##### Table of Contents



SECURITIES AND EXCHANGE
    COMMISSION
 Washington, D.C. 20549
  FORM 10-K
  þ

ANNUAL REPORT PURSUANT TO
    SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934FOR THE FISCAL YEAR ENDED
    JUNE 30, 2006o

TRANSITION REPORT PURSUANT TO
    SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934FOR THE TRANSITION PERIOD
    FROM          TO       COMMISSION FILE NUMBER
    000-30083
  QUALSTAR CORPORATION
  CALIFORNIA

95-3927330(STATE OF
    INCORPORATION)

(I.R.S. EMPLOYER ID
    NO.)   3990-B HERITAGE OAK COURT, SIMI VALLEY, CA 93063
 (805) 583-7744
   Securities registered pursuant to Section 12(b) of the
    Act:
    Title
    of Each Class:

Name
    of Each Exchange on Which Registered:Common Stock

The NASDAQ Stock Market LLC   Securities registered pursuant to Section 12(g) of the
    Act:
    None
  o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
 o o þ
  Rule 12b-2).  Yes o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE
  Form 10-K.




---



##### 



QUALSTAR
    CORPORATION
  FORM 10-K
  FOR THE FISCAL
    YEAR ENDED JUNE 30, 2006
  INDEX
  
  PART IItem 1.


Business


1Executive Officers
    of the Registrant


12Item 1A.


Risk
    Factors


13Item 1B.


Unresolved Staff
    Comments


22Item 2.


Properties


22Item 3.


Legal
    Proceedings


22Item 4.


Submission of
    Matters to a Vote of Security Holders


22PART IIItem 5.


Market for
    Registrants Common Equity, Related Stockholder Matters,
    and Issuer Purchases of Equity Securities


22Item 6.


Selected Financial
    Data


23Item 7.


Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


24Item 7A.


Quantitative and
    Qualitative Disclosures about Market Risk


30Item 8.


Financial
    Statements and Supplementary Data


30Item 9.


Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


51Item 9A.


Controls and
    Procedures


51Item 9B.


Other
    Information


51PART IIIItem 10.


Directors and
    Executive Officers of the Registrant


52Item 11.


Executive
    Compensation


52Item 12.


Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


52Item 13.


Certain
    Relationships and Related Transactions


52Item 14.


Principal
    Accountant Fees and Services


52PART IVItem 15.


Exhibits and
    Financial Statement Schedules


53Signatures


54Exhibit Index


55EXHIBIT 10.4EXHIBIT 10.45EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2




---



##### Table of Contents



FORWARD-LOOKING
    STATEMENTS
  Form 10-K
 PART IITEM 1. BUSINESSINTRODUCTION



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



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



Qualstar was incorporated in California in 1984. Our initial
    products were IBM compatible 9-track
    reel-to-reel
    tape drives. In 1995, we entered the tape automation market with
    a series of tape libraries incorporating 8mm tape drives. Since
    that time, we have introduced a succession of tape library
    models designed to work with the leading automation-capable tape
    drive technologies. Automated tape libraries and related
    products, such as tape drives and tape media, represented
    approximately 66.2% of revenues for fiscal 2006, approximately
    75.1% of revenues for fiscal 2005, and approximately 81.4% of
    revenues for fiscal 2004. Sales of power supplies, services and
    other products accounted for the balance of our revenues.



In July 2002, we purchased the assets of N2Power, Incorporated,
    a supplier of ultra small high efficiency open-frame switching
    power supplies. Power supplies provided by N2Power are utilized
    within some of our tape library products as well as sold to
    original equipment manufacturers and contract manufacturers for
    incorporation into their products. N2Power products are sold
    under the N2Power brand name as well as under a private label
    brand name through independent sales representatives and

1




---



##### Table of Contents



INDUSTRY
    BACKGROUND
    FACTORS DRIVING
    GROWTH IN DATA STORAGE
  
    Increased demand from Internet businesses.  The
    growth in the Internet has created businesses that depend on the
    creation, access to and archival storage of data. We believe
    this demand will continue to grow as individuals and businesses
    increase their reliance on the Internet for communications,
    commerce and data retrieval.
    Growth in new types of data.  New types of data
    are also fueling the growth in data storage. For example,
    graphics, audio, video, medical and security images, and
    multi-media uses such as video on demand, require far greater
    storage capacity than text and financial data.
    Recognition of the critical importance of
    data.  Corporate databases contain useful
    information about customer records, order patterns and other
    factors that can be analyzed and transformed into a valuable
    asset and a competitive advantage. The ability to efficiently
    store, manage and protect this information is important to the
    value and success of many businesses. The usefulness of past and
    present data is further enhanced by sophisticated data mining
    software applications that can access and analyze large
    databases.
    Growing awareness of the need for disaster
    protection.  Companies are recognizing that
    without their data they may not survive. Natural disasters, as
    well as overt and covert actions targeted at individual
    companies, classes of users or whole countries, can destroy data
    and entire data centers, threatening a companys very
    existence. Systematic replication and secure off-site storage of
    corporate data is recognized as the best defense against
    catastrophic data loss. Tape libraries are a key technology in
    most corporate data disaster protection plans.
    Compliance with new regulatory requirements for records
    retention.  Many businesses now have to deal with
    new regulatory requirements from various governmental agencies
    that require businesses to retain data for longer periods of
    time. The regulations that have received the most visibility
    include HIPAA requirements covering medical records;
    Sarbanes-Oxley, which addresses corporate governance; and
    Rule 17a under the Securities Exchange Act of 1934,
    regarding recordkeeping requirements for the securities
    industry. These regulations and others are projected to increase
    demand for long-term storage capacity over the next few years.
    Growth in network computing applications and
    data.  The use of computer networks has shifted
    critical information and applications to network servers to
    allow more people to gain access to stored data as well as to
    create new data. As the speed of network computing has
    increased, numerous new applications have become feasible such
    as computer fax and
    e-mail, all
    of which generate progressively more data. Organizations are
    increasingly aware of the need to protect this data, as networks
    become a mission-critical element of many operations. 2




---



##### Table of Contents




    Decrease in the costs of storing data.  The
    costs of data storage have decreased with advances in technology
    and improved manufacturing processes. We expect these costs to
    continue to decrease. The decrease in the cost of data storage
    encourages the storage of more data and makes it more cost
    effective to simply add more storage capacity than to remove old
    data, which in the past may have been purged periodically.  ADVANCES IN
    STORAGE MANAGEMENT TECHNOLOGIES
    
