Qualstar F4Q09 (Qtr End 6/30/09) Earnings Call Transcript

| About: Qualstar Corporation (QBAK)

Qualstar Corporation (NASDAQ:QBAK)

F4Q09 Earnings Call

September 25, 2009 5:00 pm ET


Lasov Glawson - Financial Relations Board

William J. Gervais - President, Chief Executive Officer, Director

Nidhi H. Andalon - Chief Financial Officer


Gil Arya - Wedbush Securities

Anthony Chizara - Key Equity Investors Incorporated


Welcome to the Qualstar fourth quarter fiscal 2009 conference call. (Operator Instructions) I would now like to turn the conference over to [Lasov] Glawson, Financial Relations Board. Go ahead, sir.

Lasov Glawson

Thank you and welcome, everybody. This afternoon we’ll be discussing Qualstar's fiscal 2009 fourth quarter and full year results for the period ended June 30, 2009. If you do not have copies of our press release from earlier today, you may find it posted at the investor relations section of our website at Qualstar.com. Click on investors, and then on press releases.

Providing comments on Qualstar's results and business outlook today is Bill Gervais, President and CEO of Qualstar. Bill is joined today by Nidhi Andalon, Qualstar's Chief Financial Officer.

Before we begin, I would like to preface the discussion with our Safe Harbor statement. Statements in this presentation concerning the future business, operating results, and financial condition of the company are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on management’s current expectations and are subject to a number of uncertainties that could cause actual performance and results to differ materially from the results discussed in the forward-looking statements.

Factors that could affect the company’s actual results include our ability to maintain sales in the small and mid-range libraries; whether the company’s penetration into the enterprise class library market will succeed; our ability to maintain or increase sales of our N2 power supply business; rescheduling or cancellation of customer orders; unexpected shortages of critical components; unexpected product design flaws or quality problems; and adverse changes in market demand for tape libraries or high efficiency power supplies.

The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

Further information on these and other potential factors that could affect the company’s financial results or conditions are included in Qualstar's filings with the Securities and Exchange Commission -- in particular, references made to the Risk Factors section of the company’s annual report on Form 10-K for the period ended June 30, 2009, and to management’s discussion and analysis of financial condition and results of operations section of its Form 10-K and its most recent quarterly report on Form 10-Q.

With that, I would now like to turn the call over to Bill Gervais. Bill.

William J. Gervais

Thank you and thanks to everyone for joining us. First I wanted to apologize for scheduling this call on a Friday. That was the result of a scheduling conflict having to do with customer visits I made during the previous two weeks in Europe, the Baltic and Nordic regions.

On today’s call, I’ll begin with brief comments on our operating results for the fiscal 2009 and provide an update on our recent business activities. Nidhi’s remarks will include detailed comments on our fourth quarter and full year financial results, along with our guidance for the first quarter of fiscal 2010. After that, we’ll open the call to your questions.

For the full fiscal year, our overall sales declined by 16.6% to $17.9 million from $21.5 million in the prior year. This is remarkably consistent with the results reported by two of our library competitors -- Quantum down 17.1% and Overlund Storage, down 17.3% in their latest reporting fiscal years.

For the fourth quarter, our revenues were $3.8 million, down from $4.9 million in the prior fiscal year fourth quarter. In view of the general market decline, we are starting to see evidence that tape-based data storage markets should be returning to a more normal state over the next year. This is because the underlying fundamentals driving this market continue to hold firm. Worldwide data continues to grow as more applications convert to digital content. The archival preservation of this data is increasingly mandated by authorities around the world. Tape has proven to be the most cost effective, energy efficient means of storing large amounts of data and lastly, tape is portable; therefore, can be physically removed from the primary site for added security.

On the N2 power side, the fundamentals are also still on our side. The rush toward more electrically efficient products is widespread and is expected to continue for years. Power costs continue to increase and as manufacturers around the world seem to be jumping onto the green bandwagon and making their products do more with fewer amps.

Overall, our sales were well diversified by product types, distribution channels, geography, and end applications. Our largest customer accounted for just 12.5% of revenues and our top 10 customers accounted for slightly less than 50% of revenues.

As you probably know, our revenues are divided into two major business segments, tape automation and power supplies. Revenues from the N2 power products that are utilized within our libraries are of course eliminated from the reported numbers.

For the year, tape automation contributed $12.3 million, down 29% from $17.4 million in fiscal 2008. This decline was partially offset by our growing power supply business which had a record-setting year. For the full year, power supplies accounted for $5.6 million in sales, up 38% compared to $4 million in fiscal 2008.

