Qualstar F4Q08 (Qtr End 6/30/08) Earnings Call Transcript

Sep.23.08 | About: Qualstar Corporation (QBAK)

Qualstar Corporation (NASDAQ:QBAK)

F4Q08 Earnings Call

September 23, 2008 5:00 pm ET

Executives

Tricia Ross - Financial Relations Board

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

Andrew A. Farina - Chief Financial Officer, Vice President

Analysts

Gil Luria - Wedbush Morgan

Anthony Harenzi - Key Equity Investors

William Hike - Pine Street Securities

Patrick O’Bryan - Needham & Company

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Qualstar fourth quarter 2008 conference call. (Operator Instructions) I would now like to turn the conference over to [Tricia Ross] with the Financial Relations Board. Please go ahead.

Tricia Ross

Thank you and welcome, everybody. This afternoon we will be discussing Qualstar's fiscal 2008 fourth quarter and full year results for the period ended June 30, 2008. If you do not yet have a copy 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, then on Press Releases.

Providing comments on Qualstar's results and business outlook today is Bill Gervais, President and CEO of Qualstar. He is joined by Andy Farina, Qualstar's Chief Financial Officer, and [Nicky Andolon], Qualstar's Controller.

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 increase the sales of tape libraries, which incorporate LTO tape drives, our ability to increase sales in the N2 power supply business, whether the company’s initiatives to maintain sales of its tape libraries that utilize AIT tape technology will be successful, whether the company’s XLS enterprise class tape libraries will achieve customer acceptance, 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 power supplies.

The company undertakes no obligation to publicly update any forward-looking statement, 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, 2007, and to management’s discussion and analysis of financial condition and results of operations section of its Form 10-K and its most recently quarterly report on Form 10-Q.

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

William J. Gervais

Thank you and thanks to everyone for joining us. On today’s call, I’ll begin with remarks on our operating results for fiscal 2008 and provide an update on our recent business activities. Andy Farina’s remarks will include detailed comments on our fourth quarter and full year financials, along with our guidance for the first quarter of fiscal 2009. After that, we’ll open up the call for questions.

In general, I am encouraged by our operating results during fiscal 2008. While some quarters were stronger than others this past year, our overall results were solid and showed an improvement over fiscal 2007. Qualstar generated revenues -- generated revenue growth on a year-over-year basis.

Fiscal 2008 full year revenues increased by about $850,000, totaling $21.5 million, which was an increase of about 4.1% from $20.6 million in the prior year. Our sales continued to be well diversified during the fiscal 2008 by product, channel, geography, and [end applications].

We are not overly reliant on any single market segment. Our largest customer accounted for 7.1% of revenues and our top 10 customers accounted for 40% of revenues. Overall, 47% of our sales go through our largest channel, the value-added resellers, and 26% was sold to OEM customers and their contract manufacturers.

As you know, we report in two major business segments -- tape automation and power supplies. For the year, tape automation revenues contributed $17.4 million, down slightly from $17.6 million in fiscal 2007. Power supplies accounted for $4 million, up 34% compared to $3 million in fiscal 2007.

Our overall net revenue growth of about $850,000 -- let me start that over. Our overall net revenue growth of about $850,000 during the year came primarily from the power supply business, offset by a slight decline in tape automation. Our power supplies are benefiting from increased worldwide attention to and demand for products that are more efficient and therefore less wasteful of electrical energy.

In addition to top line growth, we were able to improve our manufacturing operations during fiscal 2008, which resulted in an increase in gross profit percentage of 300 basis points to 34.6% from 31.6% in fiscal 2007. As a result of these efficiencies, we reduced our net loss to $0.06 a share for all of fiscal 2008, compared to a loss of $0.12 per share in fiscal 2007. Our quarterly break-even sales level continues to be in the low $6 million area.

In February, the board of directors initiated our first quarterly cash dividend of $0.06 per common share.

