##### 









SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-Q





|  |  |                                                                                             
|- |  | --------------------------------------------------------------------------------------------
|þ |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934 
|  |  | For the quarterly period ended March 31, 2005                                               
| 
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|  |  | For the transition period
    from           to                                             

Commission file number 000-30083


QUALSTAR CORPORATION


|                            |  |                                         
|--------------------------- |  | ----------------------------------------
|Incorporated under the laws |  | 95-3927330                              
|of the State of California  |  | (I.R.S. Employer
    Identification No.)

3990-B Heritage Oak Court


Simi Valley, CA 93063


(805) 583-7744


þ o


o þ












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QUALSTAR CORPORATION


FORM 10-Q


For the quarterly period ended March 31, 2005


Table of Contents


|                               |         |  |    |                                                                                                                  |  |  |    | 
|------------------------------ | ------- |  | -- | ---------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|                               |         |  |    | Page                                                                                                             | 
|                               |         |  |    |                                                                                                                  | 
|PART I  FINANCIAL INFORMATION
|                               | ITEM 1. |  |    | Financial Statements:                                                                                            |  |  |    | 
|                               |         |  |    | Consolidated Condensed Balance Sheets  March 31,
    2005 and June 30, 2004                                     |  |  | 3  | 
|                               |         |  |    | Consolidated Condensed Statements of Operations 
    Three months and nine months ended March 31, 2005 and 2004 |  |  | 4  | 
|                               |         |  |    | Consolidated Condensed Statements of Cash Flows  Nine
    months ended March 31, 2005 and 2004                  |  |  | 5  | 
|                               |         |  |    | Consolidated Condensed Statement of Changes in
    Shareholders Equity  Nine months ended
    March 31, 2005   |  |  | 6  | 
|                               |         |  |    | Notes to Interim Consolidated Condensed Financial Statements                                                     |  |  | 7  | 
|                               | ITEM 2. |  |    | Managements Discussion and Analysis of Financial Condition
    and Results of Operations                        |  |  | 11 | 
|                               | ITEM 3. |  |    | Qualitative and Quantitative Disclosures About Market Risk                                                       |  |  | 16 | 
|                               | ITEM 4. |  |    | Controls and Procedures                                                                                          |  |  | 16 | 
|                              
|PART II  OTHER INFORMATION   
|                               | ITEM 4. |  |    | Submission of Matters to a Vote of Security Holders                                                              |  |  | 16 | 
|                               | ITEM 6. |  |    | Exhibits                                                                                                         |  |  | 17 | 
|Signatures                     |         |  | 18 |                                                                                                                 

2



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##### 



PART I  FINANCIAL INFORMATION




|        |                     
|------- | --------------------
|ITEM 1. | Financial Statements