Our high efficiency power supplies continued to benefit from increasing interest among OEM manufacturers and deploying products that are smaller in size and more efficient.

The overall full-year gross profit percentage was 31.9%, down from 34.6% in fiscal 2008. By comparison, it was 31.6% in fiscal 2007.

While the year to year decrease in gross profit percentage is partially related to lower overhead absorption resulting from lower sales, our overall gross profit is a blend of many different products and three different market channels. As a result, gross margins will vary from one year to the next.

That said, it’s worth noting that our gross margin in both reporting segments on tape automation and power supplies were very similar to each other for the full year. Our net loss was $0.21 per diluted share for all of fiscal 2009, compared to a loss of just $0.06 per share in fiscal 2008.

Now let’s take a closer look at the results within tape automation -- we have spent the past three years transitioning our library business from small and mid-range libraries to the enterprise class or very large library segment. We began developing the XLS in 2002 when it became clear that the products at the low-end might become commodities. This is indeed what has happened in the market. We’ve been shipping large libraries now for 13 quarters and have over 80 units deployed worldwide.

The XLS was designed to compete with the market leaders Storage Tech, IBM, and Quantum. The development was an expensive undertaking for a company of our size and took three years to first customer shipments. The revenue contribution from XLS series products in fiscal 2009 was $1.5 million, essentially unchanged from the prior year. Considering that the global economy weakened during the past year, and that some competitors were down 17%, I believe the steady year-over-year performance for XLS is a favorable indicator.

Though not what we would like it to be, we have gained a modest foothold in the enterprise XLS revenues -- in the enterprise tape market, I’m sorry. XLS revenues of $528,000 in the June quarter equaled the second best quarter we’ve ever turned in on XLS, 11 units were shipped.

U.S. shipments of XLS libraries were made to a diverse group of end users, reflecting the broad utility of the product. Units were shipped to a television station in Seattle, a healthcare facility in the Midwest, two major universities, a Chicago based exhibition center operator, a Hollywood studio, and an advertising firm. Outside the U.S., units were shipped to a post production media company in Germany and a telephone service provider in Italy.

As the size of our installed base increases, we will benefit from the incremental revenues resulting from maintenance, upgrades, and add-ons to the units already in the field. It’s worth noting here that XLS revenues we report to you exclude installation labor, service contracts, and tape media associated with these libraries, as those sales are reported separately.

In spite of the challenging global economic conditions, our pipeline of potential XLS deals remains strong. The length of the sales cycle is holding at between 9 and 12 months from our initial proposal to the shipment date. Our toughest competition for big libraries is coming from IBM, Sun Microsystems, and Quantum.

You may be aware that Sun is in the process of being acquired by Oracle. It’s not yet clear to us what will happen to the tape automation group once Oracle takes over. In keeping with our ongoing commitment to expand the XLS family, we will be extending the product downward. Currently our smallest unit holds 300 tapes. We are developing an even smaller XLS in the 240 tape range. This new model is being developed in anticipation of the LTO format doubling in capacity from 800 gigabytes to 1.6 terabytes during 2010.

As new generations of tape technology increase the data capacity on a single tape, we found that enterprises with moderate storage requirements can utilize our smaller XLS libraries, namely the 300s and the 500s. The smaller models have become the mainstream of our product sales.

Moving on to our more mature tape library lines, the TLS and RLS, revenues for fiscal 2009 declined to $5.2 million from $8.5 million in fiscal 2008. These smaller libraries fit into a discretionary spending category and were significantly affected by the slow-down throughout fiscal 2009.

After a 14-year product life, the TLS family is winding down with only the LTO models remaining active. We are however continuing to develop next generation library products in the RLS series with the expectation that when market conditions improve, we will be in a stronger position with updated product offerings.

This new RLS is in the 120 tape area, nearly tripling the capacity of our biggest RLS today currently at 44 tapes. The size and features of this new unit are based on inputs from our major resellers and end user customers as well.

Tape media revenues declined to $2.1 million in fiscal 2009, down from $3.5 million last year. The decline is mostly the result of the decreasing influence of Sony in the library marketplace. Sony Media in the past has comprised the bulk of our media sales. We do not expect to see the media business return to former levels but will continue to decline going forward.

