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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-Q



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x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934


For the quarterly period ended September 30, 2003

o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934


For the transition period from _______ to _______

Commission file number 000-30083

QUALSTAR CORPORATION

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


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   x     No   o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes   o     No   x

Total shares of common stock without par value outstanding at October 24, 2003
is 12,639,609.



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TABLE OF CONTENTS



|                               |                                                                                               |                                       |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | ITEM 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS
|                               | ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | ITEM 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | ITEM 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | ITEM 1. Legal Proceedings                                                                    
|                               | ITEM 6. Exhibits and Reports on Form 8-K.                                                    
|SIGNATURES                    
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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Table of Contents

PART. I FINANCIAL INFORMATIONITEM 1. Financial Statements
    
    
    3Condensed consolidated balance sheets as of June 30, 2003 and September 30, 2003
    
    
    3Condensed consolidated statements of operations for the three months ended September 30, 2002 and 2003
    
    
    4Condensed consolidated statements of cash flows for the three months ended September 30, 2002 and 2003
    
    
    5Condensed consolidated statement of changes in shareholders equity for the three months ended September 30, 2003
    
    
    6Notes to interim condensed consolidated financial statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10ITEM 3. Qualitative and Quantitative Disclosures About Market Risk
    
    
    11ITEM 4. Controls and Procedures
    
    
    12PART. II OTHER INFORMATION
ITEM 1. Legal Proceedings
    
    
    13ITEM 6. Exhibits and Reports on Form 8-K
    
    
    13Signatures
    
    
    14


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PART I  FINANCIAL INFORMATION




ITEM 1. Financial Statements




QUALSTAR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2003 AND SEPTEMBER 30, 2003
(in thousands)

JUNE 30,
    
    SEPTEMBER 30,2003
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    6,236
    
    
    $
    8,781Marketable securities
    
    
    29,857
    
    
    
    28,340Receivables, net of allowances of $260 at June 30 and September 30
    
    
    4,535
    
    
    
    3,333Inventories
    
    
    7,091
    
    
    
    7,308Prepaid expenses and other current assets
    
    
    234
    
    
    
    543Prepaid income taxes
    
    
    1,336
    
    
    
    995Deferred income taxes
    
    
    939
    
    
    
    939Total current assets
    
    
    50,228
    
    
    
    50,239Property and equipment, net
    
    
    1,557
    
    
    
    1,484Other assets
    
    
    311
    
    
    
    298Total assets
    
    $
    52,096
    
    
    $
    52,021LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,136
    
    
    $
    1,398Accrued payroll and related liabilities
    
    
    432
    
    
    
    576Other accrued liabilities
    
    
    1,469
    
    
    
    1,458Total current liabilities
    
    
    3,037
    
    
    
    3,432Deferred income taxes
    
    
    191
    
    
    
    191Shareholders equity:Preferred stock, no par value; 5,000 shares authorized; no shares issued
    
    
    
    
    
    
    Common stock, no par value; 50,000 shares authorized, 12,640 shares
issued and outstanding at June 30, 2003 and September 30, 2003
    
    
    20,366
    
    
    
    20,366Deferred compensation
    
    
    (140
    )
    
    
    (75
    )Notes from directors
    
    
    (156
    )
    
    
    (158
    )Accumulated other comprehensive income (loss)
    
    
    (22
    )
    
    
    21Retained earnings
    
    
    28,820
    
    
    
    28,244Total shareholders equity
    
    
    48,868
    
    
    
    48,398Total liabilities and shareholders equity
    
    $
    52,096
    
    
    $
    52,021


See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2003
(in thousands, except per share amounts)
(UNAUDITED)

THREE MONTHS ENDEDSEPTEMBER 30,2002
    
    2003Net revenues
    
    $
    8,792
    
    
    $
    5,976Cost of goods sold
    
    
    5,614
    
    
    
    3,736Gross profit
    
    
    3,178
    
    
    
    2,240Operating expenses:Research and development
    
    
    833
    
    
    
    1,158Sales and marketing
    
    
    856
    
    
    
    701General and administrative
    
    
    897
    
    
    
    1,358Total operating expenses
    
    
    2,586
    
    
    
