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, 2009
 
 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.
      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 has submitted electronically and posted on
its website, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files).  Yes o 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 December 31, 2009 is
12,253,117.










QUALSTARCORPORATION


FORM
10-Q


FOR
THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009


INDEX





PART
      I — FINANCIAL INFORMATIONItem
      1.
            Financial Statements·
            Condensed Consolidated Balance Sheets — December 31, 2009 and
      June 30, 2009
            1·
            Condensed Consolidated Statements of Operations — Three and six
      months ended December 31, 2009 and 2008
            2·
            Condensed Consolidated Statements of Cash Flows — Six months
      ended December 31, 2009 and 2008
            3·
            Condensed Consolidated Statement of Changes in Shareholders’
      Equity — Six months ended December 31, 2009
            4·
            Notes to Condensed Consolidated Financial
      Statements
            5Item
      2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            13Item
      3.
            Qualitative and Quantitative Disclosures About Market
      Risk
            19Item
      4T.
            Controls and Procedures
            19PART
      II — OTHER INFORMATIONItem
      1A.
            Risk Factors
            20Item
      6.
            Exhibits
            20Signatures
            21


Index


PARTI — FINANCIAL INFORMATION





ITEM
1.FINANCIAL
STATEMENTS





QUALSTAR
CORPORATION


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
thousands)





December 31,
              2009
            
            
            June 30,
              2009(Unaudited)
            
            
            (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            2,463
            
            
            $
            3,749Marketable
      securities, short-term
            
            
            13,888
            
            
            
            16,856Receivables,
      net of allowances of $55 at December 31, 2009, and $85 at June 30,
      2009
            
            
            2,109
            
            
            
            2,305Inventories,
      net
            
            
            5,197
            
            
            
            5,822Prepaid
      expenses and other current assets
            
            
            360
            
            
            
            397Total
      current assets
            
            
            24,017
            
            
            
            29,129Property
      and equipment, net
            
            
            301
            
            
            
            361Marketable
      securities, long-term
            
            
            8,610
            
            
            
            7,056Other
      assets
            
            
            46
            
            
            
            46Total
      assets
            
            $
            32,974
            
            
            $
            36,592LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            552
            
            
            $
            649Accrued
      payroll and related liabilities
            
            
            313
            
            
            
            505Other
      accrued liabilities
            
            
            858
            
            
            
            894Total
      current liabilities
            
            
            1,723
            
            
            
            2,048Other
      long term liabilities
            
            
            34
            
            
            
            34Commitments
      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, 2009 and June 30, 2009
            
            
            18,813
            
            
            
            18,798Accumulated
      other comprehensive income
            
            
            79
            
            
            
            168Retained
      earnings
            
            
            12,325
            
            
            
            15,544Total
      shareholders’ equity
            
            
            31,217
            
            
            
            34,510Total
      liabilities and shareholders’ equity
            
            $
            32,974
            
            
            $
            36,592





See
notes to 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 31,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      Revenues
            
            $
            3,597
            
            
            $
            4,623
            
            
            $
            7,276
            
            
            $
            10,025Cost
      of goods sold
            
            
            2,403
            
            
            
            3,149
            
            
            
            5,119
            
            
            
            6,668Gross
      profit
            
            
            1,194
            
            
            
            1,474
            
            
            
            2,157
            
            
            
            3,357Operating
      expenses:Research
      and development
            
            
            809
            
            
            
            765
            
            
            
            1,611
            
            
            
            1,508Sales
      and marketing
            
            
            624
            
            
            
            753
            
            
            
            1,168
            
            
            
            1,448General
      and administrative
            
            
            645
            
            
            
            802
            
            
            
            1,316
            
            
            
            1,568Total
      operating expenses
            
            
            2,078
            
            
            
            2,320
            
            
            
            4,095
            
            
            
            4,524Loss
      from operations
            
            
            (884
            )
            
            
            (846
            )
            
            
            (1,938
            )
            
            
            (1,167
            )Investment
      Income
            
            
            86
            
            
            
            291
            
            
            
            189
            
            
            
            571Loss
      before income taxes
            
            
            (798
            )
            
            
            (555
            )
            
            
            (1,749
            )
            
            
            (596
            )Benefit
      for income taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2
            )Net
      loss
            
            $
            (798
            )
            
            $
            (555
            )
            
            $
            (1,749
            )
            
            $
            (594
            )Loss
      per common share:Basic
      and Diluted
            
            $
            (0.07
            )
            
            $
            (0.05
            )
            
            $
            (0.14
            )
            
            $
            (0.05
            )Weighted
      average common shares outstanding:Basic
      and Diluted
            
            
            12,253
            
            
            
            12,253
            
            
            
            12,253
            
            
            
            12,253Cash
      dividends declared per common share
            
            $
            0.06
            
            
            $
            0.06
            
            
            $
            0.12
            
            
            $
            0.12





See
notes to condensed consolidated financial statements.


