UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2005

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

Delaware 0-6377 77-0176309
-------- ------ ----------
(State or other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization) File Number) Identification No.)

1875 North Shoreline Boulevard, Mountain View, California 94043-1319
--------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)

(650) 969-4428
--------------
(Registrant's telephone number, including area code)

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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [x] Yes [ ] No

Number of outstanding shares of common stock, $.01 par value, at October 31,
2005: 11,436,794

Exhibit Index is on Page 35

Total number of pages is 39

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION Page Number

Item 1. Condensed Consolidated Financial Statements (Unaudited) 2
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14

Item 3. Quantitative and Qualitative Disclosures about Market Rate Risks 31

Item 4. Controls and Procedures 32

PART II. OTHER INFORMATION

Item 1. Legal Proceedings 32

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32

Item 3. Defaults Upon Senior Securities 32

Item 4. Submission of Matters to a Vote of Security Holders 32

Item 5. Other Information 33

Item 6. Exhibits 33

SIGNATURES 34

EXHIBIT INDEX 35
- -----------------------------------------------------------------------------------------------------

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

SEPTEMBER 30, MARCH 31,
2005 2005 *
---- ----

ASSETS
Current assets:
Cash and cash equivalents $ 2,246 $ 3,965
Short-term investments 15,050 6,150
Accounts receivable, net 2,770 1,934
Inventories 7,452 7,909
Prepaid and other current assets 881 1,352
---------- ----------
Total current assets 28,399 21,310

Property and equipment, net 11,808 12,532
Long-term investments -- 6,300
Equipment held for resale 5,459 4,061
Patents and other intangibles, net 913 923
Goodwill 3,321 3,321
Note receivable 205 220
Other non-current assets 185 101
---------- ----------
Total assets $ 50,290 $ 48,768
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,458 $ 2,105
Accrued liabilities 2,026 2,312
Deferred tax liability 596 641
Advance payments from customers 1,754 1,167
Deferred revenue 525 539
Bank borrowings 105 --
---------- ----------
Total current liabilities 6,464 6,764

Advance payments from customers 17,000 13,000
Deferred revenue, net of current portion 2,000 2,000
Deferred rent 442 326
---------- ----------
Total liabilities 25,906 22,090
---------- ----------

Commitments and contingencies

Stockholders' equity:
Common Stock 114 114
Additional paid-in capital 54,179 54,155
Accumulated deficit (29,404) (27,145)
Accumulated other comprehensive income 21 209
Treasury stock (526) (655)
---------- ----------
Total stockholders' equity 24,384 26,678
---------- ----------

Total liabilities and stockholders' equity $ 50,290 $ 48,768
========== ==========

* Amounts derived from audited financial statements at the date indicated.
The accompanying notes are an integral part of these condensed consolidated financial statements.

LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Three Months Ended Six Months Ended
September 30, September 30,
2005 2004 2005 2004
---- ---- ---- ----

Revenues
Total revenues.................................... $ 8,699 $ 7,773 $ 15,693 $ 16,483
--------- --------- --------- ---------

Cost of product sales.................................... 6,206 5,842 11,360 12,208
--------- --------- --------- ---------

Gross profit ..................................... 2,493 1,931 4,333 4,275
--------- --------- --------- ---------

Operating expenses:
Selling, general, and administrative expenses........ 2,612 2,809 5,743 5,843
Research and engineering expenses.................... 552 723 1,051 1574
--------- --------- --------- ---------
Total operating expenses.......................... 3,164 3,532 6,794 7,417
--------- --------- --------- ---------

Operating loss................................. (671) (1,601) (2,461) (3,142)
---------- --------- ---------- ---------

Other income, net........................................ 108 62 204 85
--------- --------- --------- ---------

Loss before income taxes....................... (563) (1,539) (2,257) (3,057)

Income tax expense (benefit)............................. 1 (18) 1 8
--------- --------- --------- ---------

Net loss....................................... $ (564) $ (1,521) $ (2,258) $ (3,065)
========= ========= ========= =========

Net loss per share:
Basic and diluted net loss per share........... $ (.05) $ (.13) $ (.20) $ (.27)
========= ========= ========= =========

Weighted-average shares of common stock used in
computing basic and diluted, net loss per share...... 11,355 11,368 11,350 11,388

The accompanying notes are an integral part of these condensed consolidated financial statements.

LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)

SIX MONTHS ENDED
SEPTEMBER 30,
2005 2004
---- ----

Cash flows from operating activities:
Net loss ................................................................... $ (2,258) $ (3,065)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization........................................... 1,286 1,352
Provision for doubtful account receivable............................... -- 2
Provision for excess and obsolete inventory............................. 258 5
Provision for product return reserve.................................... 38 209
Stock-based compensation................................................ 67 54
Loss on disposal of equipment........................................... 7 7
Changes in operating assets and liabilities:
Increase in accounts receivable......................................... (994) (180)
Decrease (increase) in inventories...................................... 116 (50)
Increase in equipment held for resale................................... (1,399) (861)
Decrease in other assets................................................ 442 169
Increase in other non-current assets.................................... (62) --
Decrease in accounts payable and accrued liabilities.................... (921) (2,253)
Increase in deferred revenue............................................ 20 2,077
Increase in deferred rent............................................... 116 --
Decrease in deferred income tax liabilities............................. -- (33)
Increase in advance payments from customers............................. 4,596 6,164
--------- ---------

Net cash provided by operating activities.......................... 1,312 3,597
--------- ---------

Cash flows from investing activities:
Purchases of property and equipment......................................... (667) (2,250)
Proceeds from sale of equipment............................................. -- 2
Investment in patents and other intangibles................................. (60) (64)
Purchases of investments.................................................... (2,600) --
Proceeds from maturities of investments..................................... -- 1,927
--------- ---------

Net cash used in investing activities.............................. (3,327) (385)
--------- ---------

Cash flows from financing activities:
Proceeds from sale of common stock through stock plans...................... 154 255
Bank loan................................................................... 108 (718)
Decrease in short-term and long-term debts.................................. -- (606)
Stock repurchases........................................................... -- (656)
--------- ---------

Net cash provided by (used in) financing activities................ 262 (1,725)
--------- ---------

Effect of exchange rate changes on cash............................ 34 40
--------- ---------

Net (decrease) increase in cash and cash equivalents............................. (1,719) 1,527

Cash and cash equivalents:
Beginning of period......................................................... 3,965 11,688
--------- ---------
End of period............................................................... $ 2,246 $ 13,215
========= =========

The accompanying notes are an integral part of these condensed consolidated financial statements.

LASERCARD CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The condensed consolidated financial statements contained herein include
the accounts of LaserCard Corporation and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

The condensed consolidated financial statements included herein have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and regulations,
although the Company believes the disclosures which are made are adequate to
make the information presented not misleading. Further, the condensed
consolidated financial statements reflect, in the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position and results of operations as of and for
the periods indicated.

These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes thereto for
the fiscal year ended March 31, 2005, included in the Company's Annual Report on
Form 10-K.

The results of operations for the three and six-month periods ended
September 30, 2005 are not necessarily indicative of results to be expected for
the entire fiscal year ending March 31, 2006.

FISCAL PERIOD: For purposes of presentation, the Company labels its
annual accounting period end as March 31 and its interim quarterly periods as
ending on the last day of the corresponding month. The Company, in fact,
operates and reports based on quarterly periods ending on the Friday closest to
month end. The 13-week second quarter of fiscal 2006 ended on September 30,
2005, and the 13-week second quarter of fiscal 2005 ended on October 1, 2004.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

FOREIGN CURRENCY TRANSACTIONS. The functional currency of the Company's
foreign subsidiaries is the local currency. The financial statements of these
subsidiaries are translated to United States dollars using period-end rates of
exchange for assets and liabilities and average rates of exchange for each
quarter for revenues and expenses. Translation gains (losses) are recorded in
accumulated other comprehensive income as a component of stockholders' equity.
Net gains and losses resulting from foreign exchange transactions are included
in selling, general and administrative expenses and were not significant during
the periods presented.

CONCENTRATION OF CREDIT RISK. The following customers accounted for more
than 10% of accounts receivable at September 30, 2005 and March 31, 2005
respectively:

SEPTEMBER 30, MARCH 31,
2005 2005
---- -----

Customer A 25% 27%
Customer B 20% --
Customer C 12% --

MAJOR CUSTOMERS. The following customers accounted for more than 10% of
revenues for the periods shown below. The revenue from these customers was
attributable to both the optical memory card and the optical card drive
segments. No other customer accounted for more than 10% of revenues during these
periods.

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---- ---- ---- ----

Customer A 36% 18% 39% 20%
Customer B 15% 47% 10% 44%
Customer C 11% -- NA --

CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS AND LONG-TERM
INVESTMENTS. The Company considers all highly liquid investments, consisting
primarily of commercial paper, discount notes and U.S. government bonds, with
maturities of three months or less at the date of purchase, to be cash
equivalents. Cash equivalents at September 30, 2005 and March 31, 2005 were $2.2
million and $4 million, respectively. As of September 30, 2005 and March 31,
2005, the Company held auction rate securities which have been accounted for as
available-for-sale and classified as short-term investments. The fair values of
the auction rate securities, based on quoted market prices, were substantially
equal to their carrying costs due to the frequency of the reset dates.
Short-term investments also include investments with maturities at date of
purchase of more than three months and up to one year and investments initially
classified as long-term with remaining maturities of less than one year. All
investments with maturities of greater than one year are classified as long-term
investments. Management determines the appropriate classification of debt
securities at the time of purchase and reevaluates the classification of
investments as of each balance sheet date.

All short-term investments, except for auction rate securities which are
recorded at fair value, and long-term investments are classified as held to
maturity and are stated in the balance sheet at amortized cost. As such
investments are classified as held to maturity, no unrealized gains or losses
are recorded. The carrying amounts of individual held to maturity securities are
reviewed at the balance sheet date for potential impairment. As of September 30,
2005 and March 31, 2005, the Company has determined that an impairment which was
"other than temporary" has not occurred.

DERIVATIVE FINANCIAL INSTRUMENTS, the Company uses short-term foreign
exchange forward contracts to mitigate foreign currency risk associated
primarily with intercompany loans (denominated in Euros) to its German
subsidiaries. Our foreign exchange forward contracts are not designated for
accounting purposes as hedging instruments under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended. Accordingly, any
gains or losses resulting from changes in the fair value of the forward contract
are reported in selling, general and administrative expenses. The gains and
losses on these forward contracts generally offset gains and losses associated
with the underlying foreign currency denominated intercompany loans. At
September 30, 2005 we had a foreign exchange forward contract with a maturity of
less than 30 days to purchase 1.9 million Euros. The fair value of the forward
contract was not material at September 30, 2005.

INVENTORIES: Inventories are stated at the lower of cost or market, with
cost determined on a first-in, first-out basis and market based on the lower of
replacement cost or estimated realizable value. The components of inventories
are (in thousands):

SEPTEMBER 30, MARCH 31,
2005 2005
---- ----

Raw materials $ 4,917 $ 4,891
Work-in-process 1,215 739
Finished goods 1,320 2,279
---------- ----------
$ 7,452 $ 7,909
========== ==========

NET LOSS PER SHARE: Basic and diluted net loss per share is computed by
dividing net loss by the weighted average number of shares of common stock
outstanding. As the effect of common stock equivalents would be antidilutive,
stock options and warrants were excluded from the calculation of diluted net
loss per share for the three-month and six-month periods ended September 30,
2005 and 2004. Accordingly, basic and diluted net loss per share were the same
for the three and six-months ended September 30, 2005 and 2004.

REVENUE RECOGNITION. Product sales primarily consist of optical cards,
optical card read/write drives and specialty cards and card printers. The
Company recognizes revenue from product sales when the following criteria are
met: (1) persuasive evidence of an arrangement exists; (2) delivery has
occurred; (3) the fee is fixed or determinable; and (4) collectibility is
reasonably assured. The Company recognizes revenue on product sales at the time
of shipment when shipping terms are F.O.B. shipping point, orders are placed
pursuant to a pre-existing sales arrangement and there are no post-shipment
obligations other than warehousing under a U.S. government subcontract or
customer acceptance criteria. Where appropriate, provision is made at the time
of shipment for estimated warranty costs and estimated returns. The total
amounts of actual warranty costs and returns activity were $58,000 and $121,000
for the three-month periods ended September 30, 2005 and 2004, respectively. The
total amount of actual warranty costs and returns activity were $106,000 and
$242,000 for the six-month periods ended September 30, 2005 and 2004,
respectively.

The Company's U.S. government subcontract requires delivery into a
secure vault located on Company premises. Shipments are made from the vault on a
shipment schedule provided by the prime contractor, which is subject to
revision, but generally not subject to cancellation, at the option of the prime
contractor. At the time the cards are delivered into the vault, title to the
cards is transferred to the government and all risks of ownership are
transferred as well. The prime contractor is invoiced, with payment due within
thirty days and the contract does not contain any return (other than for
warranty) or cancellation provisions. Pursuant to the provisions of SEC Staff
Accounting Bulletin No. 104 (SAB 104), revenue is recognized on delivery into
the vault as the Company has fulfilled its contractual obligations and the
earnings process is complete. If the Company does not receive a shipment
schedule for shipment of cards from the vault, revenue is deferred and
recognized upon shipment from the vault. In addition, revenue recognition for
future deliveries into the vault would be affected if the U.S. government
cancels the shipment schedule. As a result, the Company's revenues may fluctuate
from period to period if the Company does not continue to obtain shipment
schedules under this subcontract or if the shipment schedules are cancelled.

