**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
                  1934****For
                  the Quarterly Period Ended December 31, 2006****OR**£
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934****For
                  the Transition Period From
                  to**
 
 **Commission
        file number 000-30083**
 
 
 **QUALSTAR
        CORPORATION**
 
 **CALIFORNIA**
              **95-3927330**(State
                  of incorporation)
              (I.R.S.
                  EmployerIdentification
                  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, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
        (Check one):
 Large
        accelerated filer o Accelerated
        filer o Non-accelerated
        filer 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 December 31, 2006
        is
        12,253,117.
 
 
 
 
  **QUALSTAR
        CORPORATION**
  **FORM
        10-Q**
  **FOR
        THE
        QUARTERLY PERIOD ENDED DECEMBER 31, 2006**
  **INDEX**
  
 
 
 **PART
                  I — FINANCIAL INFORMATION****Item
                  1.**
              **Financial
                  Statements**·Consolidated
                  Condensed Balance Sheets — December 31, 2006 and June 30,
                  2006
              1·Consolidated
                  Condensed Statements of Operations — Three and Six Months ended December
                  31, 2006 and 2005
              2·Consolidated
                  Condensed Statements of Cash Flows — Six Months ended December 31, 2006
                  and 2005
              3·Consolidated
                  Condensed Statement of Changes in Shareholders’ Equity — Six months ended
                  December 31, 2006
              4·Notes
                  to Interim Consolidated Condensed Financial Statements
              5**Item
                  2.**
              **Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations**
              10**Item
                  3.**
              **Qualitative
                  and Quantitative Disclosures About Market Risk**
              16**Item
                  4.**
              **Controls
                  and Procedures**
              16**PART
                  II — OTHER INFORMATION****Item
                  6.**
              **Exhibits**
              16**Signatures**
              17
 
  
   **PART
        I —
FINANCIAL INFORMATION**
  
 **ITEM
        1.**********FINANCIAL
        STATEMENTS**
 
 **QUALSTAR
        CORPORATION**
  **CONSOLIDATED
        CONDENSED BALANCE SHEETS**
  **(In
        thousands)**
  
 **December
                  31,**
                **2006**
              
              **June
                  30,**
                **2006****(Unaudited)**
              
              **(Audited)****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              5,886
              
              $
              6,845Marketable
                  securities, short-term
              
              
              17,765
              
              
              14,040Receivables,
                  net of allowances of $150 and $118 at December 31, 2006, and June
                  30,
                  2006, respectively
              
              
              3,053
              
              
              2,700Inventories,
                  net
              
              
              6,507
              
              
              7,298Prepaid
                  expenses and other current assets
              
              
              496
              
              
              511Prepaid
                  income taxes
              
              
              166
              
              
              159Total
                  current assets
              
              
              33,873
              
              
              31,553Property
                  and equipment, net
              
              
              746
              
              
              924Marketable
                  securities, long-term
              
              
              9,814
              
              
              12,782Other
                  assets
              
              
              116
              
              
              140Total
                  assets
              
              $
              44,549
              
              $
              45,399**LIABILITIES
                  AND SHAREHOLDERS’ EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              873
              
              $
              783Accrued
                  payroll and related liabilities
              
              
              422
              
              
              466Other
                  accrued liabilities
              
              
              1,135
              
              
              1,292Total
                  current liabilities
              
              
              2,430
              
              
              2,541Commitments
                  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 at December 31, 2006 and June 30, 2006
              
              
              18,528
              
              
              18,503Accumulated
                  other comprehensive loss
              
              
              (134
              )
              
              (395
              )Retained
                  earnings
              
              
              23,725
              
              
              24,750Total
                  shareholders’ equity
              
              
              42,119
              
              
              42,858Total
                  liabilities and shareholders’ equity
              
              $
              44,549
              
              $
              45,399
 
 
 
 
 
 **See
        the accompanying notes to these interim condensed consolidated financial
        statements.**
  1
 
 **QUALSTAR
        CORPORATION**
  **CONSOLIDATED
        CONDENSED STATEMENTS OF OPERATIONS**
  **(Unaudited)
        (In thousands, except per share data)**
  
