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 June 30, 2007
 
  **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 August 6, 2007:
        11,877,940
  Exhibit
        Index is on Page 42
  Total
        number of pages is 47
 **TABLE
        OF CONTENTS**
 
 PART
                  I.
              FINANCIAL
                  INFORMATION
              Page
                  NumberItem
                  1.
              Condensed
                  Consolidated Financial Statements(Unaudited)
              2Condensed
                  Consolidated Balance Sheets (Unaudited)
              3Condensed
                  Consolidated Statements of Operations (Unaudited)
              4Condensed
                  Consolidated Statements of Cash Flows (Unaudited)
              5Notes
                  to Condensed Consolidated Financial Statements (Unaudited)
              6Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition
                  and Results of Operations
              21Item
                  3.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              30Item
                  4.
              Controls
                  and Procedures
              31PART
                  II.
              OTHER
                  INFORMATIONItem
                  1.
              Legal
                  Proceedings
              31Item
                  1A.
              Risk
                  Factors
              31Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              39Item
                  3.
              Defaults
                  Upon Senior Securities
              39Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              39Item
                  5.
              Other
                  Information
              39Item
                  6.
              Exhibits
              39SIGNATURES
              
              41EXHIBIT
                  INDEX
              
              42
  PART
          I.  FINANCIAL
          INFORMATION
 
 ITEM
          1.  CONDENSED
          CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 2
 **LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED BALANCE SHEETS**
 **(In
        thousands)**
  (Unaudited)June
                
                March30,
                    2007
                
                31,
                    2007*ASSETSCurrent
                    assets:Cash
                    and cash equivalents
                
                $
                1,991
                
                $
                3,026Short-term
                    investments
                
                
                15,600
                
                
                17,500Accounts
                    receivable, net of allowances of $75 at June 30, 2007 and $144
                    at March
                    31, 2007
                
                
                3,655
                
                
                3,489Inventories,
                    net of reserve of $864 at June 30, 2007 and $837 at March 31,
                    2007
                
                
                11,494
                
                
                11,462Deferred
                    contract costs
                
                
                100
                
                
                233Prepaid
                    and other current assets
                
                
                1,669
                
                
                1,594Total
                    current assets
                
                
                34,509
                
                
                37,304Property
                    and equipment, net
                
                
                12,557
                
                
                12,988Deferred
                    long-term contract costs
                
                
                873
                
                
                721Equipment
                    held for resale
                
                
                6,433
                
                
                6,340Patents
                    and other intangibles, net
                
                
                403
                
                
                411Notes
                    receivable
                
                
                229
                
                
                227Other
                    non-current assets
                
                
                109
                
                
                109Total
                    assets
                
                $
                55,113
                
                $
                58,100LIABILITIES
                    AND STOCKHOLDERS' EQUITYCurrent
                    liabilities:Accounts
                    payable
                
                $
                1,603
                
                $
                2,284Accrued
                    liabilities
                
                
                2,712
                
                
                2,989Deferred
                    income tax liabilities
                
                
                376
                
                
                388Advance
                    payments from customers
                
                
                1,352
                
                
                1,838Deferred
                    revenue
                
                
                1,718
                
                
                1,584Total
                    current liabilities
                
                
                7,761
                
                
                9,083Advance
                    payments from customers
                
                
                23,554
                
                
                23,554Deferred
                    revenue
                
                
                2,000
                
                
                2,000Deferred
                    rent
                
                
                947
                
                
                864Total
                    liabilities
                
                
                34,262
                
                
                35,501Stockholders'
                    equity:Common
                    stock
                
                
                119
                
                
                119Additional
                    paid-in capital
                
                
                61,611
                
                
                61,068Accumulated
                    deficit
                
                
                (41,019
                )
                
                (38,722
                )Accumulated
                    other comprehensive income
                
                
                140
                
                
                134Total
                    stockholders' equity
                
                
                20,851
                
                
                22,599Total
                    liabilities and stockholders' equity
                
                $
                55,113
                
                $
                58,100*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 EndedJune
                    30,2007
                
                2006Revenues
                
                $
                7,855
                
                $
                10,554Cost
                    of sales (includes $66 and $87 stock-based compensation inthe
                    three month period ended June 30, 2007 and 2006,
                    respectively)
                
                
                6,194
                
                
                6,389Gross
                    profit
                
                
                1,661
                
                
                4,165Operating
                    expenses:Selling,
                    general, and administrative expenses (includes$311
                    and $240 stock-based compensation in the threemonths
                    ended June 30, 2007 and 2006, respectively)
                
                
                3,489
                
                
                3,420Research
                    and development expenses (includes $60 and $106stock-based
                    compensation in the three months endedJune
                    30, 2007 and 2006, respectively)
                
                
                788
                
                
                745Total
                    operating expenses
                
                
                4,277
                
                
                4,165Operating
                    loss
                
                
                (2,616
                )
                
                -Other
                    income, net
                
                
                241
                
                
                206Income
                    (loss) before income taxes
                
                
                (2,375
                )
                
                206Income
                    tax benefit
                
                
                (16
                )
                
                (6
                )Net
                    income (loss)
                
                $
                (2,359
                )
                $
                212Net
                    income (loss) per share:Basic
                
                $
                (0.20
                )
                $
                0.02Diluted
                
                $
                (0.20
                )
                $
                0.02Weighted-average
                    shares of common stockused
                    in computing net income (loss) per share:Basic
                
                
                11,866
                
                
                11,768Diluted
                
                
                11,866
                
                
                12,280The
                    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)**
 Three
                    Months EndedJune
                    30,2007
                
                2006Cash
                    flows from operating activities:Net
                    income (loss)
                
                $
                (2,359
                )
                $
                212Adjustments
                    to reconcile net income (loss) to net cashprovided
                    by (used in) operating activities:Depreciation
                    and amortization
                
                
                731
                
                
                637Loss
                    on disposal of equipment
                
                
                2
                
                
                -Provision
                    for doubtful accounts receivable
                
                
                8
                
                
                16Provision
                    for excess and obsolete inventory
                
                
                37
                
                
                90Provision
                    for warranty reserve
                
                
                39
                
                
                77Stock-based
                    compensation
                
                
                437
                
                
                433Changes
                    in operating assets and liabilities:Decrease
                    (increase) in accounts receivable
                
                
                (155
                )
                
                1,521Decrease
                    (increase) in inventories
                
                
                (51
                )
                
                489Increase
                    in deferred contract costs
                
                
                (18
                )
                
                (807
                )Increase
                    in prepaid and other current assets
                
                
                (71
                )
                
                (174
                )Increase
                    in equipment held for resale
                
                
                (93
                )
                
                (145
                )Increase
                    in other non-current assets
                
                
                -
                
                
                (2
                )Decrease
                    in accounts payable and accrued liabilities
                
                
                (953
                )
                
                (2,485
                )Decrease
                    in deferred income tax liabilities
                
                
                (16
                )
                
                (12
                )Increase
                    in deferred revenue
                
                
                132
                
                
                19Increase
                    in long-term deferred rent
                
                
                83
                
                
                58Increase
                    (decrease) in advance payments from customers
                
                
                (488
                )
                
                413Net
                    cash provided by (used in) operating activities
                
                
                (2,735
                )
                
                340Cash
                    flows from investing activities:Purchases
                    of property and equipment
                
                
                (246
                )
                
                (1,073
                )Acquisition
                    of patents and other intangibles
                
                
                (26
                )
                
                (45
                )Purchases
                    of short-term investments
                
                
                -
                
                
                (5,900
                )Proceeds
                    from maturities of short-term investments
                
                
                1,900
                
                
                7,550Net
                    cash provided by investing activities
                
                
                1,628
                
                
                532Cash
                    flows from financing activities:Proceeds
                    from sale of common stock through stock plans
                
                
                106
                
                
                691Payment
                    of bank loan
                
                
                -
                
                
                60Net
                    cash provided by financing activities
                
                
                106
                
                
                751Effect
                    of exchange rate changes on cash and cash equivalents
                
                
                (34
                )
                
                (41
                )Net
                    increase (decrease) in cash and cash equivalents
                
                
                (1,035
                )
                
                1,582Cash
                    and cash equivalents:Beginning
                    of period
                
                
                3,026
                
                
                2,121End
                    of period
                
                $
                1,991
                
                $
                3,703The
                    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 (the “Company” and “we”) and its wholly
        owned subsidiaries. All significant intercompany accounts and transactions
        have
        been eliminated in consolidation. The consolidated balance sheet data as
        of
        March 31, 2007 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, 2007, included in the Company's Annual Report
        on Form 10-K, filed with the SEC on June 12, 2007.
 
