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 December 31, 2006




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




Delaware
              
              0-6377
              
              77-0176309(State
                  or other jurisdiction of
                incorporation
                  or organization)
              
              (Commission
                  File Number)
              
              (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 o
          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 o
                
                Accelerated
                    filer x
                
                Non-accelerated
                    filer o
 
 Indicate
          by check mark whether the registrant is a shell company (as defined in
          Rule
          12b-2 of the Exchange Act). o Yes x
          No
 
 Number
          of
          outstanding shares of common stock, $.01 par value, at January 31, 2007:
          11,835,439
  Exhibit
            Index is on Page 48
  Total
            number of pages is 48
  1




**TABLE
        OF CONTENTS**


Page
                  NumberPART
                  I.
              
              FINANCIAL
                  INFORMATIONItem
                  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
              
              35Item
                  4.
              
              Controls
                  and Procedures
              
              36PART
                  II.
              
              OTHER
                  INFORMATIONItem
                  1.
              
              Legal
                  Proceedings
              
              37Item
                  1A.
              
              Risk
                  Factors
              
              37Item
                  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
              
              45SIGNATURES
              
              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)**




December
                    31,
                  2006
                  (Unaudited)
              
              March
                    31,
                  2006*ASSETSCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              3,470
              
              $
              2,121Short-term
                  investments
              
              
              14,800
              
              
              21,350Accounts
                  receivable, net of allowance
              
              
              2,147
              
              
              4,920Inventories,
                  net of reserve
              
              
              10,598
              
              
              8,874Deferred
                  contract costs
              
              
              2,305
              
              
              1,041Prepaid
                  and other current assets
              
              
              1,618
              
              
              1,268Total
                  current assets
              
              
              34,938
              
              
              39,574Property
                  and equipment, net
              
              
              13,022
              
              
              12,306Deferred
                  long-term contract costs
              
              
              709
              
              
              —Equipment
                  held for resale
              
              
              6,248
              
              
              5,877Patents
                  and other intangibles, net
              
              
              893
              
              
              889Goodwill
              
              
              3,321
              
              
              3,321Notes
                  receivable
              
              
              223
              
              
              205Other
                  non-current assets
              
              
              114
              
              
              163Total
                  assets
              
              $
              59,468
              
              $
              62,335LIABILITIES
                  AND STOCKHOLDERS’
                  EQUITYCurrent
                  liabilities:Accounts
                  payable
              
              $
              1,783
              
              $
              3,311Accrued
                  liabilities
              
              
              2,283
              
              
              3,118Deferred
                  income tax liabilities
              
              
              561
              
              
              568Advance
                  payments from customers
              
              
              3,904
              
              
              1,772Deferred
                  revenue-current portion
              
              
              697
              
              
              459Total
                  current liabilities
              
              
              9,228
              
              
              9,228Advance
                  payments from customers
              
              
              18,500
              
              
              18,500Deferred
                  revenue
              
              
              2,000
              
              
              2,000Long-term
                  deferred rent
              
              
              781
              
              
              590Total
                  liabilities
              
              
              30,509
              
              
              30,318Stockholders’
                  equity:Common
                  stock
              
              
              118
              
              
              117Additional
                  paid-in capital
              
              
              60,474
              
              
              58,255Accumulated
                  deficit
              
              
              (31,789
              )
              
              (26,351
              )Accumulated
                  other comprehensive income (loss)
              
              
              156
              
              
              (4
              )Total
                  stockholders’
                  equity
              
              
              28,959
              
              
              32,017Total
                  liabilities and stockholders’
                  equity
              
              $
              59,468
              
              $
              62,335




*
              Amounts
                  derived from audited consolidated 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
                
                Nine
                    Months EndedDecember
                    31
                
                December
                    312006
                
                2005
                
                2006
                
                2005Revenues
                
                $
                6,184
                
                $
                10,077
                
                $
                23,032
                
                $
                25,770Cost
                      of product sales (includes $90 and $258 stock-based compensation
                      in the three and nine month periods ended
                      December 31, 2006)
                
                
                5,397
                
                
                5,890
                
                
                17,252
                
                
                17,250Gross
                    profit
                
                
                787
                
                
                4,187
                
                
                5,780
                
                
                8,520Operating
                    expenses:Selling,
                            general, and administrative expenses (includes $334 and
                            $805 stock-based
                            compensation in the three and nine month periods ended
                            December 31, 2006
                            and $34 and $101 in the three and nine month periods
                            ended December 31,
                            2005, respectively)
                
                
                3,294
                
                
                2,517
                
                
                9,712
                
                
                8,260Research
                        and development expenses (includes $83 and $291 stock-based
                        compensation
                        in the three and nine month periods ended December 31,
                        2006)
                
                
                763
                
                
                557
                
                
                2,308
                
                
                1,608Total
                    operating expenses
                
                
                4,057
                
                
                3,074
                
                
                12,020
                
                
                9,868Operating
                    income (loss)
                
                
                (3,270
                )
                
                1,113
                
                
                (6,240
                )
                
                (1,348
                )Other
                    income, net
                
                
                267
                
                
                109
                
                
                706
                
                
                313Income
                    (loss) before income taxes
                
                
                (3,003
                )
                
                1,222
                
                
                (5,534
                )
                
                (1,035
                )Income
                    tax expense (benefit)
                
                
                (25
                )
                
                68
                
                
                (96
                )
                
                69Net
                    income (loss)
                
                $
                (2,978
                )
                $
                1,154
                
                $
                (5,438
                )
                $
                (1,104
                )Net
                    income (loss) per share:Basic
                
                $
                (0.25
                )
                $
                0.10
                
                $
                (0.46
                )
                $
                (0.10
                )Diluted
                
                $
                (0.25
                )
                $
                0.10
                
                $
                (0.46
                )
                $
                (0.10
                )Weighted-average
                      shares of common stock used in computing net income (loss)
                      per
                      share:Basic
                
                
                11,827
                
                
                11,375
                
                
                11,803
                
                
                11,358Diluted
                
                
                11,827
                
                
                11,577
                
                
                11,803
                
                
                11,358




The
        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)**
  Nine
                    Months EndedDecember
                    31,2006
                
                2005Cash
                    flows from operating activities:Net
                    loss
                
                $
                (5,438
                )
                $
                (1,104
                )Adjustments
                    to reconcile net loss to net cash provided by (used in) operating
                    activities:Depreciation
                    and amortization
                
                
                2,034
                
                
                1,895Loss
                    on disposal of equipment
                
                
                63
                
                
                —Provision
                    for doubtful accounts receivable
                
                
                19
                
                
                —Provision
                    for excess and obsolete inventory
                
                
                130
                
                
                203Provision
                    for product return reserve
                
                
                —
                
                
                234Provision
                    for warranty reserve
                
                
                97
                
                
                —Stock-based
                    compensation
                
                
                1,354
                
                
                101Changes
                    in operating assets and liabilities:Decrease
                    (increase) in accounts receivable
                