    Fibre Channel.  Fibre Channel is an interface
    technology based on industry standards for the connection of
    storage devices to networks. Interface is the term used to
    describe the electronics, cabling and software used to
    facilitate communications between devices. With Fibre Channel,
    users are better able to share stored information with other
    storage devices and servers over longer distances, with faster
    data transfer speeds, thereby increasing the importance of
    storage area networks.
    Storage Area Networks.  Storage Area Network,
    or SAN, architecture applies the inherent benefits of a
    networked approach to data storage applications, which allows
    data to move efficiently and reliably between multiple storage
    devices and servers. The benefits of SAN architecture also
    include increasing the expandability of existing storage
    solutions and providing a higher level of connectivity than
    exists with traditional technologies. Additionally, SANs are
    able to provide these benefits across multiple operating systems.
    Advanced storage management software.  This
    software automatically migrates infrequently accessed data to
    the lower cost storage medium such as a tape library. A
    users request for this data at some later date will recall
    the data automatically from the tape library. This process
    reduces the overall storage cost by using the least expensive
    storage medium to store data that is not expected to be needed
    on a frequent basis. Advances in storage management software
    have increased the ability of businesses to more
    cost-effectively store, manage and retrieve data, which in turn
    allows businesses to operate more efficiently.
    Network Attached Storage.  Current storage
    devices are dependent on a file server for all commands and
    control. Network attached storage devices give storage devices
    file server functionality, which allow users to plug a storage
    device directly into a network without requiring a separate file
    server. This allows users to maintain, or even enhance, system
    performance while saving on both time and cost.  TYPES OF DATA
    STORAGE
   3




---



##### Table of Contents



TAPE LIBRARIES
    AND APPLICATIONS
        
    Automated backup.  Backup is the creation of a
    duplicate copy of current data for the purpose of recovering the
    data in the event the original is lost or damaged. An automated
    tape library, in conjunction with storage management software,
    can backup network data at any time without human intervention.
    A library with multiple tape drives can backup data using all of
    its drives simultaneously, thus significantly speeding up the
    recording process. Backup tapes can be removed from the library
    and stored in an off-site location for protection against a loss
    of the primary site.
    Archiving.  Archiving is the storage of data
    for historical purposes. When information is stored on tape,
    automated tape libraries, under application control, can catalog
    tapes for future retrieval and prevent unauthorized removal or
    corruption of data by using password or key lock protection.
    Archival tapes provide a historic record for use in fraud
    detection, audit, legal and other processes. Tape libraries are
    also used for archiving due to benefits offered by the tape
    medium, such as long-term data integrity, resistance to
    environmental contamination, ease of relocation, low cost, and
    the availability of Write Once Read Many or WORM
    tapes.
    Image management.  Storage-intensive
    applications such as satellite mapping and medical image
    management systems are turning to tape libraries because of the
    cost advantage over traditional storage methods. X-ray images or
    MRI results, for instance, must frequently be kept on file for
    years. Storing a digitized image in a tape library costs
    considerably less than storing a film copy, and can be retrieved
    years later with the click of a mouse.  DISTRIBUTION OF
    TAPE LIBRARY PRODUCTS
     4




---



##### Table of Contents



OUR
    SOLUTIONS
    back-up
      STRATEGY
    
    Offer libraries for multiple tape drive
    technologies.  We offer tape libraries for a range
    of tape drive technologies, including LTO, AIT, Super AIT, and
    SuperDLT. By offering products based on multiple tape drive
    technologies, we reduce our dependence on the success of any
    single tape technology and can offer products that target the
    specific preferences of resellers and original equipment
    manufacturers and their end user customers.
    Focus on value added reseller channels.  We
    sell our products primarily through selected value added
    resellers who have a strong market presence, have demonstrated
    the ability to work directly 5




---



##### Table of Contents



with end users, and who maintain relationships with major
    vendors of storage management software. Because we market our
    products primarily through this channel, we have implemented a
    variety of programs to support and enhance our relationships
    with our reseller partners. These programs are designed to
    benefit the reseller and increase the likelihood of selling our
    products. We intend to maintain our marketing presence in
    support of this channel. We conduct business with our value
    added resellers on an individual purchase order basis and no
    long-term purchase commitments are involved.  
    Maintain and strengthen original equipment manufacturer
    relationships.  We sell our products to several
    companies under private label or original equipment manufacturer
    relationships. Original equipment manufacturer sales enable us
    to reach some end users not served by our value added resellers.
    The same product characteristics that make our tape libraries
    attractive to value added resellers also are important to
    original equipment manufacturers. We conduct business with our
    original equipment manufacturer customers on an individual
    purchase order basis and no long-term purchase commitments are
    involved.
    Develop libraries for new tape
    technologies.  The tape drive industry is
    continuously advancing the state of technology. We will continue
    to design new libraries for those technologies that appear
    promising and that meet our standards for capacity, quality and
    reliability.    PRODUCTS
  Tape
    Libraries
    Tape Drive

Range of Tape


Maximum
    CapacityProduct
    Family

Technology

Cartridges


in
    Terabytes(1)TLS-4000

Sony AIT


12 to 600



120.0TLS-5000

Sony SAIT


33 to 264



132.0TLS-6000

Quantum SDLT


10 to 240



72.0TLS-8000

LTO


11 to 264



105.6RLS-4000

Sony AIT


22 to 70



14.0RLS-5000

Sony SAIT


16 to 44



22.0RLS-6000

Quantum SDLT


27



8.1RLS-8000

LTO


12 to 44



17.6XLS Series

LTO


295-2805
(2)


1122.0
(2)     (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)
    
    2,805 tapes and 1,122.0 terabytes reflect the product
    configuration at its initial release stage. Planned future
    releases of internal firmware will allow expansion to as high as
    6,265 tapes and 2,506.0 terabytes using LTO-3 tape technology.   6




---



##### Table of Contents




    Rapid tape drive replacement.  We design our
    libraries so that a tape drive can be replaced quickly without
    special tools. This feature minimizes the off-line time required
    when a tape drive must be replaced, and frequently avoids the
    high cost and delays of a service call.
    Fibre Channel connectivity.  We offer a Fibre
    Channel option on many of our models for connection to Storage
    Area Networks and other high performance applications.
    Closed-loop servo control.  Our tape libraries
    use digital closed-loop servo control for robotic motion to
    provide precise tape handling. This yields motion that is
    smooth, repeatable and highly reliable.
    Brushless motors.  Motors are a key component
    in any robotic system. We use only brushless electric motors in
    our tape libraries. Brushless motors provide longer life and
    less electrical noise compared to conventional brush-type
    motors. We build many of our own motors in order to obtain
    optimum performance and reliability.
    Remote management.  Many larger companies with
    global
    back-up
    requirements or disaster management programs require tape
    libraries that can be located off-site in various regions, but
    that must be administered from a single location. With our
    remote library manager, customers can put libraries anywhere in
    the world and manage them from a single administrative hub using
    a standard web browser.  back-up
  Power
    Supplies
   7