2
 Index


QUALSTARCORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)
(In thousands)





Six Months Ended
              December 31,2009
            
            
            2008OPERATING
      ACTIVITIES:Net
      loss
            
            $
            (1,749
            )
            
            $
            (594
            )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
            
            
            89
            
            
            
            110(Recovery
      of) provision for bad debts and returns, net
            
            
            (34
            )
            
            
            22Provision
      for (recovery of) inventory reserve
            
            
            174
            
            
            
            (120
            )Stock
      based compensation
            
            
            15
            
            
            
            48Loss
      (gain) on sale of securities
            
            
            1
            
            
            
            (63
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            230
            
            
            
            366Inventories
            
            
            451
            
            
            
            (126
            )Prepaid
      expenses and other assets
            
            
            37
            
            
            
            (29
            )Accounts
      payable
            
            
            (97
            )
            
            
            (452
            )Accrued
      payroll and related liabilities
            
            
            (193
            )
            
            
            (126
            )Other
      accrued liabilities
            
            
            (35
            )
            
            
            (103
            )Net
      cash used in operating activities
            
            
            (1,111
            )
            
            
            (1,067
            )INVESTING
      ACTIVITIES:Purchases
      of equipment
            
            
            (29
            )
            
            
            (23
            )Purchases
      of marketable securities
            
            
            (8,883
            )
            
            
            (19,491
            )Proceeds
      from the sale of marketable securities
            
            
            10,207
            
            
            
            20,356Net
      cash provided by investing activities
            
            
            1,295
            
            
            
            842FINANCING
      ACTIVITIES:Cash
      dividends on common shares
            
            
            (1,470
            )
            
            
            (1,470
            )Net
      cash used in financing activities
            
            
            (1,470
            )
            
            
            (1,470
            )NET
      DECREASE IN CASH AND CASH EQUIVALENTS
            
            
            (1,286
            )
            
            
            (1,695
            )CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            3,749
            
            
            
            6,744CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            2,463
            
            
            $
            5,049SUPPLEMENTAL
      CASH FLOW DISCLOSURES:Income
      taxes paid
            
            $
            10
            
            
            $
            5





See
notes to condensed consolidated financial statements.


3
 Index


QUALSTARCORPORATION


CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY


SIX
MONTHS ENDED DECEMBER 31, 2009


(Unaudited)
(In thousands)





AccumulatedOtherCommon
      Stock
            
            
            Comprehensive
            
            
            RetainedShares
            
            
            Amount
            
            
            Income
            
            
            Earnings
            
            
            TotalBalance
      at June 30, 2009
            
            
            12,253
            
            
            $
            18,798
            
            
            $
            168
            
            
            $
            15,544
            
            
            $
            34,510Share-based
      compensation
            
            
            —
            
            
            
            15
            
            
            
            —
            
            
            
            —
            
            
            
            15Cash
      dividend on common shares
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,470
            )
            
            
            (1,470
            )Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,749
            )
            
            
            (1,749
            )Change
      in unrealized losses on investments
            
            
            —
            
            
            
            —
            
            
            
            (89
            )
            
            
            —
            
            
            
            (89
            )Comprehensive
      Loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,838
            )Balance
      at December 31, 2009
            
            
            12,253
            
            
            $
            18,813
            
            
            $
            79
            
            
            $
            12,325
            
            
            $
            31,217





See
notes to condensed consolidated financial statements


4
 Index


QUALSTARCORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(Unaudited)





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
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 information included in the Qualstar Corporation Annual Report
on Form 10-K for the fiscal year ended June 30, 2009, filed with the Securities
and Exchange Commission (“SEC”) on September 25, 2009.





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.





The
Company’s wholly owned subsidiary, Qualstar Sales and Service Corporation, was
liquidated and dissolved pursuant to a plan of dissolution which was adopted by
the board of directors and approved by the sole shareholder of Qualstar Sales
and Service Corporation on June 30, 2009.  Pursuant to the plan of
dissolution, all assets of Qualstar Sales and Service Corporation were
distributed to Qualstar Corporation, and all liabilities of Qualstar Sales and
Service Corporation were assumed by Qualstar Corporation, effective June 30,
2009.





