<PAGE>

                                  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, 2002


                        Commission File Number: 000-06377


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


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


1077 Independence Avenue, Mountain View, CA                     94043-1601
-------------------------------------------               -------------------
 (Address of principal executive offices)                       (Zip Code)


                                 (650) 969-7277
               ---------------------------------------------------
              (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


     Number of outstanding shares of common stock, $.01 par value, at November
5, 2002: 10,346,707

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<CAPTION>

                                TABLE OF CONTENTS

<S>      <C>                                                                          <C>
PART I.  FINANCIAL INFORMATION                                                        Page Number

         Item 1.   Condensed Consolidated Financial Statements (Unaudited)
                       Condensed Consolidated Balance Sheets                               3
                       Condensed Consolidated Statements of Income                         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 (Unaudited)                     8

         Item 3.   Quantitative and Qualitative Disclosures about Market Rate Risks       16

         Item 4.   Controls and Procedures                                                16

PART II. OTHER INFORMATION                                                                17

         Item 4.   Submission of Matters to a Vote of Security Holders                    17

         Item 5.   Other Information                                                      17

         Item 6.   Exhibits and Reports on Form 8-K                                       17

SIGNATURES                                                                                17

CERTIFICATIONS                                                                            18

-----------------------------------------------------------------------------------------------
</TABLE>

PART I.  FINANCIAL INFORMATION

ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



                                      -2-
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<TABLE>
<CAPTION>

                                         DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                                              CONDENSED CONSOLIDATED BALANCE SHEETS
                                                           (UNAUDITED)
                                       (In thousands, except share and per share amounts)

                                                                                                  March 31,           September 30,
                                                                                                    2002                  2002
                                                                                                    ----                  ----
                                                             ASSETS
<S>                                                                                             <C>                   <C>
Current assets:
    Cash and cash equivalents ................................................................  $    8,193            $   5,722
    Short-term investments....................................................................       8,883                9,520
    Accounts receivable, net .................................................................       1,659                1,838
    Inventories ..............................................................................       4,973                5,039
    Deferred tax asset, net...................................................................       3,849                3,849
    Other current assets......................................................................         561                  386
                                                                                                ----------            ---------
       Total current assets ..................................................................      28,118               26,354
                                                                                                ----------            ---------

Property and equipment, at cost...............................................................      20,979               22,020
    Less--accumulated depreciation and amortization ..........................................     (14,561)             (15,238)
                                                                                                ----------            ---------
       Property and equipment, net............................................................       6,418                6,782
                                                                                                ----------            ---------

Long-term investments.........................................................................       1,002                2,202
Patents and other intangibles, net............................................................         612                  723
Deferred tax asset, net.......................................................................       4,563                3,512
                                                                                                ----------            ---------

            Total assets......................................................................  $   40,713            $  39,573
                                                                                                ==========            =========

                                              LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable..........................................................................  $      738             $  1,020
    Accrued liabilities ......................................................................       1,117                1,417
    Deferred revenue..........................................................................         235                  235
    Advance payments from customers...........................................................       2,551                  599
    Deferred gross profit.....................................................................       2,860                   --
                                                                                                ----------            ---------
       Total current liabilities..............................................................       7,501                3,271
    Deferred revenue, long-term...............................................................         875                  875
                                                                                                ----------            ---------

            Total liabilities.................................................................  $    8,376             $  4,146
                                                                                                ==========            =========

Stockholders' equity:
    Preferred stock, $.01 par value:
       Authorized--2,000,000 shares
       Issued--none...........................................................................          --                   --
    Common stock, $.01 par value:
       Authorized--30,000,000 shares
       Issued--10,240,687 shares at March 31, 2002 and
            10,323,382 shares at September 30, 2002...........................................         102                  103
    Additional paid-in capital................................................................      40,334               41,389
    Accumulated deficit.......................................................................      (8,099)              (6,065)
                                                                                                ----------            ---------
       Total stockholders' equity.............................................................      32,337               35,427
                                                                                                ----------            ---------

            Total liabilities and stockholders' equity........................................  $   40,713             $ 39,573
                                                                                                ==========            =========

            The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>

                                                              -3-
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<TABLE>
<CAPTION>

                                         DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                                           CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                                           (UNAUDITED)
                                            (In thousands, except per share amounts)


                                                                     Three Months Ended              Six Months Ended
                                                                        September 30,                  September 30,
                                                                    2001            2002           2001            2002
                                                                    ----            ----           ----            ----
<S>                                                               <C>             <C>            <C>             <C>
Revenues:
    Product revenue .......................................       $  3,909        $  9,529       $  7,881        $ 16,117
    License and royalty revenue ...........................            765              --          1,076              --
                                                                  --------        --------       --------        --------
       Total revenues .....................................          4,674           9,529          8,957          16,117
                                                                  --------        --------       --------        --------

Cost of product sales .....................................          2,063           5,131          4,336           8,416
                                                                  --------        --------       --------        --------

       Gross profit .......................................          2,611           4,398          4,621           7,701
                                                                  --------        --------       --------        --------

Operating expenses:
    Selling, general, and administrative expenses .........          1,170           1,438          2,364           3,008
    Research and engineering expenses .....................            736             742          1,359           1,518
                                                                  --------        --------       --------        --------
       Total operating expenses ...........................          1,906           2,180          3,723           4,526
                                                                  --------        --------       --------        --------

          Operating income ................................            705           2,218            898           3,175
                                                                  --------        --------       --------        --------

Other income ..............................................             95             108            211             214
                                                                  --------        --------       --------        --------

          Income before income taxes ......................            800           2,326          1,109           3,389

Income tax expense (benefit) ..............................           (618)            951         (1,443)          1,355
                                                                  --------        --------       --------        --------

          Net income ......................................       $  1,418        $  1,375       $  2,552        $  2,034
                                                                  ========        ========       ========        ========
Net income per share:
          Basic ...........................................       $    .14        $    .13       $    .26        $    .20
                                                                  ========        ========       ========        ========
          Diluted .........................................       $    .14        $    .13       $    .25        $    .19
                                                                  ========        ========       ========        ========

Weighted average number of common
    and common equivalent shares:
          Basic ...........................................          9,813          10,314          9,817          10,307
          Diluted .........................................         10,039          10,764         10,088          10,974