---



##### Table of Contents



3 4
    Other
    Products
    SALES AND
    MARKETING
  Sales
      
    Higher profit margins.  Focusing on this
    channel, we achieve economies that result in higher profit
    margins to be shared by both the reseller and us.
    Custom configurations.  We offer custom
    configurations of our products, such as special paint, private
    branding and non-standard options, on very short notice.
    Channel conflicts avoided.  We refer
    substantially all end user inquiries to our reseller partners.
    Frequently, our sales force will make end user visits with
    resellers to help close a pending sale.
    Credit.  We extend credit terms to resellers
    who meet our credit requirements.
    Rapid delivery.  We generally ship a product
    within one to three working days of confirming an order,
    rivaling the delivery time of competitors that use distributors
    to bring products to market.       8




---



##### Table of Contents



Marketing
        CUSTOMER SERVICE
    AND TECHNICAL SUPPORT
    
    Technical support.  Our technical support
    personnel are available twenty-four hours per day, Monday
    through Friday. Technical support personnel are available to all
    customers at no charge by telephone, facsimile and
    e-mail to
    answer questions and solve problems relating to our products.
    Estimated costs of this service are provided for when revenue is
    recognized. Our technical support personnel are trained in all
    aspects of our products. Our support staff is located at our
    headquarters in Simi Valley, California. We sell service
    contracts for
    on-site
    service of our tape libraries installed within the United States
    and Canada, which are fulfilled by IBM Corporation and
    on-site
    service contracts sold in Europe are fulfilled by Eastman Kodak
    S.A. Commercial Imaging Group.
    Sales engineering.  Our engineers provide
    pre-sales support to our resellers, and post-sales support if
    necessary. Engineers typically become involved in more complex
    problem-solving situations involving interactions between our
    products, third-party software, network server hardware and the
    network operating systems. Engineers work with resellers and end
    users over the telephone and at an end user site as required.
    Training.  We offer a product maintenance
    training program for end users, value added resellers, original
    equipment manufacturers, customer service and technical support
    personnel. We conduct training classes at our headquarters.
    Warranty.  The warranty period on our tape
    libraries is three years. Some TLS and all RLS models have three
    year advance replacement warranty coverage that provides for
    replacement of components or, if necessary, complete libraries.
    All other TLS models have a one year advance replacement
    warranty with the second and third year being
    return-to-factory
    for service at no charge. Customers may purchase extended
    advance replacement service coverage and
    on-site
    service if they are located in the United States, Canada and
    some countries within Europe.  MANUFACTURING AND
    SUPPLIERS
  eight-hour
   9




---



##### Table of Contents



off-the-shelf
    COMPETITION
        
    reliability of the robotic assembly that handles the tape
    cartridges;
    initial purchase price;
    storage capacity;
    speed of data transfer;
    compatibility with existing operating systems and storage
    management software;
    after-sale expandability of a tape library to meet increasing
    storage requirements;
    expected product life, cost of maintenance and total cost of
    ownership; and
    physical configuration and power requirements of the library. 10




---



##### Table of Contents



RESEARCH AND
    DEVELOPMENT
              INTELLECTUAL
    PROPERTY
     11




---



##### Table of Contents



EMPLOYEES
   EXECUTIVE
    OFFICERS OF THE REGISTRANT
    Executive Officers



Officers are elected by and serve at the discretion of the board
    of directors. The executive officers of Qualstar as of
    September 25, 2006 are: Name

Age

PositionWilliam J. Gervais


63


Chief Executive Officer,
    President, Director and Acting Chief Financial Officer(1)Richard A. Nelson


63


Vice President of Engineering,
    Secretary and DirectorDavid L. Griffith


49


Vice President of OperationsRobert K. Covey


59


Vice President of MarketingRobert C. King


62


Vice President of Sales     (1)
    
    Our previous Chief Financial Officer resigned effective as of
    August 18th,
    2006. We are actively searching for a new Chief Financial
    Officer. In the interim, Mr. Gervais is serving in the
    capacity of Chief Financial Officer.  Background
  William J. Gervais
  Richard A. Nelson
  David L. Griffith
  Robert K. Covey
 12




---



##### Table of Contents



Robert C. King
 ITEM 1A.
    RISK FACTORS  Form 10-K
  RISKS RELATED TO
    OUR BUSINESS
    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.
    Our lack of
    significant order backlog makes it difficult to forecast future
    revenues and operating results.
    Our research and
    development spending may not yield results that justify the
    costs incurred.
   13




---



##### Table of Contents



Our customers
    have the right to return our products in certain circumstances.
    An excessive number of returns may reduce our
    revenues.
      We may spend
    money pursuing sales that do not occur when anticipated or at
    all.
    We sell a
    significant portion of our products to customers located outside
    the United States. Currency fluctuations and increased costs
    associated with international sales could make our products
    unaffordable in foreign markets, which would reduce our revenue
    or profitability.
    
    political and economic instability may reduce demand for our
    products or our ability to market our products in foreign
    countries;
    although we denominate our international sales in
    U.S. dollars, currency fluctuations could make our products
    unaffordable to foreign purchasers or more expensive compared to
    those of foreign manufacturers;
    restrictions on the export or import of technology may reduce or
    eliminate our ability to sell in certain markets;
    greater difficulty of administering business overseas may
    increase the costs of foreign sales and support;
    foreign governments may impose tariffs, quotas and taxes on our
    products;
    longer payment cycles typically associated with international
    sales and potential difficulties in collecting accounts
    receivable may reduce the profitability of foreign
    sales; and
    our current determination not to seek ISO-9000 certification, a
    widely accepted method of establishing and certifying the
    quality of a manufacturers operations, may reduce sales.   14




---



##### Table of Contents



A failure to
    develop and maintain proprietary technology may negatively
    affect our business.
    Intellectual
    property infringement claims brought against us could be time
    consuming and expensive to defend.
    
    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.    Our warranty
    reserves may not adequately cover our warranty
    obligations.
    Our revenues and
    operating results may fluctuate unexpectedly from quarter to
    quarter, which may cause our stock price to decline.
    
    general economic conditions affecting spending for information
    technology;
    increased competition and pricing pressures;
    reductions in the size, delays in the timing, or cancellation of
    significant customer orders;
    shifts in product or distribution channel mix;
    the timing of the introduction or enhancement of products by us,
    our original equipment manufacturer customers or our competitors;
    expansions or reductions in our relationships with value added
    reseller and original equipment manufacturer customers; 15




---



##### Table of Contents




    financial difficulties affecting our value added reseller or
    original equipment manufacturer customers that render them
    unable to pay amounts owed to us;
    market acceptance of new and enhanced versions of our products;
    new product developments by storage device manufacturers, such
    as disk drives, that could render our products less cost
    effective or less competitive;
    the rate of growth in the data storage market and the various
    segments within it;
    timing and levels of our operating expenses; and
    availability of key components and performance of key suppliers.      Our officers and
    directors could implement corporate actions that are not in the
    best interests of our shareholders as a whole.
    
