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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 December 31, 2003

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[  ] |  | 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 [  ]

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

Yes [  ]    No [X]

Total shares of common stock without par value outstanding at February 6, 2004
is 12,576,699.



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TABLE OF CONTENTS



|                               |                                                                                               |                                                                     |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | ITEM 1. Financial Statements                                                                 
|                               |                                                                                               | CONSOLIDATED CONDENSED BALANCE SHEETS                              
|                               |                                                                                               | CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS                    
|                               |                                                                                               | CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS                    
|                               |                                                                                               | CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY
|                               |                                                                                               | NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS               
|                               | 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 INDEX                 
|Exhibit 31.1                  
|Exhibit 31.2                  
|Exhibit 32.1                  
|Exhibit 32.2                  



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##### Table of Contents



QUALSTAR CORPORATION
FORM 10-Q
For the quarterly period ended December 31, 2003

Table of Contents

|                                                                                              |                                                                                                                |  |      |   | 
|--------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------- |  | ---- | - | 
|                                                                                              |                                                                                                                |  | Page
|                                                                                              |                                                                                                                |  |     
|PART I  FINANCIAL INFORMATION                                                                |                                                                                                                |  |      |  
|ITEM 1. Financial Statements:                                                                 |                                                                                                                |  |      |  
|                                                                                              | Consolidated Condensed Balance Sheets  December 31, 2003 and June 30, 2003                                    |  |      | 3 | 
|                                                                                              | Consolidated Condensed Statements of Operations  Three months and six months ended December 31, 2003 and 2002 |  |      | 4 | 
|                                                                                              | Consolidated Condensed Statements of Cash Flows  Six months ended December 31, 2003 and 2002                  |  |      | 5 | 
|                                                                                              | Consolidated Condensed Statement of Changes in Shareholders Equity  Six months ended December 31, 2003       |  |      | 6 | 
|                                                                                              | Notes to Interim Consolidated Condensed Financial Statements                                                   |  |      | 7 | 
|ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                                |  | 10   |  
|ITEM 3. Qualitative and Quantitative Disclosures About Market Risk                            |                                                                                                                |  | 14   |  
|ITEM 4. Controls and Procedures                                                               |                                                                                                                |  | 15   |  
|PART II OTHER INFORMATION                                                                     |                                                                                                                |  |      |  
|ITEM 1. Legal Proceedings                                                                     |                                                                                                                |  | 16   |  
|ITEM 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                |  | 16   |  
|Signatures                                                                                    |                                                                                                                |  | 17   |  

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PART I  FINANCIAL INFORMATION




ITEM 1. Financial Statements




QUALSTAR CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
DECEMBER 31, 2003 AND JUNE 30, 2003
(in thousands)

|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |        |        | 
|------------------------------------ | ---------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------ | ------ | -------- | ------ | ------ | ------ | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        | DECEMBER 31, |        | JUNE 30,
|                                     |                                                                                          |                                                                                                                                                |                                            |        | 2003         |        | 2003    
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |         
|                                     |                                                                                          |                                                                                                                                                |                                            |        | (unaudited)  |        |          |        |       
|ASSETS                               |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|Current assets:                      |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|                                     | Cash and cash equivalents                                                                |                                                                                                                                                | $                                          | 2,894  |              |        | $        | 6,236  |       
|                                     | Marketable securities                                                                    |                                                                                                                                                |                                            | 32,972 |              |        |          | 29,857 |       
|                                     | Receivables, net of allowances of $360 and $260 at December 31
and June 30, respectively |                                                                                                                                                |                                            | 4,628  |              |        |          | 4,535  |       
|                                     | Inventories                                                                              |                                                                                                                                                |                                            | 6,462  |              |        |          | 7,091  |       
|                                     | Prepaid expenses and other current assets                                                |                                                                                                                                                |                                            | 533    |              |        |          | 234    |       
|                                     | Prepaid income taxes                                                                     |                                                                                                                                                |                                            | 945    |              |        |          | 1,336  |       
|                                     | Deferred income taxes                                                                    |                                                                                                                                                |                                            | 939    |              |        |          | 939    |       
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total current assets                       |        |              | 49,373 |          |        |        | 50,228 | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|Property and equipment, net          |                                                                                          |                                                                                                                                                | 1,460                                      |        |              |        | 1,557    |       
|Other assets                         |                                                                                          |                                                                                                                                                | 273                                        |        |              |        | 311      |       
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total assets                               |        | $            | 51,106 |          |        | $      | 52,096 | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|LIABILITIES AND SHAREHOLDERS EQUITY |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|Current liabilities:                 |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|                                     | Accounts payable                                                                         |                                                                                                                                                | $                                          | 622    |              |        | $        | 1,136  |       
|                                     | Accrued payroll and related liabilities                                                  |                                                                                                                                                |                                            | 493    |              |        |          | 432    |       
|                                     | Other accrued liabilities                                                                |                                                                                                                                                |                                            | 1,495  |              |        |          | 1,469  |       
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total current liabilities                  |        |              | 2,610  |          |        |        | 3,037  | 
|Deferred income taxes                |                                                                                          |                                                                                                                                                | 191                                        |        |              |        | 191      |       
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total liabilities                          |        |              | 2,801  |          |        |        | 3,228  | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|Shareholders equity:                |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |       
|                                     |                                                                                          | Preferred stock, no par value; 5,000 shares authorized; no shares issued                                                                       |                                            |        |             |        |          |        |       |       
|                                     |                                                                                          | Common stock, no par value; 50,000 shares authorized, 12,577 and 12,640
shares issued and outstanding at December 31 and June 30, respectively |                                            |        | 20,052       |        |          |        | 20,366 |       
|                                     | Deferred compensation                                                                    |                                                                                                                                                |                                            | (11    | )            |        |          | (140   | )     
|                                     | Notes from directors                                                                     |                                                                                                                                                |                                            | (81    | )            |        |          | (156   | )     
|                                     | Accumulated other comprehensive income (loss)                                            |                                                                                                                                                |                                            | (106   | )            |        |          | (22    | )     
|                                     | Retained earnings                                                                        |                                                                                                                                                |                                            | 28,451 |              |        |          | 28,820 |       
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total shareholders equity                 |        |              | 48,305 |          |        |        | 48,868 | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       
|                                     |                                                                                          |                                                                                                                                                | Total liabilities and shareholders equity |        | $            | 51,106 |          |        | $      | 52,096 | 
|                                     |                                                                                          |                                                                                                                                                |                                            |        |              |        |          |        |       

