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, 2006







**LASERCARD
      CORPORATION**


(Exact
      name of registrant as specified in its charter)




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





1875
      North Shoreline Boulevard, Mountain View, California 94043-1319


(Address
      of principal executive offices) (Zip Code)





(650)
      969-4428


(Registrant's
      telephone number, including area code)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports) and (2) has been subject to such filing requirements
      for
      the past 90 days. [x] Yes [ ] No





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
      accelerated filer [ ]    Accelerated
      filer [x]   Non-accelerated filer [ ]





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). [ ] Yes [x] No





Number
      of
      outstanding shares of common stock, $.01 par value, at October 31, 2006:
      11,820,993










Exhibit
      Index is on Page 48




Total
      number of pages is 48




1





**TABLE
      OF CONTENTS**


PART
                  I.
              
              FINANCIAL
                  INFORMATION
              
              Page
                  NumberItem
                  1.
              
              Condensed
                  Consolidated Financial Statements(Unaudited)
              
              2Condensed
                  Consolidated Balance Sheets (Unaudited)
              
              3Condensed
                  Consolidated Statements of Operations (Unaudited)
              
              4Condensed
                  Consolidated Statements of Cash Flows (Unaudited)
              
              5Notes
                  to Condensed Consolidated Financial Statements (Unaudited)
              
              6Item
                  2.
              
              Management’s
                  Discussion and Analysis of FinancialCondition
                  and Results of Operations
              
              19Item
                  3.
              
              Quantitative
                  and Qualitative Disclosures about Market Risk
              
              33Item
                  4.
              
              Controls
                  and Procedures
              
              34PART
                  II.
              
              OTHER
                  INFORMATIONItem
                  1.
              
              Legal
                  Proceedings
              
              35Item
                  1A.
              
              Risk
                  Factors
              
              35Item
                  2.
              
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              45Item
                  3.
              
              Defaults
                  Upon Senior Securities
              
              45Item
                  4.
              
              Submission
                  of Matters to a Vote of Security Holders
              
              45Item
                  5.
              
              Other
                  Information
              
              45Item
                  6.
              
              Exhibits
              
              46SIGNATURES
              
              47EXHIBIT
                  INDEX
              
              48












PART
      I.  FINANCIAL
      INFORMATION





ITEM
      1.  CONDENSED
      CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)








2


**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(In
      thousands)**








September30,
                2006
            
            March(Unaudited)
            
            31,
                2006*ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            $
            1,797
            
            $
            2,121Short-term
                investments
            
            
            19,800
            
            
            21,350Accounts
                receivable, net of allowance
            
            
            2,743
            
            
            4,920Inventories,
                net of reserve
            
            
            9,375
            
            
            8,874Deferred
                contract costs
            
            
            1,427
            
            
            1,041Prepaid
                and other current assets
            
            
            1,914
            
            
            1,268Total
                current assets
            
            
            37,056
            
            
            39,574Property
                and equipment, net
            
            
            12,648
            
            
            12,306Deferred
                long-term contract costs
            
            
            649
            
            
            —Equipment
                held for resale
            
            
            6,145
            
            
            5,877Patents
                and other intangibles, net
            
            
            878
            
            
            889Goodwill
            
            
            3,321
            
            
            3,321Notes
                receivable
            
            
            216
            
            
            205Other
                non-current assets
            
            
            115
            
            
            163Total
                assets
            
            $
            61,028
            
            $
            62,335LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                liabilities:Accounts
                payable
            
            $
            1,893
            
            $
            3,311Accrued
                liabilities
            
            
            2,449
            
            
            3,118Deferred
                tax liabilities
            
            
            556
            
            
            568Advance
                payments from customers
            
            
            3,154
            
            
            1,772Deferred
                revenue
            
            
            522
            
            
            459Total
                current liabilities
            
            
            8,574
            
            
            9,228Advance
                payments from customer
            
            
            18,500
            
            
            18,500Deferred
                revenue
            
            
            2,000
            
            
            2,000Long-term
                deferred rent
            
            
            706
            
            
            590Total
                liabilities
            
            
            29,780
            
            
            30,318Stockholders'
                equity:Common
                stock
            
            
            118
            
            
            117Additional
                paid-in capital
            
            
            59,848
            
            
            58,255Accumulated
                deficit
            
            
            (28,811
            )
            
            (26,351
            )Accumulated
                other comprehensive income (loss)
            
            
            93
            
            
            (4
            )Total
                stockholders' equity
            
            
            31,248
            
            
            32,017Total
                liabilities and stockholders' equity
            
            $
            61,028
            
            $
            62,335* 
                Amounts derived from audited financial statements at the date indicated.The
                accompanying notes are an integral part of these condensed consolidated
                financial statements.









3





**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(UNAUDITED)**


**(In
      thousands, except per share amounts)**


Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30
              
              September
                  302006
              
              2005
              
              2006
              
              2005Revenues
              
              $
              6,294
              
              $
              8,699
              
              $
              16,848
              
              $
              15,693Cost
                  of product sales (includes $81 and $168 stock-basedcompensation
                  in the three and six month periodsended
                  September 30, 2006)
              
              
              5,466
              
              
              6,206
              
              
              11,855
              
              
              11,360Gross
                  profit
              
              
              828
              
              
              2,493
              
              
              4,993
              
              
              4,333Operating
                  expenses:Selling,
                  general, and administrative expenses (includes$231
                  and $471 stock-based compensation in the threeand
                  six month periods ended September 30, 2006 and$35
                  and $67 in the three and six month periods endedSeptember
                  30, 2005, respectively)
              
              
              2,998
              
              
              2,612
              
              
              6,418
              
              
              5,743Research
                  and development expenses (includes $102 and $208stock-based
                  compensation in the three and six monthperiods
                  ended September 30, 2006)
              
              
              800
              
              
              552
              
              
              1,545
              
              
              1,051Total
                  operating expenses
              
              
              3,798
              
              
              3,164
              
              
              7,963
              
              
              6,794Operating
                  loss
              
              
              (2,970
              )
              
              (671
              )
              
              (2,970
              )
              
              (2,461
              )Other
                  income, net
              
              
              233
              
              
              108
              
              
              439
              
              
              204Loss
                  before income taxes
              
              
              (2,737
              )
              
              (563
              )
              
              (2,531
              )
              
              (2,257
              )Income
                  tax expense (benefit)
              
              
              (65
              )
              
              1
              
              
              (71
              )
              
              1Net
                  loss
              
              $
              (2,672
              )
              $
              (564
              )
              $
              (2,460
              )
              $
              (2,258
              )Net
                  loss per share:Basic
              
              $
              (0.23
              )
              $
              (0.05
              )
              $
              (0.21
              )
              $
              (0.20
              )Diluted
              
              $
              (0.23
              )
              $
              (0.05
              )
              $
              (0.21
              )
              $
              (0.20
              )Weighted-average
                  shares of common stockused
                  in computing net loss per share:Basic
              
              
              11,816
              
              
              11,355
              
              
              11,792
              
              
              11,350Diluted
              
              
              11,816
              
              
              11,355
              
              
              11,792
              
              
              11,350The
                  accompanying notes are an integral part of these condensed consolidated
                  financial statements.







4


**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(UNAUDITED)**


**(In
      thousands)**


Six
                  Months EndedSeptember
                  30,2006
              
              2005Cash
                  flows from operating activities:Net
                  loss
              
              $
              (2,460
              )
              $
              (2,258
              )Adjustments
                  to reconcile net loss to net cashprovided
                  by (used in) operating activities:Depreciation
                  and amortization
              
              
              1,323
              
              
              1,286Loss
                  on disposal of equipment
              
              
              -
              
              
              7Provision
                  for doubtful accounts receivable
              
              
              23
              
              
              -Provision
                  for excess and obsolete inventory
              
              
              120
              
              
              258Provision
                  for product return reserve
              
              
              -
              
              
              38Provision
                  for warranty reserve
              
              
              97
              
              
              -Stock-based
                  compensation
              
              
              847
              
              
              67Changes
                  in operating assets and liabilities:Decrease
                  (increase) in accounts receivable
              
              
              2,279
              
              
              (994
              )Decrease
                  (increase) in inventories
              
              
              (574
              )
              
              116Increase
                  in deferred contract costs
              
              
              (1,035
              )
              
              -Decrease
                  (increase) in prepaid and other current assets
              
              
              (633
              )
              
              442Increase
                  in equipment held for resale
              
              
              (267
              )
              
              (1,399
              )Decrease
                  (increase) in other non-current assets
              
              
              50
              
              
              (62
              )Decrease
                  in accounts payable and accrued liabilities
              
              
              (2,272
              )
              
              (921
              )Decrease
                  in deferred income tax liabilities
              
              
              (41
              )
              
              -Increase
                  in deferred revenue
              
              
              47
              
              
              20Increase
                  in long-term deferred rent
              
              
              116
              
              
              116Increase
                  in advance payments from customers
              
              
              1,371
              
              
              4,596Net
                  cash provided by (used in) operating activities
              
              
              (1,009
              )
              
              1,312Cash
                  flows from investing activities:Purchases
                  of property and equipment
              
              
              (1,494
              )
              
              (667
              )Acquisition
                  of patents and other intangibles
              
              
              (58
              )
              
              (60
              )Purchases
                  of short-term investments
              
              
              (15,600
              )
              
              (2,600
              )Proceeds
                  from maturities of short-term investments
              
              
              17,150
              
              
              -Net
                  cash used in investing activities:
              
              
              (2
              )
              
              (3,327
              )Cash
                  flows from financing activities:Proceeds
                  from sale of common stock through stock plans
              
              
              748
              
              
              154Proceeds
                  from bank loan
              
              
              -
              
              
              108Net
                  cash provided by financing activities
              
              
              748
              
              
              262Effect
                  of exchange rate changes on cash and cash equivalents
              
              
              (61
              )
              
              34Net
                  decrease in cash and cash equivalents
              
              
              (324
              )
              
              (1,719
              )Cash
                  and cash equivalents:Beginning
                  of period
              
              
              2,121
              
              
              3,965End
                  of period
              
              $
              1,797
              
              $
              2,246The
                  accompanying notes are an integral part of these condensed consolidated
                  financial statements.





5


**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**





**1.
      Basis of Presentation**




The
      unaudited condensed consolidated financial statements contained herein include
      the accounts of LaserCard Corporation and its wholly owned subsidiaries. All
      significant intercompany accounts and transactions have been eliminated in
      consolidation. The year-end condensed consolidated balance sheet data was
      derived from audited financial statements, but does not include all disclosures
      required by U.S. generally accepted accounting principles.




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 (SEC). Certain information and footnote
      disclosures normally included in financial statements prepared in accordance
      with U.S. generally accepted accounting principles have been condensed or
      omitted pursuant to such rules and regulations, although the Company believes
      the disclosures which are made herein 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 audited consolidated financial statements and the notes thereto for the
      fiscal year ended March 31, 2006, included in the Company's Annual Report
      on Form 10-K, filed with the SEC on June 14, 2006.





The
      results of operations for the three and six-month periods ended September 30,
      2006 are not necessarily indicative of results to be expected for the entire
      fiscal year ending March 31, 2007.





**2.
      Summary of Significant Accounting Policies**





*(1.)
      Principles of Consolidation and Basis of Presentation.* The
      accompanying consolidated financial statements have been prepared on the accrual
      basis of accounting in accordance with U.S. generally accepted accounting
      principles. The consolidated financial statements include the accounts of
      LaserCard Corporation and its wholly owned subsidiaries. All significant
      intercompany accounts and transactions have been eliminated in
      consolidation.





*(2.)
      Use of Estimates* .
      The
      preparation of consolidated financial statements in conformity with U.S.
      generally accepted accounting principles 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.





*(3.)
      Fiscal Period* .
      For
      purposes of financial statement presentation, the Company labels its annual
      accounting period end as March 31 and its interim quarterly accounting
      period ends as June 30, September 30 and December 31. 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 year 2007 ended on September
      29,
      2006, and the 13-week second quarter of fiscal year 2006 ended on September
      30,
      2005.





(4.)Foreign
      Currency Transactions . The
      functional currency of the Company's foreign subsidiary is generally the local
      currency. The financial statements of the subsidiary are translated to United
      States dollars using period-end rates of exchange for assets and liabilities
      and
      average rates of exchange for the period for revenues and expenses. Translation
      gains (losses) are recorded in accumulated other comprehensive income as a
      component of stockholders' equity. Net gains and losses resulting from foreign
      exchange transactions are included in other income, net and were not significant
      during the periods presented.





*(5.)
      Derivative Financial Instruments.* The
      Company uses short-term foreign exchange forward contracts to mitigate foreign
      currency risk associated primarily with inter-company receivables and payables,
      and loan receivables (denominated in Euros) to its German subsidiary.  Our
      foreign exchange forward contracts are not designated for accounting purposes
      as
      hedging instruments under SFAS No. 133, “Accounting for Derivative Instruments
      and Hedging Activities,” as amended.  Accordingly, any gains or losses
      resulting from changes in the fair value of the forward contract are reported
      in
      other income, net.  The gains and losses on these forward contracts
      generally offset gains and losses associated with the underlying foreign
      currency denominated inter-company receivables and payables, and loan
      receivables.  At September 30, 2006, we had a foreign exchange forward
      contract with a maturity of less than 30 days to purchase 2.3 million
      euros. The fair value of the forward contract was not material at September
      30, 2006 and March 31, 2006.







6


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




*(6.)
      Concentrations of Risk.* Financial instruments that potentially subject the Company to significant
      concentrations of credit risk consist principally of cash, cash equivalents,
      short-term investments, notes receivable and accounts receivable. The Company
      places its cash, cash equivalents and short-term investments in high-credit
      quality financial institutions. The Company is exposed to credit risk in the
      event of default by these institutions to the extent of the amount recorded
      on
      the consolidated balance sheet. As of September 30, 2006, the Company has
      invested in short-term investments including auction
      rate securities, discount notes and U.S. government bonds .
      Accounts receivable are derived from revenue earned from customers primarily
      located in the United States, Middle East, Italy and Germany. The Company
      performs ongoing credit evaluations of its customers’ financial condition and
      generally does not require collateral. The Company maintains reserves for
      potential credit losses and historically, such losses have been
      immaterial.





*(7.)
      Major Customers.* The
      following customers accounted for more than 10% of revenues for the periods
      shown below. The revenue from these customers was attributable to both the
      optical memory card and the optical card drive segments. No other customer
      accounted for more than 10% of revenues during these periods.


Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30,
              
              September
                  30,2006
              
              2005
              
              2006
              
              2005Customer
                  A
              
              
              39%
              
              
              36%
              
              
              32%
              
              
              39%Customer
                  B
              
              
              —
              
              
              15%
              
              
              14%
              
              
              10%Customer
                  C
              
              
              —
              
              
              11%
              
              
              13%
              
              
              N/A






Two
      customers accounted for 28% and 16% respectively of accounts receivable at
      September 30, 2006. Two customers accounted for 48% and 14% respectively of
      accounts receivable at March 31, 2006.





*(8.)
      Cash and Cash Equivalents, Short-term Investments and Long-term
      Investments* .
      The
      Company considers all highly liquid investments, consisting primarily of
      commercial paper, discount notes and U.S. government bonds, with maturities
      of
      three months or less at the date of purchase, to be cash equivalents. Cash
      and
      cash equivalents at September 30, 2006 and March 31, 2006 were $1.8 million
      and
      $2.1 million, respectively. The Company held auction rate securities which
      have
      been accounted for as available-for-sale and classified as short-term
      investments. The fair values of the auction rate securities, based on quoted
      market prices, were substantially equal to
      their carrying costs due to the frequency of the reset dates. Short-term
      investments also include investments with maturities at date of purchase of
      more
      than three months and investments with remaining maturities of less than one
      year. All investments with maturities at date of purchase greater than one
      year
      are classified as long-term investments. Management determines the appropriate
      classification of debt securities at the time of purchase and reevaluates the
      classification of investments as of each balance sheet date.





All
      short-term investments, except for auction rate securities which are recorded
      at
      fair value, and long-term investments are classified as held to maturity and
      are
      stated in the consolidated balance sheet at amortized cost. As such investments
      are classified as held to maturity, no unrealized gains or losses are recorded.
      The carrying amounts of individual held to maturity securities are reviewed
      at
      the consolidated balance sheet date for potential impairment. As of September
      30, 2006 and March 31, 2006, the Company has determined that an impairment
      which
      was “other than temporary” has not occurred.





7


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




*(9.)
      Fair Value of Financial Instruments* .
      The
      carrying amounts of the Company’s financial instruments including cash and cash
      equivalents, short-term investments, accounts receivable, accounts payable
      and
      accrued liabilities, approximate their fair values due to their short
      maturities. The Company had no long-term investments at September 30, 2006
      and
      March 31, 2006.





*(10.)
      Accounts Receivable.* Accounts
      receivable are net of allowance for doubtful accounts and product return
      reserves of $168,000 and $142,000 as of September 30, 2006 and March 31, 2006,
      respectively. We maintain allowances for doubtful accounts and product return
      reserves for anticipated losses resulting from the inability of our customers
      to
      make required payments and in-process product returns. We generally compute
      our
      allowances based on specifically identifying accounts that are past due that
      are
      likely not collectible. Interest receivable is accrued from investments in
      auction rate securities and other interest-bearing securities. Other receivables
      are comprised of value added tax refunds and miscellaneous items. The components
      of accounts receivable at September 30, 2006 and March 31, 2006 are (in
      thousands):





September
                30,
            
            March
                31,2006
            
            2006Trade
                receivables
            
            $
            2,527
            
            $
            4,897Allowance for
                doubtful accounts
            
            
            (90
            )
            
            (64
            )Product
                return reserves
            
            
            (78
            )
            
            (78
            )Interest
                receivable
            
            
            42
            
            
            93Other
                receivables
            
            
            342
            
            
            72Total
                receivables, net
            
            $
            2,743
            
            $
            4,920





*(11.)
      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 cost or estimated realizable value less cost
      to sell. The components of inventories as of September 30, 2006 and March 31,
      2006 are (in thousands):





September
                  30,
              
              March
                  31,2006
              
              2006Raw
                  materials
              
              $
              5,909
              
              $
              5,662Work-in-process
              
              
              1,184
              
              
              1,453Finished
                  goods
              
              
              2,282
              
              
              1,759Total
                  inventories
              
              $
              9,375
              
              $
              8,874




The
      Company establishes lower of cost or market reserves and inventory obsolescence
      reserves. Inventory reserves are generally recorded when management determines
      that an item is not readily saleable. Inventory reserves are not relieved until
      the related inventory has been sold or scrapped. The Company recorded charges
      to
      write down inventory of $30,000 and $120,000 for the three and six-months ended
      September 30, 2006, respectively and $306,000 and $251,000 for the three and
      six-months ended September 30, 2005, respectively.