Within the tape automation segment, XLS revenues for fiscal 2008 came to $1.5 million, compared to $1.75 million in fiscal 2007, our first full year of XLS shipments. Through the first half of fiscal 2008, XLS revenues were tracking ahead compared to the first half of fiscal 2007. However, in the June quarter, XLS revenues of $398,000 fell short of the exceptionally strong fourth quarter in fiscal 2007, where XLS revenues totaled $965,000.

It’s important to note that our pipeline of potential XLS sales continues to hold at the same level as in prior periods. It’s too early to know if recent turmoil in the financial markets will impact our business. However, none of the affected big-name companies are on our current sales pipeline list.

XLS shipments during the fourth quarter were made to networking and telecommunications companies, an HR staffing company, military and medical applications. Our average selling price was $66,000 during the quarter.

It’s been six years since we initiated the XLS development program and we have been shipping the product for two years now, yielding us a cumulative revenue of $3.25 million excluding service and tape media sales. Though slower than we had anticipated, we are making progress both domestically and internationally at establishing the Qualstar brand in this $1 billion plus market.

Our European sales effort started about a year ago. We now have units installed in a wide variety of applications and in six countries, in addition to the U.S.A. We continue to believe that entering this market was the correct move for a company of our background and size and we have already established a good record for product reliability in the field and responsiveness to customer needs.

We’ve now had a number of customers purchase add-on storage modules for existing XLS sites. There are two recently published installation success stories on our website under the tape systems tab on our website, then the tab solutions should be looked at.

We recently opened an XLS specific spare parts warehouse in Germany to enable us to support European installations with next day or same day spare parts availability. With our installed base of 60 XLS units, we’re now beginning to benefit from service contract renewals, tape drive upgrades, and spare parts. As the service life of enterprise plus libraries is typically 10 years or more, we expect that this post-market support-based business will continue to build over time. We are continuing to add to the product family by releasing additional models and new options.

For the year, our mature tape technology lines, the TLS and RLS series, declined to $8.5 million from $9.1 million in fiscal 2007. This decline was within our expected range and is forecast to continue into the future until replacement products come online. We have been expecting a decline in these mid-range automation products for some time now. Until the last two quarters, however, some factors have delayed this decline, most notably tape technology upgrades that are purchased to extend the useful life of existing libraries.

The lower TLS and RLS revenues experienced in each of the last two quarters would indicate that this decline is finally coming into play. If this is the case, we hope to back-fill the lost revenue with growth in the XLS product series and by power supplies until a new RLS in development comes to market.

Also within the tape automation segment, we enjoyed a gain in tape media revenues, growing to $3.5 million in fiscal 2008, up by more than 24% from $2.8 million in fiscal 2007. Tape media revenues are somewhat hard to predict and are generally funded in a different way than libraries are funded by the end customer.

While the purchase of a tape library is classed as capital equipment and therefore budgeted and approved well in advance, tape media is generally classed as an expensed supply item, where little approval may be required. As tape wears out or is sent to remote locations for archival purposes, it must be replaced to keep the library system functioning.

Service revenue was $2.7 million in fiscal 2008, down 7% from $2.9 million in fiscal 2007. Since we are bundling the first year of onsite service at no cost with our XLS products, service revenues from XLS shipments are not realized until the second and subsequent years after a unit is sold.

With increasing XLS units in the field having been deployed longer than one year, we will likely see, or start to see overall service revenue increase going forward. Nearly all domestically shipped XLS units are under maintenance contracts.

Moving on to our N2 power business, revenues in fiscal 2008 totaled $4 million, up 34% from $3 million in fiscal 2007. We shipped 76,900 units in fiscal 2008, compared to 51,500 units in fiscal 2007. For the full year, power supplies made up 19% of our business, up from 15% in the prior year. N2 power was the beneficiary of $71,000 in royalty income from a patent licensee during fiscal 2008. There was no revenue from this source during fiscal 2007.

As you may know, with N2, we have focused on a segment of the power supply market where both high efficiency and a small form factor are needed to fit into new, ever-shrinking electronic equipment designs. Our compact power supplies, coupled with electrical efficiencies ranging up to 90%, where the industry norm is 50% to 70%, provide N2 power with a competitive advantage that is gaining favor in the marketplace. For the year, N2’s gross margin percentages were consistent with the tape automation side of our business.

