SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


______________





Form
10-Q


________________





R
                  QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Quarterly Period Ended September 30, 2008OR£
                  TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Transition Period
      From                   to





Commission
file number 000-30083





QUALSTAR
CORPORATION





CALIFORNIA
              95-3927330(State
      of incorporation)
              (I.R.S.
      Employer Identification No.)





3990-B
Heritage Oak Court, Simi Valley, CA  93063


(805)
583-7744








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





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


Large
      accelerated filer o
            Accelerated
      filer o
            Non-accelerated
      filer  ̈
            Smaller
      reporting company þ





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


Total
shares of common stock without par value outstanding at October 28, 2008 is
12,253,117.
 
 QUALSTAR CORPORATION
 FORM
10-Q
 FOR
THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008
 INDEX
 
 PART
      I — FINANCIAL INFORMATIONItem
      1.
                Financial Statements·Condensed Consolidated Balance Sheets — September 30,
      2008 and June 30, 2008
                1·Condensed Consolidated Statements of Operations —
      Three months ended September 30, 2008 and 2007
                2·Condensed Consolidated Statements of Cash Flows —
      Three months ended September 30, 2008 and 2007
                3·Condensed Consolidated Statement of Changes in
      Shareholders’ Equity — Three months ended September 30,
      2008
                4·Notes to Interim Condensed Consolidated Financial
      Statements
                5Item
      2.
                Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
                12Item
      3.
                Qualitative and Quantitative Disclosures About Market
      Risk
                17Item
      4T.
                Controls and Procedures
                17PART
      II — OTHER INFORMATIONItem
      6.
                Exhibits
                18Signatures
                19
  Index
  PART I — FINANCIAL INFORMATION
 
 ITEM
1.FINANCIAL
STATEMENTS
 
 QUALSTAR
CORPORATION
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (In
thousands)
 
 September
      30,
                                          2008
                                        
                                        
                                        June
      30,
                                          2008(Unaudited)
                                        
                                        
                                        (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                        
                                        $
                                        8,526
                                        
                                        
                                        $
                                        6,744Marketable
      securities, short-term
                                        
                                        
                                        11,002
                                        
                                        
                                        
                                        11,091Receivables,
      net of allowances of $85 as of September 30, 2008, and $82 at June 30,
      2008
                                        
                                        
                                        3,243
                                        
                                        
                                        
                                        2,962Inventories,
      net
                                        
                                        
                                        6,209
                                        
                                        
                                        
                                        6,109Prepaid
      expenses and other current assets
                                        
                                        
                                        551
                                        
                                        
                                        
                                        467Total
      current assets
                                        
                                        
                                        29,531
                                        
                                        
                                        
                                        27,373Property
      and equipment, net
                                        
                                        
                                        484
                                        
                                        
                                        
                                        526Marketable
      securities, long-term
                                        
                                        
                                        11,530
                                        
                                        
                                        
                                        14,703Other
      assets
                                        
                                        
                                        55
                                        
                                        
                                        
                                        55Total
      assets
                                        
                                        $
                                        41,600
                                        
                                        
                                        $
                                        42,657LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                                        
                                        $
                                        1,245
                                        
                                        
                                        $
                                        1,197Accrued
      payroll and related liabilities
                                        
                                        
                                        420
                                        
                                        
                                        
                                        519Other
      accrued liabilities
                                        
                                        
                                        1,003
                                        
                                        
                                        
                                        1,774Total
      current liabilities
                                        
                                        
                                        2,668
                                        
                                        
                                        
                                        3,490Other
      long term liabilities
                                        
                                        
                                        46
                                        
                                        
                                        
                                        46Commitments
      and contingenciesShareholders’
      equity:Preferred
      stock, no par value; 5,000 shares authorized; no shares
    issued
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —Common
      stock, no par value; 50,000 shares authorized, 12,253 shares issued and
      outstanding as of September 30, 2008 and June 30, 2008
                                        
                                        
                                        18,729
                                        
                                        
                                        
                                        18,705Accumulated
      other comprehensive income (loss)
                                        
                                        
                                        (112
                                        )
                                        
                                        
                                        108Retained
      earnings
                                        
                                        
                                        20,269
                                        
                                        
                                        
                                        20,308Total
      shareholders’ equity
                                        
                                        
                                        38,886
                                        
                                        
                                        
                                        39,121Total
      liabilities and shareholders’ equity
                                        
                                        $
                                        41,600
                                        
                                        
                                        $
                                        42,657
 
 See
the accompanying notes to these interim condensed consolidated financial
statements.
  1
 Index
  QUALSTAR CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
(In thousands, except per share data)
  Three
      Months Ended
                      September
      30,2008
                    
                    
                    2007Net
      Revenues
                    
                    $
                    5,402
                    
                    
                    $
                    5,332Cost
      of goods sold
                    
                    
                    3,519
                    
                    
                    
                    3,708Gross
      profit
                    
                    
                    1,883
                    
                    
                    
                    1,624Operating
      expenses:Research
      and development
                    
                    
                    743
                    
                    
                    
                    728Sales
      and marketing
                    
                    
                    695
                    
                    
                    
                    759General
      and administrative
                    
                    
                    766
                    
                    
                    
                    739Total
      operating expenses
                    
                    
                    2,204
                    
                    
                    
                    2,226Loss
      from operations
                    
                    
                    (321
                    )
                    
                    
                    (602
                    )Investment
      Income
                    
                    
                    280
                    
                    
                    
                    413Loss
      before income taxes
                    
                    
                    (41
                    )
                    