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

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QUALSTAR CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
THREE MONTHS AND SIX MONTHS ENDED DECEMBER 31, 2003 AND 2002
(UNAUDITED)
(in thousands, except per share data)

|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |        | 
|------------------------------------------------- | -------------------------- | - | ------------------ | ------ | ---------------- | - | ----- | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                                                  |                            |   | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|                                                  |                            |   | DECEMBER 31,       |        | DECEMBER 31,    
|                                                  |                            |   |                    |        |                 
|                                                  |                            |   | 2003               |        | 2002             |   | 2003  |        | 2002
|                                                  |                            |   |                    |        |                  |   |       |        |     
|Net revenues                                      |                            | $ | 9,556              |        |                  | $ | 8,408 |        |      | $ | 15,532 |        |  | $ | 17,200 |       
|Cost of goods sold                                |                            |   | 5,962              |        |                  |   | 5,260 |        |      |   | 9,698  |        |  |   | 10,874 |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Gross profit                                      |                            |   | 3,594              |        |                  |   | 3,148 |        |      |   | 5,834  |        |  |   | 6,326  |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Operating expenses:                               |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|                                                  | Research and development   |   |                    | 1,064  |                  |   |       | 934    |      |   |        | 2,221  |  |   |        | 1,767  | 
|                                                  | Sales and marketing        |   |                    | 1,038  |                  |   |       | 1,049  |      |   |        | 1,738  |  |   |        | 1,905  | 
|                                                  | General and administrative |   |                    | 1,428  |                  |   |       | 1,043  |      |   |        | 2,787  |  |   |        | 1,940  | 
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Total operating expenses                          |                            |   | 3,530              |        |                  |   | 3,026 |        |      |   | 6,746  |        |  |   | 5,612  |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Income (loss) from operations                     |                            |   | 64                 |        |                  |   | 122   |        |      |   | (912   | )      |  |   | 714    |       
|Investment income                                 |                            |   | 192                |        |                  |   | 102   |        |      |   | 346    |        |  |   | 386    |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Income (loss) before provision for income taxes   |                            |   | 256                |        |                  |   | 224   |        |      |   | (566   | )      |  |   | 1,100  |       
|Provision (benefit) for income taxes              |                            |   | 49                 |        |                  |   | 145   |        |      |   | (197   | )      |  |   | 519    |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Net income (loss)                                 |                            | $ | 207                |        |                  | $ | 79    |        |      | $ | (369   | )      |  | $ | 581    |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Earnings per share:                               |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Basic earnings (loss) per share                   |                            | $ | 0.02               |        |                  | $ | 0.01  |        |      | $ | (0.03  | )      |  | $ | 0.05   |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Diluted earnings (loss) per share                 |                            | $ | 0.02               |        |                  | $ | 0.01  |        |      | $ | (0.03  | )      |  | $ | 0.05   |       
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|Shares used to compute earnings (loss) per share: |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|                                                  | Basic                      |   |                    | 12,550 |                  |   |       | 12,576 |      |   |        | 12,568 |  |   |        | 12,562 | 
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       
|                                                  | Diluted                    |   |                    | 12,604 |                  |   |       | 12,688 |      |   |        | 12,568 |  |   |        | 12,626 | 
|                                                  |                            |   |                    |        |                  |   |       |        |      |   |        |        |  |   |        |       