 **Three
                      Months Ended**
                    **December
                      31,**
                  
                  **Six
                      Months Ended**
                    **December
                      31,****2006**
                  
                  **2005**
                  
                  **2006**
                  
                  **2005**Net
                      Revenues
                  
                  $
                  5,283
                  
                  $
                  5,689
                  
                  $
                  9,942
                  
                  $
                  11,791Cost
                      of goods sold
                  
                  
                  3,649
                  
                  
                  3,767
                  
                  
                  7,006
                  
                  
                  7,965Gross
                      profit
                  
                  
                  1,634
                  
                  
                  1,922
                  
                  
                  2,936
                  
                  
                  3,826Operating
                      expenses:Research
                      and development
                  
                  
                  756
                  
                  
                  762
                  
                  
                  1,507
                  
                  
                  1,481Sales
                      and marketing
                  
                  
                  883
                  
                  
                  715
                  
                  
                  1,650
                  
                  
                  1,472General
                      and administrative
                  
                  
                  812
                  
                  
                  900
                  
                  
                  1,556
                  
                  
                  1,810Total
                      operating expenses
                  
                  
                  2,451
                  
                  
                  2,377
                  
                  
                  4,713
                  
                  
                  4,763Loss
                      from operations
                  
                  
                  (817
                  )
                  
                  (455
                  )
                  
                  (1,777
                  )
                  
                  (937
                  )Investment
                      Income
                  
                  
                  371
                  
                  
                  266
                  
                  
                  752
                  
                  
                  537Loss
                      before income taxes
                  
                  
                  (446
                  )
                  
                  (189
                  )
                  
                  (1,025
                  )
                  
                  (400
                  )Provision
                      for income taxes
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Net
                      loss
                  
                  $
                  (446
                  )
                  $
                  (189
                  )
                  $
                  (1,025
                  )
                  $
                  (400
                  )Loss
                      per share:Basic
                  
                  $
                  (0.04
                  )
                  $
                  (0.02
                  )
                  $
                  (0.08
                  )
                  $
                  (0.03
                  )Diluted
                  
                  $
                  (0.04
                  )
                  $
                  (0.02
                  )
                  $
                  (0.08
                  )
                  $
                  (0.03
                  )Shares
                      used to compute loss per share:Basic
                  
                  
                  12,253
                  
                  
                  12,253
                  
                  
                  12,253
                  
                  
                  12,253Diluted
                  
                  
                  12,253
                  
                  
                  12,253
                  
                  
                  12,253
                  
                  
                  12,253
  
 
 
 
 
 
 **See
        the accompanying notes to these interim condensed consolidated financial
        statements.**
   2
  **QUALSTAR
        CORPORATION**
  **CONSOLIDATED
        CONDENSED STATEMENTS OF CASH FLOWS**
  **(Unaudited)
        (In thousands)**
  
 
 **Six
                  Months Ended**
                **December
                  31,****2006**
              
              **2005****OPERATING
                  ACTIVITIES:**Net
                  loss
              
              $
              (1,025
              )
              $
              (400
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Share
                  based compensation
              
              
              25
              
              
              72Depreciation
                  and amortization
              
              
              216
              
              
              231Provision
                  for (recovery of) bad debts and returns, net of recoveries
              
              
              31
              
              
              (22
              )Changes
                  in operating assets and liabilities:Accounts
                  receivable, net
              
              
              (384
              )
              
              507Inventories,
                  net
              
              
              791
              
              
              (152
              )Prepaid
                  and other assets
              
              
              15
              
              
              (356
              )Prepaid
                  income taxes
              
              
              (7
              )
              
              (2
              )Accounts
                  payable
              
              
              90
              
              
              104Accrued
                  payroll and related liabilities
              
              
              (44
              )
              
              (38
              )Other
                  accrued liabilities
              
              
              (157
              )
              
              52Net
                  cash used in operating activities
              
              
              (449
              )
              
              (4
              )**INVESTING
                  ACTIVITIES:**Purchases
                  of property, equipment and leasehold improvements
              
              
              (14
              )
              
              (102
              )Proceeds
                  from sale of marketable securities
              