    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.
    We do not
    currently intend to pay dividends and therefore you will only be
    able to recover your investment in our common stock, if at all,
    by selling the shares of the stock that you own.
   16




---



##### Table of Contents



Trading in our
    stock has been limited and our stock price has been volatile.
    Consequently, it may be difficult to sell your shares.
    
    quarterly variations in operating results, especially if they
    differ from our previously announced forecasts or forecasts made
    by analysts;
    our announcements of anticipated future revenues or operating
    results;
    announcements concerning us, our competitors, our customers, or
    our industry;
    the introduction of new technology or products by us or our
    competitors;
    comments regarding us and the data storage market made by
    industry analysts or on Internet bulletin boards;
    changes in earnings estimates by analysts or changes in
    accounting policies;
    changes in product pricing policies by us or our
    competitors; and
    changes in general economic conditions.    RISKS RELATED TO
    OUR TAPE LIBRARY BUSINESS
    Our principal
    competitors devote greater financial resources to developing,
    marketing and selling automated tape libraries. Consequently, we
    may be unable to maintain or increase our market
    share.
    
    acquired other tape library companies;
    increased the geographic scope of their market;
    offered a wider range of tape library products; and
    developed and acquired proprietary software and disk based
    products that operate in conjunction with their products and the
    products of their competitors. 17




---



##### Table of Contents




    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.    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.
      
    Sony Electronics, Inc. is our sole-source supplier of AIT and
    Super AIT drives and media. In the past, Sony has allocated some
    of their products and may allocate them again in the future. In
    fiscal 2006 we derived approximately $7.9 million or 36.4%
    of our revenues, in fiscal 2005 we derived approximately
    $12.0 million, or 47.8%, of our revenues, and in fiscal
    2004 we derived approximately $16.1 million, or 51.1% of
    revenues from the sale of libraries, tape drives and tape media
    based on Sony AIT and Super AIT technologies. If Sony reduces
    its sales to us or raises its prices, we could lose revenues and
    our margins could decline.
    Quantum Corporation is our sole-source supplier of SuperDLT 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 SuperDLT tape drive requirements.
    The LTO standard was developed by an industry consortium
    consisting of IBM, Hewlett Packard and Quantum/Certance. LTO
    competes with AIT and other half-inch tape drives and media. All
    three drive suppliers also sell automated tape libraries that
    utilize LTO tape drives and compete with our products.
    Therefore, even if we receive adequate allocation, it may be at
    a price that renders our products uncompetitive.   18




---



##### Table of Contents



Our revenues
    could decline if we fail to execute our distribution strategy
    successfully.
      
    we may reach fewer customers because we depend on value added
    resellers to market to end users and these value added resellers
    may fail to market effectively or fail to devote sufficient or
    effective sales, marketing and technical support to the sales of
    our products;
    we may lose sales because many of our value added resellers sell
    products that compete with our products. These value added
    resellers may reduce their marketing efforts for our products in
    favor of products manufactured by our competitors;
    our costs may increase as value added resellers generally
    require a higher level of customer support than do original
    equipment manufacturers; and
    as the market for tape libraries matures, we expect that tape
    libraries designed for small and medium size businesses will not
    require the level of sales, marketing and technical support
    traditionally provided by value added resellers and,
    consequently, tape libraries for these customers will be
    increasingly sold through distribution channels rather than
    through value added resellers.      We rely on tape
    technology for a substantial part of our revenues. Our business
    will be harmed if demand for storage solutions using tape
    technology declines or fails to develop as we expect.
   19




---



##### Table of Contents



If we fail to
    develop and introduce new products on a timely and
    cost-effective basis, or if our products do not contain the
    features required by the marketplace, we will eventually lose
    market share and sales to more innovative competitors.
        We depend upon
    independent software vendors to provide management software that
    makes our tape libraries functional.
    
    supplying tape libraries so they can qualify their software to
    work with our tape libraries;
    evaluating their software for compatibility with our tape
    libraries;
    keeping them informed as to current and contemplated changes to
    our products; and
    referring business to them when value added resellers or end
    users inquire about software sources.  We may have to
    expend significant amounts of time and money defending or
    settling product liability claims arising from failures of our
    tape libraries.
    Undetected flaws
    could increase our costs, reduce our revenues and divert
    resources from our core business needs.
   20




---



##### Table of Contents




    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.    
    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.    RISKS RELATED TO
    OUR POWER SUPPLY BUSINESS
    We depend on a
    single contract manufacturer for the majority of our power
    supplies. Loss of this supplier could harm our
    business.
    Environmental
    health and safety laws may restrict our operations.
    Price erosion may
    have a material adverse effect on our margins and
    profitability.
   21




---



##### Table of Contents



ITEM 1B.
    UNRESOLVED STAFF COMMENTS   ITEM 2.
    PROPERTIES     ITEM 3.
    LEGAL PROCEEDINGS   ITEM 4.
    SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS   PART II ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
    MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES    Period

Date
    Range

High


LowFiscal 2006:First Quarter

July 1 
    September, 30, 2005

$
4.51


$
3.55Second Quarter

October 1 
    December 31, 2005

$
5.00


$
3.21Third Quarter

January 1 
    March 31, 2006

$
4.50


$
3.30Fourth Quarter

April 1 
    June 30, 2006

$
4.20


$
3.00Fiscal 2005:First Quarter

July 1 
    September, 30, 2004

$
6.44


$
5.00Second Quarter

October 1 
    December 31, 2004

$
6.94


$
4.33Third Quarter

January 1 
    March 31, 2005

$
5.00


$
4.00Fourth Quarter

April 1 
    June 30, 2005

$
4.55


$
3.53    22




---



##### Table of Contents



ITEM 6.
    SELECTED FINANCIAL DATA  10-K.
  Years Ended
    June 30,2006


2005


2004


2003


2002(In thousands,
    expect per share amounts)Statements of Income
    Data:Net revenues

$
21,731


$
25,144


$
31,530


$
33,557


$
37,631Cost of goods sold


14,856



16,529



19,575



21,171



23,753Gross profit


6,875



8,615



11,955



12,386



13,878Operating expenses:Research and development


3,083



3,750



4,268



3,994



2,136Sales and marketing


3,213



3,350



3,607



3,834



3,048General and administrative


3,629



3,955



5,420



4,428



5,222Total operating expenses


9,925



11,055



13,295



12,256



10,406Income (loss) from operations


(3,050
)


(2,440
)


(1,340
)


130



3,472Investment income


1,269



858



624



693



1,133Impairment loss for
    other-than-temporary
    decline in investments










(160
)






Income (loss) before income taxes


(1,781
)


(1,582
)


(876
)


823



4,605Provision (benefit) for income
    taxes


(89
)


65



(145
)


274



1,845Net income (loss)

$
(1,692
)

$
(1,647
)

$
(731
)

$
549


$
2,760Earnings (loss) per share:Basic

$
(0.14
)

$
(0.13
)

$
(0.06
)

$
0.04


$
0.22Diluted

$
(0.14
)

$
(0.13
)

$
(0.06
)