Note
2 – Recent Accounting Pronouncements





Recently
Adopted Accounting Pronouncements





On
September 15, 2009, we adopted the authoritative guidance that establishes only
two levels of U.S. generally accepted accounting principles (“GAAP”):
authoritative and nonauthoritative. The FASB Accounting Standards Codification
(the “Codification”) will become the source of authoritative U.S. accounting
principles recognized by the FASB to be applied by nongovernmental entities in
the preparation of financial statements in conformity with GAAP, except for
rules and interpretive releases of the Securities and Exchange Commission
(“SEC”), which continue to be sources of authoritative GAAP for SEC registrants.
All nongrandfathered, non-SEC accounting literature not included in the
Codification will become nonauthoritative. Adoption of the new guidance did not
have a material impact on our financial statements.





On July
1, 2009 we adopted the authoritative guidance on fair value measurement, FASB ASC 820,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). Adoption of the new guidance did not have a material impact on
our financial statements.


5
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





On July
1, 2009 we adopted the authoritative guidance issued by the Financial Accounting
Standards Board (“FASB”) on business combinations, FASB ASC 805. 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 thecapitalization of
in-process research and development at fair value, and requires theexpensing of
acquisition-related costs asincurred.  Adoption
of the new guidance did not have a material impact on our financial
statements.





On July
1, 2009 we adopted the authoritative guidance issued by the FASB that changes
the accounting and reporting for non-controlling
interests.  Noncontrolling interests 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.  Adoption of the new guidance did not have a material impact
on our financial statements.




Recent
Accounting Pronouncements Not Yet Adopted





In
January 2010, the FASB issued guidance to amend the disclosure requirements
related to recurring and nonrecurring fair value measurements. The guidance
requires new disclosures on the transfers of assets and liabilities between
Level 1 (quoted prices in active market for identical assets or liabilities) and
Level 2 (significant other observable inputs) of the fair value measurement
hierarchy, including the reasons and the timing of the transfers. Additionally,
the guidance requires a roll forward of activities on purchases, sales,
issuance, and settlements of the assets and liabilities measured using
significant unobservable inputs (Level 3 fair value measurements). The guidance
will become effective for us with the reporting period beginning January 1,
2010, except for the disclosure on the roll forward activities for Level 3 fair
value measurements, which will become effective for us with the reporting period
beginning July 1, 2011. Other than requiring additional disclosures, adoption of
this new guidance will not have a material impact on our financial
statements.





In June
2009, the FASB issued authoritative guidance which is effective for us beginning
July 1, 2010.  The new guidance requires revised evaluations of
whether entities represent variable interest entities, ongoing assessments of
control over such entities, and additional disclosures for variable interests.
Adoption of the new guidance will not have a material impact on out financial
statements.





In
October 2009, the FASB issued authoritative guidance on revenue recognition that
will become effective for us beginning July 1, 2010, with earlier adoption
permitted. Under the new guidance on arrangements that include software
elements, tangible products that have software components that are essential to
the functionality of the tangible product will no longer be within the scope of
the software revenue recognition guidance, and software-enabled products will
now be subject to other relevant revenue recognition guidance. Additionally, the
FASB issued authoritative guidance, ASU 2009-13 on revenue arrangements with
multiple deliverables that are outside the scope of the software revenue
recognition guidance, Under the new guidance, when vendor specific objective
evidence or third party evidence for deliverables in an arrangement cannot be
determined, a best estimate of the selling price is required to separate
deliverables and allocate arrangement consideration using the relative selling
price method. The new guidance includes new disclosure requirements on how the
application of the relative selling price method affects the timing and amount
of revenue recognition. We believe adoption of this new guidance 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 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.


6
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





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 38.7% of net revenues in the three months ended December 31, 2009,
and 29.3% of net revenues in the three months ended December 31, 2008. Sales
outside of North America represented approximately 31.3% of net revenues in the
six months ended December 31, 2009, and 27.2% of net revenues in the six months
ended December 31, 2008.





No single
customer accounted for more than 10% of the Company’s consolidated revenue for
the three-month period ended December 31, 2009.  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 as of December 31, 2008.





No single
customer accounted for more than 10% of the Company’s consolidated revenue for
the six-month period ended December 31, 2009.  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 as of
December 31, 2008.





