**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, 2007**
 
 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, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
        (Check one):
  Large
                  accelerated filer o
              Accelerated
                  filer o
              Non-accelerated
                  filer þ
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Exchange
        Act Rule 12b-2).  Yes o     No þ
 
 As
        of
        December 31, 2006, the aggregate market value of the common equity held by
        non-affiliates of the registrant was approximately $24,478,000.
 
 The
        total
        shares of common stock without par value outstanding at September 13, 2007
        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 2008 are incorporated by reference into Part III
        of this Form 10-K.
 **QUALSTAR
            CORPORATION**
 
 **FORM 10-K**
 
 **FOR
            THE FISCAL YEAR ENDED JUNE 30, 2007**
 
 **INDEX**
 
 **PART I**Item 1.
                  Business
                  3Executive
                      Officers of the Registrant
                  13Item 1A.
                  Risk
                      Factors
                  14Item 1B.
                  Unresolved
                      Staff Comments
                  21Item 2.
                  Properties
                  22Item 3.
                  Legal
                      Proceedings
                  22Item 4.
                  Submission
                      of Matters to a Vote of Security
                      Holders
                  22**PART II**Item 5.
                  Market
                      for Registrant’s Common Equity, Related Stockholder
                      Matters, and Issuer Purchases of Equity Securities
                  22Item 6.
                  Selected
                      Financial Data
                  23Item 7.
                  Management’s
                      Discussion and Analysis of Financial Condition and
                      Results of Operations
                  24Item 7A.
                  Quantitative
                      and Qualitative Disclosures about Market
                      Risk
                  29Item 8.
                  Financial
                      Statements and Supplementary Data
                  30Item 9.
                  Changes
                      in and Disagreements with Accountants on Accounting and
                      Financial Disclosure
                  48Item 9A.
                  Controls
                      and Procedures
                  48Item 9B.
                  Other
                      Information
                  48**PART III**Item 10.
                  Directors,
                      Executive Officers and Corporate
                      Governance
                  49Item 11.
                  Executive
                      Compensation
                  49Item 12.
                  Security
                      Ownership of Certain Beneficial Owners and Management
                      and Related Stockholder Matters
                  49Item 13.
                  Certain
                      Relationships and Related Transactions, and Director
                      Independence
                  49Item 14.
                  Principal
                      Accountant Fees and Services
                  49**PART IV**Item 15.
                  Exhibits
                      and Financial Statement Schedules
                  50Signatures
                  51Exhibit Index
                  52
  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.
 
 
 **PART I**
 
 **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/Legato, Tivoli, Symantec, CommVault and BakBone
            Software. We currently offer tape libraries for two popular tape drive
            technologies, LTO and AIT. We have discontinued sales of libraries with
            Super
            AIT and DLT tape drives due to declining demand for those tape drive
            technologies.
 
 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.
 
 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. Automated
            tape
            libraries and related products, such as tape drives and tape media, represented
            approximately 66.6% of revenues for fiscal 2007, approximately 66.2%
            of revenues
            for fiscal 2006, and approximately 75.1% of revenues for fiscal 2005.
            Sales of
            power supplies, services and other products accounted for the balance
            of our
            revenues.
 
 In
            July
            2002, we purchased the assets of N2Power, Incorporated, a supplier of
            ultrasmall
            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. Revenues from N2Power products totaled
            approximately 14.6% of revenues for fiscal 2007, 11.9% of revenues for
            fiscal
            2006 and 5.0% of revenues for fiscal 2005.
 
 Our
            power
            supplies are used to convert common alternating current  (AC) line
            voltages found in buildings and 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.
  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 growing 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 and motion picture 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, commerce and data
                      retrieval.
 
 •
                  **Growth
                      in new types of data.**  New types of data are also
                      fueling the growth in data storage. For example, graphics,
                      audio, video,
                      medical and security 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 longer
                      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.
 
 •
                  **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 such as computer fax and
                      e-mail, all of
                      which 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.
 
 **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:
  4
 *Index*
  •
                  **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, thereby increasing the importance of storage
                      area
                      networks.
 
 •
                  **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 that is not expected to be needed
                      on a
                      frequent 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.
 
 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,
            and we
            expect this trend to continue. 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.
 
 •
                  **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.
  5
 *Index*
  •
                  **Image
                      management.**  Storage-intensive applications such as
                      satellite mapping and medical image management systems are
                      turning to 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, software, 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/Legato,
            Tivoli,
            Symantec, CommVault and BakBone Software. Storage management software
            enables
            network administrators to allocate the use of storage technologies 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 and by
            referring
            business to them when value added resellers or end users inquire about
            storage
            management software sources.
  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.**   Early 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
                      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.
 
 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 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
            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 600
                  
                  240TLS-8000
                  LTO
                  
                  11
                      to 264
                  
                  211RLS-4000
                  Sony
                      AIT
                  
                  22
                      to 70
                  
                  28RLS-8000
                  LTO
                  
                  12
                      to 44
                  
                  35XLS
                      Series
                  LTO
                  
                  295-2805
                  (2)
                  2,244
                  (2)
 ____________
  (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%.
  (2)
                  2,805
                      tapes and 2,244 terabytes reflect the product configuration
                      at its initial
                      release stage. Planned future releases of internal firmware
                      will allow
                      expansion to as high as 6,265 tapes and 5,012 terabytes using
                      LTO tape
                      technology.
  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 an
            input/output port 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 many
                      of our models for connection to Storage Area Networks and other
                      high
                      performance applications.
 
 •
                  Closed-loop
                      servo control.  Our tape libraries use digital closed-loop servo
                      control for robotic motion 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, some models in the RLS series are
            designed to support dual-redundant power supplies and hot-swappable tape
            drives.
 
 Our
            XLS
            family of tape libraries is designed to be expandable from 300 to over
            6000
            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
            high efficiency solution. Initial customer shipments commenced in July
            2006.
 
 **Power
            Supplies**
 
 In
            addition to tape libraries, we design and sell ultrasmall, 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, servers, routers, switches, wireless systems
            and
            gaming devices.
  8
 *Index*
  Our
            power
            supplies are sold under the N2 Power 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 power factor design reduces loads on both generating
            stations
            and air-cooling 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’
needs.
 
 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.
 
 •
                  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, we believe
            that
            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 $5.0 million, or 24.4% of revenues in fiscal 2007, approximately
            $5.7 million, or 26.1% of revenues in fiscal 2006, and approximately
            $6.9 million, or 27.3% of revenues in fiscal 2005.
  9
 *Index*
  Our
            sales
            are spread across a broad customer base. Revenues from Qualstar’s two largest
            customers combined were approximately 11.9%, 13.4%, and 13.9% for the
            years
            ended June 30, 2007, 2006, and 2005, 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 about 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 strong customer service and technical support is an essential
            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 installed within the United States and
                      Canada, which
                      are fulfilled by IBM Corporation and on-site service contracts
                      sold in
                      Europe are fulfilled by Eastman Kodak S.A. Commercial Imaging
                      Group.
 
 •
                  **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.
 
 •
                  **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.
 
 •
                  **Training.**  We
                      offer a product maintenance training program 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 TLS and RLS tape libraries
                      and a one
                      year warranty on our XLS 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. 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.
 
 **MANUFACTURING
            AND SUPPLIERS**
 
 We
            manufacture all of our tape libraries at our facility in Simi Valley,
            California. We operate our manufacturing on one daily eight-hour shift.
            However,
            if required, we have the ability to add a second or third shift to increase
            our
            capacity.
  10
 *Index*
  To
            respond rapidly to orders, we build our tape libraries to a semi-finished
            state,
            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 semi-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 and volume requirements. Inventory planning
            and
            management is coordinated closely with suppliers to match our production
            needs.
            Many of the components assembled into our libraries are off-the-shelf
            parts,
            which reduces the risk of part shortages and allows us to maintain inventory
            of
            these parts at a minimum. A number of our component parts are not available
            off
            the shelf, but are designed to our specifications.
 
 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 intensely 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;
 •
                  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.
  11
 *Index*
  **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
            40 separate
            tape library models for eleven different tape formats over the last twelve
            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.
 
 We
            frequently develop new products in response to the availability of a
            new tape
            drive technology. As tape drive manufacturers compete in the marketplace,
            they
            continually invest in research and development to gain performance leadership
            either by offering increasingly enhanced versions of their current tape
            drive
            products or by introducing an entirely new tape drive technology. We
            benefit
            from these industry developments by utilizing the new technology in our
            products. 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
            most
            product families, 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. In some cases, entire
            subassemblies are transferable, leveraging not only engineering time
            but also
            materials purchasing, inventory stocking and manufacturing efforts.
 
 We
            continue to develop new models and new power supply 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
            2007, approximately $3.1 million in fiscal 2006, and approximately
            $3.8 million in fiscal 2005.
 