$
0.04


$
0.22Shares used to compute earnings
    (loss) per share:Basic


12,253



12,398



12,577



12,579



12,475Diluted


12,253



12,398



12,577



12,666



12,664   June 30,2006


2005


2004


2003


2002(In
    thousands)Balance Sheet Data:Cash and cash equivalents

$
6,845


$
12,210


$
6,401


$
6,236


$
4,859Marketable securities


26,822



21,854



29,376



29,857



25,987Working capital


29,012
*


25,121
*


46,534



47,191



46,507Total assets


45,399



47,223



51,647



52,096



50,758Total debt


















Shareholders equity


42,858



44,653



48,064



48,868



47,973   *
    In fiscal 2006 and 2005, certain marketable securities were
    reclassified to long-term assets. 23




---



##### Table of Contents



ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
    AND RESULTS OF OPERATIONS    OVERVIEW
            on-site
       24




---



##### Table of Contents



CRITICAL
    ACCOUNTING POLICIES AND ESTIMATES
      Revenue
    Recognition
      Allowance for
    Doubtful Accounts
    Inventory
    Valuation
   25




---



##### Table of Contents



Warranty
    Obligations
    Share-Based
    Compensation
    Accounting for
    Income Taxes
         26




---



##### Table of Contents



RESULTS OF
    OPERATIONS
    Years Ended
    June 30,2006


2005


2004Net revenues


100.0
%


100.0
%


100.0
%Cost of goods sold


68.4



65.7



62.1Gross margin


31.6



34.3



37.9Operating expenses:Research and development


14.2



14.9



13.5Sales and marketing


14.8



13.4



11.4General and administrative


16.7



15.7



17.2Loss from operations


(14.1
)


(9.7
)


(4.2
)Investment income


5.8



3.4



2.0Impairment loss for
    other-than-temporary
    decline in investments










(0.6
)Loss before provision (benefit)
    for income taxes


(8.3
)


(6.3
)


(2.8
)Provision (benefit) for income
    taxes


(0.4
)


0.3



(0.5
)Net loss


(7.9
)%


(6.6
)%


(2.3
)%     Years Ended
    June 30,2006


2005


2004Tape Library revenues:TLS


42.6
%


51.7
%


56.4
%RLS


12.2



13.1



15.554.8



64.8



71.9Other revenues:Service


14.5



10.5



7.6Media


11.4



10.3



9.5Power Supplies


11.9



5.1



1.8Upgrades, Spares, 9 Track


7.4



9.3



9.2100.0
%


100.0
%


100.0
%   Fiscal 2006
    Compared to Fiscal 2005
  Net Revenues.
    Gross Profit.
 27




---



##### Table of Contents



Research and Development.
  Sales and Marketing.
  General and Administrative.
  Investment Income.
  Provision for Income Taxes.
  Fiscal 2005
    Compared to Fiscal 2004
  Net Revenues.
      Gross Profit.
  Research and Development.
 28




---



##### Table of Contents



Sales and Marketing.
  General and Administrative.
  Investment Income and Impairment Loss for
    Other-than-Temporary
    Decline in Investments. other-than-temporary No. 03-1.
  Provision for Income Taxes.
  LIQUIDITY AND
    CAPITAL RESOURCES
         29




---



##### Table of Contents



SUMMARY OF
    CONTRACTUAL OBLIGATIONS AND COMMITMENTS
    Operating


PurchaseYear Ended
    June 30

Leases


Obligations


Total(In
    thousands)2007

$
592


$
1,698


$
2,2892008


554







5542009


570







5702010


588







5882011


307







307$
2,611


$
1,698


$
4,308     OFF-BALANCE SHEET
    ARRANGEMENTS
   ITEM 7A.
    QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET
    RISK   ITEM 8.
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA  Page(1) Consolidated Financial
    StatementsReport of Independent Registered
    Public Accounting Firm


31Consolidated Balance Sheets


32Consolidated Statements of
    Operations


33Consolidated Statements of
    Shareholders Equity


34Consolidated Statements of Cash
    Flows


35Notes to Consolidated Financial
    Statements


36  30




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
   The Board of
    Directors and Shareholders of Qualstar Corporation
              31




---



##### Table of Contents



QUALSTAR
    CORPORATION
  CONSOLIDATED
    BALANCE SHEETS
 (In
    thousands)
  June 30,2006


2005ASSETSCurrent assets:Cash and cash equivalents

$
6,845


$
12,210Marketable securities, short-term


14,040



3,700Accounts receivable, net of
    allowances of $118 at June 30, 2006 and $248 at
    June 30, 2005


2,700



3,532Inventories


7,298



7,157Prepaid expenses and other current
    assets


511



452Prepaid income taxes


159



640Total current assets


31,553



27,691Property and equipment, net


924



1,188Marketable securities, long-term


12,782



18,154Other assets


140



190Total assets

$
45,399


$
47,223LIABILITIES AND
    SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
783


$
763Accrued payroll and related
    liabilities


466



496Other accrued liabilities


1,292



1,311Total current liabilities


2,541



2,570Shareholders equity:Preferred stock, no par value;
    5,000 shares authorized; no shares issued






Common stock, no par value;
    50,000 shares authorized, 12,253 shares issued and
    outstanding as of June 30, 2006 and June 30, 2005,
    respectively


18,503



18,370Accumulated other comprehensive
    loss


(395
)


(159
)Retained earnings


24,750



26,442Total shareholders equity


42,858



44,653Total liabilities and
    shareholders equity

$
45,399


$
47,223    32




---



##### Table of Contents



QUALSTAR
    CORPORATION
  CONSOLIDATED
    STATEMENTS OF OPERATIONS
 (In thousands,
    except per share amounts)
  Years Ended
    June 30,2006


2005


2004Net revenues

$
21,731


$
25,144


$
31,530Cost of goods sold


14,856



16,529



19,575Gross profit


6,875



8,615



11,955Operating expenses:Research and development


3,083



3,750



4,268Sales and marketing


3,213



3,350



3,607General and administrative


3,629



3,955



5,420Total operating expenses


9,925



11,055



13,295Loss from operations


(3,050
)


(2,440
)


(1,340
)Investment income


1,269



858



624Impairment loss for
    other-than-temporary
    decline in investments










(160
)Loss before income taxes


(1,781
)


(1,582
)


(876
)Provision (benefit) for income
    taxes


(89
)


65



(145
)Net Loss

$
(1,692
)

$
(1,647
)

$
(731
)Loss per share:Basic

$
(0.14
)

$
(0.13
)

$
(0.06
)Diluted

$
(0.14
)

$
(0.13
)

$
(0.06
)Shares used to compute loss per
    share:Basic


12,253



12,398



12,577Diluted


12,253



12,398



12,577    33




---



##### Table of Contents



QUALSTAR
    CORPORATION
  CONSOLIDATED
    STATEMENTS OF SHAREHOLDERS EQUITY
 (In
    thousands)
  AccumulatedOtherNotes


ComprehensiveCommon
    Stock


Deferred


from


Income


RetainedShares


Amount


Compensation


Director


(Loss)