                
                2,935
                
                
                (209
                )Increase
                    in inventories
                
                
                (1,756
                )
                
                (635
                )Increase
                    in deferred contract costs
                
                
                (1,973
                )
                
                —Increase
                    in prepaid and other current assets
                
                
                (329
                )
                
                (10
                )Increase
                    in equipment held for resale
                
                
                (371
                )
                
                (1,613
                )Decrease
                    (increase) in other non-current assets
                
                
                49
                
                
                (62
                )Decrease
                    in accounts payable and accrued liabilities
                
                
                (2,581
                )
                
                (914
                )Decrease
                    in deferred income tax liabilities
                
                
                (55
                )
                
                —Increase
                    (decrease) in deferred revenue
                
                
                213
                
                
                (27
                )Increase
                    in long-term deferred rent
                
                
                191
                
                
                191Increase
                    in advance payments from customers
                
                
                2,120
                
                
                7,480Net
                    cash provided by (used in) operating activities
                
                
                (3,298
                )
                
                5,530Cash
                    flows from investing activities:Purchases
                    of property and equipment
                
                
                (2,538
                )
                
                (1,427
                )Acquisition
                    of patents and other intangibles
                
                
                (109
                )
                
                (86
                )Purchases
                    of short-term investments
                
                
                (15,600
                )
                
                (19,500
                )Proceeds
                    from maturities of short-term investments
                
                
                22,150
                
                
                11,600Net
                    cash provided by (used in) investing activities
                
                
                3,903
                
                
                (9,413
                )Cash
                    flows from financing activities:Proceeds
                    from sale of common stock through stock plans
                
                
                867
                
                
                582Payment
                    of bank loan
                
                
                —
                
                
                (108
                )Increase
                    in short-term and long-term debt
                
                
                —
                
                
                143Net
                    cash provided by financing activities
                
                
                867
                
                
                617Effect
                    of exchange rate changes on cash and cash equivalents
                
                
                (123
                )
                
                57Net
                    increase (decrease) in cash and cash equivalents
                
                
                1,349
                
                
                (3,209
                )Cash
                    and cash equivalents:Beginning
                    of period
                
                
                2,121
                
                
                3,965End
                    of period
                
                $
                3,470
                
                $
                756




The
      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 nine-month periods ended December 31,
      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 third quarter of fiscal year 2007 ended on December
      29,
      2006, and the 13-week third quarter of fiscal year 2006 ended on December 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 December 31, 2006, we had a foreign exchange forward
      contract with a maturity of less than 30 days to purchase 2.5 million
      euros. The fair value of the forward contract was not material at December
      31, 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 December 31, 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
                        December
                          31,
              
              Nine
                          Months Ended
                        December
                          31,2006
              
              2005
              
              2006
              
              2005Customer
                  A
              
              
              41
              %
              
              30
              %
              
              34
              %
              
              35
              %Customer
                  B
              
              
              —
              
              
              38
              %
              
              11
              %
              
              21
              %




Two
      customers accounted for 22% and 12% respectively of net accounts receivable
      at
      December 31, 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 December 31, 2006 and March 31, 2006 were $3.5 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 December
      31,
      2006 and March 31, 2006, the Company has determined that an impairment which
      was
“other than temporary” has not occurred.





*(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 December 31, 2006 and March 31, 2006.




7


**LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  *(10.)
        Accounts
        Receivable.* Accounts
        receivable are net of allowance for doubtful accounts and product return
        reserves of $167,000 and $142,000 as of December 31, 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 December 31, 2006 and March 31, 2006 are (in
        thousands):


December
                    31,
                  2006
              
              March
                    31,
                  2006Trade
                  receivables
              
              $
              2,129
              
              $
              4,897Allowance
                  for doubtful accounts
              
              
              (89
              )
              
              (64
              )Product
                  return reserves
              
              
              (78
              )
              
              (78
              )Interest
                  receivable
              
              
              31
              
              
              93Other
                  receivables
              
              
              154
              
              
              72Total
                  receivables, net
              
              $
              2,147
              
              $
              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 December 31, 2006 and March 31,
      2006 are (in thousands):




December
                  31,
                2006
              
              March
                  31,
                2006Raw
                  materials
              
              $
              6,945
              
              $
              5,662Work-in-process
              
              
              1,216
              
              
              1,453Finished
                  goods
              
              
              2,437
              
              
              1,759Total
                  inventories
              
              $
              10,598
              
              $
              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 inventory reserves net
      change was a net relief of $43,000 and an increase of $77,000 for the three
      and
      nine-months ended December 31, 2006, respectively. The inventory reserves net
      change was $48,000 for the three months ended December 31, 2005, and a net
      relief of $203,000 for the nine-months ended December 31, 2005.





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 December 31, 2006 and March 31, 2006 are (in
      thousands):




December
                  31,
                2006
              
              March
                  31,
                2006Parts
              
              $
              5,310
              
              $
              5,187Labor
              
              
              824
              
              
              591Other
              
              
              114
              
              
              99Total
                  equipment held for resale
              
              $
              6,248
              
              $
              5,877





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




December
                  31,
                2006
              
              March
                  31,
                2006Building
                  and land
              
              $
              875
              
              $
              803Equipment
                  and furniture
              
              
              24,723
              
              
              22,464Construction
                  in progress, includingpurchased
                  equipment
              
              
              623
              
              
              802Leasehold
                  improvements
              
              
              4,676
              
              
              4,40930,897
              
              
              28,478Less:
                  accumulated depreciation and amortization
              
              
              (17,875
              )
              
              (16,172
              )Total
                  property and equipment, net
              
              $
              13,022
              
              $
              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
      nine-months ended December 31, 2006 was $711,000 and $2,034,000 respectively
      and
      December 31, 2005 was $609,000 and $1,895,000, 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 December
      31,
      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 December 31, 2006 and March 31, 2006
      are
      (in thousands):





December
                31,
              2006
            
            March
                31,
              2006Accrued
                payroll and fringe benefits
            
            $
            362
            
            $
            1,218Accrued
                compensated absences
            
            
            385
            
            
            622Actual
                warranty reserves
            
            
            674
            
            
            648Other
                accrued liabilities
            
            
            862
            
            
            630Total
                accrued liabilities
            
            $
            2,283
            
            $
            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 condensed
      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 liabilities in the condensed 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 U.S. government’s
      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 $1,000 and
      $10,000 of revenues during the three-months ended December 31, 2006 and 2005,
      respectively, based on a zero profit margin related to a long-term contract.
      The
      Company recognized approximately $11,000 and $76,000 of revenues during the
      nine-months ended December 31, 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 $3.6 million through December 31, 2006, are recorded as advance
      payments from customers in the condensed consolidated balance sheet. As of
      December 31, 2006 and March 31, 2006, no revenue has been recognized under
      this
      contract, and costs incurred under the contract of $3 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):





December
                31,
              2006
            
            March
                31,
              2006Optical
                memory cards and freight
            
            $
            2,107
            
            $
            592Hardwareand other costs
            
            
            907
            
            
            449Total
                deferred contract costs
            
            $
            3,014
            
            $
            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 nine-month periods
      ended December 31, 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 nine-month periods ended December 31, 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
      $11.5 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 December 31, 2006, the Company had acquired $6 million of this
      equipment, classified as equipment held for resale on its condensed 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 which has been overdue since 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 condensed 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.





