<PAGE>

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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                               ----------------
                                   FORM 10-K

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

    For the fiscal year ended June 30, 2000

                                       OR

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

    For the transition period from  to

                        Commission file number 000-30083

                               ----------------
                              QUALSTAR CORPORATION
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                            <C>
                 California                                      95-3927330
        (State or other jurisdiction                          (I.R.S. Employer
      of incorporation or organization)                     Identification No.)

  6709 Independence Avenue, Canoga Park, CA                        91303
  (Address of principal executive offices)                       (Zip Code)
</TABLE>

                                 (818) 592-0061
              (Registrant's telephone number, including area code)

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

                                      None

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

                                  Common Stock
                                (Title of Class)

                               ----------------
   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]

   Indicate by check mark 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. [X]

   As of September 25, 2000, the aggregate market value of the common equity
held by non-affiliates of the registrant was approximately $70,375,000.

   As of September 25, 2000, there were 12,546,751 shares of the registrant's
shares common stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Part III of this Form 10-K is incorporated by reference from the
registrant's definitive proxy statement for its annual meeting of shareholders,
which will be filed with the Commission on or before October 30, 2000.

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<PAGE>

                           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 1--Business,"
including the section therein entitled "Risk Factors," and in "ITEM 7--
Management's Discussion and Analysis of Financial Condition and Results of
Operations." You generally can identify forward-looking statements by the use
of forward-looking terminology such as "believes," "may," "will," "expects,"
"intends," "estimates," "anticipates," "plans," "seeks," or "continues," or the
negative thereof or variations thereon or similar terminology.

                                     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,
storage arrays of tape cartridges and robotics to move the tape cartridges from
their storage locations to the tape drives under software control. Our tape
libraries provide storage solutions for organizations requiring backup,
recovery and archival storage of critical electronic information. Our tape
libraries also can provide near-online storage as an alternative to disk
drives. Our products are compatible with commonly used network operating
systems, including UNIX, Windows NT, NetWare and Linux. Our tape libraries also
are compatible with a wide range of storage management software packages, such
as those supplied by Computer Associates, Hewlett-Packard, Legato, Tivioli and
Veritas. We offer tape libraries for multiple tape drive technologies,
including those using Advanced Intelligent Tape, DLT, and quarter- inch
cartridge tape drives and media. In September 2000, we began delivering tape
libraries using the new Linear Tape Open, or LTO, Ultrium tape drives and
media.

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

   Our six senior operations executives have worked in the computer and data
storage industries for an average of more than 30 years each. Based on this
experience, we have the ability to bring new products to market in response to
changing market conditions and new opportunities as they arise. For example, we
offer Fibre Channel, a new interface technology, as an option on most of our
tape library models. In November 1999, we invested $1.1 million to acquire an
approximately 1% interest in Chaparral Network Storage, Inc. We purchase
products from Chaparral that we incorporate into our tape libraries to provide
Fibre Channel connectivity.

   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 marketplace. 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 other
tape drive technologies and tape media formats. Automated tape libraries and
related products, such as tape drives and tape media, represented

                                       2
<PAGE>

approximately 76.9% of revenues in fiscal 1999 and approximately 85.5% of
revenues for fiscal 2000. Sales of 9-track tape drives, services and other
products accounted for the balance of our revenues.

Industry Background

   Storing, managing and protecting data has become critical to the operation
of many enterprises 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 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, e-commerce, Internet
services, medical, 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 information. 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

   The following factors are contributing to the growth in data storage:

  . Increased demand from Internet and e-commerce businesses. The growth in
    the Internet and e-commerce has created businesses that depend on the
    creation, access and archival storage of data. We believe that the need
    to utilize databases 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. The growth in data is being fueled not only
    by the increase in information but also in the types of stored data. For
    example, storage of graphics, audio and MP3, video, medical and security
    images, and multi-media uses such as video on demand, require far greater
    storage capacity than text and financial data.

  . Growth in 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 new sophisticated data mining software applications that can access
    and analyze large databases.

  . Growth in network server computing applications and data. The use of
    server-based computer networks has shifted critical information and
    applications to network servers in order 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, e-mail and voicemail, all of which
    generate progressively more data. Organizations increasingly are 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. Decreases in
    costs not only encourage the storage of more data, but also make it more
    cost effective to add storage capacity than to remove old data,
    contributing to greater storage demand for data which in the past may
    have been purged manually.

                                       3
<PAGE>

 Advances in Storage Management Technologies

   The growth in data and need for storage is contributing to an evolution in
traditional storage solutions. New open standard technologies are designed to
provide high-speed connectivity for data-intensive applications across multiple
operating systems, including UNIX, Windows NT, NetWare and Linux. These new
methods of storage and data management technologies include the following:

  . Fibre Channel. Fibre Channel is a new generation of 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 data
    transfer speeds at least 10 times faster than the most common interface
    technology in use today, thereby increasing the use 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 currently exists with
    traditional technologies. Additionally, SANs are able to provide these
    benefits across multiple operating systems.

  . Advanced storage management software. The development of advanced storage
    management software has led to the use of tape as a lower-cost
    alternative to disk drives for on-line storage. 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
    and put it back on the disk file for the user. This sometimes is referred
    to as near-online storage. This process reduces the overall storage cost
    by using the least expensive storage medium to save data that is not
    expected to be needed on a frequent basis. Advances in storage management
    software have increased the ability of businesses to store, manage and
    retrieve important 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 library directly into a network without increasing demands on
    the file server or requiring a separate file server. This allows users to
    maintain, or even enhance, system performance while saving on both time
    and cost.

  . Internet-based storage backup. This solution allows individuals and
    enterprises to outsource their storage or backup of data on a cost-
    efficient basis through the services provided by Internet-based storage
    companies. Increased availability of high bandwidth Internet connections
    is a key enabler of this approach.

 Types of Data Storage

   Current non-volatile storage solutions are based primarily on three
technologies: magnetic disk, optical disk and magnetic tape. Each of these
solutions represents 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. Magnetic and optical disks provide quicker access to
stored data and generally are used when speed is important. Less frequently
used data often is migrated from magnetic or optical disks to tape storage.
Tape libraries provide a near-online solution, where less frequently used data
files are stored on tapes instead of on disks.

                                       4
<PAGE>

 Tape Libraries and Applications

   Automated tape libraries speed 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 also are capable of being
operated from a remote location or during off-hours when no attendant is on
duty. Automated tape libraries are a key component of a network administrator's
overall storage solution.

   Tape drives and tape media are two key components of tape libraries. The
costs of tape drives and tape media have declined with advances in technology,
and we expect these decreases 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 further
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 recovery in the event the original data 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 physical or
    natural disaster at the primary site.

  . Archiving. Archiving is the storage of data for historical purposes. When
    important information is stored on tape, automated tape libraries, in
    conjunction with storage management software, 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 for other
    purposes. Tape libraries also are used for archiving because of the
    benefits offered by the tape medium, such as long-term data integrity,
    resistance to environmental contamination, ease of relocation and low
    cost.

  . Digital video. Digital recording of camera images for surveillance and
    security purposes is beginning to replace traditional analog VHS
    recording in mid-size to large installations such as airports, retail
    stores, government facilities and gaming operations. This is a growing
    and increasingly important market opportunity because tape libraries
    eliminate the need for operators to load, unload, store and retrieve the
    vast number of tapes created in these facilities. Library based systems
    index, store and play back the video images on demand, thereby reducing
    the recall time and cost of operation significantly when compared to VHS
    recording and playback devices. Digital recording technology provides
    enhanced resolution and accommodates the recording of transactional data
    such as cash register receipts and credit card data alongside the video
    image, which is not possible with VHS technology.

  . 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. Tape library storage of a digitized image costs
    considerably less than storing a film copy, and can be recalled years
    later with considerably less effort.

 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

                                       5
<PAGE>

or directly from original equipment manufacturers. Many organizations, however,
do not have sufficient in-house resources but often 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 storage management 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, compatibility with multiple tape formats and storage
management software, and marketing and technical support. We expect the market
segment served by value added resellers to increase as the cost of tape library
storage continues to decline and as more organizations choose to outsource
their information technology functions.

   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
reseller distribution 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 Solution

   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 product reliability is essential to the end users of
our products due to the critical nature of the data that is being stored and
the frequent 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, assembly and testing of our products.
Our tape libraries use a minimum number of moving parts. This approach reduces
the potential for product failures, results in products that require little
maintenance and simplifies the incorporation of new tape drive technologies.

   We have designed our libraries to be placed on the floor or on a table top
without the need for a special equipment rack. We believe that this approach
provides the lowest cost solution for the largest segment of our customer base.

   The technology utilized within 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 in order to
prevent our product lines from becoming obsolete. As an example, we completed
development and commenced shipments of our Fibre Channel interface option that
converts the internal small computer systems interface on our libraries to an
external Fibre Channel interface. The small computer systems interface is an
interface standard that provides an industry-wide definition of the interface
shared between tape library devices, computer systems, and storage management
software.

   Our tape libraries are compatible with over 30 third-party storage
management software packages, such as those supplied by Computer Associates,
Hewlet-Packard, Legato, Tivoli and Veritas. 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 the lack of compatibility is a significant barrier to entry
for new tape library competitors. To ensure

                                       6
<PAGE>

compatibility, our engineers work closely with the application software vendors
during product development cycles. We do not have contracts with any
application software vendors, nor do we need access to their software code to
design our products. We maintain relationships with them by supplying
evaluation tape libraries 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
as to current and contemplated changes to our products and by referring
business to them when value added resellers or end users inquire about software
sources.

   We have focused our business primarily on supporting value added resellers
and original equipment manufacturers as the most effective and profitable
distribution channels for our tape libraries. Our solution is to offer our
resellers reliable tape libraries, multiple tape format choices, and more
attractive profit opportunities than do other tape library manufacturers. We
custom configure each of our libraries based on the resellers' requirements,
with a normal delivery time of one to three working days. Our solution for
original equipment manufacturers is to offer them control over product design
changes, qualification testing, custom colors and private labeling. We believe
these factors enhance the resellers' and original equipment manufacturers'
ability to sell our products and encourage them to remain loyal to Qualstar.

Strategy

   Our goals are to enhance our position as a supplier of automated tape
libraries and to increase our market share in each of the tape formats in which
we compete. To achieve these goals, we intend to:

  . Offer libraries for multiple tape drive technologies. We offer tape
    libraries for a range of tape drive technologies, including Advanced
    Intelligent Tape, DLT and quarter inch cartridge. We also have developed
    tape libraries based on the Linear Tape Open, or LTO, Ultrium tape media
    format and will offer these libraries when LTO tape drives become
    available. By offering products based on multiple tape drive
    technologies, we reduce our dependence on the success of any single
    technology and can offer products that target the specific preferences of
    resellers and their end-user customers.

  . Focus distribution 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
    increase the likelihood of closing a sale and to increase the reseller's
    profit margins. We intend to increase our marketing resources in support
    of this distribution channel. We conduct business with our value added
    resellers on an individual purchase order basis and no long-term
    commitments are involved. Additionally, there are no exclusive
    territories assigned to our value added resellers.

  . Maintain and strengthen original equipment manufacturer relationships. We
    sell our products to numerous 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 will continue to pursue and develop
    opportunities with original equipment manufacturers. We conduct business
    with our original equipment manufacturer customers on an individual
    purchase order basis and no long-term commitments are used.

