SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





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





FOR
THE FISCAL YEAR ENDED JUNE 30, 2008





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





FOR
THE TRANSITION PERIOD
FROM          TO


_______________





COMMISSION
FILE NUMBER 000-30083





QUALSTAR
CORPORATION





CALIFORNIA
            95-3927330(STATE
      OF INCORPORATION)
            (I.R.S.
      EMPLOYER ID NO.)





3990-B
HERITAGE OAK COURT, SIMI VALLEY, CA 93063


(805)
583-7744





Securities
registered pursuant to Section 12(b) of the Act:





Title of Each
      Class:
            Name of Each Exchange
      on Which Registered:Common
      Stock
            The
      NASDAQ Stock Market LLC





Securities
registered pursuant to Section 12(g) of the Act:


None





Indicate
by check mark whether the registrant is well-known seasoned issuer, as defined
in Rule 405 of the Securities Act of 1933.  Yes o     No
þ





Indicate
by check mark whether the registrant is not required to file reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934.  Yes o     No
þ





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports); and (2) has been subject to such filing requirements for
the past 90 days.  Yes þ     No
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  þ





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of  “accelerated filer,” “large accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):


Large
accelerated filer o    Accelerated
filer o     Non-accelerated
filer oSmaller
reporting companyþ





Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2).  Yes o     No
þ





As of
December 31, 2007, (the last business day of the registrant’s most recently
completed second fiscal quarter), the aggregate market value of the common
equity held by non-affiliates of the registrant was approximately
$25,676,000.





The total
shares of common stock without par value outstanding at September 19, 2008 is
12,253,117.





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of registrant’s definitive proxy statement for its annual meeting of
shareholders to be held in 2009 are incorporated by reference into Part III of
this Form 10-K.













QUALSTARCORPORATION





FORM
10-K





FOR
THE FISCAL YEAR ENDED JUNE 30, 2008





INDEX





PART
      IItem
      1.
            Business
            3Executive Officers of the Registrant
            13Item
      1A.
            Risk Factors
            14Item
      1B.
            Unresolved Staff Comments
            22Item
      2.
            Properties
            22Item
      3.
            Legal Proceedings
            22Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            22PART
      IIItem
      5.
            Market for Registrant’s Common Equity, Related Stockholder
      Matters, and Issuer Purchases of Equity Securities
            22Item
      6.
            Selected Financial Data
            24Item
      7.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            25Item
      7A.
            Quantitative and Qualitative Disclosures about Market
      Risk
            31Item
      8.
            Financial Statements and Supplementary
Data
            31Item
      9.
            Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
            49Item
      9A(T).
            Controls and Procedures
            49Item
      9B.
            Other Information
            50PART
      IIIItem
      10.
            Directors, Executive Officers and Corporate
      Governance
            51Item
      11.
            Executive Compensation
            51Item
      12.
            Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
            51Item
      13.
            Certain Relationships and Related Transactions, and Director
      Independence
            51Item
      14.
            Principal Accountant Fees and Services
            51PART
      IVItem
      15.
            Exhibits and Financial Statement Schedules
            52Signatures
            53Exhibit Index
            54




2
 Index





FORWARD-LOOKING
STATEMENTS





This
Annual Report on Form 10-K contains 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. 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 “ITEM 1A — Risk Factors,” and in
“ITEM 7 — Management’s Discussion and Analysis of Financial Condition and
Results of Operations.” You generally can identify forward-looking statements by
the use of forward-looking terminology such as “believes,” “may,” “will,”
“expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or
“continues,” or the negative thereof or variations thereon or similar
terminology. Forward looking statements also include the assumptions underlying
or relating to any such statements. Forward looking statements contained within
this document represent a good-faith assessment of Qualstar’s future performance
for which management believes there is a reasonable basis. Qualstar disclaims
any obligation to update the forward looking statements contained herein, except
as may be required by law.








PARTI





ITEM
1. BUSINESS


INTRODUCTION





We
design, develop, manufacture and sell automated magnetic tape libraries used to
store, retrieve and manage electronic data primarily in network computing
environments. Tape libraries consist of cartridge tape drives, tape cartridges
and robotics to move the cartridges from their storage locations to the tape
drives under software control. Our tape libraries provide data storage solutions
for organizations requiring backup, recovery and archival storage of critical
data. Our products are compatible with commonly used operating systems,
including UNIX, Windows, and Linux. Our tape libraries are also compatible with
a wide range of storage management software packages, such as those supplied by
Computer Associates, EMC, IBM, Symantec, CommVault and BakBone Software. We
currently offer tape libraries for two popular tape drive technologies, LTO and
AIT.





We sell
our tape libraries worldwide, primarily to value added resellers and original
equipment manufacturers. These customers typically integrate our tape libraries
with software from third party vendors and related hardware such as servers and
network components to provide complete storage solutions, which are then sold to
end users. We configure our libraries based on each customer’s individual
requirements, with a normal delivery time of one to five 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.





Our power
supplies are used to convert common alternating current (AC) line voltages found
in buildings to direct current (DC) voltages that are needed internally to
operate most electronic equipment. Since purchasing N2Power we have continued to
develop and market additional models and model families to broaden the product
line and increase potential business prospects.





Qualstar
was incorporated in California in 1984. 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 the leading automation-capable tape drive technologies. In July 2002, we
purchased the assets of N2Power, Incorporated, a supplier of high efficiency
open-frame switching power supplies. Power supplies provided by N2Power are
utilized within some of our tape library products as well as sold to original
equipment manufacturers and contract manufacturers for incorporation into their
products. N2Power products are sold under the N2Power brand name as well as
under a private label brand name through independent sales representatives and
distributors.





Tape
libraries and power supplies comprise Qualstar’s two operating
segments.  Revenues from our tape library segment represented
approximately 81.2% of revenues for fiscal 2008, approximately 85.4% of revenues
for fiscal 2007, and approximately 88.1% of revenues for fiscal 2006. Revenues
from our power supply segment totaled approximately 18.8% of revenues for fiscal
2008, 14.6% of revenues for fiscal 2007 and 11.9% of revenues for fiscal
2006.





3
 Index





DATA
STORAGE INDUSTRY BACKGROUND





Storing,
managing and protecting data has become critical to the operation of many
enterprises and governments as the world economy becomes increasingly
information dependent. The data storage industry is reacting in response to the
increase in the amount of data that is generated and that must be preserved. The
amount of data has been increasing due to the growth in the number of computers,
the number, size and complexity of computer networks and software applications,
and the emergence of new applications such as image processing, internet
services, medical image storage, video image storage, and other multi-media
applications. In addition, businesses continue to generate increasing amounts of
traditional business information with respect to their products, customers and
financial data. This increase in the amount of data that is generated stimulates
increases in the demand for data storage and the management of this
data.





FACTORS
DRIVING GROWTH IN DATA STORAGE





•
            Increased demand from Internet
      businesses.  The growth in the Internet has created
      businesses that depend on the creation, access to and archival storage of
      data. We believe this demand will continue to grow as individuals and
      businesses increase their reliance on the Internet for communications and
      commerce.





•
            Growth in new types of
      data.  New types of data are also fueling the growth in
      data storage. For example, graphics, audio, video and medical images, and
      multi-media uses such as video on demand, require far greater storage
      capacity than text and financial
data.





•
            Recognition of the critical
      importance of data.  Corporate
      databases contain useful information about customer records, order
      patterns and other factors that can be analyzed and transformed into a
      valuable asset and a competitive advantage. The ability to efficiently
      store, manage and protect this information is important to the value and
      success of many businesses. The usefulness of past and present data is
      further enhanced by sophisticated data mining software applications that
      can access and analyze large
databases.





•
            Growing awareness of the need
      for disaster protection.  Companies
      are recognizing that without their data they may not survive. Natural
      disasters, as well as overt and covert actions targeted at individual
      companies or classes of users, can destroy data and entire data centers,
      threatening a company’s very existence. Systematic replication and secure
      off-site storage of corporate data is recognized as the best defense
      against catastrophic data loss. Tape libraries are a key technology in
      most corporate data disaster protection
plans.





•
            Compliance with new regulatory
      requirements for records retention.  Many
      businesses now must deal with new regulatory requirements from various
      governmental agencies that require businesses to retain data for long
      periods of time. The regulations that have received the most visibility
      include HIPAA requirements covering medical records; Sarbanes-Oxley, which
      addresses corporate governance; and Rule 17a under the Securities Exchange
      Act of 1934, regarding recordkeeping requirements for the securities
      industry. These regulations and others are projected to increase demand
      for long-term storage capacity over the next few years. This pressure to
      retain records is not unique to the United States, but is a global
      concern.





•
            Growth in network computing
      applications and data.  The use
      of computer networks has shifted critical information and applications to
      network servers to allow more people to gain access to stored data as well
      as to create new data. As the speed of network computing has increased,
      numerous new applications have become feasible that generate progressively
      more data. Organizations are increasingly aware of the need to protect
      this data, as networks become a mission-critical element of many
      operations.





•
            Decrease in the costs of
      storing data.  The costs of data storage have decreased
      with advances in technology and improved manufacturing processes. We
      expect these costs to continue to decrease. The decrease in the cost of
      data storage encourages the storage of more data and makes it more cost
      effective to simply add more storage capacity than to remove old data,
      which in the past may have been purged
  periodically.





4
 Index





ADVANCES
IN DATA STORAGE MANAGEMENT TECHNOLOGIES





The
growth in data is contributing to an evolution in traditional storage solutions.
New technologies are designed to provide high-speed connectivity for
data-intensive applications across multiple operating systems. These new methods
of storage and data management technologies include the following:





•
            Fibre
      Channel.  Fibre Channel is an interface technology based
      on industry standards for the connection of storage devices to networks.
      Interface is the term used to describe the electronics, cabling and
      software used to facilitate communications between devices. With Fibre
      Channel, users are better able to share stored information with other
      storage devices and servers over longer distances, with faster data
      transfer speeds.





•
            Storage Area
      Networks.  Storage Area Network, or SAN, architecture
      applies the inherent benefits of a networked approach to data storage
      applications, which allows data to move efficiently and reliably between
      multiple storage devices and servers. The benefits of SAN architecture
      also include increasing the expandability of existing storage solutions
      and providing a higher level of connectivity than exists with traditional
      technologies. Additionally, SANs are able to provide these benefits across
      multiple operating systems.





•
            Advanced storage management
      software.  This software automatically migrates
      infrequently accessed data to the lower cost storage medium such as a tape
      library. A user’s request for this data at some later date will recall the
      data automatically from the tape library. This process reduces the overall
      storage cost by using the least expensive storage medium to store data
      needed on an infrequent basis. Advances in storage management software
      have increased the ability of businesses to more cost-effectively store,
      manage and retrieve data, which in turn allows businesses to operate more
      efficiently.





•
            Network Attached
      Storage.  Current storage devices are dependent on a file
      server for all commands and control. Network attached storage devices give
      storage devices file server functionality, which allow users to plug a
      storage device directly into a network without requiring a separate file
      server. This allows users to maintain, or even enhance, system performance
      while saving on both time and cost.





TYPES
OF DATA STORAGE





Current
non-volatile storage solutions are based primarily on two technologies: magnetic
disk and magnetic tape. These technologies represent a compromise among a
variety of competing factors including capacity, cost, speed, portability and
data reliability. Magnetic tapes are removable, which allows them to be
transported easily to an off-site location for security or protection from
physical harm. Magnetic disks provide quicker access to stored data and
generally are used when speed is important. Less frequently used data is often
migrated from magnetic disks to tape storage. Tape libraries provide an online
solution, where less frequently used data files are stored on tape at
substantially lower cost compared to disk while still providing automated
access.





TAPE
LIBRARIES AND APPLICATIONS





Tape
libraries automate the tape loading process, eliminate errors induced by human
operators, and enhance security compared to tapes that must be retrieved and
loaded manually. Tape libraries can also be operated from remote locations
around the clock, thus, eliminating the need for an operator. Automated tape
libraries are a key component in a company’s overall storage solution and data
protection strategy when large amounts of data are involved.





Tape
drives and tape media are the two key components of tape libraries. The costs of
tape drives and tape media have declined with advances in technology. As prices
decline, new applications for automated storage become justified, further
increasing the number of applications that can benefit from the use of tape
libraries. We believe that continued technological improvements in tape drives
and tape media will continue to reduce overall storage costs in the
future.





Current
and emerging applications for tape libraries include:





•
            Automated
      backup.  Backup is the creation of a duplicate copy of
      current data for the purpose of recovering the data in the event the
      original is lost or damaged. An automated tape library, in conjunction
      with storage management software, can backup network data at any time
      without human intervention. A library with multiple tape drives can backup
      data using all of its drives simultaneously, thus significantly speeding
      up the recording process. Backup tapes can be removed from the library and
      stored in an off-site location for protection against a loss of the
      primary site.





5
 Index





•
            Archiving.  Archiving
      is the storage of data for historical purposes. When information is stored
      on tape, automated tape libraries, under application control, can catalog
      tapes for future retrieval and prevent unauthorized removal or corruption
      of data by using password or key lock protection. Archival tapes provide a
      historic record for use in fraud detection, audit, legal and other
      processes. Tape libraries are also used for archiving due to benefits
      offered by the tape medium, such as long-term data integrity, resistance
      to environmental contamination, ease of relocation and low
      cost.





•
            Image
      management.  Storage-intensive applications such as
      satellite mapping and medical image management systems utilize tape
      libraries because of the cost advantage over traditional storage methods.
      X-ray images or MRI results, for instance, must frequently be kept on file
      for years. Storing a digitized image in a tape library costs considerably
      less than storing a film copy, and can be retrieved years later with the
      click of a mouse.





DISTRIBUTION
OF TAPE LIBRARY PRODUCTS





The
requirements for storage solutions vary depending on the size of an enterprise,
the type of data generated and the amount of data to be stored. With the
increased dependence on stored data, most organizations, regardless of their
size, have a heightened need for storage solutions that integrate devices such
as tape drives, tape libraries and storage management software. Those
organizations with sufficient in-house information technology resources can rely
on their internal infrastructure and expertise to design, purchase and implement
their own storage solutions. These organizations may elect to purchase equipment
from distributors or directly from the original equipment manufacturers. Many
organizations, however, do not have sufficient in-house resources but have the
same need for data storage solutions. These organizations often look to value
added resellers to design, supply and install their storage
solutions.





Value
added resellers develop and install storage solutions for enterprises that face
complex storage needs but lack the in-house capability of designing and
implementing the proper solution or have chosen to outsource these functions.
Typically, the value added reseller will select among a variety of different
hardware technologies and software options, as well as provide installation and
other services, to deliver a complete storage solution for the end user. Value
added resellers require rapid turnaround of orders, custom configuration of tape
libraries, drop shipment to their customer’s site and marketing and technical
support.





Original
equipment manufacturers generally resell products made by others under their own
brand name and typically assume responsibility for product sales, service and
support. Original equipment manufacturers enable manufacturers, such as
Qualstar, to reach end users not served by other channels and to serve select
vertical markets where specific original equipment manufacturers have
exceptional strength. Original equipment manufacturers require special services
such as product configuration control, extensive qualification testing, custom
colors and private labeling.





OUR
TAPE LIBRARY SOLUTIONS





We offer
storage solutions that respond to the growing data management challenges facing
businesses today, while addressing the unique needs of value added resellers and
original equipment manufacturers.





We
believe that high reliability is important to the end users of our products due
to the critical nature of the data that is being stored, shorter time periods
available for the back-up operations, and the operation of backup systems during
hours when personnel may not be available to respond to problems. To address
these concerns, we emphasize quality and reliability in the design,
manufacturing and testing of our products which reduces the potential for
product failures and results in products that require little
maintenance.





The
technology utilized in automated tape libraries is continuously evolving due to
advances in data recording methods, component cost reductions, advances in
semiconductor and microprocessor technologies, and a general trend toward
miniaturization in the electronics industry. This changing technology requires
that we continuously develop and market new products to prevent our product
lines from becoming obsolete.





Our tape
libraries are compatible with over 45 third-party storage management software
packages, including those supplied by Computer Associates, EMC, IBM, Symantec,
CommVault and BakBone Software. Storage management software enables network
administrators to allocate the use of storage resources among user groups or
tasks, to manage data from a central location, and to retrieve, transfer and
backup data between multiple workstations. We believe that storage management
software is a crucial component of any automated storage installation, and lack
of compatibility is a significant barrier to entry for new tape library
competitors. To ensure compatibility, our engineers work with independent
software vendors during the product development cycles. We do not have contracts
with any independent software vendors, nor do we need access to their software
code to design our products. We maintain relationships with them by making tape
libraries available so they can qualify their software to work with our tape
libraries and by evaluating their software for compatibility with our tape
libraries. We also support our relationships with them by keeping them informed
about current and anticipated changes to our products.





6
 Index





STRATEGY





Our goal
is to enhance our position as a supplier of automated tape libraries and to
maintain or increase our market share in each of the product categories in which
we compete. To achieve this goal, we intend to:





•
            Focus our development efforts
      on higher margin product categories.   In Fiscal
      2007 we began shipments of a newly-developed library system referred to as
      the XLS family of products. The XLS expands the breadth of our product
      line into the enterprise computing environment where tape capacities may
      range into the tens of thousands of tapes. We intend to continue to build
      on this product category with future product releases and enhancements in
      order to pursue this market segment where the potential margins are higher
      than we have traditionally enjoyed.





•
            Focus on value added reseller
      channels.  We sell our products primarily through
      selected value added resellers who have a strong market presence, have
      demonstrated the ability to work directly with end users, and who maintain
      relationships with major vendors of storage management software. Because
      we market our products primarily through this channel, we have implemented
      a variety of programs to support and enhance our relationships with our
      reseller partners. These programs are designed to benefit the reseller and
      increase the likelihood of selling our products. We intend to maintain our
      marketing presence in support of this channel. We conduct business with
      our value added resellers on an individual purchase order basis and no
      long-term purchase commitments are
involved.





•
            Maintain and strengthen
      original equipment manufacturer relationships.  We
      sell our products to several companies under private label or original
      equipment manufacturer relationships. Original equipment manufacturer
      sales enable us to reach some end users not served by our value added
      resellers. The same product characteristics that make our tape libraries
      attractive to value added resellers also are important to original
      equipment manufacturers. We conduct business with our original equipment
      manufacturer customers on an individual purchase order basis and no
      long-term purchase commitments are
involved.