              
              4,052
              
              
              1,968Purchases
                  of marketable securities
              
              
              (4,548
              )
              
              (5,720
              )Net
                  cash used in investing activities
              
              
              (510
              )
              
              (3,854
              )Net
                  change in cash and cash equivalents
              
              
              (959
              )
              
              (3,858
              )Cash
                  and cash equivalents, beginning of period
              
              
              6,845
              
              
              12,210Cash
                  and cash equivalents, end of period
              
              $
              5,886
              
              $
              8,352Supplemental
                  cash flow disclosure:Income
                  taxes paid
              
              $
              7
              
              $
              2
 
 
 
 
 
 
 **See
        the accompanying notes to these interim condensed consolidated financial
        statements.**
  3
 
 **QUALSTAR
        CORPORATION**
  **CONSOLIDATED
        CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**
  **SIX
        MONTHS ENDED DECEMBER 31, 2006**
  **(Unaudited)
        (In thousands)**
  
 **Accumulated****Other****Common
                  Stock**
              
              **Comprehensive**
              
              **Retained****Shares**
              
              **Amount**
              
              **Loss**
              
              **Earnings**
              
              **Total**Balance
                  at July 1, 2006
              
              
              12,253
              
              $
              18,503
              
              $
              (395
              )
              $
              24,750
              
              $
              42,858Share
                  based compensation
              
              
              —
              
              
              25
              
              
              —
              
              
              —
              
              
              25Comprehensive
                  loss:Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,025
              )
              
              (1,025
              )Change
                  in unrealized losses on
                investments
              
              
              —
              
              
              —
              
              
              261
              
              
              —
              
              
              261Comprehensive
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (764
              )Balance
                  at December 31, 2006
              
              
              12,253
              
              $
              18,528
              
              $
              (134
              )
              $
              23,725
              
              $
              42,119
 
 
 
 
 
 
 **See
        the accompanying notes to these condensed consolidated financial
        statements.**
   4
  **QUALSTAR
        CORPORATION**
  **NOTES
        TO
        CONSOLIDATED CONDENSED 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 condensed consolidated financial
        statements, including balance sheets and related interim statements of income,
        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, 2006.
  ***Basis
        of Consolidation***
 The
        consolidated financial statements include the accounts and operations of
        Qualstar and its wholly owned subsidiary, Qualstar Sales and Service
        Corporation. All significant intercompany accounts have been
        eliminated.
 
 **Note
        2 - 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 three and six months ended December 31, 2006 and
        2005:
 **In
                  Thousands**
                **(Except
                  per share amounts)****Three
                  Months Ended**
                **December
                  31,**
              
              **Six
                  Months Ended**
                **December
                  31,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Net
                  loss (a)
              
              $
              (446
              )
              $
              (189
              )
              $
              (1,025
              )
              $
              (400
              )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)
              
              $
              (0.04
              )
              $
              (0.02
              )
              $
              (0.08
              )
              $
              (0.03
              )Diluted
                  net loss per share (a)/(c)
              
              $
              (0.04
              )
              $
              (0.02
              )
              $
              (0.08
              )
              $
              (0.03
              )
  5
  **QUALSTAR
        CORPORATION**
  **NOTES
        TO
        CONSOLIDATED CONDENSED FINANCIAL STATEMENTS- (Continued)**
  **(Unaudited)
        (In thousands, except per share data)**
  
 Stock
        options are excluded for the three months and six months ended December 31,
        2006, and 2005, from the computation of diluted loss per share as the effect
        would have been antidilutive.
 
 **Note
        3** **-** **Marketable Securities**
  Marketable securities consist primarily of high-quality U.S. corporate
        securities and U.S. federal government and state government debt 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 securities that 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, 2006 and June 30,
        2006.
 
 Available-for-sale
        securities are recorded at market value. Unrealized holding gains and losses,
        net of the related income tax effect, on available-for-sale securities are
        excluded from earnings and are reported as a separate component of shareholders’
equity until realized. Dividend and interest income are recognized when earned.
        Realized gains and losses for securities classified as available-for-sale
        are
        included in earnings when the underlying securities are sold and are derived
        using the specific identification method for determining the cost of securities
        sold.
 