Service revenue was $2.7 million in fiscal 2009, unchanged from the prior year. Since we bundle the first year of on-site service at no cost with our XLS products, service revenues from XLS shipments are not booked until the second and subsequent years after a unit is sold. Nearly all domestically shipped XLS units are under service contracts.

We recently established spare parts storage depots in Boston, [Needenberg], Germany, and Israel to support the increasing number of units in remote locations. This allows us to provide faster spare parts availability in these regions.

Moving now to our N2 power business, we enjoyed a record-breaking year in fiscal 2009 with revenues up 38% to $5.6 million, up from $4 million in fiscal 2008. N2 power OEM customers now include such names as EMC, QLogic, Hewlett-Packard, IBM, Blade Networks, Emulex, and Motorola.

Power supplies represented 31% of our overall sales in 2009, up from 19% in fiscal 2008. The majority of the year-over-year growth was driven by orders from an OEM customer taking a new series of 220 through 260 watt ATX voltage units that totaled $1.4 million. These power supplies were used in gaming applications where small size and high reliability are the key to product success.

In addition, power supply revenue for the fiscal year ended -- included $73,000 in royalty income from a patent licensee on some of our smaller power products. During the second half of the fiscal year, N2 power experienced some order stretch outs as a few OEM customers adjusted their production schedules to meet demand.

After the fiscal year closed, however, most of these very same orders were pulled back in, which is a good sign as we look forward to fiscal 2010.

During this past year, N2 power made progress on several fronts with product developments that target new applications where we see increasing potential. We recently made initial production shipments of our new 375 watt product line, which will contribute only slightly to revenues in fiscal 2010’s first quarter, then more heavily in the second quarter and beyond.

At 15 watts per cubic inch, the 375 has the highest volumetric efficiency we’ve ever produced. An ideal application for this new unit is in the field of architectural lighting where high efficiency is mandatory because of the sealed nature of outdoor lighting fixtures. Our units are 88% to as high as 91% efficient.

In lighting, we are benefiting from a worldwide rush to do away with the incandescent light-bulb. N2 power is in a position to benefit from the portion of this new market that utilizes solid state lighting and requires DC voltage to feed light-emitting diode arrays. These new fixtures are used in a variety of applications, such as concert stage lighting and store fixtures. In store lighting, the savings in electricity and air conditioning costs and pay for the more expensive lamp assembly in just a few years.

Also, during fiscal 2009, we announced N2 power’s first DC to DC power supplies, the 125 and 160 watt DC to DC families are specifically designed for OEM applications where small size and high efficiency were not previously available in DC to DC supplies.

These new supplies complement the AC versions of the same families that are particularly popular with telecom gear manufacturers. New energy management schemes are being adopted in data centers that now bus DC voltages around equipment racks in lieu of AC, as was done in the past.

For the short-term, we expect the growth in the power supply segment to partially offset lower sales of legacy tape libraries while the enterprise libraries gain momentum in the market.

Our sales and marketing activities and therefore our selling expenditures are primarily focused on promoting our penetration into the enterprise class tape automation market.

Two weeks ago, we wrapped up a successful exhibit at the European IBC exhibition and conference in Amsterdam. IBC is the European equivalent of the national association of broadcaster show here in the United States. We are finding that European customers continued to be receptive to the XLS given the significant advantages it has with high storage density, lower power consumption, and cost effective architecture.

We were also surprised at the high level of interest among the Baltic region and Eastern European visitors. As broadcasters around the world are converting from analog to digital program content, more and more are turning to the LTO tape format and libraries as the most cost-effective long-term storage medium. Upcoming trade show activities will include an exhibit at the storage expo in London in October and then in November, the Lisa Show in Baltimore and the SCO9 Show in Portland.

In conclusion, while our recent results have been impacted by the global economic recession, the fundamentals behind our business remain intact. Data continues to grow at better than 50% a year; backing up and archiving that data continues to be prudent, as well as increasingly mandated by legal and regulatory requirements; tape-based systems remain the most cost-effective means for long-term data retention, with one analyst estimating that the total cost for a typical data set stored on disk is 23 times higher than the cost of a similar tape system.

And Qualstar has the financial resources and the expertise to remain focused on what we do best, tape automation. We will be one of the survivors in a market where one by one, our competitors continue to exit the market at about the rate of one a year.

With that now, I will turn the call over to Nidhi who will go into some detail on our fourth quarter financials.