Our
strategy for the power supply business is to selectively pursue market
opportunities where we can command a premium price for high-efficiency products
rather than becoming a commodity supplier. As electronic devices continue to
shrink in size, many designers are forced to consider our high-density,
high-efficiency approach. Our power supply products are made to our
specifications by contract manufacturers in China.





We
believe that our experience, efficiency and control over the development and
manufacture of new products are key factors in the successful execution of our
strategy. We design our tape libraries with a high percentage of common parts,
use quality components and minimize the number of moving parts. We utilize
proprietary techniques in the design, production and testing of our libraries in
order to simplify the manufacturing process and reduce our costs. We manufacture
all of our tape automation products at a single facility and we control our
inventory closely to provide rapid delivery to our customers. These steps allow
us to design and efficiently bring to market new products in response to
changing technology.





PRODUCTS





Tape
Libraries


We offer
a number of tape library families, each capable of incorporating one or more
tape drive technologies, as summarized in the following table:





Product
      Family
            Tape
      Drive
              Technology
            
            Range
      of Tape
              Cartridges
            
            Maximum
      Capacity
              in Terabytes(1)TLS-4000
            Sony
      AIT
            
            12
      to 360
            
            144TLS-8000
            LTO
            
            11
      to 264
            
            211RLS-4000
            Sony
      AIT
            
            22
      to 70
            
            28RLS-8000
            LTO
            
            12
      to 44
            
            35XLS
      Series
            LTO
            
            295
      to 9,639
            
            7,711





____________





(1)
            A
      Terabyte is one million megabytes, or one thousand gigabytes. The table
      shows native capacity and excludes gains fromdata compression, which can
      increase capacity by more than
100%.





7
 Index





Our tape
library families include a number of models that differ in storage capacity,
price and features. Our libraries are installed in network computing
environments ranging from small departmental networks to enterprise-wide
networks supporting hundreds of users. We believe that selling products for
multiple tape drive technologies insulates us somewhat from the dynamics of the
marketplace as various tape standards compete for market share. This helps our
products appeal to the broadest possible range of end user market segments. This
wide range of products makes us a one-stop supplier for our value added reseller
and original equipment manufacturer customers, enabling them to meet most end
user requirements for a specific tape format or data capacity.





Tape
libraries generally contain two or more tape drives and from ten to thousands of
tapes. We design our tape libraries for continuous, unattended operation.
Multiple tape drives allow simultaneous access to different data files by
different users on the network, and increase the rate at which data can move on
to, out of, or within the network. A library with multiple tape drives can back
up data using multiple drives simultaneously, significantly speeding up the
recording process. In some of our libraries, tape cartridges are stored in
removable magazines, allowing for easy bulk removal of the tapes. Our libraries
also offer features such as barcode readers to scan cartridge labels and
input/output ports for importing and exporting tapes under system control.
Several of our library models are expandable in the field by increasing the
number of tape storage positions. This feature provides the end user with the
ability to increase data capacity as storage needs grow.





We
continue to develop and release new libraries to expand our product offerings to
meet the changing demands of the marketplace. In addition, we continue to
enhance and improve our existing products to maintain our competitive
position.





Some of
our tape libraries incorporate a number of specialized features that we believe
improve reliability, serviceability and performance, including:





•
            Rapid
      tape drive replacement.  We design our libraries so that a tape
      drive can be replaced quickly without special tools. This feature
      minimizes the off-line time required when a tape drive must be replaced,
      and frequently avoids the high cost and delays of a service
      call.





•
            Fibre
      Channel connectivity.  We offer a Fibre Channel option on all of
      our models for connection to Storage Area Networks and other high
      performance applications.





•
            Closed-loop
      servo control.  Our tape libraries use a digital closed-loop
      servo to control robotic motion and to provide precise tape handling. This
      yields motion that is smooth, repeatable and highly
    reliable.





•
            Brushless
      motors.  Motors are a key component in any robotic system. We
      use only brushless electric motors in our tape libraries. Brushless motors
      provide longer life and less electrical noise compared to conventional
      brush-type motors. We build many of our own motors in order to obtain
      optimum performance and
reliability.





•
            Remote
      management.  Many larger companies with global back-up
      requirements or disaster management programs require tape libraries that
      can be located off-site in various regions, but that must be administered
      from a single location. With our remote library manager, customers can put
      libraries anywhere in the world and manage them from a single
      administrative hub using a standard web
browser.





Our RLS
series of tape libraries are designed to fit efficiently in equipment racks and
provide back-up capacity in only five standard units, or a total of 8.75 inches
of rack space. In addition, the RLS series is designed to support dual-redundant
power supplies and hot-swappable tape drives.





Our TLS
series of tape libraries are designed to be freestanding units for applications
where an equipment rack may not be available or where the library is purchased
after the original installation and rack space is fully utilized.





8
 Index




Our XLS
family of tape libraries is designed to be expandable from 295 to 9,639 tapes
and is focused on the needs of large enterprises. The XLS product is feature
rich and is intended to provide the customer with a highly reliable and highly
efficient solution.






Power
Supplies





In
addition to tape libraries, we design and sell high efficiency, open frame
switching power supplies. These power supplies are used to convert AC line
voltage to DC for use in a wide variety of electronic equipment such as
telecommunications equipment, servers, routers, switches, wireless systems and
gaming devices.





Our power
supplies are sold under the N2Power brand. We have specialized in units that are
less than 13⁄4 inches high and that are optimized for high efficiency operation.
The high efficiency allows the units to be operated in confined spaces without
heating up the surrounding equipment. These products are manufactured for us in
China and sold to original equipment manufacturers (OEM) and contract
manufacturers as well as to distributors.





We
believe that as worldwide energy concerns and energy costs rise, our high
efficiency approach will become more important. Additionally, these power
supplies are utilized within some of our tape library products.  We
have developed a line of power supply products that deliver up to twice the
power in half the space of competitive products. Manufacturers of servers,
routers, switches, telecom gear, and other process-based equipment continuously
pursue smaller, more powerful, and more efficient power sources for their
equipment to remain competitive.





Each
power supply undergoes a complete functional test and a multi hour burn-in to
insure that every unit meets our stringent quality requirements.  We
believe our high efficiency design reduces loads on both power generating
stations and air-conditioning systems.





Other
Products





We also
sell ancillary products related to our tape libraries, such as tape media, tape
magazines, cables, bar code labels and fiber channel adapters.





SALES
AND MARKETING





Sales





We sell
our tape library products primarily through value added resellers. Our sales
force will initiate contact with value added resellers who are candidates to
sell our tape libraries. We strive to develop relationships with resellers who
have expertise in storage management applications, established relationships
with end users and the experience to understand and satisfy their customers’
storage systems requirements.





We
believe that by selling directly to value added resellers, we have an advantage
over competitors who will often sell directly to end users, thereby competing
with their resellers. Some of the advantages of our strategy include the
following:





•
            Higher
      profit margins.  Focusing on this channel, we achieve economies
      that result in higher profit margins to be shared by both the reseller and
      us.





•
            Custom
      configurations.  We offer custom configurations of our products,
      such as special paint, private branding and non-standard options, on very
      short notice.





•
            Channel
      conflicts avoided.  We refer substantially all end user
      inquiries to our reseller partners. Frequently, our sales force will make
      end user visits with resellers to help close a pending
    sale.





•
            Credit.  We
      extend credit terms to resellers who meet our credit
      requirements.





9
 Index





•
            Rapid
      delivery.  We generally ship a product within one to five
      working days of confirming an order, rivaling the delivery time of
      competitors that use distributors to bring products to
    market.





Although
we sell our tape libraries primarily to value added resellers, original
equipment manufacturers are an important element of our business. The sales
cycle for original equipment manufacturers generally encompasses six months to
one year and may involve extensive product and system qualification testing,
evaluation, integration and verification. Original equipment manufacturers
typically assume responsibility for product sales, service and
support.





Our
international sales are currently directed from our corporate offices in Simi
Valley, California. All of our international sales are denominated in U.S.
dollars. Revenues from customers outside of North America were approximately
$5.8 million, or 27.2% of revenues for fiscal 2008, $5.0 million, or 24.4% of
revenues in fiscal 2007, and approximately $5.7 million, or 26.1% of revenues in
fiscal 2006.





Our sales
are spread across a broad customer base. Revenues from Qualstar’s two largest
customers combined were approximately 12.9%, 11.9% and 13.4% for the years ended
June 30, 2008, 2007, and 2006, respectively and no single customer accounted for
more than 10% of our revenue.





Marketing





We
support our sales efforts with a broad array of marketing programs designed to
generate brand awareness, attract and retain qualified value added resellers and
inform end users of the advantages of our products. We provide our resellers
with a full range of marketing materials, including product specifications,
sales literature, software connectivity information and product application
notes.





We train
our resellers to sell our products and to answer customers’ questions. We
advertise in key publications and participate in trade shows. We display our
products under the Qualstar brand name at some trade shows and participate in
other trade shows in partnership with our principal suppliers and resellers. We
support our marketing and customer support with a website that features
comprehensive marketing and product information. We conduct sales and technical
training classes for our resellers. We also conduct various promotional
activities for resellers such as cooperative advertising.





CUSTOMER
SERVICE AND TECHNICAL SUPPORT





We
believe that providing strong customer service and technical support is an
important aspect of our business. Our customer service and technical support
efforts consist of the following components:





•
            Technical
      support.  Our technical support personnel are available
      twenty-four hours per day, Monday through Friday. Technical support
      personnel are available to all customers at no charge by telephone and
      e-mail to answer questions and solve problems relating to our
      products.  Our technical support personnel are trained in all
      aspects of our products. Our support staff is located at our headquarters
      in Simi Valley, California. We sell service contracts for on-site service
      of our tape libraries, which are fulfilled by IBM Corporation in the
      United States and Canada and by Eastman Kodak S.A. Commercial Imaging
      Group in Europe.





•
            Installation services.
      Our technical support personnel provide assistance to our resellers by
      traveling to the end user’s location to assist the reseller or end user
      with setup and installation on many of our larger library systems, such as
      the XLS series of products.





•
            Training.  We
      offer a training program on product maintenance for end users, value added
      resellers, original equipment manufacturers, customer service and
      technical support personnel. We conduct training classes at our
      headquarters.





•
            Warranty.  We
      provide a three year warranty on our XLS, TLS and RLS tape libraries. Some
      TLS and all RLS models have three year advance replacement warranty
      coverage that provides for replacement of components, or if necessary,
      complete libraries.  XLS libraries sold in North America include
      one year of onsite service and XLS libraries sold outside of North America
      have one year advance replacement coverage that provides for replacement
      of components, or if necessary, complete libraries. Customers may purchase
      extended advance replacement service coverage and on-site service if they
      are located in the United States, Canada and most countries within
      Europe.





10
 Index





•
            Sales
      engineering.  Our engineers provide pre-sales support to
      our resellers, and post-sales support if necessary. Engineers typically
      become involved in more complex problem-solving situations involving
      interactions between our products, third-party software, network server
      hardware and the network operating systems. Engineers work with resellers
      and end users over the telephone and at an end user site as
      required.








MANUFACTURING
AND SUPPLIERS





We
manufacture all of our tape libraries at our facility in Simi Valley,
California. We operate our manufacturing on a single shift. However, if
required, we have the ability to add a second or third shift to increase our
capacity.





To
respond rapidly to orders, we build our tape libraries, perform full testing and
then place the tape libraries in a holding area until an order is received. Once
an order is confirmed, we remove the unit from the holding area, install tape
drives and configure the unit to meet the specific requirements of the order,
retest and then ship.





The
manufacturing cycle to bring our libraries to a finished state is approximately
five working days for our TLS and RLS libraries and approximately 30 working
days for our XLS libraries. We believe that this process represents an effective
way to control our inventory levels while maintaining the ability to fill
specific orders in short lead times. We coordinate inventory planning and
management with suppliers and customers to match our production to market
demand. Once we confirm an order, we generally ship the product within one to
five working days. We believe this response time is among the fastest in the
industry and gives us a competitive edge. Because we fill the majority of our
orders as they are received, our backlog generally is small and is not
indicative of future revenues.





We
carefully select our suppliers based on their ability to provide quality parts
that meet our specifications. Inventory planning and management is coordinated
closely with suppliers to match our production needs. We maintain an inventory
of components assembled into the libraries that are off-the-shelf and others
that are designed to our specifications.  We use off-the-shelf parts
to reduce the risk of parts shortages and keep a minimal inventory of these
parts on hand.





Tape
drives and tape media are available only from a limited number of suppliers,
some of which are sole-source providers. Some of our suppliers compete with us
by selling their own tape libraries. Any disruption in supplies of tape drives
or tape media could delay shipments of our products.





COMPETITION





The
market for automated tape libraries is competitive and characterized by rapidly
changing technology and evolving standards. Because we offer a broad range of
libraries for different tape drive technologies, we tend to have a large number
of competitors that differ depending on the particular format and performance
level. Our principal competitors in this market segment include Sun
MicroSystems, Quantum Corporation, Overland Storage, Inc., and SpectraLogic
Corporation.





Many of
our competitors have substantially greater financial and other resources, better
name recognition, larger research and development staffs, and more capabilities
in manufacturing, marketing and distributing products than we do. Our
competitors may develop new technologies and products that are more effective
than our products. We are not ISO-9000 certified, unlike some of our
competitors, which may limit some customers’ ability to purchase our
products.





As
competitors introduce products in a particular tape drive technology, the
increased competition normally results in price erosion and a reduction in gross
margins for all competitors. We cannot assure you that we will be able to
compete successfully against either current or potential competitors or that
competition will not cause a reduction in our revenues or profit margins. We
believe that our ability to compete depends on a number of factors, including
the success and timing of new product developments by us and by our competitors,
compatibility of our products with a broad range of computing systems, product
performance, reliability, price, marketing and sales execution and customer
support. Specifically, we believe that the principal competitive factors in the
selection of a tape library include:





•
            reliability
      of the robotic assembly that handles the tape
  cartridges;


•
            initial
      purchase price;





11
 Index





•
            storage
      capacity;


•
            speed
      of data transfer;


•
            compatibility
      with existing operating systems and storage management
      software;


•
            after-sale
      expandability of a tape library to meet increasing storage
      requirements;


•
            expected
      product life, cost of maintenance and total cost of ownership;
      and


•
            physical
      configuration and power requirements of the
  library.





We
believe our tape libraries compete favorably overall with respect to many of
these factors.





Our power
supply products compete in a number of markets focused on the needs of OEM and
contract manufacturers. We have concentrated on supplying units that provide
above average electrical efficiency as well as high space efficiency as measured
in watts per cubic inch.





RESEARCH
AND DEVELOPMENT





Our
research and development team consists of engineers and technicians who have
data storage and related industry experience. We have developed over 41 separate
tape library models for eleven different tape formats over the last thirteen
years.





Our
research and development efforts rely on the integration of multiple engineering
disciplines to generate products that meet market needs in a competitive and
timely fashion. Successful development of automated tape libraries requires the
integration of mechanical design, electronic design packaging, and firmware
design into a single product. Product success also relies on the engineering
group’s thorough knowledge of each of the different tape drive technologies. Our
engineers work closely with the tape drive manufacturers through the drive
development cycle to assure that reliable tape library and tape drive
combinations are brought to market.





The
design architecture of our tape libraries makes use of common parts across each
product family, allowing us to develop and introduce new products quickly. If a
new tape drive is an advanced version of one already incorporated in one or more
of our products, our time and dollar investment to incorporate the new drive can
be relatively small, with the primary focus being on verification testing. When
the form factors differ, the time and investment requirements can grow and may
require development of a new product family altogether.





We also
develop new products as we identify emerging market needs. Our sales, marketing,
product development and engineering groups identify products to fulfill customer
and marketplace needs. Our research and development group concentrates on
leveraging previous engineering investments into new products. For example, our
firmware is based on successive generations of the operating system developed
for our first library. We also use common parts in our different library series
and leverage our electro-mechanical and electronic hardware technology from
previous products into next generation designs.





We
continue to develop new power supply models and families in response to input
from our customers. The product development cycle involves circuit design,
printed circuit board layouts, prototype testing, safety agency and compliance
testing and test equipment development.





Our
research and development expenses were approximately $3.1 million in fiscal
2008, 2007 and  2006.





INTELLECTUAL
PROPERTY





We rely
on copyright protection of our firmware, as well as patent protection for some
of our designs and products. We also rely on a combination of trademark, trade
secret and other intellectual property laws to protect our proprietary rights.
However, we do not believe our intellectual property provides significant
protection from competition. We believe that, because of the rapid pace of
technological change in the tape storage industry, patent, copyright, trademark
and trade secret protection are less significant than factors such as the
knowledge, ability and experience of our personnel and timely new product
introductions.





We enter
into Employee Proprietary Information and Inventions Agreements with our
engineers along with all employees and consultants to protect our technology and
designs. However, we do not believe that such protection can preclude
competitors from developing substantially equivalent products.





12
 Index





EMPLOYEES





As of
July 31, 2008, we had 84 employees, including 29 in operations and
manufacturing, 20 in research and development, 5 in customer service and
technical support, 14 in sales and marketing, and 16 in administration and
finance. We also employ a small number of temporary employees and consultants as
needed. We are not a party to any collective bargaining agreement or other
similar agreement. We believe that we have a good relationship with our
employees.








AVAILABILITY
OF SEC FILINGS





We file
annual, quarterly and special reports, proxy statements and other information
with the Securities and Exchange Commission. You can read our SEC filings over
the Internet at the SEC’s website at http://www.sec.gov. We also make our SEC
filings available free of charge through our Internet website as soon as
reasonably practicable after we electronically file them with, or furnish them
to, the SEC. Our website address is www.qualstar.com. The
reference to our website address does not constitute incorporation by reference
into this report of the information contained at that site.