    3,217Income (loss) from operations
    
    
    592
    
    
    
    (977
    )Investment income
    
    
    284
    
    
    
    155Income (loss) before provision for income taxes
    
    
    876
    
    
    
    (822
    )Provision (benefit) for income taxes
    
    
    374
    
    
    
    (246
    )Net income (loss)
    
    $
    502
    
    
    $
    (576
    )Basic earnings (loss) per share
    
    $
    0.04
    
    
    $
    (0.05
    )Diluted earnings (loss) per share
    
    $
    0.04
    
    
    $
    (0.05
    )Shares used to compute earnings (loss) per share:Basic
    
    
    12,548
    
    
    
    12,586Diluted
    
    
    12,563
    
    
    
    12,586


See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2003
(in thousands)
(UNAUDITED)

Three Months EndedSeptember 30,2002
    
    2003OPERATING ACTIVITIES:Net income (loss)
    
    $
    502
    
    
    $
    (576
    )Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization
    
    
    88
    
    
    
    103Amortization of deferred compensation
    
    
    107
    
    
    
    65Provision for (recovery of) bad debts and returns
    
    
    12
    
    
    
    (1
    )Accrued interest on directors notes
    
    
    (5
    )
    
    
    (2
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    1,886
    
    
    
    1,203Inventories
    
    
    1,888
    
    
    
    (217
    )Prepaid expenses and other assets
    
    
    (209
    )
    
    
    (308
    )Prepaid income taxes and income taxes payable
    
    
    87
    
    
    
    341Accounts payable
    
    
    (1,021
    )
    
    
    262Accrued liabilities
    
    
    (147
    )
    
    
    133Net cash provided by operating activities
    
    
    3,188
    
    
    
    1,003INVESTING ACTIVITIES:Purchases of equipment and leasehold improvements
    
    
    (163
    )
    
    
    (18
    )Sales of marketable securities
    
    
    5,292
    
    
    
    10,555Purchases of marketable securities
    
    
    (3,000
    )
    
    
    (8,995
    )Purchase of assets of N2Power, Inc.
    
    
    (288
    )
    
    
    Net cash provided by investing activities
    
    
    1,841
    
    
    
    1,542FINANCING ACTIVITIES:Principal and interest payments on directors notes
    
    
    38
    
    
    
    Net cash provided by financing activities
    
    
    38
    
    
    
    Net increase in cash and cash equivalents
    
    
    5,067
    
    
    
    2,545Cash and cash equivalents at beginning of period
    
    
    16,363
    
    
    
    6,236Cash and cash equivalents at end of period
    
    $
    21,430
    
    
    $
    8,781Supplemental cash flow disclosure:Income taxes paid
    
    $
    250
    
    
    $
    10


See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY
THREE MONTHS ENDED SEPTEMBER 30, 2003
(in thousands)
(UNAUDITED)

ACCUMULATEDNOTES
    
    OTHERCOMMON STOCK
    
    DEFERRED
    
    FROM
    
    COMPREHENSIVE
    
    RETAINEDSHARES
    
    AMOUNT
    
    COMPENSATION
    
    DIRECTORS
    
    LOSS
    
    EARNINGS
    
    TOTALBalance at July 1, 2003
    
    
    12,640
    
    
    $
    20,366
    
    
    $
    (140
    )
    
    $
    (156
    )
    
    $
    (22
    )
    
    $
    28,820
    
    
    $
    48,868Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    65
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    65Accrued interest on directors notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Comprehensive loss:Change in unrealized losses on investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    43Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (576
    )
    
    
    (576
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (533
    )Balance at September 30, 2003
    
    
    12,640
    
    
    $
    20,366
    
    
    $
    (75
    )
    
    $
    (158
    )
    
    $
    21
    
    
    $
    28,244
    
    
    $
    48,398


See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(in thousands, except per share amounts)
(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements are
unaudited, except for the balance sheet at June 30, 2003 which is derived from
our audited financial statements, and should be read in conjunction with the
consolidated financial statements and related notes included in Qualstar
Corporations (Qualstar, us, we, or our) Annual Report on Form 10-K
filed with the Securities and Exchange Commission (SEC) on September 26, 2003.
In the opinion of management, these unaudited condensed consolidated financial
statements include all adjustments, consisting primarily of normal recurring
items, which are necessary for the fair presentation of Qualstars consolidated
financial position as of September 30, 2003, consolidated results of operations
for the three months ended September 30, 2003, and consolidated cash flows for
the three months ended September 30, 2003. Operating results for the three
month period ended September 30, 2003 are not necessarily indicative of results
to be expected for a full year.