In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs —
an Amendment of ARB No. 43, Chapter 4,” which clarifies that costs for
      abnormal amounts of idle facility expense, freight, handling costs and wasted
      material (spoilage) be recognized as current period charges. In addition,
      SFAS No. 151 requires that allocation of fixed production overheads to
      the costs of conversion be based on the normal capacity of the production
      facilities. SFAS No. 151 is effective for inventory costs incurred in
      fiscal years beginning after June 15, 2005. The Company applied SFAS No.
      151 to inventory costs incurred effective April 1, 2006. The provisions of
      this
      statement were applied prospectively. The adoption of SFAS No. 151 increased
      the
      cost of inventory by $219,000 and increased net income by the same amount for
      the first quarter of fiscal year 2007.





8





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




*(12.)
      Equipment held for resale.* Equipment
      held for resale primarily consists of parts, labor costs and other costs
      incurred to build equipment under a contract with Global Investments Group
      (GIG). Direct incremental costs associated with the purchase or construction
      of
      these items are deferred until revenue is recorded. The components of equipment
      held for resale as of September 30, 2006 and March 31, 2006 are (in
      thousands):





September
                  30,
              
              March
                  31,2006
              
              2006Parts
              
              $
              5,250
              
              $
              5,187Labor
              
              
              780
              
              
              591Other
              
              
              115
              
              
              99Total
                  equipment held for resale
              
              $
              6,145
              
              $
              5,877





*(13.)
      Property and Equipment, net* .
      The
      components of property and equipment as of September 30, 2006 and March 31,
      2006
      are (in thousands):





September
                  30,
              
              March
                  31,2006
              
              2006Building
                  and land
              
              $
              846
              
              $
              803Equipment
                  and furniture
              
              
              23,709
              
              
              22,464Construction
                  in progress, includingpurchased
                  equipment
              
              
              693
              
              
              802Leasehold
                  improvements
              
              
              4,605
              
              
              4,40929,853
              
              
              28,478Less:
                  accumulated depreciation and amortization
              
              
              (17,205
              )
              
              (16,172
              )Total
                  property and equipment, net
              
              $
              12,648
              
              $
              12,306





Property
      and equipment, including tooling, are recorded at cost. Depreciation is provided
      over the estimated useful lives which is four to seven years for equipment
      and
      furniture using the straight-line method and twenty-five years for the building
      using the straight-line method. Leasehold improvements are amortized over the
      shorter of the life of the asset or the life of the lease using the
      straight-line method. Depreciation and amortization expense for the three and
      six-months ended September 30, 2006 was $686,000 and $1,323,000 respectively
      and
      September 30, 2005 was $652,000 and $1,286,000, respectively. Maintenance and
      minor repairs and replacements are expensed when incurred. Gains and losses
      related to the disposition or retirement of property and equipment are charged
      to other income, net.  Expenditures for major software purchases for
      internal use are capitalized and depreciated using the straight-line method
      over
      the estimated useful lives of 4 years.  All direct costs are capitalized in
      accordance with Statement of Position 98-1 "Accounting for the Costs of Computer
      Software Developed or Obtained for Internal Use."





(14.)Assessment of Impairment of Tangible and Intangible Long-Lived
      Assets .
      In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets,” the Company assesses the impairment of long-lived assets
      whenever events or changes in circumstances indicate that their carrying value
      may not be recoverable from the estimated future cash flows expected to result
      from their use and eventual disposition. The Company’s long-lived assets subject
      to this evaluation include property and equipment and amortizable intangible
      assets. If the Company’s estimate of future undiscounted net cash flows is
      insufficient to recover the carrying value of the assets, the Company will
      record an impairment loss in the amount by which the carrying value of the
      assets exceeds the fair value. If assets are determined to be recoverable but
      the useful lives are shorter than originally estimated, the Company depreciates
      or amortizes the net book value of the asset over the newly determined remaining
      useful lives. As of September 30, 2006 and March 31, 2006, the fair value of
      long-lived assets exceeds the book value. Therefore, based on management’s
      assessment, no impairment loss has been recognized.





9


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




*(15.)
      Accrued Liabilities.* The
      components of accrued liabilities as of September 30, 2006 and March 31, 2006
      are (in thousands):


September
                  30,
              
              March
                  31,2006
              
              2006Accrued
                  payroll and fringe benefits
              
              $
              403
              
              $
              1,218Accrued
                  compensated absences
              
              
              606
              
              
              622Actual
                  warranty reserves
              
              
              679
              
              
              648Other
                  accrued liabilities
              
              
              761
              
              
              630Total
                  accrued liabilities
              
              $
              2,449
              
              $
              3,118






*(16.)
      Software Development Costs* .
      Development costs incurred in the research and development of new software
      products are expensed as incurred until technological feasibility in the form
      of
      a working model has been established. To date, the Company’s software
      development has been completed concurrent with the establishment of
      technological feasibility and, accordingly, all software development costs
      have
      been charged to research and development expenses in the accompanying
      consolidated statements of operations.





*(17.)
      Advance Payments from Customers* .
      The
      Company routinely receives advance payments on orders placed by its customers.
      The advance payments are recorded as a liability in the consolidated balance
      sheet until the related orders are shipped.





*(18.)
      Revenue Recognition* .
      Product
      sales primarily consist of optical card sales, sales of optical card read/write
      drives and sales of specialty cards and card printers. The Company recognizes
      revenue from product sales when the following criteria are met: (1) persuasive
      evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is
      fixed or determinable; and (4) collectibility is reasonably assured. The Company
      recognizes revenue on product sales at the time of shipment when shipping terms
      are F.O.B. shipping point, orders are placed pursuant to a pre-existing sales
      arrangement and there are no post-shipment obligations other than warehousing
      under a U.S. government subcontract or customer acceptance
      criteria.





Orders
      for Permanent Resident and Border Crossing Cards for the U.S. government require delivery into a secure Company-controlled vault. Shipments
      are made from the vault to a U.S. government site on a shipment schedule
      provided by the prime contractor, which is subject to revision, but generally
      not subject to cancellation, at the option of the prime contractor. At the
      time
      the cards are delivered into the vault, title to the cards is transferred to
      the
      U.S. government and all risks of ownership are transferred as well. The prime
      contractor is invoiced, with payment due within thirty days and the purchase
      orders do not contain any return (other than for warranty) or cancellation
      provisions. Pursuant to the provisions of SEC Staff Accounting Bulletin No.
      104
      (“SAB 104”), revenue is recognized on delivery into the vault as the Company has
      fulfilled its contractual obligations and the earnings process is complete.
      In
      the future, if the Company does not receive a shipment schedule for shipment
      of
      cards from the vault, revenue will be deferred and recognized upon shipment
      from
      the vault. In addition, revenue recognition for future deliveries into the
      vault
      would be affected if the U.S. government cancels the shipment schedule.





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





10


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




The
      Company applies the provisions of Statement of Position 81-1, "Accounting for
      Performance of Construction-Type and Certain Production-Type Contracts" (“SOP
      81-1”) in applicable contracts. Revenues on time and materials contracts are
      recognized as services are rendered at contract labor rates plus material and
      other direct costs incurred. Revenues on fixed price contracts are recognized
      on
      the percentage of completion method based on the ratio of total costs incurred
      to date compared to estimated total costs to complete the contract. Estimates
      of
      costs to complete include material, direct labor, overhead and allowable general
      and administrative expenses. In circumstances where estimates of costs to
      complete a project cannot be reasonably estimated, but it is assured that a
      loss
      will not be incurred, the percentage-of-completion method based on a zero profit
      margin, rather than the completed-contract method, is used until more precise
      estimates can be made. The full amount of an estimated loss is charged to
      operations in the period it is determined that a loss will be realized from
      the
      performance of a contract. The Company recognized approximately $9,000 and
      $24,000 of revenues during the three-months ended September 30, 2006 and 2005,
      respectively, based on a zero profit margin related to a long-term contract.
      The
      Company recognized approximately $10,000 and $66,000 of revenues during the
      six-months ended September 30, 2006 and 2005, respectively, based on a zero
      profit margin related to a long-term contract.





At
      the
      beginning of the fourth quarter of fiscal year 2006, the Company entered into
      a
      subcontract with a prime contractor for a Middle Eastern country to provide
      them
      with card personalization workstation integration for use in that country’s
      personalized national ID program which includes optical memory cards, hardware,
      and software. The contract calls for multiple deliverables, installation, and
      certain client acceptance criteria, as defined in the agreement. In applying
      the
      guidance within EITF 00-21, the Company determined the deliverables are not
      to
      be accounted for as separate units, but rather as a bundled arrangement as
      the
      fair value of the undelivered items cannot be readily determined. Therefore,
      revenue recognition on this new contract and the associated contract costs
      were
      and will be deferred until the predominant undelivered element, the card
      personalization, is delivered and accepted, commencing with the installation
      and
      acceptance of the card personalization system. Total contract revenue will
      be
      recognized ratably based on actual cards personalized and accepted and payments
      received of $2.9 million through September 30, 2006, are recorded as advance
      payments from customers on the balance sheet. As of September 30, 2006 and
      March
      31, 2006, no revenue has been recognized under this contract, and costs incurred
      under the contract of $2.1 million and $1 million, respectively, were recorded
      as deferred contract costs in the accompanying condensed consolidated balance
      sheet. The components of the current and long-term deferred contract costs
      consist of the following (in thousands):





September
                30,
            
            March
                31,2006
            
            2006Optical
                memory cards and freight
            
            $
            1,477
            
            $
            592Hardware
                and other costs
            
            
            599
            
            
            449Total
                deferred contract costs
            
            $
            2,076
            
            $
            1,041







The
      Company applies the provisions of Statement of Position (“SOP”) No. 97-2,
“Software Revenue Recognition,” as amended by Statement of Position 98-9,
“Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
      Transactions” to all transactions involving the sale of software products.
      Revenue from the license of the Company’s software products is recognized when
      persuasive evidence of an arrangement exists, the software product has been
      delivered, the fee is fixed or determinable and collectibility is probable,
      and,
      if applicable, upon acceptance when acceptance criteria are specified or upon
      expiration of the acceptance period. Software revenue was immaterial for the
      three and six-months ended September 30, 2006 and 2005.





License
      revenue, which may consist of up-front license fees and long-term royalty
      payments, is recognized as revenue when earned. There were no license revenues
      recorded for the three and six-months ended September 30, 2006 and 2005.





11


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




The
      Company sold a license, effective April 3, 2004, to Global Investments Group
      (GIG), based in Auckland, New Zealand, for card manufacturing in Slovenia.
      This
      agreement was most recently amended on October 30, 2006. For information
      regarding the accounting treatment of the original and previously amended
      agreement, refer to the Company’s Form 10-Q for the first fiscal quarter
      of 2007 filed with the SEC on August 9, 2006. The agreement, as amended on
      October 30, 2006, provides for payments to the Company of $14 million for a
      20-year license and four-year support package through March 31, 2008, which
      payment has been received. The amended agreement calls for a mandatory follow-on
      three-year support package through March 31, 2011, followed by 13 optional
      one-year support packages, all at a fee of $1 million annually. The Company
      is
      to sell the required manufacturing equipment and provide installation assistance
      and training for a fee of approximately $11 million. The equipment is to be
      installed in a facility to be built by GIG to provide a targeted initial
      manufacturing capacity of 10 million optical cards annually. As of September
      30,
      2006, the Company had acquired $6 million of this equipment, classified as
      equipment held for resale on its consolidated balance sheet. In addition to
      the
      $14 million received for the license fee and support, the Company has received
      $6.5 million for partial payment for the equipment, installation assistance,
      and
      training. GIG is also obligated to make payments of $50,000 each month (the
      "Ready Fee") beginning October 2006 to the Company until GIG provides a building
      ready to receive the manufacturing equipment. The Company intends to maintain
      possession of the equipment until the final payment currently due November
      10,
      2006, of approximately $5 million is made. For the $20.5 million the Company
      received, $18.5 million was recorded as advance payments from customer and
      $2
      million for the licensing fee was recorded as deferred revenue, which were
      both
      classified as long-term liabilities within the consolidated balance sheets.
      In
      addition to the $41 million discussed above, GIG is to pay the Company royalties
      for each card produced under the license.





The
      territories covered by the license include most of the European Union and
      eastern European regions. GIG has exclusive marketing rights in certain
      territories, with performance goals to maintain these rights. The Company will
      assign a person on site through March 31, 2011, and thereafter if GIG exercises
      the optional support to assist with quality, security and operational
      procedures, with the mutual goal that the facility and the cards made in the
      facility conform to the Company’s standards. The Company also retains rights to
      utilize up to 20% of the new facility capacity as backup and capacity buffer
      to
      augment its own card manufacturing facilities in Mountain View, California
      and
      at its German subsidiary. The granting of this license to GIG establishes a
      potential second source supplier of optical memory cards for existing and
      prospective customers who may request multiple sources for cards. The agreement
      contains various elements including a card manufacturing license, sale and
      installation of equipment, training, and ongoing support, and contingent
      payments for the sale of materials, and royalty payments for cards manufactured.





As
      a
      result of the amendment to the agreement in October 2006, the Company has
      determined that, upon delivery and installation of the equipment, and completion
      of the training, it can establish the fair value of the remaining undelivered
      support packages. The fair value of the undelivered support packages is
      determined by reference to the fair value of 13 optional one-year support
      packages, each of which is offered to the licensee at a fee of $1 million
      annually. The undelivered support packages, including the 13 optional one-year
      support packages, are substantively identical. Accordingly, the Company will
      defer revenue equal to the fair value of the undelivered support packages and
      will recognize the residual amount as revenue for the delivered items, using
      the
      residual method as prescribed in EITF 00-21. Therefore, the deferred revenue,
      using the residual method, consisting of the card manufacturing license, the
      monthly "Ready Fee", the sale and installation assistance of equipment and
      training will be recognized as revenue when the equipment is accepted and
      training has been completed, which date is dependent on GIG providing a facility
      in Slovenia. The Company defers direct and incremental expenses associated
      with
      building the card manufacturing equipment and with the delivery of other
      services for which revenue has been deferred, and the Company will recognize
      these expenses when the Company recognizes the related revenue. Royalty revenue
      will be recorded as revenue in the period when earned based upon the number
      of
      optical memory cards manufactured by the licensee as defined in the agreement.
      The Company determined this by analogy to the treatment of software licenses
      in
      accordance with SOP 97-2 whereby royalty fees receivable may be recorded as
      revenue as the customer of a software maker sublicenses its product to
      end-users. The Company determined this is analogous to the royalties earned
      by
      the Company as GIG sells optical memory cards to its customers. Raw material
      purchases will be recorded as revenue and the related cost charged to cost
      of
      goods sold in the period when shipped and the other revenue recognition criteria
      of SAB 104 are met. GIG has missed payment deadlines in June 2006 and September
      2006 leading to the amendments to the original agreement. There is no assurance
      that GIG will be able to obtain the financing required to make any future
      payments.





12





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




*(19.)
      Product Warranty* .
      Where
      appropriate, provision is made at the time of shipment for estimated warranty
      costs and estimated returns. The Company provides a limited warranty for the
      replacement of defective products. The Company’s limited warranty requires the
      Company to repair or replace defective products at no cost to the customer
      within a specified time period after sale. The Company estimates the costs
      that
      may be incurred under its limited warranty and records a liability in the amount
      of such costs at the time product revenue is recognized. Factors that affect
      the
      Company’s estimate of warranty liability include the number of units sold, and
      historical and anticipated rates of warranty claims. The Company assesses the
      adequacy of its recorded warranty liability and adjusts the amount as necessary.
      The Company utilizes historical trends and information received from its
      customers to assist in determining the appropriate estimated warranty accrual
      levels. The following table shows our warranty liability during the three and
      six months ended September 30, 2006 and 2005 (in thousands):





Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30,
              
              September
                  30,2006
              
              2005
              
              2006
              
              2005Beginning
                  balance
              
              $
              667
              
              $
              139
              
              $
              699
              
              $
              155Accruals
                  for products sold
              
              
              20
              
              
              62
              
              
              97
              
              
              107Costs
                  incurred
              
              
              (8
              )
              
              (99
              )
              
              (117
              )
              
              (160
              )Ending
                  balance
              
              $
              679
              
              $
              102
              
              $
              679
              
              $
              102







*(20.)
      Research and Development Expenses* .
      Costs
      related to research, design and development of products are charged to research
      and development expenses as incurred. Research and development costs include
      salaries, contractor fees, building and utility costs, and
      depreciation.





*(21.)
      Shipping and Handling Costs* . Shipping
      and handling costs are recorded in cost of product sales.





*(22.)
      Advertising Costs.* Advertising costs consist of development and placement costs of the Company’s
      advertising campaigns and are charged to expense when incurred. Advertising
      expense was approximately $188,000 and $183,000 for the six-months ended
      September 30, 2006 and 2005, respectively, and are included in selling, general,
      and administrative expenses. There were no such costs for the three-months
      ended
      September 30, 2006 and 2005.





*(23.)
      Stock-based Compensation* .





Effective
      April 1, 2006, the Company adopted Statement of Financial Accounting Standards
      (“SFAS”) No. 123(R), *Share-Based
      Payment* ,
      which
      requires share-based payment transactions to be accounted for using a fair
      value-based method and the recognition of the related expense in the results
      of
      operations. Prior to the adoption of SFAS No. 123(R), as permitted by SFAS
      No. 123, *Accounting
      for Stock-Based Compensation* ,
      the
      Company accounted for share-based payments to employees in accordance with
      Accounting Principles Board Opinion No. (“APB”) 25, *Accounting
      for Stock Issued to Employees* ,
      utilizing the intrinsic value method. Therefore, the Company did not recognize
      compensation cost for employee and director stock options because there was
      no
      intrinsic value. SFAS No. 123(R) allows companies to choose one of two
      transition methods: the modified prospective transition method or the modified
      retrospective transition method.





The
      Company adopted SFAS No. 123(R) using the modified prospective method of
      transition which requires compensation expense related to share based payments
      to be recognized beginning on the adoption date over the vesting period for
      awards granted after April 1, 2006 and over the remaining service period
      for the unvested portion of awards granted prior to April 1, 2006. The
      consolidated financial statements for prior periods have not been restated
      to
      reflect the impact of adopting SFAS No. 123(R).





13


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




Under
      the
      provisions of SFAS No. 123(R), stock-based compensation cost is estimated
      at the grant date based on the fair value of the award and compensation cost
      is
      recognized as an expense over the requisite service period of the award,
      generally the vesting period. The fair value of non-vested stock awards was
      determined by reference to the fair market value of the Company’s common stock
      on the date of grant. Consistent with the valuation method the Company used
      for
      disclosure-only purposes under the provisions of SFAS No. 123, the Company
      uses the Black-Scholes valuation model to estimate the fair value of option
      awards. Determining the appropriate fair value model and related assumptions
      requires judgment, including estimating stock price volatility, forfeiture
      rates
      and expected terms. The following assumptions were utilized to estimate the
      fair
      value of the Company’s stock option awards during the second quarter of fiscal
      year 2007:





Expected
      stock price
      volatility 55%


Risk
      free
      interest
      rate 4.40%
      to 4.96%


Expected
      life of
      options 4.4
      to 5
      years


Expected
      annual dividends —




The
      expected volatility rate was based on the historical volatility of the Company’s
      common stock. The expected term represents the average time options that vest
      are expected to be outstanding based on the vesting provisions and the Company’s
      historical exercise, cancellation and expiration patterns. The Company estimated
      forfeitures based on historical rates when recognizing compensation expense.
      Forfeitures were estimated based on voluntary termination behavior, as well
      as
      an analysis of actual option forfeitures.





