
The Company follows FASB ASC 220-10-45 in reporting comprehensive income. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Since the Company does not have any items of comprehensive income, the net (loss) income and comprehensive (loss) income are the same.
Revenue Recognition
For product sales, the Company recognizes revenue at the time products are shipped and title is transferred, which is in accordance with the stated shipping terms. Revenue is recognized in accordance with these shipping terms so long as a purchase order, electronic, written or phone commitment has been received or a contract has been executed, there are no uncertainties regarding customer acceptance, the sales price is fixed and determinable and collectability is deemed probable. If uncertainties exist regarding customer acceptance or collectability, revenue is recognized when those uncertainties have been resolved. The Company may allow customers to return defective products for exchange or credit within a reasonable period, which is generally less than 30 days. Returns are determined on a case-by-case basis and upon approval by management. A return is recorded in the period of the return because, based on past experience, these returns are infrequent and immaterial.
The Company provides a limited warranty on some of its products. The Company analyzes its estimated warranty costs and provides an allowance as necessary, based on experience. At June 30, 2011 and 2010, a warranty reserve was not considered necessary.
During the three and six months ended June 30, 2011 the Company generated $75,000 of revenue from sales to a relative of the Chief Executive Officer.
Cash and Cash Equivalents
The Company considers all liquid instruments purchased with maturity of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable are stated at the amount management expects to collect from outstanding balances. Management provides for probable uncollectible amounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts. Balances which are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to trade accounts receivable.
At December 31, 2010, the Company determined no allowance for doubtful accounts was necessary. The allowance for doubtful accounts at June 30, 2011 and changes in the allowance for the six months ended are as follows:
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Balance,
December 31,
2010
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Provision for
Doubtful
Account Six-
Months Ended
June 30, 2011
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Write-Offs,
Net of
Recoveries
Six-Months
Ended June
30, 2011
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Balance,
June 30, 2011
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June 30, 2011
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$
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0
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$
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2,590
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$
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0
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$
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2,590
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Inventories
Inventories consist primarily of computer hardware, parts and related products, and are valued at the lower of cost or market on a first in first out basis. The allocated cost of parts disassembled from purchased computer hardware is based on the relative fair value of the disassembled components. Substantially all inventory items are parts disassembled from purchased computer hardware. The allocation of cost does not exceed the original cost of the computer hardware. The Company closely monitors and analyzes inventory for potential obsolescence and slow-moving items on an item-by-item basis. Inventory items determined to be obsolete or slow moving are reduced to net realizable value. Inventory in-transit consists of items of inventory for which the Company has purchased and assumed the risk of loss, but which has not yet been received into stock at the Company’s facility.
Equipment
Equipment is stated at contributed fair value, net of accumulated depreciation. Expenditures for maintenance and repairs are charged to operations as incurred. Upon retirement or sale, any assets disposed are removed from the accounts and any resulting gain or loss is reflected in the results of operations. The Company’s equipment, primarily consists of computer hardware and office equipment, is depreciated or amortized using the straight-line method over three to five-year periods.
Impairment losses on long-lived assets, such as equipment, are recognized when events or changes in circumstances indicate that the undiscounted cash flows estimated to be generated by such assets are less than their carrying value and, accordingly, all or a portion of such carrying value may not be recoverable. Impairment losses are then measured by comparing the fair value of assets to their carrying amounts.
Advertising Costs
Advertising costs are expensed on the first date the advertisement takes place. Advertising expense for the three and six-months ended June 30, 2011 amounted to $31,578 and $56,631 respectively. Advertising expense for the three and six-months ended June 30, 2010 amounted to $11,101 and $5,262, respectively.
Shipping and Handling
Shipping and handling costs related to delivery of finished goods are included in cost of goods sold. During the three and six months ended June 30, 2011, shipping and handling costs amounted to $86,110 and $150,293, respectively. During the three and six months ended June 30, 2010, shipping and handling costs amounted to $76,414 and $119,321 respectively.
Goodwill
Goodwill is tested for impairment at the reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.