In May 2003, the Emerging Issues Task Force ("EITF") finalized the terms
of EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables,"
(EITF 00-21) which provides criteria governing how to identify whether goods or
services that are to be delivered separately in a bundled sales arrangement
should be accounted for separately. Deliverables are accounted for separately if
they meet all of the following criteria: a) the delivered items have stand-alone
value to the customer; b) the fair value of any undelivered items can be
reliably determined; and c) if the arrangement includes a general right of
return, delivery of the undelivered items is probable and substantially
controlled by the seller. In situations where the deliverables fall within
higher-level literature as defined by EITF 00-21, the Company applies the
guidance in that higher-level literature. Deliverables that do not meet these
criteria are combined with one or more other deliverables. The Company adopted
EITF 00-21 for any new arrangements entered into after July 1, 2003 and now
assesses all revenue arrangements against the criteria set forth in EITF 00-21.

Revenues on fixed price contracts are recognized on the percentage of completion
method based on the ratio of total costs incurred to date compared to estimated
total costs to complete the contract. Estimates of costs to complete include
material, direct labor, overhead and allowable general and administrative
expenses. In circumstances where estimates of costs to complete a project cannot
be reasonably estimated, but it is assured that a loss will not be incurred, the
percentage-of-completion method based on a zero profit margin, rather than the
completed-contract method, is used until more precise estimates can be made. The
full amount of an estimated loss is charged to operations in the period it is
determined that a loss will be realized from the performance of a contract.
During the three-month periods ended September 30, 2005 and 2004, the Company
recognized approximately $24,000 and $21,000 of revenues based on a zero profit
margin, respectively. During the six-month periods ended September 30, 2005 and
2004, the Company recognized approximately $66,000 and $86,000 of revenues based
on a zero profit margin, respectively.

The Company applies the provisions of Statement of Position (SOP) No.
97-2, "Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" to all transactions involving the sale of software products.
Revenue from the license of the Company's software products is recognized when
persuasive evidence of an arrangement exists, the software product has been
delivered, the fee is fixed or determinable and collectibility is probable, and,
if applicable, upon acceptance when acceptance criteria are specified or upon
expiration of the acceptance period. Software revenue was immaterial for
three-month and six-month periods ended September 30, 2005 and 2004.

License revenue, which may consist of up-front license fees and
long-term royalty payments, is recognized as revenue when earned. There were no
license revenue and cost of license revenue recorded for the three-month and
six-month periods ended September 30, 2005 or 2004.

In the fiscal 2005 first quarter, the Company sold a card-manufacturing
license, effective April 3, 2004, to Global Investments Group (GIG), based in
Auckland, New Zealand, for card manufacturing in Slovenia. This agreement
provides for payments to the Company of $14 million for a 20-year license and
five-year training support package, followed by $15 million paid $1 million
annually for ongoing support for an additional 15 years. Additionally, the
Company is to sell approximately $12 million worth of the required manufacturing
equipment and installation support for the new facility to be built by GIG to
provide a targeted initial manufacturing capacity of 10 million optical cards
annually. The agreement provides options to increase capacity to 30 million
cards per year. As of September 30, 2005 the Company had $5.5 million of this
equipment classified as equipment held for resale on its balance sheet. The
Company has received $19 million of payments called for in the agreements,
consisting of a partial payment for the equipment of $5 million and $14 million
for the license fee and support. For the $19 million the Company received, $17
million was recorded as advance payments from customers and $2 million for the
licensing fee was recorded as deferred revenue, which were both classified as
long term liabilities within the consolidated balance sheets. In addition to the
$41 million discussed above, GIG is to pay the Company royalties for each card
produced under the license. The territories covered by the license include most
of the European Union and eastern European regions. GIG has exclusive marketing
rights in certain territories, with performance goals to maintain these rights.
The Company will assign a person on site during the license term to assist with
quality, security and operational procedures, with the mutual goal that the
facility and the cards made in the facility conform to the Company's standards.
The Company also retains rights to utilize up to 20% of the new facility
capacity as backup and capacity buffer to augment its own card manufacturing
facilities in Mountain View, California. The granting of this license to GIG
establishes a potential second source supplier of optical memory cards for
existing and prospective customers who may request multiple sources for cards.
Revenue will be recognized over the remaining term of the agreement beginning
when operation of the factory commences which GIG has targeted for calendar year
2006.

ACCOUNTING FOR INCOME TAXES. As part of the process of preparing its
consolidated financial statements, the Company is required to estimate income
taxes in each of the jurisdictions in which it operates. This process involves
estimating the actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the consolidated balance
sheets. The Company must then assess the likelihood that the deferred tax assets
will be recovered from future taxable income and to the extent that management
believes recovery is not likely, the Company must establish a valuation
allowance. To the extent that a valuation allowance is established or increased
in a period, the Company includes an expense within the tax provision in the
statements of operations.

Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. The Company determined as of December 31,
2003, that it was necessary to increase the valuation allowance under SFAS No.
109 to the full amount of the deferred tax asset due to the Company's recent
cumulative tax loss history for the two-year period ended March 31, 2004, income
statement loss history over the previous five quarters and the difficulty in
forecasting the timing of future revenue as evidenced by the deviations in
achieved revenues from expected revenues during the previous few quarters and
taking into account the newness of certain customer relationships. As a result,
the Company determined that a full valuation allowance was required. As of
September 30, 2005, the Company continues to provide for a full valuation
allowance of $18.5 million relating to its U.S. operations.

STOCK-BASED COMPENSATION. The Company accounts for its stock-based
compensation plans using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Compensation cost for stock options, if any, is measured by the excess of the
quoted market price of the Company's stock at the date of grant over the amount
an employee must pay to acquire the stock. SFAS No. 123, "Accounting for
Stock-Based Compensation," established accounting and disclosure requirements
using a fair-value based method of accounting for stock-based employee
compensation plans. The following table illustrates the effect on net loss and
loss per share as if the Company had applied the fair value recognition
provisions of SFAS No. 123 (in thousands except per share amounts):

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---- ---- ---- ----

Net loss, as reported....................................... $ (564) $ (1,521) $ (2,258) $ (3,065)
========= ========= ========= =========

Add: Stock-based employee compensation expense
included in reported net loss........................... 35 21 67 54

Deduct: total stock-based employee compensation
determined under fair value based method for all
awards ................................................. (377) (534) (703) (966)
--------- --------- --------- ---------
Pro forma net loss.......................................... $ (906) $ (2,034) $ (2,894) $ (3,977)
========= ========= ========= =========

Loss per common share:
Basic and diluted - as reported......................... $ (.05) $ (.13) $ (.20) $ (.27)
========= ========= ========= =========
Basic and diluted - pro forma........................... $ (.08) $ (.18) $ (.25) $ (.35)
========= ========= ========= =========

Shares used in computing basic and diluted pro forma
Net loss per share:
Basic and diluted....................................... 11,355 11,368 11,350 11,388

The Company computed the fair value of each option grant on the date of
grant using the Black-Scholes option valuation model with the following
assumptions:

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---- ---- ---- ----

Risk-free interest rate......................... 4.23% 3.65% 3.81-4.23% 3.65%
Average expected life of option................. 8 years 5 years 5 years 5 years
Dividend yield.................................. 0% 0% 0% 0%
Volatility of common stock...................... 55% 55% 55% 55%
Weighted average fair value of option grants $5.93 $4.91 $3.35 $4.91

There were 30,000 and 434,800 options granted during the three and
six-month periods ended September 30, 2005, respectively. There were 39,000
options granted during both the three and six-month periods ended September 30,
2004.

3. SEGMENT REPORTING

The Company's three reportable segments are: (1) optical memory cards,
(2) optical memory card drives, maintenance and related accessories ("optical
card drives") and (3) specialty cards and card printers. The segments were
determined based on the information used by the chief operating decision maker.
The optical memory cards and optical card drives reportable segments are not
strategic business units which offer unrelated products and services; rather
these reportable segments utilize compatible technology and are marketed
jointly. Specialty cards and card printers is a strategic business unit offering
at times unrelated products and at times related products with the other
reportable segments.

The accounting policies used to derive reportable segment results are
the same as those described in the "Summary of Significant Accounting Policies."
Resources are allocated to the optical memory card and optical card drive
segments in a manner that optimizes optical memory card revenues and to the
specialty card and card printers segment in a manner that optimizes consolidated
income as determined by the chief operating decision maker. Segment revenues are
comprised of sales to external customers. Segment gross profit (loss) includes
all segment revenues less the related cost of sales. Accounts receivable, cash,
deferred income taxes, prepaid expenses, fixed assets and inventory are not
separately reported by segment to the chief operating decision maker. Therefore,
the amount of assets by segment is not meaningful. There are no inter-segment
sales or transfers. All of the Company's long-lived assets are attributable to
the United States except for $3.2 million as of September 30, 2005 and $3.4
million as of March 31, 2005 that are attributable to Germany.

The Company's chief operating decision maker is currently the Company's
Chief Executive Officer. The chief operating decision maker reviews financial
information presented on a consolidated basis that is accompanied by
disaggregated information about revenues and gross profit (loss) by segment.

The table below presents information for optical memory cards, optical
card drives and specialty cards and card printers for the three and six-month
periods ended September 30, 2005 and 2004 (in thousands):

THREE MONTHS ENDED SEPTEMBER 30, 2005 THREE MONTHS ENDED SEPTEMBER30, 2004
------------------------------------- ------------------------------------

OPTICAL OPTICAL SPECIALTY OPTICAL OPTICAL SPECIALTY
MEMORY CARD CARDS & SEGMENT MEMORY CARD CARDS & SEGMENT
CARDS DRIVES PRINTERS TOTAL CARDS DRIVES PRINTERS TOTAL

Revenue $ 5,612 $ 374 $ 2,713 $ 8,699 $ 5,116 $ 155 $ 2,498 $ 7,769
Cost of sales 3,696 533 1,977 6,206 3,466 387 1,981 5,834
Gross profit (loss) 1,916 (159) 736 2,493 1,650 (232) 517 1,935
Depreciation and
Amortization expense 403 33 69 505 374 91 66 465

SIX MONTHS ENDED SEPTEMBER 30, 2005 SIX MONTHS ENDED SEPTEMBER30, 2004
----------------------------------- ----------------------------------

OPTICAL OPTICAL SPECIALTY OPTICAL OPTICAL SPECIALTY
MEMORY CARD CARDS & SEGMENT MEMORY CARD CARDS & SEGMENT
CARDS DRIVES PRINTERS TOTAL CARDS DRIVES PRINTERS TOTAL

Revenue $ 9,477 $ 683 $ 5,533 $ 15,693 $ 10,750 $ 444 $ 5,278 $ 16,472
Cost of sales 6,448 952 3,960 11,360 7,346 914 3,924 12,184
Gross profit (loss) 3,029 (269) 1,573 4,333 3,404 (470) 1,354 4,288
Depreciation and
Amortization expense 783 64 136 983 734 78 128 940

The following is a reconciliation of segment results to amounts included
in the Company's condensed consolidated financial statements:

THREE MONTHS ENDED SEPTEMBER 30, 2005 THREE MONTHS ENDED SEPTEMBER 30, 2004
------------------------------------- -------------------------------------

SEGMENT SEGMENT
TOTAL OTHER (a) TOTAL TOTAL OTHER (a) TOTAL
----- ----- ----- ----- ----- -----

Revenue $ 8,699 $ -- $ 8,699 $ 7,769 $ 4 $ 7,773
Cost of sales 6,206 -- 6,206 5,834 8 5,842
Gross profit (loss) 2,493 -- 2,493 1,935 (4) 1,931
Depreciation and
amortization expense 505 147 652 465 178 643

SIX MONTHS ENDED SEPTEMBER 30, 2005 SIX MONTHS ENDED SEPTEMBER 30, 2004
----------------------------------- -----------------------------------

SEGMENT SEGMENT
TOTAL OTHER (a) TOTAL TOTAL OTHER (a) TOTAL
----- ----- ----- ----- ----- -----

Revenue $15,693 $ -- $15,693 $16,472 $ 11 $16,483
Cost of sales 11,360 -- 11,360 12,184 24 12,208
Gross profit (loss) 4,333 -- 4,333 4,288 (13) 4,275
Depreciation and
amortization expense 983 303 1,286 940 412 1,352

(a) Other revenue consists of miscellaneous items not associated with
segment activities. Other cost of sales, depreciation and amortization expense
represents corporate and other costs not directly associated with segment
activities.

5. OTHER COMPREHENSIVE LOSS

The following are the components of other comprehensive loss (in
thousands):

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------

2005 2004 2005 2004
---- ---- ---- ----

Net loss $ (564) $ (1,521) $ (2,258) $ (3,065)
Net change in cumulative
foreign currency translation
adjustments 16 129 (188) 94
-------- -------- -------- --------
Other comprehensive loss $ (548) $ (1,392) $ (2,446) $ (2,971)
======== ======== ======== ========

As of September 30, 2005 and March 31, 2005, the components of
accumulated other comprehensive income mainly consist of cumulative foreign
currency translation adjustments of approximately $21,000 and $209,000,
respectively.

6. RECENT ACCOUNTING PRONOUNCEMENTS

On June 1, 2005, the Financial Accounting Standards Board (FASB) issued
Statement No. 154, Accounting Changes and Error Corrections (FAS 154), a
replacement of APB No. 20, Accounting Changes and FASB Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements. FAS 154 applies to
all voluntary changes in accounting principle and changes the requirements for
accounting for and reporting of a change in accounting principle. This statement
establishes, that unless impracticable, retrospective application is the
required method for reporting a change in accounting principle in the absence of
explicit transition requirements specific to the newly adopted accounting
principle. It also requires the reporting of an error correction which involves
adjustments to previously issued financial statements similar to those generally
applicable to reporting an accounting change retrospectively. FAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company does not expect the adoption of
FAS 154 will have a material impact on its results of operations or financial
condition.