 **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.
 
 **EMPLOYEES**
 
 As
            of
            August 31, 2007, we had 87 employees, including 35 in operations and
            manufacturing, 20 in research and development, 6 in customer service
            and
            technical support, 14 in sales and marketing, and 12 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.
  12
 *Index*
  **EXECUTIVE
            OFFICERS 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 14,  2007
            are:
 
 **Name**
                  **Age**
                  **Position**William
                      J. Gervais
                  64
                  Chief
                      Executive Officer, President and DirectorRichard
                      A. Nelson
                  64
                  Vice
                      President of Engineering, Secretary and DirectorAndrew
                      A. Farina
                  61
                  Vice
                      President and Chief Financial OfficerDavid
                      L. Griffith
                  50
                  Vice
                      President of OperationsRobert
                      K. Covey
                  60
                  Vice
                      President of MarketingRobert
                      C. King
                  63
                  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.
 
 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.
  13
 *Index*
  **ITEM 1A.
            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.
 
 **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. Distributors have additional return
            privileges that extend well beyond 30 days. 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.
  14
 *Index*
  **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
            24.4% of revenues in fiscal 2007, approximately 26.1% of revenues in
            fiscal
            2006, and approximately 27.3% of revenues in fiscal 2005. 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
                      or our ability
                      to market our products in foreign
                      countries;
 
 •
                  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;
 
 •
                  longer
                      payment cycles typically associated with international sales
                      and potential
                      difficulties in collecting accounts receivable may reduce the
                      profitability of foreign
                      sales; and
 
 •
                  our
                      current determination not to seek ISO-9000 certification, a
                      widely
                      accepted method of establishing and certifying the quality
                      of a
                      manufacturer’s operations, may reduce
                      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.
 
 **Intellectual
            property infringement claims brought against us could be time
            consuming****and expensive to defend.**
 
 In
            recent
            years, there has been an increasing 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;
  15
 *Index*
  •
                  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;
 
 •
                  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.
  16
 *Index*
  **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 43% of our outstanding common stock as of June 30, 2007. 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.
 
 **We
            do not currently intend to pay dividends and therefore you will only
            be able
            to****recover your investment in our common stock, if at
            all, by
            selling the shares of the****stock that you
            own.**
 
 We
            historically have pursued a policy of reinvesting our earnings in research
            and
            development, expanding our value added reseller and original equipment
            manufacturer relationships, and expanding our manufacturing capabilities.
            Consequently, we have never paid dividends on our shares of capital stock.
            We
            currently intend to continue this policy for the foreseeable future to
            strengthen our financial and competitive position in the markets in which
            we
            operate.
 
 **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;
 
 •
                  our
                      announcements of anticipated future revenues or operating
                      results;
 
 •
                  announcements
                      concerning us, our competitors, our customers, or our
                      industry;
 
 •
                  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;
  17
 *Index*
  •
                  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.**
 
 Automated
            tape libraries and related products, such as tape drives and tape media,
            represented approximately 66.6% of our revenues for fiscal 2007, approximately
            66.2% of our revenues for fiscal 2006 and approximately 75.1% of our
            revenues
            for fiscal 2005. 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 manufacturing
            tape
            libraries. There can be no assurance that other tape drive manufacturers
            will
            not also begin to manufacture libraries.
  18
 *Index*
  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 2007 we derived approximately
                      $6.6 million or 32.2% of our revenues, in fiscal 2006 we derived
                      approximately $7.9 million, or 36.4%, of our revenues, and in fiscal
                      2005 we derived approximately $12.0 million, or 47.8% 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 primarily 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.
 
 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.
  19
 *Index*
  **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 new 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;
 
 •
                  keeping
                      them informed as to current and contemplated changes to our
                      products; and
 
 •
                  referring
                      business to them when value added resellers or end users inquire
                      about
                      software sources.
 
 **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.
  20
 *Index*
  **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 a single contract manufacturer for the majority of
            our power
            supplies.****Loss of this supplier could harm our
            business.**
 
 The
            primary supplier of our N2 Power power supplies is located in China.
            If this
            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 five
            years of favorable experience with this supplier, there can be no assurance
            that
            circumstances might not change and compel this supplier 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.
 
 **ITEM 1B.
            UNRESOLVED STAFF COMMENTS**
 
 None.
  21
 *Index*
  **ITEM 2.
            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 half
            of our
            engineering. Our lease on this facility expires in February 2011. Rent
            on this
            facility is $39,000 per month, with step-ups ranging from $2,400 to
            $2,800 per month every two years.
 
 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 2009. We closed our sales office in Surrey, United
            Kingdom in May 2007.
 
 **ITEM 3.
            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.
 
 **ITEM 4.
            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, 2007.
 
 
 **PART II**
 
 **ITEM
                      5.**
                  **MARKET
                      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
                      MATTERS, AND****ISSUER
                      PURCHASES OF EQUITY
                      SECURITIES**
 
 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**
                  
                  
                  **Low****Fiscal
                      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**Fiscal
                      2006**:First
                      Quarter
                  July 1 —
                      September, 30, 2005
                  
                  $
                  4.51
                  
                  
                  $
                  3.55Second
                      Quarter
                  October 1 —
                      December 31, 2005
                  
                  $
                  5.00
                  
                  
                  $
                  3.21Third
                      Quarter
                  January
                      1 — March 31, 2006
                  
                  $
                  4.50
                  
                  
                  $
                  3.30Fourth
                      Quarter
                  April 1 —
                      June 30, 2006
                  
                  $
                  4.20
                  
                  
                  $
                  3.00
 
 There
            were approximately 43 owners of record of Qualstar’s common stock as of
            September 13, 2007.
 
 Qualstar
            has declared no cash dividends during the periods reported. Qualstar
            does not
            currently anticipate paying cash dividends in the foreseeable future,
            but
            intends to retain any future earnings for reinvestment in its business.
            Any
            future determination to pay cash dividends will be at the discretion
            of our
            Board of Directors and will be dependent upon Qualstar’s financial condition,
            results of operations, capital requirements, terms of any debt instruments
            then
            in effect and such other factors as our Board of Directors may deem relevant
            at
            the time.
  22
 *Index*
  **ADDITIONAL
            EQUITY COMPENSATION PLAN INFORMATION**
 
 The
            following table provides additional information regarding Qualstar’s equity
            compensation plans as of June 30, 2007:
 
 **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)
                  
                  
                  585,000
                  
                  
                  $
                  4.07
                  
                  
                  
                  217,175Equity
                      compensation plans not approved by security holders
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Totals
                  
                  
                  585,000
                  
                  
                  $
                  4.07
                  
                  
                  
                  217,175
 ____________
 
 (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, 2007.
 
 
 **ITEM 6.
            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,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**
                  
                  
                  **2004**
                  
                  
                  **2003****(In
                      thousands, expect per share amounts)****Statements
                      of Income Data:**Net
                      revenues
                  
                  $
                  20,612
                  
                  
                  $
                  21,731
                  
                  
                  $
                  25,144
                  
                  
                  $
                  31,530
                  
                  
                  $
                  33,557Cost
                      of goods sold
                  
                  
                  14,092
                  
                  
                  
                  14,856
                  
                  
                  
                  16,529
                  
                  
                  
                  19,575
                  
                  
                  
                  21,171Gross
                      profit
                  
                  
                  6,520
                  
                  
                  
                  6,875
                  
                  
                  
                  8,615
                  
                  
                  
                  11,955
                  
                  
                  
                  12,386Operating
                      expenses:Research
                      and development
                  
                  
                  3,136
                  
                  
                  
                  3,083
                  
                  
                  
                  3,750
                  
                  
                  
                  4,268
                  
                  
                  
                  3,994Sales
                      and marketing
                  
                  
                  3,110
                  
                  
                  
                  3,213
                  
                  
                  
                  3,350
                  
                  
                  
                  3,607
                  
                  
                  
                  3,834General
                      and administrative
                  
                  
                  3,168
                  
                  
                  
                  3,629
                  
                  
                  
                  3,955
                  
                  
                  
                  5,420
                  
                  
                  
                  4,428Total
                      operating expenses
                  
                  
                  9,414
                  
                  
                  
                  9,925
                  
                  
                  
                  11,055
                  
                  
                  
                  13,295
                  
                  
                  
                  12,256Income
                      (loss) from operations
                  
                  
                  (2,894
                  )
                  
                  
                  (3,050
                  )
                  
                  
                  (2,440
                  )
                  
                  
                  (1,340
                  )
                  
                  
                  130Investment
                      income
                  
                  
                  1,477
                  
                  
                  
                  1,269
                  
                  
                  
                  858
                  
                  
                  
                  624
                  
                  
                  
                  693Impairment
                      loss for other-than-temporary decline in investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (160
                  )
                  
                  
                  —Income
                      (loss) before income taxes
                  
                  
                  (1,417
                  )
                  
                  
                  (1,781
                  )
                  