The
      risk-free interest rate was based on U.S. Treasury zero-coupon issues with
      maturity approximating the expected term as of the week of the grant date.
      There
      was no annual dividend rate assumed as a cash dividend is not expected to be
      declared and paid in the foreseeable future. The Company will update these
      assumptions on at least an annual basis and on an interim basis if significant
      changes to the assumptions are warranted.





With
      the
      adoption of SFAS No. 123(R), the Company recorded stock-based employee
      compensation expense of $385,000 and $799,000 for the three and six-months
      ending September 30, 2006, net of estimated forfeitures. The Company recognized
      the full impact of its equity incentive plans in the consolidated statements
      of
      operations for the three and six-months ended September 30, 2006 and did not
      capitalize any such costs in the consolidated balance sheet.





Stock-based
      compensation expense as a result of the adoption of SFAS No. 123(R) included
      in
      the Company’s consolidated statements of operations was allocated for the three
      and six-months ended September 30, 2006 as follows (in thousands):


Three Months
                  Ended
                September
                  30,
                2006
              
              
              Six
                  Months Ended
                September
                  30,
                2006Cost
                  of product sales
              
              $
              81
              
              $
              168General
                  and administrative expense
              
              
              202
              
              
              423Research
                  and development expense
              
              
              102
              
              
              208Stock-based
                  compensation expense before income tax
              
              
              385
              
              
              799Less:
                  income tax benefit
              
              
              -
              
              
              -Net
                  stock-based compensation expense after income tax
              
              $
              385
              
              $
              799


The
      Company also had an expense of $29,000 and $48,000 relating to the Employee
      Stock Purchase Plan (ESPP) which is included in the Company’s consolidated
      statements of operations for the three and six-months ended September 30, 2006,
      respectively.





14


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




The
      Company had previously adopted the provisions of SFAS No. 123, *Accounting
      for Stock-Based Compensation* ,
      as
      amended by SFAS No. 148, *Accounting
      for Stock-Based Compensation — Transition and Disclosure* ,
      through
      disclosure only. The following table illustrates the effect on net loss and
      net
      loss per share for the three and six-months ended September 30, 2005 as if
      the
      Company had applied the fair value recognition provisions of SFAS No. 123(R)
      to
      stock-based employee awards (in thousands, except for per share
      amounts):


Three
                    Months Ended
                  September
                    30, 2005
              
              
              Six
                    Months Ended
                  September
                    30, 2005Net
                  loss, as reported
              
              $
              (564
              )
              $
              (2,258
              )Add:
                  stock based employee compensation expenseincluded
                  in reported net loss, net of tax
              
              
              35
              
              
              67Deduct:
                  stock-based compensation expense determinedusing
                  fair value based method for all awards, net of tax
              
              
              (377
              )
              
              (703
              )Net
                  loss, pro forma
              
              $
              (906
              )
              $
              (2,894
              )Net
                  loss per common share:Basic
                  and diluted, as reported
              
              $
              (0.05
              )
              $
              (0.20
              )Basic
                  and diluted, proforma
              
              $
              (0.08
              )
              $
              (0.25
              )







Using
      Black-Scholes option-pricing model, the fair values of options granted during
      the three and six-months ended September 30, 2005 were calculated with the
      following weighted-average assumptions:





Three
      Months
      Ended Six
      Months Ended


September
      30, 2005   September
      30, 2005


Expected
      stock price volatility     55%     55%


Risk
      free
      interest rate      4.23%    3.81% - 4.23%


Expected
      life of
      options 8
      years 5
      years


Expected
      annual dividends     — —





The
      following table summarizes the stock option activity for the three and
      six-months ended September 30, 2006:


Weighted
                    Average
                
                AggregateStock
                
                Weighted
                    Average
                
                Remaining
                
                IntrinsicOptions
                
                Exercise
                    Price
                
                Contractual
                    Term
                
                ValueOustanding
                    at March 31, 2006
                
                
                2,063,673
                
                $
                12.27Granted
                
                
                460,250
                
                $
                15.24Exercised
                
                
                (88,729
                )
                $
                10.42Canceled/expired/forfeited
                
                
                (78,024
                )
                $
                12.42Outstanding
                    at September 30, 2006
                
                
                2,357,170
                
                $
                12.91
                
                
                5.38
                
                $
                3,595,025Options
                    vested and exercisable at September 30, 2006
                
                
                1,438,145
                
                $
                13.37
                
                
                3.92
                
                $
                1,481,013







As
      of
      September 30, 2006 there was approximately $4.8 million of total unrecognized
      compensation cost related to non-vested share-based compensation arrangements
      granted under our stock incentive plans which is expected to be recognized
      over
      the remaining vesting period through September 30, 2010.





*2004
      Equity Incentive Compensation Plan (the “2004 Plan”):* The
      2004
      Plan provides for the grant of restricted share awards, options, stock units
      and
      stock appreciation rights, any of which may or may not require the satisfaction
      of performance objectives, with respect to shares of our common stock to
      directors, officers, employees and consultants of the Company and its
      subsidiaries. The exercise price of stock options may not be less than 100%
      of
      the fair market value of the Common Stock as of the date of grant (110% of
      the
      fair market value if the grant is of an incentive stock option to an employee
      who owns more than 10% of the total combined voting power of all classes of
      the
      Company’s capital stock). Options granted may not be exercised more than 10
      years after the date of grant (five years after the date of grant if the grant
      is an incentive stock option to an employee who owns more than 10% of the total
      combined voting power of all classes of the Company’s capital stock). The Board
      of Directors specifies the term of options (previously 10 years and now 7 years)
      and the vesting schedule for exercise of options, generally 25% after one year
      and six and one quarter percent quarterly for the next 3 years.





15


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




*Employee
      Stock Purchase Plan* .
      The
      Company has an Employee Stock Purchase Plan (Stock Purchase Plan), under which
      eligible employees may designate from 2% to 6% of their compensation to be
      withheld for the purchase of shares of common stock at 67% of the average price
      over the three-day period prior to the purchase date. The differential between
      fair market value and the average price of the shares sold under the Stock
      Purchase Plan is charged to operations as a compensation expense and is taxed
      to
      the employee as income. The Company recorded compensation expense related to
      the
      Stock Purchase Plan of $29,000 and $35,000 for the three months ended September
      30, 2006 and 2005, respectively, and $48,000 and $67,000 for the six months
      ended September 30, 2006 and 2005, respectively.





*(24.)
      Comprehensive Income (Loss)* .
      Under
      SFAS No. 130, “Reporting Comprehensive Income,” comprehensive income (loss) is
      defined as the changes in equity of an enterprise except for those resulting
      from stockholders’ transactions. For the three and six-months ended September
      30, 2006 and 2005, comprehensive income (loss) is as follows (in
      thousands):








Three
                Months Ended
            
            Six
                Months EndedSeptember
                30,
            
            September
                30,2006
            
            2005
            
            2006
            
            2005Net
                loss
            
            $
            (2,672
            )
            $
            (564
            )
            $
            (2,460
            )
            $
            (2,258
            )Net
                change in cumulative foreigncurrency
                translation adjustments
            
            
            26
            
            
            16
            
            
            97
            
            
            (188
            )Other
                comprehensive loss
            
            $
            (2,646
            )
            $
            (548
            )
            $
            (2,363
            )
            $
            (2,446
            )







*(25.)
      Recent Accounting Pronouncements.* In
      July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”
(FIN 48). FIN 48 prescribes a comprehensive model for how a company should
      recognize, measure, present, and disclose in its financial statements uncertain
      tax positions that the company has taken or expects to take on a tax return.
      FIN
      48 will be effective for fiscal years beginning after December 15, 2006.
      The Company continues to evaluate the effect, if any, FIN 48 will have on our
      condensed consolidated financial statements.




Except
      for the adoption of SFAS No. 123(R) and SFAS No. 151 effective April 1,
      2006, no other recent accounting pronouncements have been issued which would
      currently have a material effect on our condensed consolidated financial
      statements.





*(26.)
      Indemnification* . The
      Company’s major sales agreements provide remedies to customers, such as defense,
      settlement, or payment of judgment for intellectual property claims related
      to
      the use of the Company’s products. The Company also has indemnified various
      vendors for certain potential claims. The Company has also entered into
      indemnification agreements with its directors and officers and the Company’s
      bylaws contain similar indemnification obligations. To date, there have been
      no
      claims made under such indemnifications and as a result the associated estimated
      fair value of the liability is not material. The Company is required to
      indemnify the investors in the Company's December 2003 financing from any third
      party claim based upon any untrue statement or alleged untrue statement of
      a
      material fact contained in the Registration Statement covering the resale of
      the
      shares purchased by such investors, or any failure by the Company to fulfill
      any
      undertaking included in the Registration Statement.





*(27.)
      Subsequent Event Disclosure-GIG Contract Amendment* .
      Subsequent to the end of the second quarter of fiscal year 2007, the Company
      amended its agreements with GIG and filed with the SEC on November 1, 2006,
      a Form 8-K dated October 30, 2006, describing and attaching the
      amendment.





16




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


**3.**  **Net
      Income (Loss) per Share**





Basic
      net
      income (loss) per share is computed by dividing net income (loss) by the
      weighted average number of shares of common stock outstanding. Diluted net
      income (loss) per share is computed by dividing net income (loss) by the
      weighted average number of shares of common stock and common stock equivalents
      outstanding. Common stock equivalents consist of stock options and warrants
      using the treasury stock method.





The
      reconciliation of the denominators of the basic and diluted net income (loss)
      per share computation for the three and six-months ended September 30, 2006
      and
      2005 is shown in the following table (in thousands, except per share
      data):





Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30,
              
              September
                  30,2006
              
              2005
              
              2006
              
              2005Net
                  loss
              
              $
              (2,672
              )
              $
              (564
              )
              $
              (2,460
              )
              $
              (2,258
              )Basic
                  net loss per share:Weighted
                  average common shares outstanding
              
              
              11,816
              
              
              11,355
              
              
              11,792
              
              
              11,350Basic
                  net loss per share
              
              $
              (0.23
              )
              $
              (0.05
              )
              $
              (0.21
              )
              $
              (0.20
              )Diluted
                  net loss per share:Weighted
                  average common shares outstanding
              
              
              11,816
              
              
              11,355
              
              
              11,792
              
              
              11,350Weighted
                  average common shares from stock option grants
              
              
              —
              
              
              —
              
              
              —
              
              
              —Weighted
                  average common shares and common stockequivalents
                  outstanding
              
              
              11,816
              
              
              11,355
              
              
              11,792
              
              
              11,350Diluted
                  net loss per share
              
              $
              (0.23
              )
              $
              (0.05
              )
              $
              (0.21
              )
              $
              (0.20
              )







Stock
      options having an exercise price greater than the average market value for
      profitable periods are excluded from the calculation of diluted net income
      per
      share, as their effect would be antidilutive. As the effect of common stock
      equivalents would be antidilutive since the Company incurred a loss in the
      three
      and six-months ended September 30, 2006 and 2005, all stock options and warrants
      were excluded from the calculation of diluted net loss per share for those
      periods.





**4.**  **Segments**





*Segment
      Reporting.*





The
      Company operates in three reportable segments: (1) optical memory cards, (2)
      optical memory card drives, including read/write drives, maintenance and related
      accessories (“optical card drives”) and (3) specialty cards and card printers.
      The segments were determined based on the information used by the chief
      operating decision maker. The optical memory cards and optical card drives
      reportable segments are not strategic business units which offer unrelated
      products and services; rather these reportable segments utilize compatible
      technology and are marketed jointly. Specialty cards and printers, which was
      acquired on March 31, 2004, is a strategic business unit offering at times
      unrelated products and at times related products with the other reportable
      segments.





The
      accounting policies used to derive reportable segment results are the same
      as
      those described in the "Summary of Significant Accounting Policies." Resources
      are allocated to the optical memory card and optical card drive segments in
      a
      manner that optimizes optical memory card revenues and to the specialty card
      and
      printers segment in a manner that optimizes consolidated income as determined
      by
      the chief operating decision maker. Segment revenues are comprised of sales
      to
      external customers. Segment gross profit (loss) includes all segment revenues
      less the related cost of sales. Accounts receivable, cash, deferred income
      taxes, prepaid expenses, fixed assets and inventory are not separately reported
      by segment to the chief operating decision maker. Therefore, the amount of
      assets by segment is not meaningful. There are no inter-segment sales or
      transfers. All of the Company’s long-lived assets are attributable to the United
      States except for $5.6 million attributable to Germany at September 30,
      2006.




The
        Company's chief operating decision maker is currently the Company's Chief
        Executive Officer. The chief operating decision maker reviews financial
        information presented on a consolidated basis that is accompanied by
        disaggregated information about revenues and gross profit (loss) by segment.
 
 The
        table
        below presents information for optical memory cards, optical card drives
        and
        specialty cards and card printers and a reconciliation of segment results
        to
        amounts included in the Company’s consolidated financial statements for the
        three and six-months ended September 30, 2006 and 2005 (in
        thousands):





17





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






T
                  h
                  r e e  M o n t h s  E n d e d  S e p t e m b e r  30,
                  2006SpecialtyOptical
              
              Optical
              
              Cards
                  &Memory
              
              Card
              
              Cards
                  &
              
              SegmentCards
              
              Drives
              
              Printers
              
              Total
              
              Other(a)
              
              TotalRevenues
              
              $
              3,279
              
              $
              115
              
              $
              2,900
              
              $
              6,294
              
              
              —
              
              $
              6,294Cost
                  of product sales
              
              
              3,035
              
              
              241
              
              
              2,190
              
              
              5,466
              
              
              —
              
              
              5,466Gross
                  profit (loss)
              
              
              244
              
              
              (126
              )
              
              710
              
              
              828
              
              
              —
              
              
              828Depreciation
                  andamortization
                  expense
              
              
              423
              
              
              45
              
              
              83
              
              
              551
              
              
              135
              
              
              686T
                  h
                  r e e  M o n t h s  E n d e d  S e p te m b e r  30,
                  2005SpecialtyOptical
              
              
              Optical
              
              
              Cards
                  &Memory
              
              
              Card
              
              
              Cards
                  &
              
              
              SegmentCards
              
              
              Drives
              
              
              Printers
              
              
              Total
              
              
              Other(a)
              
              
              TotalRevenues
              
              $
              5,612
              
              $
              374
              
              $
              2,713
              
              $
              8,699
              
              
              —
              
              $
              8,699Cost
                  of product sales
              
              
              3,696
              
              
              533
              
              
              1,977
              
              
              6,206
              
              
              —
              
              
              6,206Gross
                  profit (loss)
              
              
              1,916
              
              
              (159
              )
              
              736
              
              
              2,493
              
              
              —
              
              
              2,493Depreciation
                  andamortization
                  expense
              
              
              403
              
              
              33
              
              
              69
              
              
              505
              
              
              147
              
              
              652S
                  i
                  x  M o n t h s  E n d e d  S e p t e m b e r  30,
                  2006SpecialtyOptical
              
              
              Optical
              
              
              Cards
                  &Memory
              
              
              Card
              
              
              Cards
                  &
              
              
              SegmentCards
              
              
              Drives
              
              
              Printers
              
              
              Total
              
              
              Other(a)
              
              
              TotalRevenues
              
              $
              10,774
              
              $
              299
              
              $
              5,775
              
              $
              16,848
              
              
              —
              
              $
              16,848Cost
                  of product sales
              
              
              6,886
              
              
              603
              
              
              4,366
              
              
              11,855
              
              
              —
              
              
              11,855Gross
                  profit (loss)
              
              
              3,888
              
              
              (304
              )
              
              1,409
              
              
              4,993
              
              
              —
              
              
              4,993Depreciation
                  andamortization
                  expense
              
              
              817
              
              
              89
              
              
              164
              
              
              1,070
              
              
              253
              
              
              1,323S
                  i
                  x  M o n t h s  E n d e d  S e p t e m b e r  30,
                  2005SpecialtyOptical
              
              
              Optical
              
              
              Cards
                  &Memory
              
              
              Card
              
              
              Cards
                  &
              
              
              SegmentCards
              
              
              Drives
              
              
              Printers
              
              
              Total
              
              
              Other(a)
              
              
              TotalRevenues
              
              $
              9,477
              
              $
              683
              
              $
              5,533
              
              $
              15,693
              
              
              —
              
              $
              15,693Cost
                  of product sales
              
              
              6,448
              
              
              952
              
              
              3,960
              
              
              11,360
              
              
              —
              
              
              11,360Gross
                  profit (loss)
              
              
              3,029
              
              
              (269
              )
              
              1,573
              
              
              4,333
              
              
              —
              
              
              4,333Depreciation
                  andamortization
                  expense
              
              
              783
              
              
              64
              
              
              136
              
              
              983
              
              
              303
              
              
              1,286




(a)
            Other
                depreciation and amortization expense represents amounts charged
                to
                selling, general and administrative and research and
                development.


18


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





The
      following discussion and analysis of the Company's financial condition and
      results of operations should be read in conjunction with the condensed
      consolidated financial statements and related notes included elsewhere in this
      Form 10-Q Report and the audited consolidated financial statements and notes
      thereto for the year ended March 31, 2006, included in the Company's fiscal
      2006 Annual Report on Form 10-K.