Nidhi H. Andalon

Thanks, Bill. As Bill has already addressed the revenue and gross profit picture, I will begin by addressing the comparison of the operating expense line items in the income statement. R&D expenses for the fourth quarter of fiscal 2009 were $939,000, or 24.9% of revenues, compared to $830,000, or 16.9% of revenues in the fourth quarter of fiscal 2008.

R&D spending is currently high because we are developing products in three categories simultaneously -- power supplies, XLS, and RLS. The actual dollar increases in R&D expense were due primarily to an increase in compensation related expenses, consulting fees, and prototype materials.

Sales and marketing expenses for the fourth quarter of 2009 were $640,000, or 17% of revenue compared to $775,000, or 15.8% of revenues in the fourth quarter of fiscal 2008. The decrease in sales and marketing expense was attributed to lower sales commissions, travel and entertainment, and compensation related expenses, partially offset by an increase in advertising and promotion expenses.

General and administrative expenses $745,000 or 19.8% of sales in the fourth quarter and were down from $829,000, or 16.9% of sales in the fourth quarter of fiscal 2008. The decrease was primarily due to lower accounting and audit related expenses, and a decrease in bad debt.

The loss from operations for the fourth quarter was $1.4 million compared with a loss from operations of $468,000 in the prior year period. Investment income for the fourth quarter was $137,000, down from $302,000 in the fourth quarter of fiscal 2008. The decrease was primarily due to lower interest rates on the company’s cash, cash equivalents, and marketable securities. Additionally, our cash, cash equivalents, and marketable securities balance of $27.7 million as of the end of the fourth quarter of 2009 is down from a balance of $32.5 million as of the end of fiscal 2008. $2.9 million of this decrease was attributed to dividends on common stock paid out during the fiscal year.

Qualstar reported a fiscal 2009 fourth quarter net loss of $1.2 million or $0.10 per share. This compares to last year’s fourth quarter net loss of $166,000, or $0.01 per share. Qualstar's financial condition remains stable. As I just noted, our cash, cash equivalents, and marketable securities balance was $27.7 million, which is equivalent to approximately $2.26 per share and we have no outstanding debt.

Looking at the accounts receivable picture, our day sales outstanding were approximately 51 days at June 30, 2009 compared to 55 days at June 30, 2008. Inventory turns were the same in both fiscal years at approximately 2.0 times on an annualized basis.

Looking briefly now at the full year’s results, I will address year-over-year comparisons. As Bill noted earlier, revenues decreased 16.6% from $21.5 million in fiscal 2008 to $17.9 million in fiscal 2009. Gross profit was $5.7 million in fiscal 2009 as compared to $7.4 million in the prior year. The decrease of approximately $1.7 million was attributed to lower sales volume and an increase in scrap and inventory adjustments, and lower absorption of labor and overhead.

Research and development expenses were $3.3 million in fiscal 2009 as compared to $3.1 million in the prior year. This increase was attributed to an increase in compensation related expenses.

Sales and marketing expenses were $2.8 million in fiscal 2009 versus $3.2 million in fiscal 2008. The decrease was due primarily to lower commissions, travel and entertainment, and advertising and promotional expenses.

General and administrative expenses were $3.2 million compared to $3.4 million in fiscal 2008. The decrease was primarily due to lower accounting and audit related expenses partially offset by an increase in compensation related expenses.

Investment income of $918,000 in fiscal 2009 was down from $1.5 million in the prior year primarily due to lower interest rates and the approximate $4.9 million decrease in cash, cash equivalents, and marketable securities.

Before turning the call over for questions, I’ll wrap up my remarks by providing some guidance for the first quarter of fiscal 2010. We expect the following -- revenues in the range of $3.5 million to $3.9 million; gross margin percentage in the range of 28% to 32%; R&D expenses in the range of $820,000 to $920,000; sales and marketing in the range of $650,000 to $730,000; G&A expenses in the range of $730,000 to $800,000; and investment income in the range of $125,000 to $150,000.

That concludes our prepared remarks. Operator, we are now ready to open the call to questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Gil Arya with Wedbush Securities.

Gil Arya - Wedbush Securities

First of all in terms of your business, it sounds like the XLS and power supply, you are continuing to be on a growth path on both of those, while the rest of the businesses you talked about, the decline is continuing but other being product development that could help reverse that. At what point do you think the RLS product will start reversing the decline, the new product that you introduced will start reversing the declines?

William J. Gervais

I’m not sure if it will totally reverse it. It should certainly stop the slide. You said something that I think wasn’t quite true. You said that the -- it sounds like the XLS is on a growth path. It’s actually been flat for three years at about $1.5 million a year, so it isn’t growing yet. It’s okay. It’s paying its way but it is not growing yet, a little disappointing but I think holding steady in this market is something to be happy about.