EXECUTIVEOFFICERS OF THE REGISTRANT





Executive
Officers





Officers
are elected by and serve at the discretion of the board of directors. The
executive officers of Qualstar as of September 15, 2008 are:





Name
            Age
            PositionWilliam
      J. Gervais
            65
            Chief
      Executive Officer, President and DirectorRichard
      A. Nelson
            65
            Vice
      President of Engineering, Secretary and DirectorAndrew
      A. Farina
            62
            Vice
      President and Chief Financial OfficerDavid
      L. Griffith
            51
            Vice
      President of OperationsRobert
      K. Covey
            61
            Vice
      President of MarketingRobert
      C. King
            64
            Vice
      President of Sales








Background





William
J. Gervais is a founder of Qualstar and has been our President and a director
since our inception in 1984, and was elected Chief Executive Officer in January
2000. From 1984 until January 2000, Mr. Gervais also served as our Chief
Financial Officer. From 1981 until 1984, Mr. Gervais was President of Northridge
Design Associates, Inc., an engineering consulting firm. Mr. Gervais was a
co-founder, and served as Engineering Manager from 1976 until 1981, of
Micropolis Corporation. Mr. Gervais earned a B.S. degree in Mechanical
Engineering from California State Polytechnic University, Pomona in
1967.





Richard
A. Nelson is a founder of Qualstar and has been our Vice President of
Engineering, Secretary and a director since our inception in 1984. From 1974 to
1984, Mr. Nelson was self employed as an engineering consultant specializing in
microprocessor technology. Mr. Nelson earned a B.S. in Electronic Engineering
from California State Polytechnic University, Pomona in 1966.





Andrew A.
Farina joined Qualstar as Chief Financial Officer in November 2006. From
September 1996 to December 2005, Mr. Farina was the Chief Financial Officer of
99¢ Only Stores. From March 1993 thru September 1996, Mr. Farina was Vice
President of Finance of Crown BBK, Inc., a food brokerage business. From June
1991 to March 1993, Mr. Farina held the position of Vice President of Finance
for Benchmark Corporation. From 1976 through February 1991, Mr. Farina held
various positions, starting as divisional Controller and advancing to President
at Sirena, Inc., a division of Sara Lee.  Mr. Farina earned a B.S.
degree in Accounting from the University of Nevada in 1969 and obtained his CPA
certification in the State of California in 1974.  Mr. Farina received
his MBA from California State Polytechnic University in 1982.





13
 Index





David L.
Griffith, our Vice President of Operations, joined the company in October of
2001. From 1999 to 2001, Mr. Griffith served as the President and Chief
Executive Officer of Stardrive Solutions Inc., a software solutions provider for
the broadcast automation industry. From 1998 to 1999, Mr. Griffith was the
Corporate Vice President of Business Development at Tandberg Data ASA where he
was responsible for the development of worldwide business plans and corporate
expansion activities. From 1994 to 1998, Mr. Griffith was the President and
Chief Executive Officer of Tandberg Data, Inc. located in Simi Valley,
California. From 1990 to 1994, Mr. Griffith was the Vice President of Sales and
Marketing for Tandberg Data, Inc. From 1987 to 1990, Mr. Griffith acted as
Marketing Manager and Program Manager for the Memory Products Group of Siemens
Information Systems. Mr. Griffith received a degree in Mechanical Engineering
from California State Polytechnic University in 1980.





Robert K.
Covey has been our Vice President of Marketing since 1994. From 1986 to 1993 Mr.
Covey was regional manager of ATG Cygnet, an optical disk library firm. From
1982 to 1985, Mr. Covey served as national sales manager at Micropolis
Corporation, a former disk drive manufacturer. Mr. Covey attended Butler
University and Bentley College from 1965 to 1968.





Robert C.
King was appointed our Vice President of Sales in June 2005. From 1999 until it
was acquired by JDS Uniphase in 2004, Mr. King was Vice President, Sales for E2O
Communications, a manufacturer of optical transceivers. From 1995 to 1998 Mr.
King was Vice President, Sales and Marketing for Advanced Photonix. From 1992 to
1995, Mr. King served as Vice President, Sales and Marketing for Performance
Materials Corporation. From 1989 to 1992, Mr. King served as Vice President,
Market and Business Development for PCO, a subsidiary of Corning Incorporated.
Mr. King holds a B.S.M.E. degree from Ohio University in Athens,
Ohio.





ITEM1A. RISK FACTORS





This
Annual Report on Form 10-K contains forward-looking statements, as described at
page 3 of this report under the caption “Forward-Looking Statements.” We believe
that the risks described below are the most important factors which may cause
our actual future results of operations to differ materially from the results
projected in the forward-looking statements.








RISKS RELATED TO OUR
BUSINESS





The
principal risks applicable to our business in general are described below.
Specific risks applicable to our tape library and power supply operating
segments are described in the following subsections of Item 1A.





We have a limited number of
executives. The loss of any single executive or the failure to hire and integrate capable
new executives could harm our business.





The
success of our business is tied closely to the managerial, engineering and
business acumen of our existing executives. William J. Gervais, our President,
has been largely responsible for the development of most of our tape libraries,
has overseen our operations and growth, and established and maintained our
strategic relationships. We expect that he will continue these efforts for the
foreseeable future. Our future success will also depend on our ability to
attract, retain and motivate key executives and other key personnel, many of
whom have been instrumental in developing new technologies and strategic plans.
We may not be able to retain our existing personnel or attract additional
qualified personnel in the future. However, our current dependence on a limited
number of executives and other key personnel, for whom replacements may be
difficult to find, entails a risk that we may not be able to supervise and
manage our ongoing operations.





Our lack of significant order backlog
makes it difficult to forecast future revenues and operating
results.





We
normally ship products within a few days after orders are received.
Consequently, we do not have significant order backlog and a large portion of
our revenues in each quarter result from orders we received during that quarter.
Because backlog can be an important indicator of future revenues, our lack of
backlog makes it more difficult to forecast our future revenues. Since our
operating expenses are relatively fixed in the short term, unexpected
fluctuations in revenues could negatively impact our quarterly operating
results.





14
 Index





Our research and development spending
may not yield results that justify the costs incurred.





In recent
fiscal years we have spent substantial amounts for research and development. Our
products and markets are technologically advanced and rapidly evolving, and we
cannot be assured that these efforts will successfully provide us with new or
upgraded products that will be competitive. If these programs are not
successful, our investment in research and development will not yield
corresponding benefits to us.





Our customers have the right to
return our products in certain circumstances. An excessive number of returns may
reduce our revenues.





Our
customers have 30 days from the date of purchase to return products that do not
conform to an end user’s requirements. We may otherwise allow product returns if
we think that doing so maximizes the effectiveness of our sales channels and
promotes our reputation for quality and service. Although we estimate and
reserve for potential returns in our reported financial results, actual returns
could exceed our estimates. If the number of returns exceeds our estimates, our
financial results could be adversely impacted for the periods during which
returns are made.





We
may spend money pursuing sales that do not occur when anticipated or at
all.





Original
equipment manufacturer customers typically conduct significant evaluation,
testing, implementation and acceptance procedures before they begin to market
and sell new products. This evaluation process is lengthy and may range from six
months to one year or more. This process is complex and may require significant
sales, marketing, engineering and management resources on our part. The process
becomes more complex as we simultaneously qualify our products with multiple
customers or pursue large orders with a single customer. As a result, we may
expend resources to develop customer relationships before we recognize any
revenue from these relationships, if at all.





We sell a significant portion of our
products to customers located outside the United States. Currency fluctuations and
increased costs associated with international sales could make our products
unaffordable in foreign markets, which would reduce our revenue or
profitability.





Revenues
from shipments to customers outside of North America accounted for approximately
27.2% of revenues in fiscal 2008, 24.4% of revenues in fiscal 2007, and
approximately 26.1% of revenues in fiscal 2006. We believe that international
sales will continue to represent a significant portion of our revenues. Our
international sales subject us to a number of risks, including:





•
            political
      and economic instability may reduce demand for our products, our ability
      to market our products in foreign countries, or our ability to obtain key
      components from suppliers;





•
            although
      we denominate our international sales in U.S. dollars, currency
      fluctuations could make our products unaffordable to foreign purchasers or
      more expensive compared to those of foreign
  manufacturers;





•
            restrictions
      on the export or import of technology may reduce or eliminate our ability
      to sell in certain markets;





•
            greater
      difficulty of administering business overseas may increase the costs of
      foreign sales and support;





•
            foreign
      governments may impose tariffs, quotas and taxes on our products;
      and





•
            longer
      payment cycles typically associated with international sales and potential
      difficulties in collecting accounts receivable may reduce the
      profitability of foreign sales.





These
risks may increase our costs of doing business internationally and reduce our
revenues or profitability.





A failure to develop and maintain
proprietary technology may negatively affect our business.





We rely
on copyright protection of electronic circuits and our firmware, as well as
patent protection for some of our designs and products. We also rely on a
combination of trademark, trade secret, and other intellectual property laws and
various contract rights to protect our proprietary rights. However, we do not
believe our intellectual property rights provide significant protection from
competition. As a consequence, these rights may not preclude competitors from
developing products that are substantially equivalent or superior to our
products. In addition, many aspects of our products are not subject to
intellectual property protection and therefore can be reproduced by our
competitors.





15
 Index





Intellectual property infringement
claims brought against us could be time consuming and expensive to
defend.





In recent
years, there has been a significant amount of litigation in the United States
involving patents and other intellectual property rights. Qualstar is not
currently directly involved in any intellectual property litigation or
proceedings. However, in April 2004 we settled litigation that Raytheon Company
had filed alleging that Qualstar and eight other named defendants infringed on a
patent owned by Raytheon Company entitled “Mass Data Storage Library.” In the
future, we may become subject to other claims or inquiries regarding our alleged
unauthorized use of a third party’s intellectual property. An adverse outcome in
litigation could force us to do one or more of the following:





•
            stop
      selling, incorporating or using our products or services that use the
      challenged intellectual property;





•
            subject
      us to significant liabilities to third
parties;





•
            obtain
      from the owners of the infringed intellectual property right a license to
      sell or use the relevant technology, which license may not be available on
      reasonable terms, or at all; or





•
            redesign
      those products or services that use the infringed technology, which
      redesign may be either economically or technologically
      infeasible.





Whether
or not an intellectual property litigation claim is valid, the cost of
responding to it, in terms of legal fees and expenses and the diversion of
management resources, could harm our business.





Our
warranty reserves may not adequately cover our warranty
obligations.





We have
established reserves for the estimated liability associated with our product
warranties. However, we could experience unforeseen circumstances where these or
future reserves may not adequately cover our warranty obligations.





Our revenues and operating results
may fluctuate unexpectedly from quarter to quarter, which may cause our stock
price to decline.





Our
quarterly revenues and operating results have fluctuated in the past, and are
likely to vary significantly in the future due to several factors,
including:





•
              general
      economic conditions affecting spending for information
      technology;





•
            increased
      competition and pricing pressures;





•
            reductions
      in the size, delays in the timing, or cancellation of significant customer
      orders;





•
            shifts
      in product or distribution channel
mix;





•
            the
      timing of the introduction or enhancement of products by us, our original
      equipment manufacturer customers or our
  competitors;





•
            expansions
      or reductions in our relationships with value added reseller and original
      equipment manufacturer customers;





•
            financial
      difficulties affecting our value added reseller or original equipment
      manufacturer customers that render them unable to pay amounts owed to
      us;





•
            market
      acceptance of new and enhanced versions of our
  products;





•
            new
      product developments by storage device manufacturers, such as disk drives,
      that could render our products less cost effective or less
      competitive;





16
 Index





•
            the
      rate of growth in the data storage market and the various segments within
      it;





•
            timing
      and levels of our operating expenses;
and





•
            availability
      of key components and performance of key
  suppliers.





We
believe that period to period comparisons of our operating results may not
necessarily be reliable indicators of our future performance. It is likely that
in some future period our operating results will not meet your expectations or
those of public market analysts.





Any
unanticipated change in revenues or operating results is likely to cause our
stock price to fluctuate since such changes reflect new information available to
investors and analysts. New information may cause investors and analysts to
revalue our stock and this, in the aggregate, may cause fluctuations in our
stock price.




Our officers and directors could
implement corporate actions that are not in the best interests of our shareholders as a
whole.





Our
executive officers and directors own beneficially, in the aggregate,
approximately 42% of our outstanding common stock as of June 30, 2008. As a
result, these shareholders will be able to exercise significant control over all
matters requiring shareholder approval, including the election of directors and
approval of significant corporate transactions, which could delay or prevent
someone from acquiring or merging with us. The interests of our officers and
directors, when acting in their capacity as shareholders, may lead them
to:





•
            vote
      for the election of directors who agree with the incumbent officers’ or
      directors’ preferred corporate policy;
or





•
            oppose
      or support significant corporate transactions when these transactions
      further their interests as incumbent officers or directors, even if these
      interests diverge from their interests as shareholders per se and thus
      from the interests of other
shareholders.





Some provisions of our charter
documents may make takeover attempts difficult, which could depress the price of our stock
and inhibit your ability to receive a premium price for your
shares.





Our board
of directors has the authority, without any action by the shareholders, to issue
up to 5,000,000 shares of preferred stock and to fix the rights and preferences
of such shares. In addition, our articles of incorporation and bylaws contain
provisions that eliminate cumulative voting in the election of directors and
require shareholders to give advance notice if they wish to nominate directors
or submit proposals for shareholder approval. These provisions may have the
effect of delaying, deferring or preventing a change in control, may discourage
bids for our common stock at a premium over its market price and may adversely
affect the market price, and the voting and other rights of the holders of our
common stock.





Trading in our stock has been limited
and our stock price has been volatile. Consequently, it may be difficult to
sell your shares.





There has
been very little trading in shares of our stock and some days it does not trade
at all. This, as well as the factors listed below, has caused the price of our
stock to be volatile. Consequently, it may be difficult to sell your shares of
our stock at the price you paid for them or at a price equal to that quoted on
The Nasdaq Stock Market. Factors that may cause our stock price to fluctuate in
the future include:





•
            quarterly
      variations in operating results, especially if they differ from our
      previously announced forecasts or forecasts made by
    analysts;





•
            changes
      in or cancellation of our dividend payment
  policy;





•
            our
      announcements of anticipated future revenues or operating
      results;





•
            announcements
      concerning us, our competitors, our customers, or our
      industry;





17
 Index





•
            the
      introduction of new technology or products by us or our
      competitors;





•
            comments
      regarding us and the data storage market made by industry analysts or on
      Internet bulletin boards;





•
            changes
      in earnings estimates by analysts or changes in accounting
      policies;





•
            changes
      in product pricing policies by us or our competitors;
  and





•
            changes
      in general economic conditions.





In
addition, stock markets have experienced extreme price and volume volatility in
recent years. This volatility has had a substantial effect on the market prices
of securities of many smaller public companies for reasons frequently unrelated
or disproportionate to the operating performance of the specific companies.
These market fluctuations may adversely affect the market price of our common
stock.





RISKS
RELATED TO OUR TAPE LIBRARY BUSINESS





The
principal risks applicable specifically to our tape library operating segment
are described below.





Our principal competitors devote
greater financial resources to developing, marketing and selling automated tape libraries.
Consequently, we may be unable to maintain or increase our market
share.





We face
significant competition in developing and selling automated tape libraries.
Rapid and ongoing changes in technology and product standards could quickly
render our products less competitive, or even obsolete. We have significantly
fewer financial, technical, manufacturing, marketing and other resources than
many of our competitors and these limited resources may harm our business in
many ways. For example, in the past several years our competitors
have:





•
            acquired
      other tape library companies;





•
            increased
      the geographic scope of their
market;





•
            offered
      a wider range of tape library products;
and





•
            developed
      and acquired proprietary software and disk based products that operate in
      conjunction with their products and the products of their
      competitors.





In the
future, our competitors may leverage their greater resources to:





•
            develop,
      manufacture and market products that are less expensive or technologically
      superior to our products;





•
            attend
      more trade shows and spend more on advertising and
    marketing;





•
            reach
      a wider array of potential customers through a broader range of
      distribution channels;





•
            respond
      more quickly to new or changing technologies, customer requirements and
      standards; or





•
            reduce
      prices in order to preserve or gain market
  share.





We
believe competitive pressures are likely to continue. We cannot guarantee that
our resources will be sufficient to address this competition or that we will
manage costs and adopt strategies capable of effectively utilizing our
resources. If we are unable to respond to competitive pressures successfully,
our prices and profit margins may fall and our market share may
decrease.





Our suppliers could reduce shipments
of tape drives and tape media. If this occurs, we would be forced to curtail
production, our revenues could fall and our market share could
decline.





18
 Index





Automated
tape libraries and related products, such as tape drives and tape media,
represented approximately 62.9% of our revenues for fiscal 2008, 66.6% of our
revenues for fiscal 2007 and approximately 66.2% of our revenues for fiscal
2006. We depend on a limited number of third-party manufacturers to supply us
with the tape drives and tape media that we incorporate into our automated tape
libraries. Some tape drive manufacturers, including Sony Corporation and IBM
Corporation, compete with us by also selling tape libraries. There can be no
assurance that other tape drive manufacturers will not also begin to manufacture
or sell libraries.





Historically,
some of these suppliers have been unable to meet demand for their products and
have allocated their limited supply among customers. If suppliers limit our
supply of tape drives or tape media, we may be forced to delay or cancel
shipments of our tape libraries. The major supplier risks we face include the
following:





•
            Sony
      Electronics, Inc. is our sole-source supplier of AIT drives and media. In
      the past, Sony has allocated some of their products and may allocate them
      again in the future. In fiscal 2008 we derived approximately $5.4 million
      or 25.1% of our revenues, in fiscal 2007 we derived approximately $6.6
      million, or 32.2%, of our revenues, and in fiscal 2006 we derived
      approximately $7.9 million, or 36.4% of revenues from the sale of
      libraries, tape drives and tape media based on Sony AIT and Super AIT
      technologies. If Sony reduces its sales to us or raises its prices, we
      could lose revenues and our margins could
  decline.





•
            The
      LTO standard was developed by an industry consortium consisting of IBM,
      Hewlett Packard and Quantum Corporation. LTO competes with AIT. All three
      drive suppliers also sell automated tape libraries that utilize LTO tape
      drives and compete with our products. Therefore, even if we receive
      adequate allocation, it may be at a price that renders our products
      uncompetitive.





Our other
suppliers have in the past been, and may in the future be, unable to meet our
demand, including our needs for timely delivery, adequate quantity and high
quality. We do not have long-term supply contracts with any of our significant
suppliers. The partial or complete loss of any of our suppliers could result in
lost revenue, added costs and production delays or could otherwise harm our
business and customer relationships.