In March 2005, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations." Interpretation No. 47 clarifies that an entity must record a
liability for a "conditional" asset retirement obligation if the fair value of
the obligation can be reasonably estimated. Interpretation No. 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. Interpretation No. 47 is effective no
later than the end of the fiscal year ending after December 15, 2005. The
Company is currently evaluating the provision and does not expect the adoption
in the fourth quarter of fiscal 2006 will have a material impact on our results
of operations or financial condition.

On October 22, 2004, the American Jobs Creation Act of 2004 (the "Act")
was signed into law. The Act contains numerous changes to U.S. tax law, both
temporary and permanent in nature, including a potential tax deduction with
respect to certain qualified domestic manufacturing activities, changes in the
carryback and carryforward utilization periods for foreign tax credits and a
dividend received deduction with respect to accumulated income earned abroad.
The new law could potentially have an impact on the Company's effective tax
rate, future taxable income and cash and tax planning strategies, amongst other
affects. In December 2004, the FASB issued Staff Position No. 109-1 ("FSP
109-1"), Application of FASB Statement No. 109, Accounting for Income Taxes, to
the Tax Deduction on Qualified Production Activities Provided by the American
Jobs Creation Act of 2004 and Staff Position No. 109-2 ("FSP 109-2"), Accounting
and Disclosure Guidance for the Foreign Earnings Repatriation Provision within
the American Jobs Creation Act of 2004. FSP 109-1 clarifies that the
manufacturer's tax deduction provided for under the Act should be accounted for
as a special deduction in accordance with SFAS No. 109 and not as a tax rate
reduction. FSP 109-2 provides accounting and disclosure guidance for the
repatriation of certain foreign earnings to a U.S. taxpayer as provided for in
the Act. The Company is currently studying the impact of the one-time favorable
foreign dividend provision. Accordingly, the Company has not adjusted its income
tax expense or deferred tax liability to reflect the tax impact of any
repatriation of non-U.S. earnings it may make.

In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment"
to revise SFAS No. 123, "Accounting for Stock-Based Compensation" and supersede
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and its related
implementation guidance. It requires companies to recognize their compensation
costs related to share-based payment transactions in financial statements. These
costs are to be measured based on the fair value of the equity or liability
instruments issued. The Company will apply SFAS No. 123(R) in the first quarter
of the fiscal year ending March 31, 2007. The Company has not yet evaluated the
impact that the adoption of SFAS No. 123R will have on its financial statements.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets -- an Amendment of APB Opinion No. 29," which eliminates the
exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS No. 153 will be effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company is
currently evaluating SFAS No. 153 and does not expect the adoption will have a
material impact on its results of operations or financial condition.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs -- an
Amendment of ARB No. 43, Chapter 4," which clarifies the accounting for abnormal
amounts of idle facility expense, freight, handling costs and wasted material
(spoilage) be recognized as current period charges. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
No. 151 will be effective for inventory costs incurred in fiscal years beginning
after June 15, 2005. The Company has not evaluated the impact of SFAS No. 151 to
its overall result of operations or financial condition and does not expect the
adoption will have a material impact on its result of operations or financial
condition.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

The following discussion and analysis of the Company's financial
condition and results of operations should be read in conjunction with the
condensed consolidated financial statements and related notes included elsewhere
in this Form 10-Q Report and the consolidated financial statements and notes
thereto for the year ended March 31, 2005, included in the Company's fiscal 2005
Annual Report on Form 10-K.

FORWARD-LOOKING STATEMENTS

ALL STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACTS
ARE FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS REPORT
ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. THEY ARE NOT HISTORICAL FACTS OR GUARANTEES OF
FUTURE PERFORMANCE OR EVENTS. RATHER, THEY ARE BASED ON CURRENT EXPECTATIONS,
ESTIMATES, BELIEFS, ASSUMPTIONS, AND GOALS AND OBJECTIVES AND ARE SUBJECT TO
UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT. AS A RESULT, THE COMPANY'S ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THE STATEMENTS MADE. OFTEN SUCH STATEMENTS
CAN BE IDENTIFIED BY THEIR USE OF WORDS SUCH AS "MAY," "WILL," "INTENDS,"
"PLANS," "BELIEVES," "ANTICIPATES," "VISUALIZES," "EXPECTS," AND "ESTIMATES."
FORWARD-LOOKING STATEMENTS MADE IN THIS REPORT INCLUDE STATEMENTS AS TO THE
COMPANY'S PLANS TO MERGE ONE OF ITS GERMAN SUBSIDIARIES INTO THE OTHER DURING
CALENDAR 2005; THAT THE GERMAN SUBSIDIARIES WILL SUCCESSFULLY COMPLETE A
CONTRACT FOR A CONVENTIONAL NON-OPTICAL CARD PRODUCTION FACILITY ON OR ABOUT
DECEMBER 2006; THE COMPANY'S BELIEF THAT ITS U.S. GOVERNMENT CONTRACT WILL BE
EXTENDED OR REPLACED PRIOR TO DELIVERY OF THOSE CARDS ORDERED PRIOR TO THE
CONTRACT'S EXPIRATION IN NOVEMBER 2005; THE COMPANY'S BELIEFS AS TO CURRENT AND
POTENTIAL MARKET SEGMENTS, CUSTOMERS, AND APPLICATIONS FOR AND DEPLOYMENT OF THE
PRODUCTS OF THE COMPANY; THE ADVANTAGES OF, POTENTIAL INCOME FROM, AND DUTIES TO
BE PERFORMED UNDER THE SALE OF A SECOND-SOURCE CARD MANUFACTURING LICENSE TO
GLOBAL INVESTMENTS GROUP (GIG); FUTURE SCHEDULED PAYMENTS AND CONTINGENT
ROYALTIES UNDER THE GIG CONTRACT, GIG'S TARGETED STARTUP DATE AND PRODUCTION
CAPACITY, AND THAT THE COMPANY WILL SELL EQUIPMENT TO GIG, PROVIDE GIG WITH
INSTALLATION SUPPORT, AND HAVE ON-SITE PERSONNEL; PRODUCTION QUANTITIES,
DELIVERY RATES AND EXPECTED DELIVERY SCHEDULE, BACKLOG, AND REVENUE RECOGNITION
FOR COMPANY PRODUCTS FOR U.S. OR FOREIGN GOVERNMENT PROGRAMS; PLANS TO INCREASE
CARD PRODUCTION CAPACITY FOR ANTICIPATED INCREASES IN ORDERS INCLUDING $10
MILLION IN CAPITAL EQUIPMENT AND LEASEHOLD IMPROVEMENTS DURING THE NEXT NINE TO
TWELVE MONTHS; ANTICIPATED CONTINUED USE OF THE COMPANY'S PRODUCTS BY THE
GOVERNMENTS OF THE UNITED STATES, CANADA, A MIDDLE EASTERN COUNTRY, INDIA, COSTA
RICA AND ITALY; THE NEED FOR, EXPECTED SUCCESS OF, AND POTENTIAL BENEFITS FROM
THE COMPANY'S RESEARCH AND ENGINEERING EFFORTS AND WHETHER THEY CAN STIMULATE
CARD SALES GROWTH, THE EFFECTS OF READ/WRITE DRIVE PRICES AND SALES VOLUME ON
GROSS PROFITS OR GROSS MARGINS FROM READ/WRITE DRIVE SALES; BELIEF THAT A 10%
INCREASE OR DECREASE IN SALES WILL NOT MATERIALLY AFFECT INVENTORY RESERVES;
EXPECTATIONS REGARDING REVENUES, MARGINS, SG&A AND R&D EXPENSES, STATE INCOME
TAXES, CAPITAL RESOURCES, AND CAPITAL EXPENDITURES AND INVESTMENTS, AND THE
COMPANY'S DEFERRED TAX ASSET AND RELATED VALUATION ALLOWANCE; EXPECTED CARD
ORDERS (INCLUDING THAT AN ORDER FROM THE MIDDLE EASTERN COUNTRY IS ANTICIPATED
DURING FISCAL 2006 THIRD QUARTER) DELIVERY VOLUMES, ESTIMATES OF OPTICAL CARD
PRODUCTION CAPACITY, EXPECTED CARD YIELDS THERE FROM, THE COMPANY'S ABILITY TO
EXPAND PRODUCTION CAPACITY, AND THE COMPANY'S PLANS AND EXPECTATIONS REGARDING
THE GROWTH AND ASSOCIATED CAPITAL COSTS OF SUCH CAPACITY; ESTIMATES THAT
REVENUES AND ADVANCE PAYMENTS WILL BE SUFFICIENT TO GENERATE CASH FROM OPERATING
ACTIVITIES OVER THE NEXT 12 MONTHS DESPITE EXPECTED QUARTERLY FLUCTUATIONS;
EXPECTATIONS REGARDING MARKET GROWTH, PRODUCT DEMAND, AND THE CONTINUATION OF
CURRENT PROGRAMS; POTENTIAL EXPANSION OR IMPLEMENTATION OF GOVERNMENT PROGRAMS
UTILIZING OPTICAL MEMORY CARDS, INCLUDING WITHOUT LIMITATION, THOSE IN ITALY,
INDIA, AND A MIDDLE EASTERN COUNTRY, AND THE TIMING OF THE AWARD OF ANY PRIME
CONTRACTS FOR SUCH PROGRAMS AND THE AMOUNT OF CARD ORDERS IN SUCH PROGRAMS; AND
THE COMPANY'S PLANS, OBJECTIVES, AND EXPECTED FUTURE ECONOMIC PERFORMANCE
INCLUDING WITHOUT LIMITATION, ITS MARKETING OBJECTIVES AND DRIVE PRICING
STRATEGY.

THESE FORWARD-LOOKING STATEMENTS ARE BASED UPON THE COMPANY'S
ASSUMPTIONS ABOUT AND ASSESSMENT OF THE FUTURE, WHICH MAY OR MAY NOT PROVE TRUE,
AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO,
WHETHER THERE IS A MARKET FOR CARDS FOR HOMELAND SECURITY IN THE U.S. AND
ABROAD, AND IF SO WHETHER SUCH MARKET WILL UTILIZE OPTICAL MEMORY CARDS AS
OPPOSED TO OTHER TECHNOLOGY; CUSTOMER CONCENTRATION AND RELIANCE ON CONTINUED
U.S. AND ITALIAN GOVERNMENT BUSINESS; RISKS ASSOCIATED WITH DOING BUSINESS IN
AND WITH FOREIGN COUNTRIES; WHETHER THE COMPANY CAN SUCCESSFULLY INTEGRATE AND
OPERATE ITS RECENTLY ACQUIRED GERMAN SUBSIDIARIES AND WHETHER THE COMPANY
ENCOUNTERS DELAYS IN EFFECTING THEIR MERGER; WHETHER THE COMPANY WILL BE
SUCCESSFUL IN ASSISTING GIG WITH FACTORY STARTUP AND TRAINING; WHETHER GIG WILL
HAVE THE FINANCIAL WHEREWITHAL TO MAKE ITS REQUIRED PAYMENTS TO THE COMPANY AND
TO OPERATE THE FACILITY; WHETHER THE FACILITY WILL EFFICIENTLY PRODUCE HIGH
QUALITY OPTICAL MEMORY CARDS IN VOLUME AND THAT MEETS OUR STANDARDS; LENGTHY
SALES CYCLES AND CHANGES IN AND DEPENDENCE ON GOVERNMENT POLICY-MAKING; RELIANCE
ON VALUE-ADDED RESELLERS AND SYSTEM INTEGRATORS TO GENERATE SALES, PERFORM
CUSTOMER SYSTEM INTEGRATION, DEVELOP APPLICATION SOFTWARE, INTEGRATE OPTICAL
CARD SYSTEMS WITH OTHER TECHNOLOGIES, TEST PRODUCTS, AND WORK WITH GOVERNMENTS
TO IMPLEMENT CARD PROGRAMS; RISKS AND DIFFICULTIES ASSOCIATED WITH DEVELOPMENT,
MANUFACTURE, AND DEPLOYMENT OF OPTICAL CARDS, DRIVES, AND SYSTEMS; THE IMPACT OF
LITIGATION; THE ABILITY OF THE COMPANY OR ITS CUSTOMERS TO INITIATE AND DEVELOP
NEW PROGRAMS UTILIZING THE COMPANY'S CARD PRODUCTS; RISKS AND DIFFICULTIES
ASSOCIATED WITH DEVELOPMENT, MANUFACTURE, AND DEPLOYMENT OF OPTICAL CARDS,
DRIVES, AND SYSTEMS; POTENTIAL MANUFACTURING DIFFICULTIES AND COMPLICATIONS
ASSOCIATED WITH INCREASING MANUFACTURING CAPACITY OF CARDS AND DRIVES,
IMPLEMENTING NEW MANUFACTURING PROCESSES, AND OUTSOURCING MANUFACTURING; THE
COMPANY'S ABILITY

TO PRODUCE AND SELL READ/WRITE DRIVES IN VOLUME; THE UNPREDICTABILITY OF
CUSTOMER DEMAND FOR PRODUCTS AND CUSTOMER ISSUANCE AND RELEASE OF CORRESPONDING
ORDERS; GOVERNMENT RIGHTS TO WITHHOLD ORDER RELEASES, REDUCE THE QUANTITIES
RELEASED, AND EXTEND SHIPMENT DATES; WHETHER THE COMPANY RECEIVES A FIXED
SHIPMENT SCHEDULE, ENABLING THE COMPANY TO RECOGNIZE REVENUES ON CARDS DELIVERED
TO THE VAULT INSTEAD OF WHEN CARDS LATER ARE SHIPPED FROM THE VAULT; THE IMPACT
OF TECHNOLOGICAL ADVANCES, GENERAL ECONOMIC TRENDS, AND COMPETITIVE PRODUCTS;
THE IMPACT OF CHANGES IN THE DESIGN OF THE CARDS; AND THE POSSIBILITY THAT
OPTICAL MEMORY CARDS WILL NOT BE PURCHASED FOR THE FULL IMPLEMENTATION OF CARD
PROGRAMS IN ITALY, A MIDDLE EASTERN COUNTRY AND INDIA, OR FOR DHS PROGRAMS IN
THE U.S., OR WILL NOT BE SELECTED FOR OTHER GOVERNMENT PROGRAMS IN THE U.S. AND
ABROAD; UNANTICIPATED DELAYS IN OBTAINING US GOVERNMENT APPROVALS TO EXTEND OR
REPLACE ITS EXPIRING CONTRACT; THE RISKS SET FORTH IN THE SECTION ENTITLED
"RISKS FACTORS AND FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND
ELSEWHERE IN THIS REPORT; AND OTHER RISKS DETAILED FROM TIME TO TIME IN THE
COMPANY'S SEC FILINGS. THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS TO THE
DATE OF THIS REPORT, AND, EXCEPT AS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE UPDATES OR REVISIONS TO THESE STATEMENTS WHETHER
AS A RESULT OF NEW INFORMATION, FUTURE EVENTS, OR OTHERWISE.

