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

Qualstar Corporation ("Qualstar") was incorporated in California in 1984. Qualstar focuses its efforts on designing, developing, manufacturing and selling high efficiency AC-DC and DC-DC power supplies under its N2Power brand, and automated magnetic tape libraries used to store, retrieve and manage electronic data primarily in the network computing environment under its Qualstar brand. Tape libraries consist of cartridge tape drives, tape cartridges and robotics to move the tape cartridges from their storage locations to the tape drives under software control. Qualstar's libraries provide storage solutions for organizations requiring backup, recovery and archival storage of critical electronic information.

In July 2002, Qualstar purchased the assets of N2Power, Incorporated, a supplier of ultra-small high efficiency open frame switching power supplies. Power supplies are sold with the N2Power brand name as well as under a private label brand name to original equipment manufacturers to incorporate into computer based products for telephony, industrial, gaming, test equipment and other applications. N2Power is a division of Qualstar.

Net revenues include revenues from the sale of tape libraries, tape drives, tape cartridges, ancillary products, and power supplies. Ancillary revenues include spare parts, service, repair, and on-site service agreements net of the cost of any third party service contracts. Revenues from our tape library segment represented approximately 44.8% of revenues in fiscal 2012, 53.8% of revenues in fiscal 2011, and 62.1% of revenues in fiscal 2010. Revenues from our power supply segment represented approximately 55.2% of revenues in fiscal 2012, 46.2% of revenues in fiscal 2011, and approximately 37.9% of revenues in fiscal 2010.

Our international sales efforts are currently directed from our corporate offices in Simi Valley, California. All of our international sales are denominated in U.S. dollars. Net revenues from customers outside of North America were approximately $8.0 million, or 47.0% of revenues for fiscal 2012, $6.6 million, or 36.1% of revenues for fiscal 2011, and $5.1 million, or 33.4% of revenues for fiscal 2010.

Gross margins depend on several factors, including the cost of manufacturing, product mix and the level of competition. Larger tape libraries generally provide higher gross margins than do smaller tape libraries.

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

We have evaluated our manufacturing operations, inventory, and facility utilization and implemented a restructuring plan in the fourth quarter of fiscal 2012 to reduce our costs in an effort to return to profitability. We streamlined our product offerings by recognizing inventory reserves on the ten- to fifteen-year old TLS and RLS product lines that were experiencing declining revenue, competitive pricing pressures, and high manufacturing costs due to older generation technology, which were preventing us from competing effectively. By discontinuing these legacy product lines, we have shifted our focus to our newer, technologically competitive rack mount and enterprise level tape library product lines. We recorded a full inventory reserve of approximately $900,000 in the fourth quarter of fiscal 2012 on the discontinued TLS and RLS product lines, including finished goods, raw materials, drives and work in process.

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to customer promotional offers, sales returns, bad debts, inventories, warranty costs, investments, and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue is recognized in accordance with Accounting Standards Codification ("ASC") 605, "Revenue Recognition," when persuasive evidence of an arrangement exists, transfer of title has occurred, the price is fixed or readily determinable, and collectability is reasonable assured. Title and risk of loss transfer to the customer when the product leaves our dock in Simi Valley, California, or another shipping location designated by us. In general, these customers are allowed to return the product, free of penalty, within thirty days of shipment, if the product does not conform to its specifications.

We record an allowance for estimated sales returns based on past experience and current knowledge of our customer base. Our experience has been such that only a very small percentage of products are returned. Should our experience change, however, we may require additional allowances for sales returns.

Revenue for established products that have previously satisfied a customer's acceptance requirements and provide for full payment tied to shipment is generally recognized upon shipment and passage of title. In limited cases where a prior history of customer acceptance cannot be demonstrated or sales where customer payment dates are not determinable or when collection is not reasonably assured, revenue is deferred until customer acceptance occurs or payment has been received. On the limited shipments where sales are not recognized, gross profit is generally recorded as deferred profit in our consolidated balance sheet representing the difference between the receivable recorded and the inventory shipped. At June 30, 2012 we had deferred revenue of approximately $156,000 and no deferred profit. At June 30, 2011 we had deferred revenue of approximately $65,000 and no deferred profit.

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

We adopted ASC 820, "Fair Value Measurements and Disclosures" on July 1, 2008 for all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.

ASC 820 defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or
liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk including our own credit risk.

In addition to defining fair value, ASC 820 expands the disclosure requirements around fair value and establishes a fair value hierarchy for valuation inputs. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in
measuring fair value is observable in the market. Each fair value measurement is reported in one of the three levels that are determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

• Level 1 - inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.