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

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QUALSTAR CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2003 AND 2002
(UNAUDITED)
(in thousands)

|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |         |     |       |  
|---------------------------------------------------- | ------------------------------------------------------------------------------------ | ------------------------------------------------- | --------------------------------------------- | ------- | ---------------- | ---- | ------ | ------- | --- | ----- | -
|                                                     |                                                                                      |                                                   |                                               |         | Six Months Ended
|                                                     |                                                                                      |                                                   |                                               |         | December 31,    
|                                                     |                                                                                      |                                                   |                                               |         |                 
|                                                     |                                                                                      |                                                   |                                               |         | 2003             |      | 2002  
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |       
|OPERATING ACTIVITIES:                                |                                                                                      |                                                   |                                               |         |                  |      |        |        
|                                                     | Net income (loss)                                                                    |                                                   | $                                             | (369    | )                |      | $      | 581     |    
|                                                     | Adjustments to reconcile net income (loss) to cash
provided by operating activities: |                                                   |                                               |         |                  |      |        |         |    
|                                                     |                                                                                      | Depreciation and amortization                     |                                               |         | 208              |      |        |         | 180 |      
|                                                     |                                                                                      | Amortization of deferred compensation             |                                               |         | 129              |      |        |         | 172 |      
|                                                     |                                                                                      | Provision for (recovery of) bad debts and returns |                                               |         | 101              |      |        |         | (28 | )    
|                                                     |                                                                                      | Accrued interest on directors notes              |                                               |         | (4               | )    |        |         | (11 | )    
|                                                     |                                                                                      | Changes in operating assets and liabilities:      |                                               |         |                  |      |        |         |     |      
|                                                     |                                                                                      |                                                   | Accounts receivable                           |         |                  | (194 | )      |         |     | 2,904 |  
|                                                     |                                                                                      |                                                   | Inventories                                   |         |                  | 629  |        |         |     | 2,612 |  
|                                                     |                                                                                      |                                                   | Prepaid expenses and other assets             |         |                  | (285 | )      |         |     | (34   | )
|                                                     |                                                                                      |                                                   | Prepaid income taxes and income taxes payable |         |                  | 391  |        |         |     | (28   | )
|                                                     |                                                                                      |                                                   | Accounts payable                              |         |                  | (514 | )      |         |     | (719  | )
|                                                     |                                                                                      |                                                   | Accrued liabilities                           |         |                  | 87   |        |         |     | (129  | )
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|Net cash provided by operating activities            |                                                                                      |                                                   | 179                                           |         |                  |      | 5,500  |        
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|INVESTING ACTIVITIES:                                |                                                                                      |                                                   |                                               |         |                  |      |        |        
|                                                     | Purchases of property and equipment                                                  |                                                   |                                               | (87     | )                |      |        | (344    | )  
|                                                     | Sale of marketable securities                                                        |                                                   |                                               | 25,455  |                  |      |        | 16,407  |    
|                                                     | Purchase of marketable securities                                                    |                                                   |                                               | (28,654 | )                |      |        | (17,031 | )  
|                                                     | Purchase of assets of N2Power, Inc.                                                  |                                                   |                                               |        |                  |      |        | (288    | )  
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|Net cash used in investing activities                |                                                                                      |                                                   | (3,286                                        | )       |                  |      | (1,256 | )      
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|FINANCING ACTIVITIES:                                |                                                                                      |                                                   |                                               |         |                  |      |        |        
|                                                     | Proceeds from exercise of stock options                                              |                                                   |                                               |        |                  |      |        | 135     |    
|                                                     | Repurchase of common stock                                                           |                                                   |                                               | (314    | )                |      |        |        |    
|                                                     | Principal and interest payments on directors notes                                  |                                                   |                                               | 79      |                  |      |        | 38      |    
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|Net cash (used in) provided by financing activities  |                                                                                      |                                                   | (235                                          | )       |                  |      | 173    |        
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|Net (decrease) increase in cash and cash equivalents |                                                                                      |                                                   | (3,342                                        | )       |                  |      | 4,417  |        
|Cash and cash equivalents at beginning of period     |                                                                                      |                                                   | 6,236                                         |         |                  |      | 4,859  |        
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |        
|Cash and cash equivalents at end of period           |                                                                                      | $                                                 | 2,894                                         |         |                  | $    | 9,276  |        
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |         |    
|Supplemental cash flow disclosure:                   |                                                                                      |                                                   |                                               |         |                  |      |        |        
|                                                     | Income taxes paid                                                                    |                                                   | $                                             |        |                  |      | $      | 260     |    
|                                                     |                                                                                      |                                                   |                                               |         |                  |      |        |         |    