Sales and
costs of goods sold related to tape library products only available from one
supplier totaled approximately 6.9% and 8.3% for the three months ended December
31, 2009 and 16.3% and 20.8% for the three months ended December 31, 2008,
respectively, of total sales and cost of goods sold. Sales and costs of goods
sold related to tape library products only available from one supplier totaled
approximately 13.5% and 15.8% for the six months ended December 31, 2009 and
15.6% and 19.3% for the six months ended December 31, 2008, respectively, of
total sales and cost of goods sold.





Note
4 – Loss Per Share





Basic
loss 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):
            
            2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      loss  (a)
            
            $
            (798
            )
            
            $
            (555
            )
            
            $
            (1,749
            )
            
            $
            (594
            )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)
            
            $
            (0.07
            )
            
            $
            (0.05
            )
            
            $
            (0.14
            )
            
            $
            (0.05
            )Diluted
      net loss per share  (a)/(c)
            
            $
            (0.07
            )
            
            $
            (0.05
            )
            
            $
            (0.14
            )
            
            $
            (0.05
            )





Stock
options are excluded for the three and six-month periods ended December 31, 2009
and 2008, respectively, from the computation of diluted loss per share, as the
effect would have been anti-dilutive.


7
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





Note
5 – Marketable Securities





Marketable
securities consist primarily of commercial paper, U.S. government and agency
securities, mortgage-backed securities and corporate bonds. 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, 2009 and June 30, 2009.





The
following tables summarize the marketable securities by security type at
December 31, 2009, and June 30, 2009, respectively (in thousands):





December
      31, 2009
            
            Amortized
              Cost
            
            
            Unrealized
              Gain
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Short-term
      Securities
            
            
            Long-term
      SecuritiesUS
      Treasury obligations and U.S. Government agencies
            
            $
            19,962
            
            
            $
            58
            
            
            $
            —
            
            
            $
            20,020
            
            
            $
            12,090
            
            
            $
            7,930Collateralized
      mortgage obligations
            
            
            1,414
            
            
            
            22
            
            
            
            —
            
            
            
            1,436
            
            
            
            1,436
            
            
            
            —Corporate
      bonds
            
            
            1,043
            
            
            
            —
            
            
            
            (1
            )
            
            
            1,042
            
            
            
            362
            
            
            
            680Total
            
            $
            22,419
            
            
            $
            80
            
            
            $
            (1
            )
            
            $
            22,498
            
            
            $
            13,888
            
            
            $
            8,610





June 30, 2009
            
            Amortized
              Cost
            
            
            Unrealized
              Gain
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Short-term Securities
            
            
            Long-term SecuritiesUS
      Treasury obligations and U.S. Government agencies
            
            $
            20,616
            
            
            $
            119
            
            
            $
            —
            
            
            $
            20,735
            
            
            $
            14,110
            
            
            $
            6,625Collateralized
      mortgage obligations
            
            
            2,376
            
            
            
            47
            
            
            
            —
            
            
            
            2,423
            
            
            
            1,992
            
            
            
            431Corporate
      bonds
            
            
            752
            
            
            
            2
            
            
            
            —
            
            
            
            754
            
            
            
            754
            
            
            
            —Total
            
            $
            23,744
            
            
            $
            168
            
            
            $
            —
            
            
            $
            23,912
            
            
            $
            16,856
            
            
            $
            7,056





There
were no unrealized loss positions as of June 30, 2009. The following table shows
the gross unrealized losses and fair value of the Company’s investments with
unrealized losses that are not deemed to be other-than-temporarily impaired,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2009 (in
thousands):





Less Than 12 Months
            
            
            12 Months or Greater
            
            
            TotalDecember 31, 2009
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              LossCorporate
      bonds
            
            
            362
            
            
            
            (1
            )
            
            
            680
            
            
            
            —
            
            
            
            1,042
            
            
            
            (1
            )Total
            
            $
            362
            
            
            $
            (1
            )
            
            $
            680
            
            
            $
            —
            
            
            $
            1,042
            
            
            $
            (1
            )





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 untilrealized. 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. Loss (gain) on the sale of
marketable securities for the three months ended December 31, 2009 and 2008 was
($1,000) and $67,000, respectively. Loss (gain) on the sale of securities for
the six months ended December 31, 2009 and 2008 was ($1,000) and $63,000,
respectively.  The change in net unrealized holding gain (loss) 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, 2009 and
2008 was ($89,000) and $201,000, respectively.