                    
                    (189
                    )(Benefit)
      Provision for income taxes
                    
                    
                    (2
                    )
                    
                    
                    17Net
      loss
                    
                    $
                    (39
                    )
                    
                    $
                    (206
                    )Loss
      per share:Basic
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.02
                    )Diluted
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.02
                    )Shares
      used to compute loss per share:Basic
                    
                    
                    12,253
                    
                    
                    
                    12,253Diluted
                    
                    
                    12,253
                    
                    
                    
                    12,253
 
 See
the accompanying notes to these interim condensed consolidated financial
statements.
  2
 Index
  QUALSTAR CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
(In thousands)
 
 Three
      Months Ended
                                September
      30,2008
                              
                              
                              2007OPERATING
      ACTIVITIES:Net
      loss
                              
                              $
                              (39
                              )
                              
                              $
                              (206
                              )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Share
      based compensation
                              
                              
                              24
                              
                              
                              
                              33Loss
      (Gain) on sale of marketable securities
                              
                              
                              4
                              
                              
                              
                              (3
                              )Depreciation
      and amortization
                              
                              
                              56
                              
                              
                              
                              78Provision
      for (recovery of) bad debts and returns
                              
                              
                              2
                              
                              
                              
                              (21
                              )Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              (283
                              )
                              
                              
                              252Inventories
                              
                              
                              (100
                              )
                              
                              
                              221Prepaid
      expenses and other assets
                              
                              
                              (84
                              )
                              
                              
                              (191
                              )Prepaid
      income taxes
                              
                              
                              -
                              
                              
                              
                              3Accounts
      payable
                              
                              
                              48
                              
                              
                              
                              473Accrued
      payroll and accrued liabilities
                              
                              
                              (99
                              )
                              
                              
                              (156
                              )Income
      taxes payable
                              
                              
                              (7
                              )
                              
                              
                              -Other
      accrued liabilities
                              
                              
                              (29
                              )
                              
                              
                              (96
                              )Net
      cash (used in) provided by operating activities
                              
                              
                              (507
                              )
                              
                              
                              387INVESTING
      ACTIVITIES:Purchases
      of property, equipment and leasehold improvements
                              
                              
                              (14
                              )
                              
                              
                              (67
                              )Proceeds
      from sale of marketable securities
                              
                              
                              10,884
                              
                              
                              
                              6,299Purchases
      of marketable securities
                              
                              
                              (7,846
                              )
                              
                              
                              (5,714
                              )Net
      cash provided by investing activities
                              
                              
                              3,024
                              
                              
                              
                              518FINANCING
      ACTIVITIES:Cash
      dividends on common shares
                              
                              
                              (735
                              )
                              
                              
                              -Net
      cash used in financing activities
                              
                              
                              (735
                              )
                              
                              
                              -Net
      change in cash and cash equivalents
                              
                              
                              1,782
                              
                              
                              
                              905Cash
      and cash equivalents, beginning of period
                              
                              
                              6,744
                              
                              
                              
                              7,697Cash
      and cash equivalents, end of period
                              
                              $
                              8,526
                              
                              
                              $
                              8,602Supplemental
      cash flow disclosure:Income
      taxes paid
                              
                              $
                              5
                              
                              
                              $
                              7
 
 See
the accompanying notes to these interim condensed consolidated financial
statements.
  3
 Index
  QUALSTAR CORPORATION
 CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
 THREE
MONTHS ENDED SEPTEMBER 30, 2008
 (Unaudited)(In
thousands)
 
 AccumulatedOtherCommon
      Stock
                      
                      
                      Comprehensive
                      
                      
                      RetainedShares
                      
                      
                      Amount
                      
                      
                      (Loss)/Income
                      
                      
                      Earnings
                      
                      
                      TotalBalance
      at July 1, 2008
                      
                      
                      12,253
                      
                      
                      $
                      18,705
                      
                      
                      $
                      108
                      
                      
                      $
                      20,308
                      
                      
                      $
                      39,121Share
      based compensation
                      
                      
                      —
                      
                      
                      
                      24
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      24Comprehensive
      loss:Net
      loss
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      (39
                      )
                      
                      
                      (39
                      )Change
      in unrealized losses on investments
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      (220
                      )
                      
                      
                      —
                      
                      
                      
                      (220
                      )Comprehensive
      loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (259
                      )Balance
      at September 30, 2008
                      
                      
                      12,253
                      
                      
                      $
                      18,729
                      
                      
                      $
                      (112
                      )
                      
                      $
                      20,269
                      
                      
                      $
                      38,886
 
 See
the accompanying notes to these condensed consolidated financial
statements
  4
 Index
  QUALSTAR CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited) (In thousands, except per share
data)
 
 
 Note
1 – Basis of Presentation and Consolidation
 
 Basis
of Presentation
  In the
opinion of management, the accompanying consolidated condensed financial
statements, including balance sheets and related interim statements of
operations, cash flows, and stockholders’ equity, include all adjustments,
consisting primarily of normal recurring items, which are necessary for their
fair presentation in conformity with accounting principles generally accepted in
the United States of America (“U.S. GAAP”).
 
 Preparing
financial statements 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, share based
compensation forfeiture rates, the potential outcome of future tax consequences
of events that have been recognized in our 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.
 
 Interim
results are not necessarily indicative of results for a full
year.  The information included in this Form 10-Q should be read in
conjunction with Management’s Discussion and Analysis and the financial
statements and notes thereto included in the Qualstar Corporation Annual Report
on Form 10-K for the fiscal year ended June 30, 2008, filed with the Securities
and Exchange Commission (“SEC”) on September 24, 2008.
 