Sales Taxes
Various states and counties within those states may impose a sales tax on the Company’s sales to non-exempt customers. The Company collects the sales tax and remits the entire amount to the appropriate jurisdiction. The Companies accounting policy is to exclude the tax collected and remitted to these jurisdictions from revenue and cost of sales.
Income Taxes
Prior to the Merger Date, the Company elected to be treated as an S-Corporation for income tax purposes. Under such provisions, the Company’s taxable income is reflected on its members’ personal income tax returns. Accordingly, the Company was not subject to federal income taxes and no provision for income taxes is reflected in the accompanying financial statements for 2011 and 2010. Prior to the Merger Date, management of the Company concluded that the Company qualified as a pass-through entity and determined no uncertain tax positions existed, including the S-Corporation election and sales tax exemptions, that would require recognition in the financial statements. Generally, federal, state and local authorities may examine the Company’s tax returns for three years from the date of filing. The Company’s tax returns since 2009 are currently subject to examination.
Subsequent to the Merger Date, deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided against net deferred tax assets where the Company determines realization is not currently judged to be more likely than not.
(Loss) Income per Share
The Company follows FASB ASC 260, “Earnings per Share,” resulting in the presentation of basic and diluted earnings per share. Because the Company reported a net loss in three and six months ended June 30, 2011, potential common stock equivalents related to stock options were anti-dilutive, therefore, the amounts reported for basic and dilutive loss per share were the same. 14,035,334 and 14,131,917 of weighted average common stock equivalents related to stock options were excluded in the computation of diluted earnings per share for the three and six months ended June 30, 2011.
For the three and six months ended June 30, 2010, the amounts reported for basic and diluted earnings per share were the same because the common stock equivalents were considered anit-dilutive as the average closing market price during the periods are below the exercise price. 13,184,834 and 13,254,834 of weighted average common stock equivalents related to stock options were excluded in the computation of diluted earnings per share for the three and six months ended June 30, 2010.
Fair Value of Financial Instruments
The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, notes receivable and accounts payable approximate fair value due to the relatively short maturity of these instruments. The carrying value of the notes payable and capital lease obligations, including the current portion, approximate fair value based on the incremental borrowing rates currently available to the Company for financing with similar terms and maturities.
Fair Value Measurements
The Company determines the fair market values of its financial assets and liabilities, as well as non-financial assets and liabilities that are recognized or disclosed at fair value on a non-recurring basis, based on the fair value hierarchy established by GAAP. The Company measures its financial assets and liabilities using inputs from the three levels of the fair value hierarchy. At June 30, 2011 and December 31, 2010, the Company has no assets or liabilities that are required to be measured at fair value on a recurring or non-recurring basis.
Stock Based Compensation.
Stock based compensation is amortized to compensation expense on a straight line basis over the requisite service period of the grants using the Black-Scholes valuation model. The Company will reconsider its use of this model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model. The Company does not estimate forfeitures in its expense calculations as forfeiture history has been minor. The Company presents the excess tax benefits from the exercise of stock options as a financing cash flow in the accompanying consolidated statements of cash flows.
Recently Adopted Accounting Pronouncements
In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that provides disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the disclosure requirements effective January 1, 2011.
Recently Issued Accounting Pronouncements Not Yet Adopted
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about the fair value measurements. The amendments include the following:
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1.
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Those that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements.
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2.
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Those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.
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The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Nonpublic entities may apply the amendments in this Update early, but no earlier than for interim periods beginning after December 15, 2011.
The Company is currently evaluating the impact, if any, of ASU No. 2011-04 on the Company’s financial position and results of operations.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The presentation option under current GAAP to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity has been eliminated.
The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted because compliance with amendments is already permitted.
The Company intends to comply with the presentation on January 1, 2012.
3. F
inancing Arrangements
On December 31, 2009, the Company entered into a $25,000 note payable agreement with an employee (the “Employee Note”). Per the agreement, interest accrues monthly at 8% per annum. The agreement had no stated maturity or monthly repayment terms. During December 2010, the employee agreed to convert the principal amount per the agreement plus interest to capital in exchange for an approximately 28% ownership in the Company.