Several factors contributed to the strong growth we enjoyed in fiscal 2008. One of these was the availability of our new 275-watt product line, which began shipping around mid-year. We also enjoyed increased sales to New Horizons Electronics Corporation, a stocking distributor which began reselling our products on a worldwide basis during fiscal 2008. Also during the year, we completed the qualification of a second source supplier in China and began production with this new supplier. Having a second source reduced some of the risk we previously had with only a single source.

Subsequent to the end of the quarter, N2 power was awarded purchase orders from an OEM customer for a new series of 221-watt through 260-watt ATX voltage power supplies, totaling approximately $1.35 million, to be delivered over a nine-month period. This is the largest single order we have received to date. The power supplies will be used in gaming applications and shipments began during the current quarter, Q1.

Returning now to tape automation for a moment, our sales and marketing activities are focusing mostly on large libraries. During the fourth quarter, we continued to show and promote our XLS libraries with an exhibit at the national laboratories information technology show in Chicago, where we displayed our new 1100 Tape XLS. We also conducted an extensive three-week nationwide road show. On this trip, we transported the new 1100 XLS along with two other units some 7500 miles around the country and demonstrated it to approximately 30 prospective resellers and end users.

Since the trip, we have shipped three units that were the direct result of this tour. Two units were shipped to [inaudible], Wisconsin and one to Argon National Labs. Last week, we wrapped up a successful exhibit at the European IBC exhibition conference in Amsterdam. IBC is the Europe equivalent of the National Association of Broadcasters, or NAB show here in the United States, which we also attended.

We are finding that Europe customers are quite receptive to the XLS, given the significant advantages it has with high storage density, low power consumption, and cost-effective design approach. As broadcasters around the world are converting long-term programming content from analog to digital storage, more and more are turning to the tape format over disc as a more cost-effective long-term solution.

Upcoming activities include an exhibit at the storage expo in London in October and then the IEEE Super Computer Conference in November in Austin. This will be our first time attending this particular conference as an exhibitor.

With that, I will now turn the call over to Andy who will go into some additional details on our fourth quarter financial results and outlook. Andy.

Andrew A. Farina

Thank you, Bill. I will address the comparison of the operating expense line items in the income statement. First we’ll do the quarterly. Research and development expenses for the fourth quarter of fiscal 2008 were $830,000, or 16.9% of revenues, compared to $784,000, or 13.5% of revenue in the fourth quarter of fiscal 2007. The increase in R&D expenses was attributable to higher consulting expenses.

Sales and marketing expenses for the fourth quarter of 2008 were $775,000, or 15.8% of revenues, compared to $800,000, or 13.8% of revenue in the fourth quarter of fiscal 2007. The decrease in sales and marketing expense was attributed to lower advertising and promotional expenses.

General and administrative expenses were $829,000, or 16.9% of sales in the fourth quarter and were down from $848,000, or 14.7% of sales in the fourth quarter of fiscal 2000. The decrease was primarily due to lower bad debt expenses.

The loss from operations for the fourth quarter was $468,000, compared with a loss from operations of $186,000 in the prior period.

Investment income for the fourth quarter was $302,000, down from $413,000 in the fourth quarter of fiscal 2007. The decrease was primarily due to lower interest rates on the company’s cash, cash equivalents, and market securities compared to the same period last year.

Our cash, cash equivalents and marketable securities balance of $32.5 million as of the end of the fourth quarter of 2008 is down slightly from $33.3 million as of the same time last year.

Qualstar reported a fiscal 2008 fourth quarter net loss of $166,000, or $0.01 per share. This compares to last year’s fourth quarter net income of $245,000, or $0.02 per share.

Qualstar's financial condition remains healthy. Our cash, cash equivalents and marketable securities of $32.5 million equates to approximately $2.66 per share, which is similar to recent prior quarters. We have no outstanding debt.