 Basis
of Consolidation
  The
consolidated financial statements include the accounts and operations of
Qualstar and its wholly owned subsidiary.  All significant
intercompany accounts have been eliminated.
 
 Note
2 – Recent Accounting Pronouncements
 
 Recently
Adopted Accounting Pronouncements
  On
July 1, 2008, we adopted Financial Accounting Standards Board (“FASB”)
Statement No. 157, Fair
Value Measurements(“SFAS No. 157”) for all financial assets and
liabilities and nonfinancial assets and liabilities that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. This statement does not
require any new fair value measurements, but provides guidance on how to measure
fair value by providing a fair value hierarchy used to classify the source of
the information. See Note 4 – Financial Instruments.
  Statement
of Financial Accounting Standard (“SFAS”) No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities – Including an amendment of FASB Statement No.
115,became effective for us on July 1, 2008. SFAS No. 159
gives us the irrevocable option to elect fair value for the initial and
subsequent measurement for certain financial assets and liabilities on a
contract-by-contract basis with the difference between the carrying value before
election of the fair value option and the fair value recorded upon election as
an adjustment to beginning retained earnings. We chose not to elect the fair
value option for all marketable securities outstanding as of September 30,
2008.
 
 Recent
Accounting Pronouncements Not Yet Adopted
 
 In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles.  SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (the GAAP
hierarchy). SFAS 162 will become effective 60 days following the SEC’s
approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, “The Meaning of Present Fairly in Conformity With Generally
Accepted Accounting Principles.” We believe the adoption  of
SFAS 162 will not have a material impact our financial
statements.
  5
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
 
 In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No. 133,which requires additional disclosures about the objectives of derivative
instruments and hedging activities, the method of accounting for such
instruments under SFAS No. 133 and its related interpretations, and a tabular
disclosure of the effects of such instruments and related hedged items on our
financial position, financial performance, and cash flows.  SFAS No.
161 is effective for us beginning January 1, 2009.  We believe the
adoption of SFAS No. 161 will not have a material impact on our financial
statements.
  In
February 2008, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement
No. 157,which delays the effective date of SFAS No. 157 to
July 1, 2009 for us, for all nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). We believe
the adoption of the delayed items of SFAS No. 157 will not have a material
impact on our financial statements.
  In
December 2007, the FASB issued SFAS No. 141R, Business Combinations, which
replaces SFAS No. 141. The statement retains the purchase method of accounting
for acquisitions, but requires a number of changes, including changes in the way
assets and liabilities are recognized in the purchase accounting. It also
changes the recognition of assets acquired and liabilities assumed arising from
contingencies, requires the capitalization of in-process research and
development at fair value, and requires the expensing of acquisition-related
costs as incurred. SFAS No. 141R is effective for us beginning July 1, 2009 and
will apply prospectively to business combinations completed on or after that
date.
  In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51, which
changes the accounting and reporting for minority interests.  Minority
interests will be recharacterized as noncontrolling interests and will be
reported as a component of equity separate from the parent’s equity, and
purchases or sales of equity interests that do not result in a change in control
will be accounted for as equity transactions.  In addition, net income
attributable to the noncontrolling interest will be included in net income and,
upon a loss of control, the interest sold, as well as any interest retained,
will be recorded at fair value with any gain or loss recognized in net
income.  SFAS No. 160 is effective for us beginning July 1, 2009 and
will apply prospectively, except for the presentation and disclosure
requirements, which will apply retrospectively.  We believe the
adoption of SFAS No. 160 will not have a material impact on our
financial statements.
 
 Note
3 – Concentration of Credit Risk, Other Concentration Risks and Significant
Customers
 
 We are
exposed to foreign currency and interest rate risks.  Our interest
income is sensitive to changes in the general level of U.S. interest rates,
particularly since the majority of our investments are in shorter duration fixed
income securities. We have no outstanding debt nor do we utilize auction rate
securities or derivative financial instruments in our investment
portfolio.
 
 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 of North America represented
approximately 26.8% of net revenues in the three months ended September 30,
2008, and 22.9% of net revenues in the three months ended September 30,
2007.
 
 Two
customers accounted for 11.1% and 10.6%, respectively, or 21.7% in the
aggregate, of the Company’s consolidated revenue for the three-month period
ended September 30, 2008.  The two largest customer’s accounts
receivable balances, net of specific allowances, totaled approximately 3.9% and
16.1% of net accounts receivable, respectively.  No single customer
accounted for more than ten percent of the Company’s consolidated revenue for
the three-month period ended September 30, 2007.
 
 Sales and
costs of goods sold related to tape library products purchased from one supplier
totaled approximately 15.1% and 18% for the three months ended September 30,
2008 and 25.4% and 27.1% for the three months ended September 30, 2007,
respectively, of total sales and cost of goods sold.
  6
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
  Note
4 – Loss Per Share
 
 Qualstar
calculates loss per share in accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 128, Earnings per
Share.  Basic earnings per share has been computed by dividing
net loss by the weighted average number of common shares
outstanding.  Diluted loss per share has been computed by dividing net
loss by the weighted average common shares outstanding plus dilutive securities
or other contracts to issue common stock as if these securities were exercised
or converted to common stock.
 
