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 December 31, 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 January 30, 2009 is
12,253,117.













QUALSTARCORPORATION


FORM
10-Q


FOR
THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008


INDEX








PART
      I — FINANCIAL INFORMATIONItem
      1.
                      Financial Statements·
                      Condensed Consolidated Balance Sheets — December 31, 2008 and
      June 30, 2008
                      1·
                      Condensed Consolidated Statements of Operations — Three and Six
      Months ended December 31, 2008 and 2007
                      2·
                      Condensed Consolidated Statements of Cash Flows — Six Months
      ended December 31, 2008 and 2007
                      3·
                      Condensed Consolidated Statement of Changes in Shareholders’
      Equity — Six Months ended December 31, 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
                      18Item
      4T.
                      Controls and Procedures
                      18PART
      II — OTHER INFORMATIONItem
      6.
                      Exhibits
                      19Signatures
                      20





Index





PARTI — FINANCIAL INFORMATION





ITEM
1.FINANCIAL
STATEMENTS





QUALSTAR
CORPORATION


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
thousands)





December
      31, 2008
                                        
                                        
                                        June
      30, 2008(Unaudited)
                                        
                                        
                                        (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                        
                                        $
                                        5,049
                                        
                                        
                                        $
                                        6,744Marketable
      securities, short-term
                                        
                                        
                                        14,619
                                        
                                        
                                        
                                        11,091Receivables,
      net of allowances of $105 at December 31, 2008, and $82 at June 30,
      2008
                                        
                                        
                                        2,574
                                        
                                        
                                        
                                        2,962Inventories,
      net
                                        
                                        
                                        6,355
                                        
                                        
                                        
                                        6,109Prepaid
      expenses and other current assets
                                        
                                        
                                        496
                                        
                                        
                                        
                                        467Total
      current assets
                                        
                                        
                                        29,093
                                        
                                        
                                        
                                        27,373Property
      and equipment, net
                                        
                                        
                                        439
                                        
                                        
                                        
                                        526Marketable
      securities, long-term
                                        
                                        
                                        10,574
                                        
                                        
                                        
                                        14,703Other
      assets
                                        
                                        
                                        55
                                        
                                        
                                        
                                        55Total
      assets
                                        
                                        $
                                        40,161
                                        
                                        
                                        $
                                        42,657LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                                        
                                        $
                                        745
                                        
                                        
                                        $
                                        1,197Accrued
      payroll and related liabilities
                                        
                                        
                                        393
                                        
                                        
                                        
                                        519Other
      accrued liabilities
                                        
                                        
                                        936
                                        
                                        
                                        
                                        1,774Total
      current liabilities
                                        
                                        
                                        2,074
                                        
                                        
                                        
                                        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 December 31, 2008 and June 30, 2008
                                        
                                        
                                        18,753
                                        
                                        
                                        
                                        18,705Accumulated
      other comprehensive income
                                        
                                        
                                        309
                                        
                                        
                                        
                                        108Retained
      earnings
                                        
                                        
                                        18,979
                                        
                                        
                                        
                                        20,308Total
      shareholders’ equity
                                        
                                        
                                        38,041
                                        
                                        
                                        
                                        39,121Total
      liabilities and shareholders’ equity
                                        
                                        $
                                        40,161
                                        
                                        
                                        $
                                        42,657








See
the accompanying notes to these interim condensed consolidated financial
statements.





1
 Index





QUALSTARCORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)
(In thousands, except per share data)








Three
      Months Ended
                  December
      31,
                
                
                Six
      Months Ended
                  December
      31,2008
                
                
                2007
                
                
                2008
                
                
                2007Net
      Revenues
                
                $
                4,623
                
                
                $
                6,049
                
                
                $
                10,025
                
                
                $
                11,381Cost
      of goods sold
                
                
                3,149
                
                
                
                4,004
                
                
                
                6,668
                
                
                
                7,712Gross
      profit
                
                
                1,474
                
                
                
                2,045
                
                
                
                3,357
                
                
                
                3,669Operating
      expenses:Research
      and development
                
                
                765
                
                
                
                770
                
                
                
                1,508
                
                
                
                1,498Sales
      and marketing
                
                
                753
                
                
                