  . Develop libraries for new tape technologies. The tape drive industry
    continuously is developing new technologies. We will continue to monitor
    new product releases and design new libraries for those technologies that
    appear promising and meet our standards for capacity, quality and
    reliability.

  . Increase our rate of innovation. We plan to increase research and
    development resources in order to exploit emerging technologies and
    product opportunities. We intend to continue the expansion of our product
    lines to incorporate higher capacities and new technologies. For example,
    we are currently evaluating and plan in the future to develop products
    based on network attached storage technology.

                                       7
<PAGE>

   We believe that our experience, efficiency and strict control over the
development and manufacturing 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 produce all of our products at a single facility and control our
inventory closely to provide rapid delivery to our customers. These steps allow
us to design and bring to market new products rapidly in response to changing
technology, and maintain our profitability.

   In addition to our emphasis on developing tape libraries and continual
improvement of our products through our research and development, we made an
investment in a supplier of emerging and high technology components. In
November 1999, we invested $1.1 million to obtain an approximately 1% ownership
interest in Chaparral Network Storage, Inc. We recently incorporated Chaparral
products into our tape libraries for applications that require Fibre Channel
connectivity. We believe that Fibre Channel will displace the small computer
systems interface as the primary interface for our larger tape libraries.

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:

<TABLE>
<CAPTION>
                 Models                                      Range of    Maximum
  Product      in Product                                      Tape    Capacity in
  Family         Family   Type    Tape Drive Technology     Cartridges Terabytes(1)
-----------------------------------------------------------------------------------
  <S>          <C>        <C>  <C>                          <C>        <C>
  TDS-1000(2)       3     QIC  Tandberg SLR50, SLR100        11 to 44       2.2
-----------------------------------------------------------------------------------
  TLS-4000         12     8MM  Sony AIT, AIT2               12 to 600      30.0
                                    -----------------------------------------------
                               Ecrix VXA-1                  12 to 360      11.8
                                    -----------------------------------------------
                               Exabyte Mammoth              12 to 126       2.5
-----------------------------------------------------------------------------------
  TLS-6000          7     DLT  Quantum DLT-4000, 7000, 8000 10 to 240       9.6
                                    -----------------------------------------------
                               Benchmark DLT-1              10 to 240       9.6
-----------------------------------------------------------------------------------
  TLS-8000          7     LTO  Ultrium                      11 to 264      26.4
</TABLE>


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

(2) This is an original equipment manufacturer product and is not sold under
    the Qualstar brand name.

   Each tape library product family includes a number of models that differ in
size, 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.
Our wide range of products for competing tape drive technologies also helps to
insulate us from the occasional supply shortages from tape drive manufacturers.

   Tape libraries generally contain two or more tape drives and from seven to
thousands of tapes. We concentrate our product offerings in the middle segment
range of 10 to 360 tapes. We design our tape libraries for continuous,
unattended operation. Multiple tape drives allow simultaneous access to
different data files by

                                       8
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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 all drives simultaneously, significantly speeding up the
recording process. Within the library, tape cartridges typically are stored in
removable magazines, allowing for bulk removal of the tapes. Most of our
libraries also offer key features such as barcode readers to scan cartridge
labels, and an input/output port for importing and exporting individual tapes
under system control. Many of our library models are expandable after
installation 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 offer automated tape libraries with different data storage capacities and
data transfer rates. We continue to develop and release new libraries to expand
our product offerings in the direction of higher capacity and higher
performance units. We believe this strategy has contributed to our increasing
profit margins.

   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 in a few moments 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.

  . Inventory Sentry. This feature allows the library to be opened to inspect
    the tape cartridges visually without forcing the unit off-line for an
    unnecessary inventory cycle of all cartridges.

  . Fibre Channel connectivity. We offer a Fibre Channel option on most of
    our models to meet the needs of data-intensive applications requiring a
    high performance interface.

  . Partitioning options. Partitioning is the segmentation of a single
    library into multiple units to make several servers operate as though
    each has exclusive use of a dedicated library. We offer a wide selection
    of partitioning options for our tape libraries. Partitioning often saves
    the customer the cost of purchasing multiple small libraries when one
    larger one is sufficient.

  . Closed-loop servo control. Our tape libraries use closed-loop servo
    control for robotic motion to provide precise tape handling. By combining
    this with an all lead-screw construction, tape motion is smooth,
    repeatable and highly reliable.

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

  . Filtered, positive-pressure air systems. Our libraries use a filtered,
    positive-pressure air system to reduce dust substantially and maintain a
    high level of media integrity. Because the smallest dust particles are
    capable of causing data errors, maintaining a clean environment extends
    the life and reliability of our libraries.

   We design our tape libraries to be placed on the floor or on a table top
without the need for a special equipment rack. If requested, we provide our
customers with an adapter kit for mounting in a rack. Other manufacturers
design libraries primarily for rack-mounting, and supply an adapter for table-
top use. We have chosen our approach to distinguish ourselves from many of our
competitors. We believe that this approach provides the most convenient and
lowest cost solution for the largest segment of our customer base.

  Other Products

   We have manufactured 9-track auto-loading reel-to-reel tape drives since
1990. These units are compatible with IBM tape format standards and have served
over the years as a data interchange medium. Demand for 9-track tape drives has
been declining over many years, and we expect overall demand for 9-track tape
drives

                                       9
<PAGE>

to continue to decline in the future. In addition to our tape libraries and 9-
track tape drives, we sell ancillary products such as tape media, tape
magazines, host interface adapters, cables, bar code labels and adapters for
rack mounting our products.

Sales and Marketing

 Sales

   We sell our tape library products primarily through value added resellers.
Our direct sales force usually will initiate contact with value added resellers
who might be likely 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 respond to their customers' needs.

   We believe that by selling directly to value added resellers, we have an
advantage over competitors who force resellers to purchase through an
industrial distributor and who sometimes sell directly to end users, thereby
competing with their own resellers. Some of the advantages of our strategy
include the following:

  . Higher profit margins. By avoiding the extra distribution markup, higher
    profit margins are available to be shared by both us and the reseller.

  . Custom configurations. By circumventing the distribution step, we are
    able to offer custom configurations of our products, such as special
    paint, private branding and non-standard interface options, on very short
    notice.

  . Channel conflicts avoided. We refer all end-user inquiries to our
    reseller partners. Because they know that we will not sell directly to
    the end user, there is an attitude of cooperation between the reseller
    and us. Frequently, our sales representatives make end-user visits with
    the reseller to answer questions or help close the sale.

  . Credit. We typically extend credit to resellers if they meet our credit
    requirements. This is a service not easily obtained from distributors.

  . Rapid delivery. We generally ship a product to the reseller within one to
    three working days of confirming an order, rivaling the delivery time of
    many distributors.

   We have relationships with over 100 value added resellers, and approximately
30 independent storage management software vendors. Our sales are made on an
individual purchase order basis.

   Although we sell our tape libraries primarily to value added resellers, we
believe that original equipment manufacturers are important to our business. We
strive to work with original equipment manufacturers early in the product
development cycle so that we can obtain valuable product development feedback.
The sales cycle for original equipment manufacturers generally encompasses six
months to one year and involves extensive product and system qualification
testing, evaluation, integration and verification. Most of our sales of
automated tape libraries to original equipment manufacturers are in the
surveillance industry, primarily to Loronix Information Systems. Original
equipment manufacturers account for the majority of sales of our 9-track tape
drives. Original equipment manufacturers typically assume responsibility for
product sales, service and support.

   Because we rely heavily on the success of our value added reseller and
original equipment manufacturer customers, we depend on their ability to
market, sell and distribute our products effectively. Our revenues could
decline if we fail to execute our distribution strategy successfully or if our
value added reseller and original equipment manufacturer customers do not
implement their own strategies successfully.

   Our sales are spread across a broad customer base, with our largest
customer, Loronix Information Systems, accounting for 17.0% of revenues in
fiscal 1999, and 21.7% of revenues in the year ended June 30, 2000. Comverse
Technology, Inc. recently acquired Loronix. We do not know what effect, if any,
this will have on future orders for our products from Loronix.

                                       10
<PAGE>

   All our international sales are directed from our European sales office in
Frankfurt, Germany. All of our international sales are denominated in U.S.
dollars. Sales to customers located outside the United States were $5.1
million, or 26.4% of revenues in fiscal 1998, $7.1 million, or 24.0% of
revenues in fiscal 1999, and $12.6 million, or 25.8% of revenues for the year
ended June 30, 2000.

  Marketing

   We support our sales efforts with a broad array of marketing programs
designed to generate brand awarenes, 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 how to sell our products and how to
answer customers' questions. We advertise in key network systems publications
such as SYS Admin, Infostor, Windows NT and others, and participate in trade
shows. We display our products under the Qualstar brand name at the fall COMDEX
trade show, and participate in other trade shows in partnership with our
principal suppliers and resellers. We support our marketing and customer
service with a website that features comprehensive marketing and product
information.

   Another element of our marketing plan is our lead registration program. This
program awards value added resellers that uncover sales opportunities and
promote our products to the end user. In exchange for this effort, the reseller
is rewarded with a higher profit margin on that particular sale. The lead
registration program gives our reseller partners an advantage over their
competitors who purchase from industrial distribution channels.

   Our direct sales force conducts seminars targeting end users, often with a
sales representative from one of the storage management software vendors. In
addition, we conduct sales and technical training classes for our resellers. We
also conduct various promotional activities for resellers and end users,
including product-specific rebates, and certificates for free merchandise. We
intend to enhance and enlarge our marketing program.

Customer Service and Support

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

  . Technical support. Our technical support personnel are available Monday
    through Friday during normal business hours. Technical support personnel
    are available to all customers at no charge by telephone, facsimile 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 Canoga
    Park, California. We sell service contracts for on-site service of our
    tape libraries installed within the United States, which are fulfilled by
    IBM.

  . Sales engineering. Our engineers provide both pre- and post-sales support
    to our resellers. Systems 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. Systems engineers work with resellers and end users
    over the telephone and, in certain situations, visit the customer's site.

  . Training. We offer a product maintenance training program for both our
    value added reseller and original equipment manufacturer maintenance
    personnel. We conduct our training classes at our headquarters, as well
    as on-site at the locations of our value added resellers or original
    equipment manufacturers. We also provide videotape of the training
    classes when it is more practical.

                                       11
<PAGE>

  . Warranty. The standard warranty period on our tape libraries is three
    years. During the first year we offer immediate replacement of defective
    products at no charge, subject to availability and credit approval of the
    end user. The customer is responsible for returning the defective product
    to us in a timely manner without damage. After the first year, the
    customer must first ship the tape library to our factory, where we will
    service the product during the warranty period at no charge. We offer
    out-of-warranty factory service at a flat fee plus applicable taxes,
    duties and transportation costs. On library tape drives, we pass the
    manufacturer-provided warranty on to our reseller. Our 9-track tape
    drives are warranted for a period of one year. On-site service for
    library products is available within the United States for an extra
    charge. We contract with outside service providers to supply on-site
    service.

   Revenues from the sale of on-site service contracts and out-of-warranty
repair have not been significant.

Manufacturing and Suppliers

   We manufacture all of our products at our facility in Canoga Park,
California. We currently operate three assembly lines during one daily eight-
hour shift. As needs require, we have the ability to add a second or third
shift to increase our manufacturing capacity.