QUALSTAR CORPORATION


CONSOLIDATED CONDENSED BALANCE SHEETS


March 31, 2005 and June 30, 2004


|                                     |                                                                                                                                                                 |                                            |       |        |          |  |       |        |        | 
|------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ------ | -------- |  | ----- | ------ | ------ | 
|                                     |                                                                                                                                                                 | March 31,                                  |       |        | June 30, | 
|                                     |                                                                                                                                                                 | 2005                                       |       |        | 2004     | 
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | (Unaudited)                                |       |        |         
|                                     |                                                                                                                                                                 | (In thousands)                             |      
|ASSETS                              
|Current assets:                      |                                                                                                                                                                 |                                            |       |        |          |  |       |       
|                                     | Cash and cash equivalents                                                                                                                                       |                                            | $     | 2,434  |          |  | $     | 6,401  |       
|                                     | Marketable securities                                                                                                                                           |                                            |       | 31,663 |          |  |       | 29,376 |       
|                                     | Receivables, net of allowances of $278 as of March 31,
    2005, and $217 at June 30, 2004, respectively                                                        |                                            |       | 3,185  |          |  |       | 4,628  |       
|                                     | Inventories                                                                                                                                                     |                                            |       | 7,648  |          |  |       | 7,418  |       
|                                     | Prepaid expenses and other current assets                                                                                                                       |                                            |       | 469    |          |  |       | 470    |       
|                                     | Prepaid income taxes                                                                                                                                            |                                            |       | 638    |          |  |       | 1,072  |       
|                                     | Deferred income taxes                                                                                                                                           |                                            |       |       |          |  |       | 594    |       
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | Total current assets                       |       |        | 46,037   |  |       |        | 49,959 | 
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|Property and equipment, net          |                                                                                                                                                                 |                                            | 1,263 |        |          |  | 1,439 |       
|Other assets                         |                                                                                                                                                                 |                                            | 209   |        |          |  | 249   |       
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | Total assets                               |       | $      | 47,509   |  |       | $      | 51,647 | 
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                    
|LIABILITIES AND SHAREHOLDERS EQUITY
|Current liabilities:                 |                                                                                                                                                                 |                                            |       |        |          |  |       |       
|                                     | Accounts payable                                                                                                                                                |                                            | $     | 832    |          |  | $     | 1,171  |       
|                                     | Accrued payroll and related liabilities                                                                                                                         |                                            |       | 486    |          |  |       | 500    |       
|                                     | Other accrued liabilities                                                                                                                                       |                                            |       | 1,254  |          |  |       | 1,754  |       
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | Total current liabilities                  |       |        | 2,572    |  |       |        | 3,425  | 
|Deferred income taxes                |                                                                                                                                                                 |                                            |      |        |          |  | 158   |       
|Shareholders equity:                |                                                                                                                                                                 |                                            |       |        |          |  |       |       
|                                     | Common stock, no par value; 50,000 shares authorized,
    12,253 and 12,596 shares issued and outstanding at
    March 31, 2005 and June 30, 2004, respectively |                                            |       | 18,370 |          |  |       | 20,121 |       
|                                     | Notes from directors                                                                                                                                            |                                            |       |       |          |  |       | (45    | )     
|                                     | Accumulated other comprehensive loss                                                                                                                            |                                            |       | (304   | )        |  |       | (101   | )     
|                                     | Retained earnings                                                                                                                                               |                                            |       | 26,871 |          |  |       | 28,089 |       
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | Total shareholders equity                 |       |        | 44,937   |  |       |        | 48,064 | 
|                                     |                                                                                                                                                                 |                                            |       |        |          | 
|                                     |                                                                                                                                                                 | Total liabilities and shareholders equity |       | $      | 47,509   |  |       | $      | 51,647 | 
|                                     |                                                                                                                                                                 |                                            |       |        |          | 



