<PAGE>   1
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-Q

[Mark One]
   [X]         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                For the Quarterly Period Ended December 31, 1998

                                       OR

   [ ]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                        For the Transition Period from to


                        Commission File Number: 000-6377


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

<TABLE>
<S>                                                      <C>
          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)
</TABLE>

                                 (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 February 5, 
1999: 9,786,320

<PAGE>   2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



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

     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 included only normal recurring
adjustments) necessary to present fairly the financial position and results of
operations as of and for the periods indicated.

     It is suggested that these condensed consolidated financial statements be
read in conjunction with the financial statements and the notes thereto for the
year ended March 31, 1998 included in the Company's Form 10-K Annual Report.

     The results of operations for the nine months ended December 31, 1998 are
not necessarily indicative of results to be expected for the entire year ending
March 31, 1999.

     Fiscal Period: For purposes of presentation, the Company has indicated its
accounting period as ending on March 31 and its interim quarterly periods as
ending on the corresponding month end. The Company, in fact, operates and
reports quarterly periods ending on the Friday closest to month end. The 13-week
period presented as December 31, 1998 ended on January 1, 1999 and the 13-week
period presented as December 31, 1997 ended on January 2, 1998.

     Net Income per Share: The Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share," during the 1998 fiscal year.
SFAS 128 requires the computation of basic and diluted earnings per share. Basic
earnings per share is computed using the weighted average number of common
shares outstanding. Diluted earnings per share is computed using the weighted
average number of shares of common stock outstanding and the dilutive common
stock equivalents (using the treasury stock method). The reconciliation of the
numerators and denominators of the basic and diluted earnings per share
computation is shown on the following page.


                                      -2-

<PAGE>   3

<TABLE>
<CAPTION>
                                                      Income             Shares        Per Share
                                                    (Numerator)      (Denominator)      Amount
                                                   --------------    --------------    ---------
                                                   (In thousands)    (In thousands)
<S>                                                    <C>               <C>             <C>
For three months ended December 31, 1997
  Basic earnings per share
  Income available to common stockholders...........   $   676            9,525          $  .07
                                                                                         ======
  Common shares issuable upon exercise of
     stock options using treasury stock method ......       --              255
                                                       -------           ------
  Diluted earnings per share
  Income available to common stockholders...........   $   676            9,780          $  .07
                                                       =======           ======          ======

For three months ended December 31, 1998
  Basic earnings per share
  Income available to common stockholders...........   $ 1,003            9,781          $  .10
                                                                                         ======
  Common shares issuable upon exercise of
     stock options using treasury stock method ......       --              137
                                                       -------           ------
  Diluted earnings per share
  Income available to common stockholders...........   $ 1,003            9,918          $  .10
                                                       =======           ======          ======

For nine months ended December 31, 1997
  Basic earnings per share
  Income available to common stockholders...........   $   978            9,324          $  .10
                                                                                         ======
  Common shares issuable upon exercise of
     stock options using treasury stock method ......       --              255
                                                       -------           ------
  Diluted earnings per share
  Income available to common stockholders...........   $   978            9,579          $  .10
                                                       =======           ======          ======

For nine months ended December 31, 1998
  Basic earnings per share
  Income available to common stockholders...........   $ 2,971            9,736          $  .31
                                                                                         ======
  Common shares issuable upon exercise of
     stock options using treasury stock method ......       --              280
                                                       -------           ------
  Diluted earnings per share
  Income available to common stockholders...........   $ 2,971           10,016          $  .30
                                                       =======           ======          ======
</TABLE>

     Because they have an exercise price greater than the average market value
for the periods, stock options representing 1,138,073 shares are excluded from
the calculation of diluted earnings per share for the three months ended
December 31, 1998, and stock options representing 436,480 shares are excluded
from the calculation of diluted earnings per share for the three months ended
December 31, 1997. For the same reason, stock options representing 304,300
shares are excluded from the calculation of diluted earnings per share for the
nine months ended December 31, 1998, and stock options representing 566,480
shares are excluded from the calculation of diluted earnings per share for the
nine months ended December 31, 1997.

