Company Quick10K Filing
Qualstar
Price6.02 EPS0
Shares2 P/E66
MCap12 P/FCF56
Net Debt-4 EBIT0
TEV7 TEV/EBIT42
TTM 2019-09-30, in MM, except price, ratios
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QBAK 10K Annual Report

Part I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Note 1 - Significant Accounting Policies
Note 2 - Balance Sheet Details
Note 3 - Income Taxes
Note 4 - Preferred Stock
Note 5 - Stock Based Compensation
Note 6 - Stockholders' Equity
Note 7 - Net Earnings per Share
Note 8 - Commitments
Note 9 - Segment Information
Note 10 - Legal Proceedings
Note 11 - Benefit Plans
Note 12 - Related Party Transactions
Note 13 - Subsequent Events
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10 - K Summary
EX-21.1 ex_176012.htm
EX-23.1 ex_177980.htm
EX-31.1 ex_176013.htm
EX-31.2 ex_176014.htm
EX-32.1 ex_176015.htm
EX-32.2 ex_176016.htm

Qualstar Earnings 2019-12-31

Balance SheetIncome StatementCash Flow
30241812602012201420172020
Assets, Equity
3.82.30.9-0.6-2.0-3.52012201420172020
Rev, G Profit, Net Income
10.07.04.11.1-1.8-4.82012201420172020
Ops, Inv, Fin

10-K 1 qbak20191231_10k.htm FORM 10-K qbak20191231_10k.htm
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark one)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM  _________ TO _________

                                        

COMMISSION FILE NUMBER 001-35810

QUALSTAR CORPORATION

 (Exact Name of registrant as specified in its charter)

 

CALIFORNIA

95-3927330

(State or other jurisdiction of incorporation or organization)

 

1267 Flynn Road, Camarillo, CA

(Address of principal executive offices)

(I.R.S. Employer Identification No.)

 

93012

(Zip Code)

 

Registrant’s telephone number, including area code: (805) 583-7744

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:

Trading Symbol

Name of each exchange on which

registered:

Common Stock

QBAK

The NASDAQ Capital Market 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐     No ☑

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.   Yes ☐     No ☑

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☑  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. :

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer ☑

Smaller reporting company ☑

Emerging Growth Company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financing accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ☐     No ☑

 

The aggregate market value of the common stock held by non-affiliates of the registrant, based upon the closing sale price of $5.82 on the NASDAQ Stock Market, as of June 28, 2019 was approximately $5.8 million.

 

As of March 9, 2020, there were 1,925,025 shares of common stock without par value outstanding.

  

 

 

Documents Incorporated by Reference:

 

None

 

 

 

 

QUALSTAR CORPORATION

 

FORM 10-K

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019

 

INDEX

 

PART I

 

 

Item 1.

Business

3

Item 1A.

Risk Factors

10

Item 1B.

Unresolved Staff Comments

17

Item 2.

Properties

17

Item 3.

Legal Proceedings

17

Item 4.

Mine Safety Disclosures

17

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

18

Item 6.

Selected Financial Data

19

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

26

Item 8.

Financial Statements and Supplementary Data

27

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

48

Item 9A.

Controls and Procedures

48

Item 9B.

Other Information

49

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

49

Item 11.

Executive Compensation

55

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

59

Item 13.

Certain Relationships and Related Transactions, and Director Independence

61

Item 14.

Principal Accountant Fees and Services

62

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

63

Item 16.

Form 10-K Summary

64

 

Signatures

65

 

 

1

 

 

FORWARD-LOOKING STATEMENTS

 

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 ("Reform Act"). Forward-looking statements inherently are subject to risks and uncertainties, some of which we cannot predict or quantify. Therefore, our actual results may differ materially and adversely from the results projected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “ITEM 1A — Risk Factors,” and in “ITEM 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Words such as “believes,” “may,” “will,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” variations of such words, and similar expressions are intended to identify such forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to any such statements. Forward-looking statements contained within this document represent a good-faith assessment of Qualstar Corporation’s future performance for which management believes there is a reasonable basis. Qualstar Corporation disclaims any obligation to update the forward-looking statements contained herein, except as may be required by law.

 

2

 

PART I

 

 

 ITEM 1. BUSINESS

INTRODUCTION

 

 

Qualstar Corporation and its Subsidiaries (“Qualstar”, the “Company”, “we”, “us” or “our”) is organized into two strategic business segments, power solutions and data storage systems. Qualstar is a leading provider of data storage systems marketed under the Qualstar brand and of high efficiency and high-density power solutions marketed under the N2Power brand. Qualstar Corporation was incorporated in California in 1984 and operates four wholly owned subsidiaries. N2Power, Inc. was formed in 2017 to operate the Company’s power supply business. Qualstar Corporation Singapore Private Limited (“QC Singapore”) was created in 2014 to give the Company an engineering footprint in Singapore and better service our contract manufacturers and our Asian distribution partners and customers. On July 4, 2018, a wholly owned subsidiary of Qualstar Corporation, Qualstar Limited, was created to operate the Company’s data storage business in Europe and Africa and on September 5, 2018, a wholly-owned subsidiary of Qualstar Corporation, Q-Smart Data Private Limited, was created to operate the Company’s data storage business in Asia.

 

Qualstar’s N2Power branded power solutions products provide unique power solutions to original equipment manufacturers (“OEMs”) for a wide range of markets, including communications networking, industrial, gaming, test equipment, lighting, medical as well as other market applications. Data storage system products include highly scalable automated magnetic tape-based storage solutions that store, retrieve and manage electronic data primarily in the network computing environment and to provide solutions for organizations requiring backup, recovery and archival storage of critical electronic information.

 

Our storage products are compatible with a wide range of storage management software solutions such as those offered by Xendata, IBM, EMC, CommVault and Veritas.  We offer products addressing the storage needs of the small and mid-size business market. In addition to storage products, we offer service and support programs for our customers.  

 

Our N2Power products provide high-efficiency and high-density AC/DC and DC/DC power solutions for a variety of applications including gaming products and data center technologies such as switches, routers, data storage, servers and networking communications equipment.   With a wide variety of feature-rich standard products and the ability to create custom and semi-custom products, we offer a comprehensive product line to OEMs that require high-value, high-efficiency power supplies to meet specific applications.

 

We sell our products globally through authorized resellers and directly to OEMs. N2Power utilizes contract manufacturers in Asia to produce our power solutions products. Qualstar storage products are manufactured by our OEM suppliers in other parts of the world and are configured to order at our facility in Camarillo, California.  

 

3

 

DATA STORAGE INDUSTRY

 

 Background 

 

The data retention and archival storage markets are comprised of a few large suppliers and a number of medium and smaller companies that offer specialized products and capacity ranges.  Solutions include both disk based and tape-based systems and related software.

 

The proliferation of digital data, e-commerce, big data, digital media streaming, and data analysis has created exponential growth in the production of digital information. As regulators and companies require the longer retention of and access to archived data, the market for products to store that data cost-effectively is growing. We believe this trend will drive continued demand for tape-based data storage products.

 

Strategy

 

The primary objective of our storage business is to be a global leader in highly scalable, cost effective data retention and archival storage for the information technology markets.  To achieve this objective, we plan to:

 

 

Continue to expand our sales channels and geographies. We have begun to accelerate the promotion of Qualstar storage solutions on a global basis and will continue to add resellers outside the US in addition to adding new domestic resellers.  

 

 

 

 

Launch effective marketing campaigns that will increase market awareness of the Qualstar brand as well as reinforce tape’s role within the storage arena. We plan on advertising in select vertical markets to highlight the storage solutions Qualstar provides for those sectors. We also plan on attending trade shows with our partners in order to leverage both their coverage of their markets and their branding in the marketplace.

 

 

 

 

Produce expandable storage solutions that deliver scalability within the data center and more effective capital spending for our customers.  Expandability is a key requirement for customers with rapidly growing capacity needs. Expandability enables customers to easily and quickly add more storage while providing a cost-effective solution that can be readily budgeted during their planning cycles.

 

 

 

 

Expand our product line through private label offerings. We will continue to partner with other vertical solution providers to offer private label products.  In this way, we can provide customers with a broad product offering that expands beyond the product choices they have today.

 

 

 

 

Explore adjacent technologies to expand our functionality and footprint in the IT market.  Historically, we have been focused on products offering tape-based data storage.  We will also explore partnerships with software and disk manufacturers when reasonable to offer a complete data storage solution.

 

 

 

 

Expand our cost effective, service and support programs in international markets. We will investigate enhancing our service and support programs in international markets as we expand product sales in those regions.

  

Our Storage Solutions  

 

Today’s Linear Tape-Open (“LTO”) data storage solutions yield a compelling outcome for organizations struggling to cope with fast growing data, reliable data retention, and budgetary pressure. Qualstar offers LTO-based data storage devices for various vertically focused business units, including but not limited to, media and entertainment, oil and gas, high performance computing, education, telecom and life sciences.

 

4

 

We deliver cost effective data protection and archival storage to small and mid-sized businesses, and to more complex small and mid-sized enterprise environments with stringent performance and data availability requirements.  We provide a variety of storage solutions with a wide range of data storage capacities.

 

Q Series - Tape based data storage devices

 

Qualstar offers a full range of entry level and mid-range data storage solutions for customers ranging from 10 Terabytes to 6.72 Petabytes. Our Q8, Q40, Q48 and scalable Q80 tape libraries satisfy the required data storage capacities as well as data transfer rates of entry level and mid-range customers.

 

RLS Series - Tape based data storage devices

 

These are our “Simply Reliable” robust tape libraries that are designed and manufactured in the United States to satisfy the data storage needs of mid-range customers. With built-in library enabled encryption, individual robots in each cabinet and elevator mechanism to transfer cartridges from one cabinet to other, these tape libraries offer robust data protection at a low cost of ownership. Ranging from 50 to 474 slots offer between 600 Terabytes and 5.69 Petabytes of data storage capacity and up to a 23.8 Terabytes per hour data transfer rate.

 

XLS Series - Enterprise class tape-based storage devices

 

XLS is Qualstar’s highly modular enterprise library system delivering intelligence, density, flexibility, scalability, and ease of use, coupled with our signature reliability and value. XLS features Compass Architecture™, an advanced robotics design that yields superior reliability and density. XLS can be expanded from 435 tapes in easy increments to over 11,700 tapes offering more than 140 Petabytes of data storage capacity. Our unique LRM (Library Resource Module) and MEM (Media Expansion Module) combination allows maximum density of 1368 Terabytes per square foot.

 

  

POWER SUPPLY INDUSTRY

Background

 

The power supply industry is comprised of a few large suppliers and a vast number of smaller companies that focus on specialized products and markets.  Currently, the power solutions market for our N2Power brand products include the servers, storage and network (“SSN”), industrial and transportation (“IND”), network power systems (“NPS”), medical, gaming and lighting markets.

 

We believe the following key trends will continue to drive demand for our power solutions products:

 

 

Increasing amounts of power required by the communications infrastructure industry.  The proliferation of the internet, wireless communications, broadband applications, server and storage farms, data centers and their related infrastructures, and other new technologies have increased exponentially the amount of information transmitted around the world.  As a result, the push for higher bandwidth and more efficient and effective power solutions has been driving a faster replacement cycle for telecommunications equipment as well as strong infrastructure expansion.

     
 

Increasing demand for high conversion efficiencies, high power density and digital power management.   Efforts to reduce energy consumption in the EU, the United States and Asia are increasing the demand for high conversion efficiencies and digital power control.  In addition, groups such as the Climate Savers Computing Initiative, consortium of companies that include Google, Intel, and other eco-conscious businesses and conservation organizations are promoting the development, deployment, and adoption of smart technologies that can both improve a computer’s power efficiency and reduce its energy consumption when inactive.  Because a large portion of electrical energy waste occurs during the power conversion process, power companies have an opportunity to reduce operating costs for the end user by improving conversion efficiency. Our AC/DC power supplies provide conversion efficiency ratings up to 93%. Our digital power control technologies allow us to achieve high levels of power conversion efficiency and control that are not possible with analog designs.  Higher conversion efficiencies help reduce overall power usage and thereby cut greenhouse gas emissions and total cost of infrastructure ownership.