                  
                  (1,582
                  )
                  
                  
                  (876
                  )
                  
                  
                  823Provision
                      (benefit) for income taxes
                  
                  
                  30
                  
                  
                  
                  (89
                  )
                  
                  
                  65
                  
                  
                  
                  (145
                  )
                  
                  
                  274Net
                      income (loss)
                  
                  $
                  (1,447
                  )
                  
                  $
                  (1,692
                  )
                  
                  $
                  (1,647
                  )
                  
                  $
                  (731
                  )
                  
                  $
                  549Earnings
                      (loss) per share:Basic
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.13
                  )
                  
                  $
                  (0.06
                  )
                  
                  $
                  0.04Diluted
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.13
                  )
                  
                  $
                  (0.06
                  )
                  
                  $
                  0.04Shares
                      used to compute earnings (loss) per share:Basic
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398
                  
                  
                  
                  12,577
                  
                  
                  
                  12,579Diluted
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398
                  
                  
                  
                  12,577
                  
                  
                  
                  12,666
  23
 *Index*
 
 **Years
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**
                  
                  
                  **2004**
                  
                  
                  **2003****(In
                      thousands)****Balance
                      Sheet Data:**Cash
                      and cash equivalents
                  
                  $
                  7,697
                  
                  
                  $
                  6,845
                  
                  
                  $
                  12,210
                  
                  
                  $
                  6,401
                  
                  
                  $
                  6,236Marketable
                      securities
                  
                  
                  25,568
                  
                  
                  
                  26,822
                  
                  
                  
                  21,854
                  
                  
                  
                  29,376
                  
                  
                  
                  29,857Working
                      capital
                  
                  
                  25,152
                  
                  
                  
                  *29,012
                  
                  
                  
                  *25,121
                  
                  
                  
                  46,534
                  
                  
                  
                  47,191Total
                      assets
                  
                  
                  44,063
                  
                  
                  
                  45,399
                  
                  
                  
                  47,223
                  
                  
                  
                  51,647
                  
                  
                  
                  52,096Total
                      debt
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Shareholders’
                      equity
                  
                  
                  41,841
                  
                  
                  
                  42,858
                  
                  
                  
                  44,653
                  
                  
                  
                  48,064
                  
                  
                  
                  48,868
 ____________
 
 *
                  In
                      fiscal 2006 and 2005, certain marketable securities were reclassified
                      to
                      long-term assets.
 
 
 **ITEM 7.
            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. We have discontinued sales of libraries with
            Super
            AIT and ALT tape drives due to declining demand for those tape drive
            technologies.
 
 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 broad 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. Revenues from sales outside North America were
            approximately $5.0 million, or 24.4% of revenues in fiscal 2007,
            approximately $5.7 million, or 26.1% of revenues in fiscal 2006, and
            approximately $6.9 million, or 27.3% of revenues in fiscal
            2005.
 
 We
            also
            design, develop and sell ultra-small high-efficiency open-frame switching
            power
            supplies for original equipment manufacturers of telecommunications equipment,
            servers, routers, switches, RAIDs, and other equipment. Our power supplies
            are
            sold under the N2Power brand name through independent sales representatives
            and
            a private distributor. The primary customers are original equipment
            manufacturers and contract manufacturers.
 
 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 66.6% of
            revenues
            in fiscal 2007, approximately 66.2% of revenues in fiscal 2006, and
            approximately 75.1% of revenues in fiscal 2005. Sales of power supplies
            represented approximately 14.6% of revenues in fiscal 2007, approximately
            11.9%
            of revenues in fiscal 2006, and approximately 5.0% of revenues in fiscal
            2005.
            Sales of ancillary products and services accounted for the balance of
            our
            revenues.
  24
 *Index*
  Gross
            margins depend on several factors, including the cost of manufacturing,
            product
            mix, customer demand and the level of competition. Larger tape libraries
            provide
            higher gross margins than do smaller tape libraries primarily because
            the
            competition is less intense in this market segment.
 
 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.
 
 **Allowance
            for Doubtful Accounts**
 
 We
            estimate our allowance for doubtful accounts based on an assessment of
            the
            collectibility of specific accounts and the overall condition of accounts
            receivable. In evaluating the adequacy of the allowance for doubtful
            accounts,
            we analyze specific trade receivables, historical bad debts, customer
            credits,
            customer credit-worthiness and changes in customers’ payment terms and patterns.
            If the financial condition of our customers were to deteriorate, resulting
            in an
            impairment of their ability to make additional payments, then we may
            need to
            make additional allowances. Likewise, if we determine that we could realize
            more
            of our receivables in the future than previously estimated, we would
            adjust the
            allowance to increase income in the period we made this
            determination.
 
 **Inventory
            Valuation**
 
 We
            record
            inventories at the lower of cost or market value. We assess the value
            of our
            inventories periodically based upon numerous factors including expected
            product
            or material demand, current market conditions, technological obsolescence,
            current cost and net realizable value. If necessary, we write down our
            inventory
            for estimated obsolescence, potential shrinkage, or unmarketable inventory
            equal
            to the difference between the cost of inventory and the estimated market
            value
            based upon assumptions about future demand and market conditions. If
            technology
            changes more rapidly than expected, or market conditions become less
            favorable
            than those projected by management, additional inventory write-downs
            may be
            required.
  25
 *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. These estimates include judgments
            about
            deferred tax assets and liabilities resulting from temporary differences
            between
            assets and liabilities recognized for financial reporting purposes and
            such
            amounts recognized for tax purposes, as well as about the realization
            of
            deferred tax assets.
 
 We
            maintain a valuation allowance to reduce our deferred tax assets due
            to the
            uncertainty surrounding the timing of realizing the benefits of net deferred
            tax
            assets in future years. We have considered future taxable income and
            ongoing
            prudent and feasible tax planning strategies in assessing the need for
            such a
            valuation allowance. In the event we were to determine that we would
            be able to
            realize all or part of our net deferred tax asset in the future, the
            valuation
            allowance would be decreased accordingly.
 
 We
            may
            periodically undergo examinations by the federal and state regulatory
            authorities and the Internal Revenue Service. We may be assessed additional
            taxes and or penalties contingent on the outcome of these examinations.
            Our
            previous examinations have not resulted in any unfavorable or significant
            assessments.
 
 Our
            California tax returns for  fiscal years 2001 through 2003 were
            audited by the California Franchise Tax Board. In July 2007, we accepted
            the
            Franchise Tax Board’s proposal to resolve these tax audits, which resulted in a
            $77,000 reduction in the amount of tax refund we had expected related
            to
            research and development tax credits. We previously had booked a reserve
            of
            $55,000 related to this expected refund.
 
 The
            Company has net operating losses, capital losses, research and development
            credit and other carryforwards for tax purposes of $2.4 million at June 30,
            2007 and $1.9 million at June 30, 2006 expiring between fiscal years 2009
            and 2025, except for the state research and development credit, which
            has no
            limit on the carryforward period.
  26
 *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,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Net
                      revenues
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %Cost
                      of goods sold
                  
                  
                  68.4
                  
                  
                  
                  68.4
                  
                  
                  
                  65.7Gross
                      margin
                  
                  
                  31.6
                  
                  
                  
                  31.6
                  
                  
                  
                  34.3Operating
                      expenses:Research
                      and development
                  
                  
                  15.2
                  
                  
                  
                  14.2
                  
                  
                  
                  14.9Sales
                      and marketing
                  
                  
                  15.1
                  
                  
                  
                  14.8
                  
                  
                  
                  13.4General
                      and administrative
                  
                  
                  15.4
                  
                  
                  
                  16.7
                  
                  
                  
                  15.7Loss
                      from operations
                  
                  
                  (14.1
                  )
                  
                  
                  (14.1
                  )
                  
                  
                  (9.7
                  )Investment
                      income
                  
                  
                  7.2
                  
                  
                  
                  5.8
                  
                  
                  
                  3.4Loss
                      before provision (benefit) for income taxes
                  
                  
                  (6.9
                  )
                  
                  
                  (8.3
                  )
                  
                  
                  (6.3
                  )Provision
                      (benefit) for income taxes
                  
                  
                  0.1
                  
                  
                  
                  (0.4
                  )
                  
                  
                  0.3Net
                      loss
                  
                  
                  (7.0
                  )%
                  
                  
                  (7.9
                  )%
                  
                  
                  (6.6
                  )%
 
 We
            have
            two operating segments for financial disclosure purposes:  tape
            libraries and power supplies, as discussed in Footnote 10. The following
            table
            summarizes our revenue by major product line and by operating
            segment:
 
 **Years
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Tape
                      Library revenues:TLS
                  
                  
                  35.9
                  %
                  
                  
                  42.6
                  %
                  
                  
                  51.7
                  %RLS
                  
                  
                  8.6
                  %
                  
                  
                  12.2
                  %
                  
                  
                  13.1
                  %XLS
                  
                  
                  8.5
                  %
                  
                  
                  —
                  
                  
                  
                  —53.0
                  %
                  
                  
                  54.8
                  %
                  
                  
                  64.8
                  %Other
                      library revenues:Service
                  
                  
                  14.2
                  %
                  
                  
                  14.5
                  %
                  
                  
                  10.5
                  %Media
                  
                  
                  13.6
                  %
                  
                  
                  11.4
                  %
                  
                  
                  10.3
                  %Upgrades,
                      Spares
                  
                  
                  4.6
                  %
                  
                  
                  7.4
                  %
                  
                  
                  9.3
                  %Total
                      library  revenues
                  
                  
                  85.4
                  %
                  
                  
                  88.1
                  %
                  
                  
                  94.9
                  %Power
                      Supply revenues
                  
                  
                  14.6
                  %
                  
                  
                  11.9
                  %
                  
                  
                  5.1
                  %100.0
                  %
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %
 
 **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. We anticipate sales of our new enterprise-level XLS product
            line to capture a larger percent of our tape library revenues in fiscal
            2008.
            However, we expect sales of our TLS and RLS tape library product lines
            to
            decline in fiscal 2008.
 
