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TMCNet:  QUALSTAR CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[November 13, 2012]

QUALSTAR CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Statements in this Quarterly Report on Form 10-Q concerning the future business, operating results and financial condition of Qualstar including estimates, projections, statements relating to our business plans, objectives and operating results, and the assumptions upon which those statements are based, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements inherently are subject to risks and uncertainties, some of which we cannot predict or quantify. Our actual results may differ materially 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 our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 in "ITEM 1 Business," "Item 1A Risk Factors," and in "ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations." You generally can identify forward-looking statements by the use of forward-looking terminology such as "believes," "may," "expects," "intends," "estimates," "anticipates," "plans," "seeks," or "continues," or the negative thereof or variations thereon or similar terminology. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect the occurrence of events or circumstances in the future.


OVERVIEW Qualstar Corporation ("Qualstar") is organized into two Strategic Business Units ("SBUs"), Storage and Power Supplies. The SBUs focus on both the products and services we provide and the customers and end markets that we serve. We are focused on improving our operational and financial performance. Our top objectives are to gain additional market share, execute our operational strategy, return to profitability, generate positive cash flows and maximize our working capital by reducing our inventory.

Qualstar focuses its efforts on designing, developing, manufacturing and selling high efficiency AC-DC and DC-DC power supplies and storage products. Power supply products include ultra-small high efficiency open frame switching power supplies and provide power solutions to original equipment manufacturers to incorporate into computer based products for telephony, industrial, gaming, test equipment and other applications. Storage products include automated magnetic tape libraries used to store, retrieve and manage electronic data primarily in the network computing environment and provide solutions for organizations requiring backup, recovery and archival storage of critical electronic information.

We will continue to strategically invest in sales and marketing, engineering and service as we believe these are key drivers of our business.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES We describe our significant accounting policies in Note 1, "Summary of Significant Accounting Policies" of the notes to condensed financial statements.

16 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following table reflects, as a percentage of net revenues, statements of operations data for the periods indicated: Three Months Ended September 30, 2012 2011 Power supply revenues 44.7 % 47.6 % Storage revenues 55.3 52.4 Net revenues 100.0 100.0 Cost of goods sold 72.7 62.9 Gross profit 27.3 37.1 Operating expenses: Engineering 19.3 14.0 Sales and marketing 15.4 10.0 General and administrative 21.4 12.8 Restructuring expenses 25.5 0.0 Total operating expenses 81.6 36.8 (Loss) income from operations (54.3 ) 0.3 Other (expense) income (2.1 ) 1.0 (Loss) income before income taxes (56.4 ) 1.3 Provision for income taxes 0.0 0.0 Net (loss) Income (56.4 )% 1.3 % We have two operating segments for financial reporting purposes: power supplies and storage, as discussed in Note 12 of the Notes to Financial Statements in Item 1 of this report. The following table summarizes our revenue by operating segment: Three Months Ended September 30, 2012 2011 Power Supply revenues 44.7 % 47.6 % Storage revenues: Product 35.4 4.7 Service 19.9 8.1 Total Storage revenues 55.3 52.4 100.0 % 100.0 % 17-------------------------------------------------------------------------------- Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011Net Revenue. Net revenues decreased to $3.4 million for the three months ended September 30, 2012 from $4.6 million for the three months ended September 30, 2011, a decrease of $1.2 million, or 25.3%.

Segment Revenue Power Supplies - Net revenues from power supplies decreased to $1.5 million for the three months ended September 30, 2012 from $2.2 million for the three months ended September 30, 2011, a decrease of $0.7 million, or 29.9%. The decrease in revenues is attributed to decreased demand by original equipment manufacturers and distributors due to short term inventory tightening in two of our stronger markets, servers and telecom Storage - Net storage revenues decreased to $1.9 million for the three months ended September 30, 2012 from $2.4 million for the three months ended September 30, 2011, a decrease of $0.5 million, or 21.1%. This decrease in revenues was due to lower sales of TLS and XLS tape libraries, media and service, partially offset by a 15% increase in sales of RLS tape libraries with the addition of the expandability and encryption features.