 

5

 

Strategy

 

Our primary objective in our power supply business is to be a global leader in high-efficiency, high-density power solutions for the data center equipment, medical, gaming, test equipment, transportation, industrial and telecommunications network power markets.  To achieve this objective, we plan to:

 

 

Continue to expand our sales channels and geographies.  We promote the N2Power brand on a global basis and are targeting larger OEMs and distributers who have a presence in markets and geographies that we do not currently serve.

 

 

 

 

Continue to increase volume with our current OEM customers.  Our OEM customers are constantly changing their products and introducing new products.  We are striving to become the supplier of choice within our OEM customer base to leverage our existing relationships and drive volume growth within the same sales channel.

 

 

 

 

Continue to expand our footprint in the current markets we serve.  We are currently supporting the data center equipment, medical, gaming, test equipment, transportation, industrial and telecommunications systems markets.  We have secured several sizable OEM customers and are aiming to add new OEM customers in these markets.

 

 

 

 

Expand our product line while continuing to strive for higher power levels and greater conversion efficiencies within a smaller footprint.   Minimizing space requirements within our customers’ products is critical, and as a result there is a continuing need for smaller packaging while delivering additional power.  Our product roadmap addresses these needs and our objective is to lead the industry with the greatest efficiency in the smallest footprint with the highest power available.  In this way, we can deliver advantages to our OEM customers as they leverage our technology in their product designs.

 

 

 

 

Expand our product line through private label offerings.  We have identified a need for utilizing other manufacturers’ core products to complement our own, when we lack products in certain markets or at specific power levels. To achieve this, we will utilize our relationships with other power solutions manufacturers. 

 

 

 

 

Organize our technology resources for fast time to market on derivative products. Our customers continually request derivative configurations of our existing products.  In order to serve this market effectively, we are organizing our engineering resources for fast turnaround on these designs to shorten our OEM customers’ design cycle, leading to faster time to market. 

 

Our Power Solution Products

 

We design, develop, manufacture and market our power solution products, whose purpose is to convert, regulate, purify, manage or distribute electrical power for electronic equipment.  Our products are used in a variety of applications and convert AC current from the power grid to DC current, or modify the voltage being delivered (DC to DC).  We typically target markets where high efficiency and power density are important to our customers.

 

6

 

We sell standard, modified-standard and custom designed products.  Standard products are sold unmodified to our customers.  Modified-standard products are based on lightly modified versions of standard products.   Custom products are designed specifically to the customer’s specification and are not generally sold to other customers. Custom products may require non-recurring engineering and certification costs to bring the product to production. With our core competencies in both power and mechanical design, we are an Optimized Power Systems Manufacturer (OPSM), offering complete custom power assemblies that eliminate the need for our customers to purchase additional components to integrate our power supplies into their products.

 

CUSTOMERS

 

Our solution-focused product offerings are designed specifically for OEMs, information technology departments, and lower and middle market companies. We sell our storage products through our worldwide authorized distributor and reseller network. Power supplies are sold through distributors and direct through independent outside sales representatives. All of our products and services are designed and manufactured to address our customers’ stringent requirements and reliability standards. The following provides additional detail on our channels: 

 

 

Storage reseller channel. Our reseller channel includes systems integrators, value-added resellers (“VARs”) and value-added distributors (“VADs”). Our resellers frequently package our products as part of a comprehensive data processing system or with other storage devices as complete storage subsystem. Our resellers frequently recommend our products as replacement solutions when customers’ systems are upgraded or bundle our products with storage management software specific to the end user's system. We support the reseller channel through our dedicated field sales representatives and technical support technicians.

 

 

 

 

Storage OEM channel. OEM customers incorporate our storage products with their application software and other components to deliver a focused solution. Our products may or may not carry our label.

 

 

 

 

N2Power OEM channel. We have supply agreements with the major power supply customers who incorporate our products into their server, gaming, network and industrial product offerings.

 

 We divide our worldwide sales into three geographical regions:

 

 

The Americas: Mexico, United States, Canada, and South America;

 

 

 

 

EMEA: Europe, the Middle East and Africa;

 

 

 

 

APAC: Asia and Pacific countries.

 

7

 

We support our customers in the Americas primarily through a network of trained distribution partners and representatives located throughout the region. We support our EMEA, APAC and other foreign customers through our distributors and resellers located throughout these regions.

 

Sales to customers outside of the United States represent a significant portion of our sales. International sales are subject to various risks and uncertainties. (See "Risk Factors" in Part I, Item 1A of this report.) The following table sets forth foreign revenue by geographic area ($ in thousands):

 

   

Twelve Months Ended December 31,

 
    2019     2018  

Foreign revenue:

               

EMEA

  $ 1,696     $ 1,849  

APAC

    3,787       3,276  

Other foreign revenue

    56       147  
    $ 5,539     $ 5,272  

Foreign revenue as a percentage of total net revenue

    41.2

%

    43.1

%

 

We provide a full range of marketing materials for branded products, including product specifications, sales literature, and application notes. We also offer lead generation opportunities to key channel partners. Our sales management and engineering personnel provide support to the channel partners and visit potential customer sites to demonstrate the technical advantages of our products. We maintain press relations in the United States, and participate in trade shows worldwide.

 

CUSTOMER SERVICE AND SUPPORT

 

Customer service and support are key elements of our company strategy and critical components of our commitment to making enterprise-class support and services available to companies of all sizes. Our technical support staff is trained to assist our customers with deployment and compatibility for any combination of hardware platforms, operating systems and backup, data protection and storage management software. Our application engineers assist with complex customer issues. We maintain global toll-free service and support phone lines and we also provide self-service and support through our website and email.

 

 Standard warranties include:

 

 

Three-year standard limited warranty on our RLS and XLS tape library products;

 

 

 

 

Two-year standard limited warranty on our “Q-Series” products;

     
 

Optional 24/7 or next business day onsite service on our data storage products in many countries throughout the world; and

 

 

 

 

Three-year return to factory warranty on our N2Power products.

 

ENGINEERING 

 

Our power supply engineering team work to improve our current products and create new products. Our engineers work closely with our customers to incorporate modifications for their specific project requirements. Our data storage business utilizes consultants for any engineering requirements.

 

8

 

Our engineering efforts encompass both the USA and Singapore.  We have also formed strategic partnerships for supplementary engineering resources with third party companies to capture additional state-of-the-art technology driven power designs.  These partnerships allow us to increase our product breadth by releasing more standard and modified standard power solution products in the future.

 

We incurred engineering costs of $0.6 million for the twelve months ended December 31, 2019 and $0.5 million for the twelve months ended December 31, 2018, representing 4.4%, and 4.1% of net revenues, respectively.

 

MANUFACTURING AND SUPPLIERS

 

We perform product assembly, integration and testing for our storage products at our facility in Camarillo, California, and formerly in Simi Valley, California. Our private label storage products are manufactured in various geographical locations by a select group of suppliers. Our N2Power branded products are manufactured in China at specifically qualified contract manufacturers.  We purchase tape drives, chassis, printed circuit boards, integrated circuits, and all other major components from outside suppliers. We carefully select suppliers based on their ability to provide quality parts and components which meet technical specifications and volume requirements. We actively monitor these suppliers but we are subject to substantial risks associated with the performance of our suppliers. For certain components, we qualify a single source, which magnifies the risk of shortages and decreases our ability to negotiate with that supplier. See "If our suppliers fail to meet our component and manufacturing needs, it would delay our production and our product shipments to customers and negatively affect our operations" under the heading "Risk Factors" in Part I, Section 1A of this report. 

  

COMPETITION 

 

The worldwide data storage market is highly competitive. Competitors vary in size from small start-ups to large multi-national corporations which may have substantially greater financial, engineering and marketing resources than us. In the tape automation market, we believe our primary competitors are International Business Machines Corporation ("IBM"), Oracle/StorageTek, Dell Inc., Hewlett Packard, Overland Storage, Spectra Logic and Quantum Corporation. Key competitive factors include product features, reliability, durability, scalability and price. Barriers to entry in tape automation are relatively high as this is an established industry that is capital intensive.

 

Our primary power supply competitors are Meanwell, Artesyn, TDK Lambda, XP Power and Bel Power. Key competitive factors in these markets include price, performance, functionality, availability, interoperability, connectivity, time to market, enhancements and total value of ownership. Barriers to entry for power supply products are high as the industry is capital intensive. 

 

The markets for all of our products are characterized by significant price competition and we anticipate that our products will continue to face substantial pricing pressure. 

 

INTELLECTUAL PROPERTY 

 

We rely on a combination of trademark, trade secret and other intellectual property laws to protect our proprietary rights. Despite our efforts to protect our proprietary rights, competition in our businesses is significant. We believe that, because of the rapid pace of technological change in the tape storage and power supply industries, patent, copyright, trademark and trade secret protection are less significant than factors such as market responsiveness, knowledge, ability, the experience of our personnel, and timely new product introductions. 

 

We enter into Employee Proprietary Information and Inventions Agreements with all employees and consultants to protect our technology and designs.

 

9

 

EMPLOYEES 

 

As of December 31, 2019, we had 16 employees worldwide, 15 full-time and 1 part-time. We also employ a small number of consultants and temporary employees as needed. We are not a party to any collective bargaining agreements or other similar agreements. We believe that we have a good relationship with our employees.   

 

AVAILABILITY OF SEC FILINGS 

 

We are subject to the informational requirements of the Securities Exchange Act of 1934. Therefore, we file periodic reports, proxy statements and other information with the SEC. Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street N.E., Washington, D.C. 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically. Our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on our website as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. Our website addresses are www.qualstar.com and www.n2power.com. Information contained on our web site is not part of this report on Form 10-K or our other filings with the SEC.  

 

 ITEM 1A. RISK FACTORS 

 

Our future results of operations are subject to risks and uncertainties over which we have limited control, and which could cause our actual results to differ materially from our expectations. We are subject to all of the business risks facing manufacturing companies, including business cycles and trends in the general economy, financial market conditions, unpredicted cost variances in raw materials and purchased components, demand variations and volatility, potential loss of key personnel, supply chain disruptions, government legislation and regulation, and natural causes. The following list of risk factors is not all-inclusive. Other factors and unanticipated events could adversely affect our financial position or results of operations. We believe that the most significant potential risk factors that could adversely impact us are the following:  

 

We have had a history of operating losses and we may not sustain profitability. 

 

The Company achieved operating profitability in the years ended December 31, 2018 and 2017.  In 2019, the Company experienced a small operating loss, and prior to 2017, the Company had a history of operating losses since fiscal year ended June 30, 2004. There is no assurance that management can achieve or sustain profitability.

 

Public health threats could have an adverse effect on our operations and financial results.

 

Public health threats could adversely affect our ongoing or planned business operations. In particular, the outbreak in December 2019 of a novel coronavirus (COVID-19) in China has resulted in quarantines, restrictions on travel and other business and economic disruptions. We cannot presently predict the scope and severity of any potential business shutdowns or disruptions, but if we or any of the third parties with whom we engage, including the suppliers, distributers, resellers and other third parties with whom we conduct business, were to experience shutdowns or other business disruptions, our ability to conduct our business in the manner and on the timelines presently planned could be materially and adversely impacted.

 

We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our operating results. 

 

We operate in an industry that is generally characterized by intense competition and rapid technological change. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsellable inventory that may need to be written off and therefore could reduce our operating results. Similarly, price erosion can reduce our operating results by decreasing our revenues and our gross margins.

 

10

 

Our long-term operating results depend substantially upon our ability to continually develop, introduce, and market new and innovative products, to modify existing products, to respond to technological change, and to customize certain products to meet customer requirements. There are numerous risks inherent in this process, including the risks that we will be unable to anticipate the direction of technological change or that we will be unable to develop and market new products and applications in a timely fashion to satisfy customer demands, which could result in a decrease in our net sales and a loss of market share to our competitors. Historically, we have had write-offs of excess and obsolete inventory which negatively impacted our results of operations. In the future, excess or obsolete inventory may need to be written off, and this in turn could reduce our operating results.

 

Changes in demand or downturns in the markets we serve could affect our business and operating results.

 

The industries into which we market and sell our products are cyclical and may experience downturns. These industries also experience volatility, and future volatility as well as downturns, or any failure of these industries to recover from downturns, could materially harm our business and operating results. Likewise, if we have difficulty managing growth in our businesses, it could materially and adversely affect us. In addition, our business and financial position may be adversely affected by current and future economic conditions that cause a decline in business and consumer spending in the markets served by our or our customers’ products.