 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. We expect continued growth as a percentage
            of sales
            in our power supply revenues during fiscal 2008.
  27
 *Index*
  **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.
 
 **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.
 
 **Fiscal
            2006 Compared to Fiscal 2005**
 
 **Net
            Revenues.**  Net revenues decreased from $25.1 million in
            fiscal 2005 to $21.7 million in fiscal 2006. The decrease of approximately
            $3.4 million, or 13.5% is attributed to declining unit sales of our tape
            library products in the TLS and RLS product lines, incorporating AIT,
            SAIT, DLT,
            and LTO tape technology, in conjunction with lower average unit selling
            prices,
            partially offset by increased service and power supply revenue. Power
            supply
            revenue has doubled year over year while service revenue increased by
            approximately 19%.
 
 Revenues
            from tape libraries and drives decreased to $11.9 million, or 54.8% of
            revenues, in the year ended June 30, 2006, from $16.3 million, or
            64.8% of revenues, in the year ended June 30, 2005.
 
 **Gross
            Profit.**  Gross profit decreased from $8.6 million in
            fiscal 2005 to $6.9 million in fiscal 2006. The decrease of approximately
            $1.7 million, or 20.2%, is primarily due to lower revenues resulting in
            lower absorption of manufacturing overhead expenses, additional inventory
            reserves and lower average selling prices.
 
 **Research
            and Development.**  Research and development expenses decreased
            from $3.8 million in fiscal 2005 to $3.1 million in fiscal 2006. The
            decrease of approximately $0.7 million, or 17.8%, is due primarily to lower
            salaries associated with a decrease in headcount, as our XLS product
            line
            transitioned from the development phase to the design verification phase,
            lower
            prototype material costs and lower consulting fees.
 
 **Sales
            and Marketing.**  Sales and marketing expenses decreased from
            $3.4 million in fiscal 2005 to $3.2 million in fiscal 2006. The
            decrease of approximately $0.2 million, or 4.1%, can be attributed
            primarily to a decrease in promotion and travel related expenses.
 
 **General
            and Administrative.**  General and administrative expenses
            decreased from $4.0 million in fiscal 2005 to $3.6 million in fiscal
            2006. The decrease of approximately $0.4 million, or 8.2%, is due to lower
            legal and bad debt expenses.
 
 **Investment
            Income.**  Investment income increased to $1.3 million in
            fiscal 2006 from $0.9 million in fiscal 2005. The increase of
            $0.4 million, or 48% is due to higher average short-term security balances
            combined with higher short-term yields available during the rising interest
            rate
            environment during fiscal 2006.
 
 **Provision
            for Income Taxes.**  Provision for income taxes decreased from
            $0.1 million in fiscal 2005 to a benefit for income taxes of
            $0.1 million in fiscal 2006. The decrease of $0.2 million is due to
            the reversal of a reserve established in fiscal 2005 against research
            and
            development credits that were refunded in fiscal 2006.
  28
 *Index*
  **LIQUIDITY
            AND CAPITAL RESOURCES**
 
 Cash
            used
            by operating activities was $0.7 million in fiscal 2007 and $19,000 in
            fiscal 2006 and cash provided by operating activities was $0.2 million
            in fiscal
            2005. 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. In fiscal 2005, operating cash was primarily provided
            by
            refunds of fiscal 2002 federal and state income taxes paid and a decrease
            in
            accounts receivable, offset partially by decreases in accounts payable
            and other
            accrued liabilities.
 
 Cash
            provided by investing activities was $1.5 million in fiscal 2007, cash used
            in investing activities was $5.3 million in fiscal 2006 and cash provided
            by investing activities was $7.3 million in fiscal 2005. 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 related
            primarily
            to the purchase of marketable securities and equipment partially offset
            by sales
            of marketable securities. Cash provided by investing activities in fiscal
            2005
            related primarily to sales of marketable securities partially offset
            by
            purchases of marketable securities and equipment.
 
 Cash
            used
            in financing activities of $1.7 million for fiscal 2005 related primarily
            to
            repurchasing shares of our common stock.
 
 As
            of
            June 30, 2007, we had $7.7 million in cash and cash equivalents and
            $25.6 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, 2007:
 
 **Year
                      Ended June 30**
                  
                  **Operating
                      Leases**
                  
                  
                  **Purchase
                      Obligations**
                  
                  
                  **Total****(In
                      thousands)**2008
                  
                  $
                  603
                  
                  
                  $
                  1,543
                  
                  
                  $
                  2,1462009
                  
                  
                  620
                  
                  
                  
                  —
                  
                  
                  
                  6202010
                  
                  
                  588
                  
                  
                  
                  —
                  
                  
                  
                  5882011
                  
                  
                  307
                  
                  
                  
                  —
                  
                  
                  
                  3072012
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —$
                  2,118
                  
                  
                  $
                  1,543
                  
                  
                  $
                  3,661
 
 Purchase
            obligations in the table above represent the value of open purchase orders
            as of
            June 30, 2007. 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.
 
 **OFF-BALANCE
            SHEET ARRANGEMENTS**
 
 We
            do not
            have any off-balance sheet arrangements.
 
 **ITEM 7A.
            QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET
            RISK**
 
 We
            develop products in the United States and sell them worldwide. As a result,
            our
            financial results could be affected by factors such as changes in foreign
            currency exchange rates or weak economic conditions in foreign markets.
            As all
            sales are currently made in U.S. dollars, a strengthening of the 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
            securities. We have no outstanding debt nor do we utilize derivative
            financial
            instruments. Therefore, no quantitative tabular disclosures are
            required.
  29
 *Index*
  **ITEM 8.
            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
  30
 *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, 2007 and 2006, and the related consolidated statements of
            operations, shareholders' equity, and cash flows for each of the three
            years in
            the period ended June 30, 2007. 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, 2007 and 2006, and the consolidated results of its operations
            and
            its cash flows for each of the three years in the period ended June 30,
            2007, in
            conformity with U.S. generally accepted accounting principles.
 
 As
            discussed in Note 1 to the consolidated financial statements, Qualstar
            Corporation changed its method of accounting for share-based compensation
            in
            accordance with Statement of Financial Accounting Standard No. 123 (revised
            2004) on July 1, 2005.
 
 
 
 /s/  Ernst
                      & Young LLP
  Los
            Angeles, California
 September
            21, 2007
  31
 *Index*
  **QUALSTAR
            CORPORATION**
 
 **CONSOLIDATED
            BALANCE SHEETS**
 **(In
            thousands)**
 
 **June 30,****2007**
                  
                  
                  **2006****ASSETS**Current
                      assets:Cash
                      and cash equivalents
                  
                  $
                  7,697
                  
                  
                  $
                  6,845Marketable
                      securities, short-term
                  
                  
                  9,574
                  
                  
                  
                  14,040Accounts
                      receivable, net of allowances of $170 at June 30, 2007 and $118 at
                      June 30, 2006
                  
                  
                  3,462
                  
                  
                  
                  2,700Inventories
                  
                  
                  5,928
                  
                  
                  
                  7,298Prepaid
                      expenses and other current assets
                  
                  
                  576
                  
                  
                  
                  511Prepaid
                      income taxes
                  
                  
                  137
                  
                  
                  
                  159Total
                      current assets
                  
                  
                  27,374
                  
                  
                  
                  31,553Property
                      and equipment, net
                  
                  
                  601
                  
                  
                  
                  924Marketable
                      securities, long-term
                  
                  
                  15,994
                  
                  
                  
                  12,782Other
                      assets
                  
                  
                  94
                  
                  
                  
                  140Total
                      assets
                  
                  $
                  44,063
                  
                  
                  $
                  45,399**LIABILITIES
                      AND SHAREHOLDERS’ EQUITY**Current
                      liabilities:Accounts
                      payable
                  