***FORWARD-LOOKING
      STATEMENTS***





All
      statements contained in this report that are not historical facts are
      forward-looking statements.  The forward-looking statements in this report
      are made pursuant to the safe harbor provisions of the Private Securities
      Litigation Reform Act of 1995.  They are not historical facts or guarantees
      of future performance or events. Rather, they are based on current expectations,
      estimates, beliefs, assumptions, and goals and objectives and are subject to
      uncertainties that are difficult to predict.  As a result, the Company’s
      actual results may differ materially from the statements made.  Often such
      statements can be identified by their use of words such as “may,” “will,”
“intends,” “plans,” “believes,” “anticipates,” “visualizes,” “expects,” and
“estimates.”  Forward-looking statements made in this report include
      statements as to the Company’s belief that the expired U.S. government contract
      will be replaced with a new contract during November, 2006; the Company’s
      beliefs as to current and potential market segments, customers, and applications
      for and deployment of the products of the Company; the advantages of, potential
      income from, and duties to be performed under the sale of a second-source card
      manufacturing license to Global Investments Group (GIG); the Company’s intent to
      retain the GIG equipment until it is fully paid by GIG; future scheduled
      payments and contingent royalties under the GIG contract, GIG’s production
      capacity, and that the Company will sell equipment to GIG, provide GIG with
      installation support, and have on-site personnel; production quantities,
      delivery rates and expected delivery schedule, backlog, and revenue recognition
      for Company products for U.S. or foreign government ID card programs,
      including that the prime contractor for a Middle Eastern country will place
      a
      series of up to ten purchase orders over the next year under its contract valued
      at over $11 million, including the three orders already placed aggregating
      $3.9
      million, and that the Middle Eastern country will install the requisite
      infrastructure so that the Company can recognize revenue after card
      personalization in December, 2006; that we will ship 100 drives to the Middle
      Eastern country during December 2006; potential annual revenues being $40 to
      $50
      million at full implementation from the Italy program with expected revenues
      unable to be determined in fiscal 2007 until the Italian government informs
      our
      VAR of the roll-out plan; our expectation for no future growth from the U.S.
      Green Card and Laser Visa BCC program, with steady state revenue to average
      $9.5
      million if our contract is renewed; plans to increase card production capacity
      for anticipated increases in orders including $9 million in capital equipment
      and leasehold improvements during the next twelve months; the Company believing
      that optical memory card revenue will double from fiscal year 2007 to fiscal
      year 2008 and triple from fiscal year 2007 to fiscal year 2009; and expecting
      growth of less than 10% in the specialty card and printer segment but not
      expecting significant profit from the optical card drive market (e.g. 10% margin
      in fiscal 2007 on higher sales); the Company’s intent to update at least
      annually its FAS 123R assumptions; our intent to find another photographic
      film
      supplier should Kodak cease supplying such film and to take advantage of any
      last-buy opportunity which Kodak may choose to provide; our intent to pursue
      patent infringers by litigation, arbitration, or negotiation; the need for,
      expected success of, and potential benefits from the Company’s research and
      development efforts, including the $1,000 hand-held drive, and whether they
      can
      stimulate card sales growth; expectations regarding revenues (overall and by
      segment and by customer), margins, profit (including a loss in the second
      quarter of fiscal 2007 and likely losses in the future if full implementation
      of
      the Italian program is further delayed), and the Company’s deferred tax asset
      and related valuation allowance; our belief that our current five major
      programs, plus maybe one or two others, will be the basis for a substantial
      majority of our revenues in the near term; estimates of optical card production
      capacity, the Company’s ability to expand production capacity, and the Company’s
      plans and expectations regarding the growth and associated capital costs of
      such
      capacity; estimates that revenues and advance payments will be sufficient to
      generate cash from operating activities over the next 12 months and fund our
      planned capital expenditures despite expected quarterly fluctuations;
      expectations regarding market growth, product demand, and the continuation
      of
      current programs; and the Company's long-term revenue growth objectives, and
      drive pricing strategy.





19







These
      forward-looking statements are based upon the Company’s assumptions about and
      assessment of the future, which may or may not prove true, and involve a number
      of risks and uncertainties including, but not limited to, whether there is
      a
      market for cards for homeland security in the U.S. and abroad, and if so whether
      such market will utilize optical memory cards as opposed to other technology;
      customer concentration and reliance on continued U.S. and Italian government
      business; risks associated with doing business in and with foreign countries;
      whether the Company will be successful in assisting GIG with factory startup
      and
      training; whether GIG will have the financial wherewithal to make the balance
      of
      its required payments to the Company and to operate the facility; whether the
      facility will efficiently produce high quality optical memory cards in volume
      and that meet our standards; lengthy sales cycles and changes in and dependence
      on government policy-making; reliance on value-added resellers and system
      integrators to generate sales, perform customer system integration, develop
      application software, integrate optical card systems with other technologies,
      test products, and work with governments to implement card programs; risks
      and
      difficulties associated with development, manufacture, and deployment of optical
      cards, drives, and systems; the ability of the Company or its customers to
      initiate and develop new programs utilizing the Company's card products; risks
      and difficulties associated with development, manufacture, and deployment of
      optical cards, drives, and systems; potential manufacturing difficulties and
      complications associated with increasing manufacturing capacity of cards and
      drives, implementing new manufacturing processes, and outsourcing manufacturing;
      the Company’s ability to produce and sell read/write drives in volume; the
      unpredictability of customer demand for products and customer issuance and
      release of corresponding orders; government rights to withhold order releases,
      reduce the quantities released, and extend shipment dates; whether the Company
      receives a fixed shipment schedule, enabling the Company to recognize revenues
      on cards delivered to the vault instead of when cards later are shipped from
      the
      vault; the impact of technological advances, general economic trends, and
      competitive products; the impact of changes in the design of the cards; and
      the
      possibility that optical memory cards will not be purchased for the full
      implementation of card programs in Italy, a Middle Eastern country and India,
      or
      for DHS programs in the U.S., or will not be selected for other government
      programs in the U.S. and abroad; unanticipated delays in obtaining U.S.
      government approvals to extend or replace its expiring contract; the risks
      set
      forth in the section entitled “Risks ” and elsewhere in this report; and other
      risks detailed from time to time in the Company’s SEC filings. These
      forward-looking statements speak only as to the date of this report, and, except
      as required by law, the Company undertakes no obligation to publicly release
      updates or revisions to these statements whether as a result of new information,
      future events, or otherwise.





CRITICAL
      ACCOUNTING POLICIES





Our
      discussion and analysis of financial condition and results of operations are
      based upon our unaudited condensed consolidated financial statements, which
      have
      been prepared in accordance with U.S. generally accepted accounting principles.
      Note 2 to the condensed consolidated financial statements describes the
      significant accounting policies and methods used in the preparation of the
      condensed consolidated financial statements. The preparation of these financial
      statements requires us to make estimates and judgments that affect the reported
      amounts of assets, liabilities, revenues and expenses. On an ongoing basis,
      we
      evaluate our estimates, including those related to our revenues, inventories,
      stock-based compensation, warranties, and income taxes. We base our estimates
      on
      historical experience and on various other assumptions that are believed to
      be
      reasonable under the circumstances, the results of which form the basis for
      making judgments about the carrying values of assets and liabilities that are
      not readily apparent from other sources.





Our
      critical accounting policies are those that both (1) are most important to
      the
      portrayal of the financial condition and results of operations and (2) require
      management’s most difficult, subjective, or complex judgments, often requiring
      estimates about matters that are inherently uncertain. These critical accounting
      policies reflect our significant judgments, assumptions, and estimates used
      in
      the preparation of the condensed consolidated financial statements. Our
      management has discussed the development and selection of these critical
      accounting policies and estimates with the Audit Committee of our Board of
      Directors and the Audit Committee has reviewed our disclosures relating to
      them
      in this report. We consider the accounting policies described below to be our
      critical accounting policies:





20







*Revenue
      Recognition* .
      Product
      sales primarily consist of optical cards, optical card drives and specialty
      cards and card printers. The Company recognizes revenue from product sales
      when
      the following criteria are met: (1) persuasive evidence of an arrangement
      exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and
      (4)
      collectibility is reasonably assured. The Company recognizes revenue on product
      sales at the time of shipment when shipping terms are F.O.B. shipping point,
      orders are placed pursuant to a pre-existing sales arrangement and there are
      no
      post-shipment obligations other than warehousing under a U.S. government
      subcontract or customer acceptance criteria. Where appropriate, provision is
      made at the time of shipment for estimated warranty costs and estimated returns,
      and such provision is included in accrued liabilities in the Company’s
      consolidated balance sheet.





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





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





The
      Company applies the provisions of Statement of Position (“SOP”) No. 81-1,
      "Accounting for Performance of Construction-Type and Certain Production-Type
      Contracts" (SOP No. 81-1) in applicable contracts. Revenues on time and
      materials contracts are recognized as services are rendered at contract labor
      rates plus material and other direct costs incurred. Revenues on fixed price
      contracts are recognized on the percentage of completion method based on the
      ratio of total costs incurred to date compared to estimated total costs to
      complete the contract. Estimates of costs to complete include material, direct
      labor, overhead and allowable general and administrative expenses. In
      circumstances where estimates of costs to complete a project cannot be
      reasonably estimated, but it is assured that a loss will not be incurred, the
      percentage-of-completion method based on a zero profit margin, rather than
      the
      completed-contract method, is used until more precise estimates can be made.
      The
      full amount of an estimated loss is charged to operations in the period it
      is
      determined that a loss will be realized from the performance of a contract.
      The
      Company recognized revenue based on a zero profit margin related to a long-term
      contract of approximately $9,000 and $24,000 of revenues during the three-months
      ended September 30, 2006 and 2005, respectively, and approximately $10,000
      and
      $66,000 of revenues during the six-months ended September 30, 2006 and
      2005.





At
      the
      beginning of the fourth quarter of fiscal year 2006, the Company entered into
      a
      subcontract with a prime contractor for a Middle Eastern country to provide
      them
      with card personalization workstation integration for use in that country’s
      personalized national ID program which includes optical memory cards, hardware,
      and software. The contract calls for multiple deliverables, installation, and
      certain client acceptance criteria, as defined in the agreement. In applying
      the
      guidance within EITF 00-21, the Company determined the deliverables are not
      to
      be accounted for as separate units, but rather as a bundled arrangement as
      the
      fair value of the undelivered items cannot be readily determined. Therefore,
      revenue recognition on this new contract and the associated contract costs
      were
      and will be deferred until the predominant undelivered element, the card
      personalization, is delivered and accepted, commencing with the installation
      and
      acceptance of the card personalization system. Total contract revenue will
      be
      recognized ratably based on actual cards personalized and accepted. As of
      September 30, 2006, no revenue has been recognized under this contract, payments
      received of $2.9 million are recorded as advance payments from customers on
      the
      balance sheet, and costs incurred under the contract of $2.1 million were
      recorded as deferred contract costs under the assets on the accompanying
      consolidated balance sheet.





21







License
      revenue, which may consist of up-front license fees and royalty payments, is
      recognized as revenue when earned. There was no license revenue recorded in
      the
      three and six-months ended September 30, 2006 and 2005.





The
      Company sold a license, effective April 3, 2004, to Global Investments Group
      (GIG), based in Auckland, New Zealand, for card manufacturing in Slovenia.
      This
      agreement was most recently amended on October 30, 2006. For information
      regarding the accounting treatment of the original and previously amended
      agreement, refer to the Company’s Form 10-Q for the first
      fiscal quarter of 2007 filed with the SEC on August 9, 2006. The agreement,
      as amended on October 30, 2006, provides for payments to the Company of $14
      million for a 20-year license and four-year support package through March 31,
      2008, which payment has been received. The amended agreement calls for a
      mandatory follow-on three-year support package through March 31, 2011, followed
      by 13 optional one-year support packages, all at a fee of $1 million annually.
      The Company is to sell the required manufacturing equipment and provide
      installation assistance and training for a fee of approximately $11 million.
      The
      equipment is to be installed in a facility to be built by GIG to provide a
      targeted initial manufacturing capacity of 10 million optical cards annually.
      As
      of September 30, 2006, the Company had acquired $6 million of this equipment,
      classified as equipment held for resale on its consolidated balance sheet.
      In
      addition to the $14 million received for the license fee and support, the
      Company has received $6.5 million for partial payment for the equipment,
      installation assistance, and training. GIG is also obligated to make payments
      of
      $50,000 each month (the "Ready Fee") beginning October 2006 to the Company
      until
      GIG provides a building ready to receive the manufacturing equipment. The
      Company intends to maintain possession of the equipment until the final payment
      currently due November 10, 2006, of approximately $5 million is made. For the
      $20.5 million the Company received, $18.5 million was recorded as advance
      payments from customer and $2 million for the licensing fee was recorded as
      deferred revenue, which were both classified as long-term liabilities within
      the
      consolidated balance sheets. In addition to the $41 million discussed above,
      GIG
      is to pay the Company royalties for each card produced under the license. The
      agreement contains various elements including a card manufacturing license,
      sale
      of and installation assistance of equipment, training, and ongoing support,
      and
      contingent payments for the sale of materials, and royalty payments for cards
      manufactured.  As a result of the amendment to the agreement in October
      2006, the Company has determined that, upon delivery and installation of the
      equipment, and completion of the training, it can establish the fair value
      of
      the remaining undelivered support packages. The fair value of the undelivered
      support packages is determined by reference to the fair value of 13 optional
      one-year support packages, each of which is offered to the licensee at a fee
      of
      $1 million annually. The undelivered support packages, including the 13 optional
      one-year support packages, are substantively identical. Accordingly, the Company
      will defer revenue equal to the fair value of the undelivered support packages
      and will recognize the residual amount as revenue for the delivered items,
      using
      the residual method as prescribed in EITF 00-21. Therefore, the deferred
      revenue, using the residual method, consisting of the card manufacturing
      license, the monthly "Ready Fee", the sale and installation assistance of
      equipment and training will be recognized as revenue when the equipment is
      accepted and training has been completed, which date is dependent on GIG
      providing a facility in Slovenia. The Company defers direct and incremental
      expenses associated with building the card manufacturing equipment and with
      the
      delivery of other services for which revenue has been deferred, and the Company
      will recognize these expenses when the Company recognizes the related revenue.
      Royalty revenue will be recorded as revenue in the period when earned based
      upon
      the number of optical memory cards manufactured by the licensee as defined
      in
      the agreement. The Company determined this by analogy to the treatment of
      software licenses in accordance with SOP 97-2 whereby royalty fees receivable
      may be recorded as revenue as the customer of a software maker sublicenses
      its
      product to end-users. The Company determined this is analogous to the royalties
      earned by the Company as GIG sells optical memory cards to its customers. Raw
      material purchases will be recorded as revenue and the related cost charged
      to
      cost of goods sold in the period when shipped and the other revenue recognition
      criteria of SAB 104 are met.





The
      Company applies the provisions of Statement of Position No. 97-2, “Software
      Revenue Recognition,” as amended by Statement of Position 98-9, “Modification of
      SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” to
      all transactions involving the sale of software products. Revenue from the
      license of the Company’s software products is recognized when persuasive
      evidence of an arrangement exists, the software product has been delivered,
      the
      fee is fixed or determinable, and collectibility is probable, and, if
      applicable, upon acceptance when acceptance criteria are specified or upon
      expiration of the acceptance period. Software revenue was immaterial for the
      three and six-months ended September 30, 2006 and 2005,
      respectively.





22







*Product
      Warranty* .
      Where
      appropriate, provision is made at the time of shipment for estimated warranty
      costs and estimated returns. The Company provides a limited warranty for the
      replacement of defective products. The Company’s limited warranty requires the
      Company to repair or replace defective products at no cost to the customer
      within a specified time period after sale. The Company estimates the costs
      that
      may be incurred under its limited warranty and records a liability in the amount
      of such costs at the time product revenue is recognized. Factors that affect
      the
      Company’s estimate of warranty liability include the number of units sold, and
      historical and anticipated rates of warranty claims. The Company assesses the
      adequacy of its recorded warranty liability and adjusts the amount as necessary.
      The Company utilizes historical trends and information received from its
      customers to assist in determining the appropriate estimated warranty accrual
      levels. The following table shows our warranty liability during the three and
      six months ended September 30, 2006 and 2005 (in thousands):





Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30,
              
              September
                  30,2006
              
              2005
              
              2006
              
              2005Beginning
                  balance
              
              $
              667
              
              $
              139
              
              $
              699
              
              $
              155Accruals
                  for products sold
              
              
              20
              
              
              62
              
              
              97
              
              
              107Costs
                  incurred
              
              
              (8
              )
              
              (99
              )
              
              (117
              )
              
              (160
              )Ending
                  balance
              
              $
              679
              
              $
              102
              
              $
              679
              
              $
              102







Significant
      judgment is inherent in the selection of assumptions and the interpretation
      of
      historical experience as well as the identification of external and internal
      factors affecting the estimates of our reserves for product returns. We believe
      that the assumptions used to estimate these product sales reserves are the
      most
      reasonably likely assumptions considering known facts and circumstances.
      However, our product return activity could differ significantly from our
      estimates. If actual product returns are significantly different from our
      estimates, such differences would be accounted for in the period in which they
      become known.





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





Significant
      management judgment is required in determining the provision for income taxes
      and, in particular, any valuation allowance recorded against the Company’s
      deferred tax assets. The Company determined in fiscal year 2004 that due to
      the
      Company’s recent cumulative tax loss history for the previous three-year period,
      income statement loss history over the previous five quarters, and the
      difficulty in forecasting the timing of future revenue as evidenced by the
      deviations in achieved revenues from expected revenues during the previous
      few
      quarters and taking into account the newness of certain customer relationships,
      that it was necessary to increase the valuation allowance under SFAS No. 109
      to
      the full amount of the deferred tax asset. As a result, the Company determined
      that a full valuation allowance was required to net against its deferred tax
      assets in fiscal year 2004 and continues to have a full valuation allowance
      as
      of September 30, 2006.





The
      fiscal year 2004 acquisition of Challenge Card Design GmbH resulted in a
      deferred tax liability of $556,000 at September 30, 2006 and $568,000 at March
      31, 2006.





The
      Company's methodology for determining the realizability of its deferred tax
      assets involves estimates of future taxable income; the estimated impact of
      future stock option deductions; and the expiration dates and amounts of net
      operating loss carryforwards. These estimates are based on near-term projections
      and assumptions which management believes to be reasonable. The Company has
      had
      difficulty in the past, and expects to have continued difficulty in the future,
      in reliably forecasting its foreign business and the revenue to be received
      from
      it. This, in combination with the three-year cumulative tax loss excluding
      the
      advance payments from GIG for the period ended March 31, 2006, resulted in
      the
      Company basing its estimates of future income for these purposes on booked
      orders only. As circumstances change, the Company may in the future be able
      to
      estimate future revenue based upon its forecast revenues rather than only using
      booked orders, although the Company cannot say when this will occur.





23





The
      Company considers both the positive and negative evidence regarding its ability
      to generate sufficient future taxable income to realize its deferred tax assets.
      Positive evidence has included having achieved profitability for financial
      reporting purposes for fiscal year 2006. Other positive evidence included (1)
      the level of sales and business experienced under the Company’s various
      government programs; (2) prospects in Italy and a Middle Eastern country for
      national identification card programs; and (3) expected future orders. Negative
      evidence has included (1) the Company’s reliance on a limited number of
      customers for a substantial portion of its business; (2) the uncertainty in
      timing of anticipated orders from customers; (3) the impact of future stock
      option deductions on taxable income; (4) the financial statement loss for the
      fourth quarter of fiscal year 2003 through the first two quarters of fiscal
      year
      2006 and for the six months of fiscal year 2007; and (5) the prior three years’
cumulative tax net operating losses excluding the advance payments from GIG.
      In
      weighing the positive and negative evidence above, the Company considered the
      “more likely than not” criteria pursuant to SFAS No. 109 as well as the
      following risks: “dependence on a limited number of customers,” “lengthy sales
      cycles,” “technological change,” and “competition”. As
      described above, the Company concluded that the negative evidence outweighed
      the
      positive evidence and as a result has recorded a valuation allowance to be
      equal
      to the full amount of the deferred tax asset as of March 31, 2006 and at
      September 30, 2006.