          The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>

                                                              -4-
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<TABLE>
<CAPTION>

                                         DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                                         CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                           (UNAUDITED)
                                                         (In thousands)

                                                                                                             Six Months Ended
                                                                                                               September 30,
                                                                                                           2001            2002
                                                                                                           ----            ----
<S>                                                                                                      <C>             <C>
Cash flows from operating activities:
   Net income..........................................................................................  $  2,552        $  2,034
   Adjustments to reconcile net income to net cash provided by operating activities:
       Depreciation and amortization...................................................................       759             884
       Provision for doubtful accounts receivable......................................................         5              11
       Provision for product return reserve............................................................        --              26
       Compensation on stock plan activity ............................................................        54              43
       (Increase) decrease in deferred tax asset.......................................................    (1,557)          1,051
       Provision for excess and obsolete inventory, net................................................       288             403
       Tax benefit for stock option exercises..........................................................         6              97

   Changes in operating assets and liabilities:
       Increase in accounts receivable.................................................................      (508)           (216)
       Increase in inventories.........................................................................    (1,088)           (469)
       (Increase) decrease in other assets.............................................................       (63)            175
       Increase in accounts payable and accrued liabilities............................................       102             582
       Decrease in deferred revenue....................................................................      (119)             --
       Increase (decrease) in advance payments from customers..........................................       228          (1,952)
       Increase (decrease) in deferred gross profit....................................................        57          (2,860)
                                                                                                         --------        --------

            Net cash provided by (used for) operating activities.......................................       716            (191)
                                                                                                         --------        --------

Cash flows from investing activities:
   Purchases of property and equipment.................................................................      (669)         (1,061)
   Investment in patents and other intangibles.........................................................       (62)           (298)
   Purchases of investments............................................................................    (5,070)         (5,236)
   Proceeds from maturities of investments.............................................................     7,861           3,399
                                                                                                         --------        --------

            Net cash provided by (used for) investing activities.......................................     2,060          (3,196)
                                                                                                         --------        --------

Cash flows from financing activities:
       Proceeds from sale of common stock through stock plans..........................................       155             916
       Purchases of common stock through an open market repurchase program......... ...................      (175)             --
                                                                                                         --------        --------

            Net cash provided by (used for) financing activities.......................................       (20)            916
                                                                                                         --------        --------

            Net increase (decrease) in cash and cash equivalents.......................................     2,756          (2,471)

Cash and cash equivalents:
   Beginning of period.................................................................................     6,221           8,193
                                                                                                         --------        --------
   End of period  .....................................................................................  $  8,977        $  5,722
                                                                                                         ========        ========


                 The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>

                                                              -5-
<PAGE>

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

     BASIS OF PRESENTATION. The consolidated financial statements include the
accounts of Drexler Technology 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 generally accepted accounting principles 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 financial statements and the notes thereto for the year
ended March 31, 2002, included in the Company's Annual Report on Form 10-K.

     The results of operations for the six months ended September 30, 2002 are
not necessarily indicative of results to be expected for the entire fiscal year
ending March 31, 2003.

     FISCAL PERIOD: For purposes of presentation, the Company's annual
accounting period ends on March 31 and its interim quarterly periods end on the
corresponding month end. 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 2002 ended on September 28, 2001, and the 13-week second
quarter of fiscal 2003 ended on September 27, 2002.

     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):

                                               March 31,      September 30,
                                                 2002             2002
                                                 ----             ----
              Raw materials..................  $   3,063       $   2,764
              Work-in-process................        479             669
              Finished goods.................      1,379           1,586
              Systems and components
                 held for resale.............         52              20
                                               ---------       ---------
                                               $   4,973       $   5,039
                                               =========       =========

     RECLASSIFICATIONS. Certain items have been reclassified in the prior year
periods to conform to the current year presentation.

     RECENT ACCOUNTING PRONOUNCEMENTS. In July 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS
No. 146). SFAS No. 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. The Company is currently evaluating the provisions of
SFAS No. 146 but does not believe that the adoption will have a material impact
on its results of operations, financial position, or cash flows.

                                      -6-
<PAGE>

     NET INCOME PER SHARE: The Company computes net income per share in
accordance with SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires
companies to compute net income per share under two different methods, basic and
diluted, and present per share data for all periods in which a statement of
income is presented. Basic net income per share is computed by dividing net
income by the weighted average number of shares of common stock outstanding.
Diluted net income per share is computed by dividing net income by the weighted
average number of shares of common stock and common stock equivalents
outstanding. Common stock equivalents consist of stock options using the
treasury stock method. The reconciliation of the denominators of the basic and
diluted net income per share computation for the three months and six months
ended September 30, 2001 and September 30, 2002 is shown in the following table
(in thousands, except per share data):

<TABLE>
<CAPTION>
                                                                          Three Months Ended                Six Months Ended
                                                                            September 30,                    September 30,
                                                                       2001              2002            2001             2002
                                                                       ----              ----            ----             ----
<S>                                                                 <C>              <C>              <C>              <C>
Net income........................................................  $      1,418     $      1,375     $    2,552       $    2,034
                                                                    ============     ============     ==========       ==========

Basic earnings per share:
    Weighted average common shares outstanding....................         9,813           10,314          9,817           10,307
                                                                    ------------     ------------     ----------       ----------
Basic earnings per share..........................................  $        .14     $        .13     $      .26       $      .20
                                                                    ============     ============     ==========       ==========

Diluted earnings per share:
    Weighted average common shares outstanding....................         9,813           10,314          9,817           10,307
    Weighted average common shares from
       stock option grants........................................           226              450            271              667
                                                                    ------------     ------------     ----------       ----------

    Weighted average common shares and common
       stock equivalents outstanding..............................        10,039           10,764         10,088           10,974
                                                                    ------------     ------------     ----------       ----------

Diluted earnings per share........................................  $        .14     $        .13     $      .25       $      .19
                                                                    ============     ============     ==========       ==========
</TABLE>

     Stock options having an exercise price greater than the average market
value for the periods are excluded from the calculation of diluted earnings per
share. As their effect would be antidilutive, 1,171,190 shares and 414,200
shares are excluded from the calculation of diluted earnings per share for the
three months ended September 30, 2001 and 2002, respectively. For the same
reason, stock options representing 1,098,990 shares and 32,000 shares are
excluded from the calculation of diluted earnings per share for the six months
ended September 30, 2001 and 2002, respectively.