Our revenues could decline if we fail
to execute our distribution strategy successfully.





We
distribute and sell our automated tape libraries through value added resellers
and original equipment manufacturers, and intend to continue this strategy for
the foreseeable future. Value added resellers integrate our tape libraries with
products of other manufacturers and sell the combined products to their own
customers. Original equipment manufacturers combine our tape libraries with
their own products and sell the combined product under their own brand. We
currently devote, and intend to continue to devote, significant resources to
develop and maintain these relationships. A failure to initiate, manage and
expand our relationships with value added resellers or original equipment
manufacturers could limit our ability to grow or sustain our current level of
revenues.





Our focus
on the distribution of our products through value added resellers poses the
following risks:





•
            we
      may reach fewer customers because we depend on value added resellers to
      market to end users and these value added resellers may fail to market
      effectively or fail to devote sufficient or effective sales, marketing and
      technical support to the sales of our
products;





•
            we
      may lose sales because many of our value added resellers sell products
      that compete with our products. These value added resellers may reduce
      their marketing efforts for our products in favor of products manufactured
      by our competitors;





•
            our
      costs may increase as value added resellers generally require a higher
      level of customer support than do original equipment manufacturers;
      and





•
            as
      the market for tape libraries matures, we expect that tape libraries
      designed for small and medium size businesses will not require the level
      of sales, marketing and technical support traditionally provided by value
      added resellers and, consequently, tape libraries for these customers will
      be increasingly sold through distribution channels rather than through
      value added resellers.





We depend
upon our original equipment manufacturer customers’ ability to develop new
products, applications and product enhancements that incorporate our products in
a timely, cost-effective and customer-friendly manner. We cannot guarantee that
our original equipment manufacturer customers will meet these challenges
effectively. Original equipment manufacturers typically conduct substantial and
lengthy evaluation programs before certifying a new product for inclusion in
their product line. We may be required to devote significant financial and human
resources to these evaluation programs with no assurance that our products will
ever be selected. In addition, even if selected by the original equipment
manufacturer, there generally is no requirement that the original equipment
manufacturer purchase any particular amount of product from us or that it
refrain from purchasing competing products.





19
 Index





We do not
have any exclusive agreements with our value added resellers or original
equipment manufacturers, who purchase our products on an individual purchase
order basis. If we lose important value added resellers or original equipment
manufacturer customers, if they reduce their focus on our products or if we are
unable to obtain additional value added reseller or original equipment
manufacturer customers, our business could suffer.





We rely on tape technology for a
substantial part of our revenues. Our business will be harmed if demand for storage
solutions using tape technology declines or fails to develop as we
expect.





We derive
a high percentage of our revenues from products that incorporate some form of
tape technology. We expect to derive a high percentage of our revenues from
these products for the foreseeable future. As a result, we will continue to be
subject to the risk of a decrease in revenues if demand for these products
declines or if rising prices make it more difficult to obtain them. If products
incorporating other technologies gain comparable or superior market acceptance
and competitive price advantage, our business, financial condition and operating
results could be adversely and materially affected unless we successfully
develop and market products incorporating the new technology.





If we fail to develop and introduce
new products on a timely and cost-effective basis, or if our products do not
contain the features required by the marketplace, we will eventually lose market share and
sales to more innovative competitors.





The
market for our products is characterized by rapidly changing technology and
evolving industry standards. The future success of Qualstar will depend on our
ability to anticipate changes in technology, to develop new and enhanced
products on a timely and cost-effective basis, and to introduce, manufacture and
achieve market acceptance of these new and enhanced products. In particular, our
success will depend on the market acceptance of our XLS family of automated tape
libraries. Our RLS and TLS families of tape libraries are facing increasing
competition from products manufactured by our competitors and may face
competition from other types of storage devices that may be developed in the
future.





Development
schedules for high technology products are inherently subject to uncertainty and
there can be no assurance we will be able to meet our product development
schedules or that our development costs will be within budgeted amounts. If the
products or product enhancements developed are not deliverable due to technical
problems, quality issues or component shortages, or if such products or product
enhancements are not accepted by the marketplace or are unreliable, then our
business, financial condition and results of operations may be materially
adversely affected.





The
introduction of new storage technologies or the adoption of an industry standard
different than our current product standards could render our existing products
obsolete.




We depend upon independent software
vendors to provide storage management software that makes our tape libraries
functional.





The
utility of an automated tape library depends upon the storage management
software, which supports the library and integrates it into the user’s computing
environment to provide a complete storage solution. We do not develop and have
no control over the development of this storage management software. Instead we
rely on third party independent software vendors to develop and support this
software. Accordingly, the continued development and future growth of the market
for our products will depend partly upon the success of software vendors to meet
the overall data storage and management needs of tape library purchasers and our
ability to maintain relationships with these firms. Although we do not have
contracts with any third party independent software vendors, we maintain
relationships with them by:





•
            supplying
      tape libraries so they can qualify their software to work with our tape
      libraries;





•
            evaluating
      their software for compatibility with our tape libraries;
    and





•
            keeping
      them informed as to current and contemplated changes to our
      products.





20
 Index




We may have to expend significant
amounts of time and money defending or settling product liability claims arising from
failures of our tape libraries.





Because
our tape library customers use our products to store and backup their important
data, we face potential liability if our products fail to perform. Although we
maintain general liability insurance, our insurance may not cover potential
claims of this type or may not be adequate to indemnify us for all liability
that may be imposed. Any imposition of liability that is not covered by
insurance or that exceeds our insurance coverage could reduce our profitability
or cause us to discontinue operations.





Undetected flaws could increase our
costs, reduce our revenues and divert resources from our core business
needs.





Our tape
libraries are complex. Despite our efforts to revise and update our
manufacturing and test processes to address engineering and component changes,
we may not be able to control and eliminate manufacturing flaws adequately.
These flaws may include undetected software or hardware defects associated
with:





•
            a
      newly introduced product;





•
            a
      new version of an existing product;
or





•
            a
      product that has been integrated into a network storage solution with the
      products of other vendors.





The
variety of contexts in which errors may arise may make it difficult to identify
the source of a problem. These problems may:





•
            cause
      us to incur significant warranty, repair and replacement
      costs;





•
            divert
      the attention of our engineering personnel from our product development
      efforts;





•
            cause
      significant customer relations problems;
or





•
            damage
      our reputation.





To
address these risks, we frequently revise and update manufacturing and test
procedures to address engineering and component changes to our products. If we
fail to adequately monitor, develop and implement appropriate test and
manufacturing processes we could experience a rate of product failure that
results in substantial shipment delays, repair or replacement costs or damage to
our reputation. Product flaws may also consume our limited engineering resources
and interrupt our development efforts. Significant product failures would
increase our costs and result in the loss of future sales and be harmful to our
business.








RISKS
RELATED TO OUR POWER SUPPLY BUSINESS





The
principal risks applicable specifically to our power supply operating segment
are described below.





We primarily depend on two contract
manufacturers for the majority of our power supplies. Loss of a supplier could harm our
business.





The
primary suppliers of our N2Power power supplies are located in China. If a
manufacturer should be unable to deliver products to us on a timely basis or at
all, our power supply business could be adversely affected. Though we have many
years of favorable experience with these suppliers, there can be no assurance
that circumstances might not change and compel one or both of
these  suppliers to curtail or terminate deliveries to
us.





Price
erosion may have a material adverse effect on our margins and
profitability.





The
majority of the power supply manufactures that we compete with have
substantially more resources and more models available than we do. Additionally
the power supply business is generally characterized by intense competition.
There can be no assurances that a competitor will not choose to use its
resources to underprice our products in the market, thereby adversely affecting
our sales or margins.





21
 Index





ITEM1B. UNRESOLVED STAFF COMMENTS





None.





ITEM2. PROPERTIES





Our
headquarters, located in Simi Valley, California, consists of a single building
containing approximately 57,000 square feet housing our manufacturing, sales and
marketing, finance and administration and approximately two thirds of our
engineering staff. Our lease on this facility expires in February 2011. Rent on
this facility is $46,000 per month, with a step-up of $2,800 per month beginning
in February 2009.





We also
lease approximately 4,300 square feet of office space in Boulder, Colorado, that
houses our Advanced Development Group. The lease of the Boulder, Colorado
facility expires in May 2012.





ITEM3. LEGAL PROCEEDINGS





We are
from time to time involved in various lawsuits and legal proceedings that arise
in the ordinary course of business. At this time, we are not aware of any
pending or threatened litigation against us that we expect will have a material
adverse effect on our business, financial condition, liquidity or operating
results. Legal claims are inherently uncertain, however. We cannot assure you
that we will not be adversely affected in the future by legal
proceedings.





ITEM4. SUBMISSION OF MATTERS TO A VOTE OF
SHAREHOLDERS





No
matters were submitted to a vote of security holders during the fourth quarter
of the fiscal year ended June 30, 2008.








PART
II





ITEM5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS, AND


ISSUER
PURCHASES OF EQUITY SECURITIES





Market
Information





Qualstar’s
common stock is quoted on The NASDAQ Stock Market (NASDAQ Symbol — QBAK). The
following table sets forth the high and low closing sale prices of our common
stock as reported by NASDAQ, during the periods indicated:





Period
            Date
      Range
            
            High
            
            
            LowFiscal
    2008:First
      Quarter
            July
      1 — September, 30, 2007
            
            $
            4.00
            
            
            $
            3.25Second
      Quarter
            October
      1 — December 31, 2007
            
            $
            3.85
            
            
            $
            2.80Third
      Quarter
            January
      1 — March 31, 2008
            
            $
            3.70
            
            
            $
            2.79Fourth
      Quarter
            April
      1 — June 30, 2008
            
            $
            3.37
            
            
            $
            2.77Fiscal
    2007:First
      Quarter
            July
      1 — September, 30, 2006
            
            $
            3.51
            
            
            $
            2.60Second
      Quarter
            October
      1 — December 31, 2006
            
            $
            3.81
            
            
            $
            2.76Third
      Quarter
            January
      1 — March 31, 2007
            
            $
            3.57
            
            
            $
            2.86Fourth
      Quarter
            April
      1 — June 30, 2007
            
            $
            3.65
            
            
            $
            2.84





Holders





There
were approximately 38 owners of record of Qualstar’s common stock as of
September 19, 2008.





Dividend
Policy





Qualstar
declared no cash dividends during fiscal year 2007.  In fiscal year
2008, our Board of Directors declared the following cash dividends:





22
 Index








Declaration
      Date
            
            Dividend
      per Share
            
            Record
      Date
            
            Total
      Amount
            
            Payment
      DateFebruary
      12, 2008
            
            $
            0.06
            
            February
      26, 2008
            
            $
            735,187.02
            
            March
      11, 2008May
      1, 2008
            
            $
            0.06
            
            May
      20, 2008
            
            $
            735,187.02
            
            May
      28, 2008June
      23, 2008
            
            $
            0.06
            
            August
      28, 2008
            
            $
            735,187.02
            
            September
      5, 2008





Any
future determination to pay dividends will be at the discretion of the Company’s
Board of Directors and will depend upon, among many other factors, the Company’s
results of operations, financial condition, capital requirements and any
contractual restrictions.








Recent
Sales of Registered Securities





None








Purchases
of Equity Securities by the Issuer and Affiliated Purchasers





None





Performance
Graph





The
following graph compares the total cumulative return to our shareholders on
shares of Qualstar’s common stock during the five year period from July 1, 2003
through June 30, 2008, with the cumulative total returns of the Nasdaq Stock
Market Composite Index and the Nasdaq Computer Manufacturers’
Index.  The graph assumes that the value of the investment in
Qualstar’s common stock and each index was $100.00 on July 1, 2003.








6/03
            
            
            
            6/04
            
            
            
            6/05
            
            
            
            6/06
            
            
            
            6/07
            
            
            
            6/08Qualstar
      Corporation
            
            
            100.00
            
            
            
            111.27
            
            
            
            72.73
            
            
            
            60.91
            
            
            
            66.36
            
            
            
            57.35NASDAQ
      Composite
            
            
            100.00
            
            
            
            128.49
            
            
            
            129.74
            
            
            
            140.22
            
            
            
            169.32
            
            
            
            149.51NASDAQ
      Computer Manufacturers
            
            
            100.00
            
            
            
            129.90
            
            
            
            126.05
            
            
            
            119.32
            
            
            
            172.03
            
            
            
            162.06





23
 Index





ADDITIONAL
EQUITY COMPENSATION PLAN INFORMATION





The
following table provides additional information regarding Qualstar’s equity
compensation plans as of June 30, 2008:





Plan
      category
            
            Number
      of securities to be
              issued
      upon exercise of
              outstanding
      options,
              warrants
      and rights
            
            
            Weighted-average
              exercise
      price of
              outstanding
      options,
              warrants
      and rights
            
            
            Number
      of securities
              remaining
      available for
              future
      issuance under equity
              compensation
      plans
              (excluding
      securities
              reflected
      in column (a))(a)
            
            
            (b)
            
            
            (c)Equity
      compensation plans approved by security holders(1)
            
            
            623,000
            
            
            $
            4.00
            
            
            
            179,175Equity
      compensation plans not approved by security holders
            
            
            —
            
            
            
            —
            
            
            
            —Totals
            
            
            623,000
            
            
            $
            4.00
            
            
            
            179,175


____________





(1)
            Includes
      shares subject to stock options granted under the 1998 Stock Incentive
      Plan, and shares available for additional option grants under that plan,
      as of June 30, 2008.








ITEM6. SELECTED FINANCIAL DATA





The
following selected financial data is qualified in its entirety by and should be
read in conjunction with “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and the financial statements and notes
thereto included elsewhere in this 10-K. Our historical financial results are
not necessarily indicative of results to be expected for any future
period.


Years
      Ended June 30,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(In
      thousands, expect per share amounts)Statements
      of Operations Data:Net
      revenues
              
              $
              21,464
              
              
              $
              20,612
              
              
              $
              21,731
              
              
              $
              25,144
              
              
              $
              31,530Cost
      of goods sold
              
              
              14,043
              
              
              
              14,092
              
              
              
              14,856
              
              
              
              16,529
              
              
              
              19,575Gross
      profit
              
              
              7,421
              
              
              
              6,520
              
              
              
              6,875
              
              
              
              8,615
              
              
              
              11,955Operating
      expenses:Research
      and development
              
              
              3,100
              
              
              
              3,136
              
              
              
              3,083
              
              
              
              3,750
              
              
              
              4,268Sales
      and marketing
              
              
              3,184
              
              
              
              3,110
              
              
              
              3,213
              
              
              
              3,350
              
              
              
              3,607General
      and administrative
              
              
              3,390
              
              
              
              3,168
              
              
              
              3,629
              
              
              
              3,955
              
              
              
              5,420Total
      operating expenses
              
              
              9,674
              
              
              
              9,414
              
              
              
              9,925
              
              
              
              11,055
              
              
              
              13,295Loss
      from operations
              
              
              (2,253
              )
              
              
              (2,894
              )
              
              
              (3,050
              )
              
              
              (2,440
              )
              
              
              (1,340
              )Investment
      income
              
              
              1,517
              
              
              
              1,477
              
              
              
              1,269
              
              
              
              858
              
              
              
              624Impairment
      loss for other-than-temporary decline in investments
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (160
              )Loss
      before income taxes
              
              
              (736
              )
              
              
              (1,417
              )
              
              
              (1,781
              )
              
              
              (1,582
              )
              
              
              (876
              )Provision
      (benefit) for income taxes
              
              
              17
              
              
              
              30
              
              
              
              (89
              )
              
              
              65
              
              
              
              (145
              )Net
      loss
              
              $
              (753
              )
              
              $
              (1,447
              )
              
              $
              (1,692
              )
              
              $
              (1,647
              )
              
              $
              (731
              )Loss
      per share:Basic
      and Diluted
              
              $
              (0.06
              )
              
              $
              (0.12
              )
              
              $
              (0.14
              )
              
              $
              (0.13
              )
              
              $
              (0.06
              )Shares
      used to compute loss per share:Basic
      and Diluted
              
              
              12,253
              
              
              
              12,253
              
              
              
              12,253
              
              
              
              12,398
              
              
              
              12,577




24
 Index




Years
      Ended June 30,2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004(In
      thousands)Balance
      Sheet Data:Cash
      and cash equivalents
            
            $
            6,744
            
            
            $
            7,697
            
            
            $
            6,845
            
            
            $
            12,210
            
            
            $
            6,401Marketable
      securities
            
            
            25,794
            
            
            
            25,568
            
            
            
            26,822
            
            
            
            21,854
            
            
            
            29,376Working
      capital
            
            
            23,883
            
            
            
            25,152
            
            
            
            *29,012
            
            
            
            *25,121
            
            
            
            46,534Total
      assets
            
            
            42,657
            
            
            
            44,063
            
            
            
            45,399
            
            
            
            47,223
            
            
            
            51,647Shareholders’
      equity
            
            
            39,121
            
            
            
            41,841
            
            
            
            42,858
            
            
            
            44,653
            
            
            
            48,064


____________





*
            In
      fiscal 2006 and 2005, certain marketable securities were reclassified to
      long-term assets.








ITEM7.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS





The
following discussion and analysis should be read in conjunction with our
financial statements and notes thereto.





OVERVIEW





We
design, develop, manufacture and sell automated magnetic tape libraries used to
store, retrieve and manage electronic data primarily in network computing
environments. We currently offer tape libraries for two popular tape drive
technologies, LTO and AIT.





Many
enterprises now routinely manage very large databases, in addition to storing
information on local desktop computers. This, coupled with the growth in the
amount of data from new sources and applications, is increasing the need for
managing and storing data efficiently. Anticipating the increased demand for
tape libraries, we have developed tape libraries spanning a range of tape
formats, prices, capacity and performance. We expect our products to continue to
evolve in the future in response to emerging tape technologies and changing
customer preferences.





We have
developed a network of value added resellers who specialize in delivering
complete storage solutions to end users. End users of our products range from
small businesses requiring simple automated backup solutions to large
organizations needing complex storage management solutions. We also sell our
products to original equipment manufacturers who bundle our products with their
own and sell them as part of a complete system or solution. We assist our
customers with marketing, sales and technical support.