                  $
                  654
                  
                  
                  $
                  783Accrued
                      payroll and related liabilities
                  
                  
                  455
                  
                  
                  
                  466Other
                      accrued liabilities
                  
                  
                  1,113
                  
                  
                  
                  1,292Total
                      current liabilities
                  
                  
                  2,222
                  
                  
                  
                  2,541Commitments
                      and contingenciesShareholders’
                      equity:Preferred
                      stock, no par value; 5,000 shares authorized; no shares
                      issued
                  
                  
                  —
                  
                  
                  
                  —Common
                      stock, no par value; 50,000 shares authorized, 12,253 shares
                      issued and outstanding as of June 30, 2007 and June 30, 2006,
                      respectively
                  
                  
                  18,593
                  
                  
                  
                  18,503Accumulated
                      other comprehensive loss
                  
                  
                  (55
                  )
                  
                  
                  (395
                  )Retained
                      earnings
                  
                  
                  23,303
                  
                  
                  
                  24,750Total
                      shareholders’ equity
                  
                  
                  41,841
                  
                  
                  
                  42,858Total
                      liabilities and shareholders’ equity
                  
                  $
                  44,063
                  
                  
                  $
                  45,399
 
 See
            accompanying notes
  32
 *Index*
  **QUALSTAR
            CORPORATION**
 
 **CONSOLIDATED
            STATEMENTS OF OPERATIONS**
 **(In
            thousands, except per share amounts)**
 
 **Years
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Net
                      revenues
                  
                  $
                  20,612
                  
                  
                  $
                  21,731
                  
                  
                  $
                  25,144Cost
                      of goods sold
                  
                  
                  14,092
                  
                  
                  
                  14,856
                  
                  
                  
                  16,529Gross
                      profit
                  
                  
                  6,520
                  
                  
                  
                  6,875
                  
                  
                  
                  8,615Operating
                      expenses:Research
                      and development
                  
                  
                  3,136
                  
                  
                  
                  3,083
                  
                  
                  
                  3,750Sales
                      and marketing
                  
                  
                  3,110
                  
                  
                  
                  3,213
                  
                  
                  
                  3,350General
                      and administrative
                  
                  
                  3,168
                  
                  
                  
                  3,629
                  
                  
                  
                  3,955Total
                      operating expenses
                  
                  
                  9,414
                  
                  
                  
                  9,925
                  
                  
                  
                  11,055Loss
                      from operations
                  
                  
                  (2,894
                  )
                  
                  
                  (3,050
                  )
                  
                  
                  (2,440
                  )Investment
                      income
                  
                  
                  1,477
                  
                  
                  
                  1,269
                  
                  
                  
                  858Loss
                      before income taxes
                  
                  
                  (1,417
                  )
                  
                  
                  (1,781
                  )
                  
                  
                  (1,582
                  )Provision
                      (benefit) for income taxes
                  
                  
                  30
                  
                  
                  
                  (89
                  )
                  
                  
                  65Net
                      Loss
                  
                  $
                  (1,447
                  )
                  
                  $
                  (1,692
                  )
                  
                  $
                  (1,647
                  )Loss
                      per share:Basic
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.13
                  )Diluted
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.13
                  )Shares
                      used to compute loss per share:Basic
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398Diluted
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398
 
 See
            accompanying notes
  33
 *Index*
  **QUALSTAR
            CORPORATION**
 
 **CONSOLIDATED
            STATEMENTS OF SHAREHOLDERS’ EQUITY**
 **(In
            thousands)**
 
 **Accumulated****Notes**
                  
                  
                  **Other
                      Comprehensive****Common
                      Stock**
                  
                  
                  **From**
                  
                  
                  **Income**
                  
                  
                  **Retained****Shares**
                  
                  
                  **Amount**
                  
                  
                  **Director**
                  
                  
                  **(Loss)**
                  
                  
                  **Earnings**
                  
                  
                  **Total**Balances
                      at June 30, 2004
                  
                  
                  12,596
                  
                  
                  $
                  20,121
                  
                  
                  $
                  (45
                  )
                  
                  $
                  (101
                  )
                  
                  $
                  28,089
                  
                  
                  $
                  48,064Exercise
                      of stock options
                  
                  
                  16
                  
                  
                  
                  76
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  76Retirement
                      of shares pursuant to stock repurchase
                  
                  
                  (359
                  )
                  
                  
                  (1,827
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (1,827
                  )Principal
                      and interest payments on directors’ notes
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  45
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  45Comprehensive
                      loss:Net
                      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (1,647
                  )
                  
                  
                  (1,647
                  )Change
                      in unrealized gains (losses) on investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (58
                  )
                  
                  
                  —
                  
                  
                  
                  (58
                  )Comprehensive
                      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,705
                  )Balances
                      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
                  
                  
                  $
                  41,841
 
 See
            accompanying notes
  34
 *Index*
  **QUALSTAR
            CORPORATION**
 **CONSOLIDATED
            STATEMENTS OF CASH FLOWS**
 **(In
            thousands)**
 
 **Years
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**OPERATING
                      ACTIVITIES:Net
                      loss
                  
                  $
                  (1,447
                  )
                  
                  $
                  (1,692
                  )
                  
                  $
                  (1,647
                  )Adjustments
                      to reconcile net loss to net cash provided by (used in) operating
                      activities:Depreciation
                      and amortization
                  
                  
                  421
                  
                  
                  
                  454
                  
                  
                  
                  463Deferred
                      income taxes
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  436Provision
                      for (recovery of) bad debts and returns, net
                  
                  
                  88
                  
                  
                  
                  (31
                  )
                  
                  
                  38Stock
                      based compensation
                  
                  
                  90
                  
                  
                  
                  133
                  
                  
                  
                  —Loss
                      (gain) on sale of securities
                  
                  
                  50
                  
                  
                  
                  —
                  
                  
                  
                  (11
                  )Changes
                      in operating assets and liabilities:Accounts
                      receivable
                  
                  
                  (850
                  )
                  
                  
                  863
                  
                  
                  
                  1,058Inventories
                  
                  
                  1,370
                  
                  
                  
                  (141
                  )
                  
                  
                  261Prepaid
                      expenses and other assets
                  
                  
                  (67
                  )
                  
                  
                  (57
                  )
                  
                  
                  29Prepaid
                      income taxes and income taxes payable
                  
                  
                  22
                  
                  
                  
                  481
                  
                  
                  
                  432Accounts
                      payable
                  
                  
                  (129
                  )
                  
                  
                  20
                  
                  
                  
                  (408
                  )Accrued
                      payroll and related liabilities
                  
                  
                  (11
                  )
                  
                  
                  (30
                  )
                  
                  
                  (4
                  )Other
                      accrued liabilities
                  
                  
                  (179
                  )
                  
                  
                  (19
                  )
                  
                  
                  (443
                  )Net
                      cash provided by (used in) operating activities
                  
                  
                  (642
                  )
                  
                  
                  (19
                  )
                  
                  
                  204INVESTING
                      ACTIVITIES:Purchases
                      of equipment
                  
                  
                  (50
                  )
                  
                  
                  (142
                  )
                  
                  
                  (164
                  )Purchases
                      of marketable securities
                  
                  
                  (17,041
                  )
                  
                  
                  (13,204
                  )
                  
                  
                  (22,277
                  )Proceeds
                      from the sale of marketable securities
                  
                  
                  18,585
                  
                  
                  
                  8,000
                  
                  
                  
                  29,752Net
                      cash provided by (used in) investing activities
                  
                  
                  1,494
                  
                  
                  
                  (5,346
                  )
                  
                  
                  7,311FINANCING
                      ACTIVITIES:Principal
                      and interest payments on directors’ notes
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  45Proceeds
                      from exercise of stock options
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  76Repurchase
                      of common stock
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (1,827
                  )Net
                      cash used in financing activities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (1,706
                  )NET
                      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                  
                  
                  852
                  
                  
                  
                  (5,365
                  )
                  
                  
                  5,809CASH
                      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                  
                  
                  6,845
                  
                  
                  
                  12,210
                  
                  
                  
                  6,401CASH
                      AND CASH EQUIVALENTS, END OF PERIOD
                  
                  $
                  7,697
                  
                  
                  $
                  6,845
                  
                  
                  $
                  12,210SUPPLEMENTAL
                      CASH FLOW DISCLOSURES:Income
                      taxes paid
                  
                  $
                  7
                  
                  
                  $
                  2
                  
                  
                  $
                  5
 
 See
            accompanying notes
  35
 *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.
  36
 *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
            $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, 2007 and
            2006.
  **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.
 