3



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##### 



QUALSTAR CORPORATION


CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS


Three Months and Nine Months Ended March 31, 2005 and
2004


|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |        |   |   |        |        |  
|-------------------------------------- | -------------------------- | ------------------------------------- | ----- | ------ | ----------------- | - | ----- | ------ | - | - | ------ | ------ | - | - | ------ | ------ | -
|                                       |                            | Three Months Ended                    |       |        | Nine Months Ended |  
|                                       |                            | March 31,                             |       |        | March 31,         |  
|                                       |                            |                                       |       |        |                   |  
|                                       |                            | 2005                                  |       |        | 2004              |   |       | 2005   |   |   | 2004   |       
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|                                       |                            | (Unaudited)                           |      
|                                       |                            | (In thousands, except per share data) |      
|Net revenues                           |                            | $                                     | 5,742 |        |                   | $ | 8,302 |        |   | $ | 18,439 |        |   | $ | 23,834 |       
|Cost of goods sold                     |                            |                                       | 3,881 |        |                   |   | 5,295 |        |   |   | 11,934 |        |   |   | 14,993 |       
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Gross profit                           |                            |                                       | 1,861 |        |                   |   | 3,007 |        |   |   | 6,505  |        |   |   | 8,841  |       
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Operating expenses:                    |                            |                                       |       |        |                   |   |       |        |   |   |        |        |   |   |        |       
|                                       | Research and development   |                                       |       | 904    |                   |   |       | 1,070  |   |   |        | 2,722  |   |   |        | 3,291  |  
|                                       | Sales and marketing        |                                       |       | 822    |                   |   |       | 910    |   |   |        | 2,537  |   |   |        | 2,648  |  
|                                       | General and administrative |                                       |       | 924    |                   |   |       | 1,697  |   |   |        | 2,992  |   |   |        | 4,484  |  
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Total operating expenses               |                            |                                       | 2,650 |        |                   |   | 3,677 |        |   |   | 8,251  |        |   |   | 10,423 |       
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Loss from operations                   |                            |                                       | (789  | )      |                   |   | (670  | )      |   |   | (1,746 | )      |   |   | (1,582 | )     
|Investment income                      |                            |                                       | 219   |        |                   |   | 142   |        |   |   | 594    |        |   |   | 488    |       
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Loss before income taxes               |                            |                                       | (570  | )      |                   |   | (528  | )      |   |   | (1,153 | )      |   |   | (1,094 | )     
|Provision (benefit) for income taxes   |                            |                                       | 65    |        |                   |   | (182  | )      |   |   | 65     |        |   |   | (379   | )     
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Net loss                               |                            | $                                     | (635  | )      |                   | $ | (346  | )      |   | $ | (1,218 | )      |   | $ | (715   | )     
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Loss per share:                        |                            |                                       |       |        |                   |   |       |        |   |   |        |        |   |   |        |       
|                                       | Basic                      |                                       | $     | (0.05  | )                 |   | $     | (0.03  | ) |   | $      | (0.10  | ) |   | $      | (0.06  | )
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|                                       | Diluted                    |                                       | $     | (0.05  | )                 |   | $     | (0.03  | ) |   | $      | (0.10  | ) |   | $      | (0.06  | )
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|Shares used to compute loss per share: |                            |                                       |       |        |                   |   |       |        |   |   |        |        |   |   |        |       
|                                       | Basic                      |                                       |       | 12,253 |                   |   |       | 12,587 |   |   |        | 12,446 |   |   |        | 12,574 |  
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       
|                                       | Diluted                    |                                       |       | 12,253 |                   |   |       | 12,587 |   |   |        | 12,446 |   |   |        | 12,574 |  
|                                       |                            |                                       |       |        |                   |   |       |        |   |   |        |       