CRITICAL ACCOUNTING POLICIES

REVENUE RECOGNITION. Product sales primarily consist of optical card
sales, sales of optical card read/write drives and sales of specialty cards and
card printers. The Company recognizes revenue from product sales when the
following criteria are met: (1) persuasive evidence of an arrangement exists;
(2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement and there are no
post-shipment obligations other than warehousing under a U.S. government
subcontract or customer acceptance criteria. Where appropriate, provision is
made at the time of shipment for estimated warranty costs and estimated returns.
The total amounts of actual warranty costs and returns activity were $58,000 and
$121,000 for the three-month periods ended September 30, 2005 and 2004,
respectively. The total amount of actual warranty costs and returns activity
were $106,000 and $242,000 for the six-month periods ended September 30, 2005
and 2004, respectively.

The Company applies the provisions of Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1) in applicable contracts. Revenues on time and materials
contracts are recognized as services are rendered at contract labor rates plus
material and other direct costs incurred. Revenues on fixed price contracts are
recognized on the percentage of completion method based on the ratio of total
costs incurred to date compared to estimated total costs to complete the
contract. Estimates of costs to complete

include material, direct labor, overhead and allowable general and
administrative expenses. In circumstances where estimates of costs to complete a
project cannot be reasonably estimated, but it is assured that a loss will not
be incurred, the percentage-of-completion method based on a zero profit margin,
rather than the completed-contract method, is used until more precise estimates
can be made. The full amount of an estimated loss is charged to operations in
the period it is determined that a loss will be realized from the performance of
a contract. During the three-month periods ended September 30, 2005 and 2004,
the Company recognized approximately $24,000 and $21,000 of revenues based on a
zero profit margin, respectively. During the six-month periods ended September
30, 2005 and 2004, the Company recognized approximately $66,000 and $86,000 of
revenues based on a zero profit margin, respectively.

License revenue, which may consist of up-front license fees and royalty
payments, is recognized as revenue when earned. The second-source
card-manufacturing license sold in April 2004 to Global Investments Group
provides for royalty payments to the Company for each card produced during the
20-year term of the license agreement. This is a multi-element arrangement as
described in Emerging Issues Task Force (EITF) Issue No. 00-21; revenue derived
from the payments will be recognized from time to time over the term of the
license. Revenue will be recognized over the remaining term of the agreement
beginning when operation of the factory commences. There was no cost of license
revenue recorded for three-month and six-month periods ended September 30, 2005
and 2004, respectively

Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. As of September 30, 2005, the Company
continues to provide for a full valuation allowance of $18.5 million relating to
its U.S. operations

In the event that actual results differ from Company estimates or that
Company estimates are adjusted in future periods, the Company may need to adjust
the amount of the valuation allowance based on future determinations of whether
it is more likely than not that some or all of its deferred tax assets will be
realized. A decrease in the valuation allowance would be recorded as an income
tax benefit or a reduction of income tax expense or a credit to stockholders'
equity. The Company's net operating losses available to reduce future taxable
income expires on various dates from fiscal 2007 through fiscal 2024. To the
extent that the Company generates taxable income in jurisdictions where the
deferred tax asset relates to net operating losses that have been offset by a
full valuation allowance, the utilization of these net operating losses would
result in the reversal of the related valuation allowance.

INVENTORIES. The Company values its inventory at the lower of the actual
cost to purchase and/or manufacture the inventory or the current estimated
market value of the inventory. Management regularly reviews inventory quantities
on hand and records a provision for excess and obsolete inventory based
primarily on forecasts of product demand. Demand for read/write drives can
fluctuate significantly. In order to obtain favorable pricing, purchases of
certain read/write drive parts are made in quantities that exceed the booked
orders. The Company purchases read/write drive parts for its anticipated
read/write drive demand and takes into consideration the order-to-delivery lead
times of

vendors and the economic purchase order quantity for such parts. In addition,
the Company keeps a supply of card raw materials it deems necessary for
anticipated demand.

Management's analysis of the carrying value of its inventory is
performed on a quarterly basis. With respect to inventory carrying values, the
Company follows the principles articulated in Accounting Research Bulletin 43,
Chapter 4, "Inventory Pricing," paragraphs 5 through 7 and 10 and other
authoritative guidance (SAB 100) as it relates to determining the appropriate
cost basis of inventory and determining whether firm, noncancelable purchase
commitments should be accrued as a loss if forecasted demand is not sufficient
to utilize all such committed inventory purchases. As part of the Company's
quarterly excess/obsolete analysis, management also determines whether lower of
cost or market adjustments (i.e., where selling prices less certain costs are
not sufficient to recover inventory carrying values) are warranted; during the
six-month periods ended September 30, 2005 and 2004, the Company has not
recorded any significant lower of cost or market adjustments. In those instances
where the Company has recorded charges for excess and obsolete inventory,
management ensures that such new cost basis is reflected in the statement of
operations if that inventory is subsequently sold. The Company's inventory
reserves are based upon the lower of cost or market for slow moving or obsolete
items. As a result, the Company believes a 10% increase or decrease of sales
would not have a material impact on such reserves. The Company has not evaluated
the impact of SFAS No. 151 "Inventory Costs - Amendment of ARB No. 43, Chapter
4" and does not expect the adoption will have a material impact on its results
of operations or financial condition.

RESULTS OF OPERATIONS--FISCAL 2006 SECOND QUARTER AND FIRST SIX MONTHS
COMPARED WITH FISCAL 2005 SECOND QUARTER AND FIRST SIX MONTHS

OVERVIEW

Headquartered in Mountain View, California, LaserCard Corporation
manufactures LaserCard(R) optical memory cards, chip-ready OpticalSmart(TM)
cards, and other advanced-technology cards. In addition, the Company operates
two wholly owned subsidiaries acquired on March 31, 2004, Challenge Card Design
Plastikkarten GmbH, of Rastede, Germany, manufactures advanced-technology cards;
and cards & more GmbH, of Ratingen, Germany, markets cards, system solutions,
and thermal card printers.

The Company is in the process of merging cards & more GmbH into
Challenge Card Design Plastikkarten GmbH. This merger is expected to be
completed in this calendar year.

In addition to using its own marketing staff in California, New York,
and Germany, the Company utilizes value added reseller (VAR) companies and card
distribution licensees for the development of markets and applications for
LaserCard products. Product sales to VARs and licensees consist primarily of the
Company's optical memory cards and optical card read/write drives. The Company
also offers for sale, its customized software applications and add-on
peripherals made by other companies (such as equipment for adding a digitized
photo, fingerprint, or signature to the cards). These peripherals have not
generated material revenue for the Company but have demonstrated various system
options. The VARs/licensees may add application software, personal computers,
and other peripherals, and then resell these products integrated into data
systems. The Company is continuing its efforts to recruit new VARs and eliminate
nonproductive VARs.

Major near term growth potential for LaserCard optical memory cards are
in government-sponsored identification programs in several countries. Since
governmental card programs typically rely on policy-making, which in turn is
subject to technical requirements, budget approvals, and political
considerations, there is no assurance that these programs will be implemented as
expected or that they will include optical cards. Objectives for long-term
revenue growth include: (1) broaden the "Optical Memory" ("OM") products range
to address lower end applications characterized by higher price sensitivity, (2)
diversify OM products into, and effectively penetrate, industrial and commercial
markets, (3) expand hardware product offering to address new markets and add
value to current offering, (4) increase OM product revenues by selling more
application software and integrated solutions.

The table below presents consolidated revenue, excluding intercompany
transactions, recorded by the U.S. and German operations for the three-month and
six-month periods ended September 30, 2005 (in thousands):

THREE-MONTH ENDED SIX-MONTH ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004

U.S operations $ 6,184 $ 5,325 $ 10,370 $ 11,297
German operations 2,515 2,448 5,323 5,186

Revenues recorded by the U.S. operations are generally to a small number
of government customers located throughout the world. Revenues recorded by the
German operations are mainly for a relatively large number of commercial
customers.

The largest purchaser of LaserCard products is Anteon International
Corporation (Anteon), a value-added reseller (VAR) of the Company. Anteon is the
government contractor for LaserCard product sales to the U.S. Department of
Homeland Security (DHS), U.S. Department of State (DOS), U.S. Department of
Defense (DOD), and the government of Canada. Under government contracts with
Anteon, the DHS purchases Green Cards and DOS Laser Visa BCCs; the DOD purchases
Automated Manifest System cards; and the Canadian government purchases Permanent
Resident Cards. Encompassing all of these programs, the Company's product sales
to Anteon represented 36% and 39% for the three and six-month periods ended
September 30, 2005 and 18% and 20% for the same periods a year ago. Another
unaffiliated VAR, Laser Memory Card SPA of Italy, accounted for 15% and 10% for
the three and six-month periods ended September 30, 2005 and 47% and 44% for the
same periods a year ago mainly for the program in Italy. Another VAR, Orbit
Company Ltd., accounted for 11% in the three months ended September 30, 2005 for
the program in a Middle Eastern country.

Revenues for the major programs are shown below as a percentage of total
Company revenues

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---- ---- ---- ----

United States Green Cards and Laser Visa BCCs.......... 25% 6% 29% 9%
Canadian Permanent Resident Cards...................... 10% 9% 7% 8%
Italian Carta d'Identica Elettronica (CIE) Cards....... 15% 47% 10% 43%
National ID in a Middle Eastern Country................ 13% 1% 11% 1%

For the government of Italy, the Company received orders for Carta
d'Identita Elettronica (CIE) cards and Permesso di Soggiorno Elettronico (PSE)
cards during the second quarter in response to a law enacted by the Italian
parliament that moves the CIE and PSE optical card programs into full
implementation by requiring the issuance of electronic CIE and PSE cards instead
of paper cards beginning January 2006. The orders received by the Company during
the second quarter of fiscal 2006 were for $7 million of CIE cards scheduled for
delivery prior to December 31, 2005, and $8 million of PSE cards scheduled for
delivery prior to April 30, 2006. As the Company shipped approximately $1.2
million of cards during the second quarter, backlog at September 30, 2005,
totaled $13.8 million for these programs. According to program descriptions
released by the Italian government, CIE and PSE card orders could potentially
reach 8 to 10 million cards and one million cards per year, respectively, when
fully implemented which would result in annual revenues of $40 million to $50
million in total for CIE cards and PSE cards.

The Company's current five-year U.S. government subcontract, as extended
in May 2005, for U.S. Permanent Resident Cards (Green Cards) and Laser Visa BCCs
was announced in June 2000 and will expire on November 26, 2005, which is when
the last order under that subcontract may be placed. Backlog at September 30,
2005 for these programs, which is deliverable through January 2006, totaled $2.6
million. The Company expects that its U.S. government subcontract will be
extended or replaced with a new subcontract prior to when it makes its last
shipment under orders on hand or received in the future pursuant to the current
subcontract although no assurance can be given. This subcontract was received by
the Company through Anteon, a LaserCard VAR that is a U.S. government prime

contractor. U.S. Laser Visa Border Crossing Cards (BCCs) and Green Cards for the
U.S. Department of Homeland Security (DHS) are an important part of the
Company's revenue base. For these programs, the Company recorded card revenues
of $2.1 million and $0.5 million in the second quarters, and $4.6 million and
$1.5 million in the first six months, of fiscal 2006 and 2005, respectively.

For Canada's Permanent Resident Card program, the backlog at September
30, 2005 was $1.1 million deliverable through July 2006 at the rate of
approximately $100,000 per month. The delivery rate is subject to increase or
decrease by customer request.

For the first six months period ended September 30, 2005, the Company
shipped optical memory cards valued at $1.5 million for the national ID card
program in a Middle Eastern country. The Company anticipates an additional order
for this program later this calendar year.