During November 2010, the Company entered into a $250,000 convertible promissory note (the “Convertible Note”) with a third party. The Convertible Note calls for an original stated maturity date of two years or November 2012, unless the Convertible Note is converted to capital or the Company is in default as defined in the Convertible Note agreement prior to November 2012. The note calls for interest at prime plus 4.3% (7.55% at December 31, 2010), not to exceed the default interest rate, due and payable monthly in arrears. The Convertible Note may be converted to capital prior to the first anniversary date in exchange for a 6% interest in the Company following the merger with QSGI, Inc. As of June 30, 2011, the Convertible Note was converted to equity in exchange for approximately 11,400,000 shares of the Company’s stock, pursuant to the Share Exchange Agreement enterend into between QSGI, Inc and KruseCom, LLC on June 17, 2011. As a result of the conversion, the Company reclassified the note to equity.
On April 4, 2011, the Company entered into a $100,000 note payable agreement with a principal of KruseCom (the “Note”). Per the agreement, interest accrues monthly at 8% per annum. The agreement had no stated maturity or monthly repayment terms.
In connection with the Plan of Reorganization, the Company assumed a $150,000 contingent secured claim bearing interest at 8% per annum and being paid over 8 equal installments installments beginning 120 days after the Effective Date.
In connection with the Plan of Reorganization, the Company assumed a promissory note payable for bankruptcy legal expenses in the amount of $61,673, bearing interest at 8% per annum and being paid over 8 installments beginning 120 days after the Effective Date.
4. S
tock Options and Warrants
There were no stock options or warrants issued and approximately 193,000 options expired with prices ranging from $.03 to $2.75 in the first six months of 2011. Upon confirmation of the Plan of Reorganization, all warrants were cancelled. There were no stock options or warrants issued and 140,000 options with exercise prices ranging from $2.75 to $3.40 per share expired in the first six months of 2010. Total options outstanding and exercisable at June 30, 2011 and December 31, 2010 were 14,035,334 and 14,228,334 respectively.
5. I
ncome Taxes
Prior to the Merger Date, the Company elected to be treated as an S-Corporation for income tax purposes. Under such provisions, the Company’s taxable income is reflected on its members’ personal income tax returns. Accordingly, the Company was not subject to federal income taxes in 2010 and no provision for income taxes is reflected in the accompanying financial statements for 2010. There is no income tax benefit for the net losses for the three and six months ended June 30, 2011, since managmement has determined that the realization of the net deferred tax asset is not assured and has created a valuation allowance for the entire amount of such benefit.
The Company's policy is to record interest and penalties associated with unrecognized tax benefits as additional income taxes in the statement of operations. As of January 1, 2011, the Company had no unrecognized tax benefits, or any tax related interest of penalties. There were no changes in the Company's unrecognized tax benefits during the three and six months ended June 30, 2011. The Company did not recognize any interest or penalties during 2011 and 2010 related to unrecognized tax benefits. Tax years from 2008 through 2010 remain subject to examination by major tax jurisdictions.
6. CONCENTRATIONS AND ECONOMIC DEPENDENCY
Sales
For the three and six-months ended June 30, 2011, sales to 3 customers amounted to approximately 50% and 32%, respectively, of total sales. For the three and six-months ended June 30, 2010, sales to 4 and 1 customers amounted to approximately 44% and 20%, respectively, of total sales.
Purchases
For the three and six months ended June 30, 2011, purchases from 4 and 3 vendor amounted to approximately 54% and 50%, respectively, of total purchases. For the three and six months ended June 30, 2010, purchases from 4 and 3 vendor amounted to approximately 62% and 60%, respectively, of total purchases.