4



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QUALSTAR CORPORATION


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS


For the Nine Months Ended March 31, 2005 and 2004


|                                                 |                                                                                     |                                                   |        |         |       |   |        |         |      |  
|------------------------------------------------ | ----------------------------------------------------------------------------------- | ------------------------------------------------- | ------ | ------- | ----- | - | ------ | ------- | ---- | -
|                                                 |                                                                                     | Nine Months Ended                                 |       
|                                                 |                                                                                     | March 31,                                         |       
|                                                 |                                                                                     |                                                   |       
|                                                 |                                                                                     | 2005                                              |        |         | 2004  |  
|                                                 |                                                                                     |                                                   |        |         |       |  
|                                                 |                                                                                     | (Unaudited)                                       |       
|                                                 |                                                                                     | (In thousands)                                    |       
|OPERATING ACTIVITIES:                            |                                                                                     |                                                   |        |         |       |   |        |        
|                                                 | Net loss                                                                            |                                                   | $      | (1,218  | )     |   | $      | (715    | )   
|                                                 | Adjustments to reconcile net loss to net cash provided by
    operating activities: |                                                   |        |         |       |   |        |         |     
|                                                 |                                                                                     | Depreciation and amortization                     |        |         | 349   |   |        |         | 314  |  
|                                                 |                                                                                     | Provision for (recovery of) bad debts and returns |        |         | (2    | ) |        |         | 308  |  
|                                                 |                                                                                     | Amortization of deferred compensation             |        |         |      |   |        |         | 140  |  
|                                                 |                                                                                     | Accrued interest on directors notes              |        |         |      |   |        |         | (5   | )
|                                                 |                                                                                     | Gain on sale of securities                        |        |         | (11   | ) |        |         |     |  
|                                                 | Changes in operating assets and liabilities:                                        |                                                   |        |         |       |   |        |         |     
|                                                 |                                                                                     | Accounts receivable                               |        |         | 1,445 |   |        |         | 300  |  
|                                                 |                                                                                     | Inventories                                       |        |         | (230  | ) |        |         | (40  | )
|                                                 |                                                                                     | Prepaid expenses and other assets                 |        |         | 5     |   |        |         | (285 | )
|                                                 |                                                                                     | Prepaid income taxes                              |        |         | 434   |   |        |         | 208  |  
|                                                 |                                                                                     | Deferred income taxes                             |        |         | 436   |   |        |         |     |  
|                                                 |                                                                                     | Accounts payable                                  |        |         | (339  | ) |        |         | 108  |  
|                                                 |                                                                                     | Other accrued liabilities                         |        |         | (514  | ) |        |         | 392  |  
|                                                 |                                                                                     |                                                   |        |         |       |  
|Net cash provided by operating activities        |                                                                                     |                                                   | 355    |         |       |   | 725    |        
|                                                 |                                                                                     |                                                   |        |         |       |  
|INVESTING ACTIVITIES:                            |                                                                                     |                                                   |        |         |       |   |        |        
|                                                 | Purchases of property, equipment and leasehold improvements                         |                                                   |        | (137    | )     |   |        | (149    | )   
|                                                 | Proceeds from sale of marketable securities                                         |                                                   |        | 18,000  |       |   |        | 31,456  |     
|                                                 | Purchases of marketable securities                                                  |                                                   |        | (20,479 | )     |   |        | (34,865 | )   
|                                                 |                                                                                     |                                                   |        |         |       |  
|Net cash used in investing activities            |                                                                                     |                                                   | (2,616 | )       |       |   | (3,558 | )      
|                                                 |                                                                                     |                                                   |        |         |       |  
|FINANCING ACTIVITIES:                            |                                                                                     |                                                   |        |         |       |   |        |        
|                                                 | Proceeds from exercise of stock options                                             |                                                   |        | 76      |       |   |        | 38      |     
|                                                 | Repurchase of common stock                                                          |                                                   |        | (1,827  | )     |   |        | (314    | )   
|                                                 | Principal and interest payments on directors notes                                 |                                                   |        | 45      |       |   |        | 79      |     
|                                                 |                                                                                     |                                                   |        |         |       |  
|Net cash used in financing activities            |                                                                                     |                                                   | (1,706 | )       |       |   | (197   | )      
|                                                 |                                                                                     |                                                   |        |         |       |  
|Net decrease in cash and cash equivalents        |                                                                                     |                                                   | (3,967 | )       |       |   | (3,030 | )      
|Cash and cash equivalents at beginning of period |                                                                                     |                                                   | 6,401  |         |       |   | 6,236  |        
|                                                 |                                                                                     |                                                   |        |         |       |  
|Cash and cash equivalents at end of period       |                                                                                     | $                                                 | 2,434  |         |       | $ | 3,206  |        
|                                                 |                                                                                     |                                                   |        |         |       |  
|Supplemental cash flow disclosure:               |                                                                                     |                                                   |        |         |       |   |        |        
|                                                 | Income taxes paid                                                                   |                                                   | $      |        |       |   | $      |        |     
|                                                 |                                                                                     |                                                   |        |         |       |  