Looking at the accounts receivable picture, our day sales outstanding were approximately 55 days at June 30, 2008, compared to 54 days at June 30, 2007. Inventory turns were approximately two times on an annualized basis for the period ended June 30, 2008. This compares to an annualized inventory turn of 2.3 times for the quarter ended June 30, 2007.

Looking briefly now at the full year’s results, I will address year-over-year comparisons. As Bill noted earlier, revenues increased 4.1% from $20.6 million in fiscal ’07 to $21.5 million in fiscal ’08. Gross profit was $7.4 million in fiscal ’08 as compared to $6.5 million in the prior year. The increase of approximately $900,000, or 13.8%, was attributed to increased sales volume, a change in product mix, and efficiencies achieved in material and labor management.

Research and development expenses were $3.1 million for fiscal ’08 compared to $3.1 million in the prior year. Sales and marketing expenses were $3.2 million in fiscal ’08 versus $3.1 million in fiscal ’07. The increase of $100,000 is attributed to increases in commissions compensation partially offset by closure of our sales office in the U.K.

General and administrative expenses were $3.4 million compared to $3.2 million in fiscal ’07. The increase of $200,000, or 7%, was due to compliance work on Sarbanes-Oxley efforts and compensation expenses partially offset by decreases in bad debt and depreciation. Investment income of $1.52 million in fiscal ’08 was up slightly from $1.48 million in the prior year due to higher interest rates available in ’08.

Before turning the call over for questions, I will wrap up my remarks by providing some additional guidance for the first quarter of fiscal 2009. We expect the following: revenues in the range of $4.9 million to $5.2 million; gross margin percentage in the range of 32% to 36%; R&D expenses in the range of $790,000 to $830,000; sales and marketing in the range of $800,000 to $840,000; G&A expenses in the range of $800,000 to $880,000; and investment income in the range of $275,000 to $310,000.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Gil Luria with Wedbush.

Gil Luria - Wedbush Morgan

Thank you. Would you mind breaking out fourth quarter results by product, so the RLS, media services, power supply, and other?

Andrew A. Farina

I can do that. RLS and TLS was $1,538,000, XLS was $398,000, media was $731,000, service revenue was $797,000, miscellaneous $256,000, and N2 Power product shipments was $1,181,000, and N2 royalty was $11,000. That adds up to $4,912,000.

Gil Luria - Wedbush Morgan

The very large N2 contract that you got, I think you mentioned the power supply gross margins are at par with the rest of the business. When you get a big contract of this type, is it also comparable margins?

Andrew A. Farina

It will be slightly less but not a whole lot less. I don’t expect a contract that large over nine months will significantly pull down our gross profit. It might pull it down a half a point or so but not a lot.

Gil Luria - Wedbush Morgan

In your R&D spending right now, are you investing more in getting other add-ons and permutations to the XLS? Are you also funneling some of it back to the more mid-market offering to try to get that product set updated?

William J. Gervais

Good question. We’re spending roughly one-third of our R&D on enhancements and improvements to the XLS, roughly one-third of it on new product development here in Simi for the RLS and TLS, and about one-third of it in N2, so it is split three ways pretty evenly most of the time.

Gil Luria - Wedbush Morgan

Got it, so you are progressing on all those fronts?

William J. Gervais

Yes.

Gil Luria - Wedbush Morgan

Could you tell us what the D&A and CapEx were for the quarter, so we get a little bit of sense for cash flow?

William J. Gervais

I think we bought during the quarter not much capital expenditure. We did buy some in the current quarter which we are just about to close here but there was very little capital expenditure.

Gil Luria - Wedbush Morgan

Got it.

William J. Gervais

What was the other part of the question?

Gil Luria - Wedbush Morgan

D&A.

William J. Gervais

What’s D&A? We’re scrambling to get it.

Gil Luria - Wedbush Morgan

That’s okay. In the meantime, let me ask the question about the N buy -- I think you said it’s a little early to determine if there’s an impact from the economic environment on your results but historically speaking over the last few years, what percentage of your revenue do you think comes from financial service oriented companies?