 The
following table sets forth the computation of basic and diluted net loss per
share for the periods indicated:
 
 Three
      Months Ended
                      September
      30,In
      thousands (except per share amounts):
                    
                    2008
                    
                    
                    2007Net
      loss  (a)
                    
                    $
                    (39
                    )
                    
                    $
                    (206
                    )Weighted
      average outstanding shares of common stock (b)
                    
                    
                    12,253
                    
                    
                    
                    12,253Dilutive
      potential common shares from employee stock options
                    
                    
                    —
                    
                    
                    
                    —Common
      stock and common stock equivalents (c)
                    
                    
                    12,253
                    
                    
                    
                    12,253Loss
      per share:Basic
      net loss per share (a)/(b)
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.02
                    )Diluted
      net loss per share  (a)/(c)
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.02
                    )
 
 Stock
options are excluded for the three months ended September 30, 2008 and 2007,
respectively, from the computation of diluted loss per share, as the effect
would have been anti-dilutive.
 
 Note
5 – Marketable Securities
  Marketable
securities consist primarily of commercial paper, U.S. government and agency
securities, mortgage-backed securities and corporate bonds. In accordance with
SFAS No. 115, “Accounting for
Certain Investments in Debt and Equity Securities,” these securities are
classified in one of three categories: trading, available-for-sale, or
held-to-maturity. Trading securities are bought and held principally for the
purpose of selling them in the near term. Held-to-maturity securities are those
securities, which Qualstar has the ability and intent to hold until maturity.
All other securities not included in trading or held-to-maturity are classified
as available-for-sale. All of Qualstar’s marketable securities were classified
as available-for-sale at September 30, 2008 and June 30, 2008.
 
 Available-for-sale
securities are recorded at market value. Unrealized holding gains and losses,
net of the related income tax effect, on available-for-sale securities are
excluded from earnings and are reported as a separate component of shareholders’
equity until realized. Dividend and interest income are recognized when earned.
Realized gains and losses for securities classified as available-for-sale are
included in earnings when the underlying securities are sold and are derived
using the specific identification method for determining the cost of securities
sold.
 
 Note
6 – Financial Instruments
  We
adopted SFAS No. 157 on July 1, 2008 for all financial assets and
liabilities and nonfinancial assets and liabilities that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements.
  SFAS
No. 157 defines fair value as the price that would be received upon sale of
an asset or paid upon transfer of a liability in an orderly transaction between
market participants at the measurement date and in the principal or most
advantageous market for that asset or liability. The fair value should be
calculated based on assumptions that market participants would use in pricing
the asset or liability, not on assumptions specific to the entity. In addition,
the fair value of liabilities should include consideration of non-performance
risk including our own credit risk.
 7
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
  In
addition to defining fair value, SFAS No. 157 expands the disclosure
requirements around fair value and establishes a fair value hierarchy for
valuation inputs. The hierarchy prioritizes the inputs into three levels based
on the extent to which inputs used in measuring
fair value are observable in the market. Each fair value measurement is
reported in one of the three levels which is determined by the lowest level
input that is significant to the fair value measurement in its entirety. These
levels are:
  •
              Level
      1 – inputs are based upon unadjusted quoted prices for identical
      instruments traded in active
markets.
  •
              Level
      2 – inputs are based upon quoted prices for similar instruments in active
      markets, quoted prices for identical or similar instruments in markets
      that are not active, and model-based valuation techniques for which all
      significant assumptions are observable in the market or can be
      corroborated by observable market data for substantially the full term of
      the assets or liabilities.
  •
              Level
      3 – inputs are generally unobservable and typically reflect management’s
      estimates of assumptions that market participants would use in pricing the
      asset or liability. The fair values are therefore determined using
      model-based techniques that include option pricing models, discounted cash
      flow models, and similar
techniques.
  In
general, and where applicable, we use quoted prices in active markets for
identical assets to determine fair value. This pricing methodology applies
to our Level 1 investments such as U.S. treasuries and agency securities and
exchange-traded mutual funds. If quoted prices in active markets for
identical assets are not available to determine fair value, then we use quoted
prices for similar assets or inputs other than the quoted prices that are
observable either directly or indirectly. These investments are included in
Level 2 and consist primarily of corporate bonds,  mortgage-backed
securities, and certain agency securities.  While we own certain
mortgage-backed fixed income securities, our portfolio as of September 30, 2008
does not contain direct exposure to subprime mortgages or structured vehicles
that derive their value from subprime collateral.  Our mortgage-backed
securities are collateralized by prime residential mortgages and carry a 100%
principal and interest guarantee, primarily from Federal National Mortgage
Association and Federal Home Loan Mortgage Corporation.
  Assets
and Liabilities Measured at Fair Value on a Recurring Basis
  The
following table presents our assets and liabilities measured at fair value on a
recurring basis at September 30, 2008:
  (In
      thousands)
                  
                  Level
      1
                  
                  
                  Level
      2
                  
                  
                  Net balanceAssetsCash
                  
                  $
                  756
                  
                  
                  
                  
                  
                  $
                  756Money
      Market Mutual fund
                  
                  
                  3,848
                  
                  
                  
                  
                  
                  
                  3,848Commercial
      paper
                  
                  
                  –
                  
                  
                  $
                  3,221
                  
                  
                  
                  3,221U.S.
      government and agency securities
                  
                  
                  3,593
                  
                  
                  
                  11,157
                  
                  
                  
                  14,750Mortgage-backed
      securities
                  
                  
                  –
                  
                  
                  
                  4,039
                  
                  
                  
                  4,039Corporate
      bonds
                  
                  
                  –
                  
                  
                  
                  3,938
                  
                  
                  
                  3,938Municipal
      securities
                  
                  
                  –
                  
                  
                  