                840
                
                
                
                1,448
                
                
                
                1,600General
      and administrative
                
                
                802
                
                
                
                918
                
                
                
                1,568
                
                
                
                1,656Total
      operating expenses
                
                
                2,320
                
                
                
                2,528
                
                
                
                4,524
                
                
                
                4,754Loss
      from operations
                
                
                (846
                )
                
                
                (483
                )
                
                
                (1,167
                )
                
                
                (1,085
                )Investment
      Income
                
                
                291
                
                
                
                424
                
                
                
                571
                
                
                
                837Loss
      before income taxes
                
                
                (555
                )
                
                
                (59
                )
                
                
                (596
                )
                
                
                (248
                )(Benefit)
      Provision for income taxes
                
                
                -
                
                
                
                -
                
                
                
                (2
                )
                
                
                17Net
      loss
                
                $
                (555
                )
                
                $
                (59
                )
                
                $
                (594
                )
                
                $
                (265
                )Loss
      per share:Basic
      and Diluted
                
                $
                (0.05
                )
                
                $
                (0.00
                )
                
                $
                (0.05
                )
                
                $
                (0.02
                )Shares
      used to compute loss per share:Basic
      and Diluted
                
                
                12,253
                
                
                
                12,253
                
                
                
                12,253
                
                
                
                12,253Cash
      dividends declared per common share
                
                $
                (0.06
                )
                
                $
                (0.00
                )
                
                $
                (0.12
                )
                
                $
                (0.00
                )








See
the accompanying notes to these interim condensed consolidated financial
statements.





2
 Index





QUALSTARCORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)
(In thousands)








Six
      Months Ended
                          December
      31,2008
                        
                        
                        2007OPERATING
      ACTIVITIES:Net
      loss
                        
                        $
                        (594
                        )
                        
                        $
                        (265
                        )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Share
      based compensation
                        
                        
                        48
                        
                        
                        
                        60Gain
      on sale of marketable securities
                        
                        
                        (63
                        )
                        
                        
                        (2
                        )Depreciation
      and amortization
                        
                        
                        110
                        
                        
                        
                        153Provision
      for (recovery of) bad debts and returns
                        
                        
                        22
                        
                        
                        
                        (11
                        )Changes
      in operating assets and liabilities:Accounts
      receivable
                        
                        
                        366
                        
                        
                        
                        (59
                        )Inventories
                        
                        
                        (246
                        )
                        
                        
                        664Prepaid
      expenses and other assets
                        
                        
                        (29
                        )
                        
                        
                        (83
                        )Prepaid
      income taxes
                        
                        
                        -
                        
                        
                        
                        3Accounts
      payable
                        
                        
                        (452
                        )
                        
                        
                        300Accrued
      payroll and accrued liabilities
                        
                        
                        (126
                        )
                        
                        
                        14Income
      taxes payable
                        
                        
                        (7
                        )
                        
                        
                        -Other
      accrued liabilities
                        
                        
                        (96
                        )
                        
                        
                        (12
                        )Net
      cash (used in) provided by operating activities
                        
                        
                        (1,067
                        )
                        
                        
                        762INVESTING
      ACTIVITIES:Purchases
      of property, equipment and leasehold improvements
                        
                        
                        (23
                        )
                        
                        
                        (90
                        )Proceeds
      from sale of marketable securities
                        
                        
                        20,356
                        
                        
                        
                        16,874Purchases
      of marketable securities
                        
                        
                        (19,491
                        )
                        
                        
                        (14,587
                        )Net
      cash provided by investing activities
                        
                        
                        842
                        
                        
                        
                        2,197FINANCING
      ACTIVITIES:Cash
      dividends on common shares
                        
                        
                        (1,470
                        )
                        
                        
                        -Net
      cash used in financing activities
                        
                        
                        (1,470
                        )
                        
                        
                        -Net
      change in cash and cash equivalents
                        
                        
                        (1,695
                        )
                        
                        
                        2,959Cash
      and cash equivalents, beginning of period
                        
                        
                        6,744
                        
                        
                        
                        7,697Cash
      and cash equivalents, end of period
                        
                        $
                        5,049
                        
                        
                        $
                        10,656Supplemental
      cash flow disclosure:Income
      taxes paid
                        
                        $
                        5
                        
                        
                        $
                        7








See
the accompanying notes to these interim condensed consolidated financial
statements.