11


**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**





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 revenue for the card manufacturing
      license, the monthly “Ready
      Fee”,
      and 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
      had
      previously 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 nine month periods
      ended
      December 31, 2006 and 2005 (in thousands):





Three
                Months Ended
              December
                31,
            
            Nine
                Months Ended
              December
                31,2006
            
            2005
            
            2006
            
            2005Beginning
                balance
            
            $
            679
            
            $
            102
            
            $
            699
            
            $
            155Accruals
                for products sold
            
            
            (1
            )
            
            82
            
            
            97
            
            
            189Costs
                incurred
            
            
            (4
            )
            
            (45
            )
            
            (122
            )
            
            (205
            )Ending
                balance
            
            $
            674
            
            $
            139
            
            $
            674
            
            $
            139





*(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 nine-months ended
      December 31, 2006 and 2005, respectively, and are included in selling, general,
      and administrative expenses. There were no such costs for the three-months
      ended
      December 31, 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 for the
      three month period ended December 31, 2006:




Expected
                  stock price volatility
              55%Risk
                  free interest rate
              4.40%
                  to 4.96%Expected
                  life of options
              4.4
                  to 5 yearsExpected
                  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 at least on 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 $476,000 and $1,275,000 for the three and nine-months
      ending December 31, 2006, net of estimated forfeitures. The Company recognized
      the full amount of the stock-based employee compensation expense of its equity
      incentive plans in the condensed consolidated statements of operations for
      the
      three and nine-months ended December 31, 2006 and did not capitalize any such
      costs in the condensed 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
      nine-months ended December 31, 2006 as follows (in thousands):





Three
                  Months Ended
                December
                  31,
                2006
            
            Nine
                Months Ended
                December
                  31,
              2006Cost
                of product sales
            
            $
            90
            
            $
            258General
                and administrative expense
            
            
            303
            
            
            726Research
                and development expense
            
            
            83
            
            
            291Stock-based
                compensation expense before income tax
            
            
            476
            
            
            1,275Less:
                income tax benefit
            
            
            —
            
            
            —Net
                stock-based compensation expense after income tax
            
            $
            476
            
            $
            1,275





The
      Company also had an expense of $31,000 and $79,000 relating to the Employee
      Stock Purchase Plan (ESPP) which is included in the Company’s
      condensed consolidated statements of operations for the three and nine-months
      ended December 31, 2006, respectively.





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 nine-months ended December 31, 2005 as if
      the
      Company had applied the fair value recognition provisions of SFAS No. 123 to
      stock-based employee awards (in thousands, except for per share amounts):





14




**LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 Three
                    Months Ended
                  December
                    31, 2005
                
                Nine
                      Months Ended
                    December
                      31, 2005Net
                    income (loss), as reported
                
                $
                1,154
                
                $
                (1,104
                )Add:
                      stock based employee compensation expense included in reported
                      net income
                      (loss), net of tax
                
                
                34
                
                
                101Deduct:
                      stock-based compensation expense determined using fair value
                      based method
                      for all awards, net of tax
                
                
                (520
                )
                
                (1,222
                )Net
                    income (loss), pro forma
                
                $
                668
                
                $
                (2,225
                )Net
                    income (loss) per common share:Basic
                    and diluted, as reported
                
                $
                0.10
                
                $
                (0.10
                )Basic
                    and diluted, proforma
                
                $
                0.06
                
                $
                (0.20
                )




Using
        the
        Black-Scholes option-pricing model, the fair values of options granted during
        the three and nine-months ended December 31, 2005 were calculated with the
        following weighted-average assumptions:
  Three
                  Months Ended
                December
                  31, 2005
              
              Nine
                  Months Ended
                December
                  31, 2005Expected
                stock price volatility
              
              
              N/A
              
              
              55%Risk
                free interest rate
              
              
              N/A
              
              
              3.81%
                  - 4.23%Expected
                life of options
              
              
              N/A
              
              
              5
                  yearsExpected
                annual dividends
              
              
              N/A
              
              
              —
  There
          were no options granted during the three-month period ended December 31,
          2005.
          There were 434,800 options granted during the nine-month period ended December
          31, 2005.
 
 The
          following table summarizes the stock option activity for the nine-months
          ended
          December 31, 2006:
   Stock
                    Options
                
                Weighted
                      Average
                    Exercise
                      Price
                
                Weighted
                          Average
                        Remaining
                        Contractual
                          Term
                
                Aggregate
                    Intrinsic
                    ValueOustanding
                    at March 31, 2006
                
                
                2,063,673
                
                $
                12.27Granted
                
                
                470,250
                
                $
                15.18Exercised
                
                
                (96,360
                )
                $
                10.33Canceled/expired/forfeited
                
                
                (139,729
                )
                $
                12.25Outstanding
                    at December 31, 2006
                
                
                2,297,834
                
                $
                12.95
                
                
                5.24
                
                $
                1,903,605Options
                    vested and exercisable at December 31, 2006
                
                
                1,420,295
                
                $
                13.50
                
                
                3.86
                
                $
                511,578




As
        of
        December 31, 2006 there was approximately $4.3 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 December 31, 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
        (ESPP), 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 ESPP is charged to operations as a compensation expense and is
        taxed
        to the employee as income. The Company recorded compensation expense related
        to
        the ESPP of $31,000 and $34,000 for the three months ended December 31, 2006
        and
        2005, respectively, and $79,000 and $101,000 for the nine months ended December
        31, 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 nine-months ended December 31, 2006 and 2005,
        comprehensive income (loss) is as follows (in thousands):
  Three
                      Months Ended
                    December
                      31,
                
                Nine
                      Months Ended
                    December
                      31,2006
                
                2005
                
                2006
                
                2005Net
                    income (loss)
                
                $
                (2,978
                )
                $
                1,154
                
                $
                (5,438
                )
                $
                (1,104
                )Net
                      change in cumulative foreign currency translation
                      adjustments
                
                
                63
                
                
                (8
                )
                
                160
                
                
                (196
                )Other
                    comprehensive income (loss)
                
                $
                (2,915
                )
                $
                1,146
                
                $
                (5,278
                )
                $
                (1,300
                )


*(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.