                  506
                  
                  
                  
                  506Total
                  
                  $
                  8,197
                  
                  
                  $
                  22,861
                  
                  
                  $
                  31,058
 8
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
  Note
7 - Inventories
 
 Inventories
are stated at the lower of cost (first-in, first-out basis) or market. Inventory
is comprised as follows (in thousands):
 
 September
      30,
                      2008
                    
                    
                    June
      30,
                      2008Raw
      materials, net
                    
                    $
                    5,445
                    
                    
                    $
                    5,324Finished
      goods
                    
                    
                    764
                    
                    
                    
                    785$
                    6,209
                    
                    
                    $
                    6,109
 
 Note
8 – Warranty Obligations
 
 The
Company follows the provisions of the Financial Accounting Standards Board
(FASB) Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of the
Indebtedness of Others,  which clarifies the requirements of
Statement of Financial Accounting Standards (“SFAS”) No. 5, Accounting for Contingencies,
relating to a guarantor’s accounting for disclosures for certain guarantees.
FIN 45 requires enhanced disclosures, among other things, for certain
guarantees, including warranty accruals. Qualstar does not issue third party
guarantees, as defined, and therefore only the disclosure provisions of
FIN 45 apply.
 
 Activity
in the liability for product warranty for the periods presented were as follows
(in thousands):
 
 September 30,2008
                    
                    
                    2007Beginning
      balance
                    
                    $
                    181
                    
                    
                    $
                    174Cost
      of warranty claims
                    
                    
                    (17
                    )
                    
                    
                    (18
                    )Accruals
      for product warranties
                    
                    
                    17
                    
                    
                    
                    35Ending
      balance
                    
                    $
                    181
                    
                    
                    $
                    191
 
 Note
9 – Comprehensive Loss
 
 For the
three months ended September 30, 2008 and 2007, comprehensive loss amounted to
approximately $259,000 and $148,000, respectively. The difference between net
loss and comprehensive loss relates to the changes in the unrealized losses or
gains the Company recorded for its available-for-sale securities.
 
 Note
10 – Legal Proceedings
 
 We are
from time to time involved in various lawsuits and legal proceedings that arise
in the ordinary course of business.  At this time, we are not aware of
any pending or threatened litigation against us that we expect will have a
material adverse effect on our business, financial condition, liquidity or
operating results.  Legal claims are inherently uncertain, however,
and it is possible that the Company’s business, financial condition, liquidity
and/or operating results could be adversely affected in the future by legal
proceedings.
 
 Note
11 – Income Taxes
 
 We
recorded a benefit for income taxes of $2,000 for the three months ended
September 30, 2008. We recorded a provision for income taxes of $17,000 for the
three months ended September 30, 2007 relating to state income taxes paid during
the quarter and interest expense accrued as part of our liability resulting from
our adoption on July 1, 2007 of FIN 48, Accounting for Uncertainties in
Income Taxes – an Interpretation of FASB Statement No.
109.
  9
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
 
 The
Company has recorded a full valuation allowance against its net deferred tax
assets based on the Company’s assessment regarding the realizability of these
net deferred tax assets in future periods.
 
 Note
12 – Segment Information
 
 SFAS No. 131,
Disclosures about Segments of
an Enterprise and Related Information, establishes
standards for reporting information about operating segments. This standard
requires segmentation based on our internal organization and reporting of
revenue and operating income based upon internal accounting methods. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. Our chief operating decision maker is our Chief Executive Officer.
Our two segments are Tape Libraries and Power Supplies. The two segments
discussed in this analysis are presented in the way we internally managed and
monitored performance for the three months ended September 30, 2008 and 2007.
Our financial reporting systems present various data for management to operate
the business, including internal profit and loss statements prepared on a basis
consistent with U.S. GAAP. The tape library business has dominated our
operations, thus, our operations and reporting have been set up to accommodate a
single segment and attribute all revenues and expenses to the tape library side,
with the power supply business being an ancillary part of overall operations.
Allocations for internal resources were made for the three months ended
September 30, 2008 and 2007.
 
 Certain
assets are tracked separately by the power supplies segment, and all others are
recorded in the tape library segment for internal reporting presentations. Cash
is not segregated between the two segments, but retained by the library
segment.
 
 The types
of products and services provided by each segment are summarized
below:
  Tape Libraries — We
design, develop, manufacture and sell automated magnetic tape libraries used to
store, retrieve and manage electronic data primarily in network computing
environments. Tape libraries consist of cartridge tape drives, tape cartridges
and robotics to move the cartridges from their storage locations to the tape
drives under software control. Our tape libraries provide data storage solutions
for organizations requiring backup, recovery and archival storage of critical
data.
 
 Power Supplies — We
design, manufacture, and sell small, open frame, high efficiency switching power
supplies. These power supplies are used to convert AC line voltage to DC
voltages, or DC Voltages to other DC voltages for use in a wide variety of
electronic equipment such as telecommunications equipment, machine tools,
routers, switches, wireless systems and gaming devices.
 