Effective April 3, 2004, the Company sold a license to Global
Investments Group (GIG), based in Auckland, New Zealand, for card manufacturing
in Slovenia. This agreement provides for payments to the Company of $14 million
for a 20-year license and five-year training support package, followed by $15
million paid $1 million annually for ongoing support for an additional 15 years.
Additionally, the Company is to sell approximately $12 million worth of the
required manufacturing equipment and installation support for the new facility
to be built by GIG to provide a targeted initial manufacturing capacity of 10
million optical cards annually. The agreement provides options to increase
capacity to 30 million cards per year. As of September 30, 2005 the Company had
acquired $5.5 million of this equipment classified as equipment held for resale
on its balance sheet. The Company has received $19 million of payments called
for in the agreements, consisting of a partial payment for the equipment of $5
million and $14 million for the license fee and support. For the $19 million the
Company received, $17 million was recorded as advance payments from customers
and $2 million for the licensing fee was recorded as deferred revenue, which
were both classified as long term liabilities within the consolidated balance
sheets. In addition to the $41 million discussed above, GIG is to pay the
Company royalties for each card produced under the license. The territories
covered by the license include most of the European Union and eastern European
regions. GIG has exclusive marketing rights in certain territories, with
performance goals to maintain these rights. The Company will assign a person on
site during the license term to assist with quality, security and operational
procedures, with the mutual goal that the facility and the cards made in the
facility conform to the Company's standards. The Company also retains rights to
utilize up to 20% of the new facility capacity as backup and capacity buffer to
augment its own card manufacturing facilities in Mountain View, California. The
granting of this license to GIG establishes a potential second source supplier
of optical memory cards for existing and prospective customers who may request
multiple sources for cards. Revenue will be recognized over the remaining term
of the agreement beginning when operation of the factory commences, which GIG
has targeted for calendar 2006. Subsequent to quarter end an additional $1.5
million was received from GIG bringing the total to $20.5 million.

The Company plans to invest up to $10 million in additional capital
equipment and leasehold improvement expenditures at its facilities when
forecasts justify the investment. These expenditures could occur throughout the
next nine to twelve months, as more fully discussed under "Liquidity and Capital
Resources."

REVENUES

PRODUCT REVENUES. The Company's total revenues for the three and six
months periods ended September 30, 2005 and 2004 consisted of sales in its three
segments of (1) optical memory cards, (2) optical card read/write drives, drive
accessories, and maintenance, and (3) specialty cards and card printers, and
other miscellaneous items. Sales in all three segments increased during the
three months ended September 30, 2005 as compared to the same period a year ago,
with the largest dollar increase in optical memory card product sales. The
increases were driven by increased card volumes. The decrease in total revenues
for the six-month periods ended September 30, 2005, as compared to the same
period a year ago, was due primarily to the decrease of average selling price
for optical memory cards. The average selling price decreased due to product
mix. There was no price reduction during the period.

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,

(IN THOUSANDS, EXCEPT PERCENTAGES)

2005 2004 CHANGE 2005 2004 CHANGE
---- ---- ------ ---- ---- ------

Optical memory cards $ 5,612 $ 5,116 $ 496 $ 9,477 $10,750 $(1,273)
Percentage of total revenues 65% 66% 61% 65%

Optical card read/write drives $ 374 $ 155 $ 219 $ 683 $ 444 $ 239
Percentage of total revenues 4% 2% 4% 3%

Specialty cards and card
printers $ 2,713 $ 2,498 $ 215 $ 5,533 $ 5,278 $ 255
Percentage of total revenues 31% 32% 35% 32%

Other $ -- $ 4 $ (4) $ -- $ 11 $ (11)
Percentage of total revenues --% --% --% --%

Total revenues $ 8,699 $ 7,773 $ 926 $15,693 $16,483 $ (790)

Optical memory cards revenue by major program was as follows (in
thousands):

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,

2005 2004 2005 2004
---- ---- ---- ----

Green Cards & Laser Visas $ 2,145 $ 495 $ 4,620 $ 1,516
Italian Card Programs 1,088 3,549 1,194 6,934
Canadian Permanent Resident Cards 831 662 1,055 1,325
National ID Cards in a Middle
Eastern country 950 93 1,477 178

Sales of Green Cards and Laser Visas increased as the U.S. government
resumed orders to more closely match the issuance rate after reducing its
inventory to approximately six months worth of cards. Sales of Italian CIE cards
decreased as the second experimental phase wound down as preparations began for
full implementation in calendar 2006. Sales of national ID cards for a Middle
Eastern country increased and this program is in the early stages where
shipments are sporadic.

Optical card reader/write derive revenues consisted of revenue on
read/write drives, drive service, and related accessories. The increases in the
second quarter and first six months of fiscal 2006 as compared to the same
periods a year ago were due primarily to an increase in unit sales volume for
read/write drives.

Specialty card and card printer revenues increased in fiscal 2006
compared with fiscal 2005 mainly due to sales of non-optical cards to a Middle
Eastern country.

LICENSE FEES AND OTHER REVENUES. There were no license revenues for the
three and six-month periods ended September 30, 2005 and 2004. Effective April
3, 2004, the Company sold a second-source card-manufacturing license to the
Global Investments Group, based in Auckland, New Zealand, for card manufacturing
in Slovenia and began receiving cash payments discussed above in "Overview."
Revenue will begin to be recorded when operation of their factory commences.

BACKLOG

As of September 30, 2005, the backlog for LaserCard optical memory cards
totaled $18.2 million mostly scheduled for delivery in fiscal 2006, compared
with $6.4 million at September 30, 2004. Of this backlog, $13.8 million resulted
from the CIE and PSE card orders for the Italian Program discussed above in
"Overview". The

Company has only a few customers who generally place orders for a several-month
period so that variations in order placement from a single customer can
materially affect backlog. As a result, the relative size of our backlog has not
been a reliable indicator of future sales revenue trends.

The Company has no significant backlog for read/write drives.

In addition, the backlog for Challenge Card Design Plastikkarten GmbH
and cards & more GmbH as of September 30, 2005 for specialty cards and card
printers totaled $0.4 million euros (approximately $0.5 million) and for a
contract to develop a conventional non-optical card production facility totaled
$0.7 million euros (approximately $0.8 million). Revenue on the contract for a
conventional non-optical card production facility is being booked on a zero
profit margin basis. Therefore, the total profit under this contract will be
booked at completion on or about December 2006. The backlog for Challenge Card
Design Plastikkarten GmbH and cards & more GmbH as of September 30, 2004 for
specialty cards and card printers totaled 0.3 million euros (approximately $0.4
million) and for a contract to develop a conventional non-optical card
production facility totaled 0.8 million euros ($1 million). The prior period
backlog excludes about $1.1 million, that was included last year, for a
partially completed contract that was subsequently canceled due to the
insolvency of the customer.

GROSS MARGIN

Total gross margin was 29% for the three-month period ended September 30, 2005,
25% for the three-month period ended September 30, 2004, 28% for the six-month
period ended September 30, 2005, and 26% for the six-month period ended
September 30, 2004 as follows:

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,

(IN THOUSANDS, EXCEPT PERCENTAGES)

2005 2004 CHANGE 2005 2004 CHANGE
---- ---- ------ ---- ---- ------

Optical memory cards $ 1,916 $ 1,650 $ 266 $ 3,029 $ 3,404 $ (375)
Percentage of optical memory
cards revenue 34% 32% 32% 32%

Optical card read/write drives $ (159) $ (232) $ 73 $ (269) $ (470) $ 201
Percentage of optical card
read/write drive revenue NM NM NM NM

Specialty cards and card printers $ 736 $ 517 $ 219 $ 1,573 $ 1,354 $ 219
Percentage of specialty cards and
card printers revenue 27% 21% 29% 26%

Other $ -- $ (4) $ 4 $ -- $ (13) $ 13
Percentage of other revenues NM NM NM NM

Total gross margin $ 2,493 $ 1,931 $ 562 $ 4,333 $ 4,275 $ 58
Percentage of total revenues 29% 25% 28% 26%

OPTICAL MEMORY CARDS. Optical memory card gross margin can vary
significantly based on average selling price, sales and production volume, mix
of card types, production efficiency and yields, and changes in fixed costs. The
gross margin increase in the second quarter of fiscal 2006 as compared to the
same period a year ago was due to the increase in production unit volume and the
corresponding increased absorption of fixed costs. The decrease in gross profit
for the first six months was due to product mix partially offset by increased
manufacturing yields and efficiency. The Company anticipates that the optical
memory card gross margin will increase as revenue increases due to current
booked orders.

READ/WRITE DRIVES, MAINTENANCE, AND RELATED ITEMS. Gross margin in this
segment can vary significantly based upon sales and production volume, changes
in fixed costs, and the inclusion of optional features and software licenses on
a per-drive basis. Read/write drive gross margin is generally negative,
inclusive of fixed overhead costs, due to low sales volume. The increases in
gross margin during the second quarter and first six months of fiscal 2006 as
compared

to the same periods a year ago were primarily due to an increase in revenues.
The Company anticipates that quarterly negative gross profits will continue in
the future unless sales volume is sufficient to cover fixed costs. Also, unless
per drive system software licenses are included in future orders, the Company
believes that margins will be below 10% when sales volume is sufficient to
result in positive gross margin due to the Company's strategy to price drives at
close to the cost in order to help promote optical memory card sales.

SPECIALTY CARDS AND CARD PRINTERS. Specialty card and card printer gross
margins have historically fluctuated between 21% and 31% primarily depending
upon product mix.

OPERATING EXPENSES

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(IN THOUSANDS)

2005 2004 CHANGE 2005 2004 CHANGE
---- ---- ------ ---- ---- ------

Selling, general and administrative expenses $ 2,612 $ 2,809 $ (197) $ 5,743 $ 5,843 $ (100)
Research and engineering expenses $ 552 $ 723 $ (171) $ 1,051 $ 1,574 $ (523)

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). The decrease of
SG&A expenses in the three-month period ended September 30, 2005 as compared to
the same period a year ago was due primarily to a $72,000 decrease for salaries
and a $100,000 decrease in legal expenses. For the six-month period ended
September 30, 2005, the decrease of SG&A expenses as compared to the same period
a year ago, was due primarily to a $153,000 decrease in legal expenses. The
Company believes that SG&A expenses for the remainder fiscal 2006 will be higher
than fiscal 2005 levels, mainly due to increases in marketing and selling
expenses and management incentives.

RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card features and structures, including
various sheet-lamination card structures, the insertion of contactless chips
with radio frequency (RF) capability, OptiChip(TM), OVD (optically variable
device) products, and associated media development; enhanced optical memory card
read/write drives and read-only drives (readers); and new software products in
an effort to provide new products that can stimulate optical memory card sales
growth. For example, the Company recently has developed a prototype of a
LaserCard handheld reader. The Company anticipates that these ongoing research
and engineering efforts will result in new or enhanced card capabilities,
production-model read-only drives, or drives with advanced security features and
lower manufacturing costs; however, there is no assurance that such product
development efforts will be successful. These features are important for the
Company's existing and future optical memory card markets. The decrease in R&E
spending for fiscal 2006 is primarily due to the completion of major spending
for the LaserCard handheld reader, coupled with being between phases of the new
card media development project and the completion of a card material and other
projects. The Company anticipates the R&E spending will increase throughout the
remainder of fiscal 2006 mainly for new media and commercial product
development.

OTHER INCOME, NET

Other income, net for the second quarter of fiscal 2006 was $108,000
consisting of mainly $115,000 in interest income partially offset by $7,000 in
interest expense, compared with $62,000 for the second quarter of fiscal 2005
consisting of mainly $96,000 in interest income partially offset by $34,000 in
interest expense. The other income, net for the first six months of fiscal 2006
was $204,000 mainly consisting of $220,000 of interest income partially offset
by $16,000 in miscellaneous expenses, compared with $85,000 consisting of mainly
$186,000 in interest income partially offset by $96,000 in interest expense for
the first six months of fiscal 2005. The increase in interest income was mainly
due to the increase in interest rates on our invested funds while we eliminated
our interest expense by paying off our long-term debt during fiscal 2005.

INCOME TAXES

The Company recorded an income tax expense of $1,000 for the second
quarter of fiscal 2006 compared with an income tax benefit of $18,000 for the
second quarter of fiscal 2005. For the first six months of fiscal 2006, the
Company recorded an income tax expense of $1,000 compared with an income tax
expense of $8,000 for the first six months of fiscal 2005. The amount of the tax
benefit recorded for the first six months of fiscal 2005 was due to the

operating loss incurred in the Company's German operation in the second quarter
of fiscal 2005 while the amount of tax expenses recorded for the first six
months of fiscal 2006 was due primarily to taxes incurred in the Company's
German operations. The Company anticipates that it will record a tax provision
for state taxes if and when profitability occurs at the approximate rate of 10%
of income from U.S. operations. Also, federal alternative minimum taxes and
taxes on profits of the German operations will result in tax expense.