Reliance on merchandise vendors
The Company relies on the availability of off-lease and excess inventory computer equipment, which is unpredictable. The Company has no long-term arrangements with its vendors that assure the availability of equipment. The Company purchases equipment from many different vendors, and has no formal commitments with or from any of them. The Company is not assured that its current vendors will continue to sell equipment to it as they have in the past, or that it will be able to establish new vendor relationships that ensure equipment will be available in sufficient quantities and at favorable prices. If the Company is unable to obtain sufficient quantities of equipment at favorable prices, its business will be adversely affected. In addition, the Company may become obligated to deliver specified types of computer equipment in a short time period and, in some cases, at specified prices. Because the Company has no formal relationships with vendors, it may not be able to obtain the required equipment in sufficient quantities in a timely manner, which could adversely affect its ability to fulfill these obligations.
Access to Capital
Since inception, the Company has been able to generate sufficient funds from its operations to pay for its operating expenses. However, the Company may need to raise additional funds to finance unanticipated working capital requirements or to carry out its business plan. If funds are not available when required for unanticipated working capital needs or other transactions, the Company’s ability to carry out its business plan could be adversely affected, and it may be required to scale back operations to reflect the extent of available funding.
7.
Commitments and Contingencies
Operating Leases
At June 30, 2011 and December 31, 2010, the Company is a lessee pursuant to operating leases for office and warehouse space. The lease for office space in West Palm Beach calls for $4,000 per month, on a month-to-month basis and is cancellable with 30-days notice. The lease for warehouse space in New Jersey is for 60 months ending in December 2015. In addition to the monthly minimum rent for the New Jersey warehouse, the Company is responsible for its proportionate share of Common Area Maintenance (“CAM”). The future minimum rental commitments for the New Jersey warehouse are approximately $45,000 annually through 2014 and approximately $22,500 for 2015.
For the three and six months ended June 30, 2011, rent expense amounted to $20,381 and $57,445, respectively. For the three and six months ended June 30, 2010, rent expense amounted to $23,677 and $44,934, respectively.
8.
S
ubsequent Events
On August 26, 2011, the Company was notified that the Honorable Erik P. Kimball, United States Bankruptcy Judge, Southern District of Florida, entered a final decree to close the chapter 11 case. The signing of this order signifies the Company’s emergence from bankruptcy.
On September 16, 2011 the Board of Directors approved an additional Option Grant for each Board member in the amount of 250,000 shares of Common Stock at a strike price of $0.11 per share vesting over three years. Further, the Board of Directors approved a bonus Option Grant for the CEO and CFO in the amount of 5 million and 4 million shares respectively at a strike price of $0.11 per share contingent upon the QSGI Green, Inc. subsidiary achieving $1 million in profitability over any 12 month period for the first 5 years following the acquisition of The Gasket Guy, Inc.
On September 21, 2011, QSGI Green, Inc. (“QSGI Green”) a newly-formed, wholly-owned subsidiary of the Company completed the transactions contemplated by the Asset Purchase Agreement (the “TGG Agreement”) with The Gasket Guy, Inc (the “Seller” or “TGG”) a Florida Corporation, primarily engaged in the manufacture and installation of refrigeration gaskets throughout the United States. The Agreement provides for (1) the purchase of $412,500 of operating assets, customer lists and all operating agreements formerly used by the Seller to manufacture and install its products and generate sales, (2) the purchase of $1 million of existing accounts receivable, (3) the conversion of $565,000 of the Seller’s existing bank note (4) the issuance of a $412,500 Seller’s note bearing interest at 7.5% and maturing December 5, 2016 with minimum EBITDA thresholds and subordinated to the Bank Note noted below and (5) an earn-out based on EBITDA milestones and multiples over a five-year period to be paid in the Company’s stock or cash with a maximum of $25 million total payout. The Seller additionally signed non-competition agreements, non-disclosure agreements and five year employment agreements with the Company.
On September 26, 2011, QSGI Green (the “Borrower”) entered into a loan agreement (the “Bank Note”) with First City Bank of Commerce (the “Lender”) in the amount of $564,875 to replace the Seller’s existing bank note. The Bank Note bears interest at 7.5% and has a maturity date of September 26, 2015. The Bank Note is primarily supported by accounts receivable and inventory of QSGI Green. The Bank Note is personally guaranteed by the two previous founding owners of TGG.