**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.




16




**LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 The
          reconciliation of the denominators of the basic and diluted net income
          (loss)
          per share computation for the three and nine-months ended December 31,
          2006 and
          2005 is shown in the following table (in thousands, except per share
          data):
  Three
                        Months Ended
                      December
                        31,
                  
                  Nine
                        Months Ended
                      December
                        31,2006
                  
                  2005
                  
                  2006
                  
                  2005Net
                      income (loss)
                  
                  $
                  (2,978
                  )
                  $
                  1,154
                  
                  $
                  (5,438
                  )
                  $
                  (1,104
                  )Basic
                      net income (loss) per share:Weighted
                      average common shares outstanding
                  
                  
                  11,827
                  
                  
                  11,375
                  
                  
                  11,803
                  
                  
                  11,358Basic
                      net income (loss) per share
                  
                  $
                  (0.25
                  )
                  $
                  0.10
                  
                  $
                  (0.46
                  )
                  $
                  (0.10
                  )Diluted
                      net income (loss) per share:Weighted
                      average common shares outstanding
                  
                  
                  11,827
                  
                  
                  11,375
                  
                  
                  11,803
                  
                  
                  11,358Weighted
                      average common shares from stock option grants
                  
                  
                  —
                  
                  
                  202
                  
                  
                  —
                  
                  
                  —Weighted
                        average common shares and common stock equivalents
                        outstanding
                  
                  
                  11,827
                  
                  
                  11,577
                  
                  
                  11,803
                  
                  
                  11,358Diluted
                      net income (loss) per share
                  
                  $
                  (0.25
                  )
                  $
                  0.10
                  
                  $
                  (0.46
                  )
                  $
                  (0.10
                  )




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
        nine-months ended December 31, 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 December 31, 2006.
  17


**LASERCARD
      CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**





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 nine-months ended December
      31, 2006 and 2005 (in thousands):





Three
      Months Ended December 31, 2006





Optical
              Memory
              Cards
            
            Optical
              Card
              Drives
            
            Specialty
              Cards
                &
              Printers
            
            Segment
              Total
            
            Other
                (a)
            
            TotalRevenues
            
            $
            3,086
            
            $
            182
            
            $
            2,916
            
            $
            6,184
            
            
            —
            
            $
            6,184Cost
                of product sales
            
            
            2,745
            
            
            258
            
            
            2,394
            
            
            5,397
            
            
            —
            
            
            5,397Gross
                profit (loss)
            
            
            341
            
            
            (76
            )
            
            522
            
            
            787
            
            
            —
            
            
            787Depreciation
                andamortization
                expense
            
            
            441
            
            
            45
            
            
            83
            
            
            569
            
            
            142
            
            
            711





Three
      Months Ended December 31, 2005





Optical
              Memory
              Cards
            
            Optical
              Card
              Drives
            
            Specialty
              Cards
                &
              Printers
            
            Segment
              Total
            
            Other
                (a)
            
            TotalRevenues
            
            $
            7,651
            
            $
            219
            
            $
            2,207
            
            $
            10,077
            
            
            —
            
            $
            10,077Cost
                of product sales
            
            
            3,747
            
            
            458
            
            
            1,685
            
            
            5,890
            
            
            —
            
            
            5,890Gross
                profit (loss)
            
            
            3,904
            
            
            (239
            )
            
            522
            
            
            4,187
            
            
            —
            
            
            4,187Depreciation
                andamortization
                expense
            
            
            360
            
            
            29
            
            
            83
            
            
            472
            
            
            137
            
            
            609





Nine
      Months Ended December 31, 2006





Optical
              Memory
              Cards
            
            Optical
              Card
              Drives
            
            Specialty
              Cards
                &
              Printers
            
            Segment
              Total
            
            Other
                (a)
            
            TotalRevenues
            
            $
            13,860
            
            $
            481
            
            $
            8,691
            
            $
            23,032
            
            
            —
            
            $
            23,032Cost
                of product sales
            
            
            9,631
            
            
            861
            
            
            6,760
            
            
            17,252
            
            
            —
            
            
            17,252Gross
                profit (loss)
            
            
            4,229
            
            
            (380
            )
            
            1,931
            
            
            5,780
            
            
            —
            
            
            5,780Depreciation
                andamortization
                expense
            
            
            1,258
            
            
            134
            
            
            247
            
            
            1,639
            
            
            395
            
            
            2,034





Nine
      Months Ended December 31, 2005





Optical
              Memory
              Cards
            
            Optical
              Card
              Drives
            
            Specialty
              Cards
                &
              Printers
            
            Segment
              Total
            
            Other
                (a)
            
            TotalRevenues
            
            $
            17,128
            
            $
            902
            
            $
            7,740
            
            $
            25,770
            
            
            —
            
            $
            25,770Cost
                of product sales
            
            
            10,195
            
            
            1,410
            
            
            5,645
            
            
            17,250
            
            
            —
            
            
            17,250Gross
                profit (loss)
            
            
            6,933
            
            
            (508
            )
            
            2,095
            
            
            8,520
            
            
            —
            
            
            8,520Depreciation
                andamortization
                expense
            
            
            1,143
            
            
            93
            
            
            219
            
            
            1,455
            
            
            440
            
            
            1,895





(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 February, 2007; 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 Company will have satisfied the
      contractual requirements it has for this Middle Eastern country so that the
      Company can begin recording revenue during its March quarter on this program;
      potential annual revenues being $40 to $50 million at full implementation from
      the Italy program with expected revenues unable to be determined in calendar
      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 $9.2 million if our contract
      is
      renewed; plans to increase card production capacity for anticipated increases
      in
      orders including $7.5 million in capital equipment and leasehold improvements
      during the next fifteen months; 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 Company’s
      attempts to develop other forms of optical recording media for use in optical
      memory cards and the potential benfits derived therefrom; expectations regarding
      revenues (overall and by segment and by customer), margins, profit (including
      a
      loss in the fourth 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; our anticipation that SG&A expenses for the fourth quarter will be
      larger than for the third quarter and include about $0.4 million due primarily
      to consulting expenses related to strategic initiatives; 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; the Company’s
      plan to investigate establishing a line of credit to have in place to partially
      finance any potential acquisitions which the Company may choose to undertake;
      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 resources 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; 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; whether the Middle Eastern country will install the requisite
      infrastructure, including equipment provided by the Company, to begin
      personalizing cards in the contractually-required number of sites; whether
      the
      Company will be successful in developing alternative optical recording media;
      whether the Company will incur consulting expenses due to its strategic
      initiatives during the fourth quarter; and whether the Company is able to
      procure a line of credit given its recent losses and lack of fixed assets;
      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.





20


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:





*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.





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 $1,000 and $10,000 of revenues during the three-months ended
      December 31, 2006 and 2005, respectively, and approximately $11,000 and $76,000
      of revenues during the nine-months ended December 31, 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
      December 31, 2006, no revenue has been recognized under this contract, payments
      received of $3.6 million are recorded as advance payments from customers on
      the
      accompanying condensed consolidated balance sheet, and costs incurred under
      the
      contract of $3 million were recorded as deferred contract costs under the assets
      on the accompanying consolidated balance sheet.