 **Note
        4 - Inventories**
  Inventories are stated at the lower of cost (first-in, first-out basis) or
        market. Inventory is comprised as follows:
 
 **December
                  31, 2006**
              
              **June
                  30,**
                **2006**Raw
                  materials, net
              
              $
              5,771
              
              $
              6,473Finished
                  goods
              
              
              736
              
              
              825$
              6,507
              
              $
              7,298
 
 
 **Note
        5 - Comprehensive Loss**
  For the six months ended December 31, 2006 and 2005, comprehensive loss amounted
        to approximately $ 764,000 and
        $582,000, 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
        6 - 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.
 6
   **QUALSTAR
        CORPORATION**
  **NOTES
        TO
        CONSOLIDATED CONDENSED FINANCIAL STATEMENTS- (Continued)**
  **(Unaudited)
        (In thousands, except per share data)**
  
 **Note
        7 -
        Income Taxes**
  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
        8 -
        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
        manage and monitore performance. 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. As the power supply segment grew in
        the
        last year to represent greater than 10% of combined revenues, a framework
        for
        internal resource allocations has been implemented for the three months and
        six
        months ended December 31, 2006. Thus, the amounts indicated for the three
        months
        and six months ended December 31, 2006 include allocations for certain internal
        resources and the amounts indicated for the three months and six months ended
        December 31, 2005 were recast to reflect allocations for certain internal
        resources. Certain assets are tracked separately by the power supplies segment,
        and all others are recorded in the tape library segment for internal reporting
        presentations. Cash is not segregated between the two segments, but retained
        by
        the library segment.
 
 The
        types of products and services provided by each segment are summarized below:
 
 **Tape
        Libraries** —
        We design, develop, manufacture and sell automated magnetic tape libraries
        used
        to store, retrieve and manage electronic data primarily in network computing
        environments. Tape libraries consist of cartridge tape drives, tape cartridges
        and robotics to move the cartridges from their storage locations to the tape
        drives under software control. Our tape libraries provide data storage solutions
        for organizations requiring backup, recovery and archival storage of critical
        data.
 
 **Power
        Supplies** —
        We design, manufacture, and sell small, open frame, high efficiency switching
        power supplies. These power supplies are used to convert AC line voltage
        to DC
        voltages for use in a wide variety of electronic equipment such as
        telecommunications equipment, machine tools, routers, switches, wireless
        systems
        and gaming devices.
 
 
  7
   **QUALSTAR
        CORPORATION**
  **NOTES
        TO
        CONSOLIDATED CONDENSED FINANCIAL STATEMENTS- (Continued)**
  **(Unaudited)
        (In thousands, except per share data)**
  
 Segment
        revenue, loss before taxes and total assets were as follows:
 
 
 **Three
                  Months Ended**
                **December
                  31**
              
              **Six
                  Months Ended**
                **December
                  31,****2006**
              
              **2005**
              
              **2006**
              
              **2005****Revenue**Tape
                  Libraries:Product
              
              $
              3,604
              
              $
              4,379
              
              $
              6,751
              
              $
              9,164Service
              
              
              813
              
              
              749
              
              
              1,538
              
              
              1,529Total
                  Tape Libraries
              
              
              4,417
              
              
              5,128
              
              
              8,289
              
              
              10,693Power
                  Supplies
              
              
              866
              
              
              561
              
              
              1,653
              
              
              1,098Consolidated
                  Revenue
              
              $
              5,283
              
              $
              5,689
              
              $
              9,942
              
              $
              11,791
 
 
 **Three
                  Months Ended**
                **December
                  31**
              
              **Six
                  Months Ended**
                **December
                  31,****2006**
              
              **2005**
              
              **2006**
              
              **2005****Income
                  (Loss) before Taxes**Tape
                  Libraries..............................................
              
              $
              (499
              )
              $
              (8
              )
              $
              (1,089
              )
              $
              (101
              )Power
                  Supplies............................................
              