LIQUIDITY AND CAPITAL RESOURCES

SEPTEMBER 30, MARCH 31,
2005 2005
---- ----
(IN THOUSANDS)

Cash, cash equivalents and short-term $ 17,296 $ 10,115
investments
Cash, cash equivalents, short-term and $ 17,296 $ 16,415
long-term investments

SIX MONTHS ENDED
SEPTEMBER 30,
2005 2004 CHANGE
---- ---- ------
(IN THOUSANDS)
Net cash provided by operating activities $ 1,312 $ 3,597 $ (2,285)
Net cash used in investing activities $ (3,327) $ (385) $ (2,942)
Net cash provided by (used in) financing $ 262 $ (1,725) $ 1,987
activities

The Company's primary sources of liquidity consisted of approximately
$17.3 million in cash, cash equivalents and short-term investments and no
long-term investments as of September 30, 2005 compared to approximately $10.1
million in cash, cash equivalents and short-term investments and approximately
$6.3 million in long-term investments for a total of approximately $16.4 million
as of March 31, 2005. During the six-month period ended September 30, 2005, the
increase of $7.2 million in cash, cash equivalents and short-term investments
was primarily related to approximately $1.3 million provided by operations and
$6.3 million transferred from long-term investments. The current ratio was 4.4
to 1 as of September 30, 2005.

Cash provided by operating activities was $1.3 million for the six-month
period ended September 30, 2005 compared with $3.6 million for the same period
last year. The difference in cash provided by operating activities between the
two periods was largely due to the amount of payments received from GIG.

The Company believes that the estimated level of revenues and advance
payments over the next 12 months will be sufficient to generate cash from
operating activities over the same period. However, quarterly fluctuations are
expected. Operating cash flow could be negatively impacted to a significant
degree if GIG does not make the required payments as scheduled, or if either of
the Company's largest U.S. government programs were to be delayed, reduced,
canceled, or not extended, if the Italian CIE card program does not grow as
planned internally, and if these programs are not replaced by other card orders
or other sources of income. Over the next six to nine months, the amount of
equipment purchased for GIG will approximately equal the amount of cash the
Company expects to receive from GIG.

Other than a small short-term working capital line of credit utilized by
a subsidiary in Germany, the Company has not established a line of credit and
has no current plans to do so. The Company may negotiate a line of credit if and
when it becomes appropriate, although no assurance can be made that such
financing would be available on favorable terms or at all, if needed.

As a result of the $0.6 million net loss recorded for the fiscal 2006
second quarter, the Company's accumulated deficit increased to $29.4 million.
Stockholders' equity declined $2.3 million during the first half of fiscal 2006
due primarily to losses of approximately that amount.

The increase in net cash used for investing activities in the fiscal
2006 first six month as compared to the fiscal 2005 first six months was due
primarily to $2.6 million of net purchase of liquid investments in the first six
months of fiscal 2006 versus $1.9 million of net proceeds from maturities of
investments in the first six months of fiscal 2005 and purchases of property and
equipment of $0.7 million in the first six months of fiscal 2006 versus $2.3
million in the first six months of fiscal 2005.

The Company considers all highly liquid investments, consisting
primarily of commercial paper, discount notes, and U.S. government bonds, with
original or remaining maturities of three months or less at the date of
purchase, to be cash equivalents. All investments with original or remaining
maturities of more than three months but not more than one year at the date of
purchase are classified as short-term. Investments with original or remaining
maturities of more than one year at the date of purchase are classified as
long-term. The Company determines the length of its investments after
considering its cash requirements and yields available for the type of
investment considered by the Company. Management also determines the appropriate
classification of debt and equity securities at the time of purchase and
reevaluates the classification of investments as of each balance sheet date. As
of September 30, 2005 the Company had $15 million classified as short-term
investment and had no long-term investment, compared with $12.4 million at March
31, 2005. All auction rate securities are accounted for as available-for-sale
and all other interest-bearing securities are accounted for as held-to-maturity.

As of September 30, 2005, the Company has non-cancelable purchase orders
of $2.7 million primarily for raw materials. The Company's current card
capacity, assuming optimal card type mix, is estimated at approximately 16
million cards per year. The Company plans to purchase additional production
equipment in a series of steps when deemed appropriate by the Company. The
Company is also increasing production capacity for cards with new structures
used by the programs in Canada, Italy, and a Middle Eastern country. In addition
to investment used for expansion, the Company expects to make additional capital
expenditures for cost savings, quality improvements, and other purposes. The
Company plans to use cash on hand and cash generated from operations to fund
capital expenditures of approximately $10 million for equipment and leasehold
improvements over the next nine to twelve months for card production, read/write
drive tooling and assembly, and general support items as customer orders justify
the investment.

The decrease in net cash used for financing activities in the fiscal
2006 first six months as compared to the fiscal 2005 first six months was due
primarily to the stock repurchase from open market combined with, repayment in
full of bank loans and long-term debt during fiscal 2005.

Other than the $108,000 draw on a line of credit for working capital by
a subsidiary in Germany, there were no debt financing activities for the fiscal
2006 second quarter ended September 30, 2005.

RISK FACTORS AND FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

OUR CURRENT AND FUTURE EXPECTED REVENUES ARE DERIVED FROM A SMALL NUMBER
OF ULTIMATE CUSTOMERS SO THAT THE LOSS OF OR REDUCTIONS IN PURCHASES BY ANY ONE
ULTIMATE CUSTOMER COULD MATERIALLY REDUCE OUR REVENUES AND LEAD TO LOSSES.
During fiscal 2005 and each of the previous two fiscal years, we have derived
more than 84% of our optical memory card and drive-related revenues from four
programs - two U.S. government programs and two foreign government programs. Due
to the lengthy sales cycles, we believe that these programs, with perhaps the
addition of one or two other foreign programs, will be the basis for a
substantial majority of our revenues in the near-term. The loss of or reductions
in purchases by any one customer due to program cutbacks, competition, or other
reasons would materially reduce our revenue base. Annual or quarterly losses
occur when there are material reductions, gaps or delays in card orders from our
largest U.S. or foreign government programs or if such programs were to be
reduced in scope, delayed, canceled, or not extended and not replaced by other
card orders or other sources of income.

WE HAVE INCURRED NET LOSSES DURING THE PAST ELEVEN QUARTERS AND MAY NOT
BE ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN
PROFITABILITY. As of September 30, 2005, we had an accumulated deficit of $29
million and we incurred a loss of $2.3 million for the first six months of
fiscal 2006, $8.9 million in fiscal 2005 and $12.4 million in fiscal 2004.

Although we operated profitably for fiscal 1999 through fiscal 2003, we also
have incurred losses in fiscal 1997 and 1998 in addition to those of the past
eleven quarters. There can be no assurance that we will generate enough card
revenues in the near term or ever to become profitable. We are relying upon our
optical memory card technology to generate future product revenues, earnings,
and cash flows. If alternative technologies emerge or if we are otherwise unable
to compete, we may not be able to achieve or sustain profitability on a
quarterly or annual basis. Annual or quarterly losses would also continue if
increases in product revenues or license revenues do not keep pace with
increased selling, general, administrative, research and engineering expenses
and the depreciation and amortization expenses associated with capital
expenditures.

OUR PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE
U.S. AND ABROAD. Fiscal 2005 revenues included sales of approximately $6 million
of Green Cards and Laser Visa BCCs, and we expect revenues from these programs
in fiscal 2006 of at least $8.5 million, of which $4.6 million has been shipped
and $2.7 million is currently in backlog for shipment prior to January 31, 2006.
The Company expects these revenues could grow to up to $10 million annually
thereafter ($7.5 million for Green Cards and $2.5 million for Laser Visa BCCs)
if the government continues to personalize cards at that rate and continues to
maintain an inventory level equal to six-months of usage. Other optical memory
card programs that are emerging programs or prospective applications in various
countries include identification cards for Italy and a Middle Eastern country;
and motor vehicle registration cards in India.

For Italy, we delivered cards valued at $7.3 million in fiscal 2005 for
Phase 2 of the Italian CIE card program but only $1.2 million for the first half
of fiscal 2006. However, during the second quarter of fiscal 2006, we received a
purchase order for $7 million of these cards scheduled to be completed in
December 2005, of which $1.2 million was shipped during the second quarter, and
an $8 million order of Permesso di Soggiorno Elettronico (PSE) cards scheduled
to be completed in April 2006, for which shipments have not yet begun. There is
no assurance that the foregoing orders will be shipped or that these government
programs will be continued or implemented as anticipated.

For the ID program in a Middle Eastern country, we shipped $0.6 million
of cards during fiscal 2005 and $1.5 million in the first six months of fiscal
2006 during the experimental phase of the program. Negotiations are in process
for follow-on orders. There can be no assurance that we will be able to
successfully conclude such negotiations or that sizable orders will follow even
if we are successful.

OUR PROGRAM WITH ITALY, WHICH WE BELIEVE WILL BE OUR LARGEST CUSTOMER
FOR THE NEXT FEW YEARS, MAY BE DELAYED OR CANCELLED FOR REASONS OUTSIDE OUR
CONTROL WHICH WOULD CAUSE US TO HAVE LESS REVENUE THAN PLANNED AND WOULD LEAD TO
CONTINUED LOSSES. The Company believes that the Italian CIE card program will be
our largest customer for the next few years, comprising a significant portion of
future revenues. We are increasing capacity to meet the anticipated demand.
However, there can be no assurance that demand will increase as anticipated by
the Company. Losses would continue if Phase 3 of this program, which is full
implementation, was to be delayed, canceled, not extended, or not implemented at
the level foreseen and not be replaced by other card orders or other sources of
income, or if the government were to change its technology decisions. During
Phase 2, selected Italian cities have been issuing cards and testing the card
issuing process. The knowledge gained during Phase 2 has resulted in initiatives
to improve the issuing system and to improve the overall performance of the
program. Overcoming some of these issues may be difficult and complex and
involve third parties, which could be time consuming and expensive and lead to
delays for implementation of Phase 3.

ONE VALUE ADDED RESELLER IS THE CONTRACTOR FOR OUR U.S. AND CANADIAN
GOVERNMENT CUSTOMERS AND ANOTHER VALUE ADDED RESELLER PURCHASES CARDS FROM US
FOR THE ITALIAN NATIONAL ID CARD PROGRAM. HAVING TO REPLACE EITHER OF THESE
VALUE ADDED RESELLERS COULD INTERRUPT OUR U.S., CANADIAN, OR ITALIAN GOVERNMENT
BUSINESS. The largest purchaser of LaserCard products has been Anteon
International Corporation, one of our value-added resellers (VARs). Anteon is
the government contractor for LaserCard product sales to the U.S. Department of
Homeland Security, U.S. Department of State, U.S. Department of Defense, and the
government of Canada. Under government contracts with Anteon, the U.S.
Department of Homeland Security purchases Green Cards and U.S. Department of
State purchases Laser Visa BCCs; the U.S. Department of Defense purchases
Automated Manifest System cards; and the Canadian government purchases Permanent
Resident Cards. Encompassing all of these

programs, our product sales to Anteon represented 39% of total revenues for the
first half of fiscal 2006, 31% of total revenues for fiscal 2005, 72% of total
revenues for fiscal 2004 and 94% of total revenues for fiscal 2003. However,
since our customers are national governments, we are not dependent upon any one
specific contractor for continued revenues from these programs. Although not
anticipated, if Anteon were to discontinue its participation as contractor,
other qualified contractors could be utilized by those governments for
purchasing our products, although the process of doing so could cause the U.S.
program delays. Concerning Italy, during fiscal 2005 and 2004, 26% and 22% of
the Company's revenues were derived from sales of cards and read/write drives
for the government of Italy for its CIE card program, respectively, while the
current backlog for delivery in the second half of fiscal 2006 for CIE and
related PSE cards amounts to about 3/4 of total backlog. The revenues generated
from this program were immaterial in fiscal 2003. Card orders under this program
are placed with the Company through a VAR, Laser Memory Card SPA of Italy. This
program has entered the full implementation phase and the Company has received
an initial order worth $7 million for optical memory cards. If this program were
to be discontinued or interrupted by the Italian government, the Company would
lose one of its significant sources of optical memory card revenues.

OUR CONTRACT WITH THE U.S. GOVERNMENT, ONE OF OUR LARGER ULTIMATE
CUSTOMERS WILL EXPIRE IN NOVEMBER 2005. EVEN IF A NEW CONTRACT IS ISSUED, THE
U.S. GOVERNMENT HAS THE RIGHT TO DELAY ITS ORDERS OR COULD CHANGE ITS TECHNOLOGY
DECISIONS, WHICH WOULD RESULT IN ORDER DELAYS OR LOSSES. Our U.S. government
subcontract expires on November 26, 2005, which is therefore the last date we
may receive an order. While we have received orders for $7.3 million in optical
memory cards deliverable through January 2006, further orders will require a new
contract unless they are received by the VAR prior to November 26, 2005. Based
on events to date, the Company believes another extension to the current
contract or a follow-on contract will be issued prior to the completion of
deliveries under the existing contract; however, there is no assurance that a
follow-on contract will be issued by the U.S. government or, if not, that any
additional card orders will be received prior to November 26, 2005. Under U.S.
government procurement regulations, the government reserves certain rights, such
as the right to withhold releases, to reduce the quantities released, extend
delivery dates, reduce the rate at which cards are issued, and cancel all or
part of its unfulfilled purchase orders. Our U.S. government card deliveries
depend upon the issuance of corresponding order releases by the government to
its prime contractor and, in turn, to us, and we believe that these orders will
continue. Losses would continue if either of our largest U.S. government
programs were to be delayed, canceled, or not extended and not be replaced by
other card orders or other sources of income, or if the government were to
change its technology decisions, or if increases in product revenues or licenses
do not keep pace with increased marketing, research and engineering, and
depreciation on capital equipment. For example, the U.S. government acting
through its prime contractor delayed orders for Green Cards during fiscal 2004
due to a design change and again in the first part of fiscal 2005 because of
excess inventory, which resulted in a gap in production of several months, and
which in turn significantly affected our operating results for the first half of
fiscal 2005. Any future excess inventory held by the U.S. government for example
due to delayed funding or a slower than anticipated program volume, or any
future changes to the design of the cards may result in future gaps in orders or
production which may negatively impact our operating results.