Recent Accounting Pronouncements:

     SFAS 130: In June 1997, the Financial Accounting Standards Board (FASB)
issued SFAS 130, "Reporting Comprehensive Income," which becomes effective for
fiscal years beginning after December 15, 1997. In the quarter ended June 30,
1998, the Company adopted SFAS 130. For the three months and nine months ended
December 31, 1998, comprehensive income equalled net income.


                                      -3-

<PAGE>   4

     SFAS 131: Also in June 1997, the FASB issued SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information," which becomes effective for
fiscal years beginning after December 15, 1997. The adoption of SFAS 131 is not
expected to impact the Company's disclosures.

     SFAS 133: In June 1998, the FASB issued SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. The
pronouncement is effective for fiscal years beginning after June 15, 1999. The
statement must be applied to derivative instruments that were issued, acquired,
or substantively modified after December 31, 1997. The adoption of SFAS 133 is
not expected to impact the Company's consolidated financial position or results
of operations.


                                      -4-

<PAGE>   5

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


<TABLE>
<CAPTION>
                                                                    March 31,     December 31,
                                                                      1998           1998
                                                                    ---------     ------------
                                                                    (Audited)     (Unaudited)
<S>                                                                  <C>            <C>
                                     Assets
Current assets:
    Cash and cash equivalents ....................................   $  4,830       $  7,757
    Accounts receivable ..........................................      1,045          1,173
    Inventories ..................................................      1,470          1,286
    Other current assets .........................................        216            284
                                                                     --------       --------
       Total current assets ......................................      7,561         10,500
                                                                     --------       --------

Property and equipment, at cost ..................................     15,122         16,424
    Less--accumulated depreciation and amortization ..............    (12,244)       (12,697)
                                                                     --------       --------
       Property and equipment, net ...............................      2,878          3,727
                                                                     --------       --------

Patents, net .....................................................        809          1,100
                                                                     --------       --------

          Total assets ...........................................   $ 11,248       $ 15,327
                                                                     ========       ========

                       Liabilities and Stockholders' Equity
Current liabilities:
    Accounts payable .............................................   $    593       $    483
    Accrued payroll costs ........................................        300            321
    Advance payments from customers ..............................        463            625
    Other accrued liabilities ....................................        183            210
                                                                     --------       --------
       Total current liabilities .................................      1,539          1,639
                                                                     --------       --------

Stockholders' equity:
    Preferred stock, $.01 par value:
       Authorized--2,000,000 shares
       Outstanding--none .........................................         --             --
    Common stock, $.01 par value:
       Authorized--15,000,000 shares
       Outstanding--9,640,747 shares at March 31, 1998 and
           9,781,670 shares at December 31, 1998 .................         96             98
    Additional paid-in capital ...................................     35,330         36,375
    Accumulated deficit ..........................................    (25,717)       (22,785)
                                                                     --------       --------
       Total stockholders' equity ................................      9,709         13,688
                                                                     --------       --------

          Total liabilities and stockholders' equity .............   $ 11,248       $ 15,327
                                                                     ========       ========
</TABLE>


                                      -5-

<PAGE>   6

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


<TABLE>
<CAPTION>
                                                         Three Months Ended             Nine Months Ended
                                                            December 31,                   December 31,
                                                         1997           1998           1997           1998
                                                         ----           ----           ----           ----
<S>                                                    <C>            <C>            <C>            <C>     
Revenues ..........................................    $  3,229       $  4,056       $  7,620       $ 11,563
                                                       --------       --------       --------       --------