              
              53
              
              
              (181
              )
              
              64
              
              
              (299
              )Consolidated
                  Loss before Taxes
              
              $
              (446
              )
              $
              (189
              )
              $
              (1,025
              )
              $
              (400
              )
 
 
 **December
                  31**
              
              **December
                  31****2006**
              
              **2005****Total
                  Assets**Tape
                  Libraries
              
              $
              43,678
              
              $
              45,806Power
                  Supplies
              
              
              871
              
              
              1,025Consolidated
                  Assets
              
              $
              44,549
              
              $
              46,831
 
 
 **Note
        9 - Recent Accounting Pronouncements**
  Staff Accounting Bulletin (“SAB”) 108, *Considering
        the Effects of Prior Year Misstatements when Quantifying Current Year
        Misstatements* *,* issued
        by the SEC in September 2006 *,* requires
        analysis of misstatements using both an income statement and a balance sheet
        approach in assessing materiality and provides for a one-time cumulative
        effect
        transition adjustment. SAB 108 is effective for our fiscal year 2007 annual
        report on Form 10-K. We do not expect the adoption of SAB 108 to have a material
        impact on our consolidated financial statements.
 
 8
   **QUALSTAR
        CORPORATION**
  **NOTES
        TO
        CONSOLIDATED CONDENSED FINANCIAL STATEMENTS- (Continued)**
  **(Unaudited)
        (In thousands, except per share data)**
  
 SFAS 157, *Fair
        Value Measurements* ,
        issued by the Financial Accounting Standards Board (“FASB”) in September 2006,
        defines fair value and provides guidance on measuring fair value in generally
        accepted accounting principles, and expands disclosure requirements associated
        with fair value. SFAS 157 is effective for our fiscal year beginning July
        1,
        2008. We do not expect the adoption of SFAS 157 to have a material impact
        on our
        financial statements.
 
 The FASB issued Financial Interpretation No. 48 (FIN 48), “Accounting for
        Uncertainty in Income Taxes” in June 2006. FIN 48 prescribes a recognition and
        measurement threshold for tax positions taken or expected to be taken on
        a tax
        return and relates to the uncertainty in income taxes recognized in the
        financial statements in accordance with FAS109, Accounting for Income Taxes.
        FIN
        48 is effective for the first fiscal year beginning after December 15, 2006,
        thus, we expect to adopt it in our fiscal year beginning July 1, 2007. We
        do not
        expect the adoption of FIN 48 to have a material impact on our financial
        statements.
 
  9
 
 
 **ITEM
        2.**********MANAGEMENT’S DISCUSSION AND
        ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**
 
 
 Statements
        in this Quarterly Report on Form 10-Q concerning the future business, operating
        results and financial condition of Qualstar, including estimates, projections,
        statements relating to our business plans, objectives and operating results,
        and
        the assumptions upon which those statements are based, are forward-looking
        statements within the meaning of Section 27A of the Securities Act of 1933
        and
        Section 21E of the Securities Exchange Act of 1934. These forward-looking
        statements inherently are subject to risks and uncertainties, some of which
        we
        cannot predict or quantify. Our actual results may differ materially from
        the
        results projected in the forward-looking statements. Factors that might cause
        such a difference include, but are not limited to, those discussed in our
        Annual
        Report on Form 10-K for the fiscal year ended June 30, 2006 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 offer tape libraries for multiple tape drive technologies
        including LTO (Linear Tape-Open tape format), AIT (Advanced Intelligent Tape),
        SAIT (Super Advanced Intelligent Tape), and DLT (Digital Linear Tape) tape
        drives and media.
 
 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
        with
        theirs, which they sell as a complete system or solution. We assist our
        customers with marketing and technical support.
 
 We
        also
        design, develop, manufacture and sell small high-efficiency open-frame switching
        power supplies for original equipment manufacturers of telecommunications
        equipment, servers, routers, switches, RAIDs, and other equipment. Our power
        supplies are sold under the N2Power brand name and private label brand names
        through independent sales representatives and distributors. The primary
        customers are original equipment manufacturers and contract
        manufacturers.
 
 
 **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.
 
 10
 **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 sale, net of
        costs.
 