 

Our operating results may be impaired if demand for our technology declines or fails to develop as we expect. 

 

We will continue to be subject to the risk of a decrease in revenues if demand for our products declines or if rising prices make it more difficult to sell them. If products incorporating other technologies gain comparable or superior market acceptance and competitive price advantage, our business, financial condition and operating results could be adversely and materially affected unless we successfully develop and market products incorporating the new technology. 

 

Our principal competitors devote greater financial resources to developing, marketing and selling their products. Consequently, we may be unable to maintain or increase our market share. 

 

We face significant competition in developing and selling our products. Rapid and ongoing changes in technology and product standards could quickly render our products less competitive, or even obsolete. We have significantly fewer financial, technical, manufacturing, marketing and other resources than many of our competitors and these limited resources may impair the operating results of our business in many ways. For example, in the past our competitors have offered wider ranges of products, expanded the geographic scope of their markets, acquired other companies, and developed or acquired proprietary technologies that operate in conjunction with their products.   

 

 In the future, our competitors may leverage their greater resources to: 

 

 

develop, manufacture and market products that are less expensive or technologically superior to ours;

     
 

reach a wider array of potential customers through a broader range of marketing and distribution channels;

     
 

respond more quickly to new or changing technologies, customer requirements and standards; or

     
 

reduce prices in order to preserve or gain market share.

 

We believe competitive pressures are likely to continue. We cannot guarantee that our resources will be sufficient to address this competition or that we will manage costs and adopt strategies capable of effectively utilizing our resources. If we are unable to respond to competitive pressures successfully, our prices and profit margins may fall and our market share may decrease.

 

11

 

We rely on indirect sales channels to market and sell our branded storage products and both direct and indirect sales channels to market and sell our branded power solutions products. A loss of or deterioration in our relationship with one or more of our resellers or distributors, or our inability to establish new indirect sales channels to drive growth of our products could negatively affect our operating results. 

 

We sell the majority of our branded storage products to value-added resellers, who in turn sell our products to end users. In some cases, resellers integrate our tape libraries with products of other manufacturers and sell the combined products to their own customers. We sell our branded power solution products both direct to OEM customers (or their contract manufacturers) and to our distribution channel who in turn sell our products to OEM customers. The success of these sales channels is hard to predict, particularly over time, and we have no purchase commitments or long-term orders from them that assure us of any baseline sales through these channels. Several of our resellers and distributors carry competing product lines that they may promote over our products, which may negatively impact our sales. A reseller or distributor might not continue to purchase our products or market them effectively, and each reseller or distributor determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to their customers. Establishing new indirect sales channels globally is an important part of our strategy to drive growth of our revenue.

 

Our operating results could be adversely affected by any number of factors including: 

 

 

A change in competitive strategy that adversely affects a reseller’s or distributor’s willingness or ability to distribute our products;

     
 

Reaching fewer customers or losing sales due to ineffective efforts of resellers and distributors;

     
 

Reduced margins and increased costs associated with channel sales;

 

 

An inability to gain traction in developing new indirect sales channels for our branded products;

 

 

Any financial difficulties of our resellers, authorized distributors or direct OEM customers that result in their inability to pay amounts owed to us;

 

 

Changes in requirements or programs that allow our products to be sold by third parties to government customers; or

     
 

Changes in product requirements or certification programs that limit our ability for our products to be sold in our established current markets.

 

We do not have any exclusive agreements with our VARs or distributors who purchase our products on an individual purchase order basis. If we lose important VARs or distributors, or if they reduce their focus on our products or if we are unable to obtain additional VARs, our business could be negatively affected.

 

If our suppliers fail to meet our component and manufacturing needs, it could delay our production and our product shipments to customers and negatively affect our operations. 

 

Our products comprise many components and subassemblies produced by outside suppliers. We depend greatly on these suppliers for items that are essential to the manufacture of our products, including tape drives, printed circuit boards and integrated circuits. For certain items, we qualify only a single source, which magnifies the risk of shortages and decreases our ability to negotiate with that supplier on the basis of price. From time to time, we have been unable to obtain sufficient components that we have needed due to shortages or quality issues from some of our suppliers. If our suppliers fail to meet our manufacturing needs, it would delay our production and our product shipments to customers and negatively affect our operations. 

 

We also rely on software vendors to develop and support software needed for operation of our automated tape library products and their integration into the user’s computing environment. Accordingly, the continued development and future growth of the market for our tape library products will depend partly upon the ability of these vendors to meet the overall data storage and management needs of tape library purchasers and our ability to maintain relationships with these firms.

 

12

 

The primary suppliers of our N2Power power supplies are located in China. If a manufacturer should be unable to deliver products to us on a timely basis or at all, our power supply business could be adversely affected. Though we have had many years of favorable experience with these suppliers, there can be no assurance that circumstances might not change and compel one or more of these suppliers to curtail or terminate deliveries to us. Moreover, the use of contract manufacturers to provide our power supplies typically requires that we place production orders several months in advance of our expected need for the products. This in turn leads to risks that we may lack sufficient inventory to sell to our customers where our expectations were conservative, or that we may order excess product inventory where our expectations were optimistic. We have in the past, experienced shortages of some parts needed to manufacture our power supplies.

 

As our primary supplier is in China, issues such as natural disasters or government directed closures may adversely affect our ability to deliver product in a timely manner to our customers. The recent extension by the Chinese government of the Lunar New Year holiday to curb the spread of the Coronavirus has disrupted the supply chain for global markets and may materially and adversely impact the supply of components used in our products.

 

If we fail to develop and introduce new products on a timely and cost-effective basis, or if our products do not contain the features required by the marketplace, we may eventually lose market share and sales to competitors. 

 

The market for our products is characterized by changing technology and evolving industry standards. Our future results will depend on our ability to anticipate changes in technology, to develop new and enhanced products on a timely and cost-effective basis, and to introduce, manufacture and achieve market acceptance of these new and enhanced products. With respect to our tape library products in particular, the introduction of new storage technologies or the adoption of an industry standard different from our current product standards could render our existing products obsolete.

 

Development schedules for high technology products are inherently subject to uncertainty and there can be no assurance that we will be able to meet our product development schedules or that our development costs will be within budgeted amounts. If the products or product enhancements developed are not deliverable due to technical problems, quality issues or component shortages, or if such products or product enhancements are not accepted by the marketplace or are unreliable, then our business, financial condition and results of operations may be adversely affected. 

 

If we fail to protect our intellectual property or if others use our proprietary technology without authorization, our competitive position may suffer. 

 

We rely on a combination of trademark, trade secret, and other intellectual property laws and various contract rights to protect our proprietary rights. Despite our efforts to protect our proprietary rights, however, unauthorized parties may attempt to copy or otherwise obtain or use our products or technology. As a consequence, these rights may not preclude competitors from developing products that are substantially equivalent or superior to our products. In addition, many aspects of our products are not subject to intellectual property protection and therefore can be reproduced by others. 

 

Undetected manufacturing flaws could increase our costs, reduce our revenues and divert resources from our core business needs. 

 

Despite our efforts to revise and update our manufacturing and test processes to address engineering and component changes, we may not be able to control and eliminate manufacturing flaws adequately. These flaws may include undetected software or hardware defects associated with a newly introduced product, a new version of an existing product, or a product that has been integrated into a system or apparatus with the products of other vendors. If we fail to adequately monitor, develop and implement appropriate test and manufacturing processes we could experience a rate of product failure that results in substantial shipment delays, warranty costs or damage to our reputation. Product flaws may also consume our limited engineering resources and interrupt our development efforts. Significant product failures would increase our costs and result in the loss of future sales and be harmful to our business.

 

13

 

Much of our business is subject to risks associated with operations in foreign countries. 

 

We generate a significant percentage of our revenue internationally, and we believe that international sales will continue to represent a substantial portion of our revenues. In addition, our manufacturing of power supply products is performed by contract manufacturers in Asia. We face risks that the countries in which we conduct business, or in which we have customers, suppliers, or contract manufacturers could:

 

 

Experience financial, economic or political instability;

 

 

Adopt laws that make the enforcement of our contractual or other legal rights and remedies difficult or uncertain;

 

 

Provide inadequate intellectual property protection for our technology;

 

 

Impose restrictions on the export or import of technology that would affect our ability to obtain supplies from, or sell products into, such countries;

 

 

Impose tariffs, quotas, taxes, other market barriers;

 

 

Impose other laws, regulations or policies adversely affecting trade, investment or taxes, including those relating to the repatriation of funds and to withholding taxes; or

 

 

Experience business closures due to health threats or natural disasters.

 

Other risks and costs associated with international operations include:

 

 

Currency exchange risk, to the extent that exchange rate fluctuations could make our products unaffordable to foreign purchasers or more expensive compared to those of foreign manufacturers;

 

 

Compliance with laws and regulations in various regions in which we operate;

 

 

Greater difficulty and longer delays in collecting accounts receivable from international customers; or

 

 

Increased risk of shipping disruptions particularly in foreign countries experiencing political instability.

 

Change of board and senior management, and retention of key personnel. 

 

Turnover in key management positions could temporarily harm our financial performance and results of operations. Loss of certain members of our senior management may disrupt operations and relations with key customers and distributors and our operating results could be adversely affected. Our capacity to develop and implement new technologies depends on our ability to employ personnel with highly technical skills. If we cannot attract and retain key technical personnel, our technical expertise may suffer, and our operating results could be adversely affected. In addition, it could be difficult, time consuming and expensive to replace any key management member or other critical personnel and no guarantee exists that we will be able to recruit suitable replacements or assimilate new key management personnel into our organization to achieve our operating objectives. 

 

Intellectual property infringement claims brought against us could result in a substantial liability and significant costs, and as a result, our business, financial condition and operating results may be materially and adversely affected. 

 

From time to time, we may become subject to claims or inquiries regarding an alleged unauthorized use by us of another party’s intellectual property. While we currently believe the amount of ultimate liability, if any, with respect to any such actions will not materially affect our financial position, results of operations or liquidity, the ultimate outcome of any license discussion or litigation is uncertain. Adverse resolution of any infringement claim could subject us to substantial liabilities and require us to refrain from manufacturing and selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. As a result, our business, financial condition and operating results could be materially and adversely affected.

 

14

 

Our revenues and operating results may fluctuate unexpectedly from quarter to quarter, which may in turn affect our stock price. 

 

Our quarterly revenues and operating results have fluctuated in the past, and are likely to vary in the future due to the various factors discussed above and others, including: 

 

 

General economic conditions affecting spending and the rates of growth or decline in the markets we serve;

     
 

Variations in product order backlogs, and reductions in the size, delays in the timing, or cancellation of significant customer orders;

     
 

The timing of introductions and marketplace acceptance of new or enhanced products by us or our competitors;

     
 

Expansions or reductions in our relationships with distributors, VARs or OEM customers;

     
 

Unprofitable investments in engineering activities, or sales evaluation, testing, and acceptance processes;

     
 

Unforeseen warranty costs that exceed established reserves;

 

 

Timing and levels of our operating expenses; or

 

 

Emerging new technologies that change the nature of or need for our products.

 

We believe that period-to-period comparisons of our operating results may not necessarily be reliable indicators of our future performance. It is likely that in some future period our operating results will not meet your expectations or those of public market analysts. Any unanticipated change in revenues or operating results is likely to cause our stock price to fluctuate since such changes reflect new information available to investors and analysts. New information may cause investors and analysts to revalue our stock and this, in the aggregate, may cause fluctuations in our stock price.

 

Trading in our stock has historically been limited and our stock price has been volatile, which may affect your ability to sell your shares. 

 

The average trading volume in our stock has been historically low, with little or no trading at all on some days. This, as well as the factors listed below, has caused the price of our stock to be volatile. Consequently, it may be difficult to sell your shares of our stock at the price you paid for them or at a price equal to that quoted on the NASDAQ Stock Market. Factors that may cause our stock price to fluctuate in the future include: 

 

 

Quarterly variations in operating results, especially if they differ from our previously announced forecasts or forecasts made by analysts;

 

 

Announcements by us of anticipated future revenues or operating results, or by others concerning us, our competitors, our customers, or our industry;

 

 

The introduction of new technology or products by us or our competitors;

 

 

Comments about us and the data storage or power supply markets made by industry analysts or on Internet comment sites; or

 

 

Changes in earnings estimates by analysts or changes in accounting policies; in product pricing policies by us or our competitors; or in general economic conditions.