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 nine-months ended December 31, 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
      $11.5 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 December 31, 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, 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 which
      has been overdue since 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




22




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 revenue for the card manufacturing license, the monthly
      “Ready
      Fee”, and 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 nine-months
      ended December 31, 2006 and 2005, respectively.





*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 nine months ended
      December 31, 2006 and 2005 (in thousands):





Three
                Months Ended
              December
                31,
            
            Nine
                Months Ended
              December
                31,2006
            
            2005
            
            2006
            
            2005Beginning
                balance
            
            $
            679
            
            $
            102
            
            $
            699
            
            $
            155Accruals
                for products sold
            
            
            (1
            )
            
            82
            
            
            97
            
            
            189Costs
                incurred
            
            
            (4
            )
            
            (45
            )
            
            (122
            )
            
            (205
            )Ending
                balance
            
            $
            674
            
            $
            139
            
            $
            674
            
            $
            139





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.





23




*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 December
      31, 2006.





The
      fiscal year 2004 acquisition of Challenge Card Design GmbH resulted in a
      deferred tax liability of $561,000 at December 31, 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.





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 nine 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
      December 31, 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.





24




*Inventories.* The
      Company values its inventory at the lower of the actual cost to purchase and/or
      manufacture the inventory or the current estimated net 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.




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 third quarter of fiscal year 2007 and 2006,
      the Company did not record any lower of cost or market adjustments in the
      Company’s condensed 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.





25




*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 nine-month periods
      ended December 31, 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 nine-months
      ended
      December 31, 2006 includes $476,000 and $1,275,000 respectively of share based
      compensation expense included in the condensed consolidated statements of
      operations. As of December 31, 2006, $4.3 million of total unrecognized
      compensation cost related to unvested share-based compensation arrangements
      is
      expected to be recognized over the remaining vesting period through December
      31,
      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.


26




**RESULTS
      OF OPERATIONS—FISCAL YEAR 2007 THIRD QUARTER AND FIRST NINE MONTHS**


**COMPARED
      WITH FISCAL YEAR 2006 THIRD QUARTER AND FIRST NINE 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 secure 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
              December
                31,
            
            Nine
                Months Ended
              December
                31,2006
            
            2005
            
            2006
            
            2005U.S.
                operations
            
            $
            3,277
            
            $
            7,875
            
            $
            14,365
            
            $
            18,245German
                operations
            
            
            2,907
            
            
            2,202
            
            
            8,667
            
            
            7,525$
            6,184
            
            $
            10,077
            
            $
            23,032
            
            $
            25,770





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.





27




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





Three
                Months Ended
              December
                31,
            
            Nine
                Months Ended
              December
                31,2006
            
            2005
            
            2006
            
            2005United
                States Green Cards and Laser Visa BCCs
            
            
            33
            %
            
            23
            %
            
            28
            %
            
            27
            %Canadian
                Permanent Resident Cards
            
            
            7
            %
            
            5
            %
            
            5
            %
            
            6
            %Vehicle
                Registration in India
            
            
            8
            %
            
            3
            %
            
            6
            %
            
            4
            %Italian
                Carta d’Identità Elettronica (CIE) Cards
            
            
            —
            
            
            33
            %
            
            1
            %
            
            19
            %Italian
                Permesso di Soggiorno Elettronico (PSE) Cards
            
            
            —
            
            
            5
            %
            
            10
            %
            
            2
            %





For
      the
      government of Italy, the Company has in the past received orders for national
      ID
      CIE cards (Carta d’Identità Elettronica) and foreign worker PSE cards (Permesso
      di Soggiorno Elettronico) but did not receive any such orders during the first
      nine months of fiscal year 2007. The new government in Italy 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 the Italian government will gear up to begin the
      implementation of the CIE program and we will begin receiving follow-on orders
      to supplement the cards currently in inventory throughout Italy. 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 value added reseller (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. The Company’s subcontract has expired and it expects to receive a
      new multi-year subcontract in February, 2007 although no assurance can be given.
      For these programs, the Company recorded card revenues of $9.2 million over
      the
      last twelve months and expects this level of sales to continue in future periods
      once the subcontract is renewed. The Company currently has no backlog for these
      programs.





For
      fiscal year 2007, shipments under a subcontract for Canada’s Permanent Resident
      Cards totaled $1.2 million. The backlog for this program at December 31, 2006
      totaled $0.7 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 were originally scheduled to
      be
      completed in fiscal 2008 as the prime contractor would elect 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. The Company has
      received and shipped the first three purchase order releases totaling $3.9
      million as of December 31, 2006. In addition, the Company received a $0.3
      million purchase order for 100 additional secure optical memory card encoders,
      doubling the number of encoders originally called for in the $11 million
      contract. The Company completed shipments under this order during the quarter
      ended December 31, 2006. Revenue has not been recorded on these three releases
      or this purchase order and the cost of the items is included in deferred
      contract costs on the Company’s condensed consolidated balance sheets. The $4.2
      million amount is included in backlog until revenue is recorded. The Company
      anticipates that it will have satisfied contractual requirements and begin
      recording revenue during its March quarter on this program. Prior to the $11
      million contract, the Company recorded total revenue of $1.7 million for this
      program during its 2006 fiscal year.





28




Subsequent
      to end of the third quarter end the Company received purchase orders totaling
      $1.1 million for the Middle East program and $0.2 million for the Indian vehicle
      registration program, all shippable during the fourth quarter however revenue
      recognition on the Middle East program is subject to EITF 00-21 rules as
      discussed above. The Company is working toward booking additional card orders
      for shipment in the fourth quarter, but the Company may be unable to accomplish
      this or even if orders are received, it may not be in time for manufacturing
      to
      react. Either way, the Company believes that it is unlikely that it will receive
      card orders that are large enough and received in time for shipment during
      the
      fourth quarter to enable the Company to record a profit for that quarter. The
      Company’s near-term future profitability will be largely dependent upon the
      timing and magnitude of revenues for the Italian and Middle Eastern programs
      to
      supplement expected card revenues from the renewal of our U.S.
      programs.





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 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 million and $10 million for the three-months
      ended December 31, 2006 and 2005, respectively, and $23 million and $26 million
      for the nine-months ended December 31, 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 the nine month period ended December
      31, 2006, and the fiscal year ended March 31, 2006.