 Sales
            outside of North America represented approximately 24.4% of net revenues
            in
            fiscal 2007, approximately 26.1% of net revenues in fiscal 2006 and
            approximately 27.3% of net revenues in fiscal 2005. Revenues from Qualstar’s two
            largest customers combined were approximately 11.9%, 13.4%, and 13.9%
            for the
            years ended June 30, 2007, 2006, and 2005, respectively. At June 30,
            2007 and 2006, the two largest customer’s accounts receivable, net of specific
            allowances, totaled approximately 24.1% and 20.8% of net accounts receivable,
            respectively.
 
 *Suppliers*
 
 Sales
            and
            costs of goods sold related to tape library products purchased from one
            supplier
            totaled approximately 32.2% and 30.6% in fiscal 2007, 36.4% and 34.1%in
            fiscal
            2006, and 47.8% and 41.0% in fiscal 2005, respectively, of total sales
            and cost
            of goods sold.
 
 The
            primary supplier of our N2 Power power supplies is located in China.
            If this
            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 five
            years of favorable experience with this supplier, there can be no assurance
            that
            circumstances might not change and compel this supplier to curtail or
            terminate
            deliveries to us.
 
 **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 Period**Year
                      Ended June 30, 2007
                  
                  $
                  50,000
                  
                  
                  $
                  88,000
                  
                  
                  $
                  —
                  
                  
                  $
                  (17,000
                  )
                  
                  $
                  121,000Year
                      Ended June 30, 2006
                  
                  $
                  248,000
                  
                  
                  $
                  (31,000
                  )
                  
                  $
                  —
                  
                  
                  $
                  (167,000
                  )
                  
                  $
                  50,000Year
                      Ended June 30, 2005
                  
                  $
                  217,000
                  
                  
                  $
                  38,000
                  
                  
                  $
                  —
                  
                  
                  $
                  (7,000
                  )
                  
                  $
                  248,000
 ____________
 
 (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.
  37
 *Index*
  **Property
            and Equipment**
 
 Property
            and equipment are recorded at cost. Depreciation expense is computed
            using the
            straight-line method. Leasehold improvements are depreciated 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 an 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.
 
 **Warranty
            Obligations**
 
 Qualstar
            provides a three year warranty on its TLS and RLS tape libraries and
            a one year
            warranty on its XLS 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.
  38
 *Index*
  Activity
            in the liability for product warranty for the periods presented were
            as follows
            (in thousands):
 
 **June 30,****2007**
                  
                  
                  **2006**Beginning
                      balance
                  
                  $
                  173
                  
                  
                  $
                  133Cost
                      of warranty claims
                  
                  
                  (58
                  )
                  
                  
                  (45
                  )Accruals
                      for product warranties
                  
                  
                  59
                  
                  
                  
                  85Ending
                      balance
                  
                  $
                  174
                  
                  
                  $
                  173
 
 **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, 2007, 2006 and 2005 were approximately $604,000,
            $407,000 and $520,000, 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.
 
 **Change
            in Accounting Principle and Share-Based Compensation**
 
 The
            Company adopted Statement of Financial Accounting Standard (“SFAS”)
            No. 123(R), share-based payment, using the modified prospective application
            transition method effective July 1, 2005. The adoption of
            SFAS No. 123(R) requires companies to measure the cost of employee and
            director services received in exchange for  share-based payment awards
            based on the grant-date fair value of the award.  The Company uses the
            Black-Scholes option pricing model to determine the fair value
            of  stock option grants as of the measurement date.  The
            cost is recognized over the requisite service period ( the vesting period)
            for
            the estimated number of stock options ultimately expected to vest. The
            Company
            recognized $90,000 and $133,000 as stock based compensation expense in
            fiscal
            years 2007 and 2006, respectively.  These amounts are similar to the
            amounts reported historically in the Company’s footnotes under the pro forma
            disclosure provisions of SFAS 123.
 
 In
            accordance with SFAS 123, the Company previously measured employee stock
            option related compensation expense using the minimum value method for
            grants
            prior to the Company’s initial public offering and the Black-Scholes method
            afterward for determining the weighted average fair value of options
            granted.
            For the fiscal year ended June 30, 2005, had employee stock option related
            compensation expense been determined based on the Black-Scholes method,
            the
            Company’s net loss and loss per share would have been increased to the pro forma
            amounts indicated below (in thousands, except per share amounts):
 
 **Fiscal
                      Year****June
                      30, 2005**Net
                      loss as reported
                  
                  $
                  (1,647
                  )Stock-based
                      employee compensation cost included in reported net loss
                  
                  
                  —Pro
                      forma stock-based employee compensation cost under
                      SFAS 123
                  
                  
                  (118
                  )Pro
                      forma net loss
                  
                  $
                  (1,765
                  )Loss
                      per share:Basic —
                      as reported
                  
                  $
                  (0.13
                  )Basic —
                      pro forma
                  
                  $
                  (0.14
                  )Diluted —
                      as reported
                  
                  $
                  (0.13
                  )Diluted —
                      pro forma
                  
                  $
                  (0.14
                  )
 
 In
            computing the pro forma compensation expense under SFAS 123, a
            weighted-average fair value of $1.27 for the 2005 stock option grants
            was
            estimated at the date of grant using the minimum value option pricing
            model
            before Qualstar’s initial public offering and the Black-Scholes model afterward
            with the following assumptions:
  39
 *Index*
 
 **2005**Expected
                      dividend yield
                  
                  
                  0
                  %Risk-free
                      interest rate
                  
                  
                  3.8
                  %Expected
                      life of options
                  
                  4 yearsVolatility
                  
                  
                  36.9
                  %
 
 **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.
 
 **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 per share has been computed by dividing net
            loss by the weighted average number of common shares outstanding. Diluted
            loss
            per share has been computed by dividing net loss by the weighted average
            common
            shares outstanding plus dilutive securities or other contracts to issue
            common
            stock as if these securities were exercised or converted to common
            stock.
 
 The
            following table sets forth the calculation for basic and diluted loss
            per share
            for the periods indicated:
 
 **Year
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****(In
                      thousands)**Loss:Net
                      loss
                  
                  $
                  (1,447
                  )
                  
                  $
                  (1,692
                  )
                  
                  $
                  (1,647
                  )Shares:Weighted
                      average shares for basic loss per share
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398Stock
                      options
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Weighted
                      average shares for diluted loss per share
                  
                  
                  12,253
                  
                  
                  
                  12,253
                  
                  
                  
                  12,398
 
 Shares
            issuable under stock options of 585,000, 557,000 and 455,000 for the
            years ended
            June 30, 2007, 2006 and 2005, respectively, have been excluded from the
            computation of diluted loss per share because the effect would be
            antidilutive.
 
 **Reclassifications**
 
 Certain
            prior year amounts have been reclassified to conform to the current year
            presentation.
  40
 *Index*
  **Note 2 –
            Marketable Securities**
 
 The
            following table summarizes marketable securities by security type at
            June 30, 2007, and June 30, 2006, respectively (in
            thousands):
  
 **June 30,
                      2007**
                  
                  **Amortized
                      Cost**
                  
                  
                  **Unrealized
                      Gain**
                  
                  
                  **Unrealized
                      Loss**
                  
                  
                  **Fair
                      Value**US
                      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
 
 
 **June 30,
                      2006**
                  
                  **Amortized
                      Cost**
                  
                  
                  **Unrealized
                      Gain**
                  
                  
                  **Unrealized
                      Loss**
                  
                  
                  **Fair
                      Value**US
                      Treasury obligations and direct obligations of U.S. Government
                      agencies
                  
                  $
                  16,318
                  
                  
                  $
                  —
                  
                  
                  $
                  (229
                  )
                  
                  $
                  16,089Government
                      Sponsored Enterprise collateralized mortgage obligations
                  
                  
                  3,519
                  
                  
                  
                  —
                  
                  
                  
                  (108
                  )
                  
                  
                  3,411Corporate
                      bonds
                  
                  
                  7,380
                  
                  
                  
                  —
                  
                  
                  
                  (58
                  )
                  
                  
                  7,322Total
                  
                  $
                  27,217
                  
                  
                  $
                  —
                  
                  
                  $
                  (395
                  )
                  
                  $
                  26,822
 
 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, 2007, and June 30, 2006,
            respectively.
 
 **Less
                      Than 12 Months**
                  
                  
                  **12
                      Months or Greater**
                  
                  
                  **Total****June 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
                  )
 
 **Less
                      Than 12 Months**
                  
                  
                  **12
                      Months or Greater**
                  
                  
                  **Total****June 30,
                      2006**
                  
                  **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
                  
                  $
                  4,599
                  
                  
                  $
                  (18
                  )
                  
                  $
                  11,490
                  
                  
                  $
                  (211
                  )
                  
                  $
                  16,089
                  
                  
                  $
                  (229
                  )Government
                      Sponsored Enterprise collateralized mortgage obligations
                  
                  
                  1,757
                  
                  
                  
                  (9
                  )
                  
                  
                  1,654
                  
                  
                  
                  (99
                  )
                  
                  
                  3,411
                  
                  
                  
                  (108
                  )Corporate
                      bonds
                  
                  
                  3,340
                  
                  
                  
                  (6
                  )
                  
                  
                  3,982
                  
                  
                  
                  (52
                  )
                  
                  
                  7,322
                  
                  
                  
                  (58
                  )Total
                  
                  $
                  9,696
                  
                  
                  $
                  (33
                  )
                  
                  $
                  17,126
                  
                  
                  $
                  (362
                  )
                  
                  $
                  26,822
                  
                  
                  $
                  (395
                  )
 
 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, 2007.
 