NOTE 2. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted net
income per share for the three months ended September 30, 2002 and 2003:

THREE MONTHSSEPTEMBER 30,2002
    
    2003Numerator:Net income (loss)
    
    $
    502
    
    
    $
    (576
    )Denominator:Denominator for basic net income
(loss) per share  weighted average
shares
    
    
    12,548
    
    
    
    12,586Dilutive potential common shares
from employee stock options and
restricted stock
    
    
    15
    
    
    
    Denominator for diluted net income
(loss) per share  adjusted weighted
average shares and assumed
conversions
    
    
    12,563
    
    
    
    12,586Basic net income (loss) per share
    
    $
    0.04
    
    
    $
    (0.05
    )Diluted net income (loss) per share
    
    $
    0.04
    
    
    $
    (0.05
    )




| |  | Shares issuable under stock options of 220,000 at September 30, 2002 have
been excluded from the computation of diluted earnings per share as the
effect would have been antidilutive. All shares related to options are
excluded at September 30, 2003 due to the loss in the quarter as the effect
would have been antidilutive.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

NOTE 3. MARKETABLE SECURITIES

Marketable securities consist primarily of high-quality corporate, federal
and state government securities. These securities are classified in one of
three categories: trading, available-for-sale, or held-to-maturity. Trading
securities are bought and held principally for the purpose of selling them in
the near term. Held-to-maturity securities are those securities which the
Company 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 the Companys marketable securities were classified
as available-for-sale at June 30, 2003 and September 30, 2003.

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.

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NOTE 4. INVENTORIES

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

JUNE 30, 2003
    
    SEPTEMBER 30, 2003Raw materials
    
    $
    6,454
    
    
    $
    6,686Finished goods
    
    
    637
    
    
    
    622$
    7,091
    
    
    $
    7,308


NOTE 5. COMPREHENSIVE INCOME (LOSS)

For the three months ended September 30, 2002 and 2003, comprehensive
income (loss) amounted to approximately $0.5 million and $(0.5) million,
respectively. The difference between net income (loss) and comprehensive income
(loss) relates to the changes in the unrealized losses or gains the Company
recorded for its available-for-sale securities.

NOTE 6. STOCK BASED COMPENSATION

Employee stock options are accounted for under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, as amended and
interpreted, which requires recognition of expense when the option price is
less than the fair value of the stock at the date of grant. The Company
generally awards options for a fixed number of shares at an option price equal
to the fair value of the stock at the date of grant. The Company has adopted
the disclosure only provisions of the Financial Accounting Standards Boards
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation (SFAS 123).

If the Company recognized employee stock option related compensation
expense in accordance with SFAS 123 and used the minimum value method for
grants prior to the Companys initial public offering and the Black-Scholes
method model afterward for determining the weighted average fair value of
options granted, the Companys net income and earnings per share would have
been reduced to the pro forma amounts indicated below:

THREE MONTHSSEPTEMBER 30,2002
    
    2003Net income (loss) as reported
    
    $
    502
    
    
    $
    (576
    )Stock-based employee compensation cost included in reported
net income (loss)
    
    
    107
    
    
    
    65Pro forma stock-based employee compensation cost under SFAS 123
    
    
    (171
    )
    
    
    (120
    )Pro forma net income (loss)
    
    $
    438
    
    
    $
    (631
    )Earnings (loss) per share:Basic  as reported
    
    $
    0.04
    
    
    $
    (0.05
    )Basic  pro forma
    
    $
    0.03
    
    
    $
    (0.05
    )Diluted  as reported
    
    $
    0.04
    
    
    $
    (0.05
    )Diluted  pro forma
    
    $
    0.03
    
    
    $
    (0.05
    )Basic Weighted Average Shares
    
    
    12,548
    
    
    
    12,586Diluted Weighted Average Shares
    
    
    12,563
    
    
    
    12,586


All shares issuable under stock options at September 30, 2003 have been
excluded from the proforma diluted earnings per share computation for the three
month period ended September 30, 2003 due to the loss in the quarter.