 

15

 

In addition, stock markets have experienced extreme price and volume volatility recently. This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated or disproportionate to the operating performance of the specific companies. These market fluctuations may adversely affect the market price of our common stock.

 

Certain provisions in our charter documents and California law may hinder or prevent a change in control of our company.

 

Certain provisions of our charter documents could make it difficult for a third party to obtain control of the Company. For example, our articles of incorporation and bylaws require that stockholders must timely inform our corporate secretary before a stockholders' meeting if they wish to nominate directors or submit proposals for shareholder approval and contain provisions that eliminate cumulative voting in the election of directors. In addition, subject to the rules of the NASDAQ Stock Market, our board of directors has the authority, without any action by the shareholders, to issue up to 5,000,000 shares of preferred stock and to fix the rights and preferences of such shares. These provisions may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our common stock at a premium over its market price and may adversely affect the market price, and the voting and other rights of the holders of our common stock.

 

Our success depends in part on our CEO, who simultaneously leads other public corporations.

 

Steven N. Bronson, our Chief Executive Officer and President, simultaneously serves as the President and Chief Executive Officer of Interlink Electronics, Inc. (NASDAQ: LINK) and Chief Executive Officer and Chairman of BKF Capital Group, Inc. (OTCMKTS: BKFG). As a result, he divides his time among these companies and does not devote his full business time and attention to Qualstar’s business. Mr. Bronson currently works on average approximately 20 to 30 hours per week for Qualstar. There can be no assurance, however, that the amount of time Mr. Bronson devotes to our Company will not diminish from time to time for limited or extended periods as his other business obligations require a greater portion of his attention. Mr. Bronson is not required to spend a minimum amount of time on Qualstar business. Our continued success depends in part upon the availability and performance of Mr. Bronson, who possesses unique and extensive industry knowledge and experience as well as a deep understanding of our business and strategy. A reduction in Mr. Bronson’s services to Qualstar from their current levels due to his obligations to Interlink Electronics, BKF Capital or other organizations with which he is affiliated could have a disruptive effect, adversely impacting our ability to manage our business effectively and execute our business strategy.

 

Changes in trade policy in the United States and other countries, including changes in trade agreements and the imposition of tariffs and the resulting consequences, may have adverse impacts on our business, results of operations and financial condition.

 

The United States government has indicated and demonstrated its intent to alter its approach to international trade policy through the renegotiation, and termination, of certain existing bilateral and multi-lateral trade agreements and treaties with, and the imposition of tariffs on a wide range of products and other goods from, China and other countries. Given our primary contract manufacturer and a significant product supplier is located in China, and we have limited manufacturing elsewhere, policy changes in the United States or other countries, such as the tariffs already proposed, implemented and threatened, present particular risks for us. Tariffs already announced and implemented, and future tariffs may have an adverse effect on certain of our products. We cannot predict future trade policy, the terms of any renegotiated trade agreements or treaties, or tariffs and their impact on our business. A trade war could have a significant adverse effect on world trade and the world economy. To the extent that trade tariffs and other restrictions imposed by the United States or other countries increase the price of, or limit the amount of, our products or components or materials used in our products imported into the United States or other countries, or create adverse tax consequences, the cost or gross margin of our products may be adversely affected and the demand from our customers for products and services may be diminished. If we deem it necessary to alter all or a portion of our activities or operations in response to such policies, agreements or tariffs, our capital and operating costs may increase. Our ongoing efforts to address these risks may not be effective and may have long-term adverse effects on our operations and operating results that we may not be able to reverse. Such efforts may also take time to implement or to have effect, and may result in adverse quarterly financial results or fluctuations in our quarterly financial results. As a result, changes in international trade policy, changes in trade agreements and tariffs could adversely affect our business, results of operations and financial condition.

 

16

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

   

ITEM 2. PROPERTIES 

 

Qualstar headquarters is located in Camarillo, California. The facility is 9,910 square feet and is a 5 year and two-month lease, beginning June 1, 2019 and expiring July 31, 2024. The rent on this facility is $9,910 per month with a 3% step-up annually and an option to renew the lease for two 36 month periods.

 

Qualstar leases a 15,160 square foot facility located in Simi Valley, California. The three-year lease began December 15, 2014 and has been renewed for an additional three years, expiring February 28, 2021. Rent on this facility is $11,400 per month. On May 22, 2019, Qualstar entered into a sublease for the Simi Valley location, which previously served as Qualstar’s corporate headquarters and principal executive office. The term of the sublease commenced on July 15, 2019 and ends on February 28, 2021 (the “Term”). The base rent under the Sublease is approximately $13,000 per month.

 

During the fiscal year ended December 31, 2019, Qualstar also leased approximately 5,400 square feet of office space in Westlake Village, California.  The lease expired on January 31, 2020, and will not be renewed. Rent on this facility was $11,000 per month, with a step-up of 3% annually. Effective March 21, 2016, Qualstar entered into a sublease agreement for the Westlake Village facility. The term of the sublease expired at the same time as the term of the master lease and the tenant paid Qualstar $12,000 per month with a step-up of 3% annually.

 

Qualstar leases a facility in Singapore with 1,359 square feet for our power supply engineering staff. The two-year lease was effective April 1, 2016 and renewed for two years, expiring March 31, 2020. Rent for this facility is $2,600 per month. The lease will not be renewed.

 

ITEM 3. LEGAL PROCEEDINGS

 

Qualstar is subject to a variety of claims and legal proceedings that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in the aggregate, will not have a materially adverse impact on our financial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future. We accrue loss contingencies in connection with our commitments and contingencies, including litigation, when it is probable that a loss has occurred, and the amount of the loss can be reasonably estimated. As of December 31, 2019, no accrual was necessary for fees and costs related to loss contingency matters.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

17

 

PART II

  

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

Qualstar’s common stock is traded on The NASDAQ Capital Market or NASDAQ (Symbol — QBAK).

 

Holders

 

There were approximately 21 owners of record of Qualstar’s common stock as of March 9, 2020, not including beneficial owners who own their stock in street name through Cede & Co. and others.

 

Dividend Policy

 

No dividends were declared in the twelve months ended December 31, 2019 or 2018. Any future determination to pay dividends will be at the discretion of the Company’s Board of Directors and will depend upon, among many other factors, the Company’s results of operations, financial condition, capital requirements and any contractual restrictions.

 

Recent Sales of Unregistered Securities 

 

None

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

On December 5, 2018, the board of directors approved a stock repurchase program (the “Stock Repurchase Program”) to repurchase shares of the Company’s common stock. The program permitted repurchases of up to a maximum aggregate purchase price of $2,400,000 and the number of shares of common stock repurchased was not to exceed 409,000. The program expired December 5, 2019. The following table presents the information about purchases by Qualstar of its common stock during the quarter ended December 31, 2019:

 

   

Total Number of Shares Purchased

   

Average Price Paid Per Share

   

Total number of shares

purchased as a result

of publicly announced

plans or programs

   

Maximum or approximate

dollar value of shares yet

to be purchased under the

plans or programs

 

October 1, 2019 to October 31, 2019

    6,900     $ 5.464       140,166     $ 1,633,810  

November 1, 2019 to November 30, 2019

    5,638     $ 5.522       145,804     $ 1,596,120  

December 1, 2019 to December 5, 2019

    2,289     $ 5.678       148,093     $ 1,565,097  

 

18

 

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

 

The following table provides additional information regarding Qualstar’s equity compensation plans as of December 31, 2019:

 

Plan category

 

(a)

Number of securities to be

issued upon exercise of

outstanding options,

warrants and rights (1)

   

(b)

Weighted-average

exercise price of

outstanding

options, warrants

and rights (1)

   

(c)

Number of securities

remaining available for

future issuance

under equity

compensation plans

(excluding securities

reflected in column (a))

 

Equity compensation plans approved by security holders

    161,333     $ 7.17       138,667  

Equity compensation plans not approved by security holders

                 

Totals

    161,333     $ 7.17       138,667  

 

(1)

Includes shares subject to stock options granted under the 2017 Stock Incentive Plan and the 2008 Stock Incentive Plan as of December 31, 2019. The 2008 Stock Incentive Plan has expired and no further options may be granted under the plan. 

  

ITEM 6. SELECTED FINANCIAL DATA

 

Not required for smaller reporting companies.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes to the consolidated financial statements included later in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in “Risk Factors” and “Forward-Looking Statements.”

  

OVERVIEW

 

Qualstar Corporation was incorporated in California in 1984. Qualstar manufactures and sells automated tape libraries used to store, retrieve and manage electronic data under its Qualstar brand. Tape libraries consist of cartridge tape drives, tape cartridges and robotics to move the tape cartridges from their storage locations to the tape drives under software control. Qualstar’s tape libraries provide storage solutions for organizations requiring backup, recovery and archival storage of critical electronic information. Qualstar’s subsidiary, N2Power, Inc., designs, develops, manufactures and sells high efficiency AC-DC and DC-DC power supplies under the N2Power brand name.

 

Qualstar has developed a business plan to establish worldwide partnerships with other power supply and data storage related companies that will increase our engineering capabilities to develop new products and enable us to ‘private label’ and sell already established strategic products that fit within our portfolio of products.

 

Qualstar established a Singapore subsidiary in 2014, Qualstar Corporation Singapore Private Limited (“QC Singapore”), in furtherance of its plan to establish a power supply engineering footprint in Asia. QC Singapore has allowed us to hire strategic engineering personnel to assist in sustaining our current power products and for new product development. QC Singapore has helped us in servicing our Asian customers and allows us to enter into relationships with various Singapore technical schools that have a strong history of working with local businesses in development of new breakthrough technologies.

 

19

 

Qualstar has established two additional subsidiaries to aid the Company’s global expansion goals. On July 4, 2018, a wholly-owned subsidiary of Qualstar Corporation, Qualstar Limited, was created to support Qualstar’s data storage business in Europe, Middle East and Africa. On September 5, 2018, a wholly owned subsidiary of Qualstar Corporation, Q-Smart Data Private Limited, was created to assist the Company’s data storage business growth in the Asia Pacific region.  

 

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our discussion and analysis of our consolidated financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to loss contingencies, product life cycles and inventory obsolescence, bad debts, sales returns, warranty costs, share-based compensation forfeiture rates, and the potential outcome of future tax consequences. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. 

 

 Revenue Recognition

 

The Company recognizes revenue in accordance with Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (ASC 606), when its customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services.  To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy a performance obligation. The five-step model is applied to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services transferred to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are performance obligations and assess whether each promised good or service is distinct. We then recognize revenue in the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

 

Title and risk of loss generally pass to our customers upon shipment.  In limited circumstances where either title or risk of loss pass upon destination, we defer revenue recognition until such events occur. We derive revenues from two primary sources: products and services. Product revenue includes the shipment of product according to the agreement with our customers for data storage products and power supplies. Services include customer support (technical support), installations, consulting, and design services. A contract may include both product and services. Rarely, contracts with customers contain multiple performance obligations. For these contracts, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. Standalone selling prices are typically estimated based on observable transactions when these services are sold on a standalone basis.

 

We provide product warranties with varying lengths of time and terms. The product warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations. We also sell separately priced maintenance service contracts which qualify as service-type warranties and represent separate performance obligations. We have historically experienced a low rate of product returns under the warranty program.

 

20

 

A variety of technical services can be contracted by our customers for a designated period of time. The service contracts allow customers to call Qualstar for technical support, replace defective parts and to have onsite service provided by Qualstar’s third party contract service provider. We record revenue for contract services at the amount of the service contract, but such amount is deferred at the beginning of the service term and amortized ratably over the life of the contract.

 

Our professional services include consulting, engineer and design services. Because control transfers over time, revenue is recognized based on progress toward completion of the performance obligation. The method to measure progress toward completion requires judgment and is based on the nature of the products or services to be provided. The Company generally uses the input method to measure progress for its contracts because it best depicts the transfer of assets to the customer, which occurs as the Company incurs costs for the contracts. Under the cost-to-cost measure of progress, the progress toward completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue is recorded proportionally as costs are incurred. Costs to fulfill these obligations include labor and subcontractor costs.