On November 4, 2011 and pursuant to the Registrant’s Plan of Reorganization, a distribution of $50,000 and 10,000,000 common shares was to be distributed to Allowed General Unsecured Claim holders to extinguish all unsecured indebtedness. Additionally, 425,000 common shares are to be distributed for the extinguishment of $4,216,000 in redeemable convertible preferred stock. All distributions were to occur no later than 180 days after Plan Confirmation. The distribution was completed on November 4, 2011, thus increasing the total outstanding shares of the Registrant from 221,172,716 to 231,597,819. These shares have been reflected in the attached financial statements as if issued.
On April 9, 2012, QSGI Green, Inc., a wholly-owned subsidiary of QSGI, Inc., was notified that Moshe Schneider and Avner Harel resigned from their employment positions at the Company. Moshe Schneider and Avner Harel remain subject to a Non-Competition, Non Solicitation and Trade Secret agreement with the Company, which was executed in conjunction with and contemporaneous to the Asset Purchase Agreement dated September 21, 2011 between The Gasket Guy, Inc. (the “Seller”) and the Company.
On July 27, 2012 the Company entered into the settlement of a litigation entitled QSGI, Inc. v IBM Global Financing and International Business Machines Corp., No. 9:11-cv-80880-KLR, in the United States District Court, Southern District of Florida (the “Court”). The parties executed a Settlement Agreement regarding the litigation on July 30, 2012. The Settlement Agreement provided that the parties execute and file with the Court a Stipulation of Voluntary Dismissal of Action with Prejudice (the “Stipulation”). The Stipulation was filed on July 31, 2012 with the Court. All requirements of the Settlement have been satisfied and the Company has filed the required documents with the court to dismiss the litigation with prejudice.
On August 31, 2012 the Company received notification that Benee Scola had tendered her resignation from the Board of Directors of the Company.
On September 6, 2012 the Company appointed Jason Bodnick to the Board of Directors. Additionally, the Board of Directors approved an additional Option Grant for each Board member in the amount of 2 million shares of Common Stock at a strike price of $0.01 per share vesting over three years. Lastly, the Board of Directors approved an additional Option Grant for the CEO and CFO in the amount of 10 million and 5 million shares respectively at a strike price of $0.01 per share vesting over three years.
On December 11, 2012 the Gasket Guy, Inc.(the “Seller”) and the Company entered a Stipulation and Settlement Agreement (the “SSA”) to end all disputes between the Seller and the Company stemming from the Asset Purchase Agreement dated September 21, 2011 between the Seller and the Company. The SSA called for, return of documents, altering the length and scope of the Seller’s Non-Competition agreement, a payment to the Seller and discharge and release of any and all claims the Seller may have had against the Company. During 2013, $25,000 of inventory was tendered to the Seller in full satisfaction of the SSA.
On December 9, 2013 the Company entered into a Mediated Settlement Agreement on a civil action filed on May 24, 2013 in the Fifteenth Judicial Circuit Court in and for Palm Beach County, Florida brought by Robert W. Wright and Susan C. Wright as plaintiffs versus QSGI, Inc. as defendant. The plantiffs alleged that the Company’s attempted conversion of a $250,000 convertible note due to the plaintiffs into approximately 11,400,000 shares of QSGI, Inc.’s common stock as part of a merger transaction on June 17, 2011 was without proper authority. Plaintiffs claimed that the note had therefore not been converted and that approximately $323,000 was due and owing on the Note and that interest continued to run at the default rate of prime plus 7.3% until paid. The settlement reached resulted in agreement of a revised principle balance of $275,000 with interest only monthly payments at an annual interest rate of 5% from January 1, 2014 until June 1, 2016 at which time the principle balance would be due. The note carries no prepayment penalty and the approximately 11,400,000 shares of QSGI Common Stock are deemed to have never been delivered.
On December 13, 2013, the Board of Directors approved an employee Stock Option Grant for approximately 25 million shares at a strike price of $0.01 vesting over one to five years.
On February 17, 2014, the Board of Directors approved a contingent vesting schedule where 20% of its 2014 Option Grant will be lost if an internal Financial Statement deadline is not met on or before June 1, 2014.