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

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QUALSTAR CORPORATION
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY
SIX MONTHS ENDED DECEMBER 31, 2003
(UNAUDITED)
(in thousands)



|                                                    |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      |             |   |   |        |   |      |   |        |     |      |  
|--------------------------------------------------- | ------------------------------------------ | -------- | ------ | ------------ | - | -------- | ------ | ------------ | - | ------------- | ---- | -------- | - | -------- | ---- | ----- | - | - | ---- | ----------- | - | - | ------ | - | ---- | - | ------ | --- | ---- | -
|                                                    |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      | ACCUMULATED |   |   |        |   |      |   |        |    
|                                                    |                                            |          |        | COMMON STOCK |   |          |        |              |   | NOTES         |      | OTHER    |   |          |      |       |   |   |      |            
|                                                    |                                            |          |        |              |   | DEFERRED |        | FROM         |   | COMPREHENSIVE |      | RETAINED |   |          |      |      
|                                                    |                                            |          |        | SHARES       |   | AMOUNT   |        | COMPENSATION |   | DIRECTORS     |      | LOSS     |   | EARNINGS |      | TOTAL
|                                                    |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |      
|Balance at July 1, 2003                             |                                            |          | 12,640 |              |   | $        | 20,366 |              |   | $             | (140 | )        |   | $        | (156 | )     |   | $ | (22  | )           |   | $ | 28,820 |   |      | $ | 48,868 |    
|Amortization of deferred compensation               |                                            |          |       |              |   |          |       |              |   |               | 129  |          |   |          |     |       |   |   |     |             |   |   |       |   |      |   | 129    |    
|Retirement of shares pursuant to
stock repurchase   |                                            |          | (63    | )            |   |          | (314   | )            |   |               |     |          |   |          |     |       |   |   |     |             |   |   |       |   |      |   | (314   | )  
|Accrued interest on directors notes                |                                            |          |       |              |   |          |       |              |   |               |     |          |   |          | (4   | )     |   |   |     |             |   |   |       |   |      |   | (4     | )  
|Principal and interest payments
on directors notes |                                            |          |       |              |   |          |       |              |   |               |     |          |   |          | 79   |       |   |   |     |             |   |   |       |   |      |   | 79     |    
|Comprehensive loss:                                 |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      |             |   |   |        |   |      |   |        |    
|                                                    | Change in unrealized losses on
investments |          |        |             |   |          |        |             |   |               |      |         |   |          |      |      |   |   |      | (84         | ) |   |        |  |      |   |        | (84 | )   
|                                                    |                                            | Net loss |        |              |  |          |        |              |  |               |      |          |  |          |      |       |  |   |      |             |  |   |        |   | (369 | ) |        |     | (369 | )
|Comprehensive loss                                  |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      |             |   |   |        |   |      |   | (453   | )  
|                                                    |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      |             |   |   |        |   |      |   |        |    
|Balance at December 30, 2003                        |                                            |          | 12,577 |              |   | $        | 20,052 |              |   | $             | (11  | )        |   | $        | (81  | )     |   | $ | (106 | )           |   | $ | 28,451 |   |      | $ | 48,305 |    
|                                                    |                                            |          |        |              |   |          |        |              |   |               |      |          |   |          |      |       |   |   |      |             |   |   |        |   |      |   |        |    

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

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(in thousands, except per share data)
(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying consolidated condensed 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 consolidated condensed 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 December 31, 2003, consolidated results of operations
for the three months and six months ended December 31, 2003 and 2002, and
consolidated cash flows for the six months ended December 31, 2003 and 2002.
Operating results for the three and six month periods ended December 31, 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 and six months ended December 31, 2003
and 2002:

|                                    |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |        | 
|----------------------------------- | -------------------------------------------------------------------------------------------------------------- | - | ------------------ | ------ | ---------------- | - | ---- | ------ | ---- | - | ----- | ------ | - | - | ---- | ------ | 
|                                    |                                                                                                                |   | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|                                    |                                                                                                                |   | DECEMBER 31,       |        | DECEMBER 31,    
|                                    |                                                                                                                |   |                    |        |                 
|                                    |                                                                                                                |   | 2003               |        | 2002             |   | 2003 |        | 2002
|                                    |                                                                                                                |   |                    |        |                  |   |      |        |     
|Numerator:                          |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |       
|                                    | Net income (loss)                                                                                              |   | $                  | 207    |                  |   | $    | 79     |      |   | $     | (369   | ) |   | $    | 581    | 
|Denominator:                        |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |       
|                                    | Denominator for basic net income (loss) per
share  weighted average shares                                    |   |                    | 12,550 |                  |   |      | 12,576 |      |   |       | 12,568 |   |   |      | 12,562 | 
|                                    | Dilutive potential common shares from employee
stock options and restricted stock                              |   |                    | 54     |                  |   |      | 112    |      |   |       |       |   |   |      | 64     | 
|                                    |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |        | 
|                                    | Denominator for diluted net income (loss) per
share  adjusted weighted average shares and
assumed conversions |   |                    | 12,604 |                  |   |      | 12,688 |      |   |       | 12,568 |   |   |      | 12,626 | 
|                                    |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |        | 
|Basic net income (loss) per share   |                                                                                                                | $ | 0.02               |        |                  | $ | 0.01 |        |      | $ | (0.03 | )      |   | $ | 0.05 |       
|                                    |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |        | 
|Diluted net income (loss) per share |                                                                                                                | $ | 0.02               |        |                  | $ | 0.01 |        |      | $ | (0.03 | )      |   | $ | 0.05 |       
|                                    |                                                                                                                |   |                    |        |                  |   |      |        |      |   |       |        |   |   |      |        | 

Shares issuable under stock options of 317,000 and 616,500 for the three month
and six month period ended December 31, 2003, respectively, have been excluded
from the computation of diluted earnings per share 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 December 31, 2003 and June 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-

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sale are included in earnings when the underlying securities are sold and
are derived using the specific identification method for determining the cost
of securities sold.