• Level 2 - inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3 - inputs are generally unobservable and typically reflect management's estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

In general, and where applicable, we use quoted prices in active markets for identical assets to determine fair value. This pricing methodology applies to our Level 1 investments such as U.S. treasuries and agency securities and exchange-traded mutual funds. If quoted prices in active markets for identical assets are not available to determine fair value, then we use quoted prices for similar assets or inputs other than the quoted prices that are observable either directly or indirectly. These investments are included in Level 2 and consist primarily of corporate bonds, mortgage-backed securities, and certain agency securities. While we own certain mortgage-backed fixed income securities, our portfolio as of June 30, 2012 does not contain direct exposure to subprime mortgages or structured vehicles that derive their value from subprime collateral. Our mortgage-backed securities are collateralized by prime residential mortgages and carry a 100% principal and interest guarantee, primarily from Federal National Mortgage Association and Federal Home Loan Mortgage Corporation. Our asset-backed securities are senior tranches in regard to priority of principal repayment and are collateralized by predominantly prime-rated receivables on consumer credit card, automobile loan and utility rate reduction securities.

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

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

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

The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. When legal costs are expected to be material that the entity expects to incur in defending itself in connection with a loss contingency accrual, the loss should factor in all costs and, if the legal costs are reasonably estimable, they should be accrued in accordance with ASC 450, regardless of whether a liability can be estimated for the contingency itself. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. Changes in these factors could materially impact our financial statements.

Share-based compensation is accounted for in accordance with ASC 718, "Compensation - Stock Compensation." We use the Black-Scholes option-pricing model to determine fair value of the award at the date of grant and recognize compensation expense over the vesting period. The inputs we use for the model require the use of judgment, estimates and assumptions regarding the expected volatility of the stock, the expected term the average employee will hold the option prior to the date of exercise, expected future dividends, and the amount of share-based awards that are expected to be forfeited. Changes in these inputs and assumptions could occur and actual results could differ from these estimates, and our results of operations could be materially impacted.

We estimate our tax liability based on current tax laws in the statutory jurisdictions in which we operate in accordance with ASC 740, "Income Taxes." These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes, as well as about the realization of deferred tax assets. We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures.

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

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

We have net operating losses, capital losses, research and development credit and other carry forwards for tax purposes of $25 million at June 30, 2012 which expire between fiscal years 2013 and 2032, except for the state research and development credit, which has no limit on the carry forward period.

See Recent Accounting Guidance in Note 1 "Summary of Significant Accounting Policies" to the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on our results of operations and financial condition.

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

                                               Years Ended June 30,
                                          2012         2011         2010
Net revenues                               100.0 %      100.0 %      100.0 %
Cost of goods sold                          78.4         63.2         69.6
Gross margin                                21.6         36.8         30.4
Operating expenses:
Research and development                    15.6         15.0         20.6
Sales and marketing                         11.2         12.7         15.0
General and administrative                  19.0         13.8         17.2
Loss from operations                       (24.2 )       (4.7 )      (22.4 )
Other income                                 0.1          1.0          2.0
Loss before provision for income taxes     (24.1 )       (3.7 )      (20.4 )
Provision for income taxes                   0.1          0.0          0.0
                                           (24.2 )%      (3.7 )%     (20.4 )%

We have two operating segments for financial disclosure purposes: tape libraries and power supplies, as discussed in Footnote 11 to our financial statements. The following table summarizes our revenue by operating segment:

                              Years Ended June 30,
                          2012        2011        2010
Power Supply revenues      55.2  %     46.2  %     37.9  %
Tape Library revenues:
Product                     31.2 %      39.3 %     43.30 %
Service                     13.6 %      14.5 %      18.8 %
Total Library revenues      44.8 %      53.8 %      62.1 %
                           100.0 %     100.0 %     100.0 %

Net Revenues. Net revenues were $17.1 million in fiscal 2012 as compared to $18.3 million in fiscal 2011. The decrease of approximately $1.2 million, or 6.7% is attributed primarily to a decrease of $2.2 million in sales of tape libraries, partially offset by a $1.0 million increase in sales of power supplies.

Power Supply Segment
Revenues attributed to our power supply segment were $9.4 million, or 55.2% of revenues, in fiscal 2012 as compared to $8.5 million, or 46.2% of revenues, in fiscal 2011. The increase of $0.9 million, or 11.4%, was due to increased sales to original equipment manufacturers and distributors of an expanded power supply product line. We expect continued growth as a percentage of total sales in our power supply revenues during fiscal 2013.

Tape Library Segment
Revenues attributed to our tape library segment were $7.7 million or 44.8% of revenues in fiscal 2012, as compared to $9.8 million, or 53.8% of revenues in fiscal 2011. The decrease in tape library revenues was due to decreased sales of our tape library products in the TLS and XLS product lines and decreases in service, media and miscellaneous revenues, partially offset by increased revenues from our RLS product line. In addition, revenues in the last quarter of our fiscal year were impacted by the uncertainty surrounding our proxy contest with BKF Capital Group, which ended when our shareholders rejected BKF's attempt to replace our Board of Directors at the Special Meeting of Shareholders on June 20, 2012.

Gross Profit. Gross profit was $3.7 million in fiscal 2012 as compared to $6.7 million in fiscal 2011. The decrease of approximately $3.0 million, or 45.1%, is attributed to a decrease in revenues, change in product mix and an increase in inventory reserves. Inventory reserves increased in fiscal 2012 due to the end of life on the TLS and RLS legacy product lines, in existence for 15 and 10 years, respectively. The decline in selling prices has been impacted by technology rather than lower manufacturing costs.