 **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.
 
 **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.
 
 11
 **Accounting
        for Income Taxes**
  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,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Net
                  revenues
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %Cost
                  of goods sold
              
              
              69.1
              
              
              66.2
              
              
              70.5
              
              
              67.6Gross
                  profit
              
              
              30.9
              
              
              33.8
              
              
              29.5
              
              
              32.4Operating
                  expenses:Research
                  and development
              
              
              14.3
              
              
              13.4
              
              
              15.2
              
              
              12.6Sales
                  and marketing
              
              
              16.7
              
              
              12.6
              
              
              16.6
              
              
              12.5General
                  and administrative
              
              
              15.4
              
              
              15.8
              
              
              15.7
              
              
              15.3Total
                  operating expenses
              
              
              46.4
              
              
              41.8
              
              
              47.5
              
              
              40.4Loss
                  from operations
              
              
              (15.5
              )
              
              (8.0
              )
              
              (18.0
              )
              
              (8.0
              )Investment
                  income
              
              
              7.0
              
              
              4.7
              
              
              7.6
              
              
              4.6Loss
                  before income taxes
              
              
              (8.5
              )
              
              (3.3
              )
              
              (10.4
              )
              
              (3.4
              )Provision
                  (benefit) for income taxes
              
              
              —
              
              
              —
              
              
              —
              
              
              —Net
                  loss
              
              
              (8.5
              )%
              
              (3.3
              )%
              
              (10.4
              )%
              
              (3.4
              )%
 
 
 12
 Revenues
        are recognized upon shipment of the product to the customer, less estimated
        returns, for which provision is made at the time of sale. The following table
        summarizes our revenue by major product line:
 
 **Three
                  Months**
                **Ended**
                **December
                  31**
              
              **Six
                  Months Ended**
                **December
                  31****2006**
              
              **2005**
              
              **2006**
              
              **2005**Tape
                  Library revenues:TLS
              
              
              35.3
              %
              
              43.3
              %
              
              34.7
              %
              
              45.9
              %RLS
              
              
              6.8
              
              
              12.3
              
              
              8.5
              
              
              12.0XLS
              
              
              5.7
              
              
              0.0
              
              
              5.4
              
              
              0.047.8
              
              
              55.6
              
              
              48.6
              
              
              57.9Other
                  revenues:Service
              
              
              15.4
              
              
              13.2
              
              
              15.5
              
              
              13.0Media
              
              
              14.8
              
              
              11.8
              
              
              13.6
              
              
              12.1Power
                  Supplies
              
              
              16.4
              
              
              9.9
              
              
              16.6
              
              
              9.3Miscellaneous
              
              
              5.6
              
              
              9.5
              
              
              5.7
              
              
              7.7100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %
 
 
 **Three
        Months Ended December 31, 2006 Compared to Three Months Ended December 31,
        2005**
  **Net
        Revenue***.* Net revenues decreased to $5.3 million for the three
        months ended December 31, 2006 from $5.7 million for the three months ended
        December 31, 2005, a decrease of $0.4 million, or 7.1%. No single customer
        accounted for more than ten percent of the Company’s consolidated revenue for
        the three month periods ended December 31, 2006 and December 31, 2005*.*
 
 **Segment
          Revenue**.
          Revenues reported for the segments shown below are presented on a basis
          consistent with U.S. GAAP. Revenues reported in Note 8 - Segment Information,
          in
          Notes to Consolidated Condensed Financial Statements included in Item 1
          of this
          report, are presented in accordance with SFAS 131, *Disclosures about
          Segments of an Enterprise and Related Information*, and fiscal year 2006
          amounts have been restated for certain internal allocations.
 
 Tape
        Libraries - Net
        revenues decreased to $4.4 million for the three months ended December 31,
        2006
        from $5.1 million for the three months ended December 31, 2005, a decrease
        of
        $0.7 million, or 13.9%. The decrease in revenues is attributed to lower revenues
        from our TLS and RLS tape libraries incorporating LTO, SAIT, and DLT tape
        technologies, and miscellaneous revenues, partially offset by higher revenues
        from our XLS enterprise libraries incorporating LTO tape technology and media
        and service revenues. No single customer accounted for more than ten percent
        of
        tape library revenues for the three-month periods ended December 31, 2006
        and
        December 31, 2005.
 
