<PAGE>

                      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, 2001

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

               For the transition period from _______ to _______

                       Commission file number 000-30083

                                _______________
                             QUALSTAR CORPORATION


     Incorporated under the laws                (I.R.S. Employer Identification
      of the State of California                        No.) 95-3927330

                           3990-B Heritage Oak Court
                             Simi Valley, CA 93063

                                (805) 583-7744
                                ---------------
          Securities registered pursuant to Section 12(b) of the Act:

                                     None

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

                                 Common Stock
                               _________________
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] 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 26, 2001, the aggregate market value of the common equity
held by non-affiliates of the registrant was approximately $35,464,584.

     The total shares of common stock without par value outstanding at September
26, 2001 is 12,600,751.

                      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 29, 2001.
<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, Legato, Tivioli and Veritas. We offer tape libraries for multiple
tape drive technologies, including those using Advanced Intelligent Tape, DLT,
quarter-inch cartridge, and LTO 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 our
resellers to minimize their inventory levels and allows us to 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.

     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 approximately 85.5% of
revenues in fiscal 2000, and approximately 89.3% of revenues for fiscal 2001.
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.

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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 rather than to remove old
         data, contributing to greater storage demand for data which in the past
         may have been purged periodically.

     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 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

                                       3
<PAGE>

         servers over longer distances, with data transfer speeds significantly
         faster than the most common interface technology in use today, 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
         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 user access. 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 or protection from natural disasters. 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.

   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 this trend to continue. As prices decline, new applications for
automated storage become justified, further increasing the number of
applications that can benefit from the use of tape libraries. We believe that
continued technological improvements

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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 transaction data and credit
         card data alongside the video image, which is not possible with VHS
         recording 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. Additionally, there is a trend to
         require that these records be kept available for longer periods of
         time.

   Distribution of Tape Library Products

     The requirements for storage solutions vary depending on the size of an
enterprise, the type of data generated and the amount of data to be stored. With
the increased dependence on stored data, most organizations, regardless of their
size, have a heightened need for storage solutions that integrate devices such
as tape drives, tape libraries and storage management software. Those
organizations with sufficient in-house information technology resources can rely
on their internal infrastructure and expertise to design, purchase and implement
their own storage solutions. These organizations may elect to purchase equipment
from distributors or directly from 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

                                       5
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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,
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 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

                                       6
<PAGE>

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, quarter inch cartridge and Linear Tape Open, or
         LTO, Ultrium tape media format. 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.

     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.

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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.


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 in                                                                    Maximum
                     Product                                                Range of Tape      Capacity in
  Product 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
                                        --------------------------------------------------------------------
                                         Erix 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
                                        --------------------------------------------------------------------
                                         Quantum SDLT                         10 to 240           26.4
------------------------------------------------------------------------------------------------------------
                                         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 or tape media 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 600 tapes. We design our tape libraries for continuous,
unattended operation. Multiple tape drives allow simultaneous access to
different data files by different users on the network, and increase the rate at
which data can move on to, out of, or within the network. A library with
multiple tape drives can back up data using 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.

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     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 to meet the changing demands of the marketplace. In
addition, we continue to develop enhancements and improvements for our existing
products in order to maintain our competitive position in the marketplace.

     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 storage area networks and other high
         performance applications.

     .   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 unit is sufficient.

     .   Closed-loop servo control. Our tape libraries use digital 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 many of 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 internal
         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 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.

                                       9
<PAGE>

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 distributors
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 130 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, a division of
Comverse Technology Inc. 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, a division of Comverse Technology Inc.,
accounting for 21.7% of revenues in fiscal 2000, and 15.4% of revenues in the
year ended June 30, 2001. Stornet, Inc., our largest value added reseller,
accounted for 11.5% of our revenues during fiscal 2000 and 13.8% during the year
ended June 30, 2001.

                                       10
<PAGE>

     Our international sales are directed from our Corporate offices in Simi
Valley, California. European and Near and Middle East sales are coordinated
through 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 $7.1 million, or 24.0% of revenues in fiscal
1999, $12.6 million, or 25.8% of revenues in fiscal 2000, and $14.5 million, or
28.2% of revenues for the year ended June 30, 2001.

   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, Server/Workstation Expert, Integrated Solutions 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 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.

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 Simi Valley, California. We sell service contracts for
         on-site service of our tape libraries installed within the United
         States, which are fulfilled by IBM and Anacomp.

     .   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 end
         users, 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.

     .   Warranty.  The standard warranty period on our tape libraries is three
         years.

                                       11
<PAGE>

         During the first year we offer immediate replacement of defective
         products at no charge, subject to availability and credit approval of
         the purchaser. The purchaser 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 and most foreign
         countries 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 Simi Valley,
California. We currently operate four 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 control 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

                                       12
<PAGE>

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 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, 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 not 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 15 people who have data
storage and related industry experience. This team has developed 29 separate
tape library models for five different tape formats over the last six 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

                                       13
<PAGE>

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 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 $925,000 in fiscal 1999, $1.0
million in fiscal 2000, and $1.3 million in fiscal 2001. We anticipate
increasing our spending on research and development in the future, to increase
the flow of new products to market.

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 26, 2001, we had 106 full-time employees, including 48 in
manufacturing, 15 in research and development, 8 in customer service, 18 in
sales and marketing, and 17 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 85.5% of our revenues in fiscal 2000 and
approximately 89.3% of our revenues for the fiscal year ended June 30, 2001. We
depend on a limited number of third-party manufacturers to supply us with the
tape

                                       15
<PAGE>

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. There can be no assurance that other tape drive manufacturers
will not also begin to manufacture libraries.