Gross Profit. Gross profit represents the difference between our net revenues and cost of goods sold. Cost of goods sold consists primarily of purchased parts, direct and indirect labor costs, rent, technical support costs, depreciation, utilities, and packaging costs. Gross profit decreased to $0.9 million, or 27.3% of net revenues, for the three months ended September 30, 2012 from $1.7 million, or 37.1% of net revenues, for the three months ended September 30, 2011. The decrease in gross profit percentage is attributed to a change in product mix, an increase in inventory reserves and lower absorption of labor and overhead.

Engineering. Engineering expenses consist of engineering salaries, benefits, outside consultant fees, and purchased parts and supplies used in development activities. Engineering increased by $18,000 to $666,000 for the three months ended September 30, 2012 from $648,000 for the three months ended September 30, 2011.

Sales and Marketing. Sales and marketing expenses consist primarily of employee salaries and benefits, sales commissions, trade show costs, advertising and travel related expenses. Sales and marketing expenses increased to $531,000 for the three months ended September 30, 2012 from $461,000 for the three months ended September 30, 2011. The increase of $70,000, or 15.2%, is primarily attributed to an increase in compensation due to additional sales personnel and advertising and promotion expenses.

General and Administrative. General and administrative expenses include employee salaries and benefits and professional service fees. General and administrative expenses increased to $740,000 for the three months ended September 30, 2012 from $592,000 for the three months ended September 30, 2011. The increase of $148,000, or 25.0%, is primarily attributed to an increase in compensation and investor relations expenses.

Restructuring Expense. In the first quarter of fiscal 2013, the Company evaluated production capacity, revenue and facility size, and determined that a reduction in facility size and personnel to fit the production capacity was needed in the storage segment. This resulted in a reduction in total square footage from 56,938 square feet to approximately 38,000 square feet, or 33%, and a one-time facility restructuring charge of approximately $754,000 applied to the remaining contractual lease payments from October 2012 through December 2015 on the vacated portion of the facility in addition to contractor and moving expenses. One-time severance costs of approximately $128,000 were incurred and paid in the first quarter of fiscal 2013 within the storage segment and related to reductions in manufacturing, general and administrative and engineering. We had no restructuring expenses for the three months ended September 30, 2011.

Other Expenses and Income. Other expenses and income included $94,000 related to the settlement of litigation and investment income of $24,000 for the three months ended September 30, 2012, compared to investment income of $44,000 for the three months ended September 30, 2011.

Provision for Income Taxes. We did not record a provision or benefit for income taxes for the three months ended September 30, 2012 and 2011.

18 -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities was $1.2 million in the three months ended September 30, 2012, primarily attributed to the net loss for the period, a decrease in accounts payable, and an increase in prepaids and other assets, partially offset by an increase in other accrued liabilities and accrued payroll and related liabilities and a decrease in receivables. Net cash used in operating activities was $0.9 million in the three months ended September 30, 2011, primarily attributed to an increase in inventories and accounts receivable, partially offset by an increase in accounts payable and other accrued liabilities.

Cash provided by investing activities was $2.1 million in the three months ended September 30, 2012, primarily attributed to the sale of marketable securities, partially offset by the purchase of marketable securities and equipment. Cash used in investing activities was $0.3 million in the three months ended September 30, 2011, attributed to the purchases of marketable securities, partially offset by the sale of marketable securities.

Cash was not used in financing activities during the three months ended September 30, 2012 or 2011.

As of September 30, 2012, we had $8.2 million in cash and cash equivalents and $11.4 million in marketable securities. We believe that our existing cash and cash equivalents and cash flows from our operating activities, plus funds available from the sale of our marketable securities, will be sufficient to fund our working capital and capital expenditure needs for at least the next 12 months. 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 by us. 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 acquisition of other businesses or technologies.

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