 The
        results of operations for the three months ended June 30, 2007 are not
        necessarily indicative of results to be expected for the entire fiscal year
        ending March 31, 2008.
  *Recently
        Adopted Accounting Pronouncements:* In June
        2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
        No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of
        FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the
        accounting for uncertainty in income taxes recognized in the Company’s financial
        statements in accordance with FASB Statement No. 109, Accounting for Income
        Taxes. FIN 48 prescribes a recognition threshold and measurement attribute
        for
        the financial statement recognition and measurement of a tax position taken
        or
        expected to be taken in a tax return. This Interpretation also provides guidance
        on derecognition, classification, interest and penalties, accounting in interim
        periods, disclosure, and transition. The evaluation of a tax position in
        accordance with FIN 48 is a two-step process. The first step is recognition:
        The
        Company determines whether it is “more-likely-than-not” that a tax position will
        be sustained upon examination, including resolution of any related appeals
        or
        litigation processes, based on the technical merits of the position. In
        evaluating whether a tax position has met the “more-likely-than-not” recognition
        threshold, the Company presumes that the position will be examined by the
        appropriate taxing authority that would have full knowledge of all relevant
        information. The second step is measurement: A tax position that meets the
        “more-likely-than-not” recognition threshold is measured to determine the amount
        of benefit to recognize in the financial statements. The tax position is
        measured at the largest amount of benefit that is greater than 50 percent
        likely
        to be realized upon ultimate settlement. FIN 48 is effective for fiscal years
        beginning after December 15, 2006.
  Upon
        adoption of FIN 48 on April 1, 2007, the Company recognized a cumulative
        effect
        adjustment of $61,000, decreasing its income tax liability for unrecognized
        tax
        benefits, and decreasing the March 31, 2007 accumulated deficit balance.
        At June
        30, 2007, the Company has recorded unrecognized tax benefits of $202,000.
        The
        Company does not expect any material change in its unrecognized tax benefits
        over the next twelve months.
 
 The
        Company recognizes interest and penalties accrued on any unrecognized tax
        benefits as a component of its provision for income taxes. As of June 30,
        2007,
        the Company has accrued $48,000 for payment of interest and penalties related
        to
        unrecognized tax benefits.
  6
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 The
        table
        below shows the changes in the accumulated deficit as of June 30, 2007 (in
        thousands):
  Balance
                    at March 31, 2007, as reported
                
                $
                (38,722
                )FIN
                    48 adjustments to beginning balance
                
                
                62Net
                    loss during the period
                
                
                (2,359
                )Balance
                    at June 30, 2007
                
                $
                (41,019
                )
 Although
        the Company files U.S. federal, various state, and foreign tax returns, the
        Company’s only major tax jurisdictions are the United States, California and
        Germany.  Tax years 1993 - 2007 remain subject to examination by the
        appropriate governmental agencies due to tax loss carryovers from those
        years.
  *Recently
        Issued Accounting Pronouncements:* In
        September 2006, the FASB issued Statement No. 157, “Fair Value
        Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a
        framework for measuring fair value in generally accepted accounting principles,
        and expands disclosures about fair value measurements. SFAS No. 157 is intended
        to be applied in conjunction with other accounting pronouncements that require
        or permit fair value measurements. Although SFAS No. 157 does not require
        any
        new fair value measurements, its application may change current practice
        for
        some entities. The definition of fair value contained in SFAS No. 157 retains
        the exchange price notion inherent in earlier definitions of fair value.
        SFAS
        No. 157 clarifies that the exchange price is the price in an orderly transaction
        between market participants to sell an asset or transfer a liability in the
        principal (or most advantageous) market for the asset or liability. Accordingly,
        the definition focuses on the price that would be received to sell the asset
        or
        paid to transfer the liability at the measurement date (an exit price), not
        the
        price that would be paid to acquire the asset or received to assume the
        liability at the measurement date (an entry price). SFAS No. 157 emphasizes
        that
        fair value is a market-based measurement, not an entity-specific measurement.
        Therefore, SFAS No. 157 prescribes that a fair value measurement be
        determined based on the assumptions that market participants would use in
        pricing the asset or liability. The Company has not yet determined what impact
        this statement will have on its condensed consolidated financial
        statements.
 
 In
        February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
        Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159
        provides entities with an option to report selected financial assets and
        liabilities at fair value, with the objective to reduce both the complexity
        in
        accounting for financial instruments and the volatility in earnings caused
        by
        measuring related assets and liabilities differently. SFAS No. 159 is effective
        for fiscal years beginning after November 15, 2007. The Company has not yet
        determined what impact this statement will have on its condensed consolidated
        financial statements.
 
 **2.
        Summary of Significant Accounting Policies**
 
 *(1.)
        Principles of Consolidation and Basis of Presentation.* The
        accompanying condensed consolidated financial statements have been prepared
        in
        accordance with U. S. generally accepted accounting principles. The condensed
        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 condensed 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 presentation, the Company labels its annual accounting period
        end as
        March 31 and its 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 first quarter
        of
        fiscal year 2008 ended on June 29, 2007, and the 13-week first quarter of
        fiscal
        year 2007 ended on June 30, 2006.
  7
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 *(4.)* *Foreign
        Currency Transactions* . The
        functional currency of the Company's foreign subsidiary is generally the
        local
        currency. The financial statements of this subsidiary are translated to United
        States dollars using period-end rates of exchange for assets and liabilities
        and
        average rates of exchange for the year for revenues and expenses. Translation
        gains (losses) are recorded in accumulated other comprehensive income (loss)
        as
        a component of stockholders' equity. Net gains and losses resulting from
        foreign
        exchange transactions are included in selling, general and administrative
        expenses and were not significant during the periods presented .
 
 *(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) with 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 contracts
        are
        reported in other income.  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 loans
        receivable.  At June 30, 2007 and March 31, 2007, we had foreign exchange
        forward contracts with a maturity of less than 30 days to purchase 2.3 million
        euros. The fair value of the forward contracts was not material at June 30,
        2007
        and March 31, 2007.
 
 *(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, long-term investments and accounts receivable. The
        Company places its cash, cash equivalents, and short-term and long-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 condensed consolidated balance sheet.
        As of
        June 30, 2007 and March 31, 2007, the Company’s short-term investments consist
        of auction
        rate securities and there were no long-term investments .
        Accounts receivable are derived from revenue earned from customers primarily
        located in the United States, 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 EndedJune
                    30,2007
                
                2006Customer
                    A
                
                
                38%
                
                
                27%Customer
                    B
                
                
                <10%
                
                
                20%Customer
                    C
                
                
                ―
                
                
                20%Customer
                    D
                
                
                14%
                
                
                ―
 
 Two
        customers accounted for 28% and 26%, respectively, of accounts receivable
        at
        June 30, 2007. Two customers accounted for 31% and 17%, respectively, of
        accounts receivable at March 31, 2007.
 
 *(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 June 30, 2007 and March 31, 2007 were $2.0 million and
        $3.0
        million, respectively. As of June 30, 2007 and March 31, 2007, the Company
        held
        auction rate securities which had 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 re-evaluates
        the
        classification of investments as of each balance sheet date.
  8
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 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 condensed 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 condensed consolidated balance sheet date for potential
        impairment. As of June 30, 2007 and March 31, 2007, the Company had determined
        that an impairment which was “other than temporary” had not occurred.
 