Our
international sales efforts are currently directed from our corporate offices in
Simi Valley, California.  All of our international sales are
denominated in U.S. dollars. Net revenues from sales outside North America were
approximately $5.8 million, or 27.2% of revenues in fiscal 2008, $5.0 million,
or 24.4% of revenues in fiscal 2007, and approximately $5.7 million, or 26.1% of
revenues in fiscal 2006.





We also
design, develop and sell high-efficiency switching power supplies used in
telecommunications equipment, servers, routers, switches, RAIDs, and similar
applications. Our power supplies are sold under the N2Power brand name through
independent sales representatives and distributors. The primary customers are
original equipment manufacturers and contract manufacturers. We also utilize
these power supplies in our tape libraries.





Net
revenues include revenues from the sale of tape libraries, library tape drives,
tape cartridges, ancillary products, and power supplies. Ancillary revenues
include service, repair, and on-site service agreements net of the cost of any
third party service contracts. Automated tape libraries and related products,
such as tape drives and tape media, represented approximately 62.9% of revenues
in fiscal 2008, 66.6% of revenues in fiscal 2007, and approximately 66.2% of
revenues in fiscal 2006. Sales of power supplies represented approximately 18.8%
of revenues in fiscal 2008, 14.6% of revenues in fiscal 2007, and approximately
11.9% of revenues in fiscal 2006. Sales of ancillary products and services
accounted for the balance of our revenues.





Gross
margins depend on several factors, including the cost of manufacturing, product
mix and the level of competition. Larger tape libraries generally provide higher
gross margins than do smaller tape libraries primarily because the competition
is less intense in this market segment.





25
 Index





Research
and development activities include the design and development of new products,
as well as enhancements to existing products.





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 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 product to our customers, less estimated returns,
for which provision is made at the time of sale. Title and risk of loss transfer
to the customer when the product leaves our dock in Simi Valley, California, or
another shipping location designated by us. In general, these customers are
allowed to return the product, free of penalty, within thirty days of shipment,
if the product does not meet the end user’s requirements.





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 products are returned. Should our experience change,
however, we may require additional allowances for sales returns.





Marketable
Securities





Marketable
securities consist primarily of high-quality U.S. corporate securities and U.S.
federal government debt securities. Our marketable securities portfolio consists
of short-term securities with original maturities of greater than three months
from the date of purchase and remaining maturities of less than one year and
long-term securities with original maturities of greater than one year and less
than five years. Marketable securities are classified as available for sale and
are recorded at market value using the specific identification method;
unrealized gains and losses are reflected in other comprehensive income until
realized; realized gains and losses 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. If the credit ratings of the security
issuers deteriorate or if normal market conditions do not return in the near
future, we may be required to reduce the value of our investments through an
impairment charge and reflect them as long-term investments.




Allowance
for Doubtful Accounts





We
estimate our allowance for doubtful accounts based on an assessment of the
collectability of specific accounts and the overall condition of accounts
receivable. In evaluating the adequacy of the allowance for doubtful accounts,
we analyze specific trade receivables, historical bad debts, customer credits,
customer credit-worthiness and changes in customers’ payment terms and patterns.
If the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make additional payments, then we may need to
make additional allowances. Likewise, if we determine that we could realize more
of our receivables in the future than previously estimated, we would adjust the
allowance to increase income in the period we made this
determination.





Inventory
Valuation





We record
inventories at the lower of cost or market value. We assess the value of our
inventories periodically based upon numerous factors including expected product
or material demand, current market conditions, technological obsolescence,
current cost and net realizable value. If necessary, we write down our inventory
for estimated obsolescence, potential shrinkage, or unmarketable inventory equal
to the difference between the cost of inventory and the estimated market value
based upon assumptions about future demand and market conditions. If technology
changes more rapidly than expected, or market conditions become less favorable
than those projected by management, additional inventory write-downs may be
required.





26
 Index





Warranty
Obligations





We
provide for the estimated cost of product warranties at the time revenue is
recognized. We engage in extensive product quality programs and processes,
including active monitoring and evaluation of product failure rates, material
usage and estimation of service delivery costs incurred in correcting a product
failure. However, should actual product failure rates, material usage, or
service delivery costs differ from our estimates, revisions to the estimated
warranty liability would be required. Historically our warranty costs have not
been significant.





Share-Based
Compensation





Share-based
compensation is accounted for in accordance with SFAS 123R, “Share-Based
Payment.” We use the Black-Scholes option pricing model to determine fair value
of the award at the date of grant and recognize compensation expense over the
vesting period. The inputs we use for the model require the use of judgment,
estimates and assumptions regarding the expected volatility of the stock, the
expected term the average employee will hold the option prior to the date of
exercise, and the amount of share-based awards that are expected to be
forfeited. Changes in these inputs and assumptions could occur and actual
results could differ from these estimates, and our results of operations could
be materially impacted.





Accounting
for Income Taxes





We
estimate our tax liability based on current tax laws in the statutory
jurisdictions in which we operate in accordance with SFAS 109, “Accounting for
Income Taxes.” These estimates include judgments about deferred tax assets and
liabilities resulting from temporary differences between assets and liabilities
recognized for financial reporting purposes and such amounts recognized for tax
purposes, as well as about the realization of deferred tax
assets.  Accruals for uncertain tax positions are accounted for in
accordance with FIN 48,“Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109.”  Under FIN 48, we may recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax
position will be sustained upon examination by the taxing authorities, based on
the technical merits of the position. The tax benefits recognized in the
financial statements from such a position should be measured based on the
largest benefit that has a greater than 50% likelihood of being realized upon
ultimate settlement. FIN 48 also provides guidance on derecognition of income
tax assets and liabilities, classification of current and deferred income tax
assets and liabilities, accounting for interest and penalties associated with
tax positions, and income tax disclosures.





We
maintain a valuation allowance to reduce our deferred tax assets due to the
uncertainty surrounding the timing of realizing the benefits of net deferred tax
assets in future years. We have considered future taxable income and ongoing
prudent and feasible tax planning strategies in assessing the need for such a
valuation allowance. In the event we were to determine that we would be able to
realize all or part of our net deferred tax asset in the future, the valuation
allowance would be decreased accordingly.





We may
periodically undergo examinations by the federal and state regulatory
authorities and the Internal Revenue Service. We may be assessed additional
taxes and or penalties contingent on the outcome of these examinations. Our
previous examinations have not resulted in any unfavorable or significant
assessments.





We have
net operating losses, capital losses, research and development credit and other
carryforwards for tax purposes of $9.0 million at June 30, 2008 which expire
between fiscal years 2009 and 2025, except for the state research and
development credit, which has no limit on the carryforward period.




27
 Index





RESULTS
OF OPERATIONS





The
following table reflects, as a percentage of net revenues, statements of
operations data for the periods indicated:





Years
      Ended June 30,2008
            
            
            2007
            
            
            2006Net
      revenues
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of goods sold
            
            
            65.4
            
            
            
            68.4
            
            
            
            68.4Gross
      margin
            
            
            34.6
            
            
            
            31.6
            
            
            
            31.6Operating
      expenses:Research
      and development
            
            
            14.4
            
            
            
            15.2
            
            
            
            14.2Sales
      and marketing
            
            
            14.8
            
            
            
            15.1
            
            
            
            14.8General
      and administrative
            
            
            15.8
            
            
            
            15.4
            
            
            
            16.7Loss
      from operations
            
            
            (10.4
            )
            
            
            (14.1
            )
            
            
            (14.1
            )Investment
      income
            
            
            7.1
            
            
            
            7.2
            
            
            
            5.8Loss
      before provision (benefit) for income taxes
            
            
            (3.3
            )
            
            
            (6.9
            )
            
            
            (8.3
            )Provision
      (benefit) for income taxes
            
            
            0.1
            
            
            
            0.1
            
            
            
            (0.4
            )Net
      loss
            
            
            (3.4
            )%
            
            
            (7.0
            )%
            
            
            (7.9
            )%





We have
two operating segments for financial disclosure purposes:  tape
libraries and power supplies, as discussed in Footnote 10 to our consolidated
financial statements. The following table summarizes our revenue by major
product line and by operating segment:





Years
      Ended June 30,2008
            
            
            2007
            
            
            2006Tape
      Library revenues:TLS
            
            
            30.5
            %
            
            
            35.9
            %
            
            
            42.6
            %RLS
            
            
            9.2
            %
            
            
            8.6
            %
            
            
            12.2
            %XLS
            
            
            7.0
            %
            
            
            8.5
            %
            
            
            —46.7
            %
            
            
            53.0
            %
            
            
            54.8
            %Other
      library revenues:Service
            
            
            12.7
            %
            
            
            14.2
            %
            
            
            14.5
            %Media
            
            
            16.2
            %
            
            
            13.6
            %
            
            
            11.4
            %Upgrades,
      Spares
            
            
            5.6
            %
            
            
            4.6
            %
            
            
            7.4
            %Total
      library  revenues
            
            
            81.2
            %
            
            
            85.4
            %
            
            
            88.1
            %Power
      Supply revenues
            
            
            18.8
            %
            
            
            14.6
            %
            
            
            11.9
            %100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %








Fiscal
2008 Compared to Fiscal 2007





Net Revenues.  Net
revenues were $21.5 million in fiscal 2008 as compared to $20.6 million in
fiscal 2007. The increase of approximately $852,000, or 4.1% is attributed
primarily to an increase of $1.0 million in sales of power supplies, partially
offset by lower revenues from tape libraries.





Tape Library
Segment


Revenues
attributed to our tape library segment were $17.4 million, or 81.2% of revenues
in fiscal 2008, as compared to $17.6 million, or 85.4% of revenues in fiscal
2007. This decline in tape library revenues was due to lower sales of our tape
library products in the TLS and XLS product lines, in conjunction with lower
service revenue, partially offset by increased revenue from our RLS tape library
product line and increased sales of tape media and miscellaneous products. We
commenced sales of our new XLS product line in fiscal 2007, and sales of these
libraries accounted for 7.0% of total revenue in fiscal 2008.We anticipate sales
of our XLS product line to capture a larger percent of our tape library revenues
in fiscal 2009. However, we expect sales of our TLS and RLS tape library product
lines to decline in fiscal 2009.





Power Supply
Segment


Revenues
attributed to our power supply segment were $4.0 million, or 18.8% of revenues,
in fiscal 2008 as compared to $3.0 million, or 14.6% of revenues in fiscal 2007.
This increase was due to increased sales to original equipment manufacturers and
distributors of an expanded power supply product line. We expect continued
growth as a percentage of sales in our power supply revenues during fiscal
2009.





28
 Index





Gross Profit.  Gross
profit was $7.4 million in fiscal 2008 as compared to $6.5 million in fiscal
2007. The increase of approximately $0.9 million, or 13.8%, is attributed to
increased revenues, a change in product mix and efficiencies achieved in
material and labor management.





Research and
Development.  Research and development expenses were $3.1
million in fiscal 2008, comparable with $3.1 million in fiscal
2007.





Sales and
Marketing.  Sales and marketing expenses were $3.2 million in
fiscal 2008 as compared to $3.1 million in fiscal 2007. The increase of
approximately $0.1 million, or 3.1%, is attributed primarily to an increase in
travel and entertainment, commissions and compensation related expenses
partially offset by the closure of our United Kingdom branch
office.





General and
Administrative.  General and administrative expenses were $3.4
million in fiscal 2008 as compared to $3.2 million in fiscal 2007. The increase
of approximately $0.2 million, or 7.0%, is due to an increase in accounting and
audit expenses related to Sarbanes Oxley compliance efforts and compensation
related expenses partially offset by decreases in bad debt and depreciation and
amortization expenses.





Investment
Income.  Investment income was $1.5 million in fiscal 2008,
comparable with $1.5 million in fiscal 2007.





Provision for Income
Taxes.  Provision for income taxes was $17,000 in fiscal 2008
as compared to a provision for income taxes of  $30,000 in fiscal
2007.





Fiscal
2007 Compared to Fiscal 2006





Net Revenues.  Net
revenues were $20.6 million in fiscal 2007 as compared to $21.7 million in
fiscal 2006. The decrease of approximately $1.1 million, or 5.1% is attributed
to lower sales of our tape library products in the TLS and RLS product lines, in
conjunction with lower service and miscellaneous revenue, partially offset by
revenue from our new enterprise-level XLS tape library product line and
increased media and power supply revenue. We commenced sales of our new XLS
product line in fiscal 2007, and sales of these libraries accounted for 8.5% of
total revenue in fiscal 2007.





Tape Library
Segment


Revenues
attributed to our tape library segment were $17.6 million, or 85.4% of revenues
in fiscal 2007, as compared to $19.1 million, or 88.1% of revenues in fiscal
2006.





Power Supply
Segment


Revenues
attributed to our power supply segment were $3.0 million, or 14.6% of revenues,
in fiscal 2007 as compared to $2.6 million, or 11.9% of revenues in fiscal 2006.
This increase was due to increased sales to OEMs and distributors of an expanded
power supply product line.





Gross Profit.  Gross
profit was $6.5 million in fiscal 2007 as compared to $6.9 million in fiscal
2006. The decrease of approximately $0.4 million, or 5.2%, is comparable as a
percent of sales, resulting in comparable gross profit percentages in fiscal
years 2007 and 2006 of 31.6%.





Research and
Development.  Research and development expenses were $3.1
million in fiscal 2007, comparable with $3.1 million in fiscal
2006.





Sales and
Marketing.  Sales and marketing expenses were $3.1 million in
fiscal 2007 as compared to $3.2 million in fiscal 2006. The decrease of
approximately $0.1 million, or 3.1%, is attributed primarily to a decrease in
marketing salaries and the closing of our sales office in the United Kingdom,
offset by increased advertising and promotion expenses.





General and
Administrative.  General and administrative expenses were $3.2
million in fiscal 2007 as compared to $3.6 million in fiscal 2006. The decrease
of approximately $0.4 million, or 11.1%, is due to lower compensation related
expenses, legal and audit fees, and insurance expense, offset in part by higher
bad debt expense.





29
 Index





Investment
Income.  Investment income was $1.5 million in fiscal 2007 as
compared to $1.3 million in fiscal 2006. The increase of $0.2 million, or 16.4%
is due to reinvestment of our lower yielding maturities into higher yielding
investments and due to higher interest rates in fiscal 2007.





Provision for Income
Taxes.  Provision for income taxes was $30,000 in fiscal 2007
as compared to a benefit for income taxes of  $89,000 in fiscal 2006.
The benefit in fiscal 2006 is due to the reversal of a reserve established in
fiscal 2005 against research and development credits that were refunded in
fiscal 2006.





LIQUIDITY
AND CAPITAL RESOURCES





Cash
provided by operating activities was $1.5 million in fiscal 2008 and cash used
by operating activities was $0.7 million in fiscal 2007 and $19,000 in fiscal
2006. Cash provided by operating activities in fiscal 2008 relates primarily to
an increase in accounts payable and other accrued liabilities and a decrease in
accounts receivable. Cash used by operating activities in fiscal 2007 relates
primarily to our net loss for the year adjusted for non-cash items, an increase
in accounts receivable and a decrease in accounts payable and other accrued
liabilities, partially offset by a decrease in inventories. In fiscal 2006, the
near breakeven in operating cash resulted from the receipt of research and
development credit refunds and a decrease in accounts receivable, offset by a
net loss for the year.





Cash used
by investing activities was $0.3 million in fiscal 2008, cash provided by
investing activities was $1.5 million in fiscal 2007 and cash used in investing
activities was $5.3 million in fiscal 2006. Cash used in investing activities in
fiscal 2008 relates primarily to the purchase of marketable securities and
equipment partially offset by sales of marketable securities. Cash provided by
investing activities in fiscal 2007 relates primarily to proceeds from the sale
of marketable securities, partially offset by purchases of marketable
securities. Cash used in investing activities in fiscal 2006 relates primarily
to the purchase of marketable securities and equipment partially offset by sales
of marketable securities.





Cash used
in financing activities of $2.2 million for fiscal 2008 relates to declaring
cash dividends on shares of our common stock. Of this amount, $0.7 million
relates to a cash dividend declared by our board of directors in the fourth
quarter of fiscal 2008 and is payable in the first quarter of fiscal
2009.





As of
June 30, 2008, we had $6.7 million in cash and cash equivalents and $25.8
million in marketable securities. We believe that our existing cash and cash
equivalents 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 that we believe are strategic. We regularly evaluate other
companies and technologies for possible investment by us. In addition, we have
made and may in the future make investments in companies with whom we have
identified potential synergies. However, we have no present commitments or
agreements with respect to any material acquisition of other businesses or
technologies.








SUMMARY
OF CONTRACTUAL OBLIGATIONS AND COMMITMENTS





The
following is a summary of our future payments due under contractual obligations
as of June 30, 2008:





Year
      Ended June 30
            
            Operating
              Leases
            
            
            Purchase
              Obligations
            
            
            Total(In
      thousands)2009
            
            $
            621
            
            
            $
            2,723
            
            
            $
            3,3442010
            
            
            639
            
            
            
            —
            
            
            
            6392011
            
            
            362
            
            
            
            —
            
            
            
            3622012
            
            
            50
            
            
            
            —
            
            
            
            502013
            
            
            —
            
            
            
            —
            
            
            
            —$
            1,672
            
            
            $
            2,723
            
            
            $
            4,395





Purchase
obligations in the table above represent the value of open purchase orders as of
June 30, 2008. We believe that some of these obligations could be canceled for
payment of a nominal penalty or no penalty; however, the amount of open purchase
orders that could be canceled under such terms is difficult to
quantify.





30
 Index





OFF-BALANCE
SHEET ARRANGEMENTS





We do not
have any off-balance sheet arrangements.








ITEM7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET
RISK





We are
exposed to foreign currency and interest rate risks.  Our financial
results could be affected by changes in foreign currency exchange rates or weak
economic conditions in foreign markets. As all sales are currently made in U.S.
dollars, a strengthening of the dollar could make our products less competitive
in foreign markets. Our interest income is sensitive to changes in the general
level of U.S. interest rates, particularly since the majority of our investments
are in shorter duration fixed income securities. We have no outstanding debt nor
do we utilize derivative financial instruments. Therefore, no quantitative
tabular disclosures are required.