Earnings


TotalBalances at June 30, 2003


12,640


$
20,366


$
(140
)

$
(156
)

$
(22
)

$
28,820


$
48,868Exercise of stock options


19



69



















69Retirement of shares pursuant to
    stock repurchase


(63
)


(314
)


















(314
)Amortization of deferred
    compensation










140















140Accrued interest on
    directors notes














(6
)










(6
)Principal and interest payments on
    directors notes














117











117Comprehensive loss:Net loss






















(731
)


(731
)Change in unrealized gains
    (losses) on investments


















(239
)






(239
)Impairment loss for
    other-than-
    temporary decline in investments


















160







160Comprehensive loss


























(810
)Balances at June 30, 2004


12,596


$
20,121


$



$
(45
)

$
(101
)

$
28,089


$
48,064Exercise of stock options


16



76



















76Retirement of shares pursuant to
    stock repurchase


(359
)


(1,827
)


















(1,827
)Principal and interest payments on
    directors notes














45











45Comprehensive loss:Net loss






















(1,647
)


(1,647
)Change in unrealized gains
    (losses) on investments


















(58
)






(58
)Comprehensive loss


























(1,705
)Balances at June 30, 2005


12,253


$
18,370


$



$



$
(159
)

$
26,442


$
44,653Stock based compensation






133



















133Comprehensive loss:Net loss






















(1,692
)


(1,692
)Change in unrealized gains
    (losses) on investments


















(236
)






(236
)Comprehensive loss


























(1,928
)Balances at June 30, 2006


12,253


$
18,503


$



$



$
(395
)

$
24,750


$
42,858    34




---



##### Table of Contents



QUALSTAR
    CORPORATION
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS
 (In
    thousands)
  Years Ended
    June 30,2006


2005


2004OPERATING ACTIVITIES:Net loss

$
(1,692
)

$
(1,647
)

$
(731
)Adjustments to reconcile net loss
    to net cash provided by (used in) operating activities:Depreciation and amortization


454



463



423Deferred income taxes






436



312Provision for (recovery of) bad
    debts and returns


(31
)


38



186Stock based compensation


133







Amortization of deferred
    compensation










140Impairment loss for
    other-than-temporary
    decline in investments










160Accrued interest on
    directors notes










(6
)Gain on sale of securities






(11
)


Changes in operating assets and
    liabilities:Accounts receivable


863



1,058



(279
)Inventories


(141
)


261



(327
)Prepaid expenses and other assets


(57
)


29



(222
)Prepaid income taxes and income
    taxes payable


481



432



264Accounts payable


20



(408
)


35Accrued payroll and related
    liabilities


(30
)


(4
)


68Other accrued liabilities


(19
)


(443
)


285Net cash provided by (used in)
    operating activities


(19
)


204



308INVESTING ACTIVITIES:Purchases of equipment and
    leasehold improvements


(142
)


(164
)


(257
)Purchases of marketable securities


(13,204
)


(22,277
)


(41,123
)Proceeds from the sale of
    marketable securities


8,000



29,752



41,365Net cash provided by (used in)
    investing activities


(5,346
)


7,311



(15
)FINANCING ACTIVITIES:Principal and interest payments on
    directors notes






45



117Proceeds from exercise of stock
    options






76



69Repurchase of common stock






(1,827
)


(314
)Net cash used in financing
    activities






(1,706
)


(128
)NET INCREASE (DECREASE) IN CASH
    AND CASH EQUIVALENTS


(5,365
)


5,809



165CASH AND CASH EQUIVALENTS,
    BEGINNING OF PERIOD


12,210



6,401



6,236CASH AND CASH EQUIVALENTS, END OF
    PERIOD

$
6,845


$
12,210


$
6,401SUPPLEMENTAL CASH FLOW DISCLOSURES:Income taxes paid

$
2


$
5


$
12    35




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  Note 1 
    Accounting Policies
  Business
  reel-to-reel
    Accounting
    Principles
    Principles of
    Consolidation
    Estimates and
    Assumptions
  other-than-temporary.
  Revenue
    Recognition
  Revenue Recognition
 36




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Cash and Cash
    Equivalents
    Marketable
    Securities
  other-than-temporary available-for-sale
  No. 03-1, Other-Than-Temporary (EIFT 03-1) EITF 03-1 other-than-temporarily other-than-temporarily EITF 03-1 other-than-temporarily EITF 03-1, other-than-temporary
  Concentration of
    Credit Risk, Other Concentration Risks and Significant
    Customers
      Suppliers
     37




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
    Allowance for
    Doubtful Accounts
    ChargedBalance at


to Costs


Charged





Balance atBeginning of


and


to Other





End ofDescription

Period


Expenses


Accounts


Deductions(1)


PeriodYear Ended June 30, 2006

$
248,000


$
(31,000
)

$



$
(167,000
)

$
50,000Year Ended June 30, 2005

$
217,000


$
38,000


$



$
(7,000
)

$
248,000Year Ended June 30, 2004

$
260,000


$
186,000


$



$
(229,000
)

$
217,000     (1)
    
    Uncollectible accounts written off, net of recoveries.  Inventories
  (first-in,
  Property and
    Equipment
    Machinery and equipment

5-7 yearsFurniture and fixtures

5-7 yearsComputer equipment

3-5 years     Long-Lived
    Assets
   38




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
    Shipping and
    Handling Costs
    Warranty
    Obligations
  return-to-factory on-site
    Research and
    Development
    Advertising
    Fair Value of
    Financial Instruments
    Change in
    Accounting Principle and Share-Based Compensation
   39




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
      Fiscal Year Ended
    June 30,2005


2004(In thousands,
    except per share amounts)Net loss as reported

$
(1,647
)

$
(731
)Stock-based employee compensation
    cost included in reported net loss






140Pro forma stock-based employee
    compensation cost under SFAS 123


(118
)


(505
)Pro forma net loss

$
(1,765
)

$
(1,096
)Loss per share:Basic  as reported

$
(0.13
)

$
(0.06
)Basic  pro forma

$
(0.14
)

$
(0.09
)Diluted  as reported

$
(0.13
)

$
(0.06
)Diluted  pro forma

$
(0.14
)

$
(0.09
)       2005


2004Expected dividend yield


0%



0%Risk-free interest rate


3.8%



2.9%Expected life of options


4 years



4 yearsVolatility


36.9%



100.8%   Income
    Taxes
   40




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Comprehensive
    Income (Loss)
  available-for-sale
  Loss per
    Share
      Year Ended
    June 30,2006


2005


2004(In
    thousands)Loss:Net loss

$
(1,692
)

$
(1,647
)

$
(731
)Shares:Weighted average shares for basic
    loss per share


12,253



12,398



12,577Stock options










Weighted average shares for
    diluted loss per share


12,253



12,398



12,577     Reclassifications
    Note 2 
    Marketable Securities
    Amortized


Unrealized


Unrealized


FairJune 30,
    2006

Cost


Gain


Loss


ValueUS Treasury obligations and direct
    obligations of U.S. Government agencies