It certainly isn’t where we would like to see it on the XLS. It should be doing quite a bit more than that by now but we are not going to give up. We are going to keep on doing what we are doing to make it a success. Technically, it is a very good product and it’s priced significantly lower than the competition, so I think it’s got many elements that are going to help it succeed eventually.

The new RLS is bigger than the RLSs we’ve been shipping in the past but it is perfectly sized for certain market. But it hasn’t been released yet. We’ve just talked about it but it’s not a product we’ve announced yet so it probably won't be contributing to revenue until late in fiscal 2010 or maybe in the -- late in the third quarter and then in the fourth quarter. It’s a product that’s sized based on input from our customers and we think it hits squarely at some of the advantages -- takes away some of the advantages that some of our competitors have in terms of its form factor. And it will be a much more modern design than even the RLSs we have out there now because it will have a full touch screen front panel rather than a small 80 character display.

So I would say that I wouldn’t expect -- I don’t know what to expect for XLS in the fiscal year we’re in. If the economy turns around, it could be more than $1.5 million. I’m certainly expecting it will be but who knows how to predict the economy.

And certainly the RLS won't contribute until third or fourth quarter, so that leaves power supplies to kind of pull up the slack for us and we’ve been releasing new models in the power supply area as fast as we can and I am not going to make any projections about power supply revenue for 2010 but it certainly is one of the bright spots in the future for me.

Gil Arya - Wedbush Securities

Got it, and then in terms of Oracle and the business that they are getting with Sun when they close that deal, what’s your sense of their -- of the intentions there, of staying in that business? Have you started getting resumes from those folks at Sun that maybe think that the business is going to go away once Oracle takes over?

William J. Gervais

I think in January this year they let most of the people that we would be interested in go from store check heritage people. There was a 192 person layoff in Louisville, Colorado and amongst some of the other locations, so the resumes that came in at that time have all come and gone and those people have found other work.

We really don’t know what they are going to do with it. We know they have cut back on people. My sense is they are not going to develop anymore new products and all I can say is that Oracle is primarily a software company.

Gil Arya - Wedbush Securities

Right, and then finally on the financial front, when you started paying a dividend, it looked like you could get a lot of it out of cash flow. Now that you’ve gone through a few quarters where you’ve actually had negative cash flow, would you consider maybe replacing the dividend with a share buy-back that would kind of leave you something at the end of the day and in a smaller share count?

William J. Gervais

We constantly look at that at every board meeting and I wouldn’t want to make any predictions about what we will do. We will have paid the dividend for almost two years by the end of this year, this calendar year and at that point, we’ll take another look at it.

Gil Arya - Wedbush Securities

Got it. Thank you.


(Operator Instructions) Our next question comes from Anthony [Chizara] with Key Equity Investors Incorporated.

Anthony Chizara - Key Equity Investors Incorporated

Good afternoon. Given the guidance that you just gave us, it seems like we are going to get a little bit more of a weakening in the first quarter. Is that the right interpretation or are you just being more conservative? Because I guess you hinted to some extent that you were seeing more orders coming in, for example, in the N2 power area, so can you describe a little bit of what the market conditions look like and are things improving or are things just remaining stable?

William J. Gervais

I think the best way to characterize it overall is they are remaining stable. Of course, the Q1 is 90% over, so we have somewhat of an idea of what the revenue is going to be and I am fairly confident we will be within that range.

What we are seeing is a lot more quoting activity, both in the power supply business as well as at the high end of the library business. Of course, activity doesn’t lead to revenue for six months or more but we are seeing a higher level of activity and we seem to be exporting more libraries than we used to. We have three of them that have gone out this quarter to Brazil, for instance, just to one country.

So I think the best way to characterize it is right now it appears to be stable and we are hopeful that will pick up when people’s confidence comes back.

Anthony Chizara - Key Equity Investors Incorporated

Thank you very much.


Thank you. At this time, I do not show any further questions. I would like to turn the call back to management.

William J. Gervais

Okay. Well, thank you very much for hanging in there on a Friday afternoon with us. We appreciate you joining us this afternoon and look forward to talking to you next quarter. Thank you.


Ladies and gentlemen, this concludes the Qualstar fourth quarter fiscal 2009 conference call. You may now disconnect. Thank you for using ACT conferencing.

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