 Segment
revenue, loss before taxes and total assets were as follows (in
thousands):
 
 Three
      Months Ended
                      September
      30,2008
                    
                    
                    2007RevenueTape
      Libraries:Product
                    
                    
                    3,077
                    
                    
                    
                    3,952Service
                    
                    
                    712
                    
                    
                    
                    656Total
      Tape Libraries
                    
                    
                    3,789
                    
                    
                    
                    4,608Power
      Supplies
                    
                    
                    1,613
                    
                    
                    
                    724Consolidated
      Revenue
                    
                    
                    5,402
                    
                    
                    
                    5,332
 10
 Index
  QUALSTAR
CORPORATION
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)
 
 
 Three
      Months Ended
                      September
      30,2008
                    
                    
                    2007Income (Loss) before TaxesTape
      Libraries
                    
                    
                    (166
                    )
                    
                    
                    (117
                    )Power
      Supplies
                    
                    
                    125
                    
                    
                    
                    (72
                    )Consolidated
      Loss before Taxes
                    
                    
                    (41
                    )
                    
                    
                    (189
                    )
 
 
 September
      30,
                      2008
                    
                    
                    June
      30,
                      2008Total AssetsTape
      Libraries
                    
                    $
                    39,529
                    
                    
                    $
                    41,257Power
      Supplies
                    
                    
                    2,071
                    
                    
                    
                    1,400Consolidated
      Assets
                    
                    $
                    41,600
                    
                    
                    $
                    42,657
 11
 Index
  ITEM
2.MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
 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, 2008 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
 
 We
design, develop, manufacture and sell automated magnetic tape libraries used to
store, retrieve and manage electronic data primarily in network computing
environments. We currently offer tape libraries for two popular tape drive
technologies, LTO (Linear Tape-Open tape format) and AIT (Advanced Intelligent
Tape).
 
 We have
developed a network of value added resellers who specialize in delivering
complete storage solutions to end users. End users of our products range from
small businesses requiring simple automated backup solutions to large
organizations needing complex storage management solutions. We also sell our
products to original equipment manufacturers that incorporate our products into
theirs, which they sell as a complete system or solution. We assist our
customers with marketing and technical support.
 
 We also
design, develop and sell high-efficiency switching power supplies used in
telecommunications equipment, servers, routers, switches, RAIDs, and similar
applications. Our power supplies are sold under the N2Power brand name through
independent sales representatives and distributors. The primary customers are
original equipment manufacturers and contract manufacturers. We also utilize
these power supplies in our tape libraries.
  CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
 
 Our
discussion and analysis of our financial condition and results of operations is
based upon our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to customer promotional
offers, sales returns, bad debts, inventories, warranty costs, investments,
share based compensation, and income taxes. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
 
 We
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
  12
 Index
  Revenue
Recognition
 
 Revenue
is recognized when persuasive evidence of an arrangement exists, shipment has
occurred or services have been rendered, the fee is fixed or determinable and
collectibility is reasonably assured (less estimated returns, for which
provision is made at the time of sale) in accordance with SAB 104, Revenue
Recognition.  For product sales, title and risk of loss
transfer to the customer when the product leaves our dock in Simi Valley,
California, or another shipping location designated by us. Customers are allowed
to return the product within thirty days of shipment if the product does not
meet specifications.
 
 We record
an allowance for estimated sales returns based on past experience and current
knowledge of our customer base. Our experience has been such that only a very
small percentage of libraries are returned. Should our experience change,
however, we may require additional allowances for sales returns.
 
 Revenues
from technical support services and other services are recognized at the time
services are performed.  Revenues from service contracts entered into
with third party service providers are recognized at the time of the contract
sale, net of costs.
 
 Marketable
Securities
  All of
Qualstar’s marketable securities were classified as available-for-sale as it is
possible that some securities will be sold prior to
maturity.  Available-for-sale securities are recorded at market value.
Unrealized holding gains and losses, net of the related income tax effect, on
available-for-sale securities are excluded from earnings and are reported as a
separate component of shareholders’ equity until realized. Dividend and interest
income are recognized when earned. Realized gains and losses for securities
classified as available-for-sale are included in earnings when the underlying
securities are sold and are derived using the specific identification method for
determining the cost of securities sold.
  Financial
Instruments
  We
measure fair value on all financial assets and liabilities and nonfinancial
assets and liabilities that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually) in accordance with
SFAS No. 157, “Fair Value
Measurements.”  See “Note 6 – Financial
Instruments.”
 
 Allowance
for Doubtful Accounts
 
 We
estimate our allowance for doubtful accounts based on an assessment of the
collectibility of specific accounts and the overall condition of accounts
receivable. In evaluating the adequacy of the allowance for doubtful accounts,
we analyze specific trade receivables, historical bad debts, customer credits,
customer credit-worthiness and changes in customers’ payment terms and patterns.
If the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make additional payments, then we may need to
make additional allowances. Likewise, if we determine that we could realize more
of our receivables in the future than previously estimated, we would adjust the
allowance to increase income in the period we made this
determination.
 
 Inventory
Valuation
 
 We record
inventories at the lower of cost or market value. We assess the value of our
inventories periodically based upon numerous factors including expected product
or material demand, current market conditions, technological obsolescence,
current cost and net realizable value. If necessary, we write down our inventory
for estimated obsolescence, potential shrinkage, or unmarketable inventory equal
to the difference between the cost of inventory and the estimated market value
based upon assumptions about future demand and market conditions. If technology
changes more rapidly than expected, or market conditions become less favorable
than those projected by management, additional inventory write-downs may be
required.
 