 The
        carrying amounts of short-term investments in the form of auction rate
        securities as of June 30, 2007 and March 31, 2007 are $15.6 million and $17.5
        million, respectively.
 
 The
        Company had no long-term investment as of June 30, 2007 and March 31,
        2007.
 
 *(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.
 
 *(10.)
        Accounts Receivable.* 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 and
        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 as of June 30, 2007 and March 31, 2007 are (in
        thousands):
  June
                    30,
                
                March
                    31,2007
                
                2007Trade
                    receivables
                
                $
                3,510
                
                $
                3,383Allowance
                    for doubtful accounts
                
                
                (75
                )
                
                (66
                )Product
                    return reserves
                
                
                0
                
                
                (78
                )Interest
                    receivable
                
                
                22
                
                
                34Other
                    receivables
                
                
                198
                
                
                216Total
                    accounts receivable, net
                
                $
                3,655
                
                $
                3,489
 *(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 replacement cost or estimated realizable value less cost to
        sell. The components of inventories as of June 30, 2007 and March 31, 2007
        are
        (in thousands):
  June
                    30,
                
                March
                    31,2007
                
                2007Raw
                    materials
                
                $
                7,531
                
                $
                7,763Work-in-process
                
                
                790
                
                
                860Finished
                    goods
                
                
                3,173
                
                
                2,839Total
                    inventory, net
                
                $
                11,494
                
                $
                11,462
  The
        Company establishes lower of cost or market reserves, aged inventory reserves
        and 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. For
        the
        three months ended June 30, 2007 and 2006, the Company recorded inventory
        reserve expense of $50,000 and $90,000, respectively. We did not record any
        lower of cost or market adjustment in our condensed consolidated statements
        of
        operations for the three months ended June 30, 2007 and 2006.
  9
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 In
        November 2004, the FASB issued SFAS No. 151, “Inventory Costs ― an Amendment of
        ARB
        No. 43, Chapter 4,” (“SFAS No. 151”) 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 overhead 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 as of 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 three months ended June 30, 2006.
 
 *(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
        (Prevent). The contract was assigned to Prevent in March 2007. Direct
        incremental costs associated with the purchase or construction of these items
        are deferred until revenue is recognized. The components of equipment held
        for
        resale as of June 30, 2007 and March 31, 2007 are (in thousands):
 June
                    30,
                
                March
                    31,2007
                
                2007Parts
                
                $
                5,309
                
                $
                5,297Labor
                    costs
                
                
                1,011
                
                
                931Other
                
                
                113
                
                
                112Total
                    equipment held for resale
                
                $
                6,433
                
                $
                6,340
 *(13.)
        Property and Equipment, Net* .
        The
        components of property and equipment as of June 30, 2007 and March 31, 2007
        are
        (in thousands):
 June
                    30,
                
                March
                    31,2007
                
                2007Building
                    and land
                
                $
                896
                
                $
                885Equipment
                    and furniture
                
                
                24,532
                
                
                24,334Construction
                    in progress, includingpurchased
                    equipment
                
                
                621
                
                
                774Leasehold
                    improvements
                
                
                4,882
                
                
                4,70130,931
                
                
                30,694Less:
                    accumulated depreciation and amortization
                
                
                (18,374
                )
                
                (17,706
                )Total
                    property and equipement, net
                
                $
                12,557
                
                $
                12,988
  Property
        and equipment 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 leasehold amortization expense for the three months ended
        June
        30, 2007 and 2006 was $731,000 and $637,000, respectively. Maintenance and
        minor
        repairs and replacements are expensed when incurred. Disposition or retirement
        of property and equipment related gains and losses are charged to other income
        and expenses.
 
 Certain
        costs incurred in connection with acquisition of software for internal use
        are
        capitalized following Statement of Position (SOP) 98-1, “Accounting for the
        Costs of Computer Software Developed or Obtained for Internal Use” and EITF
        Issue No. 97-13, “Accounting for Costs Incurred in Connection with a Consulting
        Contract or an Internal Project That Combines Business Process Reengineering
        and
        Information Technology Transformation.” Capitalized software costs are included
        in the equipment and furniture account and are amortized over four to seven
        years. Software costs that do not meet capitalization criteria are expensed
        immediately.
  10
 
 **LASERCARD
            CORPORATION AND SUBSIDIARIES**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 *(14.)
        Goodwill and Other Intangible Assets.* Goodwill
        represents the excess of the purchase price over the fair value of identifiable
        net tangible and intangible assets acquired in a business combination.  In
        accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the
        Company does not amortize goodwill.  Instead, the Company evaluates
        goodwill for impairment annually in the fourth quarter and whenever events
        or
        changes in circumstances indicate that it is more likely than not that an
        impairment loss has been incurred.  At March 31, 2007, the Company
        determined that estimated future cash flows were insufficient to justify
        the
        carrying value of goodwill and other intangible assets based on management’s
        decision to suspend optical memory card production in Germany. As such, in
        the
        fourth quarter of fiscal year 2007, the Company recorded a non-cash impairment
        charge of approximately $3.8 million for the full amount of remaining goodwill
        and other intangible assets related to the Company’s purchase of Challenge Card
        Design Plastikkarten GmbH of Rastede, Germany, and Cards & More GmbH of
        Ratingen, Germany on March 31, 2004.  As of June 30, 2007 and March 31,
        2007, goodwill was fully charged to impairment. We intend to continue to
        use the
        facility and equipment to produce specialty cards although plans to use the
        facility to produce LaserCard® optical memory cards in Germany have been
        suspended.
  Definite
        life intangible assets capitalized and accumulated amortization as of June
        30,
        2007 and March 31, 2007 are as follows(in thousands):
 June
                    30,
                
                March
                    31,2007
                
                2007Patent
                    expenditures
                
                $
                3,580
                
                $
                3,554Technology
                    transfer expenditures
                
                
                545
                
                
                545Total
                    patent and other intangible expenditures
                
                
                4,125
                
                
                4,099Patent
                    accumulated amortization
                
                
                (3,177
                )
                
                (3,149
                )Technology
                    transfer accumulated amortization
                
                
                (545
                )
                
                (539
                )(3,722
                )
                
                (3,688
                )Amortizable
                    patents and other intangible, net
                
                $
                403
                
                $
                411
  *(15.)
        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 June 30, 2007 and March 31, 2007, the fair value of
        long-lived assets exceeds their book value. Therefore, no impairment loss
        has
        been recognized.
 
 *(16.)
        Accrued Liabilities.* The
        components of accrued liabilities as of June 30, 2007 and March 31, 2007
        are (in
        thousands):
 June
                    30,
                
                March
                    31,2007
                
                2007Accrued
                    payroll and fringe benefits
                
                $
                279
                
                $
                497Accrued
                    compensated absences
                
                
                602
                
                
                855Warranty
                    reserves
                
                
                672
                
                
                743Other
                    accrued liabilities
                
                
                1,159
                
                
                894Total
                    accrued liabilities
                
                $
                2,712
                
                $
                2,989
  11
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 Where
        appropriate, provision is made at the time of shipment for estimated warranty
        costs and estimated returns. We provide a limited warranty for the replacement
        of defective products. Our limited warranty requires us to repair or replace
        defective products at no cost to the customer within a specified time period
        after sale. We estimate the costs that may be incurred under our limited
        warranty and record a liability in the amount of such costs at the time product
        revenue is recognized. Factors that affect our estimate of warranty liability
        include the number of units sold, and historical and anticipated rates of
        warranty claims. We assess the adequacy of our recorded warranty liability
        and
        adjust the amount as necessary. We utilize historical trends and information
        received from our customers to assist in determining the appropriate estimated
        warranty accrual levels. The
        Company’s product warranty claims are settled through the return of defective
        products and the shipment of replacement products. The costs of warranty
        returns
        for the three months ended June 30, 2007 were approximately $109,000 mainly
        due
        to a credit issued to a customer. The costs of warranty returns for the three
        months ended June 30, 2006 were approximately $58,000. The adequacy of the
        warranty reserve is reviewed quarterly to verify that it properly reflects
        the
        remaining obligations based on the anticipated returns over the balance of
        the
        obligation period. Adjustments are made when actual return claim experience
        differs from estimates. Warranty activities for the three months ended June
        30,
        2007 and 2006 are as follow (in thousands):
  Three
                    Months EndedJune
                    30,2007
                
                
                2006Beginning
                    balance
                
                $
                743
                
                $
                648Accruals
                    for products sold
                
                
                38
                
                
                77Costs
                    incurred
                
                
                (109
                )
                
                (58
                )Ending
                    balance
                
                $
                672
                
                $
                667
  
 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.
 