NOTE 4. INVENTORIES

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

|               |  |                   |       |               |  |   |       | 
|-------------- |  | ----------------- | ----- | ------------- |  | - | ----- | 
|               |  | DECEMBER 31, 2003 |       | JUNE 30, 2003
|               |  |                   |       |              
|Raw materials  |  | $                 | 6,042 |               |  | $ | 6,454 | 
|Finished goods |  |                   | 420   |               |  |   | 637   | 
|               |  |                   |       |               |  |   |       | 
|               |  | $                 | 6,462 |               |  | $ | 7,091 | 
|               |  |                   |       |               |  |   |       | 

NOTE 5. COMPREHENSIVE INCOME (LOSS)

For the six months ended December 31, 2003 and 2002, comprehensive income
(loss) amounted to approximately $(0.45) million and $0.6 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 MONTHS |        | SIX MONTHS  
|                                                                              |  | ENDED        |        | ENDED       
|                                                                              |  | DECEMBER 31, |        | DECEMBER 31,
|                                                                              |  | 2003         |        | 2002         |  | 2003 |        | 2002
|                                                                              |  |              |        |              |  |      |        |     
|Net income (loss) as reported                                                 |  | $            | 207    |              |  | $    | 79     |      |  | $ | (369   | ) |  | $ | 581    |  
|Stock-based employee compensation cost included in reported
net income (loss) |  |              | 64     |              |  |      | 65     |      |  |   | 129    |   |  |   | 172    |  
|Pro forma stock-based employee compensation cost under SFAS 123               |  |              | (130   | )            |  |      | (146   | )    |  |   | (260   | ) |  |   | (292   | )
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Pro forma net income (loss)                                                   |  | $            | 141    |              |  | $    | (2     | )    |  | $ | (500   | ) |  | $ | 461    |  
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Earnings (loss) per share:                                                    |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Basic  as reported                                                           |  | $            | 0.02   |              |  | $    | 0.01   |      |  | $ | (0.03  | ) |  | $ | 0.05   |  
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Basic  pro forma                                                             |  | $            | 0.01   |              |  | $    | 0.00   |      |  | $ | (0.04  | ) |  | $ | 0.04   |  
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Diluted  as reported                                                         |  | $            | 0.02   |              |  | $    | 0.01   |      |  | $ | (0.03  | ) |  | $ | 0.05   |  
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Diluted  pro forma                                                           |  | $            | 0.01   |              |  | $    | 0.00   |      |  | $ | (0.04  | ) |  | $ | 0.04   |  
|                                                                              |  |              |        |              |  |      |        |      |  |   |        |   |  |   |        |  
|Basic Weighted Average Shares                                                 |  |              | 12,550 |              |  |      | 12,576 |      |  |   | 12,568 |   |  |   | 12,562 |  
|Diluted Weighted Average Shares                                               |  |              | 12,604 |              |  |      | 12,576 |      |  |   | 12,568 |   |  |   | 12,626 |  

Shares issuable under stock options of 317,000 and 616,500 for the three month
and six month period ended December 31, 2003, respectively, have been excluded
from the computation of diluted earnings per share as the effect would have
been antidilutive.

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

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amortized over 5 years. The accompanying consolidated financial statements
include the operations of N2Power from the date of acquisition.

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 is 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. During the three month and six month
periods ended December 31, 2003, the Company repurchased a total of 62,910
shares of its common stock at a total cost of $314,000. From February 12, 2003
through December 31, 2003, the Company had repurchased a total of 139,477
shares of its common stock at a total cost of approximately $658,084, or an
average price of approximately $4.72 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. On January 14, 2004, the Court held a hearing to construe
the terms of the claim and we are currently awaiting the Courts claim
construction ruling. The trial has been rescheduled from June 7, 2004 to
September 7, 2004 and 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.

OVERVIEW

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,
storage arrays of tape cartridges and robotics to move the tape cartridges from
their storage locations to the tape drives under software control. Our tape
libraries provide storage solutions for organizations requiring backup,
recovery and archival storage of critical electronic information. Our tape
libraries also can provide near-online storage as an alternative to disk
drives. Our products are compatible with commonly used network operating
systems, including UNIX, Windows NT, NetWare and Linux. Our tape libraries also
are compatible with a wide range of storage management software packages, such
as those supplied by Computer Associates, Legato, Tivioli and Veritas.