 

One of the Company’s contracts includes variable consideration that is constrained because the contract has a large number and broad range of possible consideration amounts. The Company uses an expected value method to estimate the amount of variable consideration in this contract.

 

The Company has elected the practical expedient to not disclose information about the transaction price that is unsatisfied as of December 31, 2019, because the transaction price only includes variable consideration that is constrained.

 

The Company has elected the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component for contracts where the period between when the Company transfers service and when the customer pays is one year or less.

 

Deferred service revenue is shown separately in the condensed consolidated balance sheets as current and long term.  At December 31, 2019 we had deferred service revenue of approximately $949,000.  At December 31, 2018, we had deferred service revenue of approximately $863,000.

 

Fair Value of Financial Instruments

 

We measure fair value on all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis (at least quarterly). See “Note 1 – Accounting Policies” in the accompanying notes to the consolidated financial statements. 

 

Allowance for Doubtful Accounts

 

We estimate our allowance for doubtful accounts based on an assessment of the collectability of specific accounts and the overall condition of accounts receivable. In evaluating the adequacy of the allowance for doubtful accounts, we analyze specific trade receivables, historical bad debts, customer credits, customer credit worthiness and changes in customers’ payment terms and patterns. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make additional payments, then we may need to make additional allowances. Likewise, if we determine that we could realize more of our receivables in the future than previously estimated, we would adjust the allowance to increase income in the period we made this determination.

 

Inventory Valuation

 

We record inventories at the lower of cost or market value on a first in first out basis. We assess the value of our inventories periodically based upon numerous factors including expected product or material demand, current market conditions, technological obsolescence, current cost and net realizable value. If necessary, we write down our inventory for estimated obsolescence, potential shrinkage, or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If technology changes more rapidly than expected, or market conditions become less favorable than those projected by management, additional inventory write-downs may be required.

    

21

 

Warranty Obligations

 

We provide for the estimated cost of product warranties at the time revenue is recognized. We engage in extensive product quality programs and processes, including active monitoring and evaluation of product failure rates, material usage and estimation of service delivery costs incurred in correcting a product failure. However, should actual product failure rates, material usage, or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. Historically our warranty costs have not been significant. 

 

Legal and Other Contingencies

 

The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. When legal costs that the entity expects to incur in defending itself in connection with a loss contingency accrual are expected to be material, the loss should factor in all costs and, if the legal costs are reasonably estimable, they should be accrued regardless of whether a liability can be estimated for the contingency itself. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. Changes in these factors could materially impact our financial statements. 

 

Share-Based Compensation

 

Share-based compensation is accounted for at fair value over the vesting period. We use the Black-Scholes option-pricing model to determine fair value of the award at the date of grant and recognize compensation expense over the vesting period. The inputs we use for the model require the use of judgment, estimates and assumptions regarding the expected volatility of the stock, the expected term the average employee will hold the option prior to the date of exercise, expected future dividends, and the number of share-based awards that are expected to be forfeited. Changes in these inputs and assumptions could occur and actual results could differ from these estimates, and our results of operations could be materially impacted. 

 

Accounting for Income Taxes

 

We estimate our tax liability based on current tax laws in the statutory jurisdictions in which we operate. These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes, as well as about the realization of deferred tax assets.  We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures.

 

We maintain a valuation allowance to reduce our deferred tax assets due to the uncertainty surrounding the timing of realizing the benefits of net deferred tax assets in future years. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for such a valuation allowance. In the event we were to determine that we would be able to realize all or part of our net deferred tax asset in the future, the valuation allowance would be decreased accordingly.

 

We may periodically undergo examinations by the federal and state regulatory authorities and the Internal Revenue Service. We may be assessed additional taxes and/or penalties contingent on the outcome of these examinations. Our previous examinations have not resulted in any unfavorable or significant assessments.

 

The Company has net operating loss carry forwards for federal income tax purposes of approximately $30.6 million and net operating loss carry forwards for state income tax purposes of approximately $19.0 million. The Company has engineering and other credits for tax purposes of $2.6 million. If not utilized, the federal net operating loss will start to expire beginning in 2026 and other tax credit carry forwards will start to expire beginning in 2024. If not utilized, the state net operating loss carry-forward as of December 31, 2019 will expire beginning in 2020. The state engineering credit has no limit on the carry-forward period.

 

22

 

Recent Accounting Pronouncements

 

See Recent Accounting Guidance in “Note 1 Summary of Significant Accounting Policies" in the accompanying notes to the consolidated financial statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on our results of operations and financial condition.

 

RESULTS OF OPERATIONS

 

The following table reflects, as a percentage of net revenues, consolidated statements of operations data for the periods indicated. The table summarizes the revenue for the Company’s two business segments, data storage and power supplies, as discussed in Note 11 of our consolidated financial statements, in thousands.

 

   

Twelve Months Ended

December 31,

 
   

2019

   

2018

 

Power supply revenues

  $ 5,079       37.8

%

  $ 5,927       48.5

%

Storage revenues:

                               

Product

    4,194       31.2

%

    3,111       25.4

%

Service

    4,166       31.0

%

    3,191       26.1

%

Total storage revenues

    8,360       62.2

%

    6,302       51.5

%

Net revenues

    13,439       100.0

%

    12,229       100.0

%

Cost of goods sold

    9,916       73.8

%

    7,184       58.7

%

Gross profit

    3,523       26.2

%

    5,045       41.3

%

Operating expenses:

                               

Engineering

    588       4.4

%

    502       4.1

%

Sales and marketing

    1,397       10.4

%

    1,337       10.9

%

General and administrative

    1,608       12.0

%

    1,716       14.0

%

Total operating expenses

    3,593       26.7

%

    3,555       29.1

%

Income (loss) from operations

    (70

)

    (0.5

)%

    1,490       12.2

%

Other income

    45       0.3

%

    -       -

%

Income (loss) before income taxes

    (25

)

    (0.2

)%

    1,490       12.2

%

Provision (benefit) for income taxes

    (18

)

    (0.1

)%

    4       0.0

%

Net income (loss)

  $ (7

)

    (0.1

)%

  $ 1,486       12.2

%

 

  

Comparison of the Twelve Months Ended December 31, 2019 and 2018

 

Change in Net Revenues:  

 

   

Twelve Months Ended December 31,

                 
   

2019

   

2018

   

Change

 
   

Amount

   

% of net

revenue

   

Amount

   

% of net

revenue

   

Amount

   

%

 

Power supply revenues

  $ 5,079       37.8

%

  $ 5,927       48.5

%

  $ (848

)

    (14.3

)%

Storage revenues

    8,360       62.2

%

    6,302       51.5

%

    2,058       32.7 %

Net revenues

  $ 13,439       100.0

%

  $ 12,229       100.0

%

  $ 1,210       9.9 %

 

The increase in net revenues is attributed to the segment-specific factors as set forth below.

 

23

 

Segment Revenue 

 

Power Supplies – The decrease in sales is attributed to decreased demand from our existing customers. Key customers that incorporate our power supplies have variable life cycles and production demands. As some projects are accelerating and others approach end of life, the timing of new production creates a fluctuation in sales.

 

Storage – For the fiscal year ending December 31, 2019 compared to the prior year period, we experienced revenue growth from the sale of both products and services in our data storage segment. The increase in product revenues is attributed to new vertical channel partnerships focused on media and entertainment, digital forensics, eDiscovery and video surveillance markets. With the release of the LTO8 (Linear Tape-Open) tape technology and the capacity of tape libraries increasing by 100%, the Company has seen a shift in sales to entry level and mid-size libraries. Our Q-Series product portfolio caters to the entry level and mid-size market requirements. Our service revenue increased compared to the previous year, primarily due to the product development service revenue received from our partnership with Sony Imaging Products & Solutions Inc. (“Sony”) for the development of an enterprise class optical disk archive (“ODA”) library offset with a decrease in our technical support revenue. In the quarter ended March 31, 2020, Qualstar provided a notice of termination to Sony and completed its remaining obligations under its contract with Sony.

 

Our first quarter of 2020 has been impacted by the extended Chinese New Year holiday and the unprecedented change in the global business environment brought on by COVID-19. At this time, in our power supply business, we are experiencing a delay in shipping dates to our customers, as our subcontracted manufacturers rebuild to full capacity. Although the Company has experienced few cancellations at this time, the Company is also seeing customers delay orders in both business segments as they reassess their needs.  At this time, it is difficult for us to predict the impact these events will have on our future revenue.

 

Gross Profit: 

 

   

Twelve Months Ended December 31,

                 
   

2019

   

2018

   

Change

 
   

Amount

   

% of net revenue

   

Amount

   

% of net revenue

   

Amount

   

%

 

Gross profit

  $ 3,523       26.2

%

  $ 5,045       41.3

%

  $ (1,522

)

    30.2

%

 

The Company experienced a decrease in gross profit for the year ended December 31, 2019 compared to the prior year in both of its business segments. Power supply gross profit declined primarily due to a $268,000 one-time charge related to the write down of inventory repurchased from a terminated contract manufacturer. Data Storage gross profit decreased primarily as a result of our arrangement with Sony that limited our gross profit. Our arrangement with Sony mandated different levels of gross profit during our project. During the year ended December 31, 2019 the allowed gross profit limit was 10% compared to the prior year that was not restricted.

 

Operating Expenses:

 

   

Twelve Months Ended December 31,

                 
   

2019

   

2018

   

Change

 
   

Amount

   

% of net revenue

   

Amount

   

% of net revenue

   

Amount

   

%

 

Engineering

  $ 588       4.4

%

  $ 502       4.1

%

  $ 86       17.1

%

Sales and marketing

  $ 1,397       10.4

%

  $ 1,337       10.9

%

  $ 60       4.5

%

General and administrative

  $ 1,608       12.0

%

  $ 1,716       14.0

%

  $ (108

)

    (6.3

)%

 

Engineering

 

Engineering expenses slightly increased in the twelve months ended December 31, 2019 compared to 2018, as a result of the increase in compliance costs in our power supply business related to a new requirement issued by the International Electrotechnical Commission.

 

24

 

Sales and Marketing 

 

Sales and marketing expenses remained flat during the twelve months ended December 31, 2019 compared to 2018. During the twelve months ended December 31, 2019, we added international sales consultants and marketing consultants in an effort to increase our revenues. 

 

General and Administrative 

 

General and administrative costs decreased for the twelve months ended December 31, 2019 compared to 2018, primarily due to the decrease in legal and professional fees.

 

Provision (benefit) for Income Taxes:  

 

For the twelve months ended December 31, 2019 and 2018, the Company recorded a $18,000 tax benefit and $4,000 tax provision, respectively, relating to state income taxes. The Company had a current year taxable income prior to taking into account net operating loss carryforwards for both federal and state purposes. For federal purposes, after taking into account the benefit of net operating loss carryforwards, no provision for federal taxes was necessary for the twelve months ended December 31, 2019 and 2018. For state tax purposes, after taking into account the benefit of state net operating loss carryforwards, only a small provision for state income tax was necessary, primarily due to minimum taxes in various states in which the Company has a taxable presence.

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash used in operating activities was $0.1 million in the twelve months ended December 31, 2019 compared to $0.2 million of cash provided in the twelve months ended December 31, 2018. The decline in cash provided by operations in 2019 was primarily related to the changes in assets and liabilities. In 2019, the Company had increased accounts receivables from the increase in data storage product sales during the last month of the year. Accounts receivables at December 31, 2019 were $2.4 million compared to approximately $1.8 million at December 31, 2018.

 

Cash used in investing activities was $85,000 in the twelve months ended December 31, 2019 compared to $26,000 in the twelve months ended December 31, 2018. Our investing activities primarily included warehouse racking and improvements for the new facility and new computer equipment and software.

 

Cash used in financing activities was $717,000 in the twelve months ended December 31, 2019 for the repurchase of common stock. In the twelve months ended December 31, 2018, cash used in financing activities was $54,000 for the repurchase of common stock offset with proceeds from the exercise of stock options.

 

The Company continues to focus on achieving profitability and improving cash flow.  By introducing private label products, we have been able to get similar or greater margins without developing new products ourselves, allowing for less headcount and product risk. These efforts and our increase in revenue have contributed to improvements in cash flow. In December 2018, the company implemented a stock buy-back plan to increase shareholder value which plan expired on December 5, 2019.