   In order to respond rapidly to sales orders, we build our tape libraries to
a semi-finished state in advance of receipt of an order, 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 the tape libraries to a semi-finished
state is approximately five working days. We believe that this capability
represents an effective way to minimize our inventory levels while maintaining
the ability to fill specific customer 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 a product order, we
generally ship the product to the customer within one to three 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
sales.

   We select our suppliers carefully based on their ability to provide quality
parts that consistently 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 standard 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 for integration into our products.

   Tape drives and tape recording 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. The risk of
allocation is greater upon the introduction of a new tape drive technology.
Any disruption in supplies of tape drives or tape media could delay shipments
of our products. We have experienced only one situation involving a limited
supply of components. Between January 1999 and January 2000, Sony Electronics,
Inc., our sole-source supplier of Advanced Intelligent Tape drives and tape
media, was unable to provide us with sufficient quantities of 50 gigabyte tape
media to meet our order volume. During this period, our customers generally
did not delay purchases of Advanced Intelligent Tape libraries from us because
of this shortage, but accepted delivery of tape libraries with a partial
shipment of 50 gigabyte tape media or accepted 36 gigabyte tape media, which
was available.

Competition

   The market for automated tape libraries is intensely competitive, highly
fragmented 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

                                      12
<PAGE>

format and performance level. In addition, because of growth in our
marketplace, we anticipate increased competition from other sources, ranging
from emerging to established companies, including large original equipment
manufacturers, to foreign competition. We compete in a segment of the overall
tape library market that focuses on small to mid-range network computing
environments. Our principal competitors in this market segment include
StorageTek, Quantum/ATL Products, Advanced Digital Information Corporation,
Exabyte, Overland Data, Breece Hill Technologies and Spectra Logic. Based on
revenues, we believe Advanced Digital Information Corporation has a dominant
share of this market segment, followed by Exabyte and Overland Data.

   Many of our competitors have substantially greater financial and other
resources, better name recognition, larger research and development staffs, and
more experience and 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. However, we do not believe that our current
determination not to seek ISO-9000 certification has affected our sales to
date.

   As a greater number of competitors introduce products in a particular tape
drive technology, the increased competition normally results in price erosion,
a reduction in gross margins and a loss of market share 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 sales 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, 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 network operating systems and storage
    management software;

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

  . expected product life and cost of maintenance between failures; and

  . physical configuration and power requirements of the library.

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

Research and Development

   Our research and development team consists of seven people who average over
25 years of data storage and related industry experience. This team has
developed 29 separate tape library models for four different tape formats over
the last five 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 firmware design, which is
the embedded systems software that controls the robotic movement within the
library, mechanical design, electronic design and engineering packaging into a
single product. Product success also relies on the engineering team's thorough
knowledge of each of the different tape drive technologies, as well as SCSI and
Fibre Channel interface technologies.

   We frequently develop new products in response to the availability of an
enhanced or 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

                                       13
<PAGE>

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 various tape drive manufacturers
through the drive development cycle to assure that reliable tape library and
tape drive combinations are brought to market.

   The engineering of our tape libraries to utilize common parts across product
families gives us the ability 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 focus being on verification testing.
When the form factors differ, the time and investment requirements can grow
substantially, and may require development of a new product altogether.

   We also develop new products as we identify emerging market needs. Our sales
and marketing, product development and engineering teams identify products to
fulfill customer and marketplace needs. Our research and development team
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.

   Our research and development expenses were $894,000 in fiscal 1998, $925,000
in fiscal 1999, and $1.0 million in fiscal 2000. We anticipate increasing our
spending on research and development in the future.

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 and various
contract rights 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, new product introductions and product enhancements. In addition,
we believe that establishing and maintaining good relationships with value
added resellers and original equipment manufacturer customers, and the
compatibility of many storage management software applications with our
products, are the most significant factors protecting us from new competitors.
In addition, we enter into nondisclosure agreements with our development
engineers to protect our technology and designs. However, we do not believe
that such protection can preclude competitors from developing substantially
equivalent or superior products.

Employees

   As of September 15, 2000, we had 95 full-time employees, including 60 in
manufacturing, 7 in research and development, 3 in customer service, 16 in
sales and marketing, and 9 in finance and administration. 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.

                                       14
<PAGE>

                                  RISK FACTORS

Our principal competitors devote greater financial and marketing resources to
developing 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 recent years several of our competitors
have:

  . acquired other tape library companies;

  . increased the geographic scope of their market;

  . offered a wider range of tape library products; and

  . acquired proprietary software 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.

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, and Richard A. Nelson, our Vice President of Engineering, conceived
and developed most of our tape libraries, have overseen our operations and
growth, and have established and maintained our strategic relationships. We
expect that they will continue these efforts for the foreseeable future. Our
success will depend on the contributions of our operations, marketing and
financial personnel. However, our current dependence on a limited number of
executives, 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 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 76.9% of our revenues in fiscal 1999 and
approximately 85.5% of our revenues for fiscal year ended June 30, 2000. 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. In some cases, these manufacturers are sole-source providers of
these components. One manufacturer, Quantum Corporation, also competes with us
by selling its own tape libraries.

                                       15
<PAGE>

   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 8 millimeter
    Advanced Intelligent Tape tape drives and media. Sony has allocated these
    tape drives and tape media in the past, and may allocate them again in
    the future. In the fiscal year ended June 30, 1999 we derived $9.9
    million, or 33.3%, of our revenues, and in fiscal 2000 we derived $23.7
    million, or 48.0%, of our revenues, from the sale of tape libraries and
    tape media based on Sony Advanced Intelligent Tape drives. If Sony
    reduces its sales to us or raises its prices, we could lose revenues and
    our margins could decline.

  . Quantum is our primary supplier of DLT tape drives and competes with us
    as a manufacturer of automated tape libraries. In the past, Quantum has
    allocated quantities of tape drives among its customers. It is possible
    that Quantum will allocate again, and as a result, may be unable to meet
    our future DLT tape drive requirements. This risk is heightened by
    Quantum's acquisition of ATL Products, a manufacturer, marketer and
    servicer of automated tape libraries that utilize DLT tape drives and
    compete with our products. Even if we receive an adequate allocation, it
    may be at a price that renders our products uncompetitive.

  . The Linear Tape Open standard is a new tape standard that has been
    developed by an industry consortium that is intended to compete with DLT
    tape drives and media. Manufacturers of tape drives and tape media for
    new tape formats historically have been unable to meet initial demand and
    may allocate their supply. Our suppliers of Linear Tape Open tape drives
    announced that their tape drives, originally scheduled to begin delivery
    in our second quarter of fiscal 2000, may not begin shipping until our
    second quarter of fiscal 2001. Any allocation of Linear Tape Open
    products could limit our growth.

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

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

   We distribute and sell our automated tape libraries through value added
resellers and original equipment manufacturers, and intend to continue this
strategy for the foreseeable future. Value added resellers integrate our tape
libraries with products of other manufacturers and sell the combined products
to their own customers. Original equipment manufacturers combine our tape
libraries with their own products and sell the combined product under their own
brand. We currently devote, and intend to continue to devote, significant
resources to develop 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; and

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

                                       16
<PAGE>

   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 or that it refrain from purchasing competing products.

   We do not have any exclusive or long-term 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 reseller 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
significant harm.

We rely on tape technology for all of our revenues. Our business will be harmed
if demand for storage solutions using tape technology declines or fails to grow
as rapidly as we expect.

   We derive all of our revenues from products that incorporate some form of
tape technology. We expect to derive all 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 net revenues if demand for these products declines or if
rising prices make it more difficult to obtain them. If storage products
incorporating technologies other than tape gain comparable or superior market
acceptance, our business could be harmed.

Our largest customer accounts for a significant portion of our sales and it has
no minimum or long-term purchase commitments. Our revenues and earnings may
decrease if we lose its business.

   Loronix Information Systems, our largest customer, accounted for 17.0% of
our revenues during fiscal 1999 and 21.7% of revenues during the year ended
June 30, 2000. We cannot assure you that this customer will continue to
purchase our products in the quantities it has purchased in the past, or at
all. Our revenues and earnings may decrease if any of the following factors
were to occur relating to this customer:

  . the loss of this customer due to competition from other vendors or
    consolidation;

  . substantial cancellations of orders by this customer, or the receipt of
    orders significantly below historical or anticipated amounts; or

  . any financial difficulties of this customer that results in its inability
    to pay amounts owed to us.

   Comverse Technology, Inc recently acquired Loronix. We do not know what
effect, if any, this will have on future orders for our products from Loronix.

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 may fluctuate in the future due to several factors, including:

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

  . fluctuations in product mix;

  . availability of tape media;

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

                                       17
<PAGE>

  . 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;

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

  . timing and levels of our operating expenses.

   In addition, our revenues historically have been lower in our second fiscal
quarter than in our first fiscal quarter because we typically close for one
week during the December holidays.

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

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

Our 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 results from orders placed during that quarter.
Because backlog can be an important indicator of future sales, 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 planned move to a new facility will be time-consuming and disruptive to our
business and personnel.

   Our lease on our current facility expires in January 2001. In September
2000, we entered into a new lease for a 57,000 square foot building, located in
Southern California. We plan to relocate to the new facility in January 2001.
If we fail to execute this move successfully, sales may be delayed and our
operational efficiencies and product quality could suffer.

We are a small company that is growing rapidly and have not had to meet the
responsibilities of being a public company. Rapid growth may strain the
capabilities of our managers, operations and facilities, and consequently,
could harm our business.

   From July 1, 1996 through June 30, 2000, our revenues have grown at a
compound annual growth rate of 45.6%. This growth has resulted in, and may
possibly create in the future, additional capacity requirements, new and
increased responsibilities for management personnel, and added pressures on our
operating and financial systems. For example, the disclosure and reporting
obligations of a public company will further strain our limited financial staff
and financial systems. Our facilities, personnel and operating and financial
systems may be unable to manage and sustain our current or future growth, and
additional growth may detract from our ability to respond to new opportunities
and challenges quickly. Our ability to manage any future growth effectively and
to timely comply with our public company obligations will also depend on our
ability to hire and retain qualified management, financial, sales and technical
personnel. If we are unable to manage growth effectively or hire and retain
qualified personnel, our business could be harmed. In addition, to the extent
expected revenue growth does not materialize, increases in our selling and
administrative costs that are based on anticipated revenue growth could harm
our operating results.

                                       18
<PAGE>

If we fail to develop and introduce new tape libraries on a timely and cost-
effective basis, we will eventually lose market share and sales to more
innovative competitors.

   The market for our products is characterized by changing technology and
evolving industry standards and is competitive with respect to timely
innovation. At this time, the data storage market is particularly subject to
change with the emergence of two new technologies:

  . Fibre Channel, a new method of connecting storage devices to networks,
    allows users to share information with other storage devices and servers
    over longer distances and at higher rates of data transfer.

  . Network attached storage devices allow users to plug storage devices
    directly into a network without increasing demands on the file server or
    requiring a separate file server.

   Although we currently offer a Fibre Channel interface option for our tape
libraries, we have not yet developed products based on network attached storage
technology. The introduction of new products utilizing network attached storage
or other new or alternative technologies or the emergence of new industry
standards could render our existing products obsolete or unmarketable.