 *(17.)
        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.
 
 *(18.)
        Advance Payments from Customers* .
        The
        Company routinely receives advance payments on orders placed by its customers.
        The advance payments are recorded as a liability in the condensed consolidated
        balance sheets until the related orders are shipped.
 
 *(19.)
        Revenue Recognition* .
        Product
        sales primarily consist of optical card sales, sales of optical card read/write
        drives and sales of specialty cards and card printers. The Company recognizes
        revenue from product sales when the following criteria are met: (1) persuasive
        evidence of an arrangement exists; (2) delivery has occurred; (3) the fee
        is
        fixed or determinable; and (4) collectibility is reasonably assured. The
        Company
        recognizes revenue on product sales at the time of shipment when shipping
        terms
        are F.O.B. shipping point, orders are placed pursuant to a pre-existing sales
        arrangement and there are no post-shipment obligations other than warehousing
        under a U.S. government subcontract or customer acceptance criteria. Where
        appropriate, provision is made at the time of shipment for estimated warranty
        costs and estimated returns.
 
 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. The bill and hold procedures also provide
        that
        at the end of any one-year contract term when a renewal option is not exercised,
        the U.S. government is to take final delivery of any and all of its remaining
        inventory within six months. 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 ― “Revenue
        Recognition” (“SAB 104”), revenue is recognized on delivery into the vault as
        the Company has fulfil led
        its
        contractual obligations and the earnings process is complete.
  12
 
  **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 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.
 
 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 $13,000 and
        $1,000 of revenues for the three months ended June 30, 2007 and June 30,
        2006,
        respectively, based on a zero profit margin related to a long-term contract.
 
 In
        the
        fourth quarter of fiscal year 2006, the Company entered into a subcontract
        covering product and services 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
        contract and the associated contract costs were deferred until the predominant
        undelivered element, the card personalization, was delivered and accepted,
        commencing with the installation and acceptance of the card personalization
        system. The Company determined that once the card personalization system
        was
        accepted, contract revenue would be recognized ratably based on actual cards
        personalized and accepted. As the card personalization system was accepted
        during the period, the Company began recognizing revenue under this contract
        during the quarter ended March 31, 2007 on cards that had been accepted by
        customer. The acceptance certificate received from the customer waived the
        Company's responsibility for the card personalization required prior to
        customer's acceptance. Revenue of $4 million was recognized based upon the
        total
        number of cards accepted up to that time.
 
 On
        June
        23, 2007, the Company and the prime contractor entered into an amendment
        agreement whereby the Company will provide cards and supplies according to
        a
        fixed delivery schedule for the balance of this year. In addition, the Company
        no longer has obligations pertaining to the installation of equipment, card
        personalization workstation integration or card personalization. As a result
        of
        this amendment, the Company will ratably recognize revenue upon receipt of
        the
        customer’s certificate of acceptance. Also under the amendment and associated
        sales incentives, new prices per card have been established. The subcontract
        continued to allow for optional orders at customer request over a four-year
        period, valued at up to another approximately $37 million in cards based
        on the
        new agreed upon price per card under the amendment.
  13
 
 **LASERCARD
            CORPORATION AND SUBSIDIARIES**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 During
        the three months ended June 30, 2007, we recognized revenue of approximately
        $0.9 million in addition to the $4 million recognized in fiscal year 2007
        and as
        of June 30, 2007, there remained $0.9 million of deferred revenue and $0.9
        million of deferred contract costs relating to this contract. The deferred
        contract costs consist of hardware and integration costs. At June 30, 2007,
        there was $4.4 million of backlog under this subcontract agreement.
 
 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. There was no software revenue recognized
        for the three months ended June 30, 2007. Software revenue was immaterial
        for
        the three months ended June 30, 2006.
 
 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 months ended June 30, 2007 and 2006.
 
 The
        Company entered into license and optical memory card equipment purchase and
        support agreements, effective April 3, 2004, with Global Investments Group
        (GIG), based in Auckland, New Zealand, for optical memory card manufacturing
        in
        Slovenia.  GIG transferred the license and other agreements, with our
        approval, to Prevent Global of Slovenia (Prevent) in March 2007. The agreements
        provide for payments (other than interest on late payments) to the Company
        of
        about $25.6 million which were fully paid as of March 31, 2007, for a
        20-year license, the required manufacturing equipment for a targeted initial
        manufacturing capacity of 10 million optical cards annually and installation
        support, and a four-year training and support package. Of the $25.6 million
        we
        received, $23.6 million was recorded as advance payments from customer and
        $2
        million for the licensing fee was recorded as deferred revenue. Both were
        classified as long term liabilities in the condensed consolidated balance
        sheets. As of June 30, 2007, the Company had $6.4 million of acquired equipment,
        plus direct and incremental expenses, classified as equipment held for resale
        on
        our condensed consolidated balance sheets. Beginning in the fifth year of
        the
        contract, Prevent is to pay $3 million for a three-year support package,
        and has
        options for thirteen additional years of support for payments of $1 million
        annually.  In addition to the $41.6 million discussed above, Prevent is to
        pay royalties of $0.60 per card for each card produced under the license. 
The territories covered by the license include most of the European Union
        and
        Eastern European regions.  Prevent has exclusive marketing rights in
        certain territories, with performance goals to maintain these rights. The
        Company retains rights to utilize up to 20% of the new facility capacity
        as
        backup and a capacity buffer to augment our own card manufacturing facilities
        in
        Mountain View, California and possibly at the Company’s German subsidiary. The
        granting of this license to Prevent 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 support,
        materials, and royalty payments for cards manufactured. In accordance with
        EITF
        00-21 “Revenue Arrangements with Multiple Deliverables,” the card manufacturing
        license, sale and installation of equipment, training and support package,
        have
        been accounted for as one unit of accounting, since we were unable to determine
        evidence of the fair value for the undelivered items other than ongoing support.
        The Company is able to determine evidence of fair value for the predominant
        undelivered item, which is the ongoing annual support of the manufacturing
        equipment. Accordingly, revenues for the arrangement have been deferred and
        will
        be recognized when the equipment is installed and accepted, with the exception
        of the value of the ongoing annual support of the manufacturing equipment
        which
        will be recognized quarterly as earned, beginning when the equipment is accepted
        and training has been completed, which date is dependent on Prevent establishing
        a suitable facility in Slovenia. Pursuant to FTB 90-1, “Accounting for
        Separately Priced Extended Warranty and Product Maintenance Contracts” the
        support revenue will be recognized ratably over the remaining term of the
        agreement.
  14
 
 **LASERCARD
            CORPORATION AND SUBSIDIARIES**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 *(20.)
        Research and Development Expenses* .
        Costs
        related to research, design and development of products are charged to research
        and development expense 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 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 $202,000 and $188,000 for the three months ended
        June
        30, 2007 and 2006, respectively.
  *(23.)
        Stock-based Compensation* .
        Effective April 1, 2006, the Company adopted Statement of Financial Accounting
        Standard (“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.
  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 requisite service
        period, generally 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 condensed consolidated financial
        statements for prior fiscal years have not been restated to reflect the impact
        of adopting SFAS No. 123(R).
  *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 (prior to fiscal year 2006 typically
        10 years and thereafter typically 7 years) and the vesting schedule for exercise
        of options, generally 25% after one year and 6.25% quarterly for the next
        3
        years.
 