In
      the
      event that actual results differ from these estimates or that these estimates
      are adjusted in future periods, the Company may need to adjust the amount of
      the
      valuation allowance based on future determinations of whether it is more likely
      than not that some or all of its deferred tax assets will be realized. A
      decrease in the valuation allowance would be recorded as an income tax benefit
      or a reduction of income tax expense or a credit to stockholders’ equity. The
      Company’s net operating losses available to reduce future taxable income expire
      on various dates from fiscal year 2008 through fiscal year 2024. To the extent
      that the Company generates taxable income in jurisdictions where the deferred
      tax asset relates to net operating losses that have been offset by a full
      valuation allowance, the utilization of these net operating losses would result
      in the reversal of the related valuation allowance.





*Inventories.* The
      Company values its inventory at the lower of the actual cost to purchase and/or
      manufacture the inventory or the current estimated market value of the inventory
      less cost to sell. Management regularly reviews inventory quantities on hand
      and
      records a provision for excess and obsolete inventory based primarily on
      forecasts of product demand. Demand for optical card drives can fluctuate
      significantly. In order to obtain favorable pricing, purchases of certain
      read/write drive parts are made in quantities that exceed the booked orders.
      The
      Company purchases drive parts for its anticipated demand and takes into
      consideration the order-to-delivery lead times of vendors and the economic
      purchase order quantity for such parts. In addition, the Company keeps a supply
      of card raw materials it deems necessary for anticipated demand.





Management’s
      analysis of the carrying value of card and read/write drive inventory is
      performed on a quarterly basis. With respect to inventory carrying values,
      the
      Company follows the principles articulated in SFAS No. 151 ,
      “Inventory Costs — an Amendment of ARB No. 43,
      Chapter 4,” “Inventory
      Pricing,” paragraphs 5 through 7 and 10 and other authoritative guidance (e.g.
      SAB 100) as it relates to determining the appropriate cost basis of inventory
      and determining whether firm, noncancelable purchase commitments should be
      accrued as a loss if forecasted demand is not sufficient to utilize all such
      committed inventory purchases and further clarifies the accounting for abnormal amounts of idle facility expense, freight,
      handling costs and wasted material (spoilage) be recognized as current period
      charges. In addition, SFAS No. 151 requires that allocation of fixed
      production overheads to the costs of conversion be based on the normal capacity
      of the production facilities. SFAS No. 151 is effective for inventory
      costs incurred in fiscal years beginning after June 15, 2005. The Company
      applied SFAS No. 151 to inventory costs incurred effective April 1, 2006. The
      provisions of this statement were applied prospectively.




24





Prior
      to
      the adoption of SFAS No. 151, full overhead absorption would only occur if
      we
      produced at full capacity at each operation. This resulted in the recording
      of
      the idle capacity, the difference between actual production and full capacity,
      as a period cost on the income statement for the period in which it arose.
      In
      applying SFAS No. 151, our analysis has shown that normal capacity is less
      than
      full capacity. Therefore, the amount of period cost for excess capacity is
      reduced, and the per-unit amount of overhead applied to production and inventory
      has increased. The SFAS No. 151 valuation applied on a FIFO basis resulted
      in an
      increase to the inventory value totaling $219,000 at the period of adoption
      in
      the first quarter of fiscal year 2007.




As
      part
      of the Company’s quarterly excess/obsolete inventory analysis, management also
      determines whether lower of cost or market adjustments (i.e., where selling
      prices less certain costs are not sufficient to recover inventory carrying
      values) are warranted; during the second quarter of fiscal year 2007 and 2006,
      the Company did not record any lower of cost or market adjustments in the
      Company’s consolidated statements of operations. In those instances where the
      Company has recorded charges for excess and obsolete inventory, management
      ensures that such new cost basis is reflected in the statement of operations
      if
      that inventory is subsequently sold. The Company’s inventory reserves are based
      upon the lower of cost or market for slow moving or obsolete items. As a result,
      the Company believes a 10% increase or decrease of sales would not have a
      material impact on such reserves.





***Share-Based
      Compensation***




As
      described in detail in Note 2, Share-Based Compensation, of the accompanying
      notes to condensed consolidated financial statements, effective April 1, 2006,
      we adopted the fair value recognition provisions of SFAS No. 123(R), using
      the
      modified-prospective transition method. Under the fair value recognition
      provisions of SFAS No. 123(R), share-based compensation cost is estimated at
      the
      grant date based on the fair value of the award and is recognized as expense,
      net of estimated forfeitures, ratably over the vesting period of the award.
      Calculating share-based compensation expense requires the input of highly
      subjective assumptions, including the expected term of the share-based awards,
      stock price volatility, and pre-vesting stock option forfeitures. We estimated
      the expected life of stock options granted for the three and six-month periods
      ended September 30, 2006 based upon historical vesting exercise, cancellation,
      and expiration pattern. We estimate the volatility of our common stock at the
      date of grant based on the historical volatility of our common stock. The
      assumptions used in calculating the fair value of stock-based awards represent
      our best estimates, but these estimates involve inherent uncertainties and
      the
      application of management judgment. As a result, if factors change and we use
      different assumptions, our share-based compensation expense could be materially
      different in the future. In addition, we are required to estimate the expected
      forfeiture rate and only recognize expense for those shares expected to vest.
      We
      estimate the forfeiture rate based on historical experience. If our actual
      forfeiture rate is materially different from our estimate, the stock-based
      compensation expense could be significantly different from what we have recorded
      in the current period.





As
      a
      result of adopting SFAS No. 123(R) using the modified prospective method, our
      net income applicable to common shareholders for the three and six-months ended
      September 30, 2006 includes $385,000 and $799,000 respectively of share based
      compensation expense included in the condensed consolidated statements of
      income. As of September 30, 2006, $4.8 million of total unrecognized
      compensation cost related to unvested share-based compensation arrangements
      is
      expected to be recognized over the remaining vesting period through September
      30, 2010. Prior to the adoption of SFAS No. 123(R), we provided pro forma
      disclosures of net income (loss) applicable to common shareholders and net
      income (loss) per share applicable to common shareholders as if the
      fair-value-based method had been applied. Our prior consolidated financial
      statements have not been restated.




25





**RESULTS
      OF OPERATIONS—FISCAL YEAR 2007 SECOND QUARTER AND FIRST SIX MONTHS**


**COMPARED
      WITH FISCAL YEAR 2006 SECOND QUARTER AND FIRST SIX MONTHS**





Overview





Headquartered
      in Mountain View, California, LaserCard Corporation manufactures LaserCard®
optical memory cards and card related products, including chip-ready
      OpticalSmartTM cards. In addition, the Company operates a wholly owned German
      subsidiary, Challenge Card Design Plastikkarten GmbH (“CCD”), with offices in
      Rastede and Ratingen, Germany, which manufactures specialty cards provides
      manufacturing capacity for certain steps of optical memory card production,
      and
      markets cards, system solutions, and thermal card printers. The Company
      completed the merger of cards & more GmbH into Challenge Card Design
      Plastikkarten GmbH in January 2006. The Company markets under the LaserCard
      and
      cards & more brands.





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





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





The
      table
      below presents condensed consolidated revenues, excluding inter-company
      transactions, recorded by the U.S. and German operations (in
      thousands):


Three
                  Months Ended
                September
                  30,
              
              Six
                  Months Ended
                September
                  30,2006
              
              2005
              
              2006
              
              2005U.S.
                  operations
              
              $
              3,394
              
              $
              6,184
              
              $
              11,074
              
              $
              10,370German
                  operations
              
              $
              2,900
              
              $
              2,515
              
              $
              5,774
              
              $
              5,323




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





26





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





Three
                  Months Ended
              
              Six
                  Months EndedSeptember
                  30,
              
              September
                  30,2006
              
              2005
              
              2006
              
              2005United
                  States Green Cards and Laser Visa BCCs
              
              
              32%
              
              
              25%
              
              
              26%
              
              
              29%Canadian
                  Permanent Resident Cards
              
              
              6%
              
              
              10%
              
              
              5%
              
              
              7%Italian
                  Carta d’Identità Elettronica (CIE) Cards
              
              
              6%
              
              
              15%
              
              
              2%
              
              
              10%Italian
                  Permesso di Soggiorno Elettronico (PSE) Cards
              
              
              —
              
              
              —
              
              
              12%
              
              
              —








For
      the
      government of Italy, the Company has in the past received orders for CIE cards
      (Carta d’Identità Elettronica) and PSE cards (Permesso di Soggiorno Elettronico)
      but did not receive any such orders during the first half of fiscal year 2007.
      The new government in Italy has established a commission to make recommendations
      to improve the efficiency, cost effectiveness and speed of rollout of the
      national citizen ID program. After completion of its work, we anticipate
      receiving follow-on orders. A s
      the
      card issuance infrastructure is more fully developed, CIE card orders could
      ramp
      toward their full implementation level and when the two national ID programs
      are
      fully implemented we anticipate annual revenues of $40 to $50 million over
      a
      five-year period. The Company can not forecast card orders or revenue for these
      programs until our Italian VAR receives roll out information from the Italian
      government.





U.S.
      Laser Visa Border Crossing Cards (BCCs) and Green Cards for the U.S. Department
      of Homeland Security (DHS) are an important part of the Company’s revenue base.
      For these programs, the Company recorded card revenues of $9.5 million over
      the
      last twelve months and expects this level of sales to continue in future
      periods. The Company is currently delivering on a bridge order placed after
      the
      expiration of a U.S. government subcontract in November 2005. Backlog at
      September 30, 2006 for these programs, which is deliverable through December
      2006, totaled $2 million. The Company expects to receive a new multi-year
      subcontract in November 2006 although no assurance can be given.





For
      fiscal year 2007, shipments under a subcontract for Canada’s Permanent Resident
      Cards totaled $0.8 million. The backlog at September 30, 2006 totaled $1.1
      million and is scheduled for delivery through June 2007.





In
      January 2006, the Company entered into a follow-on $11 million contract for
      a
      Middle Eastern country for the supply of secure national ID cards, installation
      and support of associated card personalization equipment, consumables and
      software. Deliveries began in February 2006 and are expected to be completed
      in
      fiscal 2008 as the prime contractor elects to place a series of up to ten
      purchase orders. In addition, the contractor has four annual purchase options
      valued at approximately $39 million in the aggregate. The cards are being issued
      to adult citizens for national identity purposes and feature the latest
      advancements in identity theft protection provided by Optical IDLock TM, a
      combination of the highly-secure LaserCard® optical memory technology and
      Embedded HologramHDTM, the new high-definition “photographic quality” etched
      image.  This subcontract is the first time that LaserCard Corporation has
      assumed responsibility for both supplying and installing personalization
      hardware, the oversight of the card personalization process, and the quality
      of
      the fully personalized cards, including the printing of cardholder information
      and encoding of data and the Embedded HologramHD. Revenue will be recognized
      as
      cards are issued after personalization, but only after the entire infrastructure
      called for in the contract has been installed and accepted which the Company
      anticipates will be in December 2006. The Company has received the first three
      purchase order releases totaling $3.9 million and has shipped the first two
      releases valued at $2.8 million prior to September 30, 2006. Revenue has not
      been recorded on these releases and the cost of the items is included in
      deferred contract costs on the Company’s consolidated balance sheets. The $3.9
      million amount is included in backlog until revenue is recorded. In addition,
      the Company received a purchase order for 100 additional secure optical memory
      card encoders, doubling the number of encoders originally called for in the
      $11
      million contract. Shipment is expected in the December quarter. For the fiscal
      year 2006, the Company recorded revenue of $1.7 million for this program, with
      all of the shipments made during the first six months of the fiscal year.





27







Effective
      April 3, 2004, the Company sold a second-source card-manufacturing license,
      including equipment, training, and support, to the Global Investments Group
      for
      card manufacturing in Slovenia and began receiving cash payments. Revenue for
      the license, equipment and initial training on this arrangement will be
      recognized when the equipment has been accepted and the training has been
      completed, which date is dependent on GIG providing a facility in Slovenia.
      Subsequent support revenue, royalties and materials supplied will be recognized
      as earned as discussed below under “ *License
      Fees and Other Revenues”.*




Revenues





The
      Company’s total revenues were $6.3 million and $8.7 million for the three-months
      ended September 30, 2006 and 2005, respectively, and $16.8 million and $15.7
      million for the six-months ended September 30, 2006 and 2005, respectively.





*Product
      Revenues.* The
      Company’s total revenues consisted of sales in its three segments of (1) optical
      memory cards, (2) optical card drives, drive accessories, and maintenance,
      and
      (3) specialty cards and card printers, as well as in other miscellaneous items.
      There were no license revenues earned in fiscal years 2007 or 2006.





The
      following table presents product revenue by segment (in thousands, except for
      percentages):


Three
                  Months Ended
                September
                  30,
              
              Six
                  Months Ended
                September
                  30,2006
              
              2005
              
              2006
              
              2005Optical
                  memory cards
              
              $
              3,279
              
              $
              5,612
              
              $
              10,774
              
              $
              9,477%
                  of total revenues
              
              
              52%
              
              
              65%
              
              
              64%
              
              
              61%Optical
                  card drives
              
              
              115
              
              
              374
              
              
              299
              
              
              683%
                  of total revenues
              
              
              2%
              
              
              4%
              
              
              2%
              
              
              4%Specialty
                  cards and card printers
              
              
              2,900
              
              
              2,713
              
              
              5,775
              
              
              5,533%
                  of total revenues
              
              
              46%
              
              
              31%
              
              
              34%
              
              
              35%Total
                  revenues
              
              $
              6,294
              
              $
              8,699
              
              $
              16,848
              
              $
              15,693




The
      following table presents optical memory card revenue by major program (in
      thousands):





Three
                  Months Ended
                September
                  30,
              
              Six
                  Months Ended
                September
                  30,2006
              
              2005
              
              2006
              
              2005U.S.
                  Green Cards & Laser Visas
              
              $
              1,994
              
              $
              2,145
              
              $
              4,337
              
              $
              4,620Italian
                  National ID Card Programs
              
              
              345
              
              
              1,088
              
              
              2,408
              
              
              1,194Canadian
                  Permanent Resident Cards
              
              
              404
              
              
              831
              
              
              822
              
              
              1,055National
                  ID Cards in a Middle Eastern country
              
              
              53
              
              
              950
              
              
              53
              
              
              1,477Vehicle
                  Registration in India
              
              
              386
              
              
              403
              
              
              774
              
              
              679All
                  other programs
              
              
              97
              
              
              195
              
              
              2,380
              
              
              452Total
                  optical memory card revenues
              
              $
              3,279
              
              $
              5,612
              
              $
              10,774
              
              $
              9,477


Optical
      memory card revenue decreased 42% for the second quarter of fiscal year 2007
      as
      compared with the second quarter of fiscal year 2006 due mainly to decreases
      in
      card unit volume for the Italian programs and Middle Eastern Country. Optical
      memory card revenue increased 14% for the first half of fiscal year 2007 as
      compared with the first half of fiscal year 2006 due mainly to increases in
      card
      unit volume for the Italian programs and sports logbook cards in Slovenia
      partially offset by a decrease in volume from a Middle Eastern Country. The
      Company believes that optical memory card revenues will double from fiscal
      year
      2007 to fiscal year 2008 and triple from fiscal year 2007 to fiscal year
      2009.





28






Optical
      card drive revenue decreased 69% for the second quarter of fiscal year 2007
      as
      compared with second quarter of fiscal year 2006 and decreased 56% for the
      first
      half of fiscal year 2007 as compared with the first half of fiscal year 2006
      due
      to lower sales volumes. Optical card drive revenue is typically variable,
      therefore; the Company does not consider this decrease to be a trend. The
      Company does not anticipate that it will derive significant profits on future
      drive sales as prices are set near the manufacturing cost in order to promote
      optical memory card sales.





Specialty
      cards and printers revenue of $2.9 million for the second quarter of fiscal
      year
      2007 increased 7% from the $2.7 million for the second quarter of fiscal year
      2006 and the $5.8 million in such revenue for the first half of fiscal year
      2007
      increased 4% from the $5.5 million recorded in the first half of fiscal year
      2006. The Company anticipates growth of less than 10% in this segment in fiscal
      year 2007.




*License
      Fees and Other Revenues* .
      There
      were no license revenues recorded for the three and six-months ended September
      30, 2006 and 2005. The Company sold a license, effective April 3, 2004, to
      Global Investments Group (GIG), based in Auckland, New Zealand, for card
      manufacturing in Slovenia. This agreement was most recently amended on October
      30, 2006. For information regarding the accounting treatment of the original
      and
      previously amended agreement, refer to the Company’s Form 10-Q for the
      first fiscal quarter of 2007 filed with the SEC on August 9, 2006. The
      agreement, as amended on October 30, 2006, provides for payments to the Company
      of $14 million for a 20-year license and four-year support package through
      March
      31, 2008, which payment has been received. The amended agreement calls for
      a
      mandatory follow-on three-year support package through March 31, 2011, followed
      by 13 optional one-year support packages, all at a fee of $1 million annually.
      The Company is to sell the required manufacturing equipment and provide
      installation assistance and training for a fee of approximately $11 million.
      The
      equipment is to be installed in a facility to be built by GIG to provide a
      targeted initial manufacturing capacity of 10 million optical cards annually.
      As
      of September 30, 2006, the Company had acquired $6 million of this equipment,
      classified as equipment held for resale on its consolidated balance sheet.
      In
      addition to the $14 million received for the license fee and support, the
      Company has received $6.5 million for partial payment for the equipment,
      installation assistance, and training. GIG is also obligated to make payments
      of
      $50,000 each month (the "Ready Fee") beginning October 2006 to the Company
      until
      GIG provides a building ready to receive the manufacturing equipment. The
      Company intends to maintain possession of the equipment until the final payment
      currently due November 10, 2006, of approximately $5 million is made. For the
      $20.5 million the Company received, $18.5 million was recorded as advance
      payments from customer and $2 million for the licensing fee was recorded as
      deferred revenue, which were both classified as long-term liabilities within
      the
      consolidated balance sheets. In addition to the $41 million discussed above,
      GIG
      is to pay the Company royalties for each card produced under the license.





The
      territories covered by the license include most of the European Union and
      eastern European regions. GIG has exclusive marketing rights in certain
      territories, with performance goals to maintain these rights. The Company will
      assign a person on site through March 31, 2011, and thereafter if GIG exercises
      the optional support to assist with quality, security and operational
      procedures, with the mutual goal that the facility and the cards made in the
      facility conform to the Company’s standards. The Company also retains rights to
      utilize up to 20% of the new facility capacity as backup and capacity buffer
      to
      augment its own card manufacturing facilities in Mountain View, California
      and
      at its German subsidiary. The granting of this license to GIG establishes a
      potential second source supplier of optical memory cards for existing and
      prospective customers who may request multiple sources for cards. The agreement
      contains various elements including a card manufacturing license, sale and
      installation of equipment, training, and ongoing support, and contingent
      payments for the sale of materials, and royalty payments for cards manufactured.