ITEM8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





Page(1)   Consolidated
      Financial StatementsReport
      of Independent Registered Public Accounting Firm
            31Consolidated
      Balance Sheets
            32Consolidated
      Statements of Operations
            33Consolidated
      Statements of Shareholders’ Equity
            34Consolidated
      Statements of Cash Flows
            35Notes
      to Consolidated Financial Statements
            36




31
 Index





Report
of Independent Registered Public Accounting Firm








The Board
of Directors and Shareholders of Qualstar Corporation





We have
audited the accompanying consolidated balance sheets of Qualstar Corporation as
of June 30, 2008 and 2007, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the three years in
the period ended June 30, 2008. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. We were not engaged
to perform an audit of the Company’s internal control over financial reporting.
Our audit included consideration of internal control over financial reporting as
a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly, we express no such opinion.  An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation.  We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Qualstar Corporation
at June 30, 2008 and 2007, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended June 30, 2008, in
conformity with U.S. generally accepted accounting principles.








/s/  Ernst
      & Young LLPLos
      Angeles, CaliforniaSeptember
      18, 2008




32
 Index





QUALSTAR
CORPORATION





CONSOLIDATED
BALANCE SHEETS


(In
thousands)





June
      30,2008
            
            
            2007ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            6,744
            
            
            $
            7,697Marketable
      securities, short-term
            
            
            11,091
            
            
            
            9,574Accounts
      receivable, net of allowance for doubtful accounts of $82 at June 30, 2008
      and $121 at June 30, 2007
            
            
            2,962
            
            
            
            3,462Inventories
            
            
            6,109
            
            
            
            5,928Prepaid
      expenses and other current assets
            
            
            467
            
            
            
            576Prepaid
      income taxes
            
            
            —
            
            
            
            137Total
      current assets
            
            
            27,373
            
            
            
            27,374Property
      and equipment, net
            
            
            526
            
            
            
            601Marketable
      securities, long-term
            
            
            14,703
            
            
            
            15,994Other
      assets
            
            
            55
            
            
            
            94Total
      assets
            
            $
            42,657
            
            
            $
            44,063LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            1,197
            
            
            $
            654Accrued
      payroll and related liabilities
            
            
            519
            
            
            
            455Other
      accrued liabilities
            
            
            1,774
            
            
            
            1,113Total
      current liabilities
            
            
            3,490
            
            
            
            2,222Other
      long-term liabilities
            
            
            46
            
            
            
            —Commitments
      and contingenciesShareholders’
      equity:Preferred
      stock, no par value; 5,000 shares authorized; no shares
    issued
            
            
            —
            
            
            
            —Common
      stock, no par value; 50,000 shares authorized, 12,253 shares issued and
      outstanding as of June 30, 2008 and June 30, 2007
            
            
            18,705
            
            
            
            18,593Accumulated
      other comprehensive income (loss)
            
            
            108
            
            
            
            (55
            )Retained
      earnings
            
            
            20,308
            
            
            
            23,303Total
      shareholders’ equity
            
            
            39,121
            
            
            
            41,841Total
      liabilities and shareholders’ equity
            
            $
            42,657
            
            
            $
            44,063





See
accompanying notes




33
 Index





QUALSTAR
CORPORATION





CONSOLIDATED
STATEMENTS OF OPERATIONS


(In
thousands, except per share amounts)





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006Net
      revenues
            
            $
            21,464
            
            
            $
            20,612
            
            
            $
            21,731Cost
      of goods sold
            
            
            14,043
            
            
            
            14,092
            
            
            
            14,856Gross
      profit
            
            
            7,421
            
            
            
            6,520
            
            
            
            6,875Operating
      expenses:Research
      and development
            
            
            3,100
            
            
            
            3,136
            
            
            
            3,083Sales
      and marketing
            
            
            3,184
            
            
            
            3,110
            
            
            
            3,213General
      and administrative
            
            
            3,390
            
            
            
            3,168
            
            
            
            3,629Total
      operating expenses
            
            
            9,674
            
            
            
            9,414
            
            
            
            9,925Loss
      from operations
            
            
            (2,253
            )
            
            
            (2,894
            )
            
            
            (3,050
            )Investment
      income
            
            
            1,517
            
            
            
            1,477
            
            
            
            1,269Loss
      before income taxes
            
            
            (736
            )
            
            
            (1,417
            )
            
            
            (1,781
            )Provision
      (benefit) for income taxes
            
            
            17
            
            
            
            30
            
            
            
            (89
            )Net
      loss
            
            $
            (753
            )
            
            $
            (1,447
            )
            
            $
            (1,692
            )Loss
      per share:Basic
      and Diluted
            
            $
            (0.06
            )
            
            $
            (0.12
            )
            
            $
            (0.14
            )Shares
      used to compute loss per share:Basic
      and Diluted
            
            
            12,253
            
            
            
            12,253
            
            
            
            12,253





See
accompanying notes





34
 Index




QUALSTAR
CORPORATION





CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY


(In
thousands)





AccumulatedOther
              ComprehensiveCommon
      Stock
            
            
            Income
            
            
            RetainedShares
            
            
            Amount
            
            
            (Loss)
            
            
            Earnings
            
            
            TotalBalances
      at June 30, 2005
            
            
            12,253
            
            
            $
            18,370
            
            
            $
            (159
            )
            
            $
            26,442
            
            
            $
            44,653Stock
      based compensation
            
            
            —
            
            
            
            133
            
            
            
            —
            
            
            
            —
            
            
            
            133Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,692
            )
            
            
            (1,692
            )Change
      in unrealized gains (losses) on investments
            
            
            —
            
            
            
            —
            
            
            
            (236
            )
            
            
            —
            
            
            
            (236
            )Comprehensive
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,928
            )Balances
      at June 30, 2006
            
            
            12,253
            
            
            $
            18,503
            
            
            $
            (395
            )
            
            $
            24,750
            
            
            $
            42,858Stock
      based compensation
            
            
            —
            
            
            
            90
            
            
            
            —
            
            
            
            —
            
            
            
            90Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,447
            )
            
            
            (1,447
            )Change
      in unrealized gains (losses) on investments
            
            
            —
            
            
            
            —
            
            
            
            340
            
            
            
            —
            
            
            
            340Comprehensive
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,107
            )Balances
      at June 30, 2007
            
            
            12,253
            
            
            $
            18,593
            
            
            $
            (55
            )
            
            $
            23,303
            
            
            $
            41,841Stock
      based compensation
            
            
            —
            
            
            
            112
            
            
            
            —
            
            
            
            —
            
            
            
            112Cumulative
      effect of a change in accounting principle (FIN48)
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (36
            )
            
            
            (36
            )Cash
      dividend on common shares
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,206
            )
            
            
            (2,206
            )Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (753
            )
            
            
            (753
            )Change
      in unrealized gains (losses) on investments
            
            
            —
            
            
            
            —
            
            
            
            163
            
            
            
            —
            
            
            
            163Comprehensive
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (590
            )Balances
      at June 30, 2008
            
            
            12,253
            
            
            $
            18,705
            
            
            $
            108
            
            
            $
            20,308
            
            
            $
            39,121





See
accompanying notes





35
 Index


QUALSTAR
CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
thousands)





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006OPERATING
      ACTIVITIES:Net
      loss
            
            $
            (753
            )
            
            $
            (1,447
            )
            
            $
            (1,692
            )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
            
            
            275
            
            
            
            421
            
            
            
            454Provision
      for bad debts and returns, net
            
            
            15
            
            
            
            88
            
            
            
            (31
            )Stock
      based compensation
            
            
            112
            
            
            
            90
            
            
            
            133(Gain)
      loss on sale of securities
            
            
            (6
            )
            
            
            50
            
            
            
            —Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            485
            
            
            
            (850
            )
            
            
            863Inventories
            
            
            (181
            )
            
            
            1,370
            
            
            
            (141
            )Prepaid
      expenses and other assets
            
            
            148
            
            
            
            (67
            )
            
            
            (57
            )Prepaid
      income taxes and income taxes payable
            
            
            144
            
            
            
            22
            
            
            
            481Accounts
      payable
            
            
            543
            
            
            
            (129
            )
            
            
            20Accrued
      payroll and related liabilities
            
            
            64
            
            
            
            (11
            )
            
            
            (30
            )Other
      accrued liabilities
            
            
            664
            
            
            
            (179
            )
            
            
            (19
            )Net
      cash provided by (used in) operating activities
            
            
            1,510
            
            
            
            (642
            )
            
            
            (19
            )INVESTING
      ACTIVITIES:Purchases
      of equipment
            
            
            (200
            )
            
            
            (50
            )
            
            
            (142
            )Purchases
      of marketable securities
            
            
            (26,359
            )
            
            
            (17,041
            )
            
            
            (13,204
            )Proceeds
      from the sale of marketable securities
            
            
            26,302
            
            
            
            18,585
            
            
            
            8,000Net
      cash (used in) provided by investing activities
            
            
            (257
            )
            
            
            1,494
            
            
            
            (5,346
            )FINANCING
      ACTIVITIES:Cash
      dividends on common shares
            
            
            (2,206
            )
            
            
            —
            
            
            
            —Net
      cash used in financing activities
            
            
            (2,206
            )
            
            
            —
            
            
            
            —NET
      (DECREASE) INCREASE  IN CASH AND CASH
EQUIVALENTS
            
            
            (953
            )
            
            
            852
            
            
            
            (5,365
            )CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            7,697
            
            
            
            6,845
            
            
            
            12,210CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            6,744
            
            
            $
            7,697
            
            
            $
            6,845SUPPLEMENTAL
      CASH FLOW DISCLOSURES:Income
      taxes paid
            
            $
            7
            
            
            $
            7
            
            
            $
            2





See
accompanying notes




36
 Index





QUALSTAR
CORPORATION





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





Note
1 – Accounting Policies





Business





Qualstar
Corporation (“Qualstar”) was incorporated in California in 1984 to develop and
manufacture IBM compatible 9-track reel-to-reel tape drives for the personal
computer and workstation marketplaces. Since 1995, Qualstar has focused its
efforts on designing, developing, manufacturing and selling automated magnetic
tape libraries used to store, retrieve and manage electronic data primarily in
the network computing environment. Tape libraries consist of cartridge tape
drives, tape cartridges and robotics to move the tape cartridges from their
storage locations to the tape drives under software control. Qualstar’s
libraries provide storage solutions for organizations requiring backup,
recovery, and archival storage of critical electronic information. Qualstar’s
tape libraries are compatible with commonly used operating systems, including
UNIX, Windows and Linux and a wide range of storage management software.
Qualstar currently offers tape libraries for LTO and AIT tape drive
technologies.





In July
2002, Qualstar purchased the assets of N2Power, Incorporated, a supplier of
ultra small high efficiency open frame switching power supplies. Power supplies
are sold with the N2Power brand name as well as under a private label brand name
to original equipment manufacturers.





Accounting
Principles





The
financial statements and accompanying notes are prepared in accordance with
generally accepted accounting principles (“GAAP”) in the United States of
America.





Principles
of Consolidation





The
consolidated financial statements include the accounts and operations of
Qualstar and its wholly owned subsidiary. All significant intercompany accounts
have been eliminated.





Estimates
and Assumptions





Preparing
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue, and expenses.
Examples include estimates of loss contingencies, product life cycles and
inventory obsolescence, bad debts, sales returns, stock-based compensation
forfeiture rates; the potential outcome of future tax consequences of events
that have been recognized in our financial statements or tax returns; and
determining when investment impairments are other-than-temporary. Actual results
and outcomes may differ from management’s estimates and
assumptions.





Revenue
Recognition





Revenue
is recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, and collectibility is reasonably
assured (less estimated returns, for which provisions are made at the time of
sale) in accordance with Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition. The
provision for estimated returns is made based on known claims and estimates of
additional returns based on historical data. Revenues from technical support
services and other services are recognized at the time the services are
performed. Revenues from service contracts entered into with third party service
providers are recognized at the time of sale, net of costs.





Cash
and Cash Equivalents





Qualstar
classifies as cash equivalents only cash and those investments that are highly
liquid, interest earning investments with a maturity of three months or less
from the date of purchase.





37
 Index




Marketable
Securities





Marketable
securities consist primarily of high-quality U.S. corporate securities and U.S.
federal government debt securities. Our marketable securities portfolio consists
of short-term securities with original maturities of greater than three months
from the date of purchase and remaining maturities of less than one year and
longer term securities with original maturities of greater than one year and
less than five years. Marketable securities are classified as available for sale
and are recorded at market value using the specific identification method;
unrealized gains and losses are reflected in other comprehensive income until
realized; realized gains and losses 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. A $6,000 gain from the sale of
marketable securities was recorded in fiscal year 2008. A $50,000 loss from the
sale of marketable securities was recorded in fiscal year 2007. No significant
gains or losses from the sale of marketable securities were recorded in fiscal
year 2006. All of Qualstar’s marketable securities were classified as
available-for-sale at June 30, 2008 and 2007.





The
Company reviews its marketable securities for any potential investment
impairments in accordance with SFAS No. 115, “Accounting for Certain Investments
in Debt and Equity Securities,” and the related guidance issued by the FASB and
SEC in order to determine if an impairment exists and if so, the classification
of the impairment as “temporary” or “other-than-temporary.”  A
temporary impairment charge results in an unrealized loss being recorded in the
other comprehensive income (loss) component of shareholders’
equity.  An other-than-temporary impairment charge is recorded as a
realized loss in the Statement of Operations and reduces net income (loss) for
the applicable accounting period.  The differentiating factors between
temporary and other-than-temporary impairment are primarily the length of time
and the extent to which the market value has been less than cost, the financial
condition and near-term prospects of the issuer and the intent and ability of
the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value.





The
Company does not believe any unrealized losses represent an other-than-temporary
impairment based on our evaluation of available evidence as of June 30,
2008.  We believe that our existing cash and short-term investments,
and our expected operating cash flows will be sufficient to fund our working
capital requirements, capital expenditures and other obligations for the
foreseeable future and will not affect our ability to execute our current
business plans.  If the credit ratings of the security issuers deteriorate
or if normal market conditions do not return in the near future, we may be
required to reduce the value of our investments through an impairment charge and
reflect them as long-term investments.





Concentration
of Credit Risk, Other Concentration Risks and Significant Customers





Qualstar
sells its products primarily through a variety of market channels including
original equipment manufacturers (OEM) and value added resellers (VAR) located
worldwide. Ongoing credit evaluations of customers’ financial condition are
performed by Qualstar, and generally, collateral is not required. Potential
uncollectible accounts have been provided for in the financial
statements.





We are
exposed to foreign currency and interest rate risks.  Our interest
income is sensitive to changes in the general level of U.S. interest rates,
particularly since the majority of our investments are in shorter duration fixed
income securities. We have no outstanding debt nor do we utilize auction rate
securities or derivative financial instruments in our investment
portfolio.





Our
financial results could be affected by changes in foreign currency exchange
rates or weak economic conditions in foreign markets. As all sales are currently
made in U.S. dollars, a strengthening of the dollar could make our products less
competitive in foreign markets. Sales outside of North America represented
approximately 27.2% of net revenues in fiscal 2008, 24.4% of net revenues in
fiscal 2007, and approximately 26.1% of net revenues in fiscal
2006.





Revenues
from Qualstar’s two largest customers combined were approximately 12.9%, 11.9%
and 13.4% for the years ended June 30, 2008, 2007, and 2006, respectively. At
June 30, 2008 and 2007, the two largest customer’s accounts receivable, net of
specific allowances, totaled approximately 14.9% and 24.1% of net accounts
receivable, respectively.





Suppliers





Sales and
costs of goods sold related to tape library products purchased from one supplier
totaled approximately 25.1% and 27.6% in fiscal 2008, 32.2% and 30.6% in fiscal
2007, and 36.4% and 34.1% in fiscal 2006, respectively, of total sales and cost
of goods sold.





The
primary suppliers of our power supplies segment, N2Power, are located in China.
If a manufacturer should be unable to deliver products to us in a timely basis
or at all, our power supply business could be adversely affected. Though we have
many years of favorable experience with these suppliers, there can be no
assurance that circumstances might not change and compel a supplier to curtail
or terminate deliveries to us.





38
 Index





Allowance
for Doubtful Accounts





The
allowance for doubtful accounts reflects our best estimate of probable losses
inherent in the accounts receivable balance. We determine the allowance based on
known troubled accounts, historical experience, and other currently available
evidence. Activity in the allowance for doubtful accounts was as
follows:





Description
            
            Balance
      at Beginning of Period
            
            
            Charged
      to Costs and Expenses
            
            
            Charged
      to Other Accounts
            
            
            Deductions(1)
            
            
            Balance
      at End of PeriodYear
      Ended June 30, 2008
            
            $
            121,000
            
            
            $
            15,000
            
            
            $
            —
            
            
            $
            (54,000
            )
            
            $
            82,000Year
      Ended June 30, 2007
            
            $
            50,000
            
            
            $
            88,000
            
            
            $
            —
            
            
            $
            (17,000
            )
            
            $
            121,000Year
      Ended June 30, 2006
            
            $
            248,000
            
            
            $
            (31,000
            )
            
            $
            —
            
            
            $
            (167,000
            )
            
            $
            50,000


____________





(1)
            Uncollectible
      accounts written off, net of
recoveries.





Inventories





Inventories
are stated at the lower of cost (first-in, first-out basis) or market. Cost
includes materials, labor, and manufacturing overhead related to the purchase
and production of inventories. We regularly review inventory quantities on hand,
future purchase commitments with our suppliers, and the estimated utility of our
inventory. If our review indicates a reduction in utility below carrying value,
we reduce our inventory to a new cost basis.





Property
and Equipment





Property
and equipment are recorded at cost. Depreciation expense is computed using the
straight-line method. Leasehold improvements are amortized over the shorter of
the estimated useful life of the asset or the term of the lease. Estimated
useful lives are as follows:





Machinery
      and equipment
            5-7
      yearsFurniture
      and fixtures
            5-7
      yearsComputer
      equipment
            3-5
      years





Expenditures
for normal maintenance and repair are charged to expense as incurred, and
improvements are capitalized. Upon the sale or retirement of property or
equipment, the asset cost and related accumulated depreciation are removed from
the respective accounts and any gain or loss is included in the results of
operations.