     REVENUE RECOGNITION. The Company recognizes revenue when the following
criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery
has occurred or services have been rendered; (3) the fee is fixed and
determinable; and (4) collectibility is reasonably assured. Where appropriate,
provision is made for estimated warranty costs and estimated returns relating to
product sales at the time revenue is recognized.

     The Company's U.S. government subcontract requires delivery to a secure,
government-funded vault built on Company premises. Deliveries are made into the
vault on a fixed schedule specified by the prime contractor. At the time the
cards are delivered to the vault, title to the cards transfers to the
government, the prime contractor is invoiced, and payment is due according to
normal trade payment terms. Revenue is recognized when the cards are shipped
from the vault, unless the Company receives a fixed schedule, notification, or
plan for shipments out of the vault, in which case revenue is recognized upon
the later of the receipt of such fixed shipment schedule or delivery of the
cards into the vault. During the second quarter of fiscal 2003, for the first
time, the Company received a fixed schedule for shipments out of the vault.
Therefore, revenue on all of the 2.17 million cards located in the vault was
recognized upon the receipt of such fixed shipment schedule. Had the Company not
received this fixed schedule, its revenue for the three months ended September
30, 2002 would have been based only on shipment of cards out of the vault, as in
prior periods, which would have reduced revenue by approximately $6.9 million.

                                      -7-
<PAGE>

     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.

     Significant management judgment is required in determining the provision
for income taxes, deferred tax assets and liabilities, and any valuation
allowance recorded against the net deferred tax assets. The Company has recorded
a valuation allowance of $5.7 million as of September 30, 2002, due to
uncertainties related to the Company's ability to utilize some of the deferred
tax assets, primarily consisting of certain net operating losses carried
forward, before they expire. The valuation allowance is based on management's
estimates of taxable income by jurisdiction in which the Company operates and
the period over which the deferred tax assets will be recoverable. In the event
that actual results differ from these estimates or that these estimates are
adjusted in future periods, the Company may need to establish an additional
valuation allowance which could materially impact the Company's results of
operations.

     CONCENTRATION OF CREDIT RISK. One United States customer comprised 98% of
accounts receivable at March 31, 2002 and 99% of accounts receivable at
September 30, 2002.

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

     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
Report and the consolidated financial statements and notes thereto for the year
ended March 31, 2002, included in the Company's fiscal 2002 Form 10-K Annual
Report.

FORWARD-LOOKING STATEMENTS

     When used in this discussion, the words "expects," "anticipates,"
"believes," "estimates," "plans," and similar expressions are intended to
identify forward-looking statements. These are statements that relate to future
periods and include statements as to the Company's read/write drive assembly,
pricing, and research and engineering efforts, including the expected
development of lower cost drives, customer-optimized drive systems, and drive
systems with advanced security features; the Company's efforts to recruit new
value-added resellers (VARs) and eliminate nonproductive VARs; the adequacy of
inventory; anticipated orders and/or shipment quantities and schedules under the
Company's U.S. government and Canadian government subcontracts; expectations
regarding revenues, margins, expenses, cash flow, capital resources, capital
expenditures and investments, and the Company's deferred tax asset and related
valuation allowance; potential reductions of federal tax cash payments due to
current Company tax benefits; the effects of read/write drive prices on gross
profits from read/write drive sales; the Company's estimates for the level of
sales of drives that would be necessary to achieve a gross profit at current
prices based on current expense levels for overhead costs; expectations
regarding the market for read/write drives, read/write drive prices, and
inventory of drives and parts; statements as to expected orders, card shipment
volumes, and card revenues for fiscal 2003; statements about selling, general,
and administrative expenses and research and engineering expenses for the
remainder of fiscal 2003; statements related to the order for 24 biometric card
verification systems and the government's test program for same; statements as
to potential customers, applications, orders, or market segments for optical
memory card products; estimates of optical card production capacity, expected
card yields therefrom, and plans and expectations regarding the growth and
associated capital costs of such capacity; estimate that revenues will be
sufficient to generate cash from operations; and expectations regarding market
growth, product demand, and foreign business including emerging programs or
prospective applications in China, India, Italy, Macedonia, Mexico, and Saudi
Arabia; and expectations as to continuation or expansion of U.S. government card
programs and other governmental card programs. Forward-looking statements are
subject to risks and uncertainties that could cause actual results to differ
materially from those projected.

     These risks and uncertainties include, but are not limited to those risks
discussed below, as well as the impact of litigation or governmental or
regulatory proceedings; the Company's ability to initiate and grow new programs
utilizing the Company's card products; the Company's reliance on value-added
resellers, licensees, or other third parties to generate

                                      -8-
<PAGE>

sales, perform customer system integration, or develop application software;
risks associated with doing business in and with foreign countries; potential
manufacturing difficulties and complications associated with increasing
manufacturing capacity of cards and drives; uncertainties associated with the
design, development, manufacture, and deployment of optical card drives and
systems; customer concentration and reliance on continued U.S. government
business; lengthy sales cycles and reliance on government policy-making; general
economic trends; 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 schedule, notification, or plan for
shipments out of the government vault enabling the Company to recognize revenues
on cards located in the vault instead of when cards later are shipped from the
vault; the impact of technological advances and competitive products and the
ability of the Company or its customers to develop software and integrate
optical card systems with other technologies; and other risks detailed from time
to time in the SEC reports of Drexler Technology Corporation, including its
Annual Report on Form 10-K for the fiscal year ended March 31, 2002.

     These forward-looking statements speak only as of the date hereof. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions, or circumstances on which any statement is based.

CRITICAL ACCOUNTING POLICIES

     REVENUE RECOGNITION. The Company recognizes revenue when the following
criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery
has occurred or services have been rendered; (3) the fee is fixed and
determinable; and (4) collectibility is reasonably assured. Where appropriate,
provision is made for estimated warranty costs and estimated returns relating to
product sales at the time revenue is recognized.