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


Three
                  Months Ended
                December
                  31,
              
              Nine
                  Months Ended
                December
                  31,2006
              
              2005
              
              2006
              
              2005Optical
                  memory cards
              
              $
              3,086
              
              $
              7,651
              
              $
              13,860
              
              $
              17,128%
                  of total revenues
              
              
              50
              %
              
              76
              %
              
              60
              %
              
              66
              %Optical
                  card drives
              
              
              182
              
              
              219
              
              
              481
              
              
              902%
                  of total revenues
              
              
              3
              %
              
              2
              %
              
              2
              %
              
              4
              %Specialty
                  cards and card printers
              
              
              2,916
              
              
              2,207
              
              
              8,691
              
              
              7,740%
                  of total revenues
              
              
              47
              %
              
              22
              %
              
              38
              %
              
              30
              %Total
                  revenues
              
              $
              6,184
              
              $
              10,077
              
              $
              23,032
              
              $
              25,770




29




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


Three
                  Months Ended
                December
                  31,
              
              Nine
                  Months Ended
                December
                  31,2006
              
              2005
              
              2006
              
              2005U.S.
                  Green Cards & Laser Visas
              
              $
              2,022
              
              $
              2,310
              
              $
              6,359
              
              $
              6,930Italian
                  National ID Card Programs
              
              
              0
              
              
              3,816
              
              
              2,408
              
              
              5,010Canadian
                  Permanent Resident Cards
              
              
              404
              
              
              505
              
              
              1,226
              
              
              1,560National
                  ID Cards in a Middle Eastern country
              
              
              0
              
              
              0
              
              
              53
              
              
              1,477Vehicle
                  Registration in India
              
              
              511
              
              
              262
              
              
              1,285
              
              
              929All
                  other programs
              
              
              149
              
              
              758
              
              
              2,529
              
              
              1,222Total
                  optical memory card revenues
              
              $
              3,086
              
              $
              7,651
              
              $
              13,860
              
              $
              17,128




Optical
      memory card revenue decreased 60% for the third quarter of fiscal year 2007
      as
      compared with the third quarter of fiscal year 2006 due mainly to decreases
      in
      card unit volume for the Italian national ID programs. Optical memory card
      revenue decreased 19% for the first nine-months of fiscal year 2007 as compared
      with the first nine-months of fiscal year 2006 due mainly to decreases in card
      unit volume for the Italian programs and the deferral of revenue recognition
      on
      shipments to a Middle Eastern country, partially offset by second quarter sales
      of sports logbook cards for Slovenia and an increase in card volume for the
      motor vehicle registration program in India.





Optical
      card drive revenue decreased 17% for the third quarter of fiscal year 2007
      as
      compared with third quarter of fiscal year 2006 and decreased 47% for the first
      nine-months of fiscal year 2007 as compared with the first nine-months 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 third quarter of fiscal
      year
      2007 increased 32% from the $2.2 million for the third quarter of fiscal year
      2006 and the $8.7 million in such revenue for the first nine-months of fiscal
      year 2007 increased 12% (of which 1% is due to the foreign exchange rate) from
      the $7.7 million recorded in the first nine months of fiscal year 2006. The
      32%
      increase in the third quarter of fiscal year 2007 was largely due to a shipment
      of printers to Pakistan. 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 nine-months ended December
      31, 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 $11.5 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
      December 31, 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 which has been overdue since 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.





30







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 revenue for the card manufacturing
      license, the monthly “Ready
      Fee”,
      and 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
      had
      previously 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
      December 31, 2006, the backlog for LaserCard® optical memory cards totaled $0.7
      million mostly scheduled for delivery in the last quarter of fiscal year 2007,
      compared with backlog of $8.3 million at March 31, 2006. This backlog as of
      December 31, 2006, was entirely for Canada’s
      Permanent Resident Cards and is scheduled for delivery through June,
      2007.





In
      addition
      to the OMC backlog, the Company has received and shipped the first three
      purchase order releases totaling $3.9 million out of the $11 million follow-on
      contract for a Middle Eastern Country for a bundled order of optical memory
      cards, read/write drives, card printers, and software. Revenue will not be
      recognized on these releases until the revenue recognition requirements of
      EITF
      00-21 have been satisfied. Additionally, the Company received a $0.3 million
      purchase order for 100 additional secure optical memory card encoders, doubling
      the number of encoders originally called for in the $11 million contract. The
      Company completed shipments under this order during the quarter ended December
      31, 2006. The $4.2 million amount is included in backlog until revenue is
      recorded. 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.





31




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





In
      addition, the backlog for Challenge
      Card Design Plastikkarten GmbH as of December 31, 2006 for specialty cards
      and
      printers totaled 0.7 million euros (approximately $0.9 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 $0.9 million) at December 31, 2006 compared
      with 0.7 million euros (approximately $0.9 million) at March 31, 2006.





Gross
      Margin





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




Three
                  Months Ended
                December
                  31,
              
              Nine
                  Months Ended
                December
                  31,2006
              
              2005
              
              2006
              
              2005Optical
                  memory cards
              
              $
              341
              
              $
              3,904
              
              $
              4,229
              
              $
              6,933%
                  of optical memory card revenues
              
              
              11
              %
              
              51
              %
              
              31
              %
              
              40
              %Optical
                  card drives
              
              
              (76
              )
              
              (239
              )
              
              (380
              )
              
              (508
              )%
                  of optical card drive revenues
              
              
              NM
              
              
              NM
              
              
              NM
              
              
              NMSpecialty
                  cards and card printers
              
              
              522
              
              
              522
              
              
              1,931
              
              
              2,095%
                  of specialty cards and card printers revenues
              
              
              18
              %
              
              24
              %
              
              22
              %
              
              27
              %Total
                  gross margin
              
              $
              787
              
              $
              4,187
              
              $
              5,780
              
              $
              8,520Total
                  gross margin %
              
              
              13
              %
              
              42
              %
              
              25
              %
              
              33
              %




*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 11% of revenue for the third
        quarter of fiscal year 2007 as compared with 51% of revenue for fiscal year
        2006
        is mainly due to the 50% decrease in sales unit volume. The decrease in optical
        memory card gross margin to 31% of revenue for the first nine months of fiscal
        year 2007 as compared with 40% of revenue for the first nine months of fiscal
        year 2006 is due to the 13% decrease in sales unit volume and a decrease
        of 8%
        in average selling price due to product mix. Additionally, gross margin
        decreased due to the impact of SFAS No. 123(R), additional equipment repairs
        and
        maintenance, increased product testing and certification requirements, coupled
        with inefficiencies resulting from slow sales. The adoption of SFAS
        No. 123(R) resulted in a decrease in gross margin of $90,000 or 3% of
        optical memory card revenue for the third quarter of fiscal year 2007, and
        $258,000 or 2% for the first nine months of fiscal year 2007.
 
 *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 18% of revenue in the third quarter of fiscal year 2007 and
        24% in
        the third quarter of fiscal year 2006. The gross margin for this segment
        on the
        first nine months of fiscal year 2007 is 22% of revenue as compared to 27%
        of
        revenue for the first nine-months of fiscal year 2006. Over the past nine
        quarters, the quarterly gross margin has ranged from 21% to 31%. Normally,
        the
        December quarter would have a decrease in revenue as compared with other
        quarters; however, we accepted orders with low margins this year in order
        to
        fill this excess capacity.
 