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

     .   Sony Electronics, Inc. is our sole-source supplier of 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, 2000 we derived
         $40.0 million, or 81.0%, of our revenues, and in fiscal 2001 we derived
         $39.8 million, or 77.1%, of our revenues, from the sale of tape
         libraries, tape drives, and tape media based on Sony Advanced
         Intelligent Tape technology. 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 and tape drive requirements.

     .   The Linear Tape Open standard is a relatively new tape standard that
         has been developed by an industry consortium that is intended to
         compete with 8mm and other half-inch 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. This risk is heightened as the LTO consortium is made up
         of IBM, Hewlett Packard, and Seagate. IBM and Hewlett Packard both
         manufacture and sell automated tape libraries that utilize LTO tape
         drives and compete with our products. Therefore, even if we receive
         adequate allocation, it may be at a price that renders our products
         uncompetitive.

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

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

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

                                       16
<PAGE>

     .    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.

     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 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.

Two customers account for a significant portion of our sales and they have no
minimum or long-term purchase commitments. Our revenues and earnings may
decrease if we lose business from these customers.

     Loronix Information Systems, a division of Comverse Technology Inc., our
largest customer, accounted for 21.7% of our revenues during fiscal 2000 and
15.4% of revenues during the year ended June 30, 2001. Stornet, Inc., our
largest value added reseller, accounted for 11.5% of our revenues during fiscal
2000 and 13.8% during the year ended June 30, 2001. We cannot assure you that
these customers will continue to purchase our products in the quantities they
have purchased in the past, or at all. Our revenues and earnings may decrease if
any of the following factors were to occur relating to either of these
customers:

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

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

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

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

                                       17
<PAGE>

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;

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

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

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

     .    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 tape media.

     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.

We are a small company that is growing rapidly. 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, 2001, our revenues have grown at a
compound annual growth rate of 36.3%. 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 being a public company has increased the burden on 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 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

                                       18
<PAGE>

not materialize, increases in our selling and administrative costs that are
based on anticipated revenue growth could harm our operating results.

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

     The market for our products is characterized by 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.

     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 long 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.

                                       19
<PAGE>

     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 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 revenue or profitability.

     Sales to customers located outside the United States accounted for
approximately 24.0% of our revenues in fiscal 1999, 25.8% in fiscal 2000, and
28.2% in the fiscal year ended June 30, 2001. 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:

                                       20
<PAGE>

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

     .    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 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;

                                       21
<PAGE>

     .    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 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 48.2% 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

                                       22
<PAGE>

          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
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.

Item 2. Properties

     All of our operations are housed in a single building containing
approximately 57,000 square feet located in Simi Valley, California. Our lease
on this facility expires in February 2011, with an early termination option
becoming available in February of 2007. Rent on this facility is $39,000 per
month, with step-ups ranging from $2,400 to $2,800 per month every two years.

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, 2001.

                                  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 26, 2001 are:

<TABLE>
<CAPTION>
Name                     Age  Position
----                     ---  --------
<S>                      <C>  <C>
William J. Gervais......  58   Chief Executive Officer, President and Director

Richard A. Nelson.......  58   Vice President of Engineering, Secretary and Director

Matthew Natalizio.......  46   Vice President and Chief Financial Officer

Daniel O. Thorlakson....  58   Vice President of Operations

Robert K. Covey.........  53   Vice President of Marketing
</TABLE>

                                       23
<PAGE>

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.

                                    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>
                                                             ---------------
   Period                    Date Range                       High     Low
-------------       -------------------------------          ------   ------
<S>                 <C>                                      <C>      <C>
Fiscal 2000:
  Fourth Quarter    June 23 - June 30, 2000                  $ 7.72   $ 7.00

Fiscal 2001:
  First Quarter     July 1 - September, 30, 2000             $13.50   $ 7.00
  Second Quarter    October 1 - December 31, 2000            $14.75   $ 6.00
  Third Quarter     January 1 - March 31, 2001               $ 9.13   $ 5.31
  Fourth Quarter    April 1 - June 30, 2001                  $ 8.00   $ 5.94
</TABLE>

     The approximate number of shareholders of record at September 26, 2001 was
73.

     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

                                       24
<PAGE>

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, 2001, all of the net proceeds from
the offering were invested in short-term, high-grade interest-bearing
securities, certificates of deposit, direct or guaranteed obligations of the
U.S. government or high-quality U.S. corporate debt securities.

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,
                                            -------------------------------------------
                                              1997     1998     1999     2000     2001
                                            -------  -------  -------  -------  -------
                                              (in thousands, expect per share amounts)
<S>                                         <C>      <C>      <C>      <C>      <C>
Statements of Income Data:
Net revenues..............................  $15,333  $19,155  $29,698  $49,352  $51,572
Cost of goods sold........................   10,768   12,892   19,058   30,915   33,216
                                            -------  -------  -------  -------  -------
Gross profit..............................    4,565    6,263   10,640   18,437   18,356
Operating expenses:
  Research and development................      916      894      925    1,027    1,279
  Sales and marketing.....................    1,146    1,277    1,941    2,643    3,399
  General and administrative..............    1,052    1,062    1,267    2,057    3,301
                                            -------  -------  -------  -------  -------
    Total operating expenses..............    3,114    3,233    4,133    5,727    7,979
                                            -------  -------  -------  -------  -------
Income from operations....................    1,451    3,030    6,507   12,710   10,377
Interest income...........................       21       35       41       54    1,225
Impairment of investment..................       --       --       --       --   (1,050)
                                            -------  -------  -------  -------  -------
Income before income taxes................    1,472    3,065    6,548   12,764   10,552
Provision for income taxes................      518    1,132    2,562    4,968    3,824
                                            -------  -------  -------  -------  -------
Net income................................      954    1,933    3,986    7,796    6,728
                                            -------  -------  -------  -------  -------
Premium paid on redemption of
 preferred stock..........................     (106)    (147)      --       --       --
                                            -------  -------  -------  -------  -------
Net income applicable to common
 shareholders.............................  $   848  $ 1,786  $ 3,986  $ 7,796  $ 6,728
                                            =======  =======  =======  =======  =======
Earnings per share:
  Basic...................................  $  0.13  $  0.28  $  0.60  $  1.10  $  0.54
  Diluted.................................  $  0.09  $  0.19  $  0.42  $  0.80  $  0.53