William J. Gervais

At this point, almost none of it. Maybe some smaller libraries but in terms of the XLS sales, Bear Stearns never was a customer and I don’t think they are going to be. Companies in that category were really not on our short list of potentials. Most of our large libraries are going into research and entertainment and other type of companies and not financial in nature.

Gil Luria - Wedbush Morgan

Got it. Well, I’ll take the answer on D&A offline then. Thank you.

William J. Gervais

Okay, well the capital expenditure during the quarter ended June 30th was $87,000.

Gil Luria - Wedbush Morgan

Got it.

William J. Gervais

And D&A was $58,000.

Gil Luria - Wedbush Morgan

Great. Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Anthony [Harenzi] with Key Equity Investors. Please go ahead.

Anthony Harenzi - Key Equity Investors

Good afternoon. A question about the stockholders’ equity -- it went from the March quarter to the June quarter, it went down about $1.8 million. Is that the markdown in securities or where did that come from?

William J. Gervais

No, that was the cash dividend that we paid out to shareholders.

Anthony Harenzi - Key Equity Investors

Okay. All right, that makes it easy. Now also, you missed the forecast for the June quarter -- was that mostly the XLS miss or did it come more across the board?

William J. Gervais

No, it was pretty much an XLS miss. We had in the first 10 days of July, we picked up a couple of shipments that we had expected in the June quarter, so it was -- I blame it all on the XLS.

Anthony Harenzi - Key Equity Investors

Okay. Can you update us on the strategy for cash at this point? Obviously you have a very large cash position and obviously the dividend is a good start of that strategy but what are you looking at at this point, given the weakness in the market, there might be some acquisition opportunities or possibly even an opportunity to buy back some shares -- what’s the current strategy?

William J. Gervais

We look at share buy-backs almost quarter and the last time we looked really hard at it in January, we decided the dividend was probably a better way right now to return some of our cash to shareholders.

In terms of acquisitions, 10 years ago there were 26 people manufacturing tape libraries as we do. Today there are six or seven, so there’s been a lot of attrition. Some of them have just disappeared and others have come to us for sale. We’ve looked at everything that’s come to us and pretty much decided that there was too much product crossover or too much liability with what they had shipped to take a chance on any acquisitions. We’re somewhat timid in that department.

So we do look at things as they come across the table. There are less and less companies in our business every year and therefore fewer people that might be interested in buying us or in us buying them. With it down to seven and one of them is IBM and the other one is Sun, there’s no chance there, of course. But we do look at everything that comes our way and unless it’s a really, really good fit, we’re not going to touch it. We’d rather just sit back and watch them die.

Anthony Harenzi - Key Equity Investors

Okay, understood. Thank you very much. Good luck in the coming quarters.

Operator

Our next question comes from the line of William [Hike] with Pine Street Securities. Please go ahead.

William Hike - Pine Street Securities

Could you just catch up -- we keep waiting for the breakout in sales, given the shrinking suppliers and the obvious demand for the product. One of these quarters, you are just going to explode on the upside so could you just talk a little bit about the distribution, the mix versus OEM and VAR? How you see that evolving and Europe in particular, I know you’ve always been excited about and it seems to be happening. Could you just kind of walk us through that in a little more detail, where we are at, what you see as being critical going forward?

William J. Gervais

Sure. The OEM portion of our business has actually been increasing, mostly because of the success at N2. That’s almost all OEM business. The reseller -- the rest of our business, it’s a little bit end user, a little bit government but the bulk of it goes to resellers and I think the ratio is holding about steady there. We have two OEM customers for our RLS -- or correction, our TLS tape libraries and they’ve been pretty steady. I think one of them has bubbled to the top of the second-largest customer. That’s someone in the graphics industry that takes our TLS libraries. But in general, the mix of OEM is going to be changing in favor of OEM as N2 succeeds and the mix in the tape automation segment is probably going to stay about the same, unless we get another OEM customer.

I can’t tell you that there are any that are promising in the pipeline. We talk to them when they come around but I can’t give you any hope that the mix is going to change radically in the next year or so.