We offer tape libraries for multiple tape drive technologies, including
those using Advanced Intelligent Tape(AIT), Super Advanced Intelligent
Tape(SAIT), Super Digital Linear Tape(SDLT), and Linear Tape Open(LTO)tape
drives and media. These tape drive technologies compete with each other in
terms of their native storage capacity as well as their ability to quickly and
efficiently read and write data. Since all models of our tape libraries are
required to have tape drives to operate, the overall performance of our tape
libraries is associated with the performance of the tape drive it contains.
Historically, our business has been focused on selling tape libraries that
incorporate AIT technology, as the majority of our revenue has been generated
from this product line. The current generation of 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. In recent quarters, we have noticed a downward trend in the
amount of library shipments which incorporate AIT technology and an upward
trend in shipments of libraries which incorporate tape drive technology based
upon a half-inch form factor such as LTO, SDLT, and SAIT.

We sell our tape libraries worldwide, primarily to value added resellers,
system integrators, and original equipment manufacturers. These customers
integrate our products with software from third party vendors to provide
storage solutions, which they in turn resell to end users. We custom configure
each of our libraries based on each customers individual requirements, with a
normal delivery time of one to three working days. This rapid fulfillment of
customer orders allows our resellers to minimize their inventory levels and
allows us to compete effectively with distribution channels used by our
competitors.

Qualstar was incorporated in California in 1984. The initial products
were IBM compatible 9-track reel-to-reel tape drives. In 1995, we entered the
tape automation market with a series of tape libraries incorporating 8mm tape
drives. Since that time, we have introduced a succession of tape library models
designed to work with 8mm and other tape drive technologies and tape media
formats.

In July 2002, we purchased the assets of N2Power, Incorporated, a supplier
of ultra small high efficiency open-frame switching power supplies. Power
supplies provided by N2Power are utilized within our tape library products as
well as sold to other OEM customers for incorporation into their products.
N2Power products are sold under the N2Power brand name through outside sales
representatives and distributors to OEMs.

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 principals generally accepted in the United States.
The preparation of these

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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, 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.

Revenue Recognition

Revenue is recognized upon shipment of products to our customers. Title
and risk of loss transfer to the customer when the product leaves our dock in
Simi Valley, California. In general, these customers are allowed to return the
product, free of penalty, within 30 days of shipment if the product does not
meet specification. After 30 days, customers generally are not allowed to
return product to us without a restocking fee. 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 ever returned. Should our experience change, however, we may
require additional allowances for sales returns.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts and returns for estimated
losses resulting from the inability of our customers to make required payments.
If the financial condition of our customers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances may be
required. In addition, if the financial condition of our customers for which
we have already established allowances were to improve, then their ability to
make payments to us would be less impaired, potentially making such allowances
unnecessary.

Inventory Reserves

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. Likewise, if
technology changes more slowly than expected, or market conditions become more
favorable than those projected by management, inventory write-downs may become
unnecessary.

Warranty Costs

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 actively 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.

Accounting for Income Taxes

We do not currently record a valuation allowance to reduce our deferred
tax assets because we believe that the assets are more likely than not to be
realized. While we have considered future taxable income and ongoing prudent
and feasible tax planning strategies in assessing the need for a valuation
allowance, in the event we were to determine that we would not be able to
realize all or part of our net deferred tax asset in the future, an adjustment
to the deferred tax asset would be charged to income in the period such
determination was made.

RESULTS OF OPERATIONS

The following table sets forth items in our statement of operations as a
percentage of net revenues for the periods presented. The data has been
derived from our unaudited consolidated condensed financial statements.

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|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|------------------------------------ |  | ------------------ | ----- | ---------------- |  | ---- | ----- | ---- |  |  | ----- | -- |  |  | ----- | -
|                                     |  | Three Months Ended |       | Six Months Ended
|                                     |  | December 31,       |       | December 31,    
|                                     |  |                    |       |                 
|                                     |  | 2003               |       | 2002             |  | 2003 |       | 2002
|                                     |  |                    |       |                  |  |      |       |     
|Net revenues                         |  |                    | 100.0 | %                |  |      | 100.0 | %    |  |  | 100.0 | %  |  |  | 100.0 | %
|Cost of revenues                     |  |                    | 62.4  |                  |  |      | 62.6  |      |  |  | 62.4  |    |  |  | 63.2  |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Gross profit                         |  |                    | 37.6  |                  |  |      | 37.4  |      |  |  | 37.6  |    |  |  | 36.8  |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Operating expenses:                  |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Research and development             |  |                    | 11.1  |                  |  |      | 11.1  |      |  |  | 14.3  |    |  |  | 10.3  |  
|Sales and marketing                  |  |                    | 10.9  |                  |  |      | 12.5  |      |  |  | 11.2  |    |  |  | 11.1  |  
|General and administrative           |  |                    | 14.9  |                  |  |      | 12.4  |      |  |  | 17.9  |    |  |  | 11.3  |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Total operating expenses             |  |                    | 36.9  |                  |  |      | 36.0  |      |  |  | 43.4  |    |  |  | 32.7  |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Income (loss) from operations        |  |                    | 0.7   |                  |  |      | 1.4   |      |  |  | (5.8  | )  |  |  | 4.1   |  
|Investment income                    |  |                    | 2.0   |                  |  |      | 1.2   |      |  |  | 2.2   |    |  |  | 2.2   |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Income (loss) before income taxes    |  |                    | 2.7   |                  |  |      | 2.6   |      |  |  | (3.6  | )  |  |  | 6.3   |  
|Provision (benefit) for income taxes |  |                    | 0.5   |                  |  |      | 1.7   |      |  |  | (1.2  | )  |  |  | 2.9   |  
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  
|Net income (loss)                    |  |                    | 2.2   | %                |  |      | 0.9   | %    |  |  | (2.4  | )% |  |  | 3.4   | %
|                                     |  |                    |       |                  |  |      |       |      |  |  |       |    |  |  |       |  