3
 Index





QUALSTARCORPORATION


CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY


SIX
MONTHS ENDED DECEMBER 31, 2008


(Unaudited)
(In thousands)





AccumulatedOtherCommon
      Stock
                  
                  
                  Comprehensive
                  
                  
                  RetainedShares
                  
                  
                  Amount
                  
                  
                  Income
                  
                  
                  Earnings
                  
                  
                  TotalBalance
      at July 1, 2008
                  
                  
                  12,253
                  
                  
                  $
                  18,705
                  
                  
                  $
                  108
                  
                  
                  $
                  20,308
                  
                  
                  $
                  39,121Share
      based compensation
                  
                  
                  —
                  
                  
                  
                  48
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  48Cash
      dividend on common shares
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (735
                  )
                  
                  
                  (735
                  )Comprehensive
      loss:Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (594
                  )
                  
                  
                  (594
                  )Change
      in unrealized losses on investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  201
                  
                  
                  
                  —
                  
                  
                  
                  201Comprehensive
      Loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (393
                  )Balance
      at December 31, 2008
                  
                  
                  12,253
                  
                  
                  $
                  18,753
                  
                  
                  $
                  309
                  
                  
                  $
                  18,979
                  
                  
                  $
                  38,041








See
the accompanying notes to these interim condensed consolidated financial
statements





4
 Index





QUALSTARCORPORATION





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 December 31,
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 ofnongovernmental
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 Boardamendments 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 on 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 29.3% of net revenues in the three months ended December 31, 2008,
and 30.4% of net revenues in the three months ended December 31, 2007. Sales
outside of North America represented approximately 27.2% of net revenues in the
six months ended December 31, 2008, and 26.9% of net revenues in the six months
ended December 31, 2007.





One
customer accounted for 15.7% of the Company’s consolidated revenue for the
three-month period ended December 31, 2008.  The customer’s accounts
receivable balance, net of specific allowances, totaled approximately 14.3% of
net accounts receivable.  No single customer accounted for more than
ten percent of the Company’s consolidated revenue for the three-month period
ended December 31, 2007.





6
 Index





QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)





One
customer accounted for 12.9% of the Company’s consolidated revenue for the
six-month period ended December 31, 2008.  The customer’s accounts
receivable balance, net of specific allowances, totaled approximately 14.3% of
net accounts receivable.  No single customer accounted for more than
ten percent of the Company’s consolidated revenue for the six-month period ended
December 31, 2007.





Sales and
costs of goods sold related to tape library products only available from one
supplier totaled approximately 16.3% and 20.8% for the three months ended
December 31, 2008 and 19.0% and   21.4% for the three months
ended December 31, 2007, respectively, of total sales and cost of goods sold.
Sales and costs of goods sold totaled approximately 15.6% and 19.3% for the six
months ended December 31, 2008 and 22.0% and 24.1% for the six months ended
December 31, 2007, respectively, of total sales and cost of goods
sold.





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
                    December
      31,
                  
                  
                  Six
      Months Ended
                    December
      31,In
      thousands (except per share amounts):
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Net
      loss  (a)
                  
                  $
                  (555
                  )
                  
                  $
                  (59
                  )
                  
                  $
                  (594
                  )
                  
                  $
                  (265
                  )Weighted
      average outstanding shares of common stock (b)
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,253Dilutive
      potential common shares from employee stock options
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Common
      stock and common stock equivalents (c)
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,253Loss
      per share:Basic
      net loss per share (a)/(b)
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.02
                  )Diluted
      net loss per share  (a)/(c)
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.02
                  )





Stock
options are excluded for the three and six month periods ended December 31, 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 December 31, 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. Gain (loss) on the sale of securities for the three months ended December
31, 2008 and 2007 was $67,000 and $(1,000), respectively.  Gain on the
sale of securities for the six months ended December 31, 2008 and 2007 was
$63,000 and $2,000, respectively.  The change in net unrealized
holding gain on available-for-sale securities that has been included in the
other comprehensive income of shareholder’s equity during the six months ended
December 31, 2008 and 2007 was $201,000 and $140,000, respectively.