     The Company's U.S. government subcontract requires delivery to a secure,
government-funded vault built on Company premises. Deliveries are made into the
vault on a fixed schedule specified by the prime contractor. At the time the
cards are delivered to the vault, title to the cards transfers to the
government, the prime contractor is invoiced, and payment is due according to
normal trade payment terms. Revenue is recognized when the cards are shipped
from the vault, unless the Company receives a fixed schedule, notification, or
plan for shipments out of the vault, in which case revenue is recognized upon
the later of the receipt of such fixed shipment schedule or delivery of the
cards into the vault. During the second quarter of fiscal 2003, for the first
time, the Company received a fixed schedule for shipments out of the vault.
Therefore, revenue on all of the 2.17 million cards located in the vault was
recognized upon the receipt of such fixed shipment schedule. Had the Company not
received this fixed schedule, its revenue for the three months ended September
30, 2002 would have been based only on shipment of cards out of the vault, as in
the past, which would have reduced revenue by approximately $6.9 million.

     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 must include an expense within the tax provision in the
statements of income to the extent such deferred tax assets were previously
recognized.

     Significant management judgment is required in determining the provision
for income taxes, deferred tax assets and liabilities, and any valuation
allowance recorded against the net deferred tax assets. The Company has recorded
a valuation allowance of $5.7 million as of September 30, 2002, due to
uncertainties related to the Company's ability to utilize some of the deferred
tax assets, primarily consisting of certain net operating losses carried
forward, before they expire. The valuation allowance is based on management's
estimates of taxable income by jurisdiction in which the Company operates and
the period over which the deferred tax assets will be recoverable. In the event
that actual results differ from these estimates or that these estimates are
adjusted in future periods, the Company may need to establish an additional
valuation allowance which could materially impact the Company's results of
operations.

                                       -9-
<PAGE>

     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 the estimated forecast of product demand. During the first six
months of fiscal 2003, the Company wrote off $393,000 of obsolete and excess
parts. As demonstrated during fiscal 2002, demand for read/write drive products
can fluctuate significantly. If the Company is unable to produce and sell
read/write drives in volumes and at prices competitive with alternate
technologies, its operating results could be harmed. In order to obtain
favorable pricing, purchases of read/write drive parts are made in quantities
that exceed the historical annual sales rate. Therefore, based upon last year's
sales quantity, the Company has more than one-year's supply of read/write drive
parts on hand. 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.
Read/write drive parts and finished goods inventory totaled $2.8 million at
September 30, 2002 compared with $3.1 million at March 31, 2002. As of September
30, 2002, finished goods inventory contained approximately 730 read/write drives
of the current design. The Company could assemble approximately 925 read/write
drives of a new design with the current parts inventory and the purchase of
about $350,000 of additional parts. The Company believes there is a market for
read/write drives to support and expand optical card sales and, based on current
proposals in process, that the read/write drive inventory on hand at September
30, 2002 will be ordered by customers. If these anticipated orders do not
materialize, the Company may need to write-down the value of its inventory for
any potential excess quantities. During fiscal 2002, the Company sold
approximately 450 read/write drives. The Company believes that sales of
approximately 475 read/write drives per quarter would be necessary to achieve a
gross profit on read/write drive sales at current selling prices and costs based
on current expense levels for overhead costs. The Company believes that the
read/write drive inventory as of September 30, 2002 is reflected at its net
realizable value. If lower cost read/write drive designs become available from
the Company before the existing parts are utilized, a portion of this inventory
may be deemed obsolete and would then require an inventory write-down. However,
it is anticipated that the introduction of any new read/write drive would be
timed to minimize this risk. In addition, the Company is investing in research
and engineering in an effort to develop new optical card drive products.

RECENT ACCOUNTING PRONOUNCEMENTS

     In July 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 is effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
Company is currently evaluating the provisions of SFAS No. 146 but does not
believe that the adoption will have a material impact on its results of
operations, financial position, or cash flows.

RESULTS OF OPERATIONS--FISCAL 2003 SECOND QUARTER AND FIRST SIX MONTHS COMPARED
WITH FISCAL 2002 SECOND QUARTER AND FIRST SIX MONTHS

OVERVIEW

     The Company's principal LaserCard(R) optical memory card market today
involves high-security, counterfeit-resistant, tamper-resistant cards for
"digital governance," defined as the utilization of digital information
technology by a nation, state, region, municipality, agency, or institution.
Within this market, the Company's largest customer for LaserCard products is the
United States government, predominantly as a result of two card programs--U.S.
Immigration and Naturalization Service (INS) "Green Card" Permanent Resident
Card and U.S. Department of State "Laser Visa" Border Crossing Card (BCC), which
the INS also refers to as the "new biometric BCC, Form DST-150." Under the
Company's current subcontract and previous subcontracts to provide cards to the
government, the Company has sold a total of approximately 18.5 million optical
memory cards as of September 30, 2002, for use as U.S. government Green Cards
and border-security Laser Visa BCCs. Canada also has started issuing the
Company's LaserCard as the new Canadian Permanent Resident Card.

                                      -10-
<PAGE>

     Optical memory card digital governance programs that are emerging programs
or prospective applications in various countries include the new national ID
cards for Italy, Macedonia, and Saudi Arabia; motor vehicle registration cards
for two states of India; building construction permit cards and children's
healthcare cards in the People's Republic of China; a document card program in
Mexico; and the expanding need for enhanced U.S. border security. Since these
card programs typically rely on government policy-making, which in turn is
subject to budget approvals and political considerations, there is no assurance
that these programs will be implemented as visualized.

     In addition to using its own marketing staff, the Company utilizes
value-added reseller (VAR) companies and card distribution licensees for the
development of commercial markets and applications for LaserCard products.
Product sales to VARs and licensees include the Company's optical memory cards,
the Company's system software, optical card read/write drives, and add-on
peripherals made by other companies (such as equipment for adding a digitized
photo, fingerprint, hand template, or signature to the cards). The
VARs/licensees may add application software, personal computers (PCs), and other
peripherals, and then resell these products integrated into data systems. The
Company is continuing its efforts to recruit new VARs and card distribution
licensees and eliminate nonproductive VARs. The Company provides customer
technical support and system software to assist VARs and licensees.

REVENUES

     For the fiscal 2003 second quarter ended September 30, 2002, the Company's
total revenues increased 104%, to $9,529,000 from $4,674,000 for the comparable
prior-year quarter. Total revenues for the fiscal 2003 first six months
increased 80% , to $16,117,000 from $8,957,000 for last year's first six months.