Three Months Ended December 31, 2003 Compared to Three Months Ended December
31, 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 December 31, 2003 were $9.6
million, compared with net revenues of $8.4 million for the three months ended
December 31, 2002, an increase of $1.2 million. Revenue was higher in the
second quarter of fiscal 2004 primarily due to a $1.4 million shipment to a
video surveillance OEM which accounted for approximately 14.5% of our net
revenues for the quarter. Although we dont believe such a large order is a
one time event, we do not anticipate receiving another order of this magnitude
in the short term.

GROSS PROFIT. Cost of goods sold consists primarily of direct labor,
purchased parts, depreciation of plant and equipment, rent, utilities, and
packaging costs. Gross profit was $3.6 million, or 37.6% of net revenues, for
the three months ended December 31, 2003, compared to $3.1 million, or 37.4% of
net revenues, for the three months ended December 31, 2002. The increase in our
gross profit as a percentage of net revenues was primarily due to a shift in
our product mix compounded with a higher unit shipment volume for the quarter
ended December 31, 2003 as compared to the same quarter a year ago. The
majority of our net revenue comes from the sale of tape libraries and drives.
Other products such as tape media and service contracts can influence our
overall gross profit margin, since they are different in nature than tape
libraries and drives. Tape media, which is available through general
distribution channels, historically has had lower gross margins when compared
to the tape libraries and drives in which it is used. Furthermore, service
revenues generally have higher gross margins as a percentage of net revenues
than do tape libraries and drives. During the three month period ended
December 31, 2003, we generated a larger percentage of our net revenue from
service than in the same period last year. In addition to product mix, our
gross margin was positively impacted since shipment volume was up approximately
24% and our fixed overhead costs were spread over a larger unit sales base.
We expect gross margin to be consistent with historical trends for the third
quarter of fiscal 2004.

RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of engineering salaries, benefits, purchased parts and supplies used
in development activities of our Advanced Development Group located in Boulder,
Colorado, as well as our engineering group located in Simi Valley, California.
Research and development expenses for the three months ended December 31, 2003
were $1.1 million, or 11.1% of net revenues, as compared to $0.9 million, or
11.1% of net revenues, for the three months ended December 31, 2002. The
increase in research and development expenses in absolute dollars was primarily
due to our multi-year research and development initiative at our Advanced
Development Group, which we established in late fiscal 2002 to develop a new
line of enterprise-class tape libraries. We expect research and development
expenses to remain at approximately the current level in absolute terms in the
third quarter of fiscal 2004.

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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 December 31, 2003 were $1.0 million or
10.9% of net revenues, compared to $1.0 million, or 12.5% of net revenues, for
the three months ended December 31, 2002.

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 December 31, 2003 were $1.4 million, or 14.9% of net revenues,

compared with $1.0 million, or 12.4% of net revenues, for the three months
ended December 31, 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, and additions to our reserve for doubtful
accounts. We expect these litigation expenses to continue at the current level
for the next several quarters. Consequently, we expect general and
administrative expenses to remain at approximately the current level during the
third quarter of fiscal 2004.

INVESTMENT INCOME. Investment income was $192,000 in the quarter ended
December 31, 2003 compared with investment income of $102,000 in the quarter
ended December 31, 2002. The increase in the current quarter is due to a
realized loss of approximately $90,000 recognized in the quarter ended December
31, 2002 attributed to the liquidation of an investment with a market value
below its carrying value.

PROVISION (BENEFIT) FOR INCOME TAXES. We recorded a provision for income
taxes of $49,000 equal to 19.1% of our pre-tax income, for the three months
ended December 31, 2003. This compares with a provision for income taxes of
$145,000, or 64.7% of pre-tax income for the three months ended December 31,
2002. The decrease in the percentage of the provision for income taxes to
pre-tax income was primarily due to $60,000 of additional provision, net of
certain items, taken during the three months ended December 31, 2002 for items
relating to prior years. The percentage of the provision for income taxes to
pre-tax income, for the three months ended December 31, 2003, was recorded to
yield an annualized effective tax rate of 34.8% based on a year to date tax
provision, and is comparable to our fiscal year 2003 rate of 33.3%. Future
operating results may change this estimate.