Shares used to compute earnings per share:
  Basic...................................    6,332    6,404    6,629    7,119   12,372
  Diluted.................................    9,065    9,290    9,467    9,742   12,668
</TABLE>

                                       25
<PAGE>

<TABLE>
<CAPTION>
                                                        June 30,
                                      -------------------------------------------
                                        1997     1998     1999     2000     2001
                                      -------  -------  -------  -------  -------
                                                    (in thousands)
<S>                                   <C>      <C>      <C>      <C>      <C>
Balance Sheet Data:
Cash and cash equivalents...........  $   912  $   798  $ 2,134  $18,976  $20,809
Working capital.....................    5,549    7,213   11,205   33,620   43,382
Total assets........................    6,967    8,461   12,950   37,984   47,878
Total debt..........................       --       --       --       --       --
Shareholders' equity................    5,850    7,614   11,640   35,032   44,689
</TABLE>

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, 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 six years
spanning a broad range of tape formats, prices, capacity and performance. Our
product mix has changed over the last four 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.

     Our international sales efforts are currently directed from our corporate
offices in Simi Valley, California. European and Near and Middle East sales are
coordinated through our European sales office in Frankfurt, Germany. 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
$7.1 million, or 24.0% of revenues, in fiscal 1999, $12.6 million, or 25.8% of
revenues in fiscal 2000, and $14.5 million, or 28.2% of revenues in fiscal 2001.

     Net revenues include revenues from the sale of tape libraries, library tape
drives, storage media, and ancillary products. Ancillary revenues include
service and repair, net of the cost of any third party service contracts,
extended warranty revenues, 9-track tape drives 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 85.5% of revenues in
fiscal 2000, and 89.3% of revenues in fiscal 2001. Sales of services and other
products accounted for the balance of our revenues.

                                       26
<PAGE>

     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 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.

     In an effort to increase the flow of new products to market, we expect that
research and development costs will increase in fiscal 2002. Our research and
development efforts are also focused on improving the feature sets of our
existing product lines.

     We expect that selling, general and administrative expenses will increase
in fiscal 2002 due to higher rent associated with our larger facility, which we
occupied in February 2001, higher marketing costs necessary to enter new
markets, larger expenditures to further develop our brand identity, and
increased costs to attract and retain qualified 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. Amortization of the deferred
compensation was approximately $227,000 during fiscal 2000 and $437,000 during
fiscal 2001, which was recorded as general and administrative expenses in the
statements of income. Total deferred compensation amortization will approximate
$430,000 in each of fiscal 2002 and 2003, and $201,000 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,
                                                   ----------------------
                                                    1999    2000    2001
                                                   ------  ------  ------
<S>                                                <C>     <C>     <C>
Net revenues......................................  100.0%  100.0%  100.0%
  Cost of goods sold..............................   64.2    62.6    64.4
                                                   ------  ------  ------
  Gross margin....................................   35.8    37.4    35.6
Operating expenses:
  Research and development........................    3.1     2.0     2.5
  Sales and marketing.............................    6.5     5.4     6.6
  General and administrative......................    4.3     4.2     6.4
                                                   ------  ------  ------
Income from operations............................   21.9    25.8    20.1
Interest income...................................    0.1     0.1     2.4
Impairment of investment..........................     --      --    (2.0)
                                                   ------  ------  ------
Income before income taxes........................   22.0    25.9    20.5
Provision for income taxes........................    8.6    10.1     7.4
                                                   ------  ------  ------
Net income........................................   13.4%   15.8%   13.1%
                                                   ======  ======  ======
</TABLE>

                                       27
<PAGE>

Fiscal 2001 Compared to Fiscal 2000

     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, 2001 were $51.6 million, an increase
of 4.5% compared to net revenues of $49.4 million for the year ended June 30,
2000. 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 $46.1 million, or 89.3% of revenues, in the year ended June 30,
2001 from $42.3 million, or 85.5% of revenues, in the year ended June 30, 2000.
Partially offsetting the increase in revenues from our tape libraries was a
decrease of $2.7 million in revenues from our 9-track tape drives to $1.1
million for the year ended June 30, 2001 from $3.8 million in the year ended
June 30, 2000. We expect sales of 9-track tape drives to continue to decline, as
this product line is near its end of life. Selling prices of our libraries
remained relatively stable during fiscal 2001. However, selling prices of tape
media and library tape drives declined during the third and fourth quarter of
fiscal 2001. The decline in selling prices of tape media and drives was the
result of AIT tape drives and media being placed in general distribution by the
manufacturer.

     Gross Profit. Gross profit was $18.4 million, or 35.6% of revenues, for the
year ended June 30, 2001, compared to $18.4 million, or 37.4% of revenues, for
fiscal 2000. Cost of goods sold consists primarily of direct labor, purchased
parts, depreciation of plant and equipment, rent, utilities, and packaging
costs. Although gross profit remained relatively stable, the decrease in gross
margin as a percentage of revenues was primarily caused by declines in selling
prices of tape media and library tape drives coupled with an increase in sales
of those products.

     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, 2001
increased 24.5% to $1.3 million as compared to $1.0 million for the year ended
June 30, 2000. This increase was due primarily to an increase in salaries
resulting from an increase in departmental headcount and for research and
development of new products and new features of our existing products.