 *Stock
        Options* :
        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(R), the Company uses the Black-Scholes valuation model to estimate the
        fair
        value of option awards. Determining the appropriate fair value model and
        related
        assumptions requires judgment, including estimating stock price volatility,
        forfeiture rates and expected terms. The following assumptions were utilized
        to
        estimate the fair value of the Company’s stock option awards during the three
        months ended June 30, 2007 and 2006:
  Three
                    Months EndedJune
                    30,2007
                
                2006Expected
                    stock price volatility
                
                
                55%
                
                
                55%Risk-free
                    interest rates
                
                
                4.93%
                
                
                5%Expected
                    life of options
                
                
                4.4
                    years
                
                
                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 life 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.
  15
  **LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  The
        risk-free interest rate was based on U.S. Treasury zero-coupon issues with
        a
        maturity approximating the expected life 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 updates these
        assumptions at least on an annual basis and on an interim basis if significant
        changes to the assumptions are warranted.
  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 months ended June 30, 2007 and 2006, and did
        not
        capitalize any such costs in the condensed consolidated balance
        sheets.
  Stock-based
        compensation expense related to stock options was recorded in the Company’s
        condensed consolidated statements of operations was allocated as follows
        (in
        thousands):
  Three
                    Months EndedJune
                    30,2007
                
                2006Cost
                    of sales
                
                $
                66
                
                $
                87Selling,
                    general and administrative expense
                
                
                283
                
                
                221Research
                    and development expense
                
                
                60
                
                
                106Stock-based
                    compensation expense before income tax
                
                
                409
                
                
                414Less:
                    income tax benefit
                
                
                ―
                
                
                ―Net
                    stock-based compensation expense after income tax
                
                $
                409
                
                $
                414
  As
        of
        June 30, 2007, about $4 million of total unrecognized compensation cost related
        to unvested share-based compensation arrangements is expected to be recognized
        over the remaining vesting period through June 30, 2011. As of June 30, 2006,
        there was approximately $7.6 million of total unrecognized compensation cost
        related to unvested share-based compensation arrangements granted under our
        stock incentive plans which is expected to be recognized over the remaining
        vesting period through June 30, 2010.
 
 We
        recorded no income tax benefit on stock based compensation expense for the
        three
        months ended June 30, 2007 and 2006, as we have cumulative operating loss
        carryovers, for which a full valuation allowance has been
        established.
 
 The
        FASB
        Staff Position ("FSP") No. 123R-3, "Transition Election Related to Accounting
        for the Tax Effects of Share-Based Payment Awards," requires an entity to
        follow
        either the transition guidance for the additional-paid-in-capital (APIC)
        pool as
        prescribed in SFAS No. 123(R) or the alternative transition method described
        in
        FSP No. 123R-3. An entity that adopts SFAS No. 123(R) using the modified
        prospective application may make a one-time election to adopt the transition
        method described in the FSP No. 123R-3, and may take up to one year from
        the
        latter of its initial adoption of SFAS No. 123(R) or the effective date of
        the
        FSP No. 123R-3 to evaluate the available transition alternatives and make
        its
        one-time election. We have elected to use the simplified method provided
        for in
        FSP FAS 123R-3 to calculate our APIC pool effective April 1, 2007. The adoption
        of the FSP did not have a material impact on our consolidated financial
        position, results of operations or cash flows.
 
 *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 had stock based compensation expense of approximately $28,000
        and
        $19,000 relating to the ESPP which was included in the Company’s condensed
        consolidated statements of operations for the three months ended June 30,
        2007
        and 2006, respectively.
  16
 
 **LASERCARD
            CORPORATION AND SUBSIDIARIES**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 *(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 months ended June 30, 2007 and
        2006, comprehensive income (loss) is as follows (in thousands):
 Three
                    Months EndedJune
                    30,2007
                
                2006Net
                    income (loss)
                
                $
                (2,359
                )
                $
                212Net
                    change in cumulative foreigncurrency
                    transaltion adjustments
                
                
                6
                
                
                71Comprehensive
                    income (loss)
                
                $
                (2,353
                )
                $
                283
 
 *(25)
        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 indemnification provisions and as a result the associated
        estimated fair value of the liability is not material.
 
 **3.**  **Net
        Income (Loss) per Share**
 
 Basic
        net
        income (loss) per share and diluted net loss per share are computed by dividing
        net income (loss) by the weighted average number of shares of common stock
        outstanding during the three months ended June 30, 2007. Diluted net income
        per
        share is computed by dividing net income by the weighted average number of
        shares of common stock and common stock equivalents outstanding during the
        three
        months ended June 30, 2007. Common stock equivalents consist of stock options
        and warrants using the treasury stock method.
  17
  **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 months ended June 30, 2007 and 2006 is
        shown
        in the following table (in thousands, except per share data):
 Three
                    Months EndedJune
                    30,2007
                
                2006Net
                    income (loss)
                
                $
                (2,359
                )
                $
                212Basic
                    net income (loss) per share:Weighted
                    average common shares outstanding
                
                
                11,866
                
                
                11,768Basic
                    net income (loss) per share
                
                $
                (0.20
                )
                $
                0.02Diluted
                    net income (loss) per share:Weighted
                    average common shares outstanding
                
                
                11,866
                
                
                11,768Weighted
                    average common shares from stock option grants
                
                
                —
                
                
                512Weighted
                    average common shares and common stockequivalents
                    outstanding
                
                
                11,866
                
                
                12,280Diluted
                    net income (loss) per share
                
                $
                (0.20
                )
                $
                0.02
  Stock
        options and warrants 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. Therefore, stock
        options to purchase 188,000 shares and warrants to purchase 174,057 shares
        were
        excluded from the calculation of diluted net income per share for the three
        months ended June 30, 2006. As the effect of common stock equivalents would
        be
        antidilutive since the Company incurred a loss in the three months ended
        June
        30, 2007, all stock options and warrants were excluded from the calculation
        of
        diluted net loss per share for that period.
 
 18
  **LASERCARD
        CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **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, systems
        and enabling services (“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 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 $3.5 million at June 30, 2007 and $3.7 million at March
        31,
        2007 that are located in Germany.
 
 The
        Company's chief operating decision maker is currently the Company's Chief
        Executive Officer. The chief operating decision maker reviews financial
        information presented on a consolidated basis that is accompanied by
        disaggregated information about revenues and gross profit (loss) by segment.
 
 19
 **LASERCARD
          CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 
 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 condensed consolidated financial statements
        for the three months ended June 30, 2007 and 2006 (in
        thousands):
  T
                    h
                    r e e  M o n t h s  E n d e d  J u n e  3 0
                    ,  2 0 0 7Optical
                
                Optical
                
                SpecialtyMemory
                
                Card
                
                Cards
                    &
                
                SegmentCards
                
                Drives
                
                Printers
                
                Total
                
                Other
                    (a)
                
                TotalRevenue
                
                $
                4,562
                
                $
                355
                
                $
                2,938
                
                $
                7,855
                
                $
                -
                
                $
                7,855Cost
                    of sales
                
                
                3,522
                
                
                438
                
                
                2,234
                
                
                6,194
                
                
                -
                
                
                6,194Gross
                    profit (loss)
                
                
                1,040
                
                
                (83
                )
                
                704
                
                
                1,661
                
                
                -
                
                
                1,661Depreciation
                    andamortization
                    expense
                
                
                454
                
                
                46
                
                
                77
                
                
                577
                
                
                154
                
                
                731T
                    h
                    r e e  M o n t h s  E n d e d  J u n e  3 0 ,  2
                    0 0 6Optical
                
                
                Optical
                
                
                SpecialtyMemory
                
                
                Card
                
                
                Cards
                    &
                
                
                SegmentCards
                
                
                Drives
                
                
                Printers
                
                
                Total
                
                
                Other
                
                
                TotalRevenue
                
                $
                7,495
                
                $
                184
                
                $
                2,875
                
                $
                10,554
                
                $
                -
                
                $
                10,554Cost
                    of sales
                
                
                3,851
                
                
                362
                
                
                2,176
                
                
                6,389
                
                
                -
                
                
                6,389Gross
                    profit (loss)
                
                
                3,644
                
                
                (178
                )
                
                699
                
                
                4,165
                
                
                -
                
                
                4,165Depreciation
                    andamortization
                    expense
                
                
                394
                
                
                44
                
                
                81
                
                
                519
                
                
                118
                
                
                637
 
 (a)
              Other
                  depreciation and amortization expense represents amounts charged
                  to
                  selling, general and administrative expense and research and development
                  expense.
 