Costs and expenses:
    Cost of sales .................................       1,709          1,982          4,214          5,674
    Selling, general, and administrative expenses..         801            973          2,193          2,647
    Research and engineering expenses .............          92             99            315            350
                                                       --------       --------       --------       --------
       Total costs and expenses ...................       2,602          3,054          6,722          8,671
                                                       --------       --------       --------       --------

          Operating income ........................         627          1,002            898          2,892

Other income and expense:
    Other income (expense), net ...................          31            (52)            26            (58)
    Interest income ...............................          43             87             94            233
    Interest expense ..............................          (2)            (2)            (5)            (5)
                                                       --------       --------       --------       --------
       Total other income, net ....................          72             33            115            170
                                                       --------       --------       --------       --------

          Income before income taxes ..............         699          1,035          1,013          3,062

Provision for income taxes ........................          23             32             35             91
                                                       --------       --------       --------       --------

          Net income ..............................    $    676       $  1,003       $    978       $  2,971
                                                       ========       ========       ========       ========

Net income per share:
          Basic ...................................    $    .07       $    .10       $    .10       $    .31
                                                       ========       ========       ========       ========
          Diluted .................................    $    .07       $    .10       $    .10       $    .30
                                                       ========       ========       ========       ========

Weighted average common shares:
          Basic ...................................       9,525          9,781          9,324          9,736
          Diluted .................................       9,780          9,918          9,579         10,016

</TABLE>


                                      -6-

<PAGE>   7

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


<TABLE>
<CAPTION>
                                                                              Nine Months Ended
                                                                                 December 31,
                                                                              1997         1998
                                                                              ----         ----
<S>                                                                         <C>           <C>    
Cash flows from operating activities:
   Net income...........................................................    $   978       $ 2,971
   Adjustments to reconcile net income to
     net cash used for operating activities:
       Depreciation and amortization ...................................        467           596
       Provision for doubtful accounts receivable ......................         --             4
       Compensation on stock plan activity .............................         14            18

   Changes in operating assets and liabilities:
       Increase  in accounts receivable ................................       (571)         (132)
       (Increase) decrease in inventories ..............................       (564)          184
       Increase in other assets ........................................        (44)          (68)
       (Decrease) increase in accounts payable and accrued expenses ....        352           (62)
       (Decrease) increase in advance payments from customers ..........     (1,207)          162
                                                                            -------       -------

         Net cash provided by (used for) operating activities ..........       (575)        3,673
                                                                            -------       -------

Cash flows from investing activities:
   Purchases of property and equipment .................................     (1,105)       (1,321)
   Increase in patents .................................................        (61)         (415)
                                                                            -------       -------

         Net cash used for investing activities ........................     (1,166)       (1,736)
                                                                            -------       -------

Cash flows from financing activities:
   Proceeds from sale of common stock ..................................      3,016           990
                                                                            -------       -------

         Net cash provided by financing activities .....................      3,016           990
                                                                            -------       -------

         Net increase in cash and cash equivalents .....................      1,275         2,927

Cash and cash equivalents:
   Beginning of period .................................................      2,916         4,830
                                                                            -------       -------
   End of period........................................................    $ 4,191       $ 7,757
                                                                            =======       =======
</TABLE>


                                      -7-

<PAGE>   8

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

     RESULTS OF OPERATIONS--FISCAL 1999 THIRD QUARTER AND FIRST NINE MONTHS
          COMPARED WITH FISCAL 1998 THIRD QUARTER AND FIRST NINE MONTHS

Revenues

     For the fiscal 1999 third quarter ended December 31, 1998, the Company's
total revenues were $4,056,000 compared with $3,229,000 for last year's third
quarter. Total revenues for the current nine-month period were $11,563,000
compared with $7,620,000 for the same period last year.

     PRODUCT SALES. Sales of LaserCard(R) optical memory cards and related
products to value-added resellers (VARs), licensees, and end-user customers were
$11,343,000 for the first nine months of fiscal 1999 versus $6,961,000 for last
year's comparable period.