     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 28.6% to $3.4 million, or 6.6% of revenues for the year ended June 30,
2001, as compared to $2.6 million, or 5.4% of revenues, for the year ended June
30, 2000. This increase was due primarily to the growth in our sales force and
associated increases in salaries and benefits of $486,000, and an increase in
sales commissions of $134,000.

     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 increased to $3.3 million for
fiscal 2001 as compared to $2.1 million for fiscal 2000. As a percentage of
revenue, general and administrative expenses increased to 6.4% for the year
ended June 30, 2001 as compared to 4.2% for the year ended June 30, 2000. The
increase in general and administrative expenses were caused by one time expenses
of $230,000 associated with the move to our new facility, increased costs of
being a publicly traded company such as directors and officers insurance and
investor relations expenses, higher rent as the result of our move to a new
facility, and higher salaries and benefits for administrative staff. The year
ended June 30, 2001 also includes deferred compensation amortization expense of
$437,000 related to equity incentives, as compared to only $227,000 of deferred
compensation amortization expense in the year ended June 30, 2000.

     Impairment of investment. During the fourth quarter of fiscal 2001, we
determined that the carrying value of our investment in Chaparral Network
Storage, Inc. exceeded its net realizable value as a result of rapid changes in
technology and the availability of capital for further development of its family
of products. Accordingly, we recognized an allowance in the amount of $1,050,000
to reduce the carrying value of the investment in Chaparral to zero.

     Investment income. Investment income increased to $1.2 million in the year
ended June 30, 2001 as compared to $54,000 in the year ended June 30, 2000. This
increase was due to a full year of investment of the initial public offering
proceeds. In

                                       28
<PAGE>

addition, net cash generated by our operations in fiscal 2001 was invested in
interest bearing securities.

     Provision for Income Taxes. The provision for income taxes was $3.8
million, or 36.2% of pre-tax income, for fiscal 2001 compared to $5.0 million,
or 38.9% of pre-tax income, for fiscal 2000.

Fiscal 2000 Compared to Fiscal 1999

     Net Revenues. 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.

     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.

                                       29
<PAGE>

Liquidity and Capital Resources

     Historically, we have funded our capital requirements with cash flows from
operations. Cash flows provided by operating activities were $1.6 million in
fiscal 1999, $2.6 million in fiscal 2000, and $6.6 million in fiscal 2001. In
each of these periods, operating cash was provided primarily by net income.
During fiscal 1999 and 2000, cash flow from operating activities was primarily
used to fund increases in receivables and inventory. In fiscal 2001, cash flow
from operating activities was primarily used to fund increases in inventories
and purchases of marketable securities.

     Cash flows used in investing activities were $274,000 in fiscal 1999, $1.1
million in fiscal 2000, and $7.2 million in fiscal 2001. 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. Cash flows used in investing activities
for fiscal 2001 related primarily to purchases of marketable securities as well
as equipment and leasehold improvements.

     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, 2001, all of which was available as of June
30, 2001. 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 9.50%
at June 30, 2000 and 6.75% at June 30, 2001.

     On September 20, 2000 we entered into a ten-year lease of a new 57,000
square foot facility. The facility is approximately twice as large as our prior
facility. We believe the new facility will allow us to improve our manufacturing
efficiency and meet our future growth projections. During January of 2001, we
moved our production equipment and personnel to the new facility as the first
phase of our relocation plan. In February of 2001, the remaining equipment and
personnel were moved to the new facility, completing the relocation plan. We
incurred capital expenditures of approximately $864,000 for equipment and
leasehold improvements associated with the move to our new facility.

     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.

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.

                                       30
<PAGE>

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

     Not applicable.

                                   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, 2001, 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 in Item 8
          commencing at 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, 2001.

  (c) Exhibits:
      --------

Exhibit No.   Description
-----------   -----------
  3.1(1)      Restated Articles of Incorporation.

  3.2(1)      Amended and Restated Bylaws.

 10.1(1)*     1998 Stock Incentive Plan, as amended and restated.

 10.2(1)      Form of Indemnification Agreement.

 10.3(2)      Lease agreement between Strategic Performance Fund-II, Inc. and
              Qualstar Corporation, dated September 20, 2000.

 23.1         Consent of Ernst & Young LLP, Independent Auditors.
________
(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.

 *    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.

                                       31
<PAGE>

Item 8.  Financial Statements and Supplementary Data

                         INDEX TO FINANCIAL STATEMENTS

                                                                          Page
                                                                          ----

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

                                      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, 2000 and 2001, and the related statements of income, shareholders'
equity, and cash flows for each of the three years in the period ended June 30,
2001. 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, 2000 and 2001, and the results of its operations and its cash flows for the
three years in the period ended June 30, 2001, 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 17, 2001

                                      F-2
<PAGE>

                             QUALSTAR CORPORATION

                                BALANCE SHEETS
                                (in thousands)

<TABLE>
<CAPTION>
                                                                                    June 30,
                                                                       ----------------------------------
                                                                           2000                  2001
                                                                       -------------        -------------
<S>                                                                    <C>                  <C>
                           ASSETS

Current assets:
   Cash and cash equivalents...............................             $      18,976        $      20,809
   Marketable securities...................................                        --                6,278
   Accounts receivable, net of allowances of $470
     in 2000 and 2001......................................                     7,276                6,379
   Inventories.............................................                     8,657               10,632
   Prepaid expenses and other current assets...............                       186                  400
   Prepaid income taxes....................................                       765                  927
   Deferred income taxes ..................................                       652                1,041
                                                                        -------------        -------------
     Total current assets..................................                    36,512               46,466
                                                                        -------------        -------------
Property and equipment, net ...............................                       377                1,126
Investment in equity securities............................                     1,050                    -
Other assets...............................................                        45                  286
                                                                        -------------        -------------
      Total assets.........................................             $      37,984        $      47,878
                                                                        =============        =============

            LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
   Accounts payable........................................             $       2,341        $       2,374
   Accrued payroll and related liabilities.................                       393                  227
   Other accrued liabilities...............................                       158                  483
                                                                        -------------        -------------
       Total current liabilities...........................                     2,892                3,084
                                                                        -------------        -------------
Deferred income taxes......................................                        60                  105

Commitments and contingencies

Shareholders' equity:
   Preferred stock, no par value; 5,000 shares authorized;
      no shares issued.....................................                        --                   --
   Common stock, no par value; 50,000 shares authorized,
     12,164 and 12,601 shares issued and outstanding as of
     June 30, 2000 and 2001, respectively..................                    18,400               20,691
   Deferred compensation...................................                    (1,534)              (1,061)
   Notes from directors....................................                      (617)                (512)
   Accumulated other comprehensive income..................                        --                   60
   Retained earnings.......................................                    18,783               25,511
                                                                        -------------        -------------
       Total shareholders' equity..........................                    35,032               44,689
                                                                        -------------        -------------
       Total liabilities and shareholders' equity                       $      37,984        $      47,878
                                                                        =============        =============
</TABLE>

                            See accompanying notes

                                      F-3
<PAGE>

                             QUALSTAR CORPORATION

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

<TABLE>
<CAPTION>
                                                                 Years Ended June 30,
                                                         ------------------------------------
                                                           1999          2000           2001
                                                          -------       -------        -------
<S>                                                       <C>           <C>            <C>
Net revenues.....................................         $29,698       $49,352        $51,572
Cost of goods sold...............................          19,058        30,915         33,216
                                                          -------       -------        -------
Gross profit.....................................          10,640        18,437         18,356
                                                          -------       -------        -------
Operating expenses:
  Research and development.......................             925         1,027          1,279
  Sales and marketing............................           1,941         2,643          3,399
  General and administrative.....................           1,267         2,057          3,301
                                                          -------       -------        -------
    Total operating expenses.....................           4,133         5,727          7,979
                                                          -------       -------        -------
Income from operations...........................           6,507        12,710         10,377
Interest income..................................              41            54          1,225
Impairment of investment.........................              --            --         (1,050)
                                                          -------       -------        -------
Income before provision for income taxes.........           6,548        12,764         10,552
Provision for income taxes.......................           2,562         4,968          3,824
                                                          -------       -------        -------
Net income.......................................         $ 3,986       $ 7,796        $ 6,728
                                                          =======       =======        =======
Earnings per share:
  Basic..........................................         $  0.60       $  1.10        $  0.54
                                                          =======       =======        =======
  Diluted........................................         $  0.42       $  0.80        $  0.53
                                                          =======       =======        =======
Share used to compute earnings per share:
  Basic..........................................           6,629         7,119         12,372
                                                          =======       =======        =======
  Diluted........................................           9,467         9,742         12,668
                                                          =======       =======        =======
</TABLE>

                            See accompanying notes

                                      F-4
<PAGE>

                             QUALSTAR CORPORATION

                      STATEMENTS OF SHAREHOLDERS' EQUITY
                                (in thousands)

<TABLE>
<CAPTION>
                                   Series A
                                Nonredeemable
                                  Preferred                                                    Accumulated
                                    Stock         Common Stock                      Notes         Other
                                -------------   ---------------     Deferred        From      Comprehensive   Retained
                                Shares Amount   Shares  Amount    Compensation    Directors       Income      Earnings    Total
                                ------ ------   ------  -------   -------------   ---------   --------------  --------   -------
<S>                             <C>    <C>      <C>     <C>       <C>             <C>         <C>             <C>        <C>
Balances at July 1, 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' note..............    --      --       --       --           --           (17)           --            --       (17)
 Net income....................    --      --       --       --           --            --            --         7,796     7,796
                                -----  ------   ------  -------   -------------   ---------   --------------  --------   --------
Balances at June 30, 2000......    --      --   12,164   18,400       (1,534)         (617)           --        18,783    35,032
 Exercise of stock options.....    --      --       62       43           --            --            --            --        43
 Initial public offering,
  issuance of common stock.....    --      --      375    2,284           --            --            --            --     2,284
 Amortization of deferred
  compensation.................    --      --       --       --          437            --            --            --       437
 Forfeiture of unvested stock
  options......................    --      --       --      (36)          36            --            --            --        --
 Accrued interest on
  directors' notes.............    --      --       --       --           --           (35)           --            --       (35)
 Principal payments on
  directors' notes.............    --      --       --       --           --           140            --            --       140
 Comprehensive income:
  Net income...................    --      --       --       --           --            --            --         6,728     6,728
  Unrealized gains on
  investments..................    --      --       --       --           --            --            60            --        60
                                                                                                                         --------
   Comprehensive income........                                                                                             6,788
                                -----  ------   ------  -------   -------------   ---------   --------------  --------   --------
Balances at June 30, 2001.....     --      --   12,601  $20,691      $(1,061)        $(512)         $ 60      $ 25,511   $ 44,689
                                =====  ======   ======  =======   =============   =========   ==============  ========   ========
</TABLE>
                                See accompanying notes

                                      F-5
<PAGE>

                             QUALSTAR CORPORATION

                           STATEMENTS OF CASH FLOWS
                                (in thousands)