 32
  Operating
        Expenses
  The
        following table presents operating expenses (in thousands):
  Three
                    Months Ended
                  December
                    31,
                
                Nine
                    Months Ended
                  December
                    31,2006
                
                2005
                
                2006
                
                2005Selling,
                    general and administrative expenses
                
                $
                3,294
                
                $
                2,517
                
                $
                9,712
                
                $
                8,260Research
                    and development expenses
                
                $
                763
                
                $
                557
                
                $
                2,308
                
                $
                1,608




*Selling,
        General, and Administrative Expenses (SG&A).* SG&A expenses
        increased approximately 31% or $0.8 million in the three months ended December
        31, 2006 as compared with the three months ended December 31, 2005 mainly
        due to
        $0.3 million from the application of SFAS No. 123(R) expenses, $0.2 million
        marketing costs, $0.1 million increased salaries due to headcount addition,
        and
        $0.1 million in increased consulting services in marketing. For the nine
        months
        ended December 31, 2006, the increase of SG&A expenses as compared to the
        nine months ended December 31, 2005 was approximately 18% or $1.5 million
        mainly
        due to increases of $0.2 million in salaries, $0.7 million of SFAS No. 123(R)
        expenses, $0.6 million of consulting fees. We anticipate that SG&A expenses
        in the fourth quarter of fiscal year 2007 will be higher than the third quarter
        of fiscal year 2007 and include about $0.4 million due primarily to consulting
        expenses related to strategic initiatives.
 
 *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, OptiChipTMpersonalized
        OVD
        (optically variable device) and other OVD features, and related 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, a significant
        project is to develop additional methods of making optical cards from other
        forms of optical recording media to enhance the existing products, add control
        over raw material sources, allow lower cost read/write drive designs, and
        simplify some card manufacturing steps. 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
        37% or $0.2 million in the three months ended December 31, 2006 as compared
        with
        the three months ended December 31, 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 nine months ended December 31, 2006,
        R&D expenses increased approximately 44% or $0.7 million as compared to the
        nine months ended December 31, 2005 mainly due to the $0.3 million impact
        of
        SFAS No. 123(R).
 
 *Other
        Income,
        Net*. Other income, net for the three months ended December 31, 2006 was
        $267,000 consisting of $272,000 in interest and other income, partially offset
        by other expense of $13,000. Other income, net for the three months ended
        December 31, 2005 was $109,000 consisting of $163,000 in interest income,
        partially offset by $17,000 loss on the sale of capital equipment and a $9,000
        loss from foreign exchange rate fluctuations. Other income, net for the nine
        months ended December 31, 2006 was $706,000 consisting mainly of $802,000
        of
        interest and other income partially offset by interest expense of $95,000
        and
        other miscellaneous expenses. Other income, net for the nine months ended
        December 31, 2005 was $313,000 consisting mainly of $387,000 of interest
        and
        other income, partially offset by $34,000 of other miscellaneous expenses.
        The
        increase in interest income is mainly due to an increase in interest
        rates.
 
 *Income
        Taxes.*The Company recorded an income tax benefit of $25,000 for the third
        quarter
        of fiscal year 2007 due to the Company’s
        foreign subsidiary’s
        loss. The Company recorded an income tax expense of $68,000 for the third
        quarter of fiscal year 2006 due to the anticipated alternative minimum tax
        on
        U.S. operations offset by a $1,000 tax benefit from the foreign subsidiary’s
        loss. The Company recorded an income tax benefit, net of $96,000 for the
        first
        nine months of fiscal year 2007 as compared to a recorded income tax expense
        of
        $69,000 during the first nine months of fiscal year 2006.
 
 33
  LIQUIDITY
        AND CAPITAL RESOURCES
 
 The
        following
        table summarizes cash, cash equivalents and investments as of December 31,
        2006
        and March 31, 2006 (in thousands):
 December
                    31,
                  2006
                
                March
                    31,
                  2006Cash,
                    cash equivalents and short-term investments
                
                $
                18,270
                
                $
                23,471
 
 The
        following
        table displays the sources and uses of cash by activity (in
        thousands):
 Nine
                    Months Ended
                  December
                    31,2006
                
                2005Net
                    cash provided by (used in) operating activities
                
                $
                (3,298
                )
                $
                5,530Net
                    cash provided by (used in) investing activities
                
                $
                3,903
                
                $
                (9,413
                )Net
                    cash provided by financing activities
                
                $
                867
                
                $
                617
 
 Cash
        used in
        operations of $3.3 million during the first nine months of fiscal year 2007
        was
        mainly due to the net loss in the amount of $5.4 million partially offset
        by
        non-cash expenses related to depreciation and stock-based compensation and
        by
        changes in operating assets and liabilities.
 
 Net
        cash
        provided by investing activities during the first nine months of fiscal year
        2007 was due to $6.5 million of net proceeds from maturing investments offset
        by
        $2.5 million in purchases of property and equipment. Net cash used in investing
        activities for the first nine months of fiscal 2006 was due primarily to
        $7.9
        million of net purchases of short-term investments and purchases of property
        and
        equipment of $1.4 million.
 
 Net
        cash
        provided by financing activities during the first nine months of fiscal year
        2007 was $0.9 million, which consisted primarily of net proceeds from the
        sale
        of common stock under the Company’s
        employee stock benefit plans as compared to $0.6 million during the first
        nine
        months of fiscal year 2006.
 
 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 recorded approximately $3.3 million of goodwill on its balance sheet
          resulting from the Company's acquisition of its German subsidiary in April,
          2004. Under GAAP, the Company will incur an impairment charge to the extent
          it
          determines that future undiscounted cash flow from the German operations
          is
          insufficient to recover the recorded goodwill which currently is extremely
          dependent on the level of Italian card manufacturing performed by them.
          The
          Company is required to make such an assessment annually. Should the Company
          not
          receive a substantial Italian order prior to release of its fiscal year
          2007
          financial statements, the Company would most likely determine that the
          goodwill
          of its German subsidiary was fully impaired which will correspondingly
          decrease
          the Company's profitability.
 The
        Company
        has not established a line of credit but plans to investigate establishing
        a
        line of credit to have in place to partially finance any potential acquisitions
        which the Company may choose to undertake.
 
 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 December 31, 2006 the Company
        had $14.8 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.
 
 34
  The
        Company
        made capital equipment and leasehold improvement purchases of approximately
        $1
        million during the third quarter of fiscal year 2007 compared with approximately
        $0.8 million during the third 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 $7.5 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 fifteen months.
 
 OFF-BALANCE
        SHEET ARRANGEMENTS
 
 The
        Company has no off-balance sheet
        arrangement as of December 31, 2006 and 2005 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 third quarter of fiscal year 2007 in the
        Company’s
        exposure to market risk for changes in interest rates.
 
 The
        following
        summarizes short-term investments at fair value, weighted average yields
        and
        expected maturity dates as of December 31, 2006 (in thousands):
 December
                    31, 2006Auction
                    rate securities
                
                $
                14,800Weighted
                    Average Yield
                
                
                5.32
                %U.S.
                    Government and Agency Obligations
                
                
                0Weighted
                    Average Yield
                
                
                0.00
                %Total
                    investments
                
                $
                14,800
  There
        were no long-term investments as of December 31, 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.
 