     For the first nine months of fiscal 1999, the Company sold nearly 3,000,000
optical memory cards compared with nearly 1,600,000 for the first nine months of
fiscal 1998. The increase in sales between the two periods resulted primarily
from shipments under United States government orders.

     Applications for the Company's LaserCard products include: medical data
applications in the United States; various programs in Europe and Asia,
including a hospital patient-record card system and a vehicle warranty and
maintenance records card; and U.S. government-related programs, including the
U.S. Department of Defense "Automated Manifest" card, the U.S. Immigration and
Naturalization Service "Green Card," and the U.S. Department of State "Laser
Visa" border crossing card.

     The Company utilizes VAR companies for the development of commercial
markets and applications for LaserCard products. Product sales to VARs include
the Company's optical memory cards, the Company's system software, and optical
card reader/writers made by a licensee of the Company, and may include 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 may add
application software, personal computers (PCs), and other peripherals, and then
resell these products, integrated into data systems, for end-user customers.

     There can be no assurances that any new or existing VAR company in any
country will be successful in its markets or field trials or that it will place
follow-on orders with the Company for additional quantities of cards and
systems. In order to upgrade its VAR customer base to increase the probability
of success, the Company will continue its efforts to recruit new VARs and
eliminate nonproductive ones. The Company provides marketing leads, customer
technical support, and system software to assist VARs.

     Software is an important factor in developing the commercial markets for
optical memory cards. The Company's system software consists of optical card
interface software/device drivers, file systems, software development tools, and
demonstration software. The Company does not provide software for specific
applications, but instead depends on its VARs to integrate optical card products
into existing software products, write new application software for specific
optical card programs, or license 


                                      -8-

<PAGE>   9

software from other VARs. Several VARs have written optical card software
programs for applications such as automobile warranty and maintenance records,
cargo manifesting, digital optical key systems, admissions/ID, data logging
systems, and various medical-related applications such as medical image storage
and health history cards. Other application software development is underway by
VARs and their customers.

     Optical memory cards are used in conjunction with card reader/writer
equipment which is connected to personal computers. The reader/writer is
integrated as a PC logical drive and has drive- letter access in the same manner
as floppy disk drives. Such reader/writers are sold to VARs and other customers
of the Company. The price, performance, and availability of such reader/writers
are factors in the commercialization of optical cards. The Company sells
reader/writers for a few thousand dollars per unit, and these units generally
include the Company's interface software/device drivers.

     At this time, the Company does not manufacture card reader/writers but
instead purchases such equipment from a Japanese licensee, Nippon Conlux Co.,
Ltd., currently the Company's sole supplier of reader/writers. However, efforts
are being made to develop a manufacturing source outside of Japan. The Company's
inventory level for reader/writers fluctuates from zero up to approximately 300
units based on the timing of purchases and sales. If market demand increases
sharply over a short period of time, an initial shortage of reader/writers could
result. Also, an interruption or change in the supply of reader/writers could
cause a delay in both reader/writer and optical memory card shipments and a
possible loss of sales, which would adversely affect operating results.

     LICENSE REVENUES. During the quarter ended December 31, 1998, the Company
received $200,000 in license revenues under an agreement to provide technical
information related to read/write equipment for optical memory cards There were
no licenses sold in the first nine months of fiscal 1998. The Company is
continuing its efforts to license its patents relating to optical data
recording, storage, and retrieval . However, the magnitude of future license
revenues, if any, cannot be predicted or inferred from past events.

     ROYALTY REVENUES. The Company cannot predict whether or when equipment or
card sales by its licensees will result in material royalties to the Company.
Therefore, the Company is not relying on royalty income and does not expect it
to be a significant factor in the near term.

Backlog

     As of December 31, 1998, the backlog for LaserCard optical memory cards was
approximately $3,000,000. Deliveries of this backlog are estimated to average
approximately 200,000 to 300,000 cards per month through about March 1999.