 
 20
 
 
 **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, results
        of operations and critical accounting policies should be read in conjunction
        with the condensed consolidated financial statements and related notes included
        elsewhere in this Form 10-Q Report and the consolidated financial statements
        and
        notes thereto for the year ended March 31, 2007, included in the Company's
        fiscal 2007 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, our 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 our beliefs as to current and potential market segments,
        customers, and applications for and deployment of our  products; the
        advantages of, potential income from, and duties to be performed under the
        sale
        of a second-source card manufacturing license to Prevent Global
        (Prevent);  our intent to retain the Prevent equipment
        until Prevent is ready to receive the equipment; future scheduled payments
        and contingent royalties under the Prevent contract, Prevents’ planned
        production capacity, and that we will sell equipment to Prevent and
        provide Prevent with installation support; production quantities, delivery
        rates and expected delivery schedule, backlog, and revenue recognition for
        our
        products for U.S. or foreign government ID card programs, potential annual
        revenues being $40 to $50 million at full implementation from the Italy programs
        with expected revenues unable to be determined until the prime contractor
        issues
        follow-on orders; our expectation for no future growth from the U.S. Green
        Card
        and Laser Visa BCC program, with steady state revenue to average $10 million
        if
        the option years are elected; plans to increase card production capacity
        for
        anticipated increases in orders including possibly $8 million in capital
        equipment and leasehold improvements during the next twelve to eighteen months;
        and expecting growth of less than 10% in the specialty card and printer segment
        and expecting negative gross profit from the optical card drive market; our
        intent to update our SFAS No. 123(R), “Shared-Based Payments,” assumptions at
        least annually; that the prime contractor for a Middle Eastern country will
        accept future shipments of cards and supplies or the customer will exercise
        the
        optional orders over a four-year period of up-to another approximately $37
        million in cards under the amended contract; 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 our research
        and
        development efforts, including our attempts to develop other forms of optical
        recording media for use in optical memory cards and the potential benefits
        derived there from; expectations regarding revenues (overall and by segment
        and
        by customer), margins, profit (including likely losses in the future if full
        implementation of the Italian program is further delayed), and our deferred
        income tax asset and related valuation allowance; that we do not expect any
        material change in our unrecognized tax benefits over the next twelve months;
        our expectations that examination of open tax years by the appropriate
        governmental agencies due to the tax loss carryovers from those years will
        pose
        no material change in our tax position; our belief that our current five
        major
        programs, plus maybe one or two others, will be the basis for a majority
        of our
        revenues in the near term; estimates of optical card production capacity,
        our
        ability to expand production capacity, and our plans and expectations regarding
        the growth and associated capital costs of such capacity; estimates that
        revenues and advance payments will be sufficient to generate cash from operating
        activities over the next twelve months and fund our actual capital expenditures
        despite expected quarterly fluctuations; expectations regarding market growth,
        product demand, and the continuation of current programs; and our long-term
        revenue growth objectives, and drive pricing strategy.
  21
  These
        forward-looking statements are based upon our 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 we will be successful in assisting Prevent with factory startup and
        training; whether Prevent will have the financial resources to make the balance
        of its required payments to us 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; our ability or our customers’ ability to initiate
        and develop new programs utilizing our 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;
        our
        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 Department of Homeland Security (DHS) programs
        in the U.S., or will not be selected for other government programs in the
        U.S.
        and abroad; whether we will be successful in developing alternative optical
        recording media; and the risks set forth in the section entitled “Risks” and
        elsewhere in this report; and other risks detailed from time to time in our
        SEC
        filings. These forward-looking statements speak only as to the date of this
        report, and, except as required by law, we undertake no obligation to publicly
        release updates or revisions to these statements whether as a result of new
        information, future events, or otherwise.
 
 CRITICAL
        ACCOUNTING POLICIES
 
 Except
        for the adoption of the Financial Accounting Standards Board (“FASB”) issued
        Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an
        interpretation of FASB Statement No. 109” (“FIN 48”) as described in Note 1
        of the Notes to Condensed Consolidated Financial Statements our critical
        accounting policies in our Annual Report on Form 10-K for the fiscal year
        ended
        March 31, 2007 have not changed materially.
  **RESULTS
        OF OPERATIONS**
 
 Overview
 
 We
        are
        headquartered in Mountain View, California where we manufacture LaserCard®
optical memory cards and card related products, including chip-ready
        Optical/SmartTM cards. In addition, we operate a wholly owned German subsidiary,
        Challenge Card Design Plastikkarten GmbH (“CCD”), with offices in Rastede and
        Ratingen, Germany, which manufactures advanced-technology cards, can provide
        manufacturing capacity for certain steps of optical memory card production,
        and
        markets cards, system solutions, and thermal card printers. We completed
        the
        merger of Cards & More GmbH into Challenge Card Design Plastikkarten GmbH in
        January 2006.
 
 We
        sell
        our products and services through partners such as value added resellers
        (VARs)
        and card distribution licensees, who generally have knowledge in specific
        markets, for the development of markets and applications for LaserCard products.
        We have sales staff located in California, New York, the Washington D.C.
        area,
        and Germany, whose principal role is developing and supporting the reseller
        channel. Revenue consists primarily of optical memory cards, optical card
        read/write drives including systems and enabling services, specialty cards,
        and
        card printers. Our VARs/licensees provide country-specific or market-specific
        services necessary for contract negotiation and also may add application
        software, personal computers, and other peripherals, and then resell these
        products as integrated solutions. We are continuing our efforts to recruit
        new
        VARs and eliminate nonproductive VARs.
 
 Major
        near term growth potential for LaserCard® optical memory cards is in
        government-sponsored identification programs in several countries. Since
        governmental card programs typically rely on policy-making, which in turn
        is
        subject to technical requirements, budget approvals, and political
        considerations, there is no assurance that these programs will be implemented
        as
        expected or that they will include optical cards. Our objectives for long-term
        revenue growth include: (1) broadening the Optical Memory (OM) product range
        to
        address lower-end applications characterized by higher price sensitivity,
        (2)
        diversifying OM products into, and effectively penetrating, industrial and
        commercial markets, (3) expanding our hardware product offering to address
        new
        markets and add value to current offerings, and (4) increasing OM product
        revenues with customized application software and enabling
        services.
  22
  The
        table
        below presents condensed consolidated revenues, excluding inter-company
        transactions, recorded by our U.S. and German operations (in
        thousands):
 Three
                    Months EndedJune
                    30,2007
                
                2006U.S.
                    operations
                
                $
                4,917
                
                $
                7,679German
                    operations
                
                
                2,938
                
                
                2,875$
                7,855
                
                $
                10,554
 
 Revenues
        recorded by our U.S. operations are generally derived from a small number
        of
        government customers located throughout the world.  Revenues recorded by
        our German operations are for a relatively large number of commercial customers,
        including universities in Germany for student identification cards and
        organizers of sporting events for secure access cards.
 