   Our future success will depend in part on our ability to anticipate changes
in technology and to incorporate this technology to develop new and enhanced
products on a timely and cost-effective basis. Risks inherent in the
development and introduction of new products include:

  . the failure of tape drive manufacturers to promote their tape drives
    adequately, resulting in fewer sales of our libraries which incorporate
    those tape drives;

  . the difficulty in forecasting customer demand accurately;

  . our inability to expand production capacity fast enough to meet customer
    demand;

  . the possibility that new products may reduce demand for our current
    products;

  . delays in our initial shipments of new products;

  . being placed on supply allocation if our sole-source suppliers
    underestimate demand for their products or face technical difficulties
    producing a new product;

  . competitors' responses to our introduction of new products;

  . the desire by original equipment manufacturer customers to evaluate new
    products for longer periods of time before making a purchase decision;

  . difficulties associated with forecasting customer returns of new products
    and the associated warranty expenses we incur for product returns; and

  . the possibility that the market may reject a new technology and products
    based on that technology.

   In addition, we must maintain the compatibility of our products with
significant future storage technologies and rely on producers of new storage
technologies to achieve and sustain market acceptance of those technologies.
Development schedules for automated data storage products are subject to
uncertainty, and we may not meet our product development schedules.

   If we are unable, for technological or other reasons, to develop products in
a timely manner or if the products or product enhancements that we develop are
not accepted by the marketplace, our revenues could decline.

We depend upon independent software developers to provide software that
integrates our libraries with computer operating systems.

   The utility of an automated tape library depends partly upon the storage
management software which supports the library and integrates it into the
user's computing environment to provide a complete storage

                                       19
<PAGE>

solution. We do not develop and have no control over the development of this
storage management software. Instead we rely on independent software developers
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 developers 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 independent software
developers, we maintain relationships with them by:

  . supplying evaluation 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.

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 our products
to us for any reason. 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 harmed for the
periods during which returns are made.

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

   Many of our original equipment manufacturer customers typically conduct
significant evaluation, testing, implementation and acceptance procedures
before they begin to market and sell new models of tape libraries. 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 efforts 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 profitability.

   Sales to customers located outside the United States accounted for
approximately 26.4% of our revenues in fiscal 1998, 24.0% in fiscal 1999, and
25.8% in the fiscal year ended June 30, 2000. We believe that international
sales will continue to represent a significant portion of our revenues. Our
foreign sales subject us to a number of risks, including:

  . 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;

  . 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;

  . political and economic instability may reduce demand for our products or
    our ability to market our products in foreign countries;

                                       20
<PAGE>

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

  . our current determination not to seek ISO-9000 certification, a widely
    accepted method of establishing and certifying the quality of a
    manufacturer's products, may reduce sales.

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

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 for performance problems of
our products. 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.

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

   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 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. While
we currently are not engaged in any material intellectual property litigation
or proceedings, we may become involved in these proceedings in the future. We
have from time to time and in the future may be subject to claims or inquiries
regarding our alleged unauthorized use of a third party's intellectual
property. An adverse outcome in litigation could force us to do one or more of
the following:

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

  . subject us to significant liabilities to third parties;

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

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

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

Undetected software or hardware flaws could increase our costs, reduce our
revenues and divert our 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

                                      21
<PAGE>

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 problems, 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.

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 52.8% of our outstanding common stock. 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 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

                                       22
<PAGE>

capabilities. Consequently, we have never paid dividends on our shares of
capital stock. We intend to continue this strategy for the foreseeable future
to strengthen our financial and competitive position in the tape library
markets.

Substantial future sales of our common stock in the public market may depress
our stock price and make it difficult for you to recover the full value of your
investment in our shares.

   Upon the release of the 180 day lock-up, on December 20, 2000, approximately
9.6 million shares will be available for sale in the public market. The sale of
substantial numbers of these shares or the market's perception that such sales
may occur after December 20, 2000 could cause our stock to decline. In
addition, the sale of these shares could impair our ability to raise capital
through the sale of additional stock.

Item 2. Properties

   All of our operations are housed in a single building containing
approximately 28,000 square feet located in Canoga Park, California. Our lease
on this facility expires in January 2001, but we have the right terminate our
lease on 90 days notice. Rent on this facility is $15,000 per month. In
September 2000, we entered into a new lease for a 57,000 square feet building
located in Southern California. We plan to relocate to the new facility in
January 2001.,

Item 3. Legal Proceedings

   We may be involved in legal proceedings from time to time in the ordinary
course of business. However, there are currently no material legal proceedings
pending or, to our knowledge, threatened against us.

Item 4. Submision 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, 2000.

                                       23
<PAGE>

                                   MANAGEMENT

Executive Officers

   Officers are elected by and serve at the discretion of the board of
directors. The executive officers of Qualstar as of September 25, 2000 are:

<TABLE>
<CAPTION>
                Name                Age Position
                ----                --- --------

 <C>                                <C> <S>
 William J. Gervais...............   57 Chief Executive Officer, President and Director

 Richard A. Nelson................   57 Vice President of Engineering, Secretary and Director

 Matthew Natalizio................   45 Vice President and Chief Financial Officer

 Daniel O. Thorlakson.............   57 Vice President of Operations

 Robert K. Covey..................   52 Vice President of Marketing
</TABLE>

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, a former manufacturer of hard disk drives. Mr. Gervais
earned a B.S. degree in Mechanical Engineering from California State
Polytechnic University 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 in 1966.

   Matthew Natalizio has been our Vice President and Chief Financial Officer
since January 2000. Prior to joining Qualstar, Mr. Natalizio served as Vice
President of Finance and Treasurer from 1994 until 1998, and as Vice President,
Operations Support from 1998 through 1999, of Superior National Insurance
Group, Inc. From 1988 until 1994, Mr. Natalizio was a Senior Audit Manager for
KPMG Peat Marwick LLP. From 1983 through 1988, Mr. Natalizio was an Audit
Manager for Ernst & Whinney. Mr. Natalizio received a B.A. degree in Economics
from the University of California, Los Angeles in 1977 and became a C.P.A. in
1985.

   Daniel O. Thorlakson has been our Vice President of Operations since 1988.
From 1983 to 1987, Mr. Thorlakson was President of Qualitech Business Systems,
a value added reseller of computer systems, networks and software. Mr.
Thorlakson earned a B.S. degree in Mechanical Engineering from the University
of Detroit in 1966.

   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 from 1965 to 1968.

                                       24
<PAGE>

                                    PART II

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters

   Qualstar commenced its initial public offering of common stock on June 23,
2000. Qualstar's common stock is quoted on the Nasdaq Stock Market's National
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:

<TABLE>
<CAPTION>
                                                               June 23 - June 30
                                                                     2000
                                                               -----------------
      Fiscal Period                                              High     Low
      -------------                                            -------- --------
      <S>                                                      <C>      <C>
      Fourth Quarter.......................................... $   7.72 $   7.00
</TABLE>

   The approximate number of shareholders of record at September 21, 2000 was
100.

   Qualstar has declared no cash dividends during the periods reported.
Qualstar does not 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 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.

Use of Proceeds From Sale of Registered Securities

   Qualstar's Registration Statement on Form S-1 (Commission File Number 333-
96009) for its initial public offering of common stock became effective on June
22, 2000, covering an aggregate of 2,875,000 shares of common stock, including
the underwriters' over-allotment option. A total of 2,875,000 shares of common
stock was sold at a price of $7.00 per share to an underwriting syndicate led
by First Security Van Kasper, Needham & Company, Inc. and Wedbush Morgan
Securities. The offering commenced on June 23, 2000 and was completed on July
18, 2000. The initial public offering resulted in gross proceeds of $20.1
million, of which $1.4 million was applied toward underwriting discounts and
commissions. Other expenses related to the offering totaled approximately $1.0
million. Net proceeds to Qualstar from the initial public offering were
approximately $17.7 million. As of June 30, 2000, all of the net proceeds from
the offering were invested in short-term, high-grade interest-bearing
securities, certificates of deposit or direct or guaranteed obligations of the
U.S. government.

                                       25
<PAGE>

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.

<TABLE>
<CAPTION>
                                              Years Ended June 30,
                                     -----------------------------------------
                                      1996    1997     1998     1999    2000
                                     ------- -------  -------  ------- -------
                                         (in thousands, except per share
                                                    amounts)
<S>                                  <C>     <C>      <C>      <C>     <C>
Statements of Income Data:
Net revenues........................ $10,974 $15,333  $19,155  $29,698 $49,352
Cost of goods sold..................   7,140  10,768   12,892   19,058  30,915
                                     ------- -------  -------  ------- -------
Gross profit........................   3,834   4,565    6,263   10,640  18,437
Operating expenses:
  Research and development..........     918     916      894      925   1,027
  Sales and marketing...............   1,016   1,146    1,277    1,941   2,643
  General and administrative........   1,107   1,052    1,062    1,267   2,057
                                     ------- -------  -------  ------- -------
    Total operating expenses........   3,041   3,114    3,233    4,133   5,727
                                     ------- -------  -------  ------- -------
Income from operations..............     793   1,451    3,030    6,507  12,710
Interest income.....................      23      21       35       41      54
                                     ------- -------  -------  ------- -------
Income before income taxes..........     816   1,472    3,065    6,548  12,764
Provision for income taxes..........     290     518    1,132    2,562   4,968
                                     ------- -------  -------  ------- -------
Net income..........................     526     954    1,933    3,986   7,796
                                     ------- -------  -------  ------- -------
Premium paid on redemption of
 preferred stock....................     --     (106)    (147)     --      --
                                     ------- -------  -------  ------- -------
Net income applicable to common
 shareholders....................... $   526 $   848  $ 1,786  $ 3,986 $ 7,796
                                     ======= =======  =======  ======= =======
Earnings per share:
  Basic............................. $  0.08 $  0.13  $  0.28  $  0.60 $  1.10
  Diluted........................... $  0.06 $  0.09  $  0.19  $  0.42 $  0.80
Shares used to compute earnings per
 share:
  Basic.............................   6,788   6,332    6,404    6,629   7,119
  Diluted...........................   9,196   9,065    9,290    9,467   9,742
<CAPTION>
                                                    June 30,
                                     -----------------------------------------
                                      1996    1997     1998     1999    2000
                                     ------- -------  -------  ------- -------
                                                 (in thousands)
<S>                                  <C>     <C>      <C>      <C>     <C>
Balance Sheet Data:
Cash and cash equivalents........... $   444 $   912  $   798  $ 2,134 $18,976
Working capital.....................   4,731   5,549    7,213   11,205  33,620
Total assets........................   5,856   6,967    8,461   12,950  37,984
Total debt..........................     --      --       --       --      --
Shareholders' equity................   5,031   5,850    7,614   11,640  35,032
</TABLE>

                                       26
<PAGE>

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 offer tape libraries for multiple tape drive
technologies, including those using Advanced Intelligent Tape, DLT, Linear Tape
Open, or LTO and quarter-inch cartridge tape drives and media.

   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 large libraries, we developed a family of tape libraries over the last five
years spanning a broad range of tape formats, prices, capacity and performance.
Our product mix has changed over the last three fiscal years as we introduced
new products to address additional tape formats and changing customer
preferences. For example, we have increased the capacity of our tape libraries
as our customers' needs for increased data storage have grown, and we have
introduced tape libraries incorporating Advanced Intelligent Tape, LTO and DLT
tape drive technologies. We expect our product mix to continue to change 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 storage solutions to end users that are installed complete and ready
to operate. 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. We assist our customers with marketing and technical support.