     PRODUCT REVENUES. Sales of LaserCard optical memory cards and related
products were $9,529,000 for the second quarter and $16,117,000 for the first
six months ended September 30, 2002 versus $3,909,000 for the second quarter and
$7,881,000 for the first six months ended September 30, 2001. The increase in
product revenues was due primarily to the sale of optical memory cards for the
U.S. government's Green Card, Laser Visa BCC, and Automated Manifest System card
programs, as described above, representing 78% of total revenues for the full
fiscal year 2002, 93% of revenues for the fiscal 2003 second quarter, and 94% of
revenues for the fiscal 2003 first six months .

     The Company sold approximately 2.84 million LaserCard optical memory cards
in the fiscal 2003 second quarter and approximately 4.78 million cards in the
fiscal 2003 first six months compared with approximately 1.14 million cards in
the fiscal 2002 second quarter and approximately 2.27 million cards in the
fiscal 2002 first six months. LaserCard revenues for the three months ended
September 30, 2002 include 2.17 million U.S. government cards that are located
in a secure, government-funded vault on the Company's premises, that have not
yet been shipped to the customer but for which the Company received a fixed
schedule during the three months ended September 30, 2002 for shipment of the
cards out of the vault.

     The Company sold 28 LaserCard read/write drives in the fiscal 2003 second
quarter and 103 drives in the fiscal 2003 first six months compared with 60
drives in the fiscal 2002 second quarter and 160 drives in the fiscal 2002 first
six months.

     Total sales during the first six months ended September 30, 2002 included
U.S. Department of State Laser Visa cards for southwestern border security; INS
Green Cards; military cargo manifest cards and read/write drives for the U.S.
Department of Defense Automated Manifest System; cards for the Canadian
government's new Permanent Resident Card program; and optical card encoder
read/write drives for the Italian government's planned electronic national ID
card program. The Company estimates that it will recognize revenues on more than
8 million cards of all types during the current fiscal year. The Company sold
approximately 4.78 million cards during the first six months of fiscal 2003.
Card sales during the remainder of fiscal 2003 ending March 31, 2003 are
expected to include about 2 million cards on order for the U.S. government,
which will be booked as revenue when the Company has both delivered the cards
into the vault and received a fixed schedule for shipment of the cards out of
the vault, and about 400,000 cards that are on order for the Canadian Permanent
Resident Card program. The balance is estimated to come primarily from
anticipated orders for programs in Italy and Macedonia.

     LICENSE FEE REVENUES. There were no license revenues for the fiscal 2003
second quarter or first six months ended September 30, 2002. For the fiscal 2002
second quarter ended September 30, 2001, the Company recognized license

                                      -11-
<PAGE>

revenue in the net amount of $765,000 in connection with settlement of the
Company's patent-infringement lawsuit against Dolby Laboratories, Inc. related
to motion picture digital sound. For the fiscal 2002 first six months, revenues
from license fees were $1,076,000. This license revenue included $956,000
(including the Dolby payment) recognized on digital sound patent licenses and
$119,000 earned on a license that allows a licensee in Italy to purchase parts
kits from the Company and assemble read/write drives from the parts kits.

BACKLOG

     As of September 30, 2002, the backlog for LaserCard optical memory cards
totaled approximately $10.4 million. Of this backlog, 71% is for U.S. government
Green Cards or Laser Visa BCCs under the Company's U.S. government subcontract
for supplying optical memory cards. As of September 30, 2001, the backlog for
LaserCard optical memory cards totaled approximately $14.7 million, consisting
of approximately $8.7 million in firm card orders under card supply contracts,
and approximately $6 million in cards produced and delivered to the
government-funded vault.

     Announced in June 2000, the Company's current U.S. government subcontract
for Green Cards and Laser Visa BCCs has an authorized maximum of $81 million for
up to 24 million cards, at an average selling price of about $3.23 per card,
over a period of up to five years. The subcontract was received by the Company
through a LaserCard VAR that is a U.S. government prime contractor, under a
competitively bid, government procurement contract. The subcontract states that
the U.S. government anticipates placing orders in units of at least one million
optical memory cards per order. The subcontract provides for an initial one-year
contract period and four additional one-year contract options.

     The Company's current U.S. government subcontract for Green Cards and Laser
Visa BCCs requires delivery to a secure, government-funded vault built on
Company premises. Deliveries are made into the vault on a fixed schedule
specified by the prime contractor. At the time the cards are delivered to the
vault, title to the cards transfers to the government, the prime contractor is
invoiced, and payment is due according to normal trade payment terms. Through
June 30, 2002, revenue was recognized when the cards were shipped from the vault
because the Company had never received a fixed schedule, notification, or plan
for shipments out of the vault. During the second quarter of fiscal 2003, for
the first time, the Company received a fixed schedule for shipment of cards from
the vault to the customer. Therefore, revenue was recognized for these cards.
Under the Company's current supply subcontract for up to 24 million optical
memory cards, the number of optical memory cards sold (and recorded as revenue)
from September 2000 through September 2002 totaled approximately 9 million
cards. In addition, the Company has supplied 9.5 million optical memory cards to
the U.S. government since 1997 under previous subcontracts.

     At September 30, 2002, the vault contained 2.17 million cards with a sales
value of $6.9 million. The $6.9 million in sales value was recorded as revenue
and the associated costs were recorded in cost of sales during the fiscal 2003
second quarter when the Company received a fixed schedule for shipments out of
the vault. These 2.17 million cards are owned by the U.S. government and are not
included in inventory on the Company's consolidated balance sheets. As of March
31, 2002, the vault contained 1.67 million cards with a sales value of $5.3
million. As the Company had not then received a fixed schedule for shipment of
these cards out of the vault, their sales value had not been recorded as
revenue. Instead, the net of the revenue value of $5.34 million and the $2.48
million cost was recorded as deferred gross profit in the amount of $2.86
million on the condensed consolidated balance sheets as of March 31, 2002. These
1.67 million cards were owned by the U.S. government and were not included in
inventory on the Company's consolidated balance sheets as of March 31, 2002.

     Card backlog as of September 30, 2002 includes scheduled deliveries under
the following card orders:

     On July 26, 2002, the Company received an order valued at $1.8 million for
400,000 optical memory cards to be supplied to the Canadian government under a
subcontract under Canada's new Permanent Resident Card program. Orders to date
under this subcontract now total 750,000 cards. Deliveries on the initial order
received in February of this year commenced in June. The purchase orders specify
that deliveries of the 750,000 cards occur over an eleven-month period. About
92,000 cards have been delivered as of September 30, 2002, leaving a backlog of
approximately 658,000 cards. The subcontract provides for a minimum purchase of
2.3 million cards over the five-year term of the subcontract.

