Note

–

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.

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.

December 31, 2019,

we had deferred revenue of approximately

$949,000

and

deferred profit. At

December 31, 2018,

we had deferred revenue of approximately

$863,000

and

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

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

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.

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

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

(

)

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.

impairment losses of long-lived assets were recognized during the periods presented.

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,
	201 9			201 8
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 (

) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (

) our own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs):

Level

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

Level

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

Level

Unobservable inputs for which there is little or

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.

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, 201 9
	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, 201 8
	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.

Recent Accounting Guidance

Recent accounting guidance

not

yet adopted

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

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

and

2019

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.

June 2018,

the FASB issued ASU

2018

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

and it did

not

have a material effect on our consolidated financial statements.

February 2018,

the FASB issued ASU

2018

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

and it did

not

have a material effect on our consolidated financial statements.