NOTE 7. BUSINESS ACQUISITIONS

On July 11, 2002, the Company acquired the assets and intellectual
properties of N2Power, Incorporated (N2Power), a privately held company which
designs and produces small and efficient open-frame switching power supplies.
The consideration for this acquisition was $250,000 plus acquisition expenses
of $38,000. The purchase price was primarily allocated to a patent which will
be amortized over 5 years. The accompanying consolidated financial statements
include the operations of N2Power from the date of acquisition.

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NOTE 8. STOCK REPURCHASE

On February 12, 2003, the Company announced that the Board of Directors
authorized a stock repurchase program of up to 500,000 shares of the Companys
common stock. The stock repurchase will be funded by available working capital.
There is no time limit for the completion of the stock repurchase program and
it may be discontinued at any time. No shares were repurchased during the
quarter ended September 30, 2003. As of September 30, 2003, the Company had
repurchased a total of 76,567 shares of its common stock at a total cost of
approximately $344,000, or an average price of approximately $4.50 per share.

NOTE 9. LEGAL PROCEEDINGS

On January 10, 2003, Raytheon Company (Raytheon) filed a complaint in
the United States District Court for the Eastern District of Texas alleging
that Qualstar and eight other named defendants infringe a patent owned by
Raytheon entitled Mass Data Storage Library. Raytheon filed an amended
complaint on or about February 6, 2003, which includes an allegation that
Qualstars tape libraries infringe Raytheons patent. The complaint seeks an
injunction against all defendants and an unspecified amount of damages.
Qualstar responded to the complaint on March 7, 2003 and denied Raytheons
allegations of infringement. The parties are currently in the process of
pre-trial discovery. A patent claims construction hearing is presently
scheduled for January 14, 2004 and a trial is scheduled for June 7, 2004, both
of which will be located in Marshall, Texas. Qualstar and our legal counsel
continue to analyze Raytheons patent and available defenses to the claims of
infringement. Based on this analysis, we believe that Raytheons claims
against us are without merit and we intend to vigorously defend against this
complaint. We do not believe the ultimate outcome of this matter will have a
material impact on our financial position or results of operations.

Qualstar
may be involved in litigation or other legal proceedings from time to
time in the normal course of business. Other than the Raytheon lawsuit
discussed above, however, there are no material actions currently
pending.

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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 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, 2003 in ITEM 1 Business, including the section therein entitled
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.

RESULTS OF OPERATIONSThree Months Ended September 30, 2003 Compared to Three Months Ended September
30, 2002.

NET REVENUES. Revenues are recognized upon shipment of the product to the
customer, less estimated returns, for which provision is made at the time of
sale.

Net
revenues for the three months ended September 30, 2003 were
$6.0 million, compared with net revenues of $8.8 million
for the three months ended September 30, 2002, a decrease of
$2.8 million. The primary reason for this decrease was reduced
demand for our tape libraries which incorporate AIT (Advanced
Intelligent Tape) technology. The current generation of 8 millimeter
AIT tape drives (AIT3) contain a maximum native capacity of
100 gigabytes per tape. In the past year, the capacity of tape
drives using the LTO (Linear Tape Open) half-inch tape format was
increased to a maximum of 200 gigabytes, native, surpassing that
of AIT tape drives. Although we offer all major tape formats in our
libraries, historically we have sold mostly AIT-based tape libraries.
Recently, sales of our libraries incorporating half-inch tape
technologies, such as LTO, SDLT (Super Digital Linear Tape) and,
more recently, SAIT (Super Advanced Intelligent Tape), have been
increasing, but these increases have not been sufficient to offset
the decline in sales of our libraries using AIT tape technology.