 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,
            2007.
  41
 *Index*
  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, 2007.
 
 The
            following tables summarize the contractual maturities of the Company’s fixed
            maturity securities (in thousands):
 
 **June 30,****2007**
                  
                  
                  **2006**Less
                      than 90 days
                  
                  $
                  —
                  
                  
                  $
                  1,557Less
                      than one year
                  
                  
                  9,574
                  
                  
                  
                  12,483Due
                      in one to five years
                  
                  
                  15,994
                  
                  
                  
                  12,782$
                  25,568
                  
                  
                  $
                  26,822
 
 
 **Note 3 –
            Inventories**
 Inventories
            consist of the following:
 
 **June 30,****2007**
                  
                  
                  **2006****(In
                      thousands)**Raw
                      materials, net
                  
                  $
                  5,234
                  
                  
                  $
                  6,473Finished
                      goods
                  
                  
                  694
                  
                  
                  
                  825$
                  5,928
                  
                  
                  $
                  7,298
 
 **Note 4 –
            Property and Equipment**
 
 The
            components of property and equipment are as follows:
 
 **June 30,****2007**
                  
                  
                  **2006****(In
                      thousands)**Leasehold
                      improvements
                  
                  $
                  546
                  
                  
                  $
                  546Furniture
                      and fixtures
                  
                  
                  984
                  
                  
                  
                  1,006Machinery
                      and equipment
                  
                  
                  2,456
                  
                  
                  
                  2,4163,986
                  
                  
                  
                  3,968Less
                      accumulated depreciation and amortization
                  
                  
                  (3,385
                  )
                  
                  
                  (3,044
                  )$
                  601
                  
                  
                  $
                  924
  42
 *Index*
  **Note 5 –
            Income Taxes**
 
 The
            provision (benefit) for income taxes is comprised of the following:
 
 **Year
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****(In
                      thousands)**Current:Federal
                  
                  $
                  —
                  
                  
                  $
                  (86
                  )
                  
                  $
                  (156
                  )State
                  
                  
                  30
                  
                  
                  
                  (3
                  )
                  
                  
                  (215
                  )30
                  
                  
                  
                  (89
                  )
                  
                  
                  (371
                  )Deferred:Federal
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  342State
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  94—
                  
                  
                  
                  —
                  
                  
                  
                  436$
                  30
                  
                  
                  $
                  (89
                  )
                  
                  $
                  65
 
 
 The
            following is a reconciliation of the statutory federal income tax rate
            to
            Qualstar’s effective income tax rate:
 
 **Year
                      Ended June 30,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Statutory
                      federal income tax benefit
                  
                  
                  (34.0
                  )%
                  
                  
                  (34.0
                  )%
                  
                  
                  (34.0
                  )%State
                      income taxes, net of federal income tax benefit
                  
                  
                  (4.0
                  )
                  
                  
                  (3.4
                  )
                  
                  
                  (3.7
                  )Non-taxable
                      investment income
                  
                  
                  0.0
                  
                  
                  
                  0.0
                  
                  
                  
                  (3.4
                  )Research
                      and development credits
                  
                  
                  (14.0
                  )
                  
                  
                  (6.5
                  )
                  
                  
                  (15.5
                  )Valuation
                      allowance
                  
                  
                  53.8
                  
                  
                  
                  36.7
                  
                  
                  
                  60.9Other
                  
                  
                  0.3
                  
                  
                  
                  2.1
                  
                  
                  
                  (0.2
                  )2.1
                  %
                  
                  
                  (5.1
                  )%
                  
                  
                  4.1
                  %
 
 The
            tax
            effect of temporary differences resulted in deferred income tax assets
            (liabilities) as follows:
 
 **June 30,****2007**
                  
                  
                  **2006****(In
                      thousands)**Deferred
                      tax assets:Net
                      operating loss carryforwards
                  
                  $
                  1,358
                  
                  
                  $
                  1,030Capital
                      loss and other credit carryforwards
                  
                  
                  445
                  
                  
                  
                  444Research
                      and development credit carryforwards
                  
                  
                  635
                  
                  
                  
                  437Allowance
                      for bad debts and returns
                  
                  
                  65
                  
                  
                  
                  45Inventory
                      reserves
                  
                  
                  320
                  
                  
                  
                  279Capitalized
                      inventory costs
                  
                  
                  34
                  
                  
                  
                  30Marketable
                      securities
                  
                  
                  21
                  
                  
                  
                  151Other
                      accruals
                  
                  
                  502
                  
                  
                  
                  455Total
                      gross deferred tax assets
                  
                  
                  3,380
                  
                  
                  
                  2,871Deferred
                      tax liabilities:Depreciation
                      and other
                  
                  
                  (107
                  )
                  
                  
                  (215
                  )Total
                      gross deferred tax liabilities
                  
                  
                  (107
                  )
                  
                  
                  (215
                  )Valuation
                      allowance
                  
                  
                  (3,273
                  )
                  
                  
                  (2,656
                  )Net
                      deferred tax assets
                  
                  $
                  —
                  
                  
                  $
                  —
 
 The
            Company placed a valuation allowance on net deferred tax assets during
            the
            fiscal years ended June 30, 2007 and 2006 based on the Company’s assessment
            regarding the realizability of such assets in future years. The Company
            has net
            operating losses, capital losses, research and development credit and
            other
            carryforwards for tax purposes of $2.4 million at June 30, 2007 and $1.9
            million at June 30, 2006 expiring between fiscal years 2009 and 2025,
            except for the state research and development credit, which has no limit
            on the
            carryforward period.
  43
 *Index*
  **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, 2007 and 2006, 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
            2007, 2006 and 2005, the Company recorded share-based compensation associated
            with outstanding stock option grants of approximately $90,000, $133,000
            and $0,
            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.
 
 **2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Expected
                      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Risk-free
                      interest rate
                  
                  
                  4.5
                  %
                  
                  
                  4.8
                  %
                  
                  
                  3.8
                  %Expected
                      life of options
                  
                  5 years
                  
                  
                  4 years
                  
                  
                  4 yearsVolatility
                  
                  
                  35.4
                  %
                  
                  
                  30.8
                  %
                  
                  
                  36.9
                  %
 
 The
            following table summarizes all stock option activity (in thousands, except
            per
            share amounts):
 
 **Options**
                  
                  **Shares**
                  
                  
                  **Weighted
                      Average Exercise Price**
                  
                  
                  **Weighted
                      Average Remaining Contractual Term**
                  
                  
                  **Aggregate
                      Intrinsic Value**Outstanding
                      at June 30, 2006
                  
                  
                  557
                  
                  
                  $
                  4.36Granted
                  
                  
                  128
                  
                  
                  
                  2.93Exercised
                  
                  
                  —
                  
                  
                  
                  —Forfeited
                      or expired
                  
                  
                  (100
                  )
                  
                  
                  4.23Outstanding
                      at June 30, 2007
                  
                  
                  585
                  
                  
                  $
                  4.07
                  
                  
                  
                  7.25
                  
                  
                  $
                  86Exercisable
                      at June 30, 2007
                  
                  
                  299
                  
                  
                  $
                  4.93
                  
                  
                  
                  3.20
                  
                  
                  $
                  21
 
 The
            weighted-average grant date fair value of options granted during the
            fiscal
            years 2007, 2006 and 2005 was $1.13, $0.96, and $1.27, respectively.
            The total
            intrinsic value of options exercised in fiscal year 2005
            was  $11,000.
 
 At
            June
            30, 2007, there was $293,000 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 2.9
            years.  The total fair value of shares vested for fiscal years 2007,
            2006 and 2005 was $78,000, $156,000 and $188,000, respectively.
  44
 *Index*
  **Note 8 –
            Purchase of N2 Power**
 
 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 is being amortized over 5 years. At June 30, 2007, accumulated
            amortization of the patent was $240,000. Amortization expense for the
            years
            ended June 30, 2007, 2006 and 2005 was $48,000 in each year.  The
            patent is fully amortized as of June 30, 2007.
 
 **Note 9 –
            Commitments**
 
 Qualstar’s
            lease agreement for its facility located in Simi Valley, California,
            expires in
            February of 2011.  The annual rent for the lease is $468,000, with
            step-ups ranging from $28,000 to $34,000 every two years. 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
            2009. The annual rent for the lease is $47,000, with a nominal 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)**2008
                  
                  $
                  6032009
                  
                  
                  6202010
                  
                  
                  5882011
                  
                  
                  3072012
                      and thereafter
                  
                  
                  —$
                  2,118
 
 Rent
            expense (including equipment rental) for the years ended June 30, 2007,
            2006, and 2005, was $665,000, $670,000, and $671,000, respectively.
 