   All of our international sales efforts currently are directed from our
Frankfurt, Germany office. We intend to continue to develop our international
markets and create additional outlets for our products. All of our
international sales are denominated in U.S. dollars. Revenues from sales to
customers located outside the United States were $5.1 million, or 26.4% of
revenues, in fiscal 1998, $7.1 million, or 24.0% of revenues, in fiscal 1999,
and $12.6 million, or 25.8% of revenues in fiscal 2000.

   Net revenues include revenues from the sale of tape libraries, library tape
drives, storage media, 9-track tape drives, and ancillary products. Ancillary
revenues include service and repair, warranty revenues net of the cost of any
third party warranty contracts, and the resale of 18- and 36-track tape drives
manufactured by a third party, which we discontinued selling in June 1999.
Automated tape libraries and related products, such as tape drives and tape
media, represented approximately 76.9% of revenues in fiscal 1999, and
approximately 85.5% of revenues in fiscal 2000. Sales of 9-track tape drives,
services and other products accounted for the balance of our revenues.

   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 of strong customer demand and less competition. Our
gross margins have benefited from a shift in demand towards our larger tape
libraries. However, some customers of larger tape libraries desire significant
quantities of tape media. Sales of large quantities of tape media partially
offset the higher gross margins associated with sales of larger tape libraries
because tape media provide significantly lower gross margins than tape
libraries. From time to time, we have been unable to meet demand for tape media
because of supply constraints. We may experience higher gross margins in
quarters when sales of tape media decrease due

                                       27
<PAGE>

to supply constraints and lower gross margins in quarters when sales of tape
media increase due to greater availability. We expect that our growth in
revenues and attractive gross margins will encourage new competitors to enter
our marketplace, which may affect our gross margins.

   We expect that our selling, general and administrative expenses will
increase due to higher rent associated with a larger facility, the opening of
our European sales office and related staffing, increased costs associated with
the responsibilities of being a public company, higher marketing, advertising
and selling costs necessary to enter new markets, expenditures to further
develop our brand identity, and increased costs to attract and retain
personnel.

   We recorded deferred compensation of approximately $1.7 million in the third
quarter of fiscal 2000, representing the difference between the exercise prices
of the options and restricted stock awards granted to employees and directors
during fiscal 2000 and the deemed fair value for accounting purposes of our
common stock on the grant dates. We amortized approximately $227,000 during
fiscal 2000, which was recorded in general and administrative expenses. Total
deferred compensation amortization will approximate $440,000 in each of fiscal
2001, 2002 and 2003, and $215,000 in fiscal 2004.

Results of Operations

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

<TABLE>
<CAPTION>
                                                         Years Ended June 30,
                                                         ----------------------
                                                          1998    1999    2000
                                                         ------  ------  ------
<S>                                                      <C>     <C>     <C>
Net revenues............................................  100.0%  100.0%  100.0%
  Cost of goods sold....................................   67.3    64.2    62.6
                                                         ------  ------  ------
  Gross margin..........................................   32.7    35.8    37.4
Operating expenses:
  Research and development..............................    4.7     3.1     2.0
  Sales and marketing...................................    6.7     6.5     5.4
  General and administrative............................    5.5     4.3     4.2
                                                         ------  ------  ------
Income from operations..................................   15.8    21.9    25.8
Interest income.........................................    0.2     0.1     0.1
                                                         ------  ------  ------
Income before income taxes..............................   16.0    22.0    25.9
Provision for income taxes..............................    5.9     8.6    10.1
                                                         ------  ------  ------
Net income..............................................   10.1%   13.4%   15.8%
                                                         ======  ======  ======
</TABLE>

 Fiscal 2000 Compared to Fiscal 1999

   Net Revenues. Revenues are recognized upon shipment of the product to the
customer, less estimated returns, for which provision is made at the time of
the sale. Revenues for the year ended June 30, 2000 were $49.4 million, an
increase of 66.2% compared to net revenues of $29.7 million for the year ended
June 30, 1999. This increase in revenues was due primarily to increasing demand
for our existing tape library models. Revenues from tape libraries and related
media increased to $42.3 million in the year ended June 30, 2000 from $22.8
million in the year ended June 30, 1999, or 85.5%. Revenues from our 9-track
tape drives increased $968,000 to $3.8 million in the year ended June 30, 2000
from $2.8 million for the year ended June 30, 1999. Partially offsetting these
increases in revenues from tape libraries and 9-track tape drives was a decline
of $2.4 million in revenue from the sale of 18- and 36-track tape drives, which
were discontinued in June 1999. Selling prices of our products remained
relatively stable during both periods. Despite the increase in revenues from
9-track tape drives during fiscal 2000, we believe that sales of this product
will decline over time. Selling prices of our products remained relatively
stable during both periods.

                                       28
<PAGE>

   Gross Profit. Gross profit was $18.4 million, or 37.4% of revenues, for the
year ended June 30, 2000, compared to $10.6 million, or 35.8% of revenues, for
fiscal 1999, representing an increase of 73.3%. Cost of goods sold consists
primarily of direct labor, purchased parts, depreciation of plant and
equipment, rent, utilities, and packaging costs. The increase in gross margin
resulted primarily from a 1.1% decline in labor and other costs as a percentage
of revenues, which was partially offset by a 0.9% increase in the cost of
material. These changes reflect a shift in our product mix toward larger
capacity tape libraries requiring greater amounts of material as compared to
the amount of labor, and operating efficiencies resulting from spreading a
larger volume of sales over relatively fixed direct and indirect expenses.

   Research and Development. Research and development expenses consist of
engineering salaries, benefits, purchased parts and supplies used in
development activities. Research and development expenses for the year ended
June 30, 2000 were $1.0 million as compared to $925,000 for the year ended June
30, 1999. This increase was due primarily to an increase in purchased parts and
supplies used in research and development activities.

   Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries, benefits, sales commissions, trade show costs, advertising,
technical support and travel related expenses. Sales and marketing expenses
increased 36.2% to $2.6 million, or 5.4% of revenues for the year ended June
30, 2000, as compared to $1.9 million, or 6.5% of revenues, for the year ended
June 30, 1999. This increase was due primarily to the growth in our sales force
and associated increases in salaries and benefits of $240,000, and travel
related expenses of $125,000, as well as an increase in sales commissions of
$191,000 due to an increase in sales.

   General and Administrative. General and administrative expenses include
employee salaries and benefits, deferred compensation related to equity
incentives, provisions for doubtful accounts and returns, and professional
service fees. General and administrative expenses as a percentage of revenues
for fiscal 1999 and fiscal 2000 were relatively constant. General and
administrative expenses were 4.3% of revenues in fiscal 1999 and 4.2% for the
year ended June 30, 2000. The year ended June 30, 2000 also includes deferred
compensation amortization expense of $227,000 related to equity incentives,
while there was no deferred compensation amortization expense in the comparable
period of the prior year. Additionally, the provision for doubtful accounts and
returns increased $50,000 due to increases in revenues and accounts
receivables.

   Provision for Income Taxes. The provision for income taxes was $5.0 million,
or 38.9% of pre-tax income, for fiscal 2000 compared to $2.6 million, or 39.1%
of pre-tax income, for 1999.

 Fiscal 1999 compared to Fiscal 1998

   Net Revenues. Revenues in fiscal 1999 were $29.7 million, an increase of
55.0% compared to revenues of $19.2 million in fiscal 1998. The increase in
revenues resulted primarily from the sales of our large capacity tape libraries
that were introduced in fiscal 1999 and increasing demand for our existing
libraries. Revenues from our tape libraries and related media increased to
$22.8 million in fiscal 1999, from $10.4 million in fiscal 1998, or an increase
of 119%. Offsetting the increase in library and related media revenues were
continuing declines in sales of our 9-,18- and 36-track tape drives. Revenues
for these products declined to $5.0 million in fiscal 1999 from $7.4 million in
fiscal 1998, a decline of $2.4 million or 32.5%. Selling prices of our products
remained relatively stable during both periods.

   Gross Profit. Gross profit was $10.6 million, or 35.8% of revenues, in
fiscal 1999 compared with $6.3 million, or 32.7% of revenues, in fiscal 1998,
representing an increase of 69.8%. The increase in gross margin during fiscal
1999 as compared to fiscal 1998 was due primarily to a 2.4% decline in labor
and other costs as a percentage of revenues, which were partially offset by a
0.3% increase in the cost of materials. These changes reflect operating
efficiencies resulting from spreading a larger volume of sales over relatively
fixed direct and indirect expenses.

                                       29
<PAGE>

   Research and Development. Research and development expenses remained
relatively constant between fiscal 1998 and fiscal 1999. During fiscal 1999,
research and development expenses increased $31,000 to $925,000, as compared to
$894,000 incurred during fiscal 1998.

   Sales and marketing. Sales and marketing expenses increased 52.0% to $1.9
million, or 6.5% of revenues, in fiscal 1999, as compared to $1.3 million, or
6.7% of revenues, for fiscal 1998. This increase was due primarily to the
growth in our sales force and associated increases in salaries and benefits of
$146,000 and travel related expenses of $58,000, as well as an increase in
sales commissions of $457,000 due to an increase in sales.

   General and Administrative. General and administrative expenses decreased as
a percentage of revenues from 5.5% for fiscal 1998 to 4.3% for fiscal 1999.
This decline was due primarily to a 55.0% increase in revenues during this
period while general and administrative expenses increased only 19.3%. The
increase in general and administrative expenses in absolute dollars during
fiscal 1999 was due primarily to an increase in the number of employees,
resulting in an increase of $47,000 in salaries and benefits. Additionally, the
provision for doubtful accounts and returns increased $255,000 due to increases
in revenues and accounts receivables.

   Provision for Income Taxes. The provision for income taxes was $2.6 million,
or 39.1% of pre-tax income, in fiscal 1999 compared to $1.1 million, or 36.9%
of pre-tax income, in fiscal 1998. The increase in the effective tax rate in
fiscal 1999 was due to the decreasing effect of research and development tax
credits.

Liquidity and Capital Resources

   Historically, we have funded our capital requirements with cash flows from
operations. Cash flows provided by operating activities were $340,000 in fiscal
1998, $1.6 million in fiscal 1999, and $2.6 million fiscal 2000. In each of
these periods, operating cash was provided primarily by net income and
increases in accounts payable. These increases in cash flows were used
primarily to fund increases in accounts receivable and inventories.

   Cash flows used in investing activities were $287,000 in fiscal 1998,
$274,000 in fiscal 1999 and $1.1 million in fiscal 2000. Cash flows used in
investing activities in fiscal 2000 related primarily to our investment of $1.1
million for an approximately 1% interest in Chaparral Network Storage, Inc., a
provider of Fibre Channel interfaces. We expect to incur capital expenditures
of approximately $750,000 for equipment and leasehold improvements associated
with our move to a larger facility during the next 12 months.

   Cash used in financing activities in fiscal 1998 resulted from our
repurchase of $219,000 of capital stock.

   On June 23, 2000 Qualstar commenced its initial public offering of 2.5
million shares of common stock at $7.00 per share, which closed on June 28,
2000. We received net proceeds of $15.3 million from this offering. Qualstar
raised an additional $2.4 million in July 2000, as a result of the underwriters
exercising their over allotment option. We have a $750,000 unsecured bank line
of credit that expires November 1, 2000, all of which was available as of June
30, 2000. Borrowings under this line of credit bear interest at the bank's
reference rate plus 1.25%. Our bank's reference rate, a variable rate, was 9.5%
at June 30, 2000. We do not intend to renew this line at expiration.