 35
  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 December 31, 2006, the Company had a foreign exchange
        forward contract with a maturity of less than 30 days to purchase 2.5 million
        euros. The fair value of the forward contract was not material at December
        31, 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. Except for the implementation of a new Enterprise
                Resource Planning (ERP) system as discussed below, there were no
                other
                significant changes in the Company’s
                internal control over financial reporting that occurred during the
                third
                quarter of fiscal year 2007**that
                have materially affected, or are reasonably likely to materially
                affect,
                such control. 
 During
        the third quarter of fiscal 2007, the Company implemented and activated a
        new
        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.
 
 36
 
 **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 September 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 nine months 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 THIRTEEN OF THE PREVIOUS SIXTEEN QUARTERS
        AND MAY NOT BE ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO REGAIN
        PROFITABILITY. Although we generated $3.3 million of profit during the three
        quarters through June 30, 2006, we incurred a loss for our quarters ended
        September 30, and December 31, 2006 and we anticipate a loss for our
        quarter ending March 31, 2007.  We incurred losses during the
        first nine months of fiscal year 2007 aggregating $5.4 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 $32 million at December 31,
        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.
  37
  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 government
        will be
        our largest customer for the next few years for the CIE and PSE card programs
        which may comprise a significant portion of future revenues. Sales of cards
        and
        drives for the government of Italy for its CIE and PSE card programs represented
        11% of total revenue for the first nine months of fiscal 2007, 31% for fiscal
        year 2006, and 26% for fiscal year 2005. During fiscal 2006, we increased
        capacity to meet the anticipated demand and we have expected a large order
        since
        the first quarter of fiscal 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 orders are further delayed, or if full
        implementation is 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 issued
        cards
        and tested 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 ORDER BACKLOG WAS FULFILLED IN DECEMBER 2006.
        IF
        THE CONTRACT IS NOT RENEWED THIS COULD RESULT IN ORDER DELAYS WHICH WOULD
        LIKELY
        LEAD TO DECREASES IN PROFIT OR INCREASES IN 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
        $10 million annually ($8 million for Green Cards and $2 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, the last orders under
        or
        as a follow-on to an expired U.S. government subcontract have been delivered.
        Further orders will require a new contract. Based on events to date, the
        Company
        believes that a follow-on multi-year contract will be issued to the Company’s
        VAR in February 2007; however, there is no assurance that a follow-on contract
        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.
 
 38
 
 THERE
        CAN
        BE NO ASSURANCE AS TO WHEN OR IF WE WILL BE ABLE TO RECOGNIZE REVENUE AS
        TO
        SHIPMENTS WE HAVE ALREADY MADE TO OUR MIDDLE EASTERN COUNTRY CUSTOMER AS
        THIRD
        PARTY ACTIONS BEYOND OUR CONTROL AFFECT WHEN WE CAN RECOGNIZE REVENUE. Applying
        revenue recognition principles to our current agreement with our Middle Eastern
        customer means that we recognize revenue as cards are issued after
        personalization, but only after the entire infrastructure called for in the
        contract has been installed and accepted. The government of the Middle Eastern
        country controls the pace at which the infrastructure is installed and the
        pace
        of card personalization. There can be no assurance that the government will
        promptly install the already-delivered infrastructure or that the government
        will ultimately choose to personalize cards with this infrastructure. Should
        the
        government choose to delay the program or to use different infrastructure,
        we
        will not recognize revenue unless we revise our agreement.
 
 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 $10 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, a national
        ID card for a Middle Eastern country, drivers license cards in South Africa,
        and
        sports logbook cards.. 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.
 
 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 on up to $7.5 million of capital expenditures during
        the
        next fifteen months based on business developments. 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.
 
 39
 
 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, except for 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.
 
 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.
 
 40
 
 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.
 
 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
        cannot
        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.
 
 41
 
 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.
 
 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 December 31, 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.
 
 42
  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 $11.5 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.
 
 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 which currently
        is extremely dependent on the level of Italian card manufacturing performed
        by them. We are required to make such an assessment annually. Should we not
        receive a substantial Italian order prior to release of our fiscal year 2007
        financial statements, we will most likely determine that the goodwill of
        our
        German subsidiary was fully impaired. 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.
  43


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.





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 implemented ERP software in the U.S. on November 1, 2006 to
      provide us the information we need to better manage and plan our business and
      enhance our financial reporting. ****** We
      plan
      to implement this same software at our German subsidiary on April 1, 2007.
      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 chose
      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.





44




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
      nine months of fiscal year 2007, we recognized approximately $1,275,000 of
      expenses due to SFAS
      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.





**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**




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





**Item
      5. - Other Information**




None.





**Item
      6. - Exhibits**




ExhibitNo.
            
            Exhibit
                Description3(I)
            
            Certificate
                of Incorporation; previously filed as Exhibit 3.1 to Annual Report
                on Form
                10-K for the fiscal year ended March 31, 2005, filed with the SEC
                on June
                15, 2005, and incorporated herein by reference3(II)
            
            Amended
                Bylaws; previously filed as Exhibit 3(II) to Report on Form 10-Q
                for
                period ended September 30, 2006 and incorporated herein by
                reference10.1
            
            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 ended 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); previously filed as Exhibit 10.2 to Report on Form 10-K for
                fiscal
                year ended March 31, 2004 and incorporated herein by
                reference




45




10.3*
            
            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, 2003 and
                incorporated herein by reference10.8
            
            Optical
                Card Manufacturing License Agreement with Global Investments Group
                ;
                previously filed 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; previously filed
                as
                Appendix A to Schedule 14A Proxy Statement for 2005 Annual Stockholders
                Meeting filed with the SEC on September 6, 2005, and incorporated
                herein
                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
      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
            
            February
                5, 2007Richard M. Haddock/s/Steven
              G. Larson
            
            Chief
                Financial Officer
            
            February
                5, 2007Steven G. Larson




47


INDEX
      TO EXHIBITS





[ITEM
      14(c)]


Exhibit
                Number
              
              Description3(I)
              
              Certificate
                  of Incorporation; previously filed as Exhibit 3.1 to Annual Report
                  on Form
                  10-K for the fiscal year ended March 31, 2005, filed with the SEC
                  on June
                  15, 2005, and incorporated herein by reference3(II)
              
              Amended
                  Bylaws; previously filed as Exhibit 3(II) to Report on Form 10-Q
                  for
                  period ended September 30, 2006 and incorporated herein by
                  reference10.1
              
              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 ended 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); previously 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, 2003
                  and
                  incorporated herein by reference10.8
              
              Optical
                  Card Manufacturing License Agreement with Global Investments Group
                  ;
                  previously filed 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; previously filed
                  as
                  Appendix A to Schedule 14A Proxy Statement for 2005 Annual Stockholders
                  Meeting filed with the SEC on September 6, 2005, and incorporated
                  herein
                  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