29





As
      a
      result of the amendment to the agreement in October 2006, the Company has
      determined that, upon delivery and installation of the equipment, and completion
      of the training, it can establish the fair value of the remaining undelivered
      support packages. The fair value of the undelivered support packages is
      determined by reference to the fair value of 13 optional one-year support
      packages, each of which is offered to the licensee at a fee of $1 million
      annually. The undelivered support packages, including the 13 optional one-year
      support packages, are substantively identical. Accordingly, the Company will
      defer revenue equal to the fair value of the undelivered support packages and
      will recognize the residual amount as revenue for the delivered items, using
      the
      residual method as prescribed in EITF 00-21. Therefore, the deferred revenue,
      using the residual method, consisting of the card manufacturing license, the
      monthly "Ready Fee", the sale and installation assistance of equipment and
      training will be recognized as revenue when the equipment is accepted and
      training has been completed, which date is dependent on GIG providing a facility
      in Slovenia. The Company defers direct and incremental expenses associated
      with
      building the card manufacturing equipment and with the delivery of other
      services for which revenue has been deferred, and the Company will recognize
      these expenses when the Company recognizes the related revenue. Royalty revenue
      will be recorded as revenue in the period when earned based upon the number
      of
      optical memory cards manufactured by the licensee as defined in the agreement.
      The Company determined this by analogy to the treatment of software licenses
      in
      accordance with SOP 97-2 whereby royalty fees receivable may be recorded as
      revenue as the customer of a software maker sublicenses its product to
      end-users. The Company determined this is analogous to the royalties earned
      by
      the Company as GIG sells optical memory cards to its customers. Raw material
      purchases will be recorded as revenue and the related cost charged to cost
      of
      goods sold in the period when shipped and the other revenue recognition criteria
      of SAB 104 are met. GIG has missed payment deadlines in June 2006 and September
      2006 leading to the amendments to the original agreement. There is no assurance
      that GIG will be able to obtain the financing required to make any future
      payments.





Backlog





As
      of
      September 30, 2006, the backlog for LaserCard® optical memory cards totaled $3.2
      million mostly scheduled for delivery in fiscal year 2007, compared with backlog
      of $6.8 million at March 31, 2006. In addition, backlog for a bundled order
      of
      optical memory cards, read/write drives, card printers, and software totaled
      $3.9 million at September 30, 2006. The Company has only a few customers who
      generally place orders for a several-month period so that variations in order
      placement from a single customer can materially affect backlog. As a result,
      the
      relative size of the Company’s backlog has not always been a reliable indicator
      of future sales revenue trends.





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





In
      addition, the backlog for Challenge Card Design Plastikkarten GmbH as of
      September 30, 2006 for specialty cards and printers totaled 1 million euros
      (approximately $1.2 million) compared with 0.8 million euros (approximately
      $1
      million) at March 31, 2006, and for a contract to develop a conventional
      non-optical card production facility totaled 0.7 million euros (approximately
      $0.8 million) at September 30, 2006 compared with 0.7 million euros
      (approximately $0.9 million) at March 31, 2006.





Gross
      Margin





The
      following table represents gross margin in absolute amount and percentage by
      segment (in thousands, except for percentages):




Three
                  Months Ended
                September
                  30,
              
              Six
                  Months Ended
                September
                  30,2006
              
              2005
              
              2006
              
              2005Optical
                  memory cards
              
              $
              244
              
              $
              1,916
              
              $
              3,888
              
              $
              3,029%
                  of optical memory card revenues
              
              
              7
              %
              
              34
              %
              
              36
              %
              
              32
              %Optical
                  card drives
              
              
              (126
              )
              
              (159
              )
              
              (304
              )
              
              (269
              )%
                  of optical card drive revenues
              
              
              NM
              
              
              NM
              
              
              NM
              
              
              NMSpecialty
                  cards and card printers
              
              
              710
              
              
              736
              
              
              1,409
              
              
              1,573%
                  of specialty cards and card printers revenues
              
              
              24
              %
              
              27
              %
              
              24
              %
              
              29
              %Total
                  gross margin
              
              $
              828
              
              $
              2,493
              
              $
              4,993
              
              $
              4,333%
                  of total revenues
              
              
              13
              %
              
              29
              %
              
              30
              %
              
              28
              %






*Optical
      Memory Cards.* Optical
      memory card gross margin can vary significantly based upon changes in average
      selling price, production and sales volumes, mix of card types, production
      efficiency and yields, and changes in fixed costs. Unit volume affects gross
      margin due to the absorption of fixed manufacturing costs. The decrease in
      optical memory card gross margin to 7% of revenue for the second quarter of
      fiscal year 2007 as compared with 34% of revenue for fiscal year 2006 is mainly
      due to the 30% increase in production unit volume and 31% decrease in sales
      unit
      volume. The increase in optical memory card gross margin to 36% of revenue
      for
      the first half of fiscal year 2007 as compared with 32% of revenue for the
      first
      half of fiscal year 2006 is due to the 16% increase in sales unit volume. The
      adoption of SFAS No. 123(R) resulted in a decrease in gross margin of
      $81,000 or 2% of optical memory card revenue for the second quarter of
      fiscal year 2007, and $168,000 for the first six months of fiscal year
      2007.





30






*Optical
      Card Drives.* Read/write drive gross profits have generally been negative, inclusive of fixed
      overhead costs, due to low sales volume and the Company’s policy to price drives
      close to manufacturing cost to promote card sales. The Company anticipates
      that
      read/write drive negative gross margins will continue in the future unless
      sales
      volume is sufficient to cover fixed costs. The Company believes sales volume
      will increase during fiscal year 2007 resulting in a positive gross margin
      of
      about 10%.





*Specialty
      cards and card printers.* The
      gross margin on specialty cards and card printers was 24% in the second quarter
      and first half of fiscal year 2007 and 27% in the second quarter and 29% in
      the
      first half of fiscal year 2006. Over the past nine quarters, the quarterly
      gross
      margin has ranged from 21% to 31%.





Operating
      Expenses


The
                  following table presents operating expenses (in
                  thousands):Three
                  Months Ended
                September
                  30,
              
              Six
                  Months Ended
                September
                  30,2006
              
              2005
              
              2006
              
              2005Selling,
                  general and administrative expenses
              
              $
              2,998
              
              $
              2,612
              
              $
              6,418
              
              $
              5,743Research
                  and development expenses
              
              $
              800
              
              $
              552
              
              $
              1,545
              
              $
              1,051





*Selling,
      General, and Administrative Expenses (SG&A).* SG&A
      expenses increased approximately 15% or $0.4 million in the three months ended
      September 30, 2006 as compared with the three months ended September 30, 2005
      mainly due to $0.2 million from the application of SFAS No. 123(R) expenses
      and $0.3 million in increased consulting services in marketing. For the six
      months ended September 30, 2006, the increase of SG&A expenses as compared
      to the six months ended September 30, 2005 was approximately 12% or $0.7 million
      mainly due to increases of $0.2 million in salaries, $0.4 million of SFAS No.
      123(R) expenses, $0.4 million of consulting fees, partially offset by a decrease
      in SOX audit fees.





*Research
      and Development Expenses (R&D)* .
      The
      Company is continuing its efforts to develop new optical memory card features
      and structures, including various sheet-lamination card structures, the
      insertion of contactless chips with radio frequency (RF) capability,
      OptiChip Ô ,
      OVD
      (optically variable device) products, and associated media development; enhanced
      optical memory card read/write drives and read-only drives (readers); and new
      software products in an effort to provide new products that can stimulate
      optical memory card sales growth. For example, the Company recently has
      developed a prototype of a LaserCard® handheld reader that is being evaluated by
      value-added resellers. The Company anticipates that these ongoing research
      and
      development efforts will result in new or enhanced card capabilities,
      production-model read-only drives, or drives with advanced security features
      and
      lower manufacturing costs; however, there is no assurance that such product
      development efforts will be successful. These features are important for the
      Company’s existing and future optical memory card markets. R&D expenses
      increased by 45% or $0.2 million in the three months ended September 30, 2006
      as
      compared with the three months ended September 30, 2005 due mainly to the $0.1
      million impact of SFAS No. 123(R) and $0.1 million in increased materials
      and purchased services for R&D projects. For the six months ended September
      30, 2006, R&D expenses increased approximately 47% or $0.5 million as
      compared to the six months ended September 30, 2005 mainly due to the $0.2
      million impact of SFAS No. 123(R).





*Other
      Income, Net* .
      Other
      income, net for the three months ended September 30, 2006 was $233,000
      consisting of $278,000 in interest and other income, partially offset by other
      expense of $36,000. Other income, net for the three months ended September
      30,
      2005 was $108,000 consisting of $116,000 in interest income, partially offset
      by
      an $8,000 loss on the sale of capital equipment. Other income, net for the
      six
      months ended September 30, 2006 was $439,000 consisting mainly of $592,000
      of
      interest income partially offset by interest expense of $158,000 and other
      miscellaneous expenses. Other income, net for the six months ended September
      30,
      2005 was $204,000 consisting mainly of $288,000 of interest income, partially
      offset by other miscellaneous expenses. The increase in interest income is
      mainly due to an increase in interest rates.





31





*Income
      Taxes.* The
      Company recorded an income tax benefit of $65,000 for the second quarter of
      fiscal year 2007 consisting of a tax benefit in the amount of $19,000 primarily
      due to the Company’s foreign subsidiary’s loss that is expected to be refunded
      in its jurisdiction, and a U.S. income tax benefit of $46,000  as
      compared to a recorded income tax expense of $1,000 for the second quarter
      of
      fiscal 2006. The Company recorded an income tax benefit, net of $71,000 for
      the
      first six months of fiscal year 2007 as compared to a recorded income tax
      expense of $1,000 during the first six months of fiscal year 2006 primarily
      due
      to taxes incurred in the Company’s foreign subsidiary.





LIQUIDITY
      AND CAPITAL RESOURCES





The
      following table summarizes cash, cash equivalents and investments as of
      September 30, 2006 and March 31, 2006 (in thousands):


September
                  30,
              
              March
                  31,2006
              
              2006Cash,
                  cash equivalents and short-term investments
              
              $
              21,597
              
              $
              23,471





The
      following table displays the sources and uses of cash by activity (in
      thousands):


Six
                  Months Ended
                September
                  30,2006
              
              2005Net
                  cash provided by (used in) operating activities
              
              $
              (1,009
              )
              $
              1,312Net
                  cash used in investing activities
              
              $
              (2
              )
              $
              (3,327
              )Net
                  cash provided by financing activities
              
              $
              748
              
              $
              262


Cash
      used
      in operations of $1 million during the first half of fiscal year 2007 was mainly
      due to the net loss partially offset by changes in operating assets and
      liabilities.





Net
      cash
      used in investing activities was immaterial during the first half of fiscal
      year
      2007. Net cash used in investing activities for the first six months of fiscal
      2006 was due primarily to $2.6 million of net purchases of liquid investments
      and purchases of property and equipment of $0.7 million.





Net
      cash
      provided by financing activities during the first half of fiscal year 2007
      was
      $0.7 million, which consisted primarily of net proceeds from the sale of common
      stock under the Company’s employee stock benefit plans.





The
      Company believes that the estimated level of revenues and customer advance
      payments over the next 12 months will be sufficient to generate cash from
      operating activities over the same period. However, quarterly fluctuations
      are
      expected. Operating cash flows could be negatively impacted to a significant
      degree if either of the Company’s largest U.S. government programs or Italian
      programs were to be delayed, reduced, canceled, or not extended; and if these
      programs are not replaced by other card orders or other sources of
      income.





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.





The
      Company considers all highly liquid investments, consisting primarily of
      commercial paper, discount notes, and U.S. government bonds, with original
      or
      remaining maturities of three months or less at the date of purchase, to be
      cash
      equivalents. All investments with original or remaining maturities of more
      than
      three months but not more than one year at the date of purchase are classified
      as short-term. Investments with original or remaining maturities of more than
      one year at the date of purchase are classified as long-term. The Company
      determines the length of its investments after considering its cash requirements
      and yields available for the type of investment considered by the Company.
      Management also determines the appropriate classification of debt and equity
      securities at the time of purchase and reevaluates the classification of
      investments as of each balance sheet date. As of September 30, 2006 the Company
      had $19.8 million classified as short-term investments and had no long-term
      investment, compared with $21.4 million classified as short-term investments
      and
      no long-term investments as of March 31, 2006. All auction rate securities
      are
      accounted for as available-for-sale and all other interest-bearing securities
      are accounted for as held-to-maturity.





32







The
      Company made capital equipment and leasehold improvement purchases of
      approximately $0.4 million during the second quarter of fiscal year 2007
      compared with approximately $0.2 million during the second quarter of fiscal
      year 2006. The Company's current card capacity, assuming optimal card type
      mix,
      is estimated at approximately 16 million cards per year. The Company plans
      to
      purchase additional production equipment in a series of steps when deemed
      appropriate by the Company. The Company has increased and, when necessary,
      will
      continue to increase production capacity for cards with new structures used
      by
      the programs in Canada, Italy, and a Middle Eastern country. In addition to
      investment used for expansion, the Company plans to make additional capital
      expenditures which are expected to yield cost savings, quality improvements,
      and
      other purposes. The Company plans to use cash on hand and cash generated from
      operations to fund capital expenditures of approximately $9 million for
      equipment and leasehold improvements for card production, read/write drive
      tooling and assembly, and general support items as customer orders justify
      the
      investment. These expenditures could occur throughout the next twelve
      months.





OFF-BALANCE
      SHEET ARRANGEMENTS





The
      Company has no off-balance sheet arrangement that has or is reasonably likely
      to
      have a current or future effect on our financial condition, changes in financial
      condition, revenues or expenses, results of operations, liquidity, capital
      expenditures, or capital resources that is material to investors.





**ITEM
      3.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**





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





o
            Commercial
                paper rated A1/P1 or debt instruments rated AAA, as rated by the
                major
                rating services





o
            Can
                readily be sold for cash





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





There
      were no material changes during the second quarter of fiscal year 2007 in the
      Company's exposure to market risk for changes in interest rates.





33




The
      following summarizes short-term investments at fair value, weighted average
      yields and expected maturity dates as of September 30, 2006 (in
      thousands):





September
                    30, 2006Auction
                    rate securities
                
                $
                19,800Weighted
                    Average Yield
                
                
                5.31%U.S.
                    Government and Agency Obligations
                
                
                0Weighted
                    Average Yield
                
                
                0.00%Total
                    investments
                
                $
                19,800




There
      were no long-term investments as of September 30, 2006.





*Foreign
      Currency Exchange Rate Risk.* The
      Company’s U.S. operations sell products in various international markets. To
      date an immaterial amount of sales have been denominated in euros. In addition,
      some raw material purchases and purchased services are denominated in euros.
      Cash provided by/used in Challenge Card Design Plastikkarten GmbH (“CCD”)
      operating activities has been immaterial.





The
      Company uses short-term foreign exchange forward contracts to mitigate foreign
      currency risk associated primarily with inter-company receivables and payables,
      and loan receivables (denominated in Euros) to its German subsidiary.  Our
      foreign exchange forward contracts are not designated for accounting purposes
      as
      hedging instruments under SFAS No. 133, “Accounting for Derivative Instruments
      and Hedging Activities,” as amended.  Accordingly, any gains or losses
      resulting from changes in the fair value of the forward contract are reported
      in
      other income, net expenses.  The gains and losses on these forward
      contracts generally offset gains and losses associated with the underlying
      foreign currency denominated inter-company receivables and payables, and loan
      receivables.  At September 30, 2006, the Company had a foreign exchange
      forward contract with a maturity of less than 30 days to purchase 2.3 million
      euros. The fair value of the forward contract was not material at September
      30, 2006.





**ITEM
      4.**  **CONTROLS
      AND PROCEDURES**





*(a)*
            *Evaluation
                of Disclosure Controls and Procedures*.
                We maintain disclosure controls and procedures that are designed
                to ensure
                that information required to be disclosed by us in reports that we
                file or
                submit under the Securities Exchange Act of 1934 is recorded, processed,
                summarized, and reported within the time periods specified in Securities
                and Exchange Commission rules and forms, and that such information
                is
                accumulated and communicated to our management, including our Chief
                Executive Officer and Chief Financial Officer, as appropriate, to
                allow
                timely decisions regarding required disclosure. In designing and
                evaluating our disclosure controls and procedures, management recognized
                that disclosure controls and procedures, no matter how well conceived
                and
                operated, can provide only reasonable, not absolute, assurance that
                the
                objectives of the disclosure controls and procedures are met.  Our
                disclosure controls and procedures have been designed to meet, and
                management believes that they meet, reasonable assurance standards. 
                Additionally, in designing disclosure controls and procedures, our
                management necessarily was required to apply its judgment in evaluating
                the cost-benefit relationship of possible disclosure controls and
                procedures. The design of any disclosure controls and procedures
                also is
                based in part upon certain assumptions about the likelihood of future
                events, and there can be no assurance that any design will succeed
                in
                achieving its stated goals under all potential future conditions.





Based
      on
      their evaluation as of the end of the period covered by this Form 10-Q, our
      Chief Executive Officer and Chief Financial Officer have concluded that, subject
      to the limitations noted above, as of such date, our disclosure controls and
      procedures were effective at the reasonable assurance level





*(b)*
            *Changes
                in Internal Control over Financial Reporting.*Our
                management is responsible for establishing and maintaining adequate
                internal control over our financial reporting, which is designed
                to
                provide reasonable assurance regarding the reliability of our financial
                reporting and the preparation of financial statements for external
                purposes in accordance with U.S. generally accepted accounting principles.
                Internal control over financial reporting includes those policies
                and
                procedures that: (i) pertain to the maintenance of records that, in
                reasonable detail, accurately and fairly reflect the transactions
                and
                dispositions of our assets; (ii) provide reasonable assurance that
                transactions are recorded as necessary to permit preparation of financial
                statements in accordance with U.S. generally accepted accounting
                principles, and that receipts and expenditures of the Company are
                being
                made only in accordance with authorizations of our management and
                directors; and (iii) provide reasonable assurance regarding
                prevention or timely detection of unauthorized acquisition, use or
                disposition of our assets that could have a material effect on the
                financial statements. There were no significant changes in the Company’s
                internal control over financial reporting that occurred during the
                second
                quarter of fiscal year 2007**that
                have materially affected, or are reasonably likely to materially
                affect,
                such control.





34




However,
      during the second quarter of fiscal 2007, the Company continued its preparation
      to implement and at the end of October 2006, implemented a new Enterprise
      Resource Planning (ERP) system designed to provide additional operational and
      financial reporting functionality in the US operations. The Company’s wholly
      owned subsidiary in Germany is scheduled to implement the same ERP system after
      fiscal year 2007, and once this implementation occurs, the entire Company will
      be integrated into one reporting system.