<TABLE>
<CAPTION>
                                                                                Years Ended June 30,
                                                                       -------------------------------------
                                                                         1999         2000            2001
                                                                       --------     ---------       --------
<S>                                                                    <C>          <C>             <C>
OPERATING ACTIVITIES:
   Net income..................................................        $  3,986     $   7,796       $  6,728
   Adjustments to reconcile net income to net cash
      provided by operating activities:
       Depreciation and amortization...........................             205           152            237
       Deferred income taxes...................................            (187)         (235)          (344)
       Provision for bad debts and returns.....................             259            50            118
       Amortization of deferred compensation...................              --           227            437
       Loss on disposal of property and equipment..............               6            --             --
       Impairment of investment................................              --            --          1,050
       Accrued interest on directors' notes....................              --           (17)           (35)
       Changes in operating assets and liabilities:
         Accounts receivable...................................          (2,330)       (2,411)           779
         Inventories...........................................            (490)       (4,006)        (1,975)
         Prepaid expenses and other assets.....................               8          (160)          (455)
         Prepaid income taxes..................................            (337)         (420)          (162)
         Accounts payable......................................             186         1,594             33
         Accrued payroll and related liabilities...............             140            26           (166)
         Other accrued liabilities.............................             124             3            325
                                                                       --------     ---------       --------
Net cash provided by operating activities......................           1,570         2,599          6,570

INVESTING ACTIVITIES:
   Purchases of equipment and leasehold improvements...........            (274)          (93)          (986)
   Purchase of investments in equity securities................              --        (1,050)            --
   Purchases of marketable securities..........................              --            --         (7,233)
   Proceeds from the sale of marketable securities.............              --            --          1,015
                                                                       --------     ---------       --------
Net cash used in investing activities..........................            (274)       (1,143)        (7,204)

FINANCING ACTIVITIES:
   Principal and interest payments on directors' notes.........              --            --            140
   Proceeds from issuance of common stock,
       net of offering costs...................................              --        15,272          2,284
   Proceeds from exercise of stock options.....................              40           114             43
                                                                       --------     ---------       --------
Net cash provided by financing activities......................              40        15,386          2,467

NET INCREASE IN CASH AND CASH EQUIVALNCES......................           1,336        16,842          1,833

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.................             798         2,134         18,976
                                                                       --------     ---------       --------
CASH AND CASH EQUIVALENTS, END OF PERIOD.......................        $  2,134     $  18,976       $ 20,809
                                                                       ========     =========       ========

SUPPLEMENTAL CASH FLOW DISCLOSURES:
   Income taxes paid...........................................        $  3,088     $   5,619       $  4,330
                                                                       ========     =========       ========
</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 and surveillance 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, 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, 24.0%
of net revenues in 1999, 25.8% of net revenues in 2000, and 26.9% of net
revenues in 2001. Revenues from Qualstar's two largest customers were 32.1%,
33.2% and 29.2% for the years ended June 30, 1999, 2000 and 2001, respectively.
At June 30, 2000 and 2001 the largest customers' accounts receivable balance
totaled 26.2% and 19.3% of total accounts receivable, respectively.

Marketable Securities

     Marketable securities consist primarily of high-quality U.S. corporate
securities. These securities are classified in one of three categories: trading,
available-for-sale, or held-to-maturity. Trading securities are bought and held
principally for the purpose of selling them in the near term. Held-to-maturity
securities are those securities which Qualstar has the ability and intent to
hold until maturity. All other securities not included in trading or
held-to-maturity are classified as available-for-sale. All of Qualstar's
marketable securities were classified as available-for-sale at June 30, 2001.
Qualstar did not own marketable securities as of June 30, 2000.

     Available-for-sale securities are recorded at market value. Unrealized
holding gains and losses, net of the related income tax effect, on
available-for-sale securities are excluded from earnings and are reported as a
separate component of shareholders' equity until realized. Dividend and interest
income are recognized when earned. Realized gains and losses for securities
classified as available-for-sale are included in earnings when the underlying
securities are sold and are derived using the specific identification method for
determining the cost of securities sold.

Inventories

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

Suppliers

     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. Sales and costs of goods sold related to products
purchased from one large supplier totaled approximately 45.4% and 57.6%,
respectively, of total sales and cost of goods sold for the year ended June 30,
2001.

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 approximate 1% interest in
Chaparral Network Storage, Inc. (Chaparral) for an aggregate purchase price of
$1,050,000. This investment is accounted for under the cost method. Chaparral
designs and manufactures RAID controllers and intelligent storage routers for
tape library applications.

                                      F-8
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

     During the fourth quarter of fiscal year 2001, management determined the
carrying value of the investment in Chaparral exceeded its net realizable value
as a result of rapid changes in technology and the availability of capital for
further development of its family of products. Accordingly, management
determined an allowance in the amount of $1,050,000 was necessary to reduce the
carrying value of the investment in Chaparral to its estimated net realizable
value. The related charge is included in the statement of income as an
impairment of investment.

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 impairment losses of long-lived assets 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.

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulleting No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under various
circumstances. The accounting and disclosures prescribed by SAB 101 were
effective in the fourth quarter of Qualstar's fiscal year ending June 30, 2001
and retroactive to the beginning of the fiscal year. The effects of the adoption
were not material to its financial position or results of operations.

Shipping and Handling Costs

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

                                      F-9
<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, 1999, 2000 and
2001 were $390,000, $470,000 and $426,000, 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).

     In March 2000, the FASB issued Financial Interpretation No. 44, "Accounting
for Certain Transactions Involving Stock Compensation--an Interpretation of APB
Opinion No. 25" or FIN 44. FIN 44 clarifies the definition of an employee for
the purpose of applying APB No. 25, the criteria for determining whether a stock
plan qualifies as a noncompensatory stock plan, the accounting consequences of
various modifications to the terms of a previously fixed stock option or award,
and the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 was generally effective July 1, 2000 and the adoption of FIN
44 has not had a material effect on Qualstar's financial statements.