GROSS PROFIT. Cost of good
sold consists primarily of direct labor, purchased parts, depreciation of plant
and equipment, rent utilities, and packaging costs. Gross profit was $2.2 million or 37.5% of net revenues, for
the three months ended September 30, 2003, compared to $3.2 million, or 36.1%
of net revenues, for the three months ended September 30, 2002. The increase in our gross
profit margin as a percentage of net revenues was primarily due to product mix.
Generally, larger tape libraries and newer tape drive technologies have higher
gross margins than do smaller tape libraries and older tape drive technologies.
Also, tape media, which we purchase and resell to our library customers,
typically have small gross margins. We anticipate that gross margin will
decline in the second quarter of fiscal 2004 because we recently reduced prices
on some of our older TLS series tape libraries in an effort to stimulate sales
growth.

RESEARCH AND DEVELOPMENT. Research and development expenses consist of
engineering salaries, benefits, purchased parts and supplies used in
development activities. Research and development expenses for the three months
ended September 30, 2003 were $1.2 million, or 19.4% of net revenues, as
compared to $0.8 million, or 9.5% of net revenues, for the three months ended
September 30, 2002. This increase was primarily due to our multi-year research
and development initiative at our Advanced Development Group, which we
established in late fiscal 2002 in Boulder, Colorado. The Advanced
Development Group is developing a new line of enterprise-class tape libraries.
We expect research and development expenses to remain at approximately these
levels in absolute terms in the second quarter of fiscal 2004.

SALES AND MARKETING. Sales and marketing expenses consist primarily of
employee salaries and benefits, sales commissions, trade show costs,
advertising, technical support and travel related expenses. Sales and marketing
expenses for the three months ended September 30, 2003 were $0.7 million or
11.7% of net revenues, compared to $0.9 million, or 9.7% of net revenues, for
the three months ended September 30, 2002. The decrease in sales and marketing
expenses was due primarily to less promotional and advertising activity
during the first quarter of fiscal 2004. We expect sales and marketing
expenses to increase in the second quarter of fiscal 2004 because we plan to
increase levels of spending on our marketing infrastructure and support certain
key sales initiatives to increase our sales opportunities.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of
employee salaries and benefits, deferred compensation related to stock options
and restricted stock awards, provision for doubtful accounts and
returns, and
professional service fees. General and administrative expenses for the three
months ended September 30, 2003 were $1.4 million, or 22.7% of net

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revenues,
compared with $0.9 million, or 10.2% of net revenues, for the three months
ended September 30, 2002. The increase in
general and administrative expenses was due primarily to an increase in
legal fees associated with our defense of a patent infringement
lawsuit brought
by Raytheon Company against nine defendants, including Qualstar. We expect
general and administrative expenses to remain static or decrease slightly in
the second quarter of fiscal 2004.

INVESTMENT INCOME. Investment income decreased to $155,000 in the quarter
ended September 30, 2003 compared with investment income of $284,000 in the
quarter ended September 30, 2002. This decrease was due primarily to an
overall shift in our investment strategy, which places more emphasis on
principal preservation than it does on income generation. In addition, the
general decline in market rates of interest has had a negative impact on our
portfolios overall performance.

PROVISION (BENEFIT) FOR INCOME TAXES. We recorded a benefit for income
taxes of $246,000 equal to 29.9% of our pre-tax loss, for the three months
ended September 30, 2003. This compares with a provision of $374,000 for
income taxes or 42.7% of pre-tax income for the three months ended
September 30, 2002. The decrease in the percentage of the provision (benefit) for
income taxes to pre-tax income (loss) was primarily due to a higher than
normal provision during the three months ended September 30, 2002 as a result
of additional provision taken for accumulated items relating to prior years.
The percentage of the provision (benefit) for income taxes to pre-tax income
(loss), for the three months ended September 30, 2003, is comparable to our
fiscal year 2003 rate of 33.3%, adjusted for state tax allocation and minor
book to tax differences.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have funded our capital requirements with net cash
provided by operating activities. Net cash provided by operating activities was
$1.0 million in the three months ended September 30, 2003
and $3.2 million in the three months ended September 30,
2002. For the three months ended September 30, 2003, cash
provided by operating activities was primarily provided by a reduction of
accounts receivables. For the three months ended September 30, 2002, cash
provided by operating activities was primarily provided by collection of
accounts receivable and reductions in inventory levels partially offset by a
decrease in accounts payable.