8
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





Note
6 – Fair Value Measurements





We
account for certain assets and liabilities at fair value. Fair value is defined
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.





The
hierarchy below prioritizes the valuation 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
similarassets 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, 2009 does not contain direct
exposure to subprime mortgages or structured vehicles that derive their value
from subprime collateral.  Our mortgage-backed securities are
collateralized by prime residential mortgages and carry a 100% principal and
interest guarantee, primarily from Federal National Mortgage Association and
Federal Home Loan Mortgage Corporation.





Assets
and Liabilities Measured at Fair Value on a Recurring Basis





The
following table presents our assets and liabilities measured at fair value on a
recurring basis at December 31, 2009 (in thousands):





Assets
            
            Level 1
            
            
            Level 2
            
            
            Net BalanceCash
            
            $
            837
            
            
            
            –
            
            
            $
            837Money
      Market Mutual fund
            
            
            1,625
            
            
            
            –
            
            
            
            1,625U.S.
      government and agency securities
            
            
            10,775
            
            
            
            9,245
            
            
            
            20,020Mortgage-backed
      securities
            
            
            –
            
            
            
            1,436
            
            
            
            1,436Corporate
      bonds
            
            
            –
            
            
            
            1,042
            
            
            
            1,042Total
            
            $
            13,237
            
            
            $
            11,723
            
            
            $
            24,960


9
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





Note
7 - Inventories





Inventories
are stated at the lower of cost (first-in, first-out basis) or market.
Inventories are comprised as follows (in thousands):





December 31,
              2009
            
            
            June 30,
              2009Raw
      materials
            
            $
            4,825
            
            
            $
            5,389Finished
      goods
            
            
            1,367
            
            
            
            1,248Subtotal
            
            
            6,192
            
            
            
            6,637Less:
      Inventory reserve
            
            
            (995
            )
            
            
            (815
            )$
            5,197
            
            
            $
            5,822





Note
8 – Warranty Obligations





We
provide for the estimated costs of hardware warranties at the time the related
revenue is recognized. We estimate the costs based on historical and projected
product failure rates, historical and projected repair costs, and knowledge of
specific product failures (if any). The specific hardware warranty terms and
conditions for tape libraries generally include parts and labor over a
three-year period. The warranty for power supplies generally is two years. We
regularly re-evaluate our estimates to assess the adequacy of the


recorded
warranty liabilities and adjust the amounts as necessary.




Activity
in the liability for product warranty for the periods presented were as follows
(in thousands):





Six Months Ended
              December 31,2009
            
            
            2008Beginning
      balance
            
            $
            167
            
            
            $
            181Cost
      of warranty claims
            
            
            (32
            )
            
            
            (33
            )Accruals
      for product warranties
            
            
            24
            
            
            
            31Ending
      balance
            
            $
            159
            
            
            $
            179





Note
9 – Comprehensive Loss





For the
six months ended December 31, 2009 and 2008, comprehensive loss amounted to
approximately $1,838,000 and $393,000, 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 marketable
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 did
not record a provision or benefit for income taxes for the six months ended
December 31, 2009. We recorded a benefit for income taxes of $2,000 for the six
months ended December 31, 2008.


10
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





The
Company has recorded a full valuation allowance against its net deferred tax
assets based on the Company’s assessment regarding the realizability of these
net deferred tax assets in future periods.





Note
12 – Segment Information





In its
operation of the business, management reviews certain financial information,
including segmented internal profit and loss statements prepared on a basis
consistent with U.S. GAAP. 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, 2009 and 2008. Allocations for internal resources were made for the
six months ended December 31, 2009 and 2008. 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 was not
segregated between the two segments, but retained by the library segment through
the third quarter of fiscal 2009. Cash was segregated between the two segments
commencing in the fourth quarter of fiscal 2009.





The types
of products and services provided by each segment are summarized
below:





Tape Libraries — We design,
develop, manufacture and sell automated magnetic tape libraries used to store,
retrieve and manage electronic data primarily in network computing environments.
Tape libraries consist of cartridge tape drives, tape cartridges and robotics to
move the cartridges from their storage locations to the tape drives under
software control. Our tape libraries provide data storage solutions for
organizations requiring backup, recovery and archival storage of critical
data.





Power Supplies — We design,
manufacture, and sell small, open frame, high efficiency switching power
supplies. These power supplies are used to convert AC line voltage to DC
voltages, or DC Voltages to other DC voltages for use in a wide variety of
electronic equipment such as telecommunications equipment, machine tools,
routers, switches, wireless systems and gaming devices.