 Warranty
Obligations
 
 We
provide for the estimated cost of product warranties at the time revenue is
recognized. We engage in extensive product quality programs and processes,
including active monitoring and evaluation of product failure rates, material
usage and estimation of service delivery costs incurred in correcting a product
failure. However, should actual product failure rates, material usage, or
service delivery costs differ from our estimates, revisions to the estimated
warranty liability would be required. Historically our warranty costs have not
been significant.
  13
 Index
  Share-Based
Compensation
 
 Share-based
compensation is accounted for in accordance with SFAS 123R, Share-Based
Payment. We use the Black-Scholes option pricing model to determine fair value
of the award at the date of grant and recognize compensation expense over the
vesting period. The inputs we use for the model require the use of judgment,
estimates and assumptions regarding the expected volatility of the stock, the
expected term the average employee will hold the option prior to the date of
exercise, and the amount of share-based awards that are expected to be
forfeited. Changes in these inputs and assumptions could occur and actual
results could differ from these estimates, and our results of operations could
be materially impacted.
 
 Accounting
for Income Taxes
  We
adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109 (FIN 48) in the
first quarter of fiscal year 2008. See Note 11 – Income Taxes to the
consolidated condensed financial statements included in this Form 10-Q for
further discussion.
 
 We
estimate our tax liability based on current tax laws in the statutory
jurisdictions in which we operate. These estimates include judgments about
deferred tax assets and liabilities resulting from temporary differences between
assets and liabilities recognized for financial reporting purposes and such
amounts recognized for tax purposes, as well as about the realization of
deferred tax assets.
 
 We
maintain a valuation allowance to reduce our deferred tax assets due to the
uncertainty surrounding the timing of realizing the benefits of net deferred tax
assets in future years. We have considered future taxable income and ongoing
prudent and feasible tax planning strategies in assessing the need for such a
valuation allowance. In the event we were to determine that we would be able to
realize all or part of our net deferred tax asset in the future, the valuation
allowance would be decreased accordingly.
 
 We may
periodically undergo examinations by the federal and state regulatory
authorities and the Internal Revenue Service. We may be assessed additional
taxes and/or penalties contingent on the outcome of these examinations. Our
previous examinations have not resulted in any unfavorable or significant
assessments.
  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
      30,2008
                    
                    
                    2007Net
      revenues
                    
                    
                    100.0
                    %
                    
                    
                    100.0
                    %Cost
      of goods sold
                    
                    
                    65.1
                    
                    
                    
                    69.5Gross
      profit
                    
                    
                    34.9
                    
                    
                    
                    30.5Operating
      expenses:Research
      and development
                    
                    
                    13.8
                    
                    
                    
                    13.7Sales
      and marketing
                    
                    
                    12.9
                    
                    
                    
                    14.2General
      and administrative
                    
                    
                    14.2
                    
                    
                    
                    13.9Total
      operating expenses
                    
                    
                    40.9
                    
                    
                    
                    41.8Loss
      from operations
                    
                    
                    (6.0
                    )
                    
                    
                    (11.3
                    )Investment
      income
                    
                    
                    5.2
                    
                    
                    
                    7.8Loss
      before income taxes
                    
                    
                    (0.8
                    )
                    
                    
                    (3.5
                    )Provision
      for income taxes
                    
                    
                    0.0
                    
                    
                    
                    0.3Net
      loss
                    
                    
                    (0.8
                    )%
                    
                    
                    (3.8
                    )%
 14
 Index
  We have
two operating segments for financial reporting purposes: tape libraries and
power supplies, as discussed in Note 12 of the Notes to Consolidated Financial
Statements in Item 1 of this report. The following table summarizes our revenue
by major product line and by operating segment:
 
 Three
      Months Ended
                      September
      30,2008
                    
                    
                    2007Tape
      Library revenues:TLS
                    
                    
                    23.6
                    %
                    
                    
                    32.6
                    %RLS
                    
                    
                    9.4
                    
                    
                    
                    10.9XLS
                    
                    
                    8.1
                    
                    
                    
                    6.641.1
                    
                    
                    
                    50.1Other
      library revenues:Service
                    
                    
                    13.2
                    
                    
                    
                    12.3Media
                    
                    
                    11.8
                    
                    
                    
                    17.3Upgrades,
      spares
                    
                    
                    4.0
                    
                    
                    
                    6.729.0
                    
                    
                    
                    36.3Total
      Library revenues
                    
                    
                    70.1
                    
                    
                    
                    86.4Power
      Supply revenues
                    
                    
                    29.9
                    
                    
                    
                    13.6100.0
                    %
                    
                    
                    100.0
                    %
 
 
 Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007
 
 Net Revenue.  Net revenues
increased to $5.4 million for the three months ended September 30, 2008 from
$5.3 million for the three months ended September 30, 2007, an increase of $0.1
million, or 1.3%. Two customers accounted for 11.1% and 10.6%, respectively, or
21.7% in the aggregate, of the Company’s consolidated revenue for the
three-month period ended September 30, 2008. No single customer accounted for
more than ten percent of the Company’s consolidated revenue for the three-month
period ended September 30, 2007.
 
 Segment Revenue
 
 Tape Libraries – Net
tape library revenues decreased to $3.8 million for the three months ended
September 30, 2008 from $4.6 million for the three months ended September 30,
2007, a decrease of $.8 million, or 18%. The decrease in revenues is attributed
primarily to a $0.5 million decline in revenues from our TLS tape library
product line and a $0.3 million decline in revenues from sales of tape media, as
well as smaller declines in sales of our RLS tape libraries and of upgrades and
spares. These declines were partially offset by a $0.1 million increase in
revenue from sales of our XLS tape library product line and a small increase in
service revenue.
 
 One
customer accounted for 15.8% of tape library revenues for the three-month period
ended September 30, 2008. No single customer accounted for more than ten percent
of tape library revenues for the three-month period ended September 30,
2007.
 