   We had no material commitments as of June 30, 2000.

   We believe that our existing cash and cash equivalents and anticipated cash
flows from our operating activities 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 expect to make
investments in companies with whom we have identified potential synergies.
However, we have no present commitments or agreements with respect to any
material acquisition of other businesses or technologies.

                                       30
<PAGE>

Item 7a. Qualitative and Quanitative 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 short-term
instruments. We have no outstanding debt nor do we utilize derivative financial
instruments. Therefore, no quantitative tabular disclosures are required.

Item 8. Financial Statements and Supplementary Data

   See Index to Financial Statements at page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

   Not applicable.


                                       31
<PAGE>

                                    PART III

   The information called for by Part III (Items 10, 11, 12 and 13) of Form 10-
K (except information as to Qualstar's executive officers, which information
follows Item 4 in this Report) will be included in Qualstar's Proxy Statement
which management intends to file with the Securities and Exchange Commission
within 120 days after the close of its fiscal year ended June 30, 2000, and is
hereby incorporated by reference to such Proxy Statement.

                                    PART IV

Item 14. Exhibits, Financials Statement Schedules and Reports on Form 8-K

  (a) (1) The following documents are filed as part of this Report:

          Financial Statements-See Index to Financial Statements at page F-1 of
          this Report.

      (2) Supplemental Schedule:

          Schedule II--Valuation and Qualifying Accounts; Allowance for
          Doubtful Accounts

      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) Reports on Form 8-K. No reports on Form 8-K were filed during the last
      quarter of the fiscal year ended June 30, 2000.

  (c) Exhibits:

<TABLE>
<CAPTION>
 Exhibit
 No.       Description
 -------   -----------
 <C>       <S>
   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.

  27.1     Financial Data Schedule
</TABLE>
--------
(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.

 *  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 14(c) of this report.

                                       32
<PAGE>

                              QUALSTAR CORPORATION

Item 8. Financial Statements and Supplementary Data

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Balance Sheets............................................................. F-3
Statements of Income....................................................... F-4
Statements of Shareholders' Equity......................................... F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>

                                      F-1
<PAGE>

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders of
Qualstar Corporation

   We have audited the accompanying balance sheets of Qualstar Corporation as
of June 30, 1999 and 2000, and the related statements of income, shareholders'
equity, and cash flows for each of the three years in the period ended June 30,
2000. Our audits also included the financial statement schedule listed at the
index in Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

   We conducted our audits in accordance with auditing standards generally
accepted in the 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. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as 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 financial position of Qualstar Corporation at
June 30, 1999 and 2000, and the results of its operations and its cash flows
for the three years in the period ended June 30, 2000, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

                                          /s/ Ernst & Young LLP

Woodland Hills, California
August 11, 2000

                                      F-2
<PAGE>

                              QUALSTAR CORPORATION

                                 BALANCE SHEETS
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                 June 30,
                                                              ----------------
                                                               1999     2000
                                                              -------  -------
<S>                                                           <C>      <C>
                           ASSETS
Current assets:
  Cash and cash equivalents.................................. $ 2,134  $18,976
  Receivables, less allowances of $420 for 1999 and $470 for
   2000......................................................   4,915    7,276
  Inventories................................................   4,651    8,657
  Prepaid expenses...........................................      31      186
  Prepaid income taxes.......................................     345      765
  Deferred income taxes......................................     398      652
                                                              -------  -------
    Total current assets.....................................  12,474   36,512
  Property and equipment, net................................     436      377
  Investment in common stock.................................     --     1,050
  Other assets...............................................      40       45
                                                              -------  -------
    Total assets............................................. $12,950  $37,984
                                                              =======  =======

            LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Accounts payable........................................... $   747  $ 2,341
  Accrued payroll and related liabilities....................     367      393
  Other accrued liabilities..................................     155      158
                                                              -------  -------
    Total current liabilities................................   1,269    2,892

Deferred income taxes........................................      41       60

Commitments and contingencies

Shareholders' equity:
  Preferred stock, no par value; 5,881 authorized, 881 shares
   of Series A convertible preferred stock, liquidation
   preference of $0.50 per share, or $441 in the aggregate,
   authorized, 881 issued and outstanding in 1999, and 5,000
   authorized and no shares issued and outstanding in 2000...     431      --
  Common stock, no par value; 50,000 shares authorized, 6,656
   and 12,164 shares issued and outstanding in 1999 and 2000,
   respectively..............................................     280   18,400
  Deferred compensation......................................     (58)  (1,534)
  Notes from directors.......................................     --      (617)
  Retained earnings..........................................  10,987   18,783
                                                              -------  -------
    Total shareholders' equity...............................  11,640   35,032
                                                              -------  -------
    Total liabilities and shareholders' equity............... $12,950  $37,984
                                                              =======  =======
</TABLE>

                             See accompanying notes

                                      F-3
<PAGE>

                              QUALSTAR CORPORATION

                              STATEMENTS OF INCOME
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                        Years Ended June 30,
                                                       ------------------------
                                                        1998     1999    2000
                                                       -------  ------- -------
<S>                                                    <C>      <C>     <C>
Net revenues.......................................... $19,155  $29,698 $49,352
Cost of goods sold....................................  12,892   19,058  30,915
                                                       -------  ------- -------
Gross profit..........................................   6,263   10,640  18,437
Operating expenses:
  Research and development............................     894      925   1,027
  Sales and marketing.................................   1,277    1,941   2,643
  General and administrative..........................   1,062    1,267   2,057
                                                       -------  ------- -------
    Total operating expenses..........................   3,233    4,133   5,727
                                                       -------  ------- -------
Income from operations................................   3,030    6,507  12,710
Interest income.......................................      35       41      54
                                                       -------  ------- -------
Income before income taxes............................   3,065    6,548  12,764
Provision for income taxes............................   1,132    2,562   4,968
                                                       -------  ------- -------
Net income............................................   1,933    3,986   7,796
Premium paid on redemption of preferred stock.........    (147)     --      --
                                                       -------  ------- -------
Net income applicable to common shareholders.......... $ 1,786  $ 3,986 $ 7,796
                                                       =======  ======= =======
Earnings per share:
  Basic............................................... $  0.28  $  0.60 $  1.10
                                                       =======  ======= =======
  Diluted............................................. $  0.19  $  0.42 $  0.80
                                                       =======  ======= =======
Shares used to compute earnings per share:
  Basic...............................................   6,404    6,629   7,119
                                                       =======  ======= =======
  Diluted.............................................   9,290    9,467   9,742
                                                       =======  ======= =======
</TABLE>


                             See accompanying notes

                                      F-4
<PAGE>

                              QUALSTAR CORPORATION

                       STATEMENTS OF SHAREHOLDERS' EQUITY
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                           Series A
                         Nonredeemable
                           Preferred
                             Stock       Common Stock                   Notes
                         -------------  ---------------    Deferred     From    Retained
                         Shares Amount  Shares  Amount   Compensation Directors Earnings   Total
                         ------ ------  ------  -------  ------------ --------- --------  -------
<S>                      <C>    <C>     <C>     <C>      <C>          <C>       <C>       <C>
Balances at July 1,
 1997...................   954  $ 467    6,332  $   132    $   --       $ --    $ 5,250   $ 5,849
  Repurchase of common
   stock................   --     --       (65)      (1)       --         --        (35)      (36)
  Retirement of
   preferred stock......   (73)   (36)     --       --         --         --       (147)     (183)
  Exercise of stock
   options..............   --     --       230       51        --         --        --         51
  Net income............   --     --       --       --         --         --      1,933     1,933
                          ----  -----   ------  -------    -------      -----   -------   -------
Balances at June 30,
 1998...................   881    431    6,497      182        --         --      7,001     7,614
  Exercise of stock
   options..............   --     --       159       40        --         --        --         40
  Deferred compensation
   related to stock
   options..............   --     --       --        58        (58)       --        --        --
  Net income............   --     --       --       --         --                 3,986     3,986
                          ----  -----   ------  -------    -------      -----   -------   -------
Balances at June 30,
 1999...................   881    431    6,656      280        (58)       --     10,987    11,640
  Initial public
   offering , issuance
   of common stock......   --     --     2,500   15,272        --         --        --     15,272
  Exercise of stock
   options..............   --     --       413      114        --         --        --        114
  Directors' notes......   --     --       --       --         --        (600)      --       (600)
  Sale of restricted
   stock to directors...   --     --       216      600        --         --        --        600
  Deferred compensation
   related to stock
   options and
   restricted stock.....   --     --       --     1,703     (1,703)       --        --        --
  Amortization of
   deferred
   compensation.........   --     --       --       --         227        --        --        227
  Conversion of
   preferred stock to
   common stock.........  (881)  (431)   2,379      431        --         --        --        --
  Accrued interest on
   directors' notes.....   --     --       --       --         --         (17)      --        (17)
  Net income............   --     --       --       --         --         --      7,796     7,796
                          ----  -----   ------  -------    -------      -----   -------   -------
Balances at June 30,
 2000...................   --   $ --    12,164  $18,400    $(1,534)     $(617)  $18,783   $35,032
                          ====  =====   ======  =======    =======      =====   =======   =======
</TABLE>

                             See accompanying notes

                                      F-5
<PAGE>

                              QUALSTAR CORPORATION

                            STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                       Years Ended June 30,
                                                      ------------------------
                                                       1998    1999     2000
                                                      ------  -------  -------
<S>                                                   <C>     <C>      <C>
OPERATING ACTIVITIES
 Net income.......................................... $1,933  $ 3,986  $ 7,796
 Adjustments to reconcile net income to net cash
  provided by operating activities:
  Depreciation and amortization......................    166      205      152
  Deferred income taxes..............................    (40)    (187)    (235)
  Provisions for bad debts and returns...............     53      259       50
  Amortization of deferred compensation..............    --       --       227
  Loss on disposal of property and equipment.........      3        6      --
  Accrued interest on directors' notes...............    --       --       (17)
  Changes in operating assets and liabilities:
   Receivables.......................................   (787)  (2,330)  (2,411)
   Inventories.......................................   (740)    (490)  (4,006)
   Prepaids and other assets.........................     14        8     (160)
   Prepaid income taxes..............................   (356)    (337)    (420)
   Accounts payable..................................     44      186    1,594
   Accrued payroll and related liabilities...........     35      140       26
   Other accrued liabilities.........................     15      124        3
                                                      ------  -------  -------
    Net cash provided by operating activities........    340    1,570    2,599

INVESTING ACTIVITIES
 Purchases of property and equipment.................   (287)    (274)     (93)
 Investment in common stock..........................    --       --    (1,050)
                                                      ------  -------  -------
    Net cash used in investing activities............   (287)    (274)  (1,143)

FINANCING ACTIVITIES
 Repurchase of common stock..........................    (36)     --       --
 Repurchase of preferred stock for retirement........   (183)     --       --
 Proceeds from issuance of common stock, net of
  offering costs.....................................    --       --    15,272
 Proceeds from exercise of stock options.............     51       40      114
                                                      ------  -------  -------
    Net cash (used in) provided by financing
     activities......................................   (168)      40   15,386

NET INCREASE (DECREASE) IN CASH AND CASH
 EQUIVALENTS.........................................   (115)   1,336   16,842
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.......    913      798    2,134
                                                      ------  -------  -------
CASH AND CASH EQUIVALENTS, END OF PERIOD............. $  798  $ 2,134  $18,976
                                                      ======  =======  =======

SUPPLEMENTAL CASH FLOW DISCLOSURES
 Income taxes paid................................... $1,557  $ 3,088  $ 5,619
                                                      ======  =======  =======
</TABLE>

                             See accompanying notes

                                      F-6
<PAGE>

                              QUALSTAR CORPORATION

                         NOTES TO FINANCIAL STATEMENTS

1. Summary of Significant 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 network computing environments. Tape libraries consist of
high-performance cartridge tape drives, storage arrays of tape cartridges and
robotics to move the tape cartridges from their storage locations to the tape
drives under software control. 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 network operating systems, including UNIX, Windows NT, NetWare, and Linux
and a wide range of storage management software. Qualstar offers tape libraries
for multiple tape drive technologies, including those using Linear Tape Open,
Advanced Intelligent Tape, DLT, and quarter inch cartridge tape media.