7
 Index





QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





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.




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 December 31, 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.





8
 Index





QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)






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 December 31, 2008:





(In
      thousands)
                
                Level
      1
                
                
                Level
      2
                
                
                Net
      balanceAssetsCash
                
                $
                474
                
                
                
                
                
                $
                474Money
      Market Mutual fund
                
                
                4,575
                
                
                
                
                
                
                4,575Commercial
      paper
                
                
                –
                
                
                
                
                
                $U.S.
      government and agency securities
                
                
                6,096
                
                
                
                11,656
                
                
                
                17,752Mortgage-backed
      securities
                
                
                –
                
                
                
                3,612
                
                
                
                3,612Corporate
      bonds
                
                
                –
                
                
                
                3,325
                
                
                
                3,325Municipal
      securities
                
                
                –
                
                
                
                503
                
                
                
                503Total
                
                $
                11,145
                
                
                $
                19,096
                
                
                $
                30,241








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):





December
      31, 2008
                  
                  
                  June
      30, 2008Raw
      materials
                  
                  $
                  6,271
                  
                  
                  $
                  6,053Finished
      goods
                  
                  
                  712
                  
                  
                  
                  785Subtotal
                  
                  
                  6,983
                  
                  
                  
                  6,838Less:
      Inventory reserve
                  
                  
                  (628
                  )
                  
                  
                  (729
                  )$
                  6,355
                  
                  
                  $
                  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):





December
      31,
                                2008
                              
                              
                              June
      30, 2008Beginning
      balance
                              
                              $
                              181
                              
                              
                              $
                              174Cost
      of warranty claims
                              
                              
                              (15
                              )
                              
                              
                              (66
                              )Accruals
      for product warranties
                              
                              
                              13
                              
                              
                              
                              72Ending
      balance
                              
                              $
                              179
                              
                              
                              $
                              181





9
 Index





QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)








Note
9 – Comprehensive Loss





For the
six months ended December 31, 2008 and 2007, comprehensive loss amounted to
approximately $393,000 and $125,000, 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 six months ended December
31, 2008. We recorded a provision for income taxes of $17,000 for the six months
ended December 31, 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.





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 six months ended December 31, 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 six months ended December
31, 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.





10
 Index





QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)








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
                    December
      31,
                  
                  
                  Six
      Months Ended
                    December
      31,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007RevenueTape
      Libraries:Product
                  
                  
                  2,520
                  
                  
                  
                  4,379
                  
                  
                  
                  5,596
                  
                  
                  
                  8,331Service
                  
                  
                  625
                  
                  
                  
                  624
                  
                  
                  
                  1,337
                  
                  
                  
                  1,280Total
      Tape Libraries
                  
                  
                  3,145
                  
                  
                  
                  5,003
                  
                  
                  
                  6,933
                  
                  
                  
                  9,611Power
      Supplies
                  
                  
                  1,478
                  
                  
                  
                  1,046
                  
                  
                  
                  3,091
                  
                  
                  
                  1,770Consolidated
      Revenue
                  
                  
                  4,623
                  
                  
                  
                  6,049
                  
                  
                  
                  10,024
                  
                  
                  
                  11,381








Three
      Months Ended
                    December
      31,
                  
                  
                  Six
      Months Ended
                    December
      31,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Income (Loss) before TaxesTape
      Libraries
                  
                  
                  (620
                  )
                  
                  
                  (220
                  )
                  
                  
                  (784
                  )
                  
                  
                  (308
                  )Power
      Supplies
                  
                  
                  65
                  
                  
                  
                  161
                  
                  
                  
                  190
                  
                  
                  
                  60Consolidated
      Loss before Taxes
                  
                  
                  (555
                  )
                  
                  
                  (59
                  )
                  
                  
                  (596
                  )
                  
                  
                  (248
                  )








December
      31, 2008
                
                
                June
      30,
                  2008Total AssetsTape
      Libraries
                
                $
                38,100
                
                
                $
                41,257Power
      Supplies
                
                
                2,061
                
                
                