5



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QUALSTAR CORPORATION


CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN
SHAREHOLDERS EQUITY


Nine Months Ended March 31, 2005


|                                                    |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |   |        |        |   |   |        |        |  
|--------------------------------------------------- | ------------------------------------------ | ------------ | ------ | - | ------ | -------------- | ------ | ------------- |  | - | -------- | - |  | -------- | ---- | ---- | ----- | - | ------ | ------ | - | - | ------ | ------ | -
|                                                    |                                            |              |        |   |        | Accumulated    |        |               |  |   |         
|                                                    |                                            | Common Stock |        |   | Notes  |                |        | Other         |  |   |          |   | 
|                                                    |                                            |              |        |   | from   |                |        | Comprehensive |  |   | Retained |   |  |         
|                                                    |                                            | Shares       |        |   | Amount |                |        | Directors     |  |   | Loss     |   |  | Earnings |      |      | Total |  
|                                                    |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |  
|                                                    |                                            |              |        |   |        | (Unaudited)    |        |               |  |   |         
|                                                    |                                            |              |        |   |        | (In thousands) |        |               |  |   |         
|Balance at June 30, 2004                            |                                            |              | 12,596 |   |        | $              | 20,121 |               |  | $ | (45      | ) |  | $        | (101 | )    |       | $ | 28,089 |        |   | $ | 48,064 |       
|Proceeds from exercise of stock options             |                                            |              | 16     |   |        |                | 76     |               |  |   |         |   |  |          |     |      |       |   |       |        |   |   | 76     |       
|Retirement of shares pursuant to stock repurchase   |                                            |              | (359   | ) |        |                | (1,827 | )             |  |   |         |   |  |          |     |      |       |   |       |        |   |   | (1,827 | )     
|Principal and interest payments on directors notes |                                            |              |       |   |        |                |       |               |  |   | 45       |   |  |          |     |      |       |   |       |        |   |   | 45     |       
|Comprehensive loss:                                 |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |   |        |        |   |   |        |       
|                                                    | Change in unrealized losses on investments |              |        |  |        |                |        |              |  |   |          |  |  |          |      | (203 | )     |   |        |       |   |   |        | (203   | )
|                                                    | Net loss                                   |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |   |        | (1,218 | ) |   |        | (1,218 | )
|                                                    |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |  
|Comprehensive loss                                  |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |   |        |        |   |   | (1,421 | )     
|                                                    |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |  
|Balance at March 31, 2005                           |                                            |              | 12,253 |   |        | $              | 18,370 |               |  | $ |         |   |  | $        | (304 | )    |       | $ | 26,871 |        |   | $ | 44,937 |       
|                                                    |                                            |              |        |   |        |                |        |               |  |   |          |   |  |          |      |      |       |  



6



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QUALSTAR CORPORATION


NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS


March 31, 2005


(in thousands, except per share data)


(UNAUDITED)




|        |                      
|------- | ---------------------
|NOTE 1. | BASIS OF PRESENTATION

,




|        |               
|------- | --------------
|NOTE 2. | LOSS PER SHARE



|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |        |   |   |       |        |  
|-------------------------- | --------------------------------------------------------------------------------------------------------- | ------------------ | ----- | ------ | ----------------- | - | ----- | ------ | - | - | ----- | ------ | - | - | ----- | ------ | -
|                           |                                                                                                           | Three Months Ended |       |        | Nine Months Ended |  
|                           |                                                                                                           | March 31,          |       |        | March 31,         |  
|                           |                                                                                                           |                    |       |        |                   |  
|                           |                                                                                                           | 2005               |       |        | 2004              |   |       | 2005   |   |   | 2004  |       
|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |       
|Numerator:                 |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |        |   |   |       |       
|                           | Net loss                                                                                                  |                    | $     | (635   | )                 |   | $     | (346   | ) |   | $     | (1,218 | ) |   | $     | (715   | )
|Denominator:               |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |        |   |   |       |       
|                           | Denominator for basic net loss per share  weighted
    average shares                                    |                    |       | 12,253 |                   |   |       | 12,587 |   |   |       | 12,446 |   |   |       | 12,574 |  
|                           | Dilutive potential common shares from employee stock options and
    restricted stock                     |                    |       |       |                   |   |       |       |   |   |       |       |   |   |       |       |  
|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |       
|                           | Denominator for diluted net loss per share  adjusted
    weighted average shares and assumed conversions |                    |       | 12,253 |                   |   |       | 12,587 |   |   |       | 12,446 |   |   |       | 12,574 |  
|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |       
|Basic net loss per share   |                                                                                                           | $                  | (0.05 | )      |                   | $ | (0.03 | )      |   | $ | (0.10 | )      |   | $ | (0.06 | )     
|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |       
|Diluted net loss per share |                                                                                                           | $                  | (0.05 | )      |                   | $ | (0.03 | )      |   | $ | (0.10 | )      |   | $ | (0.06 | )     
|                           |                                                                                                           |                    |       |        |                   |   |       |        |   |   |       |       