 Stock Split and Initial Public Offering

   In connection with Qualstar's initial public offering, on March 13, 2000 the
Board of Directors approved a 2.7-for-1 stock split of Qualstar's common stock,
which became effective March 29, 2000. All references in the accompanying
financial statements to the number of shares of common stock and per common
share amounts have been retroactively adjusted to reflect the stock split. In
addition, Qualstar's capital structure was changed, effective as of March 29,
2000, to reflect 50,000,000 authorized shares of common stock and to authorize
an additional 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.

   On June 23, 2000 Qualstar commenced its initial public offering. In the
offering Qualstar sold 2.5 million shares of common stock at $7.00 per share
and received net proceeds of $15.3 million. In July 2000, subsequent to year-
end, Qualstar sold an additional 375,000 shares of common stock resulting in
proceeds of $2.4 million, net of underwriters' commission, as a result of the
underwriters' exercising their over-allotment provisions of the underwriting
agreement. All outstanding Series A Preferred Stock automatically converted
into common stock on June 28, 2000 at a ratio of 2.7-for-1, resulting in the
issuance of 2.4 million shares of common stock.

 Cash and Cash Equivalents

   Qualstar classifies as cash equivalents only cash and those investments that
are short term, highly liquid, readily convertible to cash, and so near their
maturity that they present insignificant risk of changes in value because of
changes in interest rates.

 Concentration of Credit Risk, Other 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.
Credit losses have been within management's expectations and potential
uncollectable accounts have been provided for in the financial statements.

                                      F-7
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


   Sales to customers located outside of the United States represented 26.4% of
net revenues in 1998, 24.0% of net revenues in 1999 and 25.8% of net revenues
in 2000. Revenues from Qualstar's largest customer were 4.3%, 17.0% and 21.7%
for the years ended June 30, 1998, 1999, and 2000, respectively. At June 30,
1999 and 2000 the largest customer's accounts receivable balance totaled 19.8%
and 20.8% of total accounts receivable, respectively.

 Inventories

   Inventories are stated at the lower of cost (first-in, first-out basis) or
market.

 Suppliers

   Sales and cost of goods related to products purchased from the two largest
suppliers totaled approximately 38.0% and 47.0%, respectively, for the year
ended June 30, 1998. Sales and costs of goods sold related to products
purchased from one large supplier totaled approximately 33.0% and 41.0%,
respectively, of total sales and cost of goods sold for the year ended June 30,
1999. Sales and costs of goods sold related to products purchased from one
large supplier totaled approximately 48.0% and 59.7%, respectively, of total
sales and cost of goods sold for the year ended June 30, 2000.

 Property and Equipment

   Property and equipment is depreciated using the straight-line method over
the estimated useful lives (3 to 7 years) of the individual assets. Leasehold
improvements are amortized over the estimated useful lives, or the term of the
related leases, whichever is shorter, using the straight-line method.

 Investment in Common Stock

   In November 1999, Qualstar purchased an approximately 1% interest in
Chaparral Network Storage, Inc. (Chaparral) for an aggregate purchase price of
$1.1 million. This investment is accounted for under the cost method. Chaparral
designs and manufactures RAID controllers and intelligent storage routers for
tape library applications.

 Long-Lived Assets

   Qualstar reviews for the impairment of long-lived assets whenever events or
changes in circumstances indicate the carrying amount of any asset may not be
recoverable. 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. Qualstar
has identified no such impairment losses during the periods presented.

 Revenue Recognition

   Revenues are recognized upon shipment of the product to the customer and
when collectibility is reasonably assured, less estimated returns for which
provisions are made at the time of sale. 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.

                                      F-8
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


 Warranty Costs

   Qualstar generally provides warranties for its products ranging from one to
three years. With respect to drives and tapes used in Qualstar's products, but
manufactured by a third party, Qualstar passes on to the customer the warranty
on such drives and tapes provided by the manufacturer. A provision for costs
related to warranty expense is recorded when revenue is recognized, which is
estimated based on historical warranty costs incurred.

 Research and Development

   All research and development costs are charged to expense as incurred. These
costs consist primarily of engineering salaries, outside consultant fees,
prototype materials and applicable overhead expenses of personnel directly
involved in the design and development of new products.

 Advertising

   Qualstar expenses all costs of advertising and promotion as incurred.
Advertising and promotion expenses for the years ended June 30, 1998, 1999 and
2000, were $415,000, $390,000, and $470,000, respectively.

 Accounting for Stock Based Compensation

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

 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 carrying amounts and the tax bases of
assets and liabilities.

 Comprehensive Income

   In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
(SFAS 130). SFAS 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. To date, the Company has not had any transactions that are required
to be reported as Comprehensive Income.

 Earnings Per Share

   Qualstar calculates earnings per share in accordance with SFAS No. 128,
"Earnings per Share." Basic earnings per share has been computed by dividing
net income by the weighted average number of common shares outstanding. Diluted
earnings per share has been computed by dividing net income 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.


                                      F-9
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

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

<TABLE>
<CAPTION>
                                                         Year Ended June 30,
                                                       ------------------------
                                                        1998     1999    2000
                                                       -------  ------- -------
                                                           (in thousands)
   <S>                                                 <C>      <C>     <C>
   Earnings:
     Net income......................................  $ 1,933  $ 3,986 $ 7,796
     Premium paid on redemption of preferred stock...     (147)     --      --
                                                       -------  ------- -------
     Net income applicable to common shareholders....  $ 1,786  $ 3,986 $ 7,796
                                                       =======  ======= =======
   Shares:
     Weighted average shares for basic earnings per
      share..........................................    6,404    6,629   7,119
     Conversion of Series A Preferred Stock..........    2,476    2,379   2,376
     Stock options...................................      410      459     247
                                                       -------  ------- -------
     Weighted average shares for diluted earnings per
      share..........................................    9,290    9,467   9,742
                                                       =======  ======= =======
</TABLE>

   In 1998, Qualstar repurchased shares of preferred stock at a premium over
carrying value of $147,000.

 Segment Information

   In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" (SFAS 131). This statement establishes
standards for the way companies report information about operating segments in
annual financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
Based on the provisions of SFAS 131 and the manner in which the Chief
Operating Decision Maker analyzes the business, Qualstar has determined that
it does not have separately reportable operating segments.

 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.

 Estimates and Assumptions

   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ materially from those
estimates.

 Reclassification

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

2. Inventories

   Inventories consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                     June 30,
                                                                  --------------
                                                                   1999    2000
                                                                  ------- ------
   <S>                                                            <C>     <C>
   Raw materials................................................. $ 4,103 $7,624
   Finished goods................................................     548  1,033
                                                                  ------- ------
                                                                  $ 4,651 $8,657
                                                                  ======= ======
</TABLE>

                                     F-10
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


3. Property and Equipment

   The components of property and equipment are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                   June 30,
                                                                ----------------
                                                                 1999     2000
                                                                -------  -------
   <S>                                                          <C>      <C>
   Leasehold improvements...................................... $    23  $    23
   Furniture and fixtures......................................     561      518
   Machinery and equipment.....................................   1,406    1,542
                                                                -------  -------
                                                                  1,990    2,083
     Less accumulated depreciation and amortization............  (1,554)  (1,706)
                                                                -------  -------
                                                                $   436  $   377
                                                                =======  =======
</TABLE>

4. Credit Facility

   Qualstar has an unsecured line of credit with a bank which allows for
borrowings of up to $750,000 at the bank's reference rate (7.75% as of June 30,
1999 and 9.50% as of June 30, 2000), plus 1.25%. The line of credit agreement
was amended to extend the expiration date to November 1, 2000. As of June 30,
1999 and 2000, the Company had not borrowed against the line of credit.

5. Income Taxes

   The provision for income taxes for the years ended June 30, 1998, 1999 and
2000, is comprised of the following (in thousands):

<TABLE>
<CAPTION>
                                                       1998     1999     2000
                                                      -------  -------  -------
   <S>                                                <C>      <C>      <C>
   Current:
     Federal......................................... $   967  $ 2,222  $ 4,171
     State...........................................     205      527    1,032
                                                      -------  -------  -------
                                                        1,172    2,749    5,203
   Deferred:
     Federal.........................................     (38)    (173)    (207)
     State...........................................      (2)     (14)     (28)
                                                      -------  -------  -------
                                                          (40)    (187)    (235)
                                                      -------  -------  -------
                                                      $ 1,132  $ 2,562  $ 4,968
                                                      =======  =======  =======
</TABLE>

   The provision for income taxes was reduced by the utilization of
approximately $65,000 and $16,000 of research and development tax credits in
1998 and 1999, respectively.

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

<TABLE>
<CAPTION>
                                                       Years Ended June 30,
                                                       ----------------------
                                                        1998    1999    2000
                                                       ------  ------  ------
   <S>                                                 <C>     <C>     <C>
   Statutory federal income tax expense...............   34.0%   34.0%   34.0%
   State income taxes, net of federal income tax
    benefit...........................................    4.4     5.1     4.9
   Other..............................................   (1.5)    --      --
                                                       ------  ------  ------
                                                         36.9%   39.1%   38.9%
                                                       ======  ======  ======
</TABLE>


                                      F-11
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

   The tax effect of temporary differences resulted in deferred income tax
assets (liabilities) at June 30, 1999 and 2000, as follows (in thousands):

<TABLE>
<CAPTION>
                                                                   1999   2000
                                                                   -----  -----
   <S>                                                             <C>    <C>
   Deferred tax assets:
     Allowance for bad debts and returns.......................... $ 180  $ 201
     Capitalized inventory costs..................................    20     38
     State income taxes...........................................   152    351
     Other accruals...............................................    46     62
                                                                   -----  -----
       Total deferred tax assets..................................   398    652
   Deferred tax liabilities:
     Depreciation.................................................   (41)   (60)
                                                                   -----  -----
     Net deferred tax asset....................................... $ 357  $ 592
                                                                   =====  =====
</TABLE>

   No valuation reserve was established at June 30, 1999 and 2000, based on the
Company's expectations to realize the deferred tax asset.

6. Series A Preferred Stock

   At June 30, 1999, 880,800 shares of preferred stock had been issued as
Series A Preferred Stock. Each share of Series A Preferred Stock was
convertible into 2.7 shares of common stock. All Series A Preferred Shares
automatically converted into a total of 2.4 million shares of common stock upon
completion of Qualstar's initial public offering.