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

     Comprehensive income is accounted for according to 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. Comprehensive income includes
unrealized gains and losses on debt and equity securities classified as
available-for-sale and included as a component of shareholders' equity.

                                      F-10
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

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.

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

                                                         Year Ended June 30,
                                                    ----------------------------
                                                      1999      2000      2001
                                                    --------  --------  --------
                                                           (in thousands)
Earnings:
  Net income......................................  $  3,986  $  7,796  $  6,728

Shares:
  Weighted average shares for basic earnings per
    share.........................................     6,629     7,119    12,372
  Conversion of Series A Preferred Stock..........     2,379     2,376        --
  Stock options and restricted stock..............       459       247       296
                                                    --------  --------  --------
  Weighted average shares for diluted earnings
    per share.....................................     9,467     9,742    12,668
                                                    ========  ========  ========

Segment Information

     Based on the provisions of SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" and the manner in which the Chief Operating
Decision Maker analyzes the business, Qualstar has determined that it 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 accounting
principles generally accepted in the United States 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.

                                      F-11
<PAGE>

                              QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

2. Inventories

   Inventories consist of the following (in thousands):

                                                              June 30,
                                                         ------------------
                                                           2000      2001
                                                         --------  --------
Raw materials..........................................  $  7,624  $  9,001
Finished goods.........................................     1,033     1,631
                                                         --------  --------
                                                         $  8,657  $ 10,632
                                                         ========  ========

3. Property and Equipment

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

                                                              June 30,
                                                         ------------------
                                                           2000      2001
                                                         --------  --------
Leasehold improvements.................................  $     23  $    535
Furniture and fixtures.................................       518       725
Machinery and equipments...............................     1,542     1,768
                                                         --------  --------
                                                            2,083     3,028
  Less accumulated depreciation and amortization.......    (1,706)   (1,902)
                                                         --------  --------
                                                         $    377  $  1,126
                                                         ========  ========

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 (9.50% as of June 30,
2000 and 6.75% as of June 30, 2001), plus 1.25%. The line of credit agreement
expires on November 1, 2001. As of June 30, 2000 and 2001, the Company had not
borrowed against the line of credit.

5. Income Taxes

     The provision for income taxes for the years ended June 30, 1999, 2000 and
2001, is comprised of the following (in thousands):

<TABLE>
<CAPTION>
                                                                      Year Ended June 30,
                                                            --------------------------------------
                                                              1999           2000           2001
                                                            --------       --------       --------
<S>                                                         <C>            <C>            <C>
Current:
  Federal.........................................          $  2,222       $  4,171       $  3,414
  State...........................................               527          1,032            754
                                                            --------       --------       --------
                                                               2,749          5,203          4,168
Deferred:
  Federal.........................................              (173)          (207)          (256)
  State...........................................               (14)           (28)           (88)
                                                            --------       --------       --------
                                                                (187)          (235)          (344)
                                                            --------       --------       --------
                                                            $  2,562       $  4,968       $  3,824
                                                            ========       ========       ========
</TABLE>

                                      F-12
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

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

     The following is a reconciliation of the statutory federal income tax rate
to Qualstar's effective income tax rate:
                                                         Year Ended June 30,
                                                    ----------------------------
                                                       1999      2000      2001
                                                    --------  --------  --------
Statutory federal income tax expense..............    34.0%     34.0%     34.0%
State income taxes, net of federal income tax
  benefit.........................................     5.1       4.9       4.3
Other.............................................      --        --      (2.1)
                                                    --------  --------  --------
                                                      39.1%     38.9%     36.2%
                                                    ========  ========  ========

     The tax effect of temporary differences resulted in deferred income tax
assets (liabilities) at June 30, 2000 and 2001, as follows (in thousands):

                                                              June 30,
                                                         ------------------
                                                           2000      2001
Deferred tax assets:                                     --------  --------
  Allowance for bad debts and returns..................  $    201  $   201
  Reserve for Chaparral investment....................         --      450
  Capitalized inventory costs..........................        38       42
  State income taxes...................................       351      264
  Other accruals.......................................        62       84
                                                         --------  --------
    Total deferred tax assets..........................       652    1,041
Deferred tax liability:
  Depreciation.........................................       (60)    (105)
                                                         --------  --------
                                                         $    592  $   936
                                                         ========  ========

     No valuation reserve was established at June 30, 2000 and 2001, 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 and automatically converted into 2.4 million
shares of common stock upon completion of Qualstar's initial public offering.

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.

                                      F-13
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

     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.

     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, 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
  Granted...................................           84                 9.38           9.38
  Exercised.................................          (62)         0.22 - 2.78           0.68
  Cancelled.................................          (52)         0.56 - 9.38           3.46
                                                     ----         ------------          -----
Outstanding at June 30, 2001................          256          0.22 - 9.38           4.00
                                                     ====         ============          =====
</TABLE>

<TABLE>
<CAPTION>
                                                                  Options Exercisable
                    Options Outstanding at June 30, 2001            at June 30, 2001
                    ---------------------------------------     ------------------------
                                                  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              32               0.9             0.22            32          0.22
$0.56              24               6.8             0.56            24          0.56
$2.78             132               8.5             2.78            28          2.78
$9.38              68               9.1             9.38            --          9.38
</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.

                                      F-14
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

     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 year period.

     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 and $437,000 in fiscal 2001.