**PART
      II.  OTHER INFORMATION**





**Item
      1.**  **- Legal
      Proceedings**




From
        time
        to time we are a party to litigation matters and pending or threatened claims
        and assessments that are normal in the course of our operations. While we
        believe that the ultimate outcome of these matters will not have a material
        adverse effect on the Company's financial position, results of operations
        or
        cash flows, the outcome of these matters is not determinable and negative
        outcomes may adversely affect our financial position, liquidity, or results
        of
        operations.
  **Item
      1A. - Risk Factors**




A
        revised
        description of the risk factors associated with our business is set forth
        below.
        This description includes any material changes to and supersedes the description
        of the risk factors associated with our business previously disclosed in
        Part I,
        Item 1A of our Annual Report on Form 10-K for the fiscal year ended March
        31,
        2006, and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the
        fiscal quarter ended June 30, 2006. Because of these risk factors, as well
        as
        other factors affecting the Company’s business and operating results and
        financial condition, including those set forth elsewhere in this report,
        our
        actual future results could differ materially from the results contemplated
        by
        the forward-looking statements contained in this report and our past financial
        performance should not be considered to be a reliable indicator of future
        performance, so that investors should not use historical trends to anticipate
        results or trends in future periods.


**RISK
      FACTORS**





OUR
      CURRENT AND FUTURE EXPECTED REVENUES ARE DERIVED FROM A SMALL NUMBER OF ULTIMATE
      CUSTOMERS SO THAT THE LOSS OF OR REDUCTIONS IN PURCHASES BY ANY ONE ULTIMATE
      CUSTOMER COULD MATERIALLY REDUCE OUR REVENUES AND LEAD TO LOSSES. During
      the first half of fiscal year 2007 and
      each of the previous three fiscal years, we derived more than 60% of our optical
      memory card and drive-related revenues from five programs ― two U.S. government
      programs and three foreign government programs. Due to the lengthy sales cycles,
      we believe
      that these programs, with perhaps the addition of one or two other foreign
      programs, will be the basis for a substantial majority of our revenues in the
      near-term. The loss of or reductions in purchases by any one customer due to
      program cutbacks, competition, or other reasons would materially reduce our
      revenue base. Annual or quarterly losses occur when there are material
      reductions, gaps or delays in card orders from our largest U.S. or foreign
      government programs or if such programs were to be reduced in scope, delayed,
      canceled, or not extended and not replaced by other card orders or other sources
      of income.





WE
      INCURRED NET LOSSES DURING TWELVE OF THE PREVIOUS FIFTEEN QUARTERS AND
      MAY NOT BE ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO SUSTAIN
      PROFITABILITY. Although we generated $3.3 million of profit during the three
      quarters through June 30, 2006, we incurred a loss for our quarter ended
      September 30, 2006 and we anticipate a loss for our quarter ending December
      31, 2006.  We incurred losses during the first six months of fiscal
      year 2007 aggregating $2.5 million, and we incurred a loss of $8.9 million
      in
      fiscal year 2005 and $12.4 million in fiscal year 2004, and had an accumulated
      deficit of $29 million at September 30, 2006. There can be no assurance that
      we
      will generate enough card revenues in the near term to achieve profitability.
      We
      are relying upon our optical memory card technology to generate future product
      revenues, earnings, and cash flows. If alternative technologies emerge or if
      we
      are otherwise unable to compete, we may not be able to achieve or sustain
      profitability on a quarterly or annual basis. Annual or quarterly losses would
      also continue if increases in product revenues or license revenues do not keep
      pace with increased selling, general, administrative, research and development
      expenses and the depreciation and amortization expenses associated with capital
      expenditures.





35






OUR
      PROGRAM WITH ITALY, WHICH WE BELIEVE WILL BE OUR LARGEST CUSTOMER FOR THE NEXT
      FEW YEARS, MAY BE DELAYED OR CANCELLED FOR REASONS OUTSIDE OUR CONTROL WHICH
      WOULD CAUSE US TO HAVE LESS REVENUE THAN PLANNED AND WOULD LIKELY LEAD US TO
      INCUR OPERATING LOSSES. The Company believes that the Italian CIE and PSE card
      programs will be our largest customer for the next few years, comprising a
      significant portion of future revenues. Sales of cards and drives for the
      government of Italy for its CIE and PSE card programs represented 14% of total
      revenue for the first half of fiscal 2007, 31% for fiscal year 2006, and 26%
      for
      fiscal year 2005. We have increased capacity to meet the anticipated demand
      and
      we had expected a large order during the first quarter of fiscal 2007, and
      then
      during the second quarter of fiscal year 2007. However, this order has not
      yet
      been placed and there can be no assurance that the order will be placed in
      the
      near-term and that demand will increase and be sustained as anticipated by
      the
      Company. We would most likely incur losses if full implementation, was to be
      further delayed, or canceled, not extended, or not implemented at the level
      foreseen or if the government were to change its technology decision and no
      longer use optical memory cards. While selected Italian cities have been issuing
      cards and testing the card issuing process, full implementation is dependent
      upon card issuance infrastructure developments being successfully undertaken
      and
      the national ID card system functioning as designed, of which there can be
      no
      assurance. Also, if Laser Memory Card SpA of Italy, our VAR customer for this
      program, were to discontinue participation in this program or discontinue
      operations, interruptions could occur in orders or shipments for this program
      until a replacement could be found. Overcoming some of these issues may be
      difficult and complex and involve third parties, which could be time consuming
      and expensive and lead to further delays for implementation.








OUR
      SUBCONTRACT FOR THE U.S. GOVERNMENT, ONE OF OUR TWO LARGEST ULTIMATE CUSTOMERS,
      EXPIRED IN NOVEMBER 2005 AND IF NOT RENEWED COULD RESULT IN ORDER DELAYS WHICH
      WOULD LIKELY LEAD US TO INCUR OPERATING LOSSES. EVEN IF A NEW CONTRACT IS
      ISSUED, THE U.S. GOVERNMENT HAS THE RIGHT TO DELAY ITS ORDERS OR COULD CHANGE
      ITS TECHNOLOGY DECISIONS, WHICH WOULD RESULT IN ORDER DELAYS AND POSSIBLY IN
      OPERATING LOSSES. Our fiscal year 2006 revenues included sales of approximately
      $9.8 million of Green Cards and Laser Visa BCCs, and comprised 24% of our
      revenues. The Company expects these revenues to continue at approximately $9.5
      million annually ($7.5 million for Green Cards and $2.0 million for Laser Visa
      BCCs) if the government continues to use the Company’s cards in these programs,
      continues to personalize cards at that rate and continues to maintain an
      inventory level equal to six-months of usage. However, our U.S. government
      subcontract expired in November 2005, and we have subsequently received
      individual purchase orders while the government determines whether and to whom
      to issue a long-term contract. We have backlog as of September 30, 2006, of
      $2
      million for these programs deliverable through December 2006, but further orders
      will require a new contract or another bridge purchase order. Based on events
      to
      date, the Company believes that a follow-on multi-year contract will be issued
      to the Company’s VAR by the end of November 2006; however, there is no assurance
      that a follow-on contract or purchase order will be issued by the U.S.
      government. Under U.S. government procurement regulations, even with a contract
      in place, the government reserves certain rights, such as the right to withhold
      releases, to reduce the quantities released, extend delivery dates, reduce
      the
      rate at which cards are issued, and cancel all or part of its unfulfilled
      purchase orders. We would most likely have reduced operating results if both
      of
      our largest U.S. government programs were to be delayed, canceled, or not
      extended or if the government were to change its technology decision and no
      longer use optical memory cards. We have been advised by the program prime
      contractor that the U.S. State Department, who is the customer for LaserVisa
      Border Crosser Cards, intends to use Radio Frequency Identification (RFID)
      technology in this program starting in 2008. We intend to offer a hybrid version
      of our optical memory card including such RFID capability. There is no assurance
      we will be able to successfully win new LaserVisa orders if this technology
      change occurs as projected. The U.S. government acting through its prime
      contractor delayed orders for Green Cards during fiscal year 2004 due to a
      design change and again in the first part of fiscal year 2005 because of excess
      inventory, which resulted in a gap in production of several months, and which
      in
      turn significantly and adversely affected our operating results for the first
      half of fiscal year 2005. Any future excess inventory held by the U.S.
      government, delayed funding, slower than anticipated program volume, or any
      future changes to the design of the cards may result in future gaps in orders
      or
      production which may negatively impact our operating results. Our U.S.
      government card deliveries depend upon the issuance of corresponding order
      releases by the government to its prime contractor and then to us. If General
      Dynamics, our VAR customer and the U.S. government prime contractor for this
      program, were to discontinue participation in this program or discontinue
      operations, interruptions could occur in orders or shipments for this program
      until a replacement could be found.





36







OUR
      PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE U.S. OR
      ABROAD AND IF THE ITALIAN NATIONAL ID PROGRAM IS NOT IMPLEMENTED AS ANTICIPATED.
      Even if our U.S. Government subcontract is renewed, we do not expect future
      growth from the U.S. Green Card and Laser Visa BCC programs as we expect their
      steady state revenue to average $9.5 million annually, about the same as
      purchased in fiscal year 2006. We had revenues from Italian CIE and PSE cards
      of
      about $12 million during fiscal year 2006. During full implementation, we expect
      our revenues from these programs to grow to reach approximately $40 to $50
      million per year. In order for us to achieve our overall revenue growth goal,
      we
      will need not only for these programs to continue and reach their anticipated
      levels, of which there can be no assurance, but we will also need to win new
      business in the U.S. and abroad. Emerging optical memory card programs or
      prospective applications include motor vehicle registration cards in a few
      states in India, foreign resident identification cards in Costa Rica, and
      national ID cards for a Middle Eastern country. There can be no assurance that
      sizable orders will follow or even if ordered we will be successful in shipping
      products for any of these programs, nor can there be any assurance that we
      will
      be able to win any other new business in the U.S. or abroad which is necessary
      to grow our business to the level we desire.





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





37







THE
      TIMING OF OUR U.S. GOVERNMENT REVENUES COULD BE EXTREMELY VOLATILE AND CANNOT
      BE
      PREDICTED BECAUSE WE REQUIRE A FIXED SHIPMENT SCHEDULE IN ORDER TO RECORD
      REVENUE WHEN WE DELIVER CARDS TO A VAULT, OTHERWISE WE RECOGNIZE REVENUE WHEN
      THE CARDS ARE SHIPPED OUT OF A VAULT OR WE RECEIVE A FIXED SHIPMENT SCHEDULE
      FROM THE GOVERNMENT. We recognize revenue from product sales when the following
      criteria are met: (a) persuasive evidence of an arrangement exists; (b) delivery
      has occurred; (c) the fee is fixed or determinable; and (d) collectibility
      is
      reasonably assured. Our U.S. government subcontract requires delivery of cards
      to a secure vault controlled by the Company. Deliveries are made into the vault
      on a production schedule specified by the government or one of its specified
      agents. When the cards are delivered to the vault, all title and risk of
      ownership are transferred to the government. At the time of delivery, the prime
      contractor is invoiced, with payment due within thirty days. The contract does
      not provide for any return provisions other than for warranty. We recognize
      revenue when the cards are delivered into the vault because we have fulfilled
      our contractual obligations and the earnings process is complete. However,
      if we
      do not receive a shipment schedule for shipment from the vault, revenue is
      not
      recognized until the cards are shipped from the vault. In addition, revenue
      recognition for future deliveries into the vault would be affected if the U.S.
      government cancels the shipment schedule. As a result, our revenues may
      fluctuate from period to period if we do not continue to obtain shipment
      schedules under this subcontract or if the shipment schedules are cancelled.
      In
      this case, we would no longer recognize revenue when cards are delivered to
      the
      vault, but instead such revenue recognition would be delayed until the cards
      are
      shipped from the vault to the U.S. government.





WE
      COULD
      EXPERIENCE EQUIPMENT, RAW MATERIAL, QUALITY CONTROL, OR OTHER PRODUCTION
      PROBLEMS ESPECIALLY IN PERIODS OF INCREASING VOLUME. There can be no assurance
      that we will be able to meet our projected card manufacturing capacity if and
      when customer orders reach higher levels. We have made and intend to continue
      to
      make significant capital expenditures to expand our card manufacturing capacity.
      For example, we plan $9 million of capital expenditures during the next twelve
      months. However, since customer demand is difficult to predict, we may be unable
      to ramp up our production quickly enough to timely fill new customer orders.
      This could cause us to lose new business and possibly existing business. In
      addition, if we overestimate customer demand, we could incur significant costs
      from creating excess capacity which was the case during fiscal year 2005. We
      may
      experience manufacturing complications associated with increasing our
      manufacturing capacity of cards and drives, including the adequate production
      capacity for sheet-lamination process cards to meet order requirements and
      delivery schedules. We may also experience difficulties implementing new
      manufacturing processes, meeting customers’ quality or standards requirements,
      or outsourcing some of our manufacturing. The addition of fixed overhead costs
      increases our breakeven point and results in lower profit margins unless
      compensated for by increased product sales. When purchasing raw materials for
      our anticipated optical card demand, we take into consideration the
      order-to-delivery lead times of vendors and the economic purchase order quantity
      for such raw materials. If we over-estimate customer demand, excess raw material
      inventory can result.





WE
      ARE
      CURRENTLY OUR OWN SOLE SOURCE OF OPTICAL MEMORY CARDS AND SEVERAL OF THE STEPS
      IN OUR CARD MANUFACTURING PROCESS HAVE NO BUILT-IN REDUNDANCY. THEREFORE, WE
      ARE
      SUSCEPTIBLE TO SUPPLY INTERRUPTIONS, INCLUDING IF CERTAIN MACHINERY WERE TO
      BREAK DOWN. MUCH OF OUR MACHINERY IS COMPRISED OF CUSTOM VERSIONS OF MACHINERY
      WHICH IS MORE THAN 20 YEARS OLD. Unless and until GIG comes on line as a second
      source, of which there can be no assurance, we are the only source of our
      optical memory cards, making them in our Mountain View facility, with a few
      key
      steps in certain instances being undertaken in Germany. There is no assurance
      that the GIG facility if and when operational will be an acceptable second
      source to some of our key government accounts. We use a proprietary
      manufacturing process and several of the steps in our card manufacturing process
      have no built-in redundancy, although many of the steps do, in some cases with
      the redundancy located in Germany. We are susceptible to supply interruptions
      or
      yield decreases, when our line goes down or malfunctions. Much of our machinery
      is comprised of customized versions of machinery which has long lead times
      to
      replace and may be difficult to maintain or repair, requiring us to be
      self-reliant. Some of the machinery we use is more than 20 years old and is
      no
      longer manufactured for others, which would require us to adapt a newer version
      to our needs, which would involve additional effort on our part.





38







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





AN
      INTERRUPTION IN THE SUPPLY OF READ/WRITE DRIVE PARTS OR DIFFICULTIES ENCOUNTERED
      IN READ/WRITE DRIVE ASSEMBLY COULD CAUSE A DELAY IN DELIVERIES OF DRIVES AND
      OPTICAL MEMORY CARDS AND A POSSIBLE LOSS OF SALES, WHICH WOULD ADVERSELY AFFECT
      OUR OPERATING RESULTS. Several major components of our read/write drives are
      designed specifically for our read/write drive. For example, the optical
      recording head for the current drive is a part obtained from one supplier;
      and
      at current production volumes, it is not economical to have more than one
      supplier for this custom component. The ability to produce read/write drives
      in
      high-volume production, if required, will be dependent upon maintaining or
      developing sources of supply of components that meet our requirements for high
      volume, quality, and cost. In addition, we could encounter quality control
      or
      other production problems at high-volume production of read/write drives. We
      are
      also investing in research and development in an effort to develop new drive
      products.





IF
      WE ARE
      UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO MANUFACTURE
      AND
      ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS. The price of
      our
      read/write drive product line ranges from $1,800 to approximately $2,500
      depending on features and quantity purchased. We believe the price of our drives
      is competitive in applications requiring a large number of cards per drive,
      because the relatively low cost for our cards offsets the high cost per drive
      when compared with our major competition, IC card systems. In addition, we
      have
      undertaken a product development program for a portable read-only drive that
      has
      been sampled in limited quantities at prices less than $1,000, which we believe
      would increase our prospects for winning future business. However, there can
      be
      no assurance that our development program will be successful, that volume
      production of any new design will occur in the near term, or that significantly
      lower manufacturing costs or increased sales will result.





39







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





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





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





WE
      ARE
      DEPENDENT ON SYSTEMS INTEGRATORS FOR IMPLEMENTATION OF CARD PROGRAMS AND THEIR
      METHOD OF IMPLEMENTATION MAY NOT BE SUCCESSFUL DUE TO QUALITY OR COST. The
      Company sells to VARs and system integrators who in turn sell solutions to
      the
      government end customer. The integrators may not follow the recommendations
      we
      provide for the handling, possible incorporation of smart or RFID chips,
      processing, and/or printing on our cards and working with the government
      end-user in the card issuing process. This could lead to low quality or high
      costs or both resulting in damage to our reputation and/or loss of the contract.
      The Company works to train the integrators to avoid such situations, but can
      not
      control their work. Also, the Company can step in to demonstrate how to
      successfully implement an optical memory card issuing system. The Company plans
      to continue to offer this support then transition the card issuing process
      to
      local resources once the program is running successfully.





40







IF
      WE
      FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY BE ABLE TO
      USE
      OUR TECHNOLOGIES, WHICH COULD WEAKEN OUR COMPETITIVE POSITION, REDUCE REVENUES,
      OR INCREASE COSTS. We use a combination of patent, trademark, and trade secret
      laws, confidentiality procedures, and licensing arrangements to establish and
      protect our proprietary rights. Our existing and future patents may not be
      sufficiently broad to protect our proprietary technologies. Despite our efforts
      to protect proprietary rights, we cannot be certain that the steps we have
      taken
      will prevent the misappropriation or unauthorized use of our technologies,
      particularly in foreign countries where the laws may not protect proprietary
      rights as fully as U.S. law. Any patents we may obtain may not be adequate
      to
      protect our proprietary rights. Our competitors may independently develop
      similar technology, duplicate our products, or design around any of our issued
      patents or other intellectual property rights. Litigation may be necessary
      to
      enforce our intellectual property rights or to determine the validity or scope
      of the proprietary rights of others. This litigation could result in substantial
      costs and diversion of resources and may not ultimately be successful. We cannot
      predict whether the expiration or invalidation of our patents would result
      in
      the introduction of competitive products that would affect our future revenues
      adversely. However, since our technology is now in the commercial stage, our
      know-how and experience in volume card production, system development and
      software capabilities, brand-name recognition within our card markets, and
      dominant-supplier status for optical memory cards are of far greater importance
      than our patents. At this time, we believe that our existing patent portfolio
      is
      helpful but is no longer essential for maintaining the LaserCard®'s market
      position.





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





THE
      PRICE
      OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT VOLATILITY. The price of our
      common stock is subject to significant volatility, which may be due to
      fluctuations in revenues, earnings, liquidity, press coverage, financial market
      interest, trading volume, and stock market conditions, as well as changes in
      technology and customer demand and preferences. As a result, our stock price
      might be low at the time a stockholder wants to sell the stock. Also, since
      we
      have a relatively low number of shares outstanding (approximately 12 million
      shares) there will be more volatility in our stock if one or two major holders,
      for example, large institutional holders, attempt to sell a large number of
      shares in the open market. Furthermore, our trading volume is often small,
      meaning that a few trades may have disproportionate influence on our stock
      price. In addition, someone seeking to liquidate a sizeable position in our
      stock may have difficulty doing so except over an extended period or privately
      at a discount. Thus, if one or more stockholders were to sell or attempt to
      sell
      a large number of its shares within a short period of time, such sale or attempt
      could cause our stock price to decline. There can be no guarantee that
      stockholders will be able to sell the shares that they acquired at a price
      per
      share equal to the price they paid for the stock.