 Power
        Supplies - Net
        revenues increased to $866,000 for the three months ended December 31, 2006
        from
        $561,000 for the three months ended December 31, 2005, an increase of $305,000,
        or 54.4%. The increase in revenues is attributed to growth in both sales
        to
        contract manufacturers and distribution sales. Three customers on a standalone
        basis accounted for 36.0%, 16.5% and 13.1%, respectively, or 65.6% in the
        aggregate, of power supply sales for the three months ended December 31,
        2006.
        Two customers on a standalone basis accounted for 39.7% and 10.9%, respectively,
        or 50.6% in the aggregate, of power supply sales for the three months ended
        December 31, 2005.
 
 **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 $1.6
        million for the three months ended December 31, 2006 from $1.9 million for
        the
        three months ended December 31, 2005. The decrease of $0.3 million, or 15.0%,
        is
        primarily due to a change in product mix, under absorbed manufacturing costs,
        and increased competitive pricing pressures.
 
 13
 **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 flat at $756,000 for
        the
        three months ended December 31, 2006 compared to $762,000 for the three months
        ended December 31, 2005.
 
 **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 increased to $883,000 for the three months ended
        December 31, 2006 from $715,000 for the three months ended December 31, 2005.
        The increase of $168,000, or 23.5% is primarily due to increased advertising
        and
        promotion expenses, partially offset by lower outside commission expenses
        correlated to lower revenues.
 
 **General
        and Administrative** *.* General and administrative expenses include employee salaries and benefits
        and
        professional service fees. General and administrative expenses decreased
        to
        $812,000 for the three months ended December 31, 2006 from $900,000 for the
        three months ended December 31, 2005. The decrease of $88,000, or 9.8% is
        primarily due to decreases in legal, accounting and compensation related
        expenses partially offset by higher bad debt expense.
 
 **Investment
        Income** *.* Investment income increased to $371,000 for the three months ended December
        31,
        2006 from $266,000 for the three months ended December 31, 2005. The increase
        of
        $105,000, or 39.5% is primarily due to **** the
        current higher interest rate environment **.**
 
 **Provision
        (Benefit) for Income Taxes** *.* We did
        not record a provision or benefit for income taxes for either the three months
        ended December 31, 2006 or for the three months ended December 31, 2005.
        We have
        recorded a full valuation allowance against our net deferred tax assets based
        on
        our assessment regarding the realizability of these net deferred tax assets
        in
        future periods.
 
 
 **Six
        Months Ended December 31, 2006 Compared to Six Months Ended December 31,
        2005**
  **Net Revenue** *.* Net
        revenues decreased to $9.9 million for the six months ended December 31,
        2006
        from $11.8 million for the six months ended December 31, 2005, a decrease
        of
        $1.8 million, or 15.7%. No single customer accounted for more than ten percent
        of the Company’s consolidated revenue for the six-month periods ended December
        31, 2006 and December 31, 2005 *.*
 
 Segment
        Revenues
  Tape
        Libraries - Net
        revenues decreased to $8.3 million for the six months ended December 31,
        2006
        from $10.7 million for the six months ended December 31, 2005, a decrease
        of
        $2.4 million, or 22.5%. The decrease in revenues is attributed to lower revenues
        from our TLS and RLS tape libraries incorporating LTO, AIT, SAIT, and DLT
        tape
        technologies, and lower media and miscellaneous revenues, partially offset
        by
        higher revenues from our XLS enterprise libraries incorporating LTO tape
        technology. No single customer accounted for more than ten percent of tape
        library revenues for the six-month periods ended December 31,2006 and December
        31, 2005.
 
 Power
        Supplies - Net
        revenues increased to $1.7 million for the six months ended December 31,
        2006
        from $1.1 million for the six months ended December 31, 2005, an increase
        of
        $0.6 million, or 50.6%. The increase in revenues is attributed to growth
        in both
        sales to contract manufacturers and distribution sales. Two customers on
        a
        standalone basis accounted for 29.1% and 13.4%, respectively, or 42.5% in
        the
        aggregate, of power supply sales for the six months ended December 31, 2006.
        One
        customer on a standalone basis accounted for 34.4% in the aggregate, of power
        supply sales for the six months ended December 31, 2005.
 