 Power Supplies – Net
revenues from power supplies increased to $1.6 million for the three months
ended September 30, 2008 from $.7 million for the three months ended
September 30, 2007, an increase of $.9 million, or 122.8%.  The
increase in revenues is attributed to the launch of new power supply models and
sales to a new original equipment manufacturer customer under a nine-month
contract. Two customers accounted for 35.3% and 11.3%, respectively, or 46.6% in
the aggregate, of power supply sales for the three months ended September 30,
2008.  Three customers accounted for 19.9%, 13.4% and 9.4%,
respectively, or 42.7% in the aggregate, of power supply sales for the three
months ended September 30, 2007.
 
 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 of plant and equipment,
utilities, and packaging costs. Gross profit increased to $1.9 million for the
three months ended September 30, 2008 from $1.6 million for the three months
ended September 30, 2007.  The increase of $.3 million, or 15.9%, is
primarily due to efficiencies achieved in labor and material
management.
  15
 Index
  Research and Development.  Research and
development expenses consist of engineering salaries, benefits, outside
consultant fees, and purchased parts and supplies used in development
activities. Research and development expenses increased to $743,000 for the
three months ended September 30, 2008 from $728,000 for the three months ended
September 30, 2007.  The increase of $15,000, or 2.1%, is primarily
due to an increase in compensation related expenses.
 
 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 decreased to $695,000 for the three months ended
September 30, 2008 from $759,000 for the three months ended September 30,
2007.  The decrease of $64,000, or 8.4%, is primarily due to lower
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 $766,000 for the
three months ended September 30, 2008 from $739,000 for the three months ended
September 30, 2007.  The increase of $27,000, or 3.7%, is primarily
due to an increase in compensation related expenses.
 
 Investment Income.  Investment
income decreased to $280,000 for the three months ended September 30, 2008 from
$413,000 for the three months ended September 30, 2007. The decrease of
$133,000, or 32.2% is primarily due to the lower interest rate environment in
the recent quarter and partially due to having approximately $2.6 million less
cash, cash equivalents and marketable securities in the quarter ended September
30, 2008 compared to the prior year quarter.
  Provision for Income
Taxes.  We recorded a
benefit for income taxes of $2,000 for the three months ended September 30,
2008. We recorded a provision for income taxes of $17,000 for the three months
ended September 30, 2007 relating to state income taxes paid during the quarter
and interest expense accrued as part of our liability resulting from our
adoption on July 1, 2007 of FIN 48, Accounting for Uncertainties in
Income Taxes – an Interpretation of FASB Statement No. 109.
 
 LIQUIDITY
AND CAPITAL RESOURCES
 
 Net cash
used by operating activities was $507,000 in the three months ended September
30, 2008, primarily attributed to an increase in receivables, inventories and
prepaid expenses and a decrease in accrued payroll and related liabilities. Net
cash provided by operating activities was $387,000 in the three months ended
September 30, 2007, primarily attributed to an increase in accounts payable and
a decrease in receivables and inventories, partially offset by an increase in
prepaid expenses and other assets, and a decrease in accrued payroll and related
liabilities and other accrued liabilities.
 
 Cash
provided by investing activities was $3,024,000 in the three months ended
September 30, 2008, primarily attributed to the sale of marketable securities,
partially offset by the purchase of marketable securities.  Cash
provided by investing activities was $518,000 in the three months ended
September 30, 2007, primarily attributed to the sale of marketable securities,
partially offset by the purchase of marketable securities.
 
 Cash used
in financing activities was $735,000 in the three months ended September 30,
2008, attributed to the payment of a cash dividend of $0.06 per share that we
declared in June 2008 and paid on September 5, 2008 on shares of our common
stock.  Cash was not used in or provided by financing activities
during the three months ended September 30, 2007.
 
 As of
September 30, 2008, we had $8.5 million in cash and cash equivalents and $22.5
million in marketable securities.  We believe that our existing cash
and cash equivalents and anticipated 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 regularly 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.
  16
 Index
  ITEM
3.   QUALITATIVEAND QUANTITATIVE DISCLOSURES ABOUT
MARKET RISK
 
 We
develop products in the United States and sell them worldwide. As a result, our
financial results could be affected by factors such as 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 U.S. dollar
could make our products less competitive in foreign markets. Our interest income
is sensitive to changes in the general level of U.S. interest rates,
particularly since the majority of our investments are in short-term
instruments. We have no outstanding debt nor do we utilize derivative financial
instruments. Therefore, no quantitative tabular disclosures are
required.
 
 
 ITEM
4T.CONTROLS AND PROCEDURES
 
 We
carried out an evaluation, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of Qualstar’s
disclosure controls and procedures as of September 30, 2008, pursuant to Rule
13a-15 under the Securities Exchange Act of 1934. Based upon that evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Commission’s rules and forms, and to ensure that the
information required to be disclosed by us in reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure.
 
 We did
not make any changes in our internal control over financial reporting during the
quarter ended September 30, 2008 of Qualstar’s fiscal year ending June 30, 2009,
that materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
  17
 Index
  PART
II — OTHER INFORMATION
 
 
 ITEM
6.   EXHIBITS
 
 Exhibit
                    No.
                  Exhibit Index31.1
                  Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                  Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                  Certification
      of Principal Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.2
                  Certification
      of Principal Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.
  18
 Index
  SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 QUALSTAR
      CORPORATIONDated:
      November 12, 2008
              
              By:
              /s/    WILLIAM J.
      GERVAISWilliam
      J. GervaisChief
      Executive Officer and President(Principal
      Executive Officer)
  
 19