Research and Development. Research and development expenses were $2.7 million in fiscal 2012, comparable to $2.7 million in fiscal 2011.

Sales and Marketing. Sales and marketing expenses were $1.9 million in fiscal 2012, as compared to $2.3 million in fiscal 2011. The decrease of approximately $0.4 million, or 18.0%, is attributed to lower compensation and commission expenses related to headcount reductions and lower advertising and promotion expenses.

General and Administrative. General and administrative expenses were $3.2 million in fiscal 2012 as compared to $2.5 million in fiscal 2011. The increase of approximately $0.7 million, or 27.9%, is primarily attributed to an increase in legal and proxy expenses related to the special Shareholder meeting and legal fee accruals related to pending litigation.

Other Income and Expenses. Other income and expense in fiscal 2012 was $24,000, comprised of $0.2 million investment income, offset by $0.1 million in litigation fees.

Benefit for Income Taxes. Provision for income taxes was $16,000 in fiscal 2012 compared to a benefit for income taxes of $5,000 in fiscal 2011.

Net Revenues. Net revenues were $18.3 million in fiscal 2011 as compared to $15.3 million in fiscal 2010. The increase of approximately $3.0 million, or 19.9% is attributed primarily to an increase of $0.3 million in sales of tape libraries and $2.7 million in sales of power supplies.

Power Supply Segment
Revenues attributed to our power supply segment were $8.5 million, or 46.2% of revenues, in fiscal 2011 as compared to $5.8 million, or 37.9% of revenues, in fiscal 2010. The increase of $2.7 million, or 46.2%, was due to increased sales to original equipment manufacturers and distributors of an expanded power supply product line.

Tape Library Segment
Revenues attributed to our tape library segment were $9.8 million, or 53.8% of revenues in fiscal 2011, as compared to $9.5 million, or 62.1% of revenues in fiscal 2010. This increase in tape library revenues was due primarily to higher sales of our tape library products in the RLS and XLS product lines, partially offset by decreased revenues from our TLS product line, in conjunction with decreased sales of tape media and service revenue.

Gross Profit. Gross profit was $6.7 million in fiscal 2011 as compared to $4.6 million in fiscal 2010. The increase of approximately $2.1 million, or 44.7%, is attributed to an increase in revenues, change in product mix, a decrease in inventory reserves, and higher absorption of labor and overhead.

Research and Development. Research and development expenses were $2.7 million in fiscal 2011, as compared to $3.2 million in fiscal 2010. The decrease of approximately $0.5 million, or 12.9%, is attributed primarily to decreases in compensation expense related to headcount reductions and prototype material expenses.

Sales and Marketing. Sales and marketing expenses were $2.3 million in fiscal 2011, comparable with $2.3 million in fiscal 2010.

General and Administrative. General and administrative expenses were $2.5 million in fiscal 2011 as compared to $2.6 million in fiscal 2010. The decrease of approximately $0.1 million, or 4.3%, is primarily due to decreases in compensation expense related to headcount reductions and accounting and investor relations expenses.

Investment Income. Investment income was $0.2 million in fiscal 2011, compared to $0.3 million in fiscal 2010. The decrease of approximately $0.1 million is attributed to lower rates in the current economic environment and a $1.6 million decrease in the principal balance of our cash, cash equivalents and marketable securities.

Benefit for Income Taxes. Benefit for income taxes was $5,000 in fiscal 2011.

Cash used in operating activities was $1.5 million in each of fiscal 2012 and 2011, and $1.7 million in fiscal 2010. Cash used in operating activities in fiscal 2012 relates primarily to our net loss for the year, an increase in inventories and a decrease in accrued payroll and related liabilities, partially offset by inventory reserves and an increase in accounts payable and other accrued liabilities. Cash used in operating activities in fiscal 2011 relates primarily to our net loss for the year and an increase in accounts receivable and inventories, partially offset by an increase in accounts payable. Cash used in operating activities in fiscal 2010 relates primarily to our net loss for the year and an increase in accounts receivable, partially offset by a decrease in inventories and an increase in accounts payable.

Cash provided by investing activities was $4.0 million in fiscal 2012, $4.2 million in fiscal 2011 and $1.7 million in fiscal 2010. Cash provided by investing activities in all three fiscal years relates primarily to proceeds from the sale of marketable securities, partially offset by purchases of marketable securities and equipment.

Cash was not used in financing activities in fiscal years 2012 and 2011. Cash used in financing activities was $1.5 million in fiscal 2010, relating to cash dividends declared on shares of our common stock.

As of June 30, 2012, we had $7.4 million in cash and cash equivalents and $13.5 million in marketable securities. We believe that our existing cash and cash equivalents and funds available from the sale of our marketable securities will be sufficient to fund our working capital and capital expenditure needs for . . .