Six Months Ended December 31, 2003 Compared to Six Months Ended December 31,
2002.

NET REVENUES. Net revenues for the six months ended December 31, 2003 were
$15.5 million, compared with net revenues of $17.2 million for the six months
ended December 31, 2002, a decrease of $1.7 million. Revenue was lower for the
six months ended December 31, 2003 due to reduced demand for our tape libraries
which incorporate AIT (Advanced Intelligent Tape) technology. 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. Gross profit was $5.8 million or 37.6% of net revenues, for
the six months ended December 31, 2003, compared to $6.3 million, or 36.8% of
net revenues, for the six months ended December 31, 2002. The increase in our
gross profit as a percentage of net revenues was primarily due to a more
favorable shift in our 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. In addition, service revenues
generally have higher gross margins than do tape libraries and drives. Media,
which is available through general distribution channels, historically has had
a lower gross margin when compared to the tape libraries and drives in which it
is used. During the six month period ended December 31, 2003, we generated a
larger portion of our net revenues from service and less from media than the
same period one year ago.

RESEARCH AND DEVELOPMENT. Research and development expenses for the six
months ended December 31, 2003 were $2.2 million, or 14.3% of net revenues, as
compared to $1.8 million, or 10.3% of net revenues, for the six months ended
December 31, 2002. The increase in research and development costs are 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.

SALES AND MARKETING. Sales and marketing expenses for the six months ended
December 31, 2003 were $1.7 million, or 11.2% of net revenues, compared to $1.9
million, or 11.1% of net revenues, for the six months ended December 31, 2002.

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GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
six months ended December 31, 2003 were $2.8 million, or 17.9% of net revenues,
compared with $1.9 million, or 11.3% of net revenues, for the six months ended
December 31, 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, and additions to our reserve for doubtful accounts.

INVESTMENT INCOME. Investment income for the six months ended December 31,
2003 was $346,000 comparable with investment income of $386,000 for the six
months ended December 31, 2002.

PROVISION (BENEFIT) FOR INCOME TAXES. The benefit for income taxes was
$(197,000), or 34.8% of pre-tax loss, for the six months ended December 31,
2003, compared to a provision for income taxes of $519,000, or 47.2% of pre-tax
income, for the six months ended December 31, 2002. The decrease in the
percentage of the provision (benefit) for income taxes to pre-tax income (loss)
was primarily due to $60,000 of additional provision, net of certain items,
taken during the three months ended December 31, 2002 for items relating to
prior years.

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
$0.2 million in the six months ended December 31, 2003 and $5.5 million in the
six months ended December 31, 2002. For the six months ended December 31, 2003,
cash provided by operating activities was primarily provided by a reduction in
inventories and the receipt of a cash tax refund from the Internal Revenue
Service, partially offset by a decrease in accounts payable. For the six months
ended December 31, 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 used in investing activities was $3.3 million during the first
six months of fiscal year 2004, primarily attributed to purchases of marketable
securities. Net cash used in investing activities was $1.3 million during the
first six months of fiscal year 2003, attributed to the purchase of marketable
securities, property and equipment, and the assets of N2Power.

There was no significant cash used or provided by financing activities
during the six month period ended December 31, 2003, or December 31, 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 used
$314,000 to repurchase common stock during the six months ended December 31,
2003.

As of December 31, 2003, we had $2.9 million in cash and cash equivalents
and $33.0 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 December 31, 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. On January 14, 2004, the Court held a hearing to construe
the terms of the claim and we are currently awaiting the Courts claim
construction ruling. The trial has been rescheduled from June 7, 2004 to
September 7, 2004 and 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.




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

(a)  Exhibits:

|            |  |                                                                                                        
|----------- |  | -------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                            
|            |  |                                                                                                        
|31.1        |  | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 
|31.2        |  | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|32.1        |  | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 
|32.2        |  | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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



| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) On October 9, 2003, we furnished information pursuant to Item 12 of Form
8-K relating to lower than anticipated revenues for the first quarter of
fiscal 2004.
|
| | (2) On October 30, 2003, we furnished information pursuant to Item 12 of
Form 8-K relating to our results of operations for the first quarter of
fiscal 2004.     

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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 CORPORATION
|                         |  |                      |  |                               
|Dated: February 13, 2004 |  | By:                  |  | /s/ WILLIAM J. GERVAIS        
|                         |  |                      |  |                               
|                         |  |                      |  | William J. Gervais, President,
|                         |  |                      |  | Chief Executive Officer       
|                         |  |                      |  |                               
|Dated: February 13, 2004 |  | By:                  |  | /s/ 
FREDERIC T. BOYER        
|                         |  |                      |  |                               
|                         |  |                      |  | Frederic T. Boyer             
|                         |  |                      |  | Principal Financial Officer   

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EXHIBIT INDEX

|            |  |                                                                                                        
|----------- |  | -------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                            
|            |  |                                                                                                        
|31.1        |  | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 
|31.2        |  | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|32.1        |  | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 
|32.2        |  | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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