Long-Lived
Assets





Qualstar
reviews the impairment of long-lived assets whenever events or changes in
circumstances indicate the carrying amount of any asset may not be recoverable,
in accordance with The Statement of Financial Accounting Standards (SFAS) No.
144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” An
impairment loss would be recognized when the estimated undiscounted future cash
flows expected to result from the use of the asset and its eventual disposition
is less than the carrying amount. If impairment is indicated, the amount of the
loss to be recorded is based upon an estimate of the difference between the
carrying amount and the fair value of the asset. Fair value is based upon
discounted cash flows expected to result from the use of the asset and its
eventual disposition and other valuation methods. There were no impairment
losses of long-lived assets recognized during the periods
presented.





Shipping
and Handling Costs





Qualstar
records all charges for outbound shipping and handling as revenue. All inbound
shipping and fulfillment costs are classified as costs of goods
sold.




39
 Index





Warranty
Obligations





Qualstar
provides a three year warranty on its XLS, TLS and RLS tape libraries. Some TLS
and all RLS models have three year advance replacement warranty coverage that
provides for replacement of components, or if necessary, complete libraries. All
other TLS models have a one-year advance replacement warranty with the second
and third year being return-to-factory for service at no charge. XLS libraries
sold in North America have a one year onsite service warranty and XLS libraries
sold outside of North America have one year advance replacement warranty
coverage that provides for replacement of components, or if necessary, complete
libraries. A provision for costs related to warranty expense is recorded when
revenue is recognized, which is estimated based on historical warranty costs
incurred. Customers may purchase extended advance replacement service coverage
and on-site service if they are located in the United States, Canada and most
countries within Europe.





The
Company follows the provisions of the Financial Accounting Standards Board
(FASB) Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness
of Others,” which clarifies the requirements of Statement of Financial
Accounting Standards (SFAS) No. 5, “Accounting for Contingencies,” relating to a
guarantor’s accounting for and disclosures for certain guarantees. FIN 45
requires enhanced disclosures, among other things, for certain guarantees,
including warranty accruals. Qualstar does not issue third party guarantees, as
defined, and therefore only the disclosure provisions of FIN 45
apply.





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





June
      30,2008
            
            
            2007Beginning
      balance
            
            $
            174
            
            
            $
            173Cost
      of warranty claims
            
            
            (66
            )
            
            
            (58
            )Accruals
      for product warranties
            
            
            72
            
            
            
            59Ending
      balance
            
            $
            181
            
            
            $
            174





Research
and Development





All
research and development costs are charged to expense as incurred. These costs
consist primarily of engineering salaries, benefits, outside consultant fees,
purchased parts and supplies directly involved in the design and development of
new products, and facilities and other internal costs.





Advertising





Advertising
and promotion expenses include costs associated with direct and indirect
marketing, trade shows and public relations. Qualstar expenses all costs of
advertising and promotion as incurred. Advertising and promotion expenses for
the years ended June 30, 2008, 2007 and 2006 were approximately $576,000,
$604,000 and $407,000, respectively.





Fair
Value of Financial Instruments





The
carrying amounts reported in the balance sheets for cash and cash equivalents,
accounts receivable and accounts payable approximate their fair values due to
the short term nature of these financial instruments.





Share-Based
Compensation





We
account for share-based compensation in accordance with SFAS No, 123(R), Share-Based Payment. Under
the fair value recognition provisions of this statement, share-based
compensation cost is measured at the grant date based on fair value of the award
and is recognized as expense over the applicable vesting period of the stock
award (generally four years) using the straight-line method.





Income
Taxes





Income
taxes are accounted for using the liability method in accordance with SFAS 109,
“Accounting for Income Taxes.” Under this method, deferred tax liabilities and
assets are recognized for the expected future tax consequences of temporary
differences between the financial statement and tax bases of assets and
liabilities, and for the expected future tax benefit to be derived from tax
credits and loss carryforwards. Current income tax expense or benefit represents
the amount of income taxes expected to be payable or refundable for the current
year. A valuation allowance is established when, in the opinion of management,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized.





40
 Index





Comprehensive
Income (Loss)





Comprehensive
income (loss) is accounted for according to SFAS No. 130, “Reporting
Comprehensive Income” (SFAS 130). Comprehensive income (loss) includes
unrealized gains and losses on debt and equity securities classified as
available-for-sale and included as a component of shareholders’
equity.





Loss
per Share





Qualstar
calculates earnings (loss) per share in accordance with SFAS No. 128, “Earnings
per Share.” Basic earnings (loss) per share has been computed by dividing net
loss by the weighted average number of common shares outstanding. Diluted
earnings (loss) per share has been computed by dividing net loss by the weighted
average common shares outstanding plus dilutive securities or other contracts to
issue common stock as if these securities were exercised or converted to common
stock.





The
following table sets forth the calculation for basic and diluted loss per share
for the periods indicated:





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006(In
      thousands)Loss:Net
      loss
            
            $
            (753
            )
            
            $
            (1,447
            )
            
            $
            (1,692
            )Shares:Weighted
      average shares for basic and diluted loss per share
            
            
            12,253
            
            
            
            12,253
            
            
            
            12,253





Shares
issuable under stock options of 623,000, 585,000 and 557,000 for the years ended
June 30, 2008, 2007 and 2006, respectively, have been excluded from the
computation of diluted loss per share as the effect would be
antidilutive.





Reclassifications





Certain
prior year amounts have been reclassified to conform to the current year
presentation.





Note
2 – Marketable Securities





The
following table summarizes marketable securities by security type at June 30,
2008, and June 30, 2007, respectively (in thousands):





June
      30, 2008
            
            Amortized
              Cost
            
            
            Unrealized
              Gain
            
            
            Unrealized
              Loss
            
            
            Fair
              ValueUS
      Treasury obligations and direct obligations of U.S. Government
      agencies
            
            $
            15,483
            
            
            $
            74
            
            
            $
            (27
            )
            
            $
            15,530Government
      Sponsored Enterprise collateralized mortgage obligations
            
            
            4,548
            
            
            
            52
            
            
            
            —
            
            
            
            4,600Commercial
      Paper
            
            
            798
            
            
            
            —
            
            
            
            —
            
            
            
            798Corporate
      bonds
            
            
            4,355
            
            
            
            18
            
            
            
            (17
            )
            
            
            4,356Municipal
      bonds
            
            
            502
            
            
            
            8
            
            
            
            —
            
            
            
            510Total
            
            $
            25,686
            
            
            $
            152
            
            
            $
            (44
            )
            
            $
            25,794








June
      30, 2007
            
            Amortized
              Cost
            
            
            Unrealized
              Gain
            
            
            Unrealized
              Loss
            
            
            Fair
              ValueUS
      Treasury obligations and direct obligations of U.S. Government
      agencies
            
            $
            15,357
            
            
            $
            —
            
            
            $
            (41
            )
            
            $
            15,316Government
      Sponsored Enterprise collateralized mortgage obligations
            
            
            4,570
            
            
            
            —
            
            
            
            (11
            )
            
            
            4,559Commercial
      Paper
            
            
            1,287
            
            
            
            —
            
            
            
            —
            
            
            
            1,287Corporate
      bonds
            
            
            3,904
            
            
            
            —
            
            
            
            (4
            )
            
            
            3,900Municipal
      bonds
            
            
            505
            
            
            
            1
            
            
            
            —
            
            
            
            506Total
            
            $
            25,623
            
            
            $
            1
            
            
            $
            (56
            )
            
            $
            25,568





41
 Index





The
following tables show the gross unrealized losses and fair value of the
Company’s investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at June 30, 2008, and June 30, 2007, respectively.





Less
      Than 12 Months
            
            
            12
      Months or Greater
            
            
            TotalJune
      30, 2008
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              Loss(In
      thousands)US
      Treasury obligations and direct obligations of U.S. Government
      agencies
            
            $
            —
            
            
            $
            —
            
            
            $
            6,334
            
            
            $
            (26
            )
            
            $
            6,334
            
            
            $
            (26
            )Government
      Sponsored Enterprise collateralized mortgage obligations
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Corporate
      bonds
            
            
            599
            
            
            
            (1
            )
            
            
            639
            
            
            
            (17
            )
            
            
            1,238
            
            
            
            (18
            )Total
            
            $
            599
            
            
            $
            (1
            )
            
            $
            6,973
            
            
            $
            (43
            )
            
            $
            7,572
            
            
            $
            (44
            )








Less
      Than 12 Months
            
            
            12
      Months or Greater
            
            
            TotalJune
      30, 2007
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              Loss
            
            
            Fair
              Value
            
            
            Unrealized
              Loss(In
      thousands)US
      Treasury obligations and direct obligations of U.S. Government
      agencies
            
            $
            —
            
            
            $
            —
            
            
            $
            14,668
            
            
            $
            (41
            )
            
            $
            14,668
            
            
            $
            (41
            )Government
      Sponsored Enterprise collateralized mortgage obligations
            
            
            —
            
            
            
            —
            
            
            
            3,552
            
            
            
            (11
            )
            
            
            3552
            
            
            
            (11
            )Corporate
      bonds
            
            
            —
            
            
            
            —
            
            
            
            2,071
            
            
            
            (4
            )
            
            
            2,071
            
            
            
            (4
            )Total
            
            $
            —
            
            
            $
            —
            
            
            $
            20,291
            
            
            $
            (56
            )
            
            $
            20,291
            
            
            $
            (56
            )





U.S.
Treasury Obligations.  The unrealized losses on the Company’s
investments in U.S. Treasury obligations and direct obligations of U.S.
Government agencies were caused by interest rate increases. The contractual
terms of these investments do not permit the issuer to settle the securities at
a price less than the amortized cost of the investment. Because the Company has
the ability and intent to hold these investments until a recovery of fair value,
which may be maturity, the Company does not consider these investments to be
other-than-temporarily impaired at June 30, 2008.





Government
Sponsored Enterprise (GSE) Collateralized Mortgage
Obligations.  Freddie Mac and Fannie Mae are identified as GSEs. The
unrealized losses on the Company’s investment in GSE collateralized mortgage
obligations were caused by interest rate increases. The cash flows of these
investments are guaranteed by the GSE. Because the decline in market value is
attributable to changes in interest rates and not credit quality and because the
Company has the ability and intent to hold these investments until a recovery of
fair value, which may be maturity, the Company does not consider these
investments to be other-than-temporarily impaired at June 30, 2008.





Corporate
Bonds.  The unrealized losses on the Company’s investments in
corporate bonds were caused by interest rate increases. The contractual terms of
these investments do not permit the issuer to settle the securities at a price
less than the amortized cost of the investment. Because the Company has the
ability and intent to hold these investments until a recovery of fair value,
which may be maturity, the Company does not consider these investments to be
other-than-temporarily impaired at June 30, 2008.





The
following tables summarize the contractual maturities of the Company’s fixed
maturity securities and GSE collateralized mortgage obligations based on cash
flows (in thousands):





June
      30,2008
            
            
            2007Less
      than 90 days
            
            $
            —
            
            
            $
            —Less
      than one year
            
            
            11,091
            
            
            
            9,574Due
      in one to five years
            
            
            14,703
            
            
            
            15,994$
            25,794
            
            
            $
            25,568





42
 Index





Note
3 – Inventories


Inventories
consist of the following:





June
      30,2008
            
            
            2007(In
      thousands)Raw
      materials, net
            
            $
            5,324
            
            
            $
            5,234Finished
      goods
            
            
            785
            
            
            
            694$
            6,109
            
            
            $
            5,928





Note
4 – Property and Equipment





The
components of property and equipment are as follows:





June
      30,2008
            
            
            2007(In
      thousands)Leasehold
      improvements
            
            $
            566
            
            
            $
            546Furniture
      and fixtures
            
            
            1,002
            
            
            
            984Machinery
      and equipment
            
            
            2,610
            
            
            
            2,4564,178
            
            
            
            3,986Less
      accumulated depreciation and amortization
            
            
            (3,652
            )
            
            
            (3,385
            )$
            526
            
            
            $
            601





Note
5 – Income Taxes





The
provision (benefit) for income taxes is comprised of the following:





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006(In
      thousands)Current:Federal
            
            $
            —
            
            
            $
            —
            
            
            $
            (86
            )State
            
            
            17
            
            
            
            30
            
            
            
            (3
            )17
            
            
            
            30
            
            
            
            (89
            )Deferred:Federal
            
            
            —
            
            
            
            —
            
            
            
            —State
            
            
            —
            
            
            
            —
            
            
            
            ——
            
            
            
            —
            
            
            
            —$
            17
            
            
            $
            30
            
            
            $
            (89
            )





The
following is a reconciliation of the statutory federal income tax rate to
Qualstar’s effective income tax rate:





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006Statutory
      federal income tax benefit
            
            
            (34.0
            )%
            
            
            (34.0
            )%
            
            
            (34.0
            )%State
      income taxes, net of federal income tax benefit
            
            
            (4.7
            )
            
            
            (4.0
            )
            
            
            (3.4
            )Research
      and development credits
            
            
            5.2
            
            
            
            (14.0
            )
            
            
            (6.5
            )Valuation
      allowance
            
            
            38.4
            
            
            
            53.8
            
            
            
            36.7Other
            
            
            (2.5
            )
            
            
            0.3
            
            
            
            2.12.4
            %
            
            
            2.1
            %
            
            
            (5.1
            )%





43
 Index




The tax
effect of temporary differences resulted in deferred income tax assets
(liabilities) as follows:





June
      30,2008
            
            
            2007(In
      thousands)Deferred
      tax assets:Net
      operating loss carryforwards
            
            $
            1,681
            
            
            $
            1,358Capital
      loss and other credit carryforwards
            
            
            467
            
            
            
            445Research
      and development credit carryforwards
            
            
            597
            
            
            
            635Allowance
      for bad debts and returns
            
            
            44
            
            
            
            65Inventory
      reserves
            
            
            289
            
            
            
            320Capitalized
      inventory costs
            
            
            31
            
            
            
            34Marketable
      securities
            
            
            (41
            )
            
            
            21Other
      accruals
            
            
            511
            
            
            
            502Total
      gross deferred tax assets
            
            
            3,579
            
            
            
            3,380Deferred
      tax liabilities:Depreciation
      and other
            
            
            (85
            )
            
            
            (107
            )Total
      gross deferred tax liabilities
            
            
            (85
            )
            
            
            (107
            )Valuation
      allowance
            
            
            (3,494
            )
            
            
            (3,273
            )Net
      deferred tax assets
            
            $
            —
            
            
            $
            —





The
Company placed a valuation allowance on net deferred tax assets during the
fiscal years ended June 30, 2008 and 2007 based on the Company’s assessment
regarding the realizability of such assets in future years. The Company has net
operating loss carryforwards for federal income tax purposes of approximately
$4.3 million as of June 30, 2008 and $3.5 million as of June 30,
2007.  The Company has net operating loss carryforwards for state
income tax purposes of approximately $3.8 million as of June 30, 2008 and $3.2
million as of June 30, 2007. The Company had research and development credit and
other credits for tax purposes of $0.9 million at June 30, 2008 and $0.8 million
at June 30, 2007. If not utilized, the federal net operating loss and tax credit
carryforwards will expire beginning in 2025. If not utilized, the state net
operating loss carryforward will expire beginning in 2009.  The state
research and development credit has no limit on the carryforward
period.





FIN
48





On July
1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement No. 109, which provides a
financial statement recognition threshold and measurement attribute for a tax
position taken or expected to be taken in a tax return. Under FIN 48, the
Company may recognize the tax benefit from an uncertain tax position only if it
is more likely than not that the tax position will be sustained on examination
by the taxing authorities, based on the technical merits of the position. The
tax benefits recognized in the financial statements from such a position should
be measured based on the largest benefit that has a greater than 50% likelihood
of being realized upon ultimate settlement. FIN 48 also provides guidance on
derecognition of income tax assets and liabilities, classification of current
and deferred income tax assets and liabilities, accounting for interest and
penalties associated with tax positions, and income tax
disclosures.





Adopting
FIN 48 had the following impact on the Company’s financial statements: increased
long-term liabilities and reduced retained earnings by $36,000. In addition, the
Company recognized a decrease in deferred tax assets of approximately $146,000
for unrecognized tax benefits relating to tax credit carryforwards, which was
accounted for as a reduction to the July 1, 2007 valuation
allowance.





The
following table summarizes the activity related to the Company’s unrecognized
tax benefits:





TotalBalance
      at July 1, 2007
            
            $
            36,100Increases
      related to current year tax positions
            
            
            1,200Related
      interest and penalty
            
            
            9,100Balance
      at June 30, 2008
            
            $
            46,400





44
 Index





While the
Company expects that the amount of its unrecognized tax benefits will change in
the next twelve months, the Company does not expect this change to have a
significant impact on its results of operations or financial
position.  In addition, future changes in the unrecognized tax benefit
will have no impact on the Company’s effective tax rate due to the existence of
the valuation allowance.





The
Company’s policy is to include interest and penalties on unrecognized tax
benefits in income tax expense, but is not significant at June 30,
2008.   The Company files its tax returns by the laws of the
jurisdictions in which it operates.  The Company’s federal tax returns
after 2002 and California tax returns after 2003 are still subject to
examination.  Various state jurisdictions tax years remain open to
examination as well, though the Company believes any additional assessment will
be immaterial to its consolidated financial statements.





Note
6 – Preferred Stock





Qualstar’s
capital structure allows for the Board of Directors to authorize 5,000,000
shares of preferred stock. The Board of Directors has authority to fix the
rights, preferences, privileges and restrictions, including voting rights, of
these shares of preferred stock without any future vote or action by the
shareholders. At June 30, 2008 and 2007, there were no outstanding shares of
preferred stock.





Note
7 – Shared Based Stock Option Plans





The
Company has one share-based compensation plan as described below. During fiscal
2008, 2007 and 2006, the Company recorded share-based compensation associated
with outstanding stock option grants of approximately $112,000, $90,000 and
$133,000, respectively. No income tax benefit was recognized in the income
statement for share-based arrangements in any period presented.





Qualstar
adopted a stock option plan (1998 Stock Incentive Plan) under which incentive
and nonqualified stock options could be granted for an aggregate of no more than
1,215,000 shares of common stock. Under the terms of the plan, options could be
issued at an exercise price of not less than 100% of the fair market value of
common stock on the date of grant. If an incentive stock option is granted to an
individual owning more than 10% of the total combined voting power of all stock,
the exercise price of the option may not be less than 110% of the fair market
value of the underlying shares on the date of grant. These option awards
typically vest based on 4 years of continuous service at a rate of 25% per year
and terminate as specified in each option agreement, but terminate no later than
ten years after the date of grant.