 **Note 10 –
            Segment Information**
 
 Based
            on
            the provisions of SFAS No. 131, “Disclosures about Segments of an
            Enterprise and Related Information (SFAS No. 131)” 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 30****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Revenue**
                  
                  **(in
                      thousands)**Tape
                      Libraries:Product
                  
                  $
                  14,676
                  
                  
                  $
                  16,008
                  
                  
                  $
                  21,231Service
                  
                  
                  2,929
                  
                  
                  
                  3,144
                  
                  
                  
                  2,638Total
                      Tape Libraries
                  
                  
                  17,605
                  
                  
                  
                  19,152
                  
                  
                  
                  23,869Power
                      Supplies
                  
                  
                  3,007
                  
                  
                  
                  2,579
                  
                  
                  
                  1,275Consolidated
                      Revenue
                  
                  $
                  20,612
                  
                  
                  $
                  21,731
                  
                  
                  $
                  25,144
  45
 *Index*
 
 **Year
                      Ended June 30****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Loss
                      before Taxes**
                  
                  **(in
                      thousands)**Tape
                      Libraries
                  
                  $
                  (1,310
                  )
                  
                  $
                  (1,434
                  )
                  
                  $
                  (1,427
                  )Power
                      Supplies
                  
                  
                  (107
                  )
                  
                  
                  (347
                  )
                  
                  
                  (155
                  )Consolidated
                      Loss before Income Taxes
                  
                  $
                  (1,417
                  )
                  
                  $
                  (1,781
                  )
                  
                  $
                  (1,582
                  )
 
 **Year
                      Ended June 30****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Total
                      Assets**
                  
                  **(in
                      thousands)**Tape
                      Libraries
                  
                  $
                  43,228
                  
                  
                  $
                  44,312
                  
                  
                  $
                  46,317Power
                      Supplies
                  
                  
                  835
                  
                  
                  
                  1,087
                  
                  
                  
                  906Consolidated
                      Assets
                  
                  $
                  44,063
                  
                  
                  $
                  45,399
                  
                  
                  $
                  47,223
 
 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 2007, 2006, and 2005. 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, 2007, 2006 and 2005 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.
 
 **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,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****(In
                      thousands)**Revenues:North
                      America
                  
                  $
                  15,582
                  
                  
                  $
                  16,051
                  
                  
                  $
                  18,281Europe
                  
                  
                  3,196
                  
                  
                  
                  3,467
                  
                  
                  
                  4,933Asia
                      Pacific
                  
                  
                  1,330
                  
                  
                  
                  1,610
                  
                  
                  
                  1,264Other
                  
                  
                  504
                  
                  
                  
                  603
                  
                  
                  
                  666$
                  20,612
                  
                  
                  $
                  21,731
                  
                  
                  $
                  25,144
  46
 *Index*
  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 $43,000, $59,000, and $67,000 for the years ended June 30, 2007,
            2006, and 2005 respectively.
 
 **Note 13 –
            Related Party Transactions**
 
 Qualstar’s
            outside counsel is a member of its board of directors. During the years
            ended
            June 30, 2007, 2006, and 2005 Qualstar paid $69,000, $94,000, and $105,000,
            respectively to the law firm in which the director is a shareholder for
            general
            business purposes.
 
 **Note 14 –
            Recent Accounting Pronouncements**
 
 In
            June
            2006, The Financial Accounting Standards Board (FASB) issued Financial
            Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income
            Taxes.” FIN 48 prescribes a recognition and measurement threshold for tax
            positions taken or expected to be taken on a tax return and relates to
            the
            uncertainty in income taxes recognized in the financial statements in
            accordance
            with FAS 109, Accounting for Income Taxes. FIN 48 is effective for the
            first fiscal year beginning after December 15, 2006, thus, we expect to
            adopt it in our fiscal year beginning July 1, 2007.  We do not
            expect the adoption of FIN 48 to have a material impact on our financial
            statements.
 
 In
            2007,
            we adopted Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of
            Prior Year Misstatements when Quantifying Current Year
            Misstatements.”  SAB 108 requires companies to quantify misstatements
            using both a balance sheet (iron curtain) and an income statement (rollover)
            approach to evaluate whether either approach results in an error that
            is
            material in light of relevant quantitative and qualitative factors, and
            provides
            for a one-time cumulative effect transition adjustment.  The adoption
            of SAB No. 108 did not have an impact on our financial statements.
 
 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.
  47
 *Index*
  **Note 15 –
            Quarterly Results of Operations (Unaudited)**
 
 **Three
                      Months Ended****June 30,**
                  
                  
                  **March 31,**
                  
                  
                  **December 31,**
                  
                  
                  **September 30,****(In
                      thousands, except per share amounts)****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
                  )**Fiscal
                      2006:**Net
                      sales
                  
                  $
                  4,888
                  
                  
                  $
                  5,052
                  
                  
                  $
                  5,689
                  
                  
                  $
                  6,102Gross
                      profit
                  
                  
                  1,603
                  
                  
                  
                  1,446
                  
                  
                  
                  1,922
                  
                  
                  
                  1,904Net
                      loss
                  
                  $
                  (694
                  )
                  
                  $
                  (598
                  )
                  
                  $
                  (189
                  )
                  
                  $
                  (211
                  )Net
                      loss per share:Basic
                  
                  $
                  (0.06
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.02
                  )Diluted
                  
                  
                  (0.06
                  )
                  
                  
                  (0.05
                  )
                  
                  
                  (0.02
                  )
                  
                  
                  (0.02
                  )
 
  **ITEM 9.** **CHANGES
            IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
            FINANCIAL DISCLOSURE**
 
 None.
 
 
 **ITEM 9A. 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, 2007, pursuant to
            Rule 13a-15 under the Securities Exchange Act of 1934. Based upon that
            evaluation, our Chief Executive Officer and Chief Financial Officer concluded
            that our disclosure controls and procedures are effective to ensure that
            information required to be disclosed by us in reports that we file or
            submit
            under the Exchange Act is recorded, processed, summarized and reported
            within
            the time periods specified in the Commission’s rules and forms, and to ensure
            that the information required to be disclosed by us in reports that we
            file or
            submit under the Exchange Act is accumulated and communicated to our
            management,
            including our Chief Executive Officer and Chief Financial Officer, as
            appropriate, to allow timely decisions regarding required
            disclosure.
 
 We
            did
            not make any changes in our internal control over financial reporting
            during the
            fourth quarter of fiscal 2007 that materially affected, or are reasonably
            likely
            to materially affect, our internal control over financial
            reporting.
 
 
 **ITEM 9B. OTHER
            INFORMATION**
 
 None.
 
 **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, 2007, and is hereby incorporated by reference to such Proxy
            Statement.
  48
 *Index*
  **ITEM 10. 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,
            2007.
 
 
 **ITEM 11. 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, 2007.
 
 
 **ITEM 12. 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, 2007.
 
 
 **ITEM 13. 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, 2007.
 
 
 **ITEM 14. 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,
            2007.
  49
 *Index*
  **PART IV**
 
 **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.**
                  
                  **Description**3.1(1)
                  
                  Restated
                      Articles of Incorporation.3.2(1)
                  
                  Amended
                      and Restated Bylaws.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.
  *
                  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.
  50
 *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 26, 2007
                  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,William
                      J. Gervais
                  
                  President
                      and Director(principal
                      executive officer)/s/  RICHARD
                      A. NELSON
                  
                  Vice
                      President, Engineering
                  
                  September 26,
                      2007Richard
                      A. Nelson
                  
                  Secretary
                      and Director/s/  CARL
                      W. GROMADA
                  
                  Director
                  
                  September 26,
                      2007Carl
                      W. Gromada/s/  STANLEY
                      W. CORKER
                  
                  Director
                  
                  September 26,
                      2007Stanley
                      W. Corker/s/  ROBERT
                      E. RICH
                  
                  Director
                  
                  September 26,
                      2007Robert
                      E. Rich/s/  ROBERT
                      A. MEYER
                  
                  Director
                  
                  September 26,
                      2007Robert
                      A. Meyer/s/  ANDREW
                      A. FARINA
                  
                  Vice-President
                      and CFO
                  
                  September 26,
                      2007Andrew
                      A. Farina
                  
                  (principal
                      financial officer)
  51
 *Index*
  **EXHIBIT INDEX**
 
 **Exhibit
                      No.**
                  
                  **Description**3.1(1)
                  
                  Restated
                      Articles of Incorporation.3.2(1)
                  
                  Amended
                      and Restated Bylaws.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.*
                  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.
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