William Hike - Pine Street Securities

And how about Europe in general -- by country, by product, just a little flavor in there?

William J. Gervais

We really started the XLS marketing in Europe in a concentrated way about a year ago -- last October, a year ago from October. And to date, I don’t see a lot of sales activity that resulted from it. I see more inquiries, I see more quoting going on, which always downstream means that there will be something happening eventually but the Europeans are kind of -- they’ve got to get to know you before they will take on your product or buy your product and that’s kind of a two- or three-year process, so we started it a year ago and maybe I would guess over the next fiscal year, we’ll begin to see some yield from that money we’ve been spending over there.

We’re doing the -- as I said, the storage expo next month in London. We did one last week in Amsterdam and then of course we’ll be doing the [CBIT] show again in March, so that’s the bulk of our trade show activity for the European market.

We also have an event on the 10th of October at Euro Disney where we are introducing the XLS to resellers in France. This will be our first exposure of the XLS in that country, so it is beginning to happen but they don’t jump on the bandwagon real quick like Americans do when something else comes along. They are very slow to buy your product. But by the same token, once they do, they buy it forever.

William Hike - Pine Street Securities

Right -- given European shows -- but you have enough reason to believe that it’s worth waiting that two or three years, putting that expense in, that there will be a reward at the end of the tunnel?

William J. Gervais

Absolutely believe that. At one time during our nine-track era, 50% of our sales were exported so we are in the low 20s right now, I believe. We’re around 30% right now. There’s no reason to believe that can’t grow.

One of the nice things about the library market is that there’s really no foreign competition. They are all virtually made in the United States, with the exception of BDT, which does their manufacturing in Mexico. They are a German company but most of the libraries in the class where we operate are all made here in the United States, so we don’t have foreign competition to worry about.

If somebody needs one in the world, it’s going to come from one of us suppliers.

William Hike - Pine Street Securities

Got it. That was my next question. And finally just to comment, this is just my opinion, everyone can disagree, is I agree with the dividend, not the buy-back. I’m still optimistic that this thing is -- you know, sales are going to blow out at some point when we least expect it and I would rather have the shares outstanding for liquidity. If you buy it back, then the cash is gone, we’ve lost the cushion, so I just want to tell you that I support the current strategy.

William J. Gervais

Okay. Thank you. We think it’s the right thing to do and we hope to be able to continue it.

William Hike - Pine Street Securities

Very good.

Operator

(Operator Instructions) Our next question comes from the line of Patrick O’Bryan with Needham & Company.

Patrick O’Bryan - Needham & Company

Good afternoon. Bill, maybe you could expand on the N2 OEM win -- what kind of linearity you guys expect over the next three quarters and does this represent a significant in-road for future orders?

William J. Gervais

Yes, these are used -- these are -- I can’t mention the name of the customer but it is a gaming application; more specifically, lotto machines and this particular customer won an entire state and we are -- I would guess that it will be pretty linear through the nine months, so roughly one-third of it will be in the quarter that we’ll be reporting in seven weeks and the other two-thirds will be spread over the next two quarters.

The second part of the contract, which is actually much bigger than the first part, the part we’re fulfilling right now, is for lotto machines for the entire country of Italy, so it’s a different version of the power supply that we are shipping right now. It’s got a few more amps on one of the outputs but basically the voltages, when I mentioned they are ATX voltages. What that means is that those are the voltages required by a PC. A lot of these lotto machines, or all of them virtually have a PC inside of them for communications and so these are very specialized PCs in a low profile package that will go in convenience stores and hotels and every place they sell lotto tickets, and it drives the printer that prints the lottery tickets.

So first was one entire state and the second part of the contract, which we’ll be fulfilling from September, or from October to about March will be for used in the country of Italy for their gaming machines, or lotto machines.

Patrick O’Bryan - Needham & Company

Okay. Thank you very much.

William J. Gervais

That’s where that one is going. This was not a standard power supply. It was a special and I think they came to us because we were able to respond in a very quick way and start meeting their production requirements very quickly for a non-standard power supply.