     About 77% of the December 31, 1998 backlog is for U.S. government orders;
as is the case in all U.S. government procurement, the government reserves the
right to change specifications, delay deliveries, and cancel all or part of the
orders.


                                      -9-

<PAGE>   10

Margins

     For the fiscal 1999 first nine months ended December 31, 1998, the gross
margin on product sales was 50% compared with 45% for last year's first nine
months, due largely to the increase in card sales volume. The gross margin can
fluctuate with changes in product mix between cards and card reader/writer
equipment, which has lower gross profit margins than cards. The Company believes
the gross margin percentage probably will not reach 50% for the fiscal 1999
fourth quarter ending March 31, 1999.

Income and Expenses

     SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). For the fiscal 1999
third quarter, SG&A expenses were $973,000 compared with $801,000 for the third
quarter of fiscal 1998. For the fiscal 1999 first nine months, SG&A expenses
were $2,647,000 compared with $2,193,000 for the first nine months of fiscal
1998. The majority of the increases for the fiscal 1999 third quarter and first
nine months is attributable to higher expenses for payroll, marketing, and
customer technical support activities. This increased spending is expected to
continue for the remainder of fiscal 1999.

     RESEARCH AND ENGINEERING EXPENSES. Research and engineering expenses were
$99,000 for the third quarter of fiscal 1999 compared with $92,000 for the third
quarter of fiscal 1998, and were $350,000 for the first nine months of fiscal
1999 compared with $315,000 for the first nine months of fiscal 1998. Future
projects will require increased spending as the optical card industry grows.

     OTHER INCOME AND EXPENSE. Total net other income for the first nine months
of fiscal 1999 was $170,000 compared with $115,000 for the first nine months of
fiscal 1998. The Company purchases Japanese yen for payment of reader/writers
purchased from a Japanese supplier. Equipment delivery dates and payment dates
do not coincide. Thus, the Company's normal operations are subject to gains or
losses on fluctuations in the yen/dollar exchange rate. Net other income for the
fiscal 1999 first nine months included a loss of $58,000 on foreign currency
exchange versus a gain of $26,000 for the first nine months of last year.

     Interest income for the first nine months of fiscal 1999 was $233,000
compared with $94,000 for the year-earlier period. The increase in interest
income for fiscal 1999 was due generally to increases in average invested funds.
The Company's interest expense on short-term loans was $5,000 for the first nine
months of fiscal 1999 and $5,000 for first nine months of fiscal 1998.

                                    LIQUIDITY

     As of December 31, 1998, the Company had cash and cash equivalents of
$7,757,000 and had no long-term debt.

     Net cash provided by operating activities was $3,673,000 during the first
nine months of fiscal 1999 compared with $575,000 used for operating activities
during the first nine months of fiscal 1998. The change was due mainly to the
increase in card sales, as discussed above, and changes in operating assets and
liabilities.


                                      -10-

<PAGE>   11

     The current level of revenues is sufficient to generate cash from
operations after expenses. Fluctuations in operating assets and liabilities will
use cash in some quarters and provide cash in other quarters. Losses could recur
if U.S. government orders decrease and there are delays in other customers'
development of optical-card-based programs and corresponding commercialization
of the Company's optical cards and related products.

     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 given that such financing would be
available, if needed.

     As a result of the $2,971,000 profit recorded for the first nine months of
fiscal 1999, the Company's accumulated deficit was reduced to $22,785,000 at
December 31, 1998. During the fiscal 1999 first nine months, stockholders'
equity increased to $13,688,000 because of the $2,971,000 profit and $990,000
received by the Company for stock issued during the first nine months of fiscal
1999 under the Employee Stock Purchase Plan and the 1991 Stock Option Plan.