SINCE THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LONG AND
UNPREDICTABLE, WE HAVE DIFFICULTY PREDICTING FUTURE REVENUE GROWTH. Obtaining
substantial orders usually involves a lengthy sales cycle, requiring marketing
and technical time and expense with no guarantee that substantial orders will
result. This long sales cycle results in uncertainties in predicting operating
results, particularly on a quarterly basis. In addition, since our major
marketing programs involve the U.S. government and various foreign governments
and quasi-governmental organizations, additional uncertainties and extended
sales cycles can result. Factors which increase the length of the sales cycle
include government regulations, bidding procedures, budget cycles, and other
government procurement procedures, as well as changes in governmental
policy-making.

THE TIMING OF OUR U.S. GOVERNMENT REVENUES IS NOT UNDER OUR CONTROL AND
CANNOT BE PREDICTED BECAUSE WE REQUIRE A FIXED SHIPMENT SCHEDULE IN ORDER TO
RECORD REVENUE WHEN WE DELIVER CARDS TO A VAULT, OTHERWISE WE RECOGNIZE REVENUE
WHEN THE CARDS ARE SHIPPED OUT OF A VAULT OR WE RECEIVE A FIXED SHIPMENT
SCHEDULE FROM THE GOVERNMENT. We recognize revenue from product sales when the
following criteria are met: (a) persuasive evidence of an arrangement exists;
(b) delivery has occurred; (c) the fee is fixed or determinable; and (d)
collectibility is reasonably assured.

Our U.S. government subcontract requires delivery of cards to a secure
vault built on our premises. Deliveries are made into the vault on a production
schedule specified by the government or one of its specified agents. When the
cards are delivered to the vault, all title and risk of ownership are
transferred to the government. At the time of delivery, the prime contractor is
invoiced, with payment due within thirty days. The contract does not provide for
any return provisions other than for warranty. We recognize revenue when the
cards are delivered into the vault because we have fulfilled our contractual
obligations and the earnings process is complete. However, if we do not receive
a shipment schedule for shipment from the vault, revenue is not recognized until
the cards are shipped from the vault. In addition, revenue recognition for
future deliveries into the vault would be affected if the U.S. government
cancels the shipment schedule. As a result, our revenues may fluctuate from
period to period if we do not continue to obtain shipment schedules under this
subcontract or if the shipment schedules are cancelled. In this case, we would
no longer recognize revenue when cards are delivered to the vault, but instead
such revenue recognition would be delayed until the cards are shipped from the
vault to the U.S. government.

WE COULD EXPERIENCE EQUIPMENT, RAW MATERIAL, QUALITY CONTROL, OR OTHER
PRODUCTION PROBLEMS ESPECIALLY IN PERIODS OF INCREASING VOLUME. There can be no
assurance that we will be able to meet our projected card manufacturing capacity
if and when customer orders reach higher levels. We have made and intend to
continue to make significant capital expenditures to expand our card
manufacturing capacity. However, since customer demand is difficult to predict,
we may be unable to ramp up our production quickly enough to timely fill new
customer orders. This could cause us to lose new business and possibly existing
business. In addition, if we overestimate customer demand, we could incur
significant costs from creating excess capacity which was the case during fiscal
2005. We may experience manufacturing complications associated with increasing
our manufacturing capacity of cards and drives, including the adequate
production capacity for sheet-lamination process cards to meet order
requirements and delivery schedules. We may also experience difficulties
implementing new manufacturing processes or outsourcing some of our
manufacturing. The addition of fixed overhead costs increases our breakeven
point and results in lower profit margins unless compensated for by increased
product sales. When purchasing raw materials for our anticipated optical card
demand, we take into consideration the order-to-delivery lead times of vendors
and the economic purchase order quantity for such raw materials. If we
over-estimate customer demand, excess raw material inventory can result.

IF WE ARE UNABLE TO BUY RAW MATERIALS IN SUFFICIENT QUANTITIES AND ON A
TIMELY BASIS, WE WILL NOT BE ABLE TO DELIVER PRODUCTS TO CUSTOMERS ON TIME WHICH
COULD CAUSE US TO LOSE CUSTOMERS, AND OUR REVENUES COULD DECLINE. We depend on
sole source and limited source suppliers for optical card raw materials. Such
materials include plastic films used in optical memory card production, which
are available from one supplier in the U.S. and from multiple foreign suppliers.
Processing chemicals, inks, and bonding adhesives are obtained from various U.S.
and foreign suppliers. Certain photographic films are commercially available
solely from Eastman Kodak Company, of the United States. No assurance can be
given that Kodak will continue to supply such photographic films on a
satisfactory basis and in sufficient quantities. If Kodak were to discontinue
manufacturing the film from which our optical media is made, we would endeavor
to establish an alternate supplier for such film, although the purchase price
could increase and reliability and quality could decrease from a new supplier.
No assurance can be given that there will be adequate demand to attract a second
source. In addition, an alternate supplier could encounter technical issues in
producing the film as there may be know-how and manufacturing expertise which
Kodak has developed over the years which an alternate supplier may have
difficulty to replicate. We have pre-purchased a long-term supply of the film
used to produce mastering loops for prerecording cards. With regard to the film
from which our optical media is made, we currently have an order which Kodak has
accepted with deliveries scheduled through April 2006. If Kodak announced that
it was no longer going to sell film, we would request that Kodak provide us with
a last-buy opportunity which we would plan to take maximum advantage of,
although no assurance can be given that Kodak would provide us with such an
opportunity. We have film on hand plus on order that we believe would provide us
with an adequate supply to meet anticipated demand until we could locate and
begin volume purchases from a second source.

AN INTERRUPTION IN THE SUPPLY OF READ/WRITE DRIVE PARTS OR DIFFICULTIES
ENCOUNTERED IN READ/WRITE DRIVE ASSEMBLY COULD CAUSE A DELAY IN DELIVERIES OF
DRIVES AND OPTICAL MEMORY CARDS AND A POSSIBLE LOSS OF SALES, WHICH WOULD
ADVERSELY AFFECT OUR OPERATING RESULTS. Several major components of our
read/write drives are designed specifically for our read/write drive. For
example, the optical recording head for the current drive is a part

obtained from one supplier; and at current production volumes, it is not
economical to have more than one supplier for this custom component. The ability
to produce read/write drives in high-volume production, if required, will be
dependent upon maintaining or developing sources of supply of components that
meet our requirements for high volume, quality, and cost. In addition, we could
encounter quality control or other production problems at high-volume production
of read/write drives. We are also investing in research and engineering in an
effort to develop new drive products.

IF WE ARE UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO
MANUFACTURE AND ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS.
The price of our standard read/write drive ranges from $1,800 to just under
$2,000 depending on quantity purchased. We believe the price of our drives is
competitive in applications requiring a large number of cards per each drive,
because the relatively low cost for our cards offsets the high cost per drive
when compared with our major competition, IC card systems. In addition, we have
undertaken a product development program for a portable read-only drive now
available in prototype, which we believe would increase our prospects for
winning future business. However, there can be no assurance that our development
program will be successful, that production of any new design will occur in the
near term, or that significantly lower manufacturing costs or increased sales
will result.

WE MAY NOT BE ABLE TO ADAPT OUR TECHNOLOGY AND PRODUCTS TO COMMERCIAL
APPLICATIONS WHICH GENERATE MATERIAL AMOUNTS OF REVENUE AND PROFIT. THIS WOULD
LIMIT THE FUTURE GROWTH OF OUR BUSINESS TO THE GOVERNMENT SECTOR AND THE LACK OF
DIVERSIFICATION EXPOSES US TO ENHANCED RISK OF COMPETITION. We are seeking
commercial applications for our optical memory products in order to lessen our
dependence upon the government sector. Our efforts to develop OpticalProximity
with HID Corporation are but one example. We may be unsuccessful in these
efforts in which case we would not obtain the diversity of revenues we are
seeking for the future. If the use of our technology remains limited to secure
ID card applications for government use, then we are more susceptible to other
technologies and products making in-roads or to political pressures or changing
laws

IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE DATA CARD
INDUSTRY AND IN THE INFORMATION TECHNOLOGY INDUSTRY GENERALLY, WE MAY NOT BE
ABLE TO EFFECTIVELY COMPETE FOR FUTURE BUSINESS. The information technology
industry is characterized by rapidly changing technology and continuing product
evolution. The future success and growth of our business will require the
ability to maintain and enhance the technological capabilities of the LaserCard
product line. There can be no assurance that the Company's products currently
sold or under development will remain competitive or provide sustained revenue
growth.

SEVERAL OF OUR FOREIGN PROGRAMS INVOLVE OUR CARDS AS PART OF A SOLUTION
WHICH INCLUDES TECHNOLOGIES OF THIRD PARTIES THAT ARE INTEGRATED BY OUR SYSTEMS
INTEGRATOR CUSTOMER OR SUBCONTRACTOR. WE THEREFORE DO NOT HAVE CONTROL OVER THE
OVERALL SYSTEM WHICH COULD LEAD TO TECHNICAL AND COMPATIBILITY ISSUES WHICH ARE
DIFFICULT, EXPENSIVE, AND TIME CONSUMING TO SOLVE. THIS COULD CAUSE OUR ULTIMATE
CUSTOMERS, GENERALLY GOVERNMENTS, TO FIND FAULT IN OPTICAL CARDS AND SWITCH TO
OTHER SOLUTIONS EVEN THOUGH OUR OPTICAL TECHNOLOGY IS NOT THE ROOT CAUSE. In
certain of our current foreign programs such as Italy, India, and a Middle
Eastern country, and possibly in future other programs, various third party
technologies such as contact or contactless chips will be added to our cards.
The embedding or addition of other technologies to the LaserCard OMC, especially
when contracted to independent third parties, could potentially lead to
technical, compatibility and other issues. In such circumstances, it may be
difficult to determine whether a fault originated with the Company's technology
or that of a co-supplier. If such faults occur, they could be difficult,
expensive, and time-consuming to resolve. Such difficulties could lead to our
ultimate customers, the foreign governments, switching to other technologies
even though optical technology is not the root cause. The resulting loss of
customers would adversely affect our revenues.

IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY
BE ABLE TO USE OUR TECHNOLOGIES, WHICH COULD WEAKEN OUR COMPETITIVE POSITION,
REDUCE REVENUES, OR INCREASE COSTS. We use a combination of patent, trademark,
and trade secret laws, confidentiality procedures, and licensing arrangements to
establish and protect our proprietary rights. Our existing and

future patents may not be sufficiently broad to protect our proprietary
technologies. Despite our efforts to protect proprietary rights, we cannot be
certain that the steps we have taken will prevent the misappropriation or
unauthorized use of our technologies, particularly in foreign countries where
the laws may not protect proprietary rights as fully as U.S. law. Any patents we
may obtain may not be adequate to protect our proprietary rights. Our
competitors may independently develop similar technology, duplicate our
products, or design around any of our issued patents or other intellectual
property rights. Litigation may be necessary to enforce our intellectual
property rights or to determine the validity or scope of the proprietary rights
of others. This litigation could result in substantial costs and diversion of
resources and may not ultimately be successful. We cannot predict whether the
expiration or invalidation of our patents would result in the introduction of
competitive products that would affect our future revenues adversely. However,
since our technology is now in the commercial stage, our know-how and experience
in volume card production, system development and software capabilities,
brand-name recognition within our card markets, and dominant-supplier status for
optical memory cards are of far greater importance than our patents. At this
time, we believe that our existing patent portfolio is helpful but is no longer
essential for maintaining the LaserCard's market position.

THE MARKETS FOR OUR PRODUCTS ARE COMPETITIVE, AND IF WE ARE UNABLE TO
COMPETE SUCCESSFULLY, REVENUES COULD DECLINE OR FAIL TO GROW. Our optical memory
cards may compete with optical memory cards that can be manufactured and sold by
three of our licensees (although none is currently doing so) and with other
types of portable data storage cards and technologies used for the storage and
transfer of digital information. These may include integrated circuit/chip
cards; 2-dimensional bar code cards and symbology cards; magnetic-stripe cards;
thick, rigid CD-read only cards or recordable cards; PC cards; radio frequency,
or RF, chip cards; and small, digital devices such as data-storage keys, tokens,
finger rings, and small cards and tags. The financial and marketing resources of
some of the competing companies are greater than our resources. Competitive
product factors include system/card portability, interoperability,
price-performance ratio of cards and associated equipment, durability,
environmental tolerance, and card security. Although we believe our cards offer
key technological and security advantages for certain applications, the current
price of optical card read/write drives is a competitive disadvantage in some of
our targeted markets. However, we believe the price of our drives is competitive
in applications requiring a large number of cards per each drive, because the
relatively low cost for our cards offsets the high cost per drive when compared
with our major competition, IC card systems. In countries where the
telecommunications infrastructure is extensive and low cost, centralized
databases and wide-area networks may limit the penetration of optical memory
cards. These trends toward Internet, intranet, and remote wireless networks will
in some cases preclude potential applications for our cards.