In order to do that, we built about 500 or 600 of them here locally and at the same time as we tooled up for it and began importing them from our manufacturing source in China. So right now, we’ve just about wound up the shipments of the ones that were built locally and they are coming in almost weekly on palettes from the source in China and we are turning them around and shipping them right back out again.

So it’s a very nice contract, a little less margin than we are used to getting but it’s very nice business. The biggest order -- I said it’s the biggest order that N2 has ever received. It’s really the biggest order that Qualstar has ever received.

Patrick O’Bryan - Needham & Company

Thanks for the further granularity.

Operator

Our next question is a follow-up from the line of William Hike with Pine Street Securities.

William Hike - Pine Street Securities

[inaudible] to the N2 -- any reason to believe there’s a follow-on? It sounds like this customer likes you but I would think that his orders are uncertain. And the second question, what are you doing in R&D in N2? I remember when you increased the wattage a while back, everyone was surprised and it worked out beautifully. Is there -- are we going to 300 or 350 or what’s the next thing that happens there?

William J. Gervais

Okay, well there’s no question this is a one-shot deal. If they are successful at gaining anymore states, then we hope to be their supplier but it’s not an ongoing forever kind of a thing. And we face competition too -- you know, once this thing is flowing and becomes mature, they may go out for quotations from other people and so we’ll be competing just like we normally do for the additional follow-on business.

In terms of N2, we kind of last spring when we saw the chance to get this order, we dropped what we were doing on the next development in order to put this one ahead of everything and we are now getting back to, now that this one is flowing, getting back to what is the next development and that’s a 350-watt power supply. We bought rights from a company to manufacture it under license and that has been through two redesigns, because we didn’t really like the way it worked and we are now in our third iteration of the design, which is longer than I like to take. It’s been a year-and-a-half. But we are getting close to be able to announce the 350-watt power supply as the next product.

One nice thing about that power supply is it’s now getting up there in the wattage range. We’ll be able to consider using it in our own XLS as well and not have to buy the ones we are buying from an outside power supply manufacturer, at some point in time. For now, we are just working on bringing the 350 to engineering release.

These power supplies are very painful to get out, we found, because of all the agency approvals that are involved in bringing them to market. There’s five or six different testing labs that we use to -- before we can put the badges on it, including UL and PSA and European qualifications, and there’s not only safety but there’s emissions requirements as well, so even when we are through with the design and we think it works, we might find out that we have to go lay it out yet again to move a trace or two to reduce emissions. You end up in these things with traces, opposite traces on the printed circuit board just for the purpose of canceling the emissions potential, so the layout of the board is kind of the secret sauce that gets you through some of these agency approvals and the N2 crew has been doing it for quite a while but still we end up laying a board out two and three times before it goes to production and that’s why it’s taking so long.

William Hike - Pine Street Securities

Very interesting. Does going to 350 open up any particular new market that you haven’t been in or --

William J. Gervais

Yes, we know there’s a market for it and in fact, we’ve had to turn down some business because we put that other product ahead of it, the 220, 260. And we know that we are missing some opportunities because we don’t have it today, let’s say. That’s the next one that we’ll be releasing.

William Hike - Pine Street Securities

Very good. Thank you.

Operator

Thank you. There are no further questions. Mr. Gervais, I’ll turn it back to you for closing comments.

William J. Gervais

Thank you, gentlemen. In closing fiscal 2008, it was a solid year for Qualstar and we demonstrated progress towards returning the company toward profitability. The primary keys to our success are the XLS product line and continued solid growth in our power supply business. As always, we will look forward to sharing our progress with you next quarter. Thank you once again for joining us this afternoon and for your continued support.

Operator

Thank you, sir. Ladies and gentlemen, that will conclude today’s teleconference. If you would like to listen to a replay of today’s conference, please dial into 303-590-3000 or 1-800-405-2236 and enter the access code of 11119174, followed by the pound sign. We thank you again for your participation and at this time, you may disconnect. Have a nice day.

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