                                      -12-
<PAGE>

     On September 24, 2002, the Company received a $7.4 million order for 2.3
million U.S. government multi-biometric ID cards to be used as INS Green Cards
denoting permanent resident status or as U.S. Department of State Laser Visa
BCCs for southwestern border security. This was the seventh in a series of
LaserCard orders received under the Company's U.S. government subcontract,
discussed above. Including this order, a total of 11.3 million cards have been
ordered thus far under the subcontract, and 9 million cards have been sold and
recorded as revenue. The $7.4 million LaserCard order calls for deliveries
beginning in October 2002 at a rate slightly above $1 million per month for
seven months. Revenue will be recognized on this order when the cards are
shipped from the vault, unless the Company receives a fixed schedule,
notification, or plan for shipments for this order out of the vault, in which
case revenue will be recognized upon the later of the receipt of such fixed
shipment schedule or delivery of the cards into the vault.

     In addition, on October 4, 2002, following the close of the fiscal 2003
second quarter, the Company received a $177,000 order for 24 of its new
LaserCard biometric identity verification systems and related software and
biometric analysis tools for use in a test program at Los Angeles and Atlanta
airports and at specified Mexican border crossing points in Arizona, California,
and Texas, for biometric ID border crossing/tracking. These LaserCard identity
verification systems are designed to function with the more than 5 million
Drexler-manufactured Laser Visa BCCs issued by the INS and U.S. Department of
State since 1998. The biometric verification system can quickly confirm validity
of the government-issued cards, read and display digitally stored photographs
and other digital data from the cards, and biometrically verify the cardholders'
live fingerprints with the fingerprint templates stored on the cards at time of
card issuance. The Space and Naval Warfare Systems Center, San Diego, will
conduct the tests.

GROSS PROFIT

     Excluding license and royalty revenue, the gross margin on product sales
was 46% for the fiscal 2003 second quarter and 48% for the fiscal 2003 first six
months compared with 47% for the fiscal 2002 second quarter and 45% for the
fiscal 2002 first six months.

     OPTICAL MEMORY CARDS. The Company continues to depend on gross profit
generated from optical memory card sales. Gross profit on optical memory card
sales was approximately $4.7 million for the fiscal 2003 second quarter and $8.1
million for the fiscal 2003 first six months compared with approximately $2
million for the fiscal 2002 second quarter and $3.8 million for the fiscal 2002
first six months. The increase in gross profit for the fiscal 2003 second
quarter and first six months was mainly due to the higher sales volume of cards.
Optical memory card gross profit and margins can vary based on average selling
price, sales and production volume, mix of card types, production efficiency and
yields, and changes in fixed costs.

     READ/WRITE DRIVES. For the fiscal 2003 second quarter, gross profit on
read/write drive sales was a negative gross profit of about $440,000 compared
with a negative gross profit of $155,000 for the fiscal 2002 second quarter. For
the fiscal 2003 first six months, gross profit on read/write drive sales was a
negative gross profit of $600,000 compared with a negative gross profit of about
$290,000 for the fiscal 2002 first six months. The negative gross profit is due
to (a) the provision for inventory write-offs of $273,000 in the fiscal 2003
second quarter and $72,000 in the fiscal 2002 second quarter and (b) fixed
overhead costs which were expensed during the relevant periods. Currently, the
Company's priority is to increase the number of read/write drives in the
marketplace rather than maximizing per-unit gross profit on read/write drives.

     The Company believes that potential markets for read/write drives include
the U.S. Immigration and Naturalization Service, U.S. Department of State, the
U.S. armed forces, Canada, Italy, and several other countries. The Company
maintains an inventory of read/write drive parts and finished drives that it
believes is adequate to meet customer demand. However, 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 the Company's
operating results.

INCOME AND EXPENSES

     SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). SG&A expenses were
$1,438,000 for the fiscal 2003 second quarter compared with $1,170,000 for the
fiscal 2002 second quarter. The increase of $268,000 for the fiscal 2003 second

                                      -13-
<PAGE>

quarter compared with the fiscal 2002 second quarter was due mainly to a
$165,000 increase in marketing and selling expenditures. For the fiscal 2003
first six months, SG&A expenses were $3,008,000 compared with $2,364,000 for the
fiscal 2002 first six months. The increase of $644,000 for the fiscal 2003 first
six months compared with the fiscal 2002 first six months was due mainly to a
$393,000 increase in marketing and selling expenditures and a $134,000 increase
in legal and accounting fees. The Company believes that SG&A expenses for fiscal
2003 will remain above fiscal 2002 levels, mainly due to increases in marketing
expenses, increases in the cost of insurance, and other general increases.

     RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card read/write drives and read-only
drives and software products in order to provide new products that can stimulate
sales growth. The Company anticipates that these R&E efforts will result in
lower cost drives, customer-optimized drive systems, and drive systems with
advanced security features. R&E expenses were $742,000 for the fiscal 2003
second quarter compared with $736,000 for the comparable prior-year period. For
the fiscal 2003 first six months, R&E expenses were $1,518,000 compared with
$1,359,000 for the fiscal 2002 first six months. These increases were due to the
increase in read/write and read-only drive manufacturing engineering and product
development during the fiscal 2003 periods versus the fiscal 2002 periods. The
Company anticipates that R&E expenses for the remainder of fiscal 2003 will
increase, primarily due to optical memory card drive development efforts and
optical card-related research and engineering.

     OTHER INCOME AND EXPENSE. Total net other income for the fiscal 2003 second
quarter was $108,000, consisting of interest income, compared with $95,000 for
interest income in the fiscal 2002 second quarter. Total net other income for
the first six months of fiscal 2003 consisted of $214,000 of interest income
compared with $211,000 of interest income for the first six months of fiscal
2002. The nominal increases for both periods reflect higher amounts invested,
partially offset by lower interest rates on invested funds.