|        |                         
|------- | ------------------------
|NOTE 3. | STOCK BASED COMPENSATION



7



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##### 



QUALSTAR CORPORATION


NOTES TO CONSOLIDATED CONDENSED FINANCIAL
STATEMENTS  (Continued)






|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                  |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                                                  |  | March 31,          |        |   | March 31,         |  
|                                                                                  |  |                    |        |   |                   |  
|                                                                                  |  | 2005               |        |   | 2004              |   |        | 2005 |  |   | 2004   |  
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Net loss as reported                                                              |  | $                  | (635   | ) |                   | $ | (346   | )    |  | $ | (1,218 | ) |  | $ | (715   | )
|Stock-based employee compensation cost included in reported net
    income (loss) |  |                    |       |   |                   |   | 11     |      |  |   |       |   |  |   | 140    |  
|Pro forma stock-based employee compensation cost under
    SFAS 123               |  |                    | (68    | ) |                   |   | (128   | )    |  |   | (204   | ) |  |   | (384   | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Pro forma net loss                                                                |  | $                  | (703   | ) |                   | $ | (463   | )    |  | $ | (1,422 | ) |  | $ | (959   | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Loss per share:                                                                   |  |                    |        |   |                   |   |        |      |  |   |        |   |  |   |        |  
|Basic  as reported                                                               |  | $                  | (0.05  | ) |                   | $ | (0.03  | )    |  | $ | (0.10  | ) |  | $ | (0.06  | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Basic  pro forma                                                                 |  | $                  | (0.06  | ) |                   | $ | (0.04  | )    |  | $ | (0.11  | ) |  | $ | (0.08  | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Diluted  as reported                                                             |  | $                  | (0.05  | ) |                   | $ | (0.03  | )    |  | $ | (0.10  | ) |  | $ | (0.06  | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Diluted  pro forma                                                               |  | $                  | (0.06  | ) |                   | $ | (0.04  | )    |  | $ | (0.11  | ) |  | $ | (0.08  | )
|                                                                                  |  |                    |        |   |                   |   |        |      |  |   |        |  
|Basic Weighted Average Shares                                                     |  |                    | 12,253 |   |                   |   | 12,587 |      |  |   | 12,446 |   |  |   | 12,574 |  
|Diluted Weighted Average Shares                                                   |  |                    | 12,253 |   |                   |   | 12,587 |      |  |   | 12,446 |   |  |   | 12,574 |  



|        |                      
|------- | ---------------------
|NOTE 4. | MARKETABLE SECURITIES







8



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##### 



QUALSTAR CORPORATION


NOTES TO CONSOLIDATED CONDENSED FINANCIAL
STATEMENTS  (Continued)






|        |            
|------- | -----------
|NOTE 5. | INVENTORIES



|               |  |                |       |  |               |   |       | 
|-------------- |  | -------------- | ----- |  | ------------- | - | ----- | 
|               |  | March 31, 2005 |       |  | June 30, 2004 |  
|               |  |                |       |  |               |  
|Raw materials  |  | $              | 6,629 |  |               | $ | 6,370 | 
|Finished goods |  |                | 1,019 |  |               |   | 1,048 | 
|               |  |                |       |  |               |  
|               |  | $              | 7,648 |  |               | $ | 7,418 | 
|               |  |                |       |  |               |  



|        |                   
|------- | ------------------
|NOTE 6. | COMPREHENSIVE LOSS





|        |                 
|------- | ----------------
|NOTE 7. | STOCK REPURCHASE





|        |                  
|------- | -----------------
|NOTE 8. | LEGAL PROCEEDINGS





|        |             
|------- | ------------
|NOTE 9. | INCOME TAXES





9



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##### 



QUALSTAR CORPORATION


NOTES TO CONSOLIDATED CONDENSED FINANCIAL
STATEMENTS  (Continued)




|         |                                 
|-------- | --------------------------------
|NOTE 10. | RECENT ACCOUNTING PRONOUNCEMENTS











10



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##### 





|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|ITEM 2. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations



OVERVIEW








CRITICAL ACCOUNTING POLICIES AND ESTIMATES








| |                    
| | -------------------
| | Revenue Recognition



11



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##### 









| |                                
| | -------------------------------
| | Allowance for Doubtful Accounts





| |                    
| | -------------------
| | Inventory Valuation





| |                     
| | --------------------
| | Warranty Obligations





| |                            
| | ---------------------------
| | Accounting for Income Taxes







12



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##### 





RESULTS OF OPERATIONS




|                                     |  |                    |       |    |                   |  |       |      |  |  |       |    |  |  |       |   
|------------------------------------ |  | ------------------ | ----- | -- | ----------------- |  | ----- | ---- |  |  | ----- | -- |  |  | ----- | --
|                                     |  | Three Months Ended |       |    | Nine Months Ended | 
|                                     |  | March 31,          |       |    | March 31,         | 
|                                     |  |                    |       |    |                   | 
|                                     |  | 2005               |       |    | 2004              |  |       | 2005 |  |  | 2004  |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Net revenues                         |  |                    | 100.0 | %  |                   |  | 100.0 | %    |  |  | 100.0 | %  |  |  | 100.0 | % 
|Cost of goods sold                   |  |                    | 67.6  |    |                   |  | 63.8  |      |  |  | 64.7  |    |  |  | 62.9  |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Gross profit                         |  |                    | 32.4  |    |                   |  | 36.2  |      |  |  | 35.3  |    |  |  | 37.1  |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Operating expenses:                  |  |                    |       |    |                   |  |       |      |  |  |       |    |  |  |       |   
|Research and development             |  |                    | 15.7  |    |                   |  | 12.9  |      |  |  | 14.8  |    |  |  | 13.8  |   
|Sales and marketing                  |  |                    | 14.3  |    |                   |  | 11.0  |      |  |  | 13.8  |    |  |  | 11.1  |   
|General and administrative           |  |                    | 16.1  |    |                   |  | 20.4  |      |  |  | 16.2  |    |  |  | 18.8  |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Total operating expenses             |  |                    | 46.1  |    |                   |  | 44.3  |      |  |  | 44.8  |    |  |  | 43.7  |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Loss from operations                 |  |                    | (13.7 | )  |                   |  | (8.1  | )    |  |  | (9.5  | )  |  |  | (6.6  | ) 
|Investment income                    |  |                    | 3.8   |    |                   |  | 1.7   |      |  |  | 3.2   |    |  |  | 2.0   |   
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Loss before income taxes             |  |                    | (9.9  | )  |                   |  | (6.4  | )    |  |  | (6.3  | )  |  |  | (4.6  | ) 
|Provision (benefit) for income taxes |  |                    | 1.1   |    |                   |  | (2.2  | )    |  |  | 0.4   |    |  |  | (1.6  | ) 
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   
|Net loss                             |  |                    | (11.0 | )% |                   |  | (4.2  | )%   |  |  | (6.7  | )% |  |  | (3.0  | )%
|                                     |  |                    |       |    |                   |  |       |      |  |  |       |   



|                                          |  |                    |       |   |                   |  |       |      |  |  |       |   |  |  |       |  
|----------------------------------------- |  | ------------------ | ----- | - | ----------------- |  | ----- | ---- |  |  | ----- | - |  |  | ----- | -
|                                          |  | Three Months Ended |       |   | Nine Months Ended | 
|                                          |  | March 31,          |       |   | March 31,         | 
|                                          |  |                    |       |   |                   | 
|                                          |  | 2005               |       |   | 2004              |  |       | 2005 |  |  | 2004  |  
|                                          |  |                    |       |   |                   |  |       |      |  |  |       |  
|Tape library revenues:                    |  |                    |       |   |                   |  |       |      |  |  |       |   |  |  |       |  
|TLS                                       |  |                    | 45.4  | % |                   |  | 56.9  | %    |  |  | 51.2  | % |  |  | 58.3  | %
|RLS                                       |  |                    | 14.1  |   |                   |  | 17.5  |      |  |  | 13.0  |   |  |  | 16.0  |  
|                                          |  |                    |       |   |                   |  |       |      |  |  |       |  
|                                          |  |                    | 59.5  |   |                   |  | 74.4  |      |  |  | 64.2  |   |  |  | 74.3  |  
|                                          |  |                    |       |   |                   |  |       |      |  |  |       |  
|Other revenues:                           |  |                    |       |   |                   |  |       |      |  |  |       |   |  |  |       |  
|Service                                   |  |                    | 10.9  |   |                   |  | 5.8   |      |  |  | 10.4  |   |  |  | 7.3   |  
|Media                                     |  |                    | 10.5  |   |                   |  | 11.7  |      |  |  | 10.0  |   |  |  | 9.4   |  
|Power Supplies, Spares, Upgrades, 9 Track |  |                    | 19.1  |   |                   |  | 8.1   |      |  |  | 15.4  |   |  |  | 9.0   |  
|                                          |  |                    |       |   |                   |  |       |      |  |  |       |  
|                                          |  |                    | 100.0 | % |                   |  | 100.0 | %    |  |  | 100.0 | % |  |  | 100.0 | %
|                                          |  |                    |       |   |                   |  |       |      |  |  |       |  