 Historically,
        the largest purchaser of LaserCard products has been a U.S. Government
        contractor, General Dynamics Information Technology (GDIT), previously Anteon
        International Corporation. GDIT is the government contractor for LaserCard
        product sales to the U.S. Department of Homeland Security (DHS), U.S. Department
        of State (DOS), U.S. Department of Defense (DOD), and the government of Canada.
        Under government contracts with GDIT, the DHS purchases Green Cards and DOS
        Laser Visa Border Crossing Cards; the DOD purchases Automated Manifest System
        cards; and the Canadian government purchases Permanent Resident Cards.
        Encompassing all of these programs, our product sales to GDIT represented
        38%
        and 27% of the total revenues during the three months ended June 30, 2007
        and
        2006, respectively. Another unaffiliated company, Laser Memory Card S.p.A.,
        of
        Italy, accounted for 20% of our total revenues during the three months ended
        June 30, 2006 mainly for secure government ID card programs in Italy. The
        revenue for this customer during the three months ended June 30, 2007 was
        immaterial. A third company, Prevent LOK, accounted for 20% of the total
        revenue
        during the three months ended June 30, 2006 for sports logbook cards in
        Slovenia. A fourth company, Omar K. Alesayi Communications & Space Services
        Co., Ltd. (ACSS), accounted for 14% of total revenue during the three months
        ended June 30, 2007 for a national ID card program in a Middle Eastern
        country.
 
 Our
        major
        government programs are shown below as a percentage of total revenues:
 Three
                    Months EndedJune
                    30,2007
                
                2006U.S.
                    Green Cards & Laser Visas
                
                
                35%
                
                
                22%National
                    ID Cards in a Middle Eastern Country
                
                
                14%
                
                
                ―Vehicle
                    Registration in India
                
                
                8%
                
                
                4%Canadian
                    Permanent Resident Cards
                
                
                2%
                
                
                4%Italian
                    Carta d'Identita Elettonica (CIE) Cards
                
                
                <1%
                
                
                1%Italian
                    Permesso di Soggiorno Elettronico (PSE) Cardsand
                    Carta di Soggiorno Elettronico (CSE) Cards
                
                
                ―
                
                
                20%
 
 The
        CIE
        program has been largely stalled since January 2006 following a change of
        government and the instigation of a review designed to reduce cost and improve
        efficiency of the program. In March 2007, we believe a major hurdle to the
        reactivation of the CIE program was removed when a government decree was
        published establishing the fee each citizen will pay when issued a card.
        This
        cleared the way to resume CIE issuance from the government’s substantial card
        inventory and to implement the national ID card issuance infrastructure.
        If and
        as this occurs, and assuming the national ID card system functions as designed,
        CIE and PSE card orders could ramp toward their full implementation level
        which
        could potentially result in annual revenues of $40 to $50 million. We received
        and shipped a small order for foreign language versions of the CIE card during
        the three months ended June 30, 2007. The issuance system for PSE cards is
        in
        place and operating and the government is in possession of a substantial
        card
        inventory. There was no backlog for these programs at June 30, 2007. We believe
        that for the fiscal year ending March 31, 2008, follow-on orders for both
        programs will be received and significant card revenue will be realized although
        it remains unclear when the prime contractor will issue follow-on
        orders.
  23
  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 our revenue base. For
        these
        programs, we recorded card revenues of $2.7 million and $2.3 million for
        the
        three months ended June 30, 2007 and 2006, respectively. We received a five-year
        follow-on U.S. government subcontract in March 2007 with an initial one-year
        term and four one-year extension options. Backlog at June 30, 2007, for these
        programs, which is deliverable through September 2007, totaled $2.1 million.
        We
        expect to receive follow-on purchase orders throughout the life of the
        subcontract although no assurance can be given.
 
 Under
        a
        subcontract for Canada’s Permanent Resident Cards, we recorded revenue of $0.2
        million and $0.4 million for the three months ended June 30, 2007 and 2006,
        respectively. The backlog at June 30, 2007, was $0.5 million and will most
        likely be delivered in the three months ending September 30, 2007. The delivery
        quantity is subject to fluctuation at customer request depending on varying
        Permanent Resident approval rates.
 
 During
        the three months ended June 30, 2007, we recognized revenue under a subcontract
        for the supply of secure national ID cards to a Middle Eastern government
        of
        approximately $0.9 million in addition to the $4 million recognized in fiscal
        year 2007. This followed earlier deliveries of cards and card encoders under
        previous contracts and purchase orders.  The cards are being issued to
        adult citizens for national identity purposes and feature the latest
        advancements in identity fraud protection provided by Optical IDLockTM, a
        combination of the highly-secure LaserCard® optical memory technology and
        Embedded HologramHDTM, the new high-definition “photographic quality” etched
        image security feature.
 
 At
        June
        30, 2007, there was $4.4 million of backlog under this subcontract agreement.
        The subcontract continues to allow for optional orders at customer request
        over
        a four-year period, valued at up to another approximately $37 million in
        cards
        based on the new agreed upon price per card under the amendment. See Notes
        2,
        Item 19 of the notes to condensed consolidated financial statements for a
        full
        discussion of the subcontract.
 
 Effective
        April 3, 2004, we sold a second-source card-manufacturing license, including
        equipment, training, and support, to Global Investments Group (GIG), based
        in
        Auckland, New Zealand, for card manufacturing in Slovenia and began receiving
        associated cash payments. Recently, and with our approval, GIG transferred
        the
        license to Prevent Global of Slovenia (Prevent). We will begin to recognize
        revenue on this arrangement over the remaining term of the agreement starting
        when the equipment has been accepted and the training has been completed,
        which
        date is in turn dependent on Prevent establishing a suitable facility in
        Slovenia .
        Refer
        to Notes 2, Item 19 of the notes to condensed consolidated financial statements
        for a full disclosure of the Prevent agreement.
 
 During
        the third quarter of fiscal year 2007, we implemented and activated a new
        ERP
        system designed to provide additional operational and financial reporting
        functionality in the US operations.  Thorough selection, planning, testing,
        and implementation processes were instituted to ensure that internal control
        over financial reporting was in place. We followed Statement
        of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed
        or Obtained for Internal ** Use,”
and
        EITF Issue No. 97-13, "Accounting for Costs Incurred in Connection with a
        Consulting Contract or an Internal Project That Combines Business Process
        Reengineering and Information Technology Transformation," to address the
        accounting for this internal-use computer software. These pronouncements
        provide
        guidance for determining which costs should be accounted for as internal-use
        software and require that certain costs incurred during design and installation
        of internal-use software be capitalized, costs incurred in the preliminary
        project stage and system maintenance costs be expensed as incurred, and costs
        incurred in conjunction with business process re-engineering activities (which
        are distinguished from software development costs) be expensed as incurred.
        We
        capitalized about $474,000 of software costs as of March 31, 2007 related
        to the
        ERP initiative and charged approximately $211,000 inclusive of labor in selling,
        general and administrative expenses during fiscal year 2007. There were no
        material software costs incurred during the first three months ended June
        30,
        2007.
  24
  Lastly , we may
        invest up to $8 million in additional capital equipment and leasehold
        improvement expenditures at our facilities when orders and forecasts justify
        the
        investment. These expenditures could occur throughout the next twelve to
        eighteen months, as more fully discussed under “Management’s Discussion and
        Analysis--Liquidity and Capital Resources,” of the Form 10-K for the fiscal year
        ended March 31, 2007.
 
 Revenues
 
 *Product
        Revenues.* Our
        total revenues consisted of sales in our three segments of (1) optical memory
        cards, (2) optical card drives, drive accessories, maintenance, systems and
        enabling services, and (3) specialty cards and card printers, as well as
        in
        other miscellaneous items. Product revenues were $7.9 million for the three
        months ended June 30, 2007 versus $10.6 million for the three months ended
        June
        30, 2006.
 