     If Qualstar recognized employee stock option-related compensation expense
in accordance with SFAS 123 and used the minimum value method for grants prior
to Qualstar's initial public offering and the Black-Scholes model afterward for
determining the weighted average fair value of options granted during 1999, 2000
and 2001, its pro forma net income would have been $4.0 million, $7.8 million,
and $6.6 million, respectively. The pro forma basic income per share would have
been $0.60, $1.09, and $0.53 for 1999, 2000, and 2001 respectively. The pro
forma diluted income per share would have been $0.42, $0.80, and $0.52 for 1999,
2000 and 2001, 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 1999, 2000 and 2001 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 $0.94 for 1999, $5.59 for 2000, and $5.88 for
2001 stock option grants was estimated at the date of grant using the minimum
value option pricing model before Qualstar's initial public offering and the
Black Scholes model afterward with the following assumptions.

<TABLE>
<CAPTION>
                                                     1999      2000      2001
                                                    -------   -------   -------
<S>                                                 <C>       <C>       <C>
Expected dividend yield..........................       0%         0%        0%
Risk-free interest rate..........................     6.0%       6.5%      6.5%
Expected life of options.........................  5 years    5 years   5 years
Volatility.......................................       --         --     69.0%
</TABLE>

8. Commitments

     During fiscal year 2001, Qualstar entered into a new lease agreement for a
facility located in Simi Valley, California. The lease agreement expires in
February of 2011, with an early termination option becoming available in
February of 2007. The annual rent for the lease is $464,000, with step-ups
ranging from $28,000 to $34,000 every two years. Future minimum lease payments
under this lease are as follows:

                                     F-15
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
Year ending                                          Minimum lease payment
-----------                                          ---------------------
<S>                                                  <C>
2002............................................          $  464,000
2003............................................             476,000
2004............................................             492,000
2005............................................             505,000
2006............................................             522,000
Thereafter......................................           2,587,000
                                                           ---------
                                                          $5,046,000
                                                          ==========
</TABLE>

     Rent expense (including equipment rental) for the years ended June 30,
1999, 2000, and 2001, was $202,000, 209,000 and $366,000, 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>
                                                         Year Ended June 30,
                                                    ----------------------------
                                                      1999      2000      2001
                                                    --------  --------  --------
<S>                                                 <C>       <C>       <C>
Revenues:
  North America..................................   $23,032   $37,789   $37,700
  Europe.........................................     4,504     7,594     9,850
  Asia...........................................     1,380     3,642     3,754
  Other..........................................       782       327       268
                                                    --------  --------  --------
                                                    $29,698   $49,352   $51,572
                                                    ========  ========  ========
</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 90 days of employment and may
contribute up to 15% of their compensation. Qualstar may make matching
contributions 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, $33,000 and $44,000 for the years ended June 30, 1999,
2000 and 2001, respectively.

11. Related Party Transactions

     Qualstar's outside counsel became a member of its board of directors, 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
its initial public offering. During the year ended June 30, 2001, Qualstar paid
$175,000 to the law firm in which the director is a shareholder, of which
$70,000 related to the initial public offering with the remainder for general
business purposes.

                                     F-16
<PAGE>

                             QUALSTAR CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

12. Quarterly Results of Operations (unaudited)

<TABLE>
<CAPTION>
                                                    Three Months Ended
                                    -----------------------------------------------
                                    September 30,  December 31,  March 31,  June 30,
                                    -----------------------------------------------
                                        (in thousands, except per share amounts)
<S>                                 <C>            <C>           <C>        <C>
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

Fiscal 2001:
Net sales.........................     $13,853        $15,510     $11,106   $11,103
Gross profit......................       5,121          5,745       3,710     3,780
Net income(1).....................       2,313          2,298       1,345       772

Net earnings per share:
  Basic...........................     $  0.19        $  0.19     $  0.11   $  0.06
  Diluted.........................        0.18           0.18        0.11      0.06
</TABLE>

(1)  As discussed in Note 1 to these financial statements, net income during the
fourth quarter of fiscal year 2001 was adversely affected due to a $1,050,000
reserve established by management to reduce the carrying value of the investment
in Chaparral to zero.

                                     F-17
<PAGE>

                                                                     SCHEDULE II

                             QUALSTAR CORPORATION

                       VALUATION AND QUALIFYING ACCOUNTS
                        ALLOWANCE FOR DOUBTFUL ACCOUNTS
               For the Years Ended June 30, 1999, 2000, and 2001

<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,
  1999...............  $165,000     $259,000     $ --       $  4,000      $420,000
Year Ended June 30,
  2000...............   420,000      152,000       --        102,000       470,000
Year Ended June 30,
  2001...............   470,000      118,000       --        118,000       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 27, 2001


                                      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 27, 2001
___________________________     President and Director
       William J. Gervais      (principal executive officer)

   /s/ Richard A. Nelson      Vice President, Engineering      September 27, 2001
___________________________     Secretary and Director
       Richard A. Nelson

   /s/ Matthew Natalizio      Vice President and Chief         September 27, 2001
                                 Financial Officer
___________________________     (principal financial
       Matthew Natalizio        and accounting officer)

                              Director                         September 27, 2001
---------------------------
       Bruce E. Gladsone

   /s/ Trude C. Taylor        Director                         September 27, 2001
---------------------------
       Trude C. Taylor

   /s/ Robert E. Rich         Director                         September 27, 2001
---------------------------
       Robert E. Rich

   /s/ Robert T. Webber       Director                         September 27, 2001
---------------------------
       Robert T. Webber
</TABLE>

                                      S-2
<PAGE>

                                 EXHIBIT INDEX


Exhibit No.   Description
-----------   -----------
  3.1(1)      Restated Articles of Incorporation.

  3.2(1)      Amended and Restated Bylaws.

 10.1(1)*     1998 Stock Incentive Plan, as amended and restated.

 10.2(1)      Form of Indemnification Agreement.

 10.3(2)      Lease agreement between Strategic Performance Fund-II, Inc. and
              Qualstar Corporation, dated September 20, 2000.

 23.1         Consent of Ernst & Young LLP, Independent Auditors.

-------
(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.

  *  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.