 

As of December 31, 2019, the Company had $3.9 million in cash and cash equivalents and $100,000 in restricted cash used as collateral for our corporate credit cards. We believe that our existing cash and cash equivalents will be sufficient to fund our working capital and capital expenditure needs for at least twelve months from the date of this report. We may utilize cash to invest in businesses, products or technologies that we believe are strategic. We periodically evaluate other companies and technologies for possible investment. In addition, we have made and may in the future make investments in companies with whom we have identified potential synergies. However, we have no present commitments or agreements with respect to any material investment in or acquisition of other businesses or technologies. In the event that we require additional capital to meet our business needs, there can be no assurance that additional funding will be available to us when needed or, if available, that it can be obtained on commercially reasonable terms.

 

25

 

SUMMARY OF CONTRACTUAL OBLIGATIONS AND COMMITMENTS

 

The following is a summary of our future payments due, offset by sublease income, under contractual obligations as of December 31, 2019 (in thousands):

 

Contractual Obligations:

 

Total

   

Less than 1 Year

   

1 to 4 Years

 

Operating Leases

  $ 573     $ 96     $ 477  

 

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not have any off-balance sheet arrangements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not required for smaller reporting companies.

 

26

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

Page

Financial Statements

 

Reports of Independent Registered Public Accounting Firms

28

Consolidated Balance Sheets

29

Consolidated Statements of Comprehensive Income (Loss)

30

Consolidated Statements of Shareholders’ Equity

31

Consolidated Statements of Cash Flows

32

Notes to Consolidated Financial Statements

33

 

27

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

To the Board of Directors and Stockholders of
Qualstar Corporation & Subsidiaries

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Qualstar Corporation & Subsidiaries (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for the years ended December 31, 2019 and 2018, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial positions of the Company as of December 31, 2019 and 2018, and the consolidated results of its operations and its cash flows for the years ended December 31, 2019 and 2018, in conformity with accounting principles generally accepted in the United States of America.

 

Explanatory Paragraph – Change in Accounting Principle

 

As discussed in Note 1 to the financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of ASU No. 2016-02, Leases (Topic 842), as amended, effective January 1, 2019, using the modified retrospective approach.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

/s/RBSM LLP

 

We have served as the Company’s auditor since 2017.

 

Larkspur, CA

 

March 19, 2020

 

28

 

 

QUALSTAR CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

   

December 31,

 
   

2019

   

2018

 

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 3,863     $ 4,781  

Restricted cash

    100       100  

Accounts receivable, net

    2,366       1,809  

Inventories, net

    2,540       2,897  

Prepaid expenses and other current assets

    211       180  

Total current assets

    9,080       9,767  
                 

Property and equipment, net

    122       112  

Right-of-use

    676        

Other assets

    160       119  

Total assets

  $ 10,038     $ 9,998  
                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

               

Current liabilities:

               

Accounts payable

  $ 1,029     $ 1,023  

Accrued payroll and related liabilities

    192       185  

Deferred service revenue

    702       736  

Lease liabilities, short term

    252        

Other accrued liabilities

    368       559  

Total current liabilities

    2,543       2,503  
                 

Other long-term liabilities

    52       40  

Lease liabilities, long term

    453        

Deferred service revenue, long term

    247       127  

Total long-term liabilities

    752       167  

Total liabilities

    3,295       2,670  
                 

Commitments and contingencies (Note 10)

           

Shareholders’ equity:

               

Preferred stock, no par value; 5,000,000 shares authorized; no shares issued

           

Common stock, no par value; 50,000,000 shares authorized; 1,925,025 and 2,030,017 shares issued and outstanding as of December 31, 2019 and 2018, respectively

    18,848       19,426  

Accumulated deficit

    (12,105

)

    (12,098

)

Total shareholders’ equity

    6,743       7,328  

Total liabilities and shareholders’ equity

  $ 10,038     $ 9,998  

 

The accompanying notes are integral to the consolidated financial statements.

  

29

 

 

QUALSTAR CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands, except per share amounts)

 

 

   

Twelve Months Ended

December 31,

 
   

2019

   

2018

 
                 

Net revenues

  $ 13,439     $ 12,229  

Cost of goods sold

    9,916       7,184  

Gross profit

    3,523       5,045  

Operating expenses:

               

Engineering

    588       502  

Sales and marketing

    1,397       1,337  

General and administrative

    1,608       1,716  

Total operating expenses

    3,593       3,555  

Income (loss) from operations

    (70

)

    1,490  

Other income

    45       -  

Income (loss) before income taxes

    (25

)

    1,490  

Provision (benefit) for income taxes

    (18

)

    4  

Net income (loss)

  $ (7

)

  $ 1,486  

Comprehensive income (loss)

  $ (7

)

  $ 1,486  
                 

Net income (loss) per share:

               

Basic

  $ 0.00     $ 0.73  

Diluted

  $ 0.00     $ 0.72  

Shares used to compute net income (loss) per share:

               

Basic

    1,925       2,030  

Diluted

    1,925       2,057  

 

The accompanying notes are integral to the consolidated financial statements.

 

 

30

 

 

QUALSTAR CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

 

   

Common Stock

   

Accumulated

Other

Comprehensive

Income

   

Accumulated

         
   

Shares

   

Amount

   

(Loss)

   

Deficit

   

Total

 

Balances at December 31, 2017

    2,043     $ 19,480     $     $ (13,584 )   $ 5,896  

Exercise of stock options

    5       39                   39  

Stock repurchase

    (18

)

    (93

)

                (93  

Share-based compensation

                             

Net income

                      1,486       1,486  

Balances at December 31, 2018

    2,030     $ 19,426     $     $ (12,098 )   $ 7,328  

Exercise of stock options

                                       

Stock repurchase

    (130

)

    (717

)

                (717

)

Share-based compensation

    25       139                   139  

Net income (loss)

                      (7

)

    (7

)

Balances at December 31, 2019

    1,925     $ 18,848           $ (12,105

)

  $ 6,743  

 

The accompanying notes are integral to the consolidated financial statements.

 

31

 

 

QUALSTAR CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   

Twelve Months Ended

December 31,

 
   

2019

   

2018

 
                 

Cash flows from operating activities:

               

Net income (loss)

  $ (7

)

  $ 1,486  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

               

Depreciation and amortization

    45       86  

Loss on disposal of assets

    31        

Provision for (recovery of) doubtful accounts, net

    (16

)

    3  

Provision for inventory reserve

    418       362  

Share-based compensation

    139        

Amortization of right of use

    (280

)

     

Changes in assets and liabilities:

               

Accounts receivable

    (541

)

    (10

)

Inventories

    (61

)

    (1,695

)

Prepaid expenses and other assets

    (73

)

    (68

)

Accounts payable

    6       (42

)

Accrued payroll and related liabilities

    7       12  

Deferred service revenue

    86       (64

)

Lease liabilities

    287        

Other accrued liabilities

    (157

)

    93  

Net cash provided by (used in) operating activities

    (116

)

    163  
                 

Cash flows from investing activities:

               

Purchases of equipment

    (85

)

    (26

)

Net cash provided by (used in) investing activities

    (85

)

    (26

)

                 

Cash flow from financing activities:

               

Purchase of common stock

    (717

)

    (93

)

Proceeds from the exercise of stock options

          39  

Net cash provided by (used in) financing activities

    (717

)

    (54

)

                 

Net increase (decrease) in cash, restricted cash and cash equivalents

    (918

)

    83  

Cash, restricted cash and cash equivalents, beginning of period

    4,881       4,798  

Cash, restricted cash and cash equivalents, end of period

  $ 3,963     $ 4,881  
                 

Supplemental disclosure of cash flow information:

               

Income taxes paid

  $ 11     $ 32  

 

The accompanying notes are integral to the consolidated financial statements.

 

32

 

QUALSTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 1 – Significant Accounting Policies

 

Business

  

Qualstar Corporation and its Subsidiaries (“Qualstar”, the “Company”, “we”, “us” or “our”) is organized into two strategic business segments, power solutions and data storage systems. Qualstar is a leading provider of data storage systems marketed under the Qualstar brand and of high efficiency and high-density power solutions marketed under the N2Power brand. Qualstar’s N2Power branded power solutions products provide unique power solutions to original equipment manufacturers (“OEMs”) for a wide range of markets, including communications networking, industrial, gaming, test equipment, lighting, medical as well as other market applications. Data storage system products include highly scalable automated magnetic tape-based storage solutions used to store, retrieve and manage electronic data primarily in the network computing environment and to provide solutions for organizations requiring backup, recovery and archival storage of critical electronic information.

 

Qualstar Corporation was incorporated in California in 1984 and operates four subsidiaries. N2Power, Inc. was formed in 2017 to operate the Company’s power supply business and Qualstar Corporation Singapore Private Limited (“QC Singapore”) was created in 2014 to give the Company an engineering footprint in Singapore and better service our contract manufacturers and our Asian distribution partners and customers. Qualstar has established two additional subsidiaries to aid in the Company’s global expansion. On July 4, 2018, a wholly-owned subsidiary of Qualstar Corporation, Qualstar Limited, was created to operate the Company’s data storage business in Europe and Africa. On September 5, 2018, a wholly-owned subsidiary of Qualstar Corporation, Q-Smart Data Private Limited, was created to operate the Company’s data storage business in Asia.  

 

We sell our products globally through authorized resellers, distributers, and directly to OEMs. N2Power utilizes contract manufacturers in Asia to produce our power solutions products. Our storage products are manufactured by our OEM suppliers in other parts of the world and configured to order by us at our facility in Camarillo, California.  

 

The consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries, N2Power, Inc., Qualstar Corporation Singapore Private Limited, Qualstar Limited and Q-Smart Data Private Limited. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Accounting Principles

 

The consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

 

Estimates and Assumptions

 

Preparing financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples include estimates of loss contingencies, product life cycles and inventory obsolescence, bad debts, sales returns, warranty costs, share-based compensation forfeiture rates, the tax consequences of events that have been recognized in our consolidated financial statements or tax returns and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from management’s estimates and assumptions.

 

33

 

Revenue Recognition

 

The Company recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services.  To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy a performance obligation. The five-step model is applied to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services transferred to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are performance obligations and assess whether each promised good or service is distinct. We then recognize revenue in the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

 

Title and risk of loss generally pass to our customers upon shipment.  In limited circumstances where either title or risk of loss pass upon destination, we defer revenue recognition until such events occur. We derive revenues from two primary sources: products and services. Product revenue includes the shipment of product according to the agreement with our customers for data storage products and power supplies. Services include customer support (technical support), installations, consulting, and design services. A contract may include both product and services. Rarely, contracts with customers contain multiple performance obligations. For these contracts, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. Standalone selling prices are typically estimated based on observable transactions when these services are sold on a standalone basis.

 

A variety of technical services can be contracted by our customers for a designated period of time. The service contracts allow customers to call Qualstar for technical support, replace defective parts and to have onsite service provided by Qualstar’s third party contract service provider. We record revenue for contract services at the amount of the service contract, but such amount is deferred at the beginning of the service term and amortized ratably over the life of the contract.

 

At December 31, 2019, we had deferred revenue of approximately $949,000 and no deferred profit. At December 31, 2018, we had deferred revenue of approximately $863,000 and no deferred profit. 

 

Cash and Cash Equivalents

 

Qualstar classifies as cash equivalents only cash and those investments that are highly liquid, interest-earning investments with original maturities of three months or less from the date of purchase.

 

Restricted Cash

 

At December 31, 2019 and 2018, $100,000 in cash is restricted for use as collateral for the Company’s credit cards.

 

Concentration of Credit Risk, Other Concentration Risks and Significant Customers

 

Qualstar sells its products primarily through value added resellers located worldwide. Ongoing credit evaluations of customers’ financial condition are performed by Qualstar, and generally, collateral is not required. Potential uncollectible accounts have been provided for in the financial statements.

 

We have no outstanding debt nor do we utilize auction rate securities or derivative financial instruments in our investment portfolio. Cash and other investments may be in excess of FDIC insurance limits.

 

Our financial results could be affected by changes in foreign currency exchange rates or weak economic conditions in foreign markets. As all sales are currently made in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Sales outside North America represented approximately 58.8% of net revenues for the twelve months ended December 31, 2019 and 43.1% of net revenues for the twelve months ended December 31, 2018.