     The Company's total deferred income tax asset was $15,445,000 at March 31,
1998. If utilized, the total deferred income tax asset would reduce future tax
expense on the profit-and-loss statement by $12,275,000 and would reduce future
tax payments by $15,445,000. Included are amounts derived from federal income
tax net operating losses that will expire at various dates from 2001 through
2012, amounts from state income tax net operating losses that will expire at
various dates from 1999 through 2002, and amounts from tax credits that will
expire from 2000 through 2004, except for alternative minimum tax credits which
have no expiration. The ability of the Company to utilize this deferred tax
asset is contingent upon generating sufficient income within the stated time
periods. In view of the uncertain value of this asset, the Company has recorded
a full valuation allowance against it; therefore, no part of the total deferred
tax asset of $15,445,000 has been added to stockholders' equity on the Company's
balance sheet.

     For the production of state-of-the-art optical memory cards, the Company's
card production capacity is approximately 5 million cards per year. This
capacity can be expanded to 8 million cards per year over a six-month period
with an expenditure of only $1.5 million, previously budgeted for this purpose.
The Company plans to purchase additional production equipment in a series of
steps 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 the
investment used for expansion, the Company also will make additional capital
expenditures for cost savings, quality improvements, and other purposes. The
Company believes that during the next few years, capital expenditures may range
between $1.5 million to $3 million per year for card production equipment and
automatic inspection equipment.

     During the first nine months of fiscal 1999, Company employees and
consultants purchased from the Company 132,670 shares of registered common
stock, at an average price of $7.18 per share, through the exercise of stock
options under the Company's 1991 Stock Option Plan, which resulted in cash
receipts to the Company of $952,000 . As of December 31, 1998, Company employees
and consultants held unexercised, vested, in-the-money options to purchase
501,000 shares of common stock at exercise prices ranging from $4.56 to $11.81
per share, for a weighted average of $8.35 per share. These stock options, if
exercised with cash, would provide the Company with cash in the amount of
$4,185,000. However, optionees are permitted to exercise Company stock options
using shares they already own. During the first nine months of fiscal
1999,optionees surrendered 5,877 previously owned shares to purchase 8,880 new
shares through the exercise of stock options.


                                      -11-

<PAGE>   12

                               YEAR 2000 READINESS

     INFORMATION TECHNOLOGY SYSTEMS. For purposes of upgrading in response to
ordinary business requirements, rather than in connection with Year 2000
preparedness, the Company comprehensively renovated its internal computer and
network systems during the past three years. As a result, the Company has
virtually no hardware systems more than three years old. Similarly, with the
exception of the Company's manufacturing tracking system, which is scheduled for
routine replacement with a Year 2000 compliant system within the next year, most
of the Company's software systems operate with recent Microsoft products, which
Microsoft has indicated are Year 2000 compliant. The Company has conducted an
internal audit of its information technology systems; and, based on this review
and on information provided by the manufacturers, the Company does not believe
that the prospect of Year 2000 disruption of its information technology systems
is likely to be material. With respect to information processing conducted for
the Company by third parties, such as payroll processing and banking, the
Company has obtained explicit assurances of Year 2000 compliance.

     EMBEDDED SYSTEMS. Among the Company's embedded systems, including plant and
manufacturing systems, the Company has identified only one date-sensitive
system, which is amenable to manual adjustment to bypass any potential Year 2000
interruption. With respect to certain plant systems controlled by third parties,
including certain security systems, the Company has obtained explicit assurances
of Year 2000 compliance.

     THIRD PARTY RELATIONSHIPS; CONTINGENCY PLANS. The Company has requested
information from certain key suppliers, customers, and VARs with respect to Year
2000 preparedness. The Company is assessing the responses received to date and
will follow up with non-respondents during the current quarter. Interruptions in
supply of key components, such as OEM equipment and raw materials for the
Company's products, could interfere with the Company's ability to continue
supplying its products. The Company anticipates that, if its review of suppliers
indicates a potential for such an interruption, it will initiate a program of
increasing backup inventory against that contingency. Similarly, an interruption
in the ability of key purchasers to continue to meet payment obligations to the
Company could hinder the Company's cash flow. Such key customers include the
U.S. Immigration and Naturalization Service, the U.S. Department of Defense, and
the Company's VARs supporting those accounts. The Company currently maintains
substantial cash reserves against that contingency.