THE PRICE OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT VOLATILITY. The
price of our common stock is subject to significant volatility, which may be due
to fluctuations in revenues, earnings, liquidity, press coverage, financial
market interest, low trading volume, and stock market conditions, as well as
changes in technology and customer demand and preferences. As a result, our
stock price might be low at the time a stockholder wants to sell the stock.
Also, since we have a relatively low number of shares outstanding (approximately
11 million shares) there will be more volatility in our stock if one or two
major holders, for example, large institutional holders, attempt to sell a large
number of shares in the open market. There also is a large short position in our
stock, which can create volatility when borrowed shares are sold short and later
if shares are purchased to cover the short position. Furthermore, our trading
volume is often small, meaning that a few trades may have disproportionate
influence on our stock price. In addition, someone seeking to liquidate a
sizeable position in our stock may have difficulty doing so except over an
extended period or privately at a discount. Thus, if one or more stockholders
were to sell or attempt to sell a large number of its shares within a short
period of time, such sale or attempt could cause our stock price to decline.
There can be no guarantee that stockholders will be able to sell the shares that
they acquired at a price per share equal to the price they paid for the stock.

WE ARE SUBJECT TO RISKS ASSOCIATED WITH CHANGES IN FOREIGN CURRENCY
EXCHANGE RATES. Part of the manufacturing process of the LaserCard products that
we sell in Italy takes place in our operations in Germany. Also, some of the raw
materials we use to manufacture optical memory cards are sourced in Europe.
These costs are denominated in euros, the currency used in much of Europe.
However, when we sell our finished products the prices that we charge are
denominated in United States dollars. Accordingly, we are subject to exposure if
the exchange rate for euros increases in relation to the United States dollar.
During fiscal 2005, we experienced a $0.2 million loss on foreign currency
exchange. As of September 30, 2005, we had not entered into a forward exchange
contract to hedge against or potentially minimize the foreign currency exchange
risk related to transactions

other than those related to intercompany and external payables and receivables.

WE SOLD A SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL INVESTMENTS
GROUP (GIG), UNDER WHICH WE WILL PROVIDE CERTAIN FACTORY SET-UP AND TRAINING
SERVICES. IF WE ARE NOT SUCCESSFUL OR IF GIG IS UNABLE TO FINANCE THIS
OPERATION, THE SECOND-SOURCE SUPPLY OF OPTICAL CARDS WILL NOT MATERIALIZE. IF WE
AND GIG ARE SUCCESSFUL, THE SECOND-SOURCE WILL COMPETE WITH US FOR BUSINESS. If
GIG is not successful, but current and potential customers require a second
source of optical memory cards (which is a common business practice) they could
decide to use alternate technology cards, such as chip cards, that have
multiple-source suppliers. We are obligated to deliver approximately $12 million
worth of the required manufacturing equipment and installation support to GIG
for its to-be-built new card manufacturing facility in Slovenia, to provide a
targeted initial manufacturing capacity of 10 million optical cards annually. If
GIG is successful, this will supply a second source for optical memory cards. We
will also be assigning personnel to be on site during the license term to assist
with quality, security, and operational procedures, with a mutual goal that the
facility and the cards made in Slovenia conform to our standards. If cards are
not produced in conformance with our quality standards, the reputation and
marketability of optical memory card technology could be damaged. If the factory
does not become operational and produce quality cards in high volume, or if GIG
is unable to raise sufficient capital to build, equip and operate this facility,
we would not obtain the hoped-for benefits--including ongoing royalties, sales
of raw materials to GIG, expansion of the European market, and a bona fide
second source for optical memory cards. On the other hand, if and when the
factory is successfully manufacturing the cards in high volume, it will compete
against us for business in certain territories, which could reduce our potential
card revenues if the market does not expand. Revenue will be recognized over the
remaining term of the agreement beginning when operation of the factory
commences. The Company could incur greater expenses than it anticipates for the
purchase and installation of the required manufacturing equipment thereby
reducing cash and anticipated profits.

WE MAY NOT BE ABLE TO ATTRACT, RETAIN OR INTEGRATE KEY PERSONNEL, WHICH
MAY PREVENT US FROM SUCCEEDING. We may not be able to retain our key personnel
or attract other qualified personnel in the future. Our success will depend upon
the continued service of key management personnel. The loss of services of any
of the key members of our management team, including our chief executive
officer, president, the managing directors of our German operations, vice
president of business development or our vice president of finance and
treasurer, or our failure to attract and retain other key personnel could
disrupt operations and have a negative effect on employee productivity and
morale, thus decreasing production and harming our financial results. In
addition, the competition to attract, retain and motivate qualified personnel is
intense.

OUR CALIFORNIA FACILITIES ARE LOCATED IN AN EARTHQUAKE ZONE AND THESE
OPERATIONS COULD BE INTERRUPTED IN THE EVENT OF AN EARTHQUAKE, FIRE, OR OTHER
DISASTER. Our card manufacturing, corporate headquarters, and drive assembly
operations, administrative, and product development activities are located near
major earthquake fault lines. In the event of a major earthquake, we could
experience business interruptions, destruction of facilities and/or loss of
life, all of which could materially adversely affect us. Likewise, fires,
floods, or other events could similarly disrupt our operations and interrupt our
business.

ACTS OF TERRORISM OR WAR MAY ADVERSELY AFFECT OUR BUSINESS. Acts of
terrorism, acts of war, and other events may cause damage or disruption to our
properties, business, employees, suppliers, distributors, resellers, and
customers, which could have an adverse effect on our business, financial
condition, and operating results. Such events may also result in an economic
slowdown in the United States or elsewhere, which could adversely affect our
business, financial condition, and operating results.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RATE RISKS

INTEREST RATE RISK. The Company invests its cash, beyond that needed for
daily operations, in high quality debt securities. In doing so, the Company
seeks primarily to preserve the value and liquidity of its capital and,
secondarily, to safely earn income from these investments. To accomplish these
goals, the Company invests only in debt securities issued by (a) the U.S.
Treasury and U.S. government agencies, state agencies and corporations and (b)
debt instruments that meet the following criteria:

o Commercial paper rated A1/P1 or debt instruments rated AAA, as
rated by the major rating services
o Can readily be sold for cash

Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted because of a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, the Company's future investment income
may fall short of expectations because of changes in interest rates or we may
suffer losses in principal if forced to sell securities that have seen a decline
in market value because of changes in interest rates.

There were no material changes during the second quarter of fiscal 2006
in the Company's exposure to market risk for changes in interest rates.

The following summarizes short-term and long-term investments at fair
value, weighted average yields and expected maturity dates as of September 30,
2005 (in thousands):

FISCAL YEARS
2006 2007 TOTAL
---- ---- -----

Auction rate securities $ 7,750 $ -- $ 7,750
Weighted Average Yield 2.59% -- 2.59%
U.S. Government and Agency Obligations 7,224 -- 7,224
Weighted Average Yield 3.77% -- 3.77%
-------- -------- --------

Total Investments $ 14,974 $ -- $ 14,974
======== ======== ========

FOREIGN CURRENCY EXCHANGE RATE RISK. The Company's U.S. Operations sell
products in various international markets. To date an immaterial amount of sales
have been denominated in euros. In addition, some raw material purchases and
purchased services are denominated in euros. As of September 30, 2005, the
outstanding balance of a debt relating to the acquisition of Challenge Card
Design Plastikkarten GmbH and cards & more GmbH, of Germany was immaterial.
Accordingly, the exchange rate risk related to this debt is minimal.

In September 2005, the Company entered into a short-term forward
exchange contract to hedge intercompany loans receivable which denominated in
Euro to minimize the foreign currency exchange risk. As of September 30, 2005,
the short-term forward exchange contract was outstanding with a notional amount
of Euro 1.9 million and the Company is required to close the position on October
28, 2005. This contract primarily hedges intercompany loans receivable with the
respective gains and losses being reported in SG&A. Accordingly, these gains and
losses were not material for the three and six-month periods ended September 30,
2005.

The income statements of the Company's non-U.S. operations are
translated into U.S. dollars at the average exchange rate in each applicable
period. To the extent the U.S. dollar weakens against euro, the translation of
euro denominated transactions results in increased revenues, operating expenses
and net income for the non-U.S. operations. Similarly, the Company's revenues,
operating expenses and net income will decrease for the non-U.S. operations if
the U.S. dollar strengthens against euro. For the six-month period ended
September 30, 2005, the fluctuation of the average exchange rate as compared to
the average exchange rate from fiscal 2005 was immaterial. Additionally, the
assets and liabilities of the non-U.S. operations are translated into U.S.
dollars at exchange rates in effect as of the applicable balance sheet dates,
and revenue and expense accounts of these operations are translated at average
exchange rates during the applicable period the transactions occur. Translation
gains and losses are included as an adjustment to stockholders' equity.

ITEM 4. CONTROLS AND PROCEDURES

(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's
principal executive officer and principal financial officer have
evaluated the Company's disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14(c) and 15d-14(c)) as of the end of the
period covered by this Form 10-Q and have determined that they are
reasonable taking into account the totality of the circumstances.

(B) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
significant changes in the Company's internal control over financial
reporting that occurred during the second quarter of fiscal 2006 that
have materially affected, or are reasonably likely to materially affect,
such control.

PART II. OTHER INFORMATION

ITEM 1. - LEGAL PROCEEDINGS

None

ITEM 2. - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. - DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Company's September 23, 2005 Annual Meeting of Stockholders, the
Company's stockholders

(i) re-elected the existing Board of Directors.
(ii) ratified the selection of Odenberg, Ullakko, Muranishi & Co., LLP as
independent registered public accounting firm.
(iii) approved an amendment of the 2004 Equity Incentive Compensation Plan to
increase by 315,000 the number of shares reserved for issuance
thereunder.

Of the 11,345,164 shares of common stock outstanding as of the record
date of July 27, 2005, a total of 10,233,492 shares were voted in person or by
proxy, representing 90% of the total votes eligible to be cast, constituting a
majority and more than a quorum of the outstanding shares entitled to vote.
Votes cast in connection with the election of directors were: Christopher J.
Dyball (10,150,510 votes for re-election, 82,982 votes withheld), Richard M.
Haddock (10,150,171 votes for re-election, 83,321 votes withheld), Arthur H.
Hausman (9,451,510 votes for re-election, 781,982 votes withheld), Donald E.
Mattson (10,133,540 votes for election, 99,952 votes withheld), Dan Maydan
(10,089,824 votes for re-election, 143,668 votes withheld), Albert J. Moyer
(10,140,110 votes for election, 93,382 votes withheld) and Walter F. Walker
(9,453,579 votes for re-election, 779,913 votes withheld).

For Proposal 2 Ratification of the Company's Independent Registered
Public Accounting Firm, 10,155,629 shares were voted in favor, and there were
45,497 negative votes, 32,366 abstentions, and no broker non-votes.

For Proposal 3 Approval of an amendment to the 2004 Equity Incentive
Compensation Plan, 3,202,354 shares were voted in favor, and there were 966,530
negative votes, 40,939 abstentions, and 6,023,669 broker non-votes.

There were no other matters submitted to a vote of security holders
during the period for which this report is filed.

ITEM 5. - OTHER INFORMATION

None.

ITEM 6. - EXHIBITS

Exhibit No. Exhibit Description
----------- -------------------

3(I) Certificate of Incorporation: Exhibit 3.1 of the
registrant's annual report on Form 10-K for the fiscal
year ended March 31, 2005, filed with the SEC on June 15,
2005, is hereby incorporated by reference

3(II) Bylaws: Exhibit 3.2 of the registrant's annual report on
Form 10-K for the fiscal year ended March 31, 2005, filed
with the SEC on June 15, 2005, is hereby incorporated by
reference

10.1-10.8 Material Contracts: Exhibits 10.1 through 10.8 listed in
registrant's annual report on Form 10-K for the fiscal
year ended March 31, 2005, filed with the SEC on June 15,
2005, are hereby incorporated by reference.

31.1 Rule 13a-14(a) Certification of Richard M. Haddock, chief
executive officer is filed herewith.

31.2 Rule 13a-14(a) Certification of Steven G. Larson, chief
financial officer is filed herewith.

32.1 Section 1350 Certification of Richard M. Haddock, chief
executive officer is filed herewith.

32.2 Section 1350 Certification of Steven G. Larson, chief
financial officer is filed herewith.

The above-listed exhibits are filed herewith. No other exhibits are
included in this report as the contents of the required exhibits are either not
applicable to Registrant, to be provided only if Registrant desires, or
contained elsewhere in this report.

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:

LASERCARD CORPORATION
(Registrant)

Signature Title Date
--------- ----- ----

/s/ Richard M. Haddock Chief Executive Officer November 03, 2005
- ---------------------------
Richard M. Haddock

/s/ Steven G. Larson Chief Financial Officer November 03, 2005
- ---------------------------
Steven G. Larson

INDEX TO EXHIBITS

[ITEM 14(c)]
Exhibit
Number Description
- ------ -----------

3(I) Certificate of Incorporation: Exhibit 3.1 of the registrant's
annual report on Form 10-K for the fiscal year ended March 31,
2005, filed with the SEC on June 15, 2005, is hereby
incorporated by reference

3(II) Bylaws: Exhibit 3.2 of the registrant's annual report on Form
10-K for the fiscal year ended March 31, 2005, filed with the
SEC on June 15, 2005, is hereby incorporated by reference

10.1-10.8 Material Contracts: Exhibits 10.1 through 10.8 listed in
registrant's annual report on Form 10-K for the fiscal year
ended March 31, 2005, filed with the SEC on June 15, 2005, are
hereby incorporated by reference.

31.1 Rule 13a-14(a) Certification of Richard M. Haddock, chief
executive officer is filed herewith.

31.2 Rule 13a-14(a) Certification of Steven G. Larson, chief
financial officer is filed herewith.

32.1 Section 1350 Certification of Richard M. Haddock, chief
executive officer is filed herewith.

32.2 Section 1350 Certification of Steven G. Larson, chief financial
officer is filed herewith.