 

34

 

Revenues from Qualstar’s largest customer totaled approximately 23.5% and 12.6% of revenues for the twelve months ended December 31, 2019 and 2018, respectively. At December 31, 2019, the largest customer’s accounts receivable balance, net of specific allowances, totaled approximately 23.4% of net accounts receivable. At December 31, 2018, the largest customer’s accounts receivable balance, net of specific allowances, totaled approximately 2.0% of net accounts receivable.

 

Suppliers

 

The primary suppliers of our power supplies segment, N2Power, are located in China. The primary suppliers of our tape storage products are located in California and Germany. If a manufacturer should be unable to deliver products to us in a timely basis or at all, our power supply or data storage business could be adversely affected. Though we have many years of favorable experience with these suppliers, there can be no assurance that circumstances might not change and compel a supplier to curtail or terminate deliveries to us.

 

Allowance for Doubtful Accounts

 

The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows (in thousands):

 

Description

 

Balance at

Beginning

of

Period

   

Charged

to Costs

and

Expenses

   

Charged

to Other

Accounts

   

Deductions

(1)

   

Balance at

End of

Period

 
                                         

Twelve months ended December 31, 2019

  $ 57     $     $     $ (17

)

  $ 40  

Twelve months ended December 31, 2018

  $ 54     $ 8     $     $ (5

)

  $ 57  

 

(1)

Uncollectible accounts written off, net of recoveries.

  

Inventories, net

 

Inventories are stated at the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis.

 

Property and Equipment, net

 

Property and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation expense is computed using the straight-line method. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the term of the lease. Estimated useful lives are as follows:

 

Machinery and equipment (in years)

    5   -   7  

Furniture and fixtures (in years)

    5   -   7  

Leasehold Improvements (in years)

    3   -   5  

Computer equipment (in years)

    3   -   5  

 

Expenditures for normal maintenance and repairs are charged to expense as incurred, and improvements are capitalized. Upon the sale or retirement of property or equipment, the asset cost and related accumulated depreciation are removed from the respective accounts and any gain or loss is included in the results of operations.

 

Long-Lived Assets

 

Qualstar reviews the impairment of long-lived assets whenever events or changes in circumstances indicate the carrying amount of any asset may not be recoverable. An impairment loss would be recognized when the estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than the carrying amount. If impairment is indicated, the amount of the loss to be recorded is based upon an estimate of the difference between the carrying amount and the fair value of the asset. Fair value is based upon discounted cash flows expected to result from the use of the asset and its eventual disposition and other valuation methods. No impairment losses of long-lived assets were recognized during the periods presented.

 

35

 

Shipping and Handling Costs

 

Qualstar records all customer charges for outbound shipping and handling to freight revenue. All inbound and outbound shipping and fulfillment costs are classified as costs of goods sold.

 

Warranty Obligations

 

We provide a three-year advance replacement warranty on all XLS and RLS libraries and a two-year warranty on our Q-Series libraries. This includes replacement of components, or if necessary, complete libraries. XLS libraries sold in North America also include one year of onsite service. Customers may purchase on-site service if they are located in the United States, Canada, and selected countries in Europe, Asia Pacific and Latin America. All customers may purchase extended warranty service coverage upon expiration of the standard warranty.

 

We provide a three-year warranty on all power supplies that includes repair or if necessary, replacement of the power supply.

 

A provision for costs related to warranty expense is recorded when revenue is recognized, which is estimated based on historical warranty costs incurred. 

Activity in the liability for product warranty (included in other accrued liabilities) for the periods presented is as follows (in thousands):

 

   

December 31,

 
   

2019

   

2018

 

Beginning balance

  $ 365     $ 322  

Cost of warranty claims

    (21

)

    (15

)

Accruals for product warranties

    (54

)

    58  

Ending balance

  $ 290     $ 365  

 

Engineering

 

All engineering costs are charged to expense as incurred. These costs consist primarily of engineering salaries, benefits, outside consultant fees, purchased parts and supplies directly involved in the design and development of new products, facilities and other internal costs.

 

Advertising

 

Advertising and promotion expenses include costs associated with direct and indirect marketing, trade shows and public relations. Qualstar expenses all costs of advertising and promotion as incurred. Advertising and promotion expenses for the years ended December 31, 2019 and 2018 were approximately $82,000 and $92,000, respectively.

 

Fair Value Measurements

 

We determine fair value measurements based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, we follow the following fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) our own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs):

 

Level 1:  Observable inputs such as quoted prices for identical assets or liabilities in active markets;

 

Level 2:  Other inputs observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs; and

 

Level 3:  Unobservable inputs for which there is little or no market data and which requires the owner of the assets or liabilities to develop its own assumptions about how market participants would price these assets or liabilities.

 

36

 

Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of assets and liabilities and their placement within the fair value hierarchy.

  

The following table presents our cash and cash equivalents and restricted cash measured at fair value on a recurring basis at December 31, 2019 and 2018 (in thousands):

 

   

December 31, 2019

 
   

Adjusted

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Fair

Value

   

Cash &

Cash

Equivalents

 

Level 1:

                                       

Cash

  $ 3,863     $ -     $ -     $ 3,863     $ 3,863  

Restricted Cash

    100       -       -       100       100  

Total

  $ 3,963     $ -     $ -     $ 3,963     $ 3,963  

 

   

December 31, 2018

 
   

Adjusted

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Fair

Value

   

Cash &

Cash

Equivalents

 

Level 1:

                                       

Cash

  $ 4,781     $ -     $ -     $ 4,781     $ 4,781  

Restricted Cash

    100       -       -       100       100  

Total

  $ 4,881     $ -     $ -     $ 4,881     $ 4,881  

 

Share-Based Compensation

 

Share-based compensation cost is measured at the grant date based on fair value of the award and is recognized as expense over the applicable vesting period (vesting can be immediate or over a period of four years) of the stock award using the straight-line method.

 

Income Taxes

 

Income taxes are accounted for using the liability method. Under this method, deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities, and for the expected future tax benefit to be derived from tax credits and loss carry forwards. Current income tax expense or benefit represents the amount of income taxes expected to be payable or refundable for the current year. A valuation allowance is established when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

Earnings per Share

 

Basic net earnings per share has been computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of diluted common shares, which is inclusive of common stock equivalents from unexercised stock options.  Unexercised stock options are considered to be common stock equivalents if, using the treasury stock method, they are determined to be dilutive.

 

37

 

Recent Accounting Guidance

 

Recent accounting guidance not yet adopted

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes, which is intended to simplify the accounting standard and improve the usefulness of information provided in the financial statements. We intend to implement this new accounting guidance effective January 1, 2021, however early adoption is permitted. we are currently assessing the impact this new accounting guidance will have on our financial statements.

 

Recent accounting guidance adopted 

 

FASB issued ASU 2016-02, ASU 2018-09, ASU 2018-10, 2018-11, and 2019-01 to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements and to provide guidance related to accounting for leases, such as the application of an implicit rate, lessee reassessment of lease classification and certain transition adjustments. The Company elected ASU-11’s alternative transition approach of recording lease liabilities and right-of-use assets via a cumulative effect adjustment to retained earnings at the date of adoption. Effective January 1, 2019, the Company adopted ASU 2016-02, ASU 2018-09, ASU 2018-10, 2018-11 and 2019-0. The result is the recording of the lease liability and the right-of-use asset to the balance sheet and it did not have a material effect on our consolidated results of operations or consolidated cash flows.

 

In June 2018, the FASB issued ASU 2018-07 as a simplification for the accounting for non-employee share-based payment transactions resulting from expanding the scope of Topic 718, Compensation-Stock Compensation. This standard is effective for fiscal years beginning after December 15, 2018. Effective January 1, 2019, the Company adopted ASU 2018-07 and it did not have a material effect on our consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02 to provide guidance related to adjustments for deferred tax assets and liabilities based on the changes created by the U.S. federal government tax bill enacted December 22, 2017. This standard is effective for fiscal years beginning after December 15, 2018. Effective January 1, 2019, the Company adopted ASU 2018-02 and it did not have a material effect on our consolidated financial statements.

 

  

 

Note 2 – Balance Sheet Details

 

Inventories, net

 

Inventories consist of the following, in thousands:

 

   

December 31,

2019

   

December 31,

2018

 
                 

Raw materials

  $ 199     $ 136  

Finished goods

    2,341       2,761  

Inventories, net

  $ 2,540     $ 2,897  

 

38

 

Property and Equipment, net

 

The components of property and equipment are as follows, in thousands:

 

   

December 31,

2019

   

December 31,

2018

 
                 

Leasehold improvements

  $ 163     $ 114  

Furniture and fixtures

    268       286  

Machinery and equipment

    609       844  

Total property and equipment

    1,040       1,244  

Less accumulated depreciation and amortization

    (918

)

    (1,132

)

Property and equipment, net

  $ 122     $ 112  

 

Depreciation and amortization expense for the year ended December 31, 2019 and 2018 was $45,000 and $85,000, respectively.

 

 

Accrued Payroll and Related Liabilities

 

The components of accrued payroll and related liabilities are as follows, in thousands:

 

   

December 31,

2019

   

December 31,

2018

 
                 

Accrued salaries and payroll taxes

  $ 69     $ 66  

Accrued vacation

    123       119  

Accrued bonuses

    -       -  

Total accrued payroll and related liabilities

  $ 192     $ 185  

 

Other Accrued Liabilities

 

The components of other accrued liabilities are as follows, in thousands:

 

   

December 31,

2019

   

December 31,

2018

 
                 

Accrued warranty

  $ 290     $ 365  

Accrued commissions

    55       41  

Accrued contingent legal fees

    -       100  

Accrued deferred rent

    -       22  

Other accrued liabilities

    23       31  

Total other accrued liabilities

  $ 368     $ 559  

 

39
 

 

 

Note 3 – Income Taxes

 

The provision for (benefit from) income taxes is comprised of the following (in thousands):

 

   

December 31,

2019

   

December 31,

2018

 

Current:

               

Federal (Net of a 2018 net operating loss benefit of $288)

  $     $  

State (Net of a 2018 and 2019 net operating loss benefit of $35 and $97, respectively)

    7       3  

Foreign

    5       1  

Provision for income taxes

  $ 12     $ 4  

Deferred:

               

Federal

           

State

    (30

)

     

Deferred income tax

  $ (30 )   $  

Net income tax expense

  $ (18

)

  $ 4  

 

The following is a reconciliation of the statutory federal income tax rate to Qualstar’s effective income tax rate:

 

   

Twelve Months Ended

December 31,

 
   

2019

   

2018

 

Statutory federal income tax benefit

    21.0

%

    21.0

%

State income taxes, net of federal income tax benefit

    (7.9

)

    6.6  

Foreign income taxes, net of federal income tax benefit

    (13.2

)

     

Deferred tax adjustment – NOL

    42.6        

Valuation allowance

    8.2       (26.6

)

Other

    0.2       (0.6

)

Effective income tax rate

    50.9

%

    0.4

%

 

The tax effect of temporary differences resulted in deferred income tax assets (liabilities) as follows (in thousands):

 

   

December 31,

2019

   

December 31, 2018

 

Deferred tax assets:

               

Net operating loss carry forwards

  $ 7,734     $ 7,675  

Engineering credit carry forwards

    1,920       1,919  

Inventory reserves

    503       558  

Capital loss and other credit carry forwards

    6        

Allowance for bad debts and returns

    13       16  

Stock compensation

    330       287  

Capitalized inventory costs, stock compensation and other accuals

    389       233  

Total gross deferred tax assets

    10,895       10,688  

Less valuation allowance on deferred tax assets

    (10,686

)

    (10,688

)

Net deferred tax assets

    209        
                 

Deferred tax liabilities:

               

Depreciation and other

           

Right to use property

    (179

)

     

Total deferred tax liabilities

    (179

)

     

Net deferred taxes

  $ 30     $  

 

40

 

On December 22, 2017, H.R. 1 (the “Tax Act”), originally known as the Tax Cuts and Jobs Act, was enacted in the United States. In addition to reducing the corporate tax rate to 21% effective January 1, 2018, the Tax Act contains many other tax provisions that affect recorded deferred tax assets and liabilities. The majority of these new provisions are also effective as of January 1, 2018, though there are a few that are effective during the 2017 calendar year. Although for 2017 the Company had federal alternative minimum tax (“AMT”) of approximately $12,000, the Tax Act eliminated the AMT effective January 1, 2018, and provides that any AMT credit carryforwards will be refunded. Accordingly, the 2017 AMT tax liability is being treated as a receivable, and was not treated as a current tax expense in 2017. In addition, the Tax Act provided new rules related to global intangible low-taxed income (“GILTI”). The Tax Act provides that a U.S. shareholder of any controlled foreign corporation (“CFC”) must include in taxable income its pro rata shares of GILTI income. The Company accounts for taxes related to GILTI as such income is incurred, however, currently, the Company’s share of GILTI income is immaterial.