 **Gross
        Profit** *.* Gross
        profit decreased to $2.9 million for the six months ended December 31, 2006
        from
        $3.8 million for the six months ended December 31, 2005. The decrease of
        $0.9
        million, or 23.3%, is primarily due to a change in product mix, under absorbed
        manufacturing costs, and increased competitive pricing pressures.
 
 14
 **Research
        and Development** *.* Research and development expenses remained flat at $1.5 million for the six
        months ended December 31, 2006 compared to $1.5 million for the six months
        ended
        December 31, 2005.
 
 
 **Sales
        and Marketing** *.* Sales
        and marketing expenses increased to $1.7 million for the six months ended
        December 31, 2006 from $1.5 million for the six months ended December 31,
        2005.
        The increase of $0.2 million, or 12.1% is primarily due to increased advertising
        and promotion expenses, partially offset by lower outside commission expenses
        correlated to lower revenues and lower compensation related
        expenses.
 
 **General
        and Administrative** *.* General and administrative expenses decreased to $1.6 million for the six
        months
        ended December 31, 2006 from $1.8 million for the six months ended December
        31,
        2005. The decrease of $0.2 million, or 14.0% is primarily due to decreases
        in
        legal, accounting and compensation related expenses partially offset by higher
        bad debt expense.
 
 **Investment
        Income** *.* Investment income increased to $752,000 for the six months ended December
        31,
        2006 from $537,000 for the six months ended December 31, 2005. The increase
        of
        $215,000, or 40.0% is primarily due to **** the
        current higher interest rate environment **.**
 
 **Provision
        (Benefit) for Income Taxes** *.* We did
        not record a provision or benefit for income taxes for either the six months
        ended December 31, 2006 or for the six months ended December 31, 2005. We
        have
        recorded a full valuation allowance against our net deferred tax assets based
        on
        our assessment regarding the realizability of these net deferred tax assets
        in
        future periods.
 
 **LIQUIDITY
        AND CAPITAL RESOURCES**
  Cash
        used in operating activities was $449,000 in the six months ended December
        31,
        2006, primarily attributed to the net loss for the quarter and an increase
        in
        receivables, partially offset by a decrease in inventories and prepaids and
        other assets, and an increase in accounts payable. Cash used by operating
        activities was $4,000 in the six months ended December 31, 2005, primarily
        attributed to increases in inventories, prepaids and other assets and prepaid
        income taxes, partially offset by a decrease in accounts receivable.
 
 Cash
        used in investing activities was $510,000 in the six months ended December
        31,
        2006, primarily attributed to the purchase of marketable securities, partially
        offset by the sale of marketable securities. Cash used in investing activities
        was $3.8 million in the six months ended December 31, 2005, primarily attributed
        to the purchase of marketable securities.
 
 Cash
        was not used in or provided by financing activities during the six months
        ended
        December 31, 2006 or the six months ended December 31, 2005.
 
 As
        of
        December 31, 2006, we had $5.9 million in cash and cash equivalents and $27.6
        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.
 
 
 15
 
 **ITEM
        3.
        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.
 
 
 
 **ITEM
        4.**********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, 2006, 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, 2006 that materially affected, or are reasonably
        likely to materially affect, our internal control over financial
        reporting.
 
 
 **PART
        II —
OTHER INFORMATION**
  
 **ITEM
        6.
        EXHIBITS**
 
 **Exhibit
                  No.**
              **Exhibit
                  Index**31.1
              Certification
                  of Principal Executive Officer pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.31.2
              Certification
                  of Principal Financial Officer pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.32.1
              Certification
                  of Principal Executive Officer pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.32.2
              Certification
                  of Principal Financial Officer pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.
  16
 
  **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 14, 2007
                By:
                /s/
                    WILLIAM
                    J. GERVAISWilliam
                    J.
                    GervaisChief
                    Executive Officer, President and Director(Principal
                    Executive Officer)By:
                /s/ 
                    ANDREW  A.  FARINAAndrew
                    A.
                    FarinaPrincipal
                    Financial Officer




17