Segment
revenue, loss before taxes and total assets were as follows (in
thousands):





Three Months Ended
              December 31,
            
            
            Six Months Ended
              December 30,2009
            
            
            2008
            
            
            2009
            
            
            2008RevenueTape
      Libraries:Product
            
            $
            1,911
            
            
            $
            2,520
            
            
            $
            3,667
            
            
            $
            5,596Service
            
            
            715
            
            
            
            625
            
            
            
            1,447
            
            
            
            1,337Total
      Tape Libraries
            
            
            2,626
            
            
            
            3,145
            
            
            
            5,114
            
            
            
            6,933Power
      Supplies
            
            
            971
            
            
            
            1,478
            
            
            
            2,162
            
            
            
            3,091Consolidated
      Revenue
            
            $
            3,597
            
            
            $
            4,623
            
            
            $
            7,276
            
            
            $
            10,024





Three Months Ended
              December 31,
            
            
            Six Months Ended
              December 31,2009
            
            
            2008
            
            
            2009
            
            
            2008Income (Loss) before TaxesTape
      Libraries
            
            $
            (616
            )
            
            $
            (620
            )
            
            $
            (1,507
            )
            
            $
            (784
            )Power
      Supplies
            
            
            (182
            )
            
            
            65
            
            
            
            (242
            )
            
            
            190Consolidated
      Loss before Taxes
            
            $
            (798
            )
            
            $
            (555
            )
            
            $
            (1,749
            )
            
            $
            (596
            )


11
 Index


QUALSTAR
CORPORATION





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- (Continued)





December 31,
              2009
            
            
            June 30,
              2009Total AssetsTape
      Libraries
            
            $
            33,737
            
            
            $
            37,172Power
      Supplies
            
            
            (763
            )
            
            
            (580
            )Consolidated
      Assets
            
            $
            32,974
            
            
            $
            36,592





Note
13 – Subsequent Event





The
Company has performed an evaluation of subsequent events through February 11,
2010, the date the Company issued these financial statements.


12
 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, 2009 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 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 part of a 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 some of 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.


13
 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).  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). 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.


14
 Index


Share-Based
Compensation





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
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. See Note 11 – Income Taxes.





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 31,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      revenues
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of goods sold
            
            
            66.8
            
            
            
            68.1
            
            
            
            70.4
            
            
            
            66.5Gross
      profit
            
            
            33.2
            
            
            
            31.9
            
            
            
            29.6
            
            
            
            33.5Operating
      expenses:Research
      and development
            
            
            22.5
            
            
            
            16.5
            
            
            
            22.1
            
            
            
            15.0Sales
      and marketing
            
            
            17.3
            
            
            
            16.3
            
            
            
            16.1
            
            
            
            14.4General
      and administrative
            
            
            17.9
            
            
            
            17.3
            
            
            
            18.1
            
            
            
            15.6Total
      operating expenses
            
            
            57.7
            
            
            
            50.1
            
            
            
            56.3
            
            
            
            45.0Loss
      from operations
            
            
            (24.5
            )
            
            
            (18.2
            )
            
            
            (26.7
            )
            
            
            (11.5
            )Investment
      income
            
            
            2.4
            
            
            
            6.3
            
            
            
            2.6
            
            
            
            5.7Loss
      before income taxes
            
            
            (22.1
            )
            
            
            (11.9
            )
            
            
            (24.1
            )
            
            
            (5.8
            )Provision
      for income taxes
            
            
            0.0
            
            
            
            0.0
            
            
            
            0.0
            
            
            
            0.0Net
      loss
            
            
            (22.1
            )%
            
            
            (11.9
            )%
            
            
            (24.1
            )%
            
            
            (5.8
            )%


15
 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
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Tape
      Library revenues:TLS
            
            
            17.8
            %
            
            
            25.8
            %
            
            
            18.8
            %
            
            
            24.6
            %RLS
            
            
            6.0
            
            
            
            5.1
            
            
            
            5.4
            
            
            
            7.4XLS
            
            
            22.7
            
            
            
            4.8
            
            
            
            15.2
            
            
            
            6.646.5
            
            
            
            35.7
            
            
            
            39.4
            
            
            
            38.6Other
      library revenues:Service
            
            
            19.9
            
            
            
            13.5
            
            
            
            19.9
            
            
            