$
16,318


$



$
(229
)

$
16,089Government Sponsored Enterprise
    collateralized mortgage obligations


3,519







(108
)


3,411Corporate bonds


7,380







(58
)


7,322Total

$
27,217


$



$
(395
)

$
26,822   41




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
  Amortized


Unrealized


Unrealized


FairJune 30,
    2005

Cost


Gain


Loss


ValueUS Treasury obligations and direct
    obligations of U.S. Government agencies

$
12,703


$



$
(85
)

$
12,618Government Sponsored Enterprise
    collateralized mortgage obligations


2,492







(20
)


2,472Corporate bonds


5,816







(54
)


5,762Total

$
21,011


$



$
(159
)

$
20,852   other-than-temporarily
  Less Than 12
    Months


12 Months or
    Greater


TotalFair


Unrealized


Fair


Unrealized


Fair


UnrealizedJune 30,
    2006

Value


Loss


Value


Loss


Value


Loss(In
    thousands)US Treasury obligations and direct
    obligations of U.S. Government agencies

$
4,599


$
(18
)

$
11,490


$
(211
)

$
16,089


$
(229
)Government Sponsored Enterprise
    collateralized mortgage obligations


1,757



(9
)


1,654



(99
)


3,411



(108
)Corporate bonds


3,340



(6
)


3,982



(52
)


7,322



(58
)Total

$
9,696


$
(33
)

$
17,126


$
(362
)

$
26,822


$
(395
)   Less Than 12
    Months


12 Months or
    Greater


TotalFair


Unrealized


Fair


Unrealized


Fair


UnrealizedJune 30,
    2005

Value


Loss


Value


Loss


Value


Loss(In
    thousands)US Treasury obligations and direct
    obligations of U.S. Government agencies

$
3,973


$
(27
)

$
8,645


$
(58
)

$
12,618


$
(85
)Government Sponsored Enterprise
    collateralized mortgage obligations


934



(3
)


1,538



(17
)


2,472



(20
)Corporate bonds


4,054



(41
)


1,708



(13
)


5,762



(54
)Total

$
8,961


$
(71
)

$
11,891


$
(88
)

$
20,852


$
(159
)   U.S. Treasury Obligations other-than-temporarily
  Government Sponsored Enterprise (GSE) Collateralized Mortgage
    Obligations.
 42




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
  other-than-temporarily
  Corporate Bonds other-than-temporarily
    June 30,2006


2005Less than 90 days

$
1,557



Less than one year


12,483


$
3,700Due in one to two years


5,990



9,692Due in two to five years


6,792



8,462$
26,822


$
21,854   Note 3 
    Inventories
    June 30,2006


2005(In
    thousands)Raw materials, (net)

$
6,473


$
6,196Finished goods


825



961$
7,298


$
7,157   Note 4 
    Property and Equipment
    June 30,2006


2005(In
    thousands)Leasehold improvements

$
546


$
546Furniture and fixtures


1,006



994Machinery and equipment


2,416



2,3203,968



3,860Less accumulated depreciation and
    amortization


(3,044
)


(2,672
)$
924


$
1,188  43




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Note 5 
    Income Taxes
    Year Ended
    June 30,2006


2005


2004(In
    thousands)Current:Federal

$
(86
)

$
(156
)

$
(451
)State


(3
)


(215
)


(6
)(89
)


(371
)


(457
)Deferred:Federal






342



257State






94



55



436



312$
(89
)

$
65


$
(145
)     Year Ended
    June 30,2006


2005


2004Statutory federal income tax
    benefit


(34.0
)%


(34.0
)%


(34.0
)%State income taxes, net of federal
    income tax benefit


(3.4
)


(3.7
)


(4.2
)Non-taxable investment income


0.0



(3.4
)


(16.0
)Research and development credits


(6.5
)


(15.5
)


(22.8
)Valuation allowance


36.7



60.9



55.2Amortization of deferred
    compensation


0.0



0.0



5.4Other


2.1



(0.2
)


(0.2
)(5.1
)%


4.1
%


(16.6
)%     June 30,2006


2005(In
    thousands)Deferred tax assets:Net operating loss carryforwards

$
1,030


$
610Capital loss and other credit
    carryforwards


444



501Research and development credit
    carryforwards


437



471Allowance for bad debts and returns


45



102Inventory reserves


279



167Capitalized inventory costs


30



40Marketable securities


151



0Other accruals


455



331Total gross deferred tax assets


2,871



2,222Deferred tax liabilities:Depreciation and other


(215
)


(215
)Total gross deferred tax
    liabilities


(215
)


(215
)Valuation allowance


(2,656
)


(2,007
)Net deferred tax assets

$



$
  44




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
     Note 6 
    Preferred Stock
    Note 7 
    Shared Based Stock Option Plans
        2006


2005


2004Expected dividend yield


0%



0%



0%Risk-free interest rate


4.8%



3.8%



2.9%Expected life of options


4 years



4 years



4 yearsVolatility


30.8%



36.9%



100.8%  45




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
     Weighted


Weighted
    Average


AggregateAverage


Remaining


IntrinsicOptions

Shares


Exercise
    Price


Contractual
    Term


ValueOutstanding at June 30, 2005


455


$
4.80Granted


136



3.02Exercised






Forfeited or expired


(34
)


4.90Outstanding at June 30, 2006


557


$
4.36



7.39


$
45Exercisable at June 30, 2006


299


$
5.06



5.98



       Weighted
    AverageGrant DateNonvested
    Shares

Shares


Fair
    ValueNonvested at June 30, 2005


193


$
1.72Granted


136



0.96Vested


(84
)


1.87Forfeited


(18
)


2.15Nonvested at June 30, 2006


227


$
1.18     Restricted
    Shares
    paid-in-capital
 46




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Note 8 
    Purchase of N2 Power
    Note 9 
    Commitments
    step-up
    MinimumYear
    Ending

Lease
    Payment2007

$
592,0002008


554,0002009


570,0002010


588,0002011


307,000$
2,611,000     Note 10 
    Segment Information
      Year Ended
    June 302006


2005


2004RevenueTape Libraries:Product


16,008



21,231



28,573Service


3,144



2,638



2,386Total Tape Libraries


19,152



23,869



30,959Power Supplies


2,579



1,275



571Consolidated Revenue


21,731



25,144



31,530  47




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Year Ended
    June 302006


2005


2004Loss
    before TaxesTape Libraries


(1,434
)


(1,427
)


(556
)Power Supplies


(347
)


(155
)


(320
)Consolidated Loss before Taxes


(1,781
)


(1,582
)


(876
)   Year Ended
    June 302006


2005


2004Total
    AssetsTape Libraries


44,312



46,317



51,239Power Supplies


1,087



906



408Consolidated Assets


45,399



47,223



51,647   Disclosures about Segments of an
    Enterprise and Related Information
    Tape Libraries
  Power Supplies
   48