 

As previously indicated, the Company records a valuation allowance against its net deferred income tax assets in accordance with ASC 740 “Income Taxes” when in management’s judgment, it is more likely than not that the deferred income tax assets will not be realized in the foreseeable future. For the year ended December 31, 2019 and 2018, the Company placed a valuation allowance on net deferred tax assets. With the exception of a small amount of deferred California taxes, the Company continues to fully offset its deferred tax assets with a valuation allowance, despite generating income in 2018 and 2017 given the Company’s significant book losses prior to 2017 and the current year book and tax loss. With regard to California deferred tax assets, since Qualstar files on a separate company basis, and Qualstar generated book income for 2017 and 2018, and a small loss for 2019, the Company expects to generate income in the subsequent year, therefore the Company reduced a small amount of the valuation allowance related to Qualstar’s separate company net operating loss carryovers.

 

The Company had net operating loss carry-forwards for federal income tax purposes of approximately $30.7 million as of December 31, 2019 and $30.4 million as of December 31, 2018.  The Company had net operating loss carry-forwards for state income tax purposes of approximately $19.0 million as of December 31, 2019 and $19.7 million as of December 31, 2018. The Company had engineering and other credit carryforwards for tax purposes of $2.7 million as of December 31, 2019 and $2.7 million as of December 31, 2018.

 

If not utilized, the federal net operating loss will expire beginning in 2026, and other tax credit carry-forwards will expire beginning in 2024. If not utilized, the state net operating loss carry-forward as of December 31, 2019 will begin to expire beginning in 2020.  The state engineering credit has no limit on the carry-forward period.

 

For U.S. purposes, the Company has completed its evaluation, as of December 31, 2017, of the net operating loss (“NOL”) and credit carryforward utilization limitations under Internal Revenue Code, as amended (the “Code”) Section 382 and 383, change of ownership rules. Code sections 382 and 383 impose certain limitations on the use of NOL or credit carryforwards in certain situations, including when a company has a change in ownership as defined in such sections. As of December 31, 2017, the Company has determined that it has not had a change in ownership within the meaning of IRC Sections 382 and 383. Management, at the date of this filing, is of the opinion that its NOL and credit carryforwards that can be utilized each year.

 

The following table summarizes the activity related to the Company’s uncertain tax positions (in thousands):

 

   

December 31,

2019

   

December 31,

2018

 
                 

Beginning Balance

  $ 29     $ 29  

Increases related to tax positions taken in current year

           

Increases related to tax positions taken in prior year

           

Decreases due to lapse of statute of limitations

           

Related interest and penalties, net of federal tax benefit

           

Balance at December 31

  $ 29     $ 29  

 

The deferred tax asset amounts related to NOL and credit carryforwards have been reduced by approximately $527,000 of uncertain tax positions. The Company expects that any future changes in the unrecognized tax benefit will have no impact on the Company’s effective tax rate due to the existence of the valuation allowance.

 

41

 

The Company’s policy is to include interest and penalties on uncertain tax positions in income tax expense, but they are not significant at December 31, 2019. The Company files its tax returns by the laws of the jurisdictions in which it operates. The Company’s federal tax returns for fiscal years December 31, 2016 and subsequent and California tax returns for fiscal years December 31, 2015 and subsequent, are still subject to examination. Various state and foreign jurisdictions’ tax years remain open to examination as well, though the Company believes any additional assessment will be immaterial to its consolidated financial statements. The Internal Revenue Service performed an audit of the tax period December 31, 2017, the result was no change. The Company does not have any open examinations as of December 31, 2019. As of December 31, 2019, the operations of Qualstar Limited were not material for tax purposes and had no significant impact on the year-end tax provision.

 

 

Note 4 – Preferred Stock

 

Qualstar’s Articles of Incorporation allow for the Board of Directors to issue up to 5,000,000 shares of preferred stock. The Board of Directors has authority to fix the rights, preferences, privileges and restrictions, including voting rights, of these shares of preferred stock without any future vote or action by the shareholders. At December 31, 2019 and 2018, there were no outstanding shares of preferred stock.

  

 

Note 5 –Stock Based Compensation

 

The Company granted to Steven N. Bronson, the Company’s President and Chief Executive Officer, 50,000 restricted stock units (the “Restricted Stock Units”) for shares of the Company’s common stock under the terms of the Company’s 2017 Stock Option and Incentive Plan and an associated Restricted Stock Unit Agreement with Mr. Bronson (the “Restricted Stock Unit Agreement”).  The Restricted Stock Units were awarded pursuant to that certain employment agreement entered into between the Company and Mr. Bronson on April 13, 2019.  25,000 of the 50,000 restricted stock units vested and the underlying 25,000 shares of common stock became issuable as approved by the Company’s Compensation Committee on December 18, 2019. The share-based compensation of $139,000 was recorded for the twelve months ended December 31, 2019. No share-based compensation associated with outstanding stock options and restricted stock grants was recorded during the twelve months ended December 31, 2018.  No income tax benefit was recognized in the statements of comprehensive income (loss) for share-based arrangements in any period presented.

 

Stock Option Plan

 

The Company has two share-based compensation plans as described below.

 

Qualstar adopted the 2008 Stock Incentive Plan (the “2008 Plan”) under which incentive and nonqualified stock options and restricted stock may be granted for shares of common stock. The 2008 Plan expired in 2018 and no additional options may be granted under that plan. However, 3,333 options that were previously granted under the 2008 Plan will continue under their terms.

 

The 2017 Stock Incentive Plan (the “2017 Plan”) permits the award of stock options (both incentive and non-qualified options), stock appreciation rights, restricted stock, restricted stock units, unrestricted stock, performance shares, dividend equivalent rights and cash-based awards to employees (including executive officers), directors and consultants of the Company and its subsidiaries. The 2017 Plan authorizes the issuance of an aggregate of 300,000 shares of common stock and the plan is administered by the Compensation Committee of the Company’s Board of Directors.

 

With respect to options, the fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses various assumptions, such as volatility, expected term and risk-free interest rate. Expected volatilities are based on the historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee termination in determining forfeiture rates. The expected term of options granted is estimated based on the vesting term of the award, historical employee exercise behavior, expected volatility of the Company’s stock and an employee’s average length of service. The risk-free interest rate used in this model correlates to a U.S. constant rate Treasury security with a contractual life that approximates the expected term of the option award.

 

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No options were granted in the fiscal years ended December 31, 2019 and 2018. The following table summarizes the assumptions used in the Black-Scholes model to determine the fair value of stock options granted in the fiscal year ended December 31, 2017.

 

   

Fiscal Year Ended

December 31, 2017

 

Expected lives, in years

    5.0  

Estimated volatility

    36.89%  

Dividend yield

     

Risk-free interest rate

    1.92%  

Weighted average fair value on grant date

    $2.50  

 

The following table summarizes all stock option activity:

 

Options

 

Shares

   

Weighted

Average

Exercise

Price per

Share

   

Weighted

Average

Remaining

Contractual

Term

(years)

   

Aggregate

Intrinsic

Value

 

Outstanding at December 31, 2017

    188,033     $ 7.38       8.63        

Granted

                       

Exercised

    (5,500

)

    7.08              

Forfeited, canceled or expired

    (4,533

)

    15.23              

Outstanding at December 31, 2018

    178,000       7.19       8.63        

Granted

                       

Exercised

                       

Forfeited, canceled or expired

    (16,667

)

    7.38              

Outstanding at December 31, 2019

    161,333     $ 7.17       7.49        

Exercisable at December 31, 2019

    161,333     $ 7.17       7.49        

 

At December 31, 2019 and 2018, there is no unrecognized compensation cost related to non-vested share-based compensation awards granted. No options vested during the years ended December 31, 2019 and 2018.

 

Restricted Stock Units

 

On October 29, 2019, the Company granted to Steven N. Bronson, the Company’s President and Chief Executive Officer, 50,000 restricted stock units (the “Restricted Stock Units”) for shares of the Company’s common stock under the terms of the Company’s 2017 Stock Option and Incentive Plan and an associated Restricted Stock Unit Agreement with Mr. Bronson (the “Restricted Stock Unit Agreement”). The Restricted Stock Units were awarded pursuant to that certain employment agreement entered into between the Company and Mr. Bronson on April 13, 2019. For each of the fiscal years ended December 31, 2019 and December 31, 2020, Restricted Stock Units for 25,000 shares of the Company’s common stock shall vest and the underlying common stock shall become issuable subject to the Company’s achievement of financial and performance objectives for the applicable fiscal year established by the Company’s Compensation Committee. Subject to the satisfaction of certain conditions, unvested Restricted Stock Units shall also vest and the underlying common stock shall become issuable upon Mr. Bronson’s death or disability, in the event the Company terminates Mr. Bronson’s employment without cause or if Mr. Bronson terminates his employment with the Company for good reason, and in the event of a change in control of the Company. The Compensation Committee approved vesting for the 25,000 shares on December 18, 2019.

 

 

Note 6 – Stockholders’ Equity

 

On December 5, 2018, the board of directors approved a stock repurchase program (the “Stock Repurchase Program”) to repurchase shares of the Company’s common stock. The program permitted repurchases of up to a maximum aggregate purchase price of $2,400,000 and the number of shares of Common Stock subject to repurchase was not to exceed 409,000. Under the Stock Repurchase Program, during in the fiscal years ended December 31, 2019 and 2018, 18,102 and 129,991 shares were repurchased, respectively, with a total of 148,093 shares having been repurchased since the program began. The program expired December 5, 2019.

 

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Note 7Net Earnings Per Share

 

Basic net earnings per share has been computed by dividing net income or loss by the weighted average number of common shares outstanding.   Diluted net earnings per share has been computed by dividing net earnings by the weighted average common shares outstanding plus dilutive securities or other contracts to issue common stock as if these securities were exercised or converted to common stock.

 

The following table sets forth the computation of basic and diluted net income or loss per share for the periods indicated, in thousands, except per share amounts.

 

   

December 31,

2019

   

December 31,

2018

 

In thousands (except per share amounts):

               

Net income (a)

  $ (7

)

  $ 1,486  

Weighted average outstanding shares of common stock (b)

    1,925       2,030  

Dilutive potential common shares from employee stock options

    -       27  

Common stock and common stock equivalents (c)

    1,925       2,057  

Income per share:

               

Basic net income per share (a)/(b)

  $ 0.00     $ 0.73  

Diluted net income per share (a)/(c)

  $ 0.00     $ 0.72  

 

 

For the twelve months ended December 31, 2019 and 2018, 161,333 and 4,666 outstanding stock options were excluded from the calculation of diluted net income per share as their inclusion would have been anti-dilutive.

 

 

Note 8 – Commitments

 

Lease Agreements

 

The Company has entered into a new lease in Camarillo, California for its corporate headquarters beginning June 1, 2019. The facility is 9,910 square feet and is a 5 year and two-month lease, expiring July 31, 2024. The rent on this facility is $9,910 per month with a 3% step-up annually. Qualstar subleases a portion of the warehouse space to Interlink Electronics, Inc. (“Interlink”) and BKF Capital Group, Inc. (“BKF”) and is reimbursed for the space and other related expenses on a monthly basis. As described in Note 12, Interlink and BKF are related parties.

 

Qualstar leases a 15,160 square foot facility located in Simi Valley, California. The three-year lease began December 15, 2014 and has been renewed for an additional three years, expiring February 28, 2021. Rent on this facility is $11,000 per month with a step-up of 3% annually. On May 22, 2019, Qualstar entered into a Standard Sublease Multi-Tenant (the “Sublease”), with Stillwater Agency, Inc., a California corporation (“Stillwater”), for the Simi Valley location, which previously served as Qualstar’s corporate headquarters location and principal executive office. The term of the Sublease commenced on July 15, 2019 and ends on February 28, 2021