                1,400Consolidated
      Assets
                
                $
                40,161
                
                
                $
                42,657




11
 Index





ITEM2.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
                  December
      31,
                
                
                Six
      Months Ended
                  December
      31,2008
                
                
                2007
                
                
                2008
                
                
                2007Net
      revenues
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of goods sold
                
                
                68.1
                
                
                
                66.2
                
                
                
                66.5
                
                
                
                67.8Gross
      profit
                
                
                31.9
                
                
                
                33.8
                
                
                
                33.5
                
                
                
                32.2Operating
      expenses:Research
      and development
                
                
                16.5
                
                
                
                12.7
                
                
                
                15.0
                
                
                
                13.2Sales
      and marketing
                
                
                16.3
                
                
                
                13.9
                
                
                
                14.4
                
                
                
                14.1General
      and administrative
                
                
                17.3
                
                
                
                15.2
                
                
                
                15.6
                
                
                
                14.6Total
      operating expenses
                
                
                50.1
                
                
                
                41.8
                
                
                
                45.0
                
                
                
                41.9Loss
      from operations
                
                
                (18.2
                )
                
                
                (8.0
                )
                
                
                (11.5
                )
                
                
                (9.7
                )Investment
      income
                
                
                6.3
                
                
                
                7.0
                
                
                
                5.7
                
                
                
                7.4Loss
      before income taxes
                
                
                (11.9
                )
                
                
                (1.0
                )
                
                
                (5.8
                )
                
                
                (2.3
                )Provision
      for income taxes
                
                
                0.0
                
                
                
                0.0
                
                
                
                0.0
                
                
                
                0.1Net
      loss
                
                
                (11.9
                )%
                
                
                (1.0
                )%
                
                
                (5.8
                )%
                
                
                (2.4
                )%





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
                  December 31,
                
                
                Six
      Months Ended
                  December
      31,2008
                
                
                2007
                
                
                2008
                
                
                2007Tape
      Library revenues:TLS
                
                
                25.8
                %
                
                
                33.1
                %
                
                
                24.6
                %
                
                
                32.9
                %RLS
                
                
                5.1
                
                
                
                10.6
                
                
                
                7.4
                
                
                
                10.8XLS
                
                
                4.8
                
                
                
                8.8
                
                
                
                6.6
                
                
                
                7.735.7
                
                
                
                52.5
                
                
                
                38.6
                
                
                
                51.4Other
      library revenues:Service
                
                
                13.5
                
                
                
                10.3
                
                
                
                13.3
                
                
                
                11.3Media
                
                
                13.9
                
                
                
                15.1
                
                
                
                12.8
                
                
                
                16.1Upgrades,
      spares
                
                
                4.9
                
                
                
                4.8
                
                
                
                4.5
                
                
                
                5.732.3
                
                
                
                30.2
                
                
                
                30.6
                
                
                
                33.1Total
      Library revenues
                
                
                68.0
                
                
                
                82.7
                
                
                
                69.2
                
                
                
                84.4Power
      Supply revenues
                
                
                32.0
                
                
                
                17.3
                
                
                
                30.8
                
                
                
                15.6100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %





Three
Months Ended December 31, 2008 Compared to Three Months Ended December 31,
2007





Net Revenue.  Net revenues
decreased to $4.6 million for the three months ended December 31, 2008 from $6.0
million for the three months ended December 31, 2007, a decrease of $1.4
million, or 23.6%. One customer accounted for 15.7% of the Company’s
consolidated revenue for the three-month period ended December 31,
2008.  The customer’s accounts receivable balance, net of specific
allowances, totaled approximately 14.3% of net accounts
receivable.  No single customer accounted for more than ten percent of
the Company’s consolidated revenue for the three-month period ended December 31,
2007.





Segment Revenue





Tape Libraries – Net
tape library revenues decreased to $3.1 million for the three months ended
December 31, 2008 from $5.0 million for the three months ended December 31,
2007, a decrease of $1.9 million, or 37.2%. The decrease in revenues is
attributed to a $1.5 million decline in revenues from our TLS, RLS and XLS tape
library product lines and a $0.3 million decline in revenues from sales of tape
media and a $0.1 million decline in revenues from sales of upgrades and
spares.