   During 1998, Qualstar paid $183,000 for the retirement of 73,200 shares of
Series A Preferred Stock.

7. Stock Option Plans

   Qualstar adopted a stock option plan in 1985 under which incentive stock
options and nonqualified stock options could be granted for an aggregate of no
more than 1,350,000 shares of common stock. Under the terms of the plan,
incentive stock options and nonqualified options could be issued at an exercise
price of not less than 100% and 85%, respectively, of the fair market value of
common stock as determined by the board of directors on the date of grant.
Options are exercisable in annual installments as specified in each stock
option agreement. Incentive stock options and nonqualified stock options
terminate as specified in each option agreement, but no later than ten years
after the date of grant unless an extension is granted by the board of
directors. The stock option plan expired on March 27, 1995. No new shares may
be granted under the plan after that date; however, outstanding stock options
may be exercised in accordance with their terms.

   Qualstar adopted a new stock option plan in 1998 (1998 Stock Incentive Plan)
under which incentive and nonqualified stock options could be granted for an
aggregate of no more than 270,000 shares of common stock. During fiscal 2000,
Qualstar amended and restated the 1998 stock option plan to increase the pool
of options and shares of restricted stock that 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 as determined by the board of directors
(or board appointed administrator) 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. Options are exercisable in annual installments and terminate as
specified in each option agreement, but terminate no later than ten years after
the date of grant.


                                      F-12
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

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

<TABLE>
<CAPTION>
                                                       Exercise      Weighted
                                              Stock   Price Per      Average
                                             Options    Share     Exercise Price
                                             ------- ------------ --------------
   <S>                                       <C>     <C>          <C>
   Outstanding at July 1, 1997..............   818   $0.15 - 0.26     $0.23
     Granted................................   121           0.56      0.56
     Exercised..............................  (229)   0.15 - 0.26      0.22
                                              ----   ------------     -----
   Outstanding at June 30, 1998.............   710    0.15 - 0.56      0.29
     Granted................................    27           1.11      1.11
     Exercised..............................  (159)   0.22 - 0.56      0.25
     Cancelled..............................   (16)          0.56      0.56
                                              ----   ------------     -----
   Outstanding at June 30, 1999.............   562    0.22 - 1.11      0.34
     Granted................................   137           2.78      2.78
     Exercised..............................  (413)   0.22 - 0.56      0.28
                                              ----   ------------     -----
   Outstanding at June 30, 2000.............   286   $0.22 - 2.78     $1.60
                                              ====   ============     =====
</TABLE>

<TABLE>
<CAPTION>
                                                       Options Exercisable
                 Options Outstanding at June 30, 2000    at June 30, 2000
                 ------------------------------------- --------------------
                                              Weighted             Weighted
                  Number of  Weighted Average Average   Number of  Average
     Exercise      Shares       Remaining     Exercise   Shares    Exercise
   Price Range   Outstanding Contractual Life  Price   Exercisable  Price
   -----------   ----------- ---------------- -------- ----------- --------
   <S>           <C>         <C>              <C>      <C>         <C>
   $0.22              65           0.8          0.22        65       0.22
   $0.56 - 1.11       84           8.2          0.74        31       0.68
   $2.78             137           9.6          2.78        --       2.78
</TABLE>

   On January 14, 2000, each of Qualstar's four non-employee directors were
granted and purchased 54,000 shares of restricted stock pursuant to the 1998
Stock Incentive Plan at a price of $2.78 per share. Each director paid for the
shares with a promissory note in the amount of $150,000 secured by the
purchased shares. Interest on the notes accrues at the rate of 6.21% and is
payable annually. Payments of principal on the notes are due in four equal
annual installments beginning in January 2002. Qualstar, solely at its
discretion, has the right to repurchase each director's restricted shares at
the original purchase price upon termination of service for any reason.
Qualstar's repurchase right lapses and the shares vest ratably over four years
based upon each year of service as a director.

   On January 14, 2000, Qualstar granted stock options to purchase a total of
137,700 shares under the 1998 Stock Incentive Plan at an exercise price of
$2.78 per share. These stock options vest over a four years.

   Upon issuance of the restricted stock and granting of stock options in
January 2000, Qualstar recorded a deferred compensation charge of $1.7 million
related to both the option and restricted stock awards for the difference
between the exercise price and the deemed fair market value for accounting
purposes on the date of the grant. The deferred compensation recorded is being
amortized over the four year vesting period, which resulted in compensation
expense of $227,000 in fiscal 2000.

   If Qualstar recognized employee stock option-related compensation expense in
accordance with SFAS 123 and used the minimum value method for determining the
weighted average fair value of options granted during 1998, 1999 and 2000, its
pro forma net income applicable to common shareholders would have been $1.8
million, $4.0 million and $7.8 million , respectively. The pro forma basic
income per share would have been $0.28, $0.60 and $1.09 for 1998, 1999 and
2000, respectively. The pro forma diluted income per share would

                                      F-13
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

have been $0.19, $0.42 and $0.80 for 1998, 1999 and 2000, respectively. For
purposes of pro forma disclosures, the estimated fair value of the options is
amortized over the options' vesting periods. The pro forma effect on net income
for 1998, 1999 and 2000 is not representative of the pro forma effect on net
income or loss in future years because compensation expense in future years
will reflect the amortization of a larger number of stock options granted in
several succeeding years.

   In computing the pro forma compensation expense under SFAS 123, a weighted-
average fair value of $0.14 for 1998, $0.94 for 1999 and $5.59 for 2000 stock
option grants was estimated at the date of grant using the minimum value option
pricing model with the following assumptions.

<TABLE>
<CAPTION>
                                                       1998     1999     2000
                                                      -------  -------  -------
   <S>                                                <C>      <C>      <C>
   Expected dividend yield...........................       0%       0%       0%
   Risk-free interest rate...........................     6.0%     6.0%     6.5%
   Expected life of options.......................... 5 years  5 years  5 years
</TABLE>

8. Commitments

   Qualstar leases its facility under a lease arrangement expiring January 31,
2001, at an annual rent of $184,000. Qualstar's management can terminate the
lease agreement with 90 days notice. Future minimum lease payments under this
lease and other operating leases are $112,000.

   Rent expense (including equipment rental) for the years ended June 30, 1998,
1999 and 2000, was $184,000, $202,000 and $209,000, respectively.

   Qualstar may be involved in litigation and other legal matters from time to
time in the normal course of business. However, there currently are no material
proceedings pending or, to the knowledge of management, threatened against
Qualstar.

9. Geographic Information

   Information regarding revenues attributable to the Qualstar's primary
geographic operating regions is as follows (in thousands):

<TABLE>
<CAPTION>
                                                          Years Ended June 30,
                                                        ------------------------
                                                          1998    1999    2000
                                                        -------- ------- -------
   <S>                                                  <C>      <C>     <C>
   Revenues:
     North America..................................... $ 14,428 $23,032 $37,789
     Europe............................................    2,751   4,504   7,594
     Asia..............................................    1,041   1,380   3,642
     Other.............................................      935     782     327
                                                        -------- ------- -------
                                                        $ 19,155 $29,698 $49,352
                                                        ======== ======= =======
</TABLE>

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

10. 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 one year of employment and may
contribute up to 15% of their compensation. Qualstar may make matching
contributions

                                      F-14
<PAGE>

                              QUALSTAR CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

at a rate of 25% up to 6% of the amount contributed by eligible participants at
the discretion of management. Qualstar's contributions under the Plan totaled
$27,000, $27,000 and $33,000 for the years ended June 30, 1998, 1999 and 2000,
respectively.

11. Related Party Transactions

   Qualstar's outside counsel became a member of its board of director, in
January 2000. During the year ended June 30, 2000, Qualstar paid $429,000 to
the law firm in which the director is a shareholder, of which $407,000 related
to our initial public offering.

12. Quarterly Results of Operations (unaudited)

<TABLE>
<CAPTION>
                                                Three Months Ended
                                   ---------------------------------------------
                                   September 30, December 31, March 31, June 30,
                                   ------------- ------------ --------- --------
<S>                                <C>           <C>          <C>       <C>
Fiscal 1999:
Net sales.........................    $ 6,588      $ 6,151     $ 7,904  $ 9,055
Gross profit......................      2,395        2,112       3,117    3,016
Net income........................        874          672       1,282    1,158

Net earnings per share:
  Basic...........................    $  0.13      $  0.10     $  0.20  $  0.17
  Diluted.........................       0.10         0.07        0.13     0.12

Fiscal 2000:
Net sales.........................    $11,430      $11,092     $12,374  $14,456
Gross profit......................      4,328        4,214       4,398    5,497
Net income........................      1,879        1,711       1,900    2,306
Net earnings per share:
  Basic...........................    $  0.28      $  0.25     $  0.27  $  0.30
  Diluted.........................       0.20         0.18        0.19     0.23
</TABLE>


                                      F-15
<PAGE>

                                                                     SCHEDULE II

                              QUALSTAR CORPORATION

                       VALUATION AND QUALIFYING ACCOUNTS
                        ALLOWANCE FOR DOUBTFUL ACCOUNTS
               For the Years Ended June 30, 1998, 1999, and 2000

<TABLE>
<CAPTION>
        Column A          Column B  Column C             Column D     Column E
------------------------ ---------- --------          -------------- ----------
                                    Charged
                         Balance at to Costs Charged                 Balance at
                         Beginning    and    to Other                  End of
      Description        of Period  Expenses Accounts Deductions (1)   Period
------------------------ ---------- -------- -------- -------------- ----------
<S>                      <C>        <C>      <C>      <C>            <C>
Year Ended June 30,
 1998...................  $150,000  $ 53,000  $ --       $ 38,000     $165,000
Year Ended June 30,
 1999...................   165,000   259,000    --          4,000      420,000
Year Ended June 30,
 2000...................   420,000   152,000    --        102,000      470,000
</TABLE>
--------
(1) Uncollectible accounts written off, net of recoveries.

                                      S-1
<PAGE>

                                   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.

Date: September 28, 2000

                                          QUALSTAR CORPORATION

                                          By:    /s/ William J. Gervais
                                             -----------------------------
                                                    William 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.

<TABLE>
<CAPTION>
            Signature                            Title                       Date
            ---------                            -----                       ----

<S>                                <C>                                <C>
   /s/ William J. Gervais          Chief Executive Officer,            September 28, 2000
_________________________________   President and Director
       William J. Gervais           (principal executive officer)

   /s/ Richard A. Nelson           Vice President, Engineering,        September 28, 2000
_________________________________   Secretary and Director
        Richard A. Nelson

   /s/ Matthew Natalizio           Vice President and Chief            September 28, 2000
_________________________________   Financial Officer (principal
        Matthew Natalizio           financial and accounting
                                    officer)

   /s/ Bruce E. Gladstone          Director                            September 28, 2000
_________________________________
       Bruce E. Gladstone

    /s/ Trude C. Taylor            Director                            September 28, 2000
_________________________________
         Trude C. Taylor

     /s/ Robert E. Rich            Director                            September 28, 2000
_________________________________
         Robert E. Rich

    /s/ Robert T. Webber           Director                            September 28, 2000
_________________________________
        Robert T. Webber
</TABLE>

                                      S-2