| |                                                                                     
| | ------------------------------------------------------------------------------------
| | Three Months Ended March 31, 2005 Compared to Three
    Months Ended March 31, 2004.

Net Revenues.


13



---



##### 



Gross Profit.


Research and Development.


Sales and Marketing.


General and Administrative.


Investment Income.


Provision (Benefit) for Income Taxes.




| |                                                                                   
| | ----------------------------------------------------------------------------------
| | Nine Months Ended March 31, 2005 Compared to Nine
    Months Ended March 31, 2004.

Net Revenues.


Gross Profit.


14



---



##### 



Research and Development.


Sales and Marketing.


General and Administrative.


Investment Income.


Provision (Benefit) for Income Taxes.


LIQUIDITY AND CAPITAL RESOURCES










15



---



##### 







|        |                                                               
|------- | --------------------------------------------------------------
|ITEM 3. | Quantitative and Qualitative Disclosures About Market
    Risk





|        |                        
|------- | -----------------------
|ITEM 4. | Controls and Procedures





PART II  OTHER INFORMATION




|        |                                                    
|------- | ---------------------------------------------------
|ITEM 4. | Submission of Matters to a Vote of Security Holders





| |                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. The following persons were elected as directors to serve
    a one year term expiring at the Annual Meeting of Stockholders
    to be held in 2006 or until their successors are elected and
    qualified:

|                   |  |                      |            |          |           |  |           | 
|------------------ |  | -------------------- | ---------- | -------- | --------- |  | --------- | 
|                   |  | Number of Votes Cast |           
|                   |  |                      |           
|Name               |  | For                  |            |          | Authority | 
|                   |  |                      |            |          |           | 
|                   |  |                      |            | Withheld |          
|William J. Gervais |  |                      | 9,829,461  |          |           |  | 1,584,901 | 
|Richard A. Nelson  |  |                      | 9,829,461  |          |           |  | 1,584,901 | 
|Carl W. Gromada    |  |                      | 11,383,055 |          |           |  | 31,307    | 
|Jose M. Miyar      |  |                      | 11,382,555 |          |           |  | 31,807    | 
|Robert E. Rich     |  |                      | 11,383,055 |          |           |  | 31,307    | 
|Robert T. Webber   |  |                      | 11,382,555 |          |           |  | 31,807    | 

16



---



##### 





|        |         
|------- | --------
|ITEM 6. | Exhibits

Exhibits:


|        |    |             |  |                                                                                                            
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 31 | .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.

17



---



##### 



SIGNATURES






| |                     
| | --------------------
| | QUALSTAR CORPORATION



| |     |                       
| | --- | ----------------------
| | By: | /s/ WILLIAM J. GERVAIS

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





| |     |                      
| | --- | ---------------------
| | By: | /s/ FREDERIC T. BOYER

| |                            
| | ---------------------------
| |                            
| | Frederic T. Boyer          
| | Principal Financial Officer



18



---



##### 



EXHIBIT INDEX


|        |    |             |  |                                                                                                            
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 31 | .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.

19