            13.3Media
            
            
            3.6
            
            
            
            13.9
            
            
            
            7.6
            
            
            
            12.8Upgrades,
      spares
            
            
            3.0
            
            
            
            4.9
            
            
            
            3.4
            
            
            
            4.526.5
            
            
            
            32.3
            
            
            
            30.9
            
            
            
            30.6Total
      Library revenues
            
            
            73.0
            
            
            
            68.0
            
            
            
            70.3
            
            
            
            69.2Power
      Supply revenues
            
            
            27.0
            
            
            
            32.0
            
            
            
            29.7
            
            
            
            30.8100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %





Three
Months Ended December 31, 2009 Compared to Three Months Ended December 31,
2008





Net Revenue.  Net revenues
decreased to $3.6 million for the three months ended December 31, 2009 from $4.6
million for the three months ended December 31, 2008, a decrease of $1.0
million, or 22.2%. No single customer accounted for more than 10% of the
Company’s consolidated revenue for the three-month period ended December 31,
2009.  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 as of December 31,
2008.





Segment Revenue





Tape Libraries – Net
tape library revenues decreased to $2.6 million for the three months ended
December 31, 2009 from $3.1 million for the three months ended December 31,
2008, a decrease of $0.5 million, or 16.5%. The decrease in revenues is
attributed primarily to a $0.6 million decline in revenues from our TLS product
line and a $0.5 million decline in sales of tape media, offset in part by a $0.6
million increase in revenues from our XLS product line. Sales of our TLS tape
libraries have declined in part because demand for libraries using AIT tape
drives has continued to decline and we expect this trend to
continue.





Power Supplies – Net
revenues from power supplies decreased to $1.0 million for the three months
ended December 31, 2009 from $1.5 million for the three months ended December
31, 2008, a decrease of $0.5 million, or 34.3%. The decrease in revenues is
attributed to lower sales to original equipment manufacturer customers and
distributors.





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 $1.2 million, or 33.2%
of net revenues, for the three months ended December 31, 2009 from $1.5 million,
or 31.9% of net revenues, for the three months ended December 31,
2008.  The increase in gross profit percentage is attributed to a
change in product mix, partially offset by lower absorption of labor and
overhead and an increase in inventory reserves.


16
 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 remained comparable at $0.8 million for the
three months ended December 31, 2009 and $0.8 million for the three months ended
December 31, 2008.





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 $0.6 million for the three months ended
December 31, 2009 from $0.7 million for the three months ended December 31,
2008.  The decrease of $0.1 million, or 17.1%, is primarily due to a
decrease in compensation related to reductions in personnel and a decrease 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 $0.6 million for
the three months ended December 31, 2009 from $0.8 million for the three months
ended December 31, 2008.  The decrease of $0.2 million, or 19.6%, is
primarily due to a decrease in compensation related to reductions in personnel
and bad debt expenses.





Investment Income.  Investment
income decreased to $0.1 million for the three months ended December 31, 2009
from $0.3 million for the three months ended December 31, 2008. The decrease of
$0.2 million, or 70.4% is primarily due to the lower interest rate environment
and partially due to having approximately $5.3 million less cash, cash
equivalents and marketable securities in the quarter ended December 31, 2009
compared to the prior year quarter.





Provision for Income
Taxes.  We did not
record a provision or benefit for income taxes for the three months ended
December 31, 2009 or for the three months ended December 31, 2008.





Six
Months Ended December 31, 2009 Compared to Six Months Ended December 31,
2008





Net Revenue.  Net revenues
decreased to $7.3 million for the six months ended December 31, 2009 from $10.0
million for the six months ended December 31, 2008, a decrease of $2.7 million,
or 27.4%. No single customer accounted for more than 10% of the Company’s
consolidated revenue for the six-month period ended December 31, 2009. 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 as of December 31, 2008.





Segment Revenue





Tape Libraries – Net
tape library revenues decreased to $5.1 million for the six months ended
December 31, 2009 from $6.9 million for the six months ended December 31, 2008,
a decrease of $1.8 million, or 26.25%. The decrease in revenues is attributed
primarily to a $1.4 million decline in revenues from our TLS and RLS product
lines and a $0.9 million decline in revenues from tape media and miscellaneous
items, partially offset by a $0.4 million increase in revenues from our XLS
product line and a $0.1 million increase in service revenues. Sales of our TLS
tape libraries have declined in part because demand for libraries using AIT tape
drives has continued to decline and we expect this trend to
continue.