One
customer accounted for 13.5% of tape library revenues for the three-month period
ended December 31, 2008. No single customer accounted for more than ten percent
of tape library revenues for the three-month period ended December 31,
2007.





Power Supplies – Net
revenues from power supplies increased to $1.5 million for the three months
ended December 31, 2008 from $1.0 million for the three months ended December
31, 2007, an increase of $.5 million, or 41.3%.  The increase in
revenues is attributed to the launch of a new power supply model and sales to a
new original equipment manufacturer customer under a nine-month contract. Two
customers accounted for 49.0% and 14.4%, respectively, or 63.4% in the
aggregate, of power supply sales for the three months ended December 31,
2008.  Two customers accounted for 28.9% and 15.0%, respectively, or
43.9% in the aggregate, of power supply sales for the three months ended
December 31, 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 decreased to $1.5 million, or 31.9%
of net revenues, for the three months ended December 31, 2008 from $2.0 million,
or 33.8% of net revenues, for the three months ended December 31,
2007.  The decrease in gross profits in the current quarter, both in
absolute dollars and as a percentage of net revenues, is primarily due to a
change in product mix, partially offset by efficiencies achieved in labor and
overhead.





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 remained comparable at $0.8
million for the three months ended December 31, 2008 and $0.8 million for the
three months ended December 31, 2007.





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 $0.7 million for the three months ended
December 31, 2008 from $0.8 million for the three months ended December 31,
2007.  The decrease of $0.1 million, or 10.4%, is primarily due to a
decrease in commission expense correlated to lower revenues and lower
advertising and promotion expenses partially offset by an increase in sales
consulting expenses.





General and
Administrative.  General and
administrative expenses include employee salaries and benefits and professional
service fees. General and administrative expenses decreased to $0.8 million for
the three months ended December 31, 2008 from $0.9 million for the three months
ended December 31, 2007.  The decrease of $0.1 million, or 12.6%, is
primarily due to a decrease in accounting and audit related expenses including
fees associated with the Sarbanes Oxley compliance efforts that were completed
in fiscal 2008, partially offset by an increase in compensation related
expenses.





Investment Income.  Investment
income decreased to $0.3 million for the three months ended December 31, 2008
from $0.4 million for the three months ended December 31, 2007. The decrease of
$0.1 million, or 31.4% is primarily due to the lower interest rate environment
in the recent quarter and partially due to having approximately $3.8 million
less cash, cash equivalents and marketable securities in the quarter ended
December 31, 2008 compared to the prior year quarter.




Provision for Income
Taxes.  We did not
record a benefit for income taxes for the three months ended December 31, 2008
or for the three months ended December 31, 2007.





Six
Months Ended December 31, 2008 Compared to Six Months Ended December 31,
2007





Net Revenue.  Net revenues
decreased to $10.0 million for the six months ended December 31, 2008 from $11.4
million for the three months ended December 31, 2007, a decrease of $1.4
million, or 11.9%. One customer accounted for 12.9% of the Company’s
consolidated revenue for the six-month period ended December 31,
2008.  The customer’s accounts receivable balance, net of specific
allowances, totaled approximately 14.3% of net accounts
receivable.  No single customer accounted for more than ten percent of
the Company’s consolidated revenue for the six-month period ended December 31,
2007.





Segment Revenue





Tape Libraries – Net
tape library revenues decreased to $6.9 million for the six months ended
December 31, 2008 from $9.6 million for the six months ended December 31, 2007,
a decrease of $2.7million, or 27.9%. The decrease in revenues is attributed to a
$2.0 million decline in revenues from our TLS, RLS and XLS tape library product
lines, a $0.5 million decline in revenues from sales of tape media, and a $0.2
million decline in sales of upgrades and spares.





Two
customers accounted for 12.3% and 10.6%, respectively, or 22.9% in the
aggregate, of tape library revenues for the six-month period ended December 31,
2008.  No single customer accounted for more than ten percent of tape
library revenues for the six-month period ended December 31, 2007.