The fair
value of each option award is estimated on the date of grant using the
Black-Scholes option valuation model that uses the assumptions noted in the
following table. Expected volatilities are based on the historical volatility of
the Company’s stock. The Company uses historical data to estimate option
exercise and employee termination in determining forfeiture rates and evaluates
separate groups of employees by functional area that have similar historical
exercise behavior. The expected term of options granted is estimated based on
the vesting term of the award, historical employee exercise behavior, expected
volatility of the Company’s stock and an employee’s average length of service.
The risk-free interest rate used in this model correlates to a U.S. constant
rate Treasury security with a contractual life that approximates the expected
term of the option award. Weighted-average numbers have been used below as
indicated.





2008
            
            
            2007
            
            
            2006Expected
      dividend yield
            
            
            7.77
            %
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.5
            %
            
            
            4.5
            %
            
            
            4.8
            %Expected
      life of options
            
            6
      years
            
            
            5
      years
            
            
            4
      yearsVolatility
            
            
            34.6
            %
            
            
            35.4
            %
            
            
            30.8
            %





45
 Index




The
following table summarizes all stock option activity (in thousands, except per
share amounts):





Options
            
            Shares
            
            
            Weighted
      Average Exercise Price per Share
            
            
            Weighted
      Average Remaining Contractual Term
            
            
            Aggregate
      Intrinsic ValueOutstanding
      at June 30, 2007
            
            
            585
            
            
            $
            4.07Granted
            
            
            38
            
            
            
            3.06Exercised
            
            
            —
            
            
            
            —Forfeited
      or expired
            
            
            —
            
            
            
            —Outstanding
      at June 30, 2008
            
            
            623
            
            
            $
            4.00
            
            
            
            6.47
            
            
            $
            3Exercisable
      at June 30, 2008
            
            
            399
            
            
            $
            4.54
            
            
            
            3.80
            
            
            $
            1





The
weighted-average grant date fair value per share of options granted during the
fiscal years 2008, 2007 and 2006 was $0.48, $1.13, and $0.96,
respectively.





At June
30, 2008, there was $199,000 of total unrecognized compensation cost related to
nonvested share-based compensation awards granted under the Plan.  The
cost is expected to be recognized over a weighted-average period of 2.2
years.  The total fair value of shares vested for fiscal year 2008,
2007 and 2006 was $112,000, $78,000 and $156,000, respectively.





Note
8 – Purchase of N2Power





On July
11, 2002, Qualstar acquired the assets and intellectual properties of N2Power,
Incorporated, a privately held company which designed and produced small and
efficient open-frame switching power supplies. The consideration for this
acquisition amounted to $250,000 plus acquisition expenses of $38,000. The
purchase price was primarily allocated to a patent, in the amount of $240,000,
which was amortized over 5 years. At June 30, 2008, accumulated amortization of
the patent was $240,000. Amortization expense for the years ended June 30, 2007
and 2006 was $48,000 and $48,000, respectively.  The patent was fully
amortized as of June 30, 2007.





Note
9 – Commitments





Qualstar’s
lease agreement for its facility located in Simi Valley, California, expires in
January of 2011.  Rent on this facility is $46,000 per month, with a
step-up of $2,800 per month beginning in February 2009. The Company provides for
rent expense on a straight-line basis over the lease term.





Qualstar’s
lease agreement for its facility located in Boulder, Colorado, expires in May of
2012. Rent on this facility is $4,500 per month, with a step-up of approximately
3% annually. The Company provides for rent expense on a straight-line basis over
the lease term.





Future
minimum lease payments under these leases are as follows:




Year
      Ending June 30,
            
            Minimum
      Lease Payment(in
      thousands)2009
            
            $
            6212010
            
            
            6392011
            
            
            3622012
            
            
            502013
      and thereafter
            
            
            —$
            1,672





Rent
expense (including equipment rental) for the years ended June 30, 2008, 2007,
and 2006, was $725,000, $665,000, and $670,000, respectively.





46
 Index





Note
10 – Segment Information





Based on
the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and
Related Information,” and the manner in which the Chief Operating Decision Maker
analyzes the business, Qualstar has determined that it has two separate
operating segments.





Segment
revenue, loss before income taxes and total assets were as follows:





Year
      Ended June 302008
            
            
            2007
            
            
            2006Revenue
            
            (in
      thousands)Tape
      Libraries:Product
            
            $
            14,711
            
            
            $
            14,676
            
            
            $
            16,008Service
            
            
            2,718
            
            
            
            2,929
            
            
            
            3,144Total
      Tape Libraries
            
            
            17,429
            
            
            
            17,605
            
            
            
            19,152Power
      Supplies
            
            
            4,035
            
            
            
            3,007
            
            
            
            2,579Consolidated
      Revenue
            
            $
            21,464
            
            
            $
            20,612
            
            
            $
            21,731





Year
      Ended June 302008
            
            
            2007
            
            
            2006Loss
      before Taxes
            
            (in
      thousands)Tape
      Libraries
            
            $
            (938
            )
            
            $
            (1,310
            )
            
            $
            (1,434
            )Power
      Supplies
            
            
            202
            
            
            
            (107
            )
            
            
            (347
            )Consolidated
      Loss before Income Taxes
            
            $
            (736
            )
            
            $
            (1,417
            )
            
            $
            (1,781
            )





Year
      Ended June 302008
            
            
            2007
            
            
            2006Total
      Assets
            
            (in
      thousands)Tape
      Libraries
            
            $
            41,257
            
            
            $
            43,228
            
            
            $
            44,312Power
      Supplies
            
            
            1,400
            
            
            
            835
            
            
            
            1,087Consolidated
      Assets
            
            $
            42,657
            
            
            $
            44,063
            
            
            $
            45,399





SFAS No.
131, establishes standards for reporting information about operating segments.
This standard requires segmentation based on our internal organization and
reporting of revenue and operating income based upon internal accounting
methods. Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. Our chief operating decision maker is our Chief Executive
Officer. Our two segments are Tape Libraries and Power Supplies. The two
segments discussed in this analysis are presented the way we internally managed
and monitored performance in fiscal years 2008, 2007, and 2006. Our financial
reporting systems present various data for management to operate the business,
including internal profit and loss statements prepared on a basis consistent
with U.S. GAAP. For the years ended June 30, 2008, 2007 and 2006 amounts do not
reflect allocations for certain internal resources, pension expense, legal
expense, accounting fees, and other items. However, this represented the
measurement data used by the chief operating decision maker in evaluating
performance. The tape library business has dominated our operations, thus, our
operations and reporting have been set up to accommodate a single segment and
attribute all revenues and expenses to the tape library side, with the power
supply business being an ancillary part of overall operations. As the power
supply segment grew in fiscal 2006 to represent greater than 10% of combined
revenues, a framework for internal resource allocations for labor, including
direct, indirect and overhead was implemented in fiscal 2006.





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





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





47
 Index





Power Supplies — The Company
designs, develops, and sells ultra small, open frame, high efficiency switching
power supplies. These power supplies are used to convert AC line voltage to DC
for use in a wide variety of electronic equipment such as telecommunications
equipment, machine tools, routers, switches, wireless systems and gaming
devices.





Certain
assets are tracked separately by the power supplies segment, and all others are
recorded in the tape library segment for internal reporting presentations. Cash
is not segregated between the two segments, but retained by the library
segment.





Geographic
Information





Information
regarding revenues attributable to the Qualstar’s primary geographic operating
regions is as follows:





Year
      Ended June 30,2008
            
            
            2007
            
            
            2006(In
      thousands)Revenues:North
      America
            
            $
            15,619
            
            
            $
            15,582
            
            
            $
            16,051Europe
            
            
            3,779
            
            
            
            3,196
            
            
            
            3,467Asia
      Pacific
            
            
            1,433
            
            
            
            1,330
            
            
            
            1,610Other
            
            
            633
            
            
            
            504
            
            
            
            603$
            21,464
            
            
            $
            20,612
            
            
            $
            21,731





The
geographic classification of revenues is based upon the location to which the
product is shipped. Qualstar does not have any significant long-lived assets
outside of the United States.





Note
11 – Legal Proceedings





The
Company is from time to time involved in various lawsuits and legal proceedings
that arise in the ordinary course of business. At this time, management is not
aware of any pending or threatened litigation against the Company that we expect
will have a material adverse effect on our business, financial condition,
liquidity or operating results. Legal claims are inherently uncertain, however.
There can be no assurance that the Company will not be adversely affected in the
future by legal proceedings.





Note
12 – Benefit Plans





Qualstar
has a voluntary deferred compensation plan (the Plan) qualifying for treatment
under Internal Revenue Code Section 401(k). All employees are eligible to
participate in the Plan following three months of service of employment and may
contribute up to 100% of their compensation on a pre-tax basis, not to exceed
the annual IRS maximum. Qualstar, at the discretion of management, may make
matching contributions in an amount equal to 25% of the first 6% of compensation
contributed by eligible participants. Qualstar’s contributions under the Plan
totaled $46,000, $43,000, and $59,000 for the years ended June 30, 2008, 2007,
and 2006, respectively.





Note
13 – Related Party Transactions





Qualstar’s
outside counsel is a member of its board of directors. During the years ended
June 30, 2008, 2007, and 2006 Qualstar paid $83,000, $69,000, and $94,000,
respectively to the law firm in which the director is a shareholder for general
business purposes.





Note
14 – Recent Accounting Pronouncements





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which
defines fair value, establishes a framework for measuring fair value in GAAP,
and expands disclosures about fair value measurements.   SFAS 157
does not require any new fair value measurements, but provides guidance on how
to measure fair value by providing a fair value hierarchy used to classify the
source of the information.  We expect to adopt SFAS 157 in our fiscal
year beginning July 1, 2008.  We do not expect the adoption of SFAS
157 to have a material impact on our financial statements.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.”  SFAS 159 gives us the
irrevocable option to carry many financial assets and liabilities at fair
values, with changes in fair value recognized in earnings.  We expect
to adopt SFAS 159 in our fiscal year beginning July 1, 2008.  We do
not expect the adoption of SFAS 159 to have a material impact on our financial
statements.





48
 Index





Note
15 – Quarterly Results of Operations (Unaudited)





Three
      Months EndedJune
      30,
            
            
            March
      31,
            
            
            December
      31,
            
            
            September
      30,(In
      thousands, except per share amounts)Fiscal
      2008:Net
      sales
            
            $
            4,912
            
            
            $
            5,171
            
            
            $
            6,049
            
            
            $
            5,332Gross
      profit
            
            
            1,966
            
            
            
            1,786
            
            
            
            2,045
            
            
            
            1,624Net
      loss
            
            $
            (166
            )
            
            $
            (322
            )
            
            $
            (59
            )
            
            $
            (206
            )Net
      loss per share:Basic
            
            $
            (0.01
            )
            
            $
            (0.03
            )
            
            $
            (0.00
            )
            
            $
            (0.02
            )Diluted
            
            
            (0.01
            )
            
            
            (0.03
            )
            
            
            (0.00
            )
            
            
            (0.02
            )Fiscal
      2007:Net
      sales
            
            $
            5,786
            
            
            $
            4,884
            
            
            $
            5,283
            
            
            $
            4,659Gross
      profit
            
            
            2,246
            
            
            
            1,338
            
            
            
            1,634
            
            
            
            1,302Net
      Income (loss)
            
            $
            245
            
            
            $
            (667
            )
            
            $
            (446
            )
            
            $
            (579
            )Net
      loss per share:Basic
            
            $
            0.02
            
            
            $
            (0.06
            )
            
            $
            (0.04
            )
            
            $
            (0.05
            )Diluted
            
            
            0.02
            
            
            
            (0.06
            )
            
            
            (0.04
            )
            
            
            (0.05
            )








ITEM9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





None.








ITEM9A(T). CONTROLS AND PROCEDURES





Evaluation of Disclosure
Controls and Procedures





We
carried out an evaluation, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of Qualstar’s
disclosure controls and procedures as of June 30, 2008, pursuant to Rule 13a-15
under the Securities Exchange Act of 1934. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Commission’s rules and forms, and to ensure that the information required
to be disclosed by us in reports that we file or submit under the Exchange Act
is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.





Changes in Internal Control
over Financial reporting





We did
not make any changes in our internal control over financial reporting during the
fiscal fourth quarter ended June 30, 2008 that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





Management’s Report on
Internal Control over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Our internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Our management assessed the
effectiveness of our internal control over financial reporting as of June 30,
2008. In making this assessment, it used the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control – Integrated Framework. Based on our assessment, we have concluded that,
as of June 30, 2008, our internal control over financial reporting was effective
based on those criteria.





49
 Index





This
annual report does not include an attestation report of the registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.








ITEM9B. OTHER INFORMATION





None.




50
 Index





PART
III





The
information called for by Items 10, 11, 12, 13 and 14 of Part III of Form 10-K
(except information as to Qualstar’s executive officers, which is included under
Part I, Item 1 of this Report) will be included in Qualstar’s Proxy Statement to
be filed with the Securities and Exchange Commission within 120 days after the
close of its fiscal year ended June 30, 2008, and is hereby incorporated by
reference to such Proxy Statement.








ITEM10. DIRECTORS, EXECUTIVE OFFICERS  AND CORPORATE
GOVERNANCE





A list of
our executive officers and biographical information appears in Part I, Item 1 of
this report. Information about our Directors may be found under the caption
“Election of Directors” of our Proxy Statement (the “Proxy Statement”). That
information is incorporated herein by reference.





Additional
information in response to this item is incorporated herein by reference to our
proxy statement to be filed within 120 days after our fiscal year ended June 30,
2008.








ITEM11. EXECUTIVE COMPENSATION





Information
in response to this item is incorporated by reference to our proxy statement to
be filed within 120 days of our fiscal year ended June 30, 2008.








ITEM12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS





Information
in response to this item is incorporated by reference to our proxy statement to
be filed within 120 days of our fiscal year ended June 30, 2008.








ITEM13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE





Information
in response to this item is incorporated by reference to our proxy statement to
be filed within 120 days of our fiscal year ended June 30, 2008.








ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





Information
in response to this item is incorporated by reference to our proxy statement to
be filed within 120 days of our fiscal year ended June 30, 2008.





51
 Index




PARTIV








ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





(a)  
The financial statements are set forth under Item 8 of this Annual Report on
Form 10-K.





All other
schedules have been omitted since the required information is not present in
amounts sufficient to require submission of the schedule, or because the
required information is included in the consolidated financial statements or
notes thereto.











(b)  
Exhibits:





Exhibit
              No.
            
            Description3.1(1)
            
            Restated
      Articles of Incorporation.3.2(4)
            
            Bylaws,
      as amended and restated January 14, 2000.3.3(4)
            
            Amendment
      to Bylaws, adopted December 21, 2007.10.1(1)*
            
            1998
      Stock Incentive Plan, as amended and restated.10.2(1)
            
            Form
      of Indemnification Agreement.10.3(2)
            
            Lease
      agreement between Strategic Performance Fund-II, Inc. and Qualstar
      Corporation, dated September 20, 2000.14.1(3)
            
            Code
      of Business Conduct and Ethics21.1
            
            Subsidiaries
      of Qualstar Corporation23.1
            
            Consent
      of Independent Registered Public Accounting Firm.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.


____________




(1)
            Incorporated
      by reference to the designated exhibits to Qualstar’s registration
      statement on Form S-1 (Commission File No. 333-96009), declared effective
      by the Commission on June 22, 2000.(2)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-Q
      for the fiscal quarter ended September 30, 2000.(3)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-K
      for the fiscal year ended June 30, 2004.(4)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-Q
      for the fiscal quarter ended December 31, 2007.*
            Each
      of these exhibits constitutes a management contract, compensatory plan or
      arrangement required to be filed as an exhibit to this report pursuant to
      Item 15(b) of this report.





52
 Index




SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) 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
      CORPORATIONDate:
      September 24, 2008
            By:
            /s/WILLIAM J.
      GERVAISWilliam
      J. Gervais,Chief
      Executive Officer and President





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.





Signature
            Title
            Date/s/  WILLIAM
      J. GERVAIS
            Chief
      Executive Officer,
            September
      24, 2008William
      J. Gervais
            President
      and Director(principal
      executive officer)/s/  RICHARD
      A. NELSON
            Vice
      President, Engineering
            September
      24, 2008Richard
      A. Nelson
            Secretary
      and Director/s/  CARL
      W. GROMADA
            Director
            September
      24, 2008Carl
      W. Gromada/s/  STANLEY
      W. CORKER
            Director
            September
      24, 2008Stanley
      W. Corker/s/  ROBERT
      E. RICH
            Director
            September
      24, 2008Robert
      E. Rich/s/  ROBERT
      A. MEYER
            Director
            September
      24, 2008Robert
      A. Meyer/s/  ANDREW
      A. FARINA
            Vice-President
      and CFO
            September
      24, 2008Andrew
      A. Farina
            (principal
      financial officer)





53
 Index




EXHIBITINDEX





Exhibit
              No.
            
            Description3.1(1)
            
            Restated
      Articles of Incorporation.3.2(4)
            
            Bylaws,
      as amended and restated January 14, 2000.3.3(4)
            
            Amendment
      to Bylaws, adopted December 21, 2007.10.1(1)*
            
            1998
      Stock Incentive Plan, as amended and restated.10.2(1)
            
            Form
      of Indemnification Agreement.10.3(2)
            
            Lease
      agreement between Strategic Performance Fund-II, Inc. and Qualstar
      Corporation, dated September 20, 2000.14.1(3)
            
            Code
      of Business Conduct and Ethics21.1
            
            Subsidiaries
      of Qualstar Corporation23.1
            
            Consent
      of Independent Registered Public Accounting Firm.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.


____________





(1)
            Incorporated
      by reference to the designated exhibits to Qualstar’s registration
      statement on Form S-1 (Commission File No. 333-96009), declared effective
      by the Commission on June 22, 2000.(2)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-Q
      for the fiscal quarter ended September 30, 2000.(3)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-K
      for the fiscal year ended June 30, 2004.(4)
            Incorporated
      by reference to the designated exhibit to Qualstar’s Report on Form 10-Q
      for the fiscal quarter ended December 31, 2007.*
            Each
      of these exhibits constitutes a management contract, compensatory plan or
      arrangement required to be filed as an exhibit to this report pursuant to
      Item 15(b) of this report.






54