     PRETAX PROFIT. Pretax profit for the fiscal 2003 second quarter increased
by $1,526,000, or 191% over last year's second quarter, mainly due to the
$1,787,000 increase in gross profit, offset by a $274,000 increase in operating
expenses. Pretax profit for the fiscal 2003 first six months increased by
$2,280,000, or 206% over last year's first six months, mainly due to the
$3,080,000 increase in gross profit, offset by an $803,000 increase in operating
expenses.

     INCOME TAXES. Despite a significant increase in pre-tax income for the
fiscal 2003 second quarter and first six months, net income declined compared
with the prior-year periods, primarily due to income taxes. Results for the
quarter ended September 30, 2002 included a provision for income tax EXPENSE of
$951,000 compared with an income tax BENEFIT of $618,000 for the quarter ended
September 30, 2001. Results for the six months ended September 30, 2002 included
a provision for income tax EXPENSE of $1,355,000 compared with an income tax
BENEFIT of $1,443,000 for the six months ended September 30, 2001. The income
tax benefits recorded in the fiscal 2002 periods resulted from the recognition
of deferred tax assets against which the Company had previously provided a
valuation allowance due to uncertainty that those assets would be realized. As
of March 31, 2002, the Company had recognized all prior federal income tax
benefits for income statement purposes, but still has substantial benefits to
reduce actual tax payments, as described below. As such, the Company recorded
income tax expense for the fiscal 2003 second quarter and first six months based
on its estimated annual effective tax rate.

     The Company analyzes its deferred tax assets with regard to potential
realization. The Company has established a valuation allowance on a portion of
the deferred tax assets based upon the uncertainty of their realization. The
Company has considered estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the amount of the valuation
allowance. Any benefit from the reversal of the valuation allowance would be
recorded as a credit to stockholders' equity as such assets relate to net
operating loss carryforwards due to stock option exercises.

     The Company has recorded $7.4 million of deferred tax assets which will be
available to offset future tax cash payments; the Company has an additional $5.7
million of deferred tax assets not recognized which, if and when realized, would
also be available to offset future tax cash payments.

LIQUIDITY AND CAPITAL RESOURCES

     As of September 30, 2002, the Company had cash, cash equivalents, and
short-term investments of $15,242,000, a current ratio of 8.1 to 1, and no
long-term debt.

                                      -14-
<PAGE>

     Net cash used for operating activities was $191,000 for the fiscal 2003
first six months compared with $716,000 provided by operating activities for
last year's first six months. The major categories comprising cash provided and
used for operating activities are (in thousands):

<TABLE>
<CAPTION>
                                                                                 Six Months Ended
                                                                                   September 30,
                                                                               2001            2002
                                                                               ----            ----
<S>                                                                          <C>             <C>
          Earnings before taxes, depreciation, and amortization...........   $  1,868        $ 4,273
          Provisions for doubtful accounts receivable, product return
             reserve, and excess and obsolete inventory, net       .......        293            440
          Increase (decrease) in deferred gross profit....................         57         (2,860)
          Tax payments....................................................        218             --
          Increase in accounts receivable.................................       (508)          (216)
          Increase in inventory...........................................     (1,088)          (469)
          Increase in accounts payable and accrued liabilities............        102            582
          Increase (decrease) in advance payments from customers
             and deferred revenue.........................................        109         (1,952)
          Other ..........................................................       (335)            11
                                                                             --------        -------

                                                                             $    716        $  (191)
                                                                             ========        =======
</TABLE>

     The Company believes that the estimated level of revenues over the next 12
months will be sufficient to generate cash from operations. Operating cash flow
could be negatively impacted to a significant degree if the Company's 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 increases in
product revenues or licenses do not keep pace with increased marketing and R&E
expenditures.

     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 $2,034,000 of net income recorded for the fiscal 2003
first six months, the Company's accumulated deficit decreased to $6,065,000.
Stockholders' equity increased to $35,427,000 due to the net income recorded and
$916,000 in additions to equity in connection with sales of common stock through
the Company's stock-option and employee stock-purchase plans.

     Net cash used for investing activities was $3,196,000 for the fiscal 2003
first six months compared with $2,060,000 provided by investing activities for
the fiscal 2002 first six months. These amounts include a net increase of
$1,837,000 from purchases and maturities of liquid investments for the fiscal
2003 first six months and a net decrease of $2,791,000 for the fiscal 2002 first
six months, purchases of property and equipment of $1,061,000 for the fiscal
2003 first six months and $669,000 for the fiscal 2002 first six months, and
increases in patents and other intangibles of $298,000 for the fiscal 2003 first
six months and $62,000 for the fiscal 2002 first six months.

     The Company considers all highly liquid investments, consisting primarily
of commercial paper, taxable notes, and U.S. government agency notes, with
original maturities of three months or less when purchased, to be cash
equivalents. All investments with original maturities of more than three months
but not more than one year, are classified as short-term investments. Management
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, 2002, the Company had $9,520,000
classified as short-term investments, compared with $8,883,000 at March 31,
2002. All marketable securities were classified as held-to-maturity. Cash, cash
equivalents, and short-term investments were $15,242,000 at September 30, 2002
and $17,076,000 at March 31, 2002. Long-term investments, which have maturities
ranging from 12 months to 15 months, were $2,202,000 at September 30, 2002
compared with $1,002,000 at March 31, 2002.

                                      -15-
<PAGE>

     For optical memory card production, the Company added capital equipment and
leasehold improvements of approximately $685,000 during the fiscal 2003 first
six months compared with $345,000 during the fiscal 2002 first six months. The
Company's card production capacity is approximately 11 million cards per year,
depending on card type, color-printing specifications, and numerical
serialization requirements, which is double the actual card production of more
than 5 million cards for fiscal 2002. The Company plans to purchase additional
production equipment as optical memory card orders expand to justify production
capacity increases, to a rate of up to 25 million cards per year. 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 believes that during the next few years, capital expenditures will be a
minimum of $3 million per year for card production equipment and automatic
inspection equipment to support growth of optical memory card production.

     For the fiscal year 2003 ending March 31, 2003, the Company expects foreign
business to rise substantially, increasing the estimated total of optical memory
card shipments on which revenues will be recognized to more than 8 million
cards, up from 5.6 million cards for fiscal 2002. The Company believes it is
capable of supporting this expected LaserCard revenue growth, should it occur,
without raising additional equity capital, since as of September 30, 2002, the
Company has cash, cash equivalents, and short-term investments of $15,242,000,
and no debt.