Power Supplies – Net
revenues from power supplies increased to $3.1 million for the six months ended
December 31, 2008 from $1.8 million for the six months ended December 31, 2007,
an increase of $1.3 million, or 74.6%.  The increase in revenues is
attributed to the launch of a new power supply model and sales to a new original
equipment manufacturer customer under a nine-month contract. Two customers
accounted for 42.0% and 12.8%, respectively, or 54.8% in the aggregate, of power
supply sales for the six months ended December 31, 2008.  Two
customers accounted for 20.9% and 14.3%, respectively, or 35.2% in the
aggregate, of power supply sales for the six months ended December 31,
2007.





16
 Index





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 decreased to $3.4 million for the
six months ended December 31, 2008 from $3.7 million for the six months ended
December 31, 2007.  However, gross profit as a percentage of net
revenues increased to 33.5% for the six months ended December 31, 2008 compared
to 32.2% for the six months ended December 31, 2007.  The increase in
gross profits as a percentage of net revenue for the six months ended December
31, 2008 is primarily due to efficiencies achieved in labor and overhead,
partially offset by a change in product mix.





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 remained comparable at $1.5
million for the six months ended December 31, 2008 and $1.5 million for the six
months ended December 31, 2007.





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 $1.4 million for the six months ended
December 31, 2008 from $1.6 million for the six months ended December 31,
2007.  The decrease of $0.2 million, or 9.5%, is primarily due to a
decrease in commission expense correlating to lower revenues and lower
advertising and promotion expenses partially offset by an increase in sales
consulting expenses.





General and
Administrative.  General and
administrative expenses include employee salaries and benefits and professional
service fees. General and administrative expenses decreased to $1.6 million for
the six months ended December 31, 2008 from $1.7 million for the six months
ended December 31, 2007.  The decrease of $0.1 million, or 5.3%, is
primarily due to a decrease in accounting and audit related expenses including
fees associated with the Sarbanes Oxley compliance efforts that were completed
in fiscal 2008, partially offset by an increase in compensation related
expenses.





Investment Income.  Investment
income decreased to $0.6 million for the six months ended December 31, 2008 from
$0.8 million for the six months ended December 31, 2007. The decrease of $0.2
million, or 31.8% is primarily due to the lower interest rate environment in the
recent quarters and partially due to having approximately $3.8 million less
cash, cash equivalents and marketable securities in the six month period ended
December 31, 2008 compared to the prior year six month period.




Provision for Income
Taxes.  We recorded a
benefit for income taxes of $2,000 for the six months ended December 31, 2008.
We recorded a provision for income taxes of $17,000 for the six months ended
December 31, 2007 relating to state income taxes paid 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 $1.1 million in the six months ended December
31, 2008, primarily attributed to the net loss for the period, an increase in
inventories and a decrease in accounts payable, other accrued liabilities and
accrued payroll and related liabilities, partially offset by a decrease in
receivables. Net cash provided by operating activities was $762,000 in the six
months ended December 31, 2007, primarily attributed to an decrease in
inventories and an increase in accounts payable, partially offset by an increase
in prepaid expenses and other assets, and the net loss from
operations.





Cash
provided by investing activities was $842,000 in the six months ended December
31, 2008, primarily attributed to the sale of marketable securities, partially
offset by the purchase of marketable securities.  Cash provided by
investing activities was $2.2 million in the six months ended December 31, 2007,
primarily attributed to the sale of marketable securities, partially offset by
the purchase of marketable securities and the purchase of fixed
assets.





Cash used
in financing activities was $1.5 million in the six months ended December 31,
2008, attributed to the payment of cash dividends of $0.06 per share that we
declared on June 23, 2008 and November 11, 2008 and paid on September 5, 2008
and December 4, 2008, respectively, on shares of our common
stock.  Cash was not used in or provided by financing activities
during the six months ended December 31, 2007.





As of
December 31, 2008, we had $5.0 million in cash and cash equivalents and $25.2
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.





17
 Index





ITEM3.   QUALITATIVE AND 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.





ITEM4T.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 December 31, 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 December 31, 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.





18
 Index





PARTII — OTHER INFORMATION




ITEM
6.   EXHIBITS





ExhibitNo.
                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.





19
 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:
      February 12, 2009
                By:
                /s/    WILLIAM J.
      GERVAISWilliam
      J. GervaisChief
      Executive Officer and President(Principal
      Executive Officer)






20