41







WE
      ARE
      SUBJECT TO RISKS ASSOCIATED WITH CHANGES IN FOREIGN CURRENCY EXCHANGE RATES.
      Part of the manufacturing process of certain LaserCard products that we sell
      outside the U.S.A. takes place in our operations in Germany. Also, some of
      the
      raw materials we use to manufacture optical memory cards are sourced in Europe.
      These costs are denominated in euros, the currency used in much of Europe.
      However, when we sell our finished products the prices that we charge are
      denominated in United States dollars. Accordingly, we are subject to exposure
      if
      the exchange rate for euros increases in relation to the United States dollar.
      During fiscal year 2005, we experienced a $0.2 million loss on foreign currency
      exchange. The losses on foreign currency exchange for both fiscal years 2006
      and
      2004 were immaterial. As of September 30, 2006, we had not entered into a
      forward exchange contract to hedge against or potentially minimize the foreign
      currency exchange risk related to transactions other than those related to
      inter-company and external payables and receivables.





WE
      SOLD A
      SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL INVESTMENTS GROUP (GIG),
      UNDER WHICH WE WILL PROVIDE CERTAIN FACTORY SET-UP AND TRAINING SERVICES. IF
      WE
      ARE NOT SUCCESSFUL OR IF GIG IS UNABLE TO FINANCE THIS OPERATION, THE
      SECOND-SOURCE SUPPLY OF OPTICAL CARDS WILL NOT MATERIALIZE. IF WE AND GIG ARE
      SUCCESSFUL, THE SECOND-SOURCE WILL COMPETE WITH US FOR BUSINESS. If GIG is
      not
      successful, but current and potential customers require a second source of
      optical memory cards (which is a common business practice) they could decide
      to
      use alternate technology cards, such as chip cards, that have multiple-source
      suppliers. If GIG makes its remaining $5.05 million payment, we will be
      obligated to deliver approximately $11 million worth of the required
      manufacturing equipment and installation support to GIG for its to-be-built
      new
      card manufacturing facility in Slovenia, to provide a targeted initial
      manufacturing capacity of 10 million optical cards annually. If GIG is
      successful, this will supply a second source for optical memory cards. We will
      also be assigning personnel to be on site during the license term to assist
      with
      quality, security, and operational procedures, with a mutual goal that the
      facility and the cards made in Slovenia conform to our standards. If cards
      are
      not produced in conformance with our quality standards, the reputation and
      marketability of optical memory card technology could be damaged. If the factory
      does not become operational and produce quality cards in high volume, or if
      GIG
      is unable to raise sufficient capital to build, equip and operate this facility,
      we would not obtain the hoped-for benefits--including ongoing royalties, sales
      of raw materials to GIG, expansion of the European market, and a bona fide
      second source for optical memory cards. The Company and GIG agreed to
      restructure the contract to make the final thirteen years of support optional
      at
      $1 million per year and to delay the due date of the $5.05 million balance
      due
      to November 10, 2006. The Company intends to maintain possession of the
      equipment until the final payments are made. On the other hand, if and when
      the
      factory is successfully manufacturing the cards in high volume, it will compete
      against us for business in certain territories, which could reduce our potential
      card revenues if the market does not expand. Revenue will be recognized over
      the
      remaining term of the agreement beginning when the equipment has been accepted
      and training completed, which date is dependent on GIG providing a facility
      in
      Slovenia. The Company could incur greater expenses than it anticipates for
      the
      purchase and installation of the required manufacturing equipment thereby
      reducing cash and anticipated profits.





42






WHEN
      WE
      ACQUIRED OUR GERMAN SUBSIDIARY IN APRIL, 2004, WE RECOGNIZED APPROXIMATELY
      $3.3
      MILLION AS GOODWILL ON OUR BALANCE SHEET. WE MAY INCUR AN IMPAIRMENT CHARGE
      TO
      THE EXTENT WE DETERMINE THAT IT IS NOT LIKLEY THAT THE UNDISCOUNTED CASH FLOW
      FROM OUR GERMAN OPERATIONS IS SUFFICIENT TO RECOVER THE RECORDED GOODWILL.
      When
      we acquired our German subsidiary in April, 2004, we recognized approximately
      $3.3 million as goodwill on our balance sheet. We acquired this subsidiary
      for
      several reasons, including obtaining a more visible European presence and
      vertically integrating a supplier of ours, and therefore consider the
      acquisition to have been a success. However, under GAAP, we will need to incur
      an impairment charge to the extent we determine that future undiscounted cash
      flow is insufficient to recover the recorded goodwill. This will be determined
      in part by the profitability of the German operations. We are required to make
      such an assessment annually. Any such impairment charge will correspondingly
      decrease our profitability and could lead to a decline in our stock
      price.





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





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





FOREIGN
      GOVERNMENT INTERVENTION COULD ADVERSELY AFFECT RESULTS OF OPERATIONS. Economic,
      political and other risks associated with foreign operations could adversely
      affect our international sales.  We sell our products worldwide and
      therefore, our business could be subject to risks due to changes in a country’s
      or region’s political or economic conditions.  Differing tax laws and
      changes in those laws may also affect future results of our
      operations.





PANDEMICS
      THROUGHOUT THE WORLD COULD ADVERSELY AFFECT OUR BUSINESS. The occurrence of
      a
      pandemic such as the Bird Flu coupled with the lack of government readiness
      and
      support in those countries where we do business could temporarily impede our
      revenue growth.





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





43







WE
      HAVE
      IMPLEMENTED ENTERPRISE RESOURCE PLANNING (“ERP”) SOFTWARE TO PROVIDE US THE
      INFORMATION WE NEED TO BETTER MANAGE AND PLAN OUR BUSINESS AND ENHANCE OUR
      FINANCIAL REPORTING. IF THIS IMPLEMENTATION IS UNSUCCESSFUL, IT COULD ADVERSELY
      IMPACT RATHER THAN ENHANCE OUR ABILITY TO MANAGE AND GROW OUR BUSINESS. Our
      ability to successfully implement our business plan and comply with regulations
      requires an effective planning and management process. We expect that we will
      need to continue to improve existing, and implement new, operational and
      financial systems, procedures and controls to manage our business effectively
      in
      the future. We have implemented an ERP software to provide us the information
      we
      need to better manage and plan our business and enhance our financial
      reporting. ****** Such
      implementations are costly and require personnel time and attention in order
      to
      succeed and can be problematic. Any disruption in the transition to, new or
      enhanced systems, procedures or controls, could harm our ability to accurately
      forecast sales demand, manage our supply chain and record and report financial
      and management information on a timely and accurate basis. A comprehensive
      evaluation through acceptance testing, end-user training, and extensive control
      environment was put in place leading up to the decision to switch to the new
      ERP
      system. Strict monitoring of the operational and financial results within the
      new ERP system is anticipated to occur on a daily basis. The Company has chosen
      not to run the old and new systems in parallel except for transactions related
      to the manufacture of optical memory cards and with a switchover plan has
      committed to the new system. Should unexpected issues arise with the new system
      as it is on-line and in operation, the Company could have difficulty in
      obtaining the information it requires to run its business effectively and
      generate financial reports. These unexpected issues, should they arise, could
      be
      difficult to resolve and their resolution could take time and substantial
      management attention.





AS
      A
      RESULT OF OUR REQUIRED ANNUAL EVALUATION OF OUR INTERNAL CONTROLS OVER FINANCIAL
      REPORTING, WE MAY IDENTIFY INTERNAL CONTROL WEAKNESSES NEEDING REMEDIATION,
      WHICH COULD HARM OUR REPUTATION. We
      have
      completed the first and second annual evaluation of our internal controls over
      financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
      2002 for the fiscal years ended March 31, 2005 and 2006. Although our
      assessment, testing and evaluation resulted in our conclusion that as of both
      March 31, 2006 and 2005, our internal controls over financial reporting were
      effective, we cannot predict the outcome of our testing in future periods.
      B ecause
      of
      the inherent limitation of disclosure controls, no evaluation of such controls
      can provide absolute assurance that all control issues and instances of fraud,
      if any, within the Company have been detected. If
      our
      internal controls are found to be ineffective in future periods, our reputation
      could be harmed. We may incur additional expenses and commitment of management’s
      time in connection with further evaluations, both of which could materially
      increase our operating expenses and accordingly reduce our net income.




BEGINNING
      WITH OUR FISCAL YEAR 2007, WE ARE REQUIRED
      TO RECORD COMPENSATION EXPENSE FOR STOCK OPTIONS. AS A RESULT OF THE RESULTING
      SIGNIFICANT EXPENSES, IT WILL BE MORE DIFFICULT FOR US TO CONTINUE TO BE
      PROFITABLE AND ANY PROFITABILITY WE ACHIEVE WILL BE REDUCED SIGNIFICANTLY.
In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Financial Accounting Standard 123(R) (SFAS No. 123(R)) that requires the fair
      value of all equity-based awards granted to employees be recognized in the
      statement of operations as compensation expense, for fiscal years beginning
      after December 15, 2005, rather than just to disclose such expense in a footnote
      as we have done in the previous years. Given our outstanding options and our
      current intention to continue to grant options in the future as an incentive
      and
      retention tool for our employees, the adoption of this accounting standard
      will
      reduce our profitability as measured by generally accepted accounting principles
      (GAAP) which may adversely affect our stock price. For example, during the
      first
      half of fiscal year 2007, we recognized approximately $799,000 of expenses
      due
      toSFAS
      No. 123(R)which we
      would not otherwise have recognized. Such adoption could also lead us to reduce
      or otherwise alter our use of stock options which we believe help align our
      employees’ long-term interests with increasing our enterprise value. This could,
      in turn, hurt our ability to recruit employees and retain existing employees
      and
      directors.


44







**Item
      2. - Unregistered Sales of Equity Securities and Use of
      Proceeds**





None





**Item
      3. - Defaults Upon Senior Securities**





None





**Item
      4. - Submission of Matters to a Vote of Security Holders**





At
      the
      Company's September 22, 2006 Annual Meeting of Stockholders, the Company's
      stockholders





(i)
            elected
                the Board of Directors.


(ii)
            ratified
                the selection of Odenberg, Ullakko, Muranishi & Co., LLP as
                independent registered public accounting
                firm.


(iii)
            approved
                an amendment of the 2004 Equity Incentive Compensation Plan to increase
                by
                575,000 the number of shares reserved for issuance
                thereunder.





Of
      the
      11,810,360 shares of common stock outstanding as of the record date of July
      26,
      2006, a total of 10,565,122 shares were voted in person or by proxy,
      representing 89.46% 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: Bernard C. Bailey
      (10,210,071 votes for election, 355,051 votes withheld), Richard M. Haddock
      (10,214,439 votes for re-election, 350,683 votes withheld), Arthur H.
      Hausman (10,024,701 votes for re-election, 540,421 votes withheld), Donald
      E.
      Mattson (10,201,563 votes for re-election, 363,559 votes withheld), Dan Maydan
      (10,072,350 votes for re-election, 492,772 votes withheld), Albert J. Moyer
      (10,066,399 votes for re-election, 498,723 votes withheld) and Walter F. Walker
      (9,733,808 votes for re-election, 831,314 votes withheld).





For
      Proposal 2 Ratification of the Company’s independent registered public
      accounting firm, 10,416,422 shares were voted in favor, and there were 35,220
      negative votes, 113,480 abstentions, and no broker non-votes.





For
      Proposal 3 Approval of an amendment to the 2004 Equity Incentive Compensation
      Plan, 3,649,855 shares were voted in favor, and there were 1,924,141 negative
      votes, 144,945 abstentions, and 4,846,181 broker non-votes.




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





**Item
      5. - Other Information**





None.


45


**Item
      6. - Exhibits**


Exhibit
                  No.
              
              Exhibit
                  Description3(I)
              
              Certificate
                  of Incorporation: Exhibit 3.1 of the registrant’s annual report on Form
                  10-K for the fiscal year ended March 31, 2005, filed with the SEC
                  on June
                  15, 2005, is hereby incorporated by reference3(II)
              
              Bylaws
                  are filed herewith to reflect the change in the annual stockholder
                  meeting
                  in Section 2.210.1
              
              Building
                  lease agreement with Renault & Handley Employees Investment Co. for
                  2644-2648 Bayshore Parkway, Mountain View, CA; previously filed
                  as Exhibit
                  10.1 to Report on Form 10-Q for period ending December 31, 2003
                  and
                  incorporated herein by reference10.2
              
              Building
                  lease agreement with Shoreline Park LLC for 1395 Charleston Road,
                  Mountain
                  View, CA (mailing address 1875 North Shoreline Boulevard, Mountain
                  View,
                  CA) filed as Exhibit 10.2 to Report on Form 10-K for fiscal year
                  ended
                  March 31, 2004 and incorporated herein by reference10.3*
              
              Amended
                  and Restated Stock Option Plan; previously filed as Exhibit 10.4.1
                  to
                  Report on Form 10-Q for period ended September 30, 2002 and
                  incorporated herein by reference10.7
              
              Stock
                  and Warrant Purchase Agreement (as amended); previously filed as
                  Exhibit
                  99.2 to Report on Form 10-Q for period ended December 31,
                  200310.8
              
              Optical
                  Card Manufacturing License Agreement with Global Investments Group
                  (portions omitted pursuant to a request for confidential treatment);
                  filed
                  as Exhibit as Exhibit 10.8 to Report on Form 10-K for fiscal year
                  ended
                  March 31, 2004 and incorporated herein by reference.10.9*
              
              2004
                  Equity Incentive Compensation Plan, as Amended. Appendix A to Schedule
                  14A
                  Proxy Statement for 2005 Annual Stockholders Meeting filed with
                  the SEC on
                  September 6, 2005, is hereby incorporated by reference.10.10
              
              June
                  29, 2006 Amendment to License and Equipment Agreement with Global
                  Investments Group and Prevent LOK; previously filed as Exhibit
                  10.10 to
                  Report on Form 10-Q for period ending June 30, 2006, and incorporated
                  herein by reference**10.11
              
              October
                  27, 2006 Modified Third Amendment to License and Equipment Agreements
                  with
                  Global Investments Group and Prevent LOK; previously filed as Exhibit
                  10.11 to Form 8-K dated October 30, 2006, which was filed with
                  the SEC on
                  November 1, 2006, and incorporated herein by reference31.1
              
              Rule
                  13a-14(a) Certification of Richard M. Haddock, chief executive
                  officer is
                  filed herewith.31.2
              
              Rule
                  13a-14(a) Certification of Steven G. Larson, chief financial officer
                  is
                  filed herewith.32.1
              
              Section
                  1350 Certification of Richard M. Haddock, chief executive officer
                  is filed
                  herewith.32.2
              
              Section
                  1350 Certification of Steven G. Larson, chief financial officer
                  is filed
                  herewith.


Exhibits
      3(II), 31.1, 31.2, 32.1, and 32.2 are filed herewith while the other exhibits
      are incorporated by reference. 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.





*
            Indicates
                management contract or compensatory plan or
                arrangement.


**
            Portions
                were omitted pursuant to a request for confidential
                treatment.


46





SIGNATURES





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized:





LASERCARD
      CORPORATION


(Registrant)








Signature
              
              Title
              
              Date/s/Richard
                  M.
                  Haddock
              
              Chief
                  Executive Officer
              
              November
                  6, 2006Richard
                  M. Haddock/s/Steven
                  G.
                  Larson
              
              Chief
                  Financial Officer
              
              November
                  6, 2006Steven
                  G. Larson


47


INDEX
      TO
      EXHIBITS





[ITEM
      14(c)]


Exhibit
                Number
              
              Description3(I)
              
              Certificate
                  of Incorporation: Exhibit 3.1 of the registrant’s annual report on Form
                  10-K for the fiscal year ended March 31, 2005, filed with the SEC
                  on June
                  15, 2005, is hereby incorporated by reference3(II)
              
              Bylaws
                  are filed herewith to reflect the change in the annual stockholder
                  meeting
                  in Section 2.210.1
              
              Building
                  lease agreement with Renault & Handley Employees Investment Co. for
                  2644-2648 Bayshore Parkway, Mountain View, CA; previously filed
                  as Exhibit
                  10.1 to Report on Form 10-Q for period ending December 31, 2003
                  and
                  incorporated herein by reference10.2
              
              Building
                  lease agreement with Shoreline Park LLC for 1395 Charleston Road,
                  Mountain
                  View, CA (mailing address 1875 North Shoreline Boulevard, Mountain
                  View,
                  CA) filed as Exhibit 10.2 to Report on Form 10-K for fiscal year
                  ended
                  March 31, 2004 and incorporated herein by reference10.3*
              
              Amended
                  and Restated Stock Option Plan; previously filed as Exhibit 10.4.1
                  to
                  Report on Form 10-Q for period ended September 30, 2002 and
                  incorporated herein by reference10.7
              
              Stock
                  and Warrant Purchase Agreement (as amended); previously filed as
                  Exhibit
                  99.2 to Report on Form 10-Q for period ended December 31,
                  200310.8
              
              Optical
                  Card Manufacturing License Agreement with Global Investments Group
                  (portions omitted pursuant to a request for confidential treatment);
                  filed
                  as Exhibit as Exhibit 10.8 to Report on Form 10-K for fiscal year
                  ended
                  March 31, 2004 and incorporated herein by reference.10.9*
              
              2004
                  Equity Incentive Compensation Plan, as Amended. Appendix A to Schedule
                  14A
                  Proxy Statement for 2005 Annual Stockholders Meeting filed with
                  the SEC on
                  September 6, 2005, is hereby incorporated by reference.10.10
              
              June
                  29, 2006 Amendment to License and Equipment Agreement with Global
                  Investments Group and Prevent LOK; previously filed as Exhibit
                  10.10 to
                  Report on Form 10-Q for period ending June 30, 2006, and incorporated
                  herein by reference**10.11
              
              October
                    27, 2006 Modified Third Amendment to License and Equipment Agreements
                    with
                    Global Investments Group and Prevent LOK; previously filed as
                    Exhibit
                    10.11 to Form 8-K dated October 30, 2006, which was filed with
                    the SEC on
                    November 1, 2006, and incorporated herein by
                    reference31.1
              
              Rule
                  13a-14(a) Certification of Richard M. Haddock, chief executive
                  officer is
                  filed herewith.31.2
              
              Rule
                  13a-14(a) Certification of Steven G. Larson, chief financial officer
                  is
                  filed herewith.32.1
              
              Section
                  1350 Certification of Richard M. Haddock, chief executive officer
                  is filed
                  herewith.32.2
              
              Section
                  1350 Certification of Steven G. Larson, chief financial officer
                  is filed
                  herewith.




*
            Indicates
                management contract or compensatory plan or
                arrangement.


**
            Portions
                were omitted pursuant to a request for confidential
                treatment.


48