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Geographic
    Information
    Year Ended
    June 30,2006


2005


2004(In
    thousands)Revenues:North America

$
16,051


$
18,281


$
21,312Europe


3,467



4,933



4,842Asia Pacific


1,610



1,264



4,279Other


604



666



1,097$
21,732


$
25,144


$
31,530     Note 11 
    Legal Proceedings
      Note 12 
    Benefit Plans
    Note 13 
    Related Party Transactions
   49




---



##### Table of Contents



QUALSTAR
    CORPORATION
  NOTES TO
    CONSOLIDATED
    FINANCIAL STATEMENTS  (Continued)
   Note 14 
    Recent Accounting Pronouncements
    Note 15 
    Quarterly Results of Operations (Unaudited)
  Three Months
    EndedJune 30,


March 31,


December 31,


September 30,(In thousands,
    except per share amounts)Fiscal 2006:Net sales

$
4,888


$
5,052


$
5,689


$
6,102Gross profit


1,603



1,446



1,922



1,904Net loss


(694
)


(598
)


(189
)


(211
)Net loss per share:Basic

$
(0.06
)

$
(0.05
)

$
(0.02
)

$
(0.02
)Diluted


(0.06
)


(0.05
)


(0.02
)


(0.02
)Fiscal 2005:Net sales

$
6,706


$
5,742


$
6,392


$
6,305Gross profit


2,110



1,861



2,311



2,333Net loss


(429
)


(635
)


(347
)


(236
)Net loss per share:Basic

$
(0.04
)

$
(0.05
)

$
(0.03
)

$
(0.02
)Diluted


(0.04
)


(0.05
)


(0.03
)


(0.02
)  50




---



##### Table of Contents



ITEM 9. CHANGES
    IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
    FINANCIAL DISCLOSURE   ITEM 9A. CONTROLS
    AND PROCEDURES  Rule 13a-15
   ITEM 9B. OTHER
    INFORMATION   51




---



##### Table of Contents



PART III  Form 10-K
 ITEM 10. DIRECTORS
    AND EXECUTIVE OFFICERS OF THE REGISTRANT     ITEM 11. EXECUTIVE
    COMPENSATION   ITEM 12. SECURITY
    OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT   ITEM 13. CERTAIN
    RELATIONSHIPS AND RELATED TRANSACTIONS   ITEM 14. PRINCIPAL
    ACCOUNTANT FEES AND SERVICES   52




---



##### Table of Contents



PART IV ITEM 15. EXHIBITS AND
    FINANCIAL STATEMENT SCHEDULES  Form 10-K.
    Exhibits:
  ExhibitNo.

Description3
.1(1)

Restated Articles of Incorporation.3
.2(1)

Amended and Restated Bylaws.10
.1(1)*

1998 Stock Incentive Plan, as
    amended and restated.10
.2(1)

Form of Indemnification Agreement.10
.3(2)

Lease agreement between Strategic
    Performance Fund-II, Inc. and Qualstar Corporation, dated
    September 20, 2000.10
.4*

Base salaries payable to executive
    officers during the fiscal year ending June 30, 2007.10
.5*

Cash bonus plan for executive
    officers for fiscal year ending June 30, 2007.14
.1(3)

Code of Business Conduct and Ethics21
.1

Subsidiaries of Qualstar
    Corporation23
.1

Consent of Independent Registered
    Public Accounting Firm.31
.1

Certification of Principal
    Executive Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.31
.2

Certification of Principal
    Financial Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.32
.1

Certification of Principal
    Executive Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.32
.2

Certification of Principal
    Financial Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.     (1)
    
    Incorporated by reference to the designated exhibits to
    Qualstars registration statement on
    Form S-1
    (Commission File
    No. 333-96009),
    declared effective by the Commission on June 22, 2000.(2)
    
    Incorporated by reference to the designated exhibit to
    Qualstars Report on
    Form 10-Q
    for the fiscal quarter ended September 30, 2000.(3)
    
    Incorporated by reference to the designated exhibit to
    Qualstars Report on
    Form 10-K
    for the fiscal year ended June 30, 2004.*
    
    Each of these exhibits constitutes a management contract,
    compensatory plan or arrangement required to be filed as an
    exhibit to this report pursuant to Item 15(b) of this
    report. 53




---



##### Table of Contents



SIGNATURES    QUALSTAR CORPORATION
   By:
    /s/  WILLIAM
    J. GERVAIS   Chief Executive Officer and President
     Signature

Title

Date/s/  WILLIAM
    J. GERVAISWilliam
    J. Gervais

Chief Executive Officer,
    President and Director
    (principal executive officer and principal financial officer)

September 28, 2006/s/  RICHARD
    A. NELSONRichard
    A. Nelson

Vice President, Engineering
    Secretary and Director

September 28, 2006/s/  CARL
    W. GROMADACarl
    W. Gromada

Director

September 28, 2006/s/  STANLEY
    W. CORKERStanley
    W. Corker

Director

September 28, 2006/s/  ROBERT
    E. RICHRobert
    E. Rich

Director

September 28, 2006/s/  ROBERT
    A. MEYERRobert
    A. Meyer

Director

September 28, 2006/s/  NIDHI
    H. ANDALONNidhi
    H. Andalon

Controller

September 28, 2006  54




---



##### Table of Contents



EXHIBIT INDEX  ExhibitNo.

Description3
.1(1)

Restated Articles of Incorporation.3
.2(1)

Amended and Restated Bylaws.10
.1(1)*

1998 Stock Incentive Plan, as
    amended and restated.10
.2(1)

Form of Indemnification Agreement.10
.3(2)

Lease agreement between Strategic
    Performance Fund-II, Inc. and Qualstar Corporation, dated
    September 20, 2000.10
.4*

Base salaries payable to executive
    officers during the fiscal year ending June 30, 2007.10
.5*

Cash bonus plan for executive
    officers for fiscal year ending June 30, 2007.14
.1(3)

Code of Business Conduct and Ethics21
.1

Subsidiaries of Qualstar
    Corporation23
.1

Consent of Independent Registered
    Public Accounting Firm.31
.1

Certification of Principal
    Executive Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.31
.2

Certification of Principal
    Financial Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.32
.1

Certification of Principal
    Executive Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.32
.2

Certification of Principal
    Financial Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.     (1)
    
    Incorporated by reference to the designated exhibits to
    Qualstars registration statement on
    Form S-1
    (Commission File
    No. 333-96009),
    declared effective by the Commission on June 22, 2000.(2)
    
    Incorporated by reference to the designated exhibit to
    Qualstars Report on
    Form 10-Q
    for the fiscal quarter ended September 30, 2000.(3)
    
    Incorporated by reference to the designated exhibit to
    Qualstars Report on
    Form 10-K
    for the fiscal year ended June 30, 2004.*
    
    Each of these exhibits constitutes a management contract,
    compensatory plan or arrangement required to be filed as an
    exhibit to this report pursuant to Item 15(b) of this
    report. 55