Net cash provided by investing activities was $1.5 million during the
first three months of fiscal year 2004, primarily attributed to the net sale of
marketable securities. Net cash provided by investing activities was $1.8
million during the first three months of fiscal year 2003. The primary cause
of this increase were net sales of marketable securities, offset partially by
purchases of fixed assets and the assets of N2Power, Inc.

There was no significant cash used or provided by financing activities
during the three month period ended September 30, 2003, or September 30, 2002.

On February 12, 2003, we announced that our Board of Directors had
authorized a program to repurchase up to 500,000 shares of our common stock in
open market transactions, block purchases or private transactions. These stock
repurchases will be funded by available working capital and are not expected to
negatively impact our liquidity. There is no time limit for the completion of
the stock repurchase program and it may be discontinued at any time. We did not
repurchase any shares during the quarter ended September 30, 2003.

As of September 30, 2003, we had $8.8 million in cash and cash equivalents
and $28.3 million in marketable securities. We believe our existing cash and
cash equivalents, plus anticipated cash flows from our operating activities,
and 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 we believe are strategic. We periodically evaluate other
companies and technologies for possible investment by us. In addition, we have
made and expect to 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.




ITEM 3. Quantitative and Qualitative 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.
Since all sales are currently made in U.S. dollars, a strengthening of the US
dollar could make our products less competitive in foreign markets. Our
investment income is sensitive to changes in the general level of US 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.

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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 our
Chief financial Officer, of the effectiveness of the design and operation of
Qualstars disclosure controls and procedures as of September 30, 2003,
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 those disclosure controls and procedures were adequate to ensure
that information required to be disclosed in this report is recorded,
processed, summarized and reported in a timely basis.

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PART II  OTHER INFORMATION




ITEM 1. Legal Proceedings

On January 10, 2003, Raytheon Company (Raytheon) filed a complaint in
the United States District Court for the Eastern District of Texas alleging
that Qualstar and eight other named defendants infringe a patent owned by
Raytheon entitled Mass Data Storage Library. Raytheon filed an amended
complaint on or about February 6, 2003, which includes an allegation that
Qualstars tape libraries infringe Raytheons patent. The complaint seeks an
injunction against all defendants and an unspecified amount of damages.
Qualstar responded to the complaint on March 7, 2003 and denied Raytheons
allegations of infringement. The parties are currently in the process of
pre-trial discovery. A patent claims construction hearing is presently
scheduled for January 14, 2004 and a trial is scheduled for June 7, 2004, both
of which will be located in Marshall, Texas. Qualstar and our legal counsel
continues to analyze Raytheons patent and available defenses to the claims of
infringement. Based on this analysis, we believe that Raytheons claims
against us are without merit and we intend to vigorously defend against this
complaint. We do not believe the ultimate outcome of this matter will have a
material impact on our financial position or results of operations.

From
time to time, we may be involved in litigation or other legal
proceedings
in the normal course of business. Other than the Raytheon lawsuit
discussed above, however, there are no material actions currently
pending.




ITEM 6. Exhibits and Reports on Form 8-K.

(a) Exhibits:

Exhibit No.
    
    Description31.1
    
    Certification of Principal Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    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 200232.2
    
    Certification of Principal Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.


(b) Reports on Form 8-K. We filed the following current reports on Form
8-K during the first quarter of fiscal 2004:



| | (1) |  | Current Report on From 8-K dated August 21, 2003, containing
the August 21, 2003 press release
related to our announcement of first quarter fiscal 2004 results.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

QUALSTAR CORPORATIONDated: November 13, 2003
    
    /s/ WILLIAM J. GERVAISWilliam J. Gervais, President,Chief Executive OfficerDated: November 13, 2003
    
    /s/ FREDERIC T. BOYERFrederic T. BoyerPrincipal Financial Officer


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EXHIBIT INDEX

Exhibit No.
    
    Description31.1
    
    Certification of Principal Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    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 200232.2
    
    Certification of Principal Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.


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