     In connection with the manufacturing and design of read/write drives and
related systems, the Company added capital equipment and leasehold improvements
of approximately $220,000 during the fiscal 2003 first six months compared with
$324,000 during the fiscal 2002 first six months. The Company expects that
during fiscal 2003, it will make capital investments of between $400,000 and
$800,000 relating to read/write drives and systems.

     Net cash provided by financing activities was $916,000 for the fiscal 2003
first six months compared with net cash of $20,000 used for by financing
activities for the fiscal 2002 first six months. Financing activities included
proceeds on sales of common stock through the Company's stock-option and
employee stock-purchase plans. Sales of common stock through stock plans were in
the amounts of $916,000 for the fiscal 2003 first six months and $155,000 for
the fiscal 2002 first six months.

     During fiscal 2001, the Company commenced a share repurchase program under
which up to 200,000 shares of common stock could be purchased by the Company
from time to time in Nasdaq Stock Market transactions in an aggregate amount not
exceeding $3 million. During the fiscal 2002 first quarter, the Company used
$175,000 of cash for share repurchases. As of June 30, 2001, the Company had
completed this program.

     There were no debt financing activities for the first six months of fiscal
2003 or 2002.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RATE RISKS

     INTEREST RATE RISK. There were no material changes during the fiscal 2003
second quarter to the Company's exposure to market risk for changes in interest
rates.

     FOREIGN CURRENCY EXCHANGE RATE RISK. There were no material changes during
the fiscal 2003 second quarter to the Company's foreign currency exchange rate
risk.

ITEM 4.   CONTROLS AND PROCEDURES

     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)) within the 90 days prior to the filing of this Form 10-Q and have
determined that they are reasonable taking into account the totality of the
circumstances.

     CHANGES IN INTERNAL CONTROLS. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation, which was shortly
prior to the release of the Company's earnings statement for the period covered
by this Form 10-Q.

                                      -16-
<PAGE>

PART II.  OTHER INFORMATION

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

     At the Company's September 27, 2002 Annual Meeting of Stockholders, the
Company's stockholders (i) re-elected the existing Board of Directors, (ii)
approved an amendment to the Stock Option Plan to increase the number of shares
reserved thereunder by 275,000 shares, and (iii) rejected a stockholder proposal
concerning dividends.

     Of the 10,313,379 shares of common stock outstanding as of the record date
of July 31, 2002, a total of 9,396,799 shares were voted by proxy, representing
91.11% 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: Jerome Drexler (8,983,334 votes
for re-election, 413,465 votes withheld), Christopher J. Dyball (8,990,779 votes
for election, 406,020 votes withheld), Richard M. Haddock (8,990,679 votes for
election, 406,120 votes withheld), Arthur H. Hausman (8,980,009votes for
re-election, 416,790 votes withheld), Dan Maydan (8,852,597 votes for
re-election, 544,202 votes withheld), William E. McKenna (8,846,552 votes for
re-election, 550,247 votes withheld), and Walter F. Walker (7,610,556 votes for
re-election, 1,786,243 votes withheld). On the amendment to the Stock Option
Plan, 6,509,770 shares were voted in favor, and there were 2,865,019 negative
votes, 22,009 abstentions, and one broker non-vote. On the stockholder's
proposal concerning dividends, 477,167 shares were voted in favor, and there
were 5,977,311 negative votes, 99,896 abstentions, and 2,842,425 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

     The Company's Audit Committee has approved certain non-audit services
provided or to be provided by PricewaterhouseCoopers LLP, the Company's
independent accountants. These services relate to consultation, advice, and
other services in connection with tax planning and compliance, SEC registration
statements and regulatory matters, and application of generally accepted
accounting principles.

ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibit No.     Exhibit Description

          10.4.1          Amended and Restated Stock Option Plan

     (b)  No reports on Form 8-K were filed by Registrant during the period for
          which this report is filed.

SIGNATURES

     Pursuant to the requirements 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:

<TABLE>
<CAPTION>
                             DREXLER TECHNOLOGY CORPORATION (Registrant)

<S>                          <C>
Date: November 7, 2002       /s/ Jerome Drexler
                             --------------------------------------------------------------
                             Jerome Drexler, Chairman of the Board of Directors
                             and Chief Executive Officer (Principal Executive Officer)

Date: November 7, 2002       /s/ Steven G. Larson
                             --------------------------------------------------------------
                             Steven G. Larson, Vice President of Finance and Treasurer
                             (Principal Financial Officer and Principal Accounting Officer)
</TABLE>

THE CERTIFICATION STATEMENTS BY REGISTRANT'S CHIEF EXECUTIVE OFFICER AND CHIEF
FINANCIAL OFFICER RELATING TO THIS QUARTERLY REPORT ON FORM 10-Q, AS REQUIRED BY
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C. SECTION 1350), HAVE
BEEN SUBMITTED TO THE SECURITIES AND EXCHANGE COMMISSION AS ADDITIONAL
CORRESPONDENCE ACCOMPANYING THIS REPORT.

                                      -17-
<PAGE>

                                 CERTIFICATIONS
                                 --------------

     I, Jerome Drexler, certify that:

     1. I have reviewed this quarterly report on Form 10-Q of Drexler Technology
Corporation, a Delaware corporation;

     2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

     3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

     4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        (a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

        (b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

        (c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

     5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):

        (a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

        (b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

     6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date:  November 7, 2002


By:          /s/ Jerome Drexler
     -------------------------------------
     Jerome Drexler, Chairman of the Board
         (Principal Executive Officer)

                                      -18-
<PAGE>

                                 CERTIFICATIONS
                                 --------------

     I, Steven G. Larson, certify that:

     1. I have reviewed this quarterly report on Form 10-Q of Drexler Technology
Corporation, a Delaware corporation;

     2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

     3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

     4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        (a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

        (b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

        (c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;

     5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):

        (a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

        (b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

     6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date:  November 7, 2002


By:                 /s/ Steven G. Larson
     ------------------------------------------------------
     Steven G. Larson, Vice President Finance and Treasurer
               (Principal Financial Officer)

                                      -19-

<PAGE>

EXHIBIT INDEX

                               INDEX TO EXHIBITS
                                  [ITEM 14(c)]

Exhibit
Number       Description
------       -----------

10.4.1       Amended and Restated Stock Option Plan



                                       20