     COSTS OF YEAR 2000 PREPARATION; EFFECT ON THE COMPANY'S BUSINESS. Based
upon the factors described above, the Company's separately identifiable costs to
prepare for Year 2000 contingencies to date and estimated costs for future
efforts are not material and, apart from contingencies beyond the Company's
reasonable ability to foresee or control, such as general economic or
infrastructure disruption, the Company does not anticipate that Year 2000 issues
would have a material effect on the Company's business, other than possibly to
require the Company to invest in backup inventory, to draw down cash reserves,
or both. To the extent the Company incurs costs specifically relating to Year
2000 preparedness, the Company will expense those costs during the period in
which they are incurred.

     ASSUMPTIONS AND UNCERTAINTIES. The Company's expectations about future
costs associated with Year 2000 preparedness, and potential effects of Year 2000
disruptions, are subject to uncertainties which could allow a greater financial
impact than currently anticipated. Factors that could influence the amount and
timing of future costs and effects include the Company's success in identifying
systems and programs that contain, or are subject to corruption as a result of
receiving data containing,


                                      -12-

<PAGE>   13

two-digit year codes; the nature and amount of programming required to upgrade,
or the cost required to replace, each affected program or system; the rates and
magnitude of effort required for labor and consulting with the appropriate
skills for remediation; the availability of replacement systems and components;
and the success of the Company's customers and suppliers in addressing Year 2000
issues.

                           FORWARD-LOOKING STATEMENTS

     Certain statements made in this report relating to plans, objectives, and
economic performance go beyond historical information and may provide an
indication of future results. To that extent, they are forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, and each is subject to factors that could cause actual results
to differ from those in the forward-looking statement. In particular, the
ability of the Company to maintain a profitable level of optical memory card
sales is subject to risks and uncertainties with respect to customer
diversification, customer expansion, the economic availability of
reader/writers, the implementation of ongoing commercial applications by
customers, and the economic configuration and operation of the Company's card
manufacturing facility for increased output levels. Such factors are described
above, in the Com pany's Report on Form 10-K, and in other documents filed by
the Company from time to time with the Securities and Exchange Commission.

PART II. OTHER INFORMATION

ITEM 3. LEGAL PROCEEDINGS

     The status of actions for infringement of the Company's patents covering
digital sound encoded on motion picture film, is reported in the Company's Form
10-Q for the quarter ended September 30, 1998. On December 14, 1998, the Company
filed substantially identical complaints in the U.S. District Court of the
Northern District of California against additional producers, distributors, and
exhibitors of motion pictures with Sony SDDS and Dolby Digital soundtracks,
respectively.

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

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

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<S>          <C>                   <C>
      (a)    Exhibit No.           Exhibit Description

               27                  Financial Data Schedule
</TABLE>

     The above-listed exhibit is 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.

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


                                      -13-

<PAGE>   14

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:

                                   DREXLER TECHNOLOGY CORPORATION (Registrant)

Date: February 9, 1999             /s/Jerome Drexler
                                   ---------------------------------------------
                                   Jerome Drexler, Chairman of the Board of 
                                   Directors and Chief Executive Officer 
                                   (Principal Executive Officer)

Date: February 9, 1999             /s/Steven G. Larson
                                   ---------------------------------------------
                                   Steven G. Larson, Vice President of Finance
                                   and Treasurer


                                      -14-

<PAGE>   15

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT 
NUMBER                   EXHIBIT DESCRIPTION                               PAGE
-------                  -------------------                               ----
<S>                      <C>                                                <C>
  27                     Financial Data Schedule
</TABLE>