Power Supplies – Net
revenues from power supplies decreased to $2.2 million for the six months ended
December 31, 2009 from $3.1 million for the six months ended December 31, 2008,
a decrease of $0.9 million, or 30.1%. The decrease in revenues is attributed to
lower sales to original equipment manufacturer customers.





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 $2.2 million, or 29.6%
of net revenues, for the six months ended December 31, 2009 from $3.4 million,
or 33.5% of net revenues, for the six months ended December 31,
2008.  The decrease in gross profit is attributed to lower revenues,
an increase in inventory reserves, and lower absorption of 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 increased to $1.6 million for the
six months ended December 31, 2009 from $1.5 million for the six months ended
December 31, 2008. The increase of $0.1 million, or 6.8% is primarily due to an
increase in consulting fees and miscellaneous expenses.


17
 Index


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 $1.2 million for the six months ended
December 31, 2009 from $1.5 million for the six months ended December 31,
2008.  The decrease of $0.3 million, or 19.3%, is primarily due to a
decrease in compensation related to reductions in personnel, commission expenses
and 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 $1.3 million for
the six months ended December 31, 2009 from $1.6 million for the six months
ended December 31, 2008.  The decrease of $0.3 million, or 16.1%, is
primarily due to a decrease in compensation related to reductions in personnel
and bad debt expenses.





Investment Income.  Investment
income decreased to $0.2 million for the six months ended December 31, 2009 from
$0.6 million for the six months ended December 31, 2008. The decrease of $0.4
million, or 66.9% is primarily due to the lower interest rate environment and
partially due to having approximately $5.3 million less cash, cash equivalents
and marketable securities in the six months ended December 31, 2009 compared to
the prior year quarter.





Provision for Income
Taxes.  We did not
record a provision or benefit for income taxes for the six months ended December
31, 2009. We recorded a benefit for income taxes of $2,000 for the six months
ended December 31, 2008.





LIQUIDITY
AND CAPITAL RESOURCES





Net cash
used by operating activities remained comparable at $1.1 million in the six
months ended December 31, 2009 and December 31, 2008. Net cash used by operating
activities in the six months ended December 31, 2009 was primarily attributed to
the net loss for the period and decreases in accounts payable, accrued payroll
and related liabilities, partially offset by decreases in accounts receivable
and inventories. Net cash used by operating activities in the six months ended
December 31, 2008, was primarily attributed to the net loss for the period, an
increase in inventories and decreases in accounts payable, other accrued
liabilities, and accrued payroll and related liabilities, partially offset by a
decrease in accounts receivable.





Cash
provided by investing activities was $1.3 million in the six months ended
December 31, 2009, primarily attributed to the sale of marketable securities,
partially offset by the purchase of marketable securities.  Cash
provided by investing activities was $0.8 million in the six months ended
December 31, 2008, primarily attributed to proceeds from the sale of marketable
securities, partially offset by the purchase of marketable
securities.





Cash used
in financing activities was $1.5 million in the six months ended December 31,
2009, attributed to the payment of cash dividends of $0.06 per share of our
common stock in each of the first and second quarters of fiscal
2010.  Cash used in financing activities during the six months ended
December 31, 2008 was also $1.5 million, attributed to the payment of cash
dividends of $0.06 per share of our common stock in each of the first and second
quarters of fiscal 2009.





As of
December 31, 2009, we had $2.5 million in cash and cash equivalents and $22.5
million in marketable securities.  We believe that our existing cash
and cash equivalents and anticipated cash flows from our operating activities,
plus funds available from the sale of our marketable securities, will be
sufficient to fund our working capital and capital expenditure needs for at
least the next 12 months. We may utilize cash to invest in businesses, products
or technologies that we believe are strategic. We regularly evaluate other
companies and technologies for possible investment by us. In addition, we have
made and may in the future make investments in companies with whom we have
identified potential synergies. However, we have no present commitments or
agreements with respect to any material acquisition of other businesses or
technologies.


18
 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, 2009, 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, 2009 of Qualstar’s fiscal year ending June 30, 2010,
that materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.


19
 Index


PARTII — OTHER INFORMATION





ITEM
1A.   Risk
Factors





There
have been no significant changes to the risk factors disclosed in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2009.





ITEM6.   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.


20
 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 11, 2010
            By:
            /s/    WILLIAM J.
      GERVAISWilliam
      J. GervaisChief
      Executive Officer and President(Principal
      Executive Officer)






21