 The
        following table presents our product revenue by segment (in thousands, except
        for percentages):
 Three
                    Months EndedJune
                    30,2007
                
                2006Optical
                    memory cards
                
                $
                4,562
                
                $
                7,495%
                    of total revenues
                
                
                58
                %
                
                71
                %Optical
                    cards drives
                
                
                355
                
                
                184%
                    of total revenues
                
                
                5
                %
                
                2
                %Specialty
                    cards and card printers
                
                
                2,938
                
                
                2,875%
                    of total revenues
                
                
                37
                %
                
                27
                %Total
                    revenues
                
                $
                7,855
                
                $
                10,554
 
 The
        following table presents our optical memory card revenue by major program
        (in
        thousands):
  Three
                    Months EndedJune
                    30,2007
                
                2006U.S.
                    Green Cards & Laser Visas
                
                $
                2,730
                
                $
                2,343Italian
                    National ID Card Programs
                
                
                29
                
                
                2,131Canadian
                    Permanent Resident Cards
                
                
                182
                
                
                418National
                    ID Cards in a Middle Eastern Country
                
                
                865
                
                
                -Vehicle
                    Registration in India
                
                
                599
                
                
                388All
                    other programs
                
                
                157
                
                
                2,215Total
                    optical memory card revenues
                
                $
                4,562
                
                $
                7,495
 
 Optical
        memory card revenue decreased for the first quarter of fiscal year 2008 as
        compared with first quarter of fiscal year 2007 due mainly to the decrease
        in
        card unit volume for the Italian CIE program and a sport membership card
        program
        included in “All other programs” above.
 
 Revenue
        in the optical card drive segment, including systems and enabling services,
        grew
        about $0.2 million in the first quarter of fiscal year 2008 as compared with
        first quarter of fiscal year 2007 due mainly to activity in the national
        ID card
        program for a Middle Eastern government. We do not anticipate that we will
        derive significant profits in the near term on drive sales as prices are
        set
        near the manufacturing cost in order to promote optical memory card
        sales.
  25
 
 Specialty
        cards and printers revenue was approximately $2.9 million for the first quarter
        of both fiscal year 2008 and fiscal year 2007. We anticipate growth of less
        than
        10% in this segment through the remainder of fiscal year 2008.
  *License
        Fees and Other Revenues* .  There
        were no license revenues during the first quarter of either fiscal year 2008
        and
        fiscal year 2007. We entered into license and optical memory card equipment
        purchase and support agreements, effective April 3, 2004, with GIG, for optical
        memory card manufacturing in Slovenia.  GIG transferred the license and
        other agreements, with our approval, to Prevent in March 2007. Refer to Notes
        2,
        Item 19 of the notes to condensed consolidated financial statements for a
        full
        disclosure of the Prevent agreement.
 
 Backlog
 
 As
        of
        June 30, 2007, the backlog for LaserCard® optical memory cards totaled $7
        million scheduled for delivery in fiscal year 2008, compared with $5.7 million
        at March 31, 2007. We have only a few customers who generally place orders
        for a
        period of several months to a year or more so that variations in order placement
        from a single customer can materially affect backlog.  As a result, the
        relative size of our backlog has not been a reliable indicator of future
        sales
        revenue trends.
 
 In
        addition, the backlog as of June 30, 2007, for specialty cards and printers
        totaled 0.8 million euros (approximately $1.0 million) compared with 0.6
        million
        euros (approximately $0.8 million) at March 31, 2007 and for a contract to
        develop a conventional non-optical card production facility totaled 0.7 million
        euros (approximately $0.9 million) at both June 30, 2007 and March 31, 2007.
 
 We
        have
        backlog of $0.4 million for read/write drives at June 30, 2007. We had no
        significant backlog for read/write drives at March 31, 2007.
 
 Gross
        Margin
 
 The
        following table represents our gross margin in absolute amount and as a
        percentage of revenue by segment (in thousands, except for
        percentages):
 Three
                    Months EndedJune
                    30,2007
                
                2006Optical
                    memory cards
                
                $
                1,040
                
                $
                3,644%
                    of optical memory card revenues
                
                
                23
                %
                
                49
                %Optical
                    cards drives
                
                
                (83
                )
                
                (178
                )%
                    of optical card drive revenues
                
                
                NM
                
                
                NMSpecialty
                    cards and card printers
                
                
                704
                
                
                699%
                    of specialty cards and card printers revenues
                
                
                24
                %
                
                24
                %Total
                    gross margin
                
                $
                1,661
                
                $
                4,165%
                    of product revenue
                
                
                21
                %
                
                39
                %
 
 *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 greatly affects
        gross margin due to the absorption of fixed manufacturing costs. The decrease
        in
        optical memory card gross margin to 23% of revenue for the three months ended
        June 30, 2007, as compared with 49% of revenue for the three months ended
        June
        30 2006, is mainly due to the 37% decrease in production and sales unit volume
        and the resultant loss of efficiencies and economies of scale.
 
 *Optical
        Card Drives.* Read/write drive gross profits have been negative over the past three years,
        inclusive of fixed overhead costs, due to low sales volume and our policy
        to
        price drives close to manufacturing cost to promote card sales. This segment
        also includes enabling services, also with lower margins than optical memory
        cards. We anticipate that read/write drive negative gross margins will continue
        in the future unless sales volume is sufficient to cover fixed costs.
  26
  *Specialty
        Cards and Card Printers.* The
        gross margin on specialty cards and card printers was 24% in the three months
        ended June 30, 2007 and 2006. Over the past three years, the quarterly gross
        margins have generally been in the low to mid 20% range.
 
 Operating
        Expenses
 
 The
        following table presents operating expenses for the three months ended June
        30,
        2007 and 2006 (in thousands, except for percentage):
 Three
                    Months EndedJune
                    30,2007
                
                2006Selling,
                    general and administrative expenses
                
                $
                3,489
                
                $
                3,420Percent
                    of change from prior year
                
                
                2
                %Research
                    and development expenses
                
                $
                788
                
                $
                745Percent
                    of change from prior year
                
                
                6
                %
 
 *Selling,
        General, and Administrative Expenses (SG&A).* Increase
        in SG&A expenses was immaterial during the three months ended June 30, 2007,
        as compared with the three months ended June 30, 2006. However, we believe
        that
        SG&A expenses for fiscal year 2008 will be higher than fiscal year 2007
        levels, mainly due to expected increases in marketing and selling expenses
        as
        well as due to a budgeted bonus in fiscal year 2008 to executives and employees
        compared to no bonus to executives in fiscal year 2007.
 
 *Research
        and* *Development
        Expenses (R&D)* .
        R&D
        expenses increased by $43,000, or 6%, during the three months ended June
        30,
        2007 as compared with the three months ended June 30, 2006. We are continuing
        our efforts
        to develop new optical memory card features and structures, including various
        composite card structures to allow the insertion of contactless chips with
        radio
        frequency (RF) capability, dual-interface (contact-contactless) with optical
        memory, OVD
        (optically variable device) products, and other market-driven requirements.
        We
        are also performing optical media development to allow new form factors for
        more
        flexibility in card layouts and integrated security features; enhanced optical
        memory card read/write drives for both increased reliability and ease of
        use and
        integration, and new versions of read-only drives (readers) to meet various
        operational requirements such as office desktop units or handheld field units
        with integrated displays, biometrics, and RFID capability; along with new
        software products in an effort to provide new products that can stimulate
        optical memory card sales growth. For example, we recently have developed a new Green Card Authenticator application based on the
        LaserCard ® reader
        that is currently being evaluated in the market, which allows employers to
        quickly validate potential employees’ Green Cards in real time during the hiring
        process. Additionally,
        after a year of in-house evaluation of our OpticalProximity system for building
        access control, we have completed installation at our first customer location,
        as a test and evaluation site. In our German subsidiary, we recently completed
        the development of a new integrated card personalization system and have
        shipped
        several systems to customers in the past year. We anticipate  that
        these ongoing research and development efforts
        should result in enhanced card features and capabilities, new versions of
        read-only drives, and drives with advanced security features and/or lower
        manufacturing costs; however, there is no assurance that such product
        development efforts will be successful. T hese
        features are important for our existing
        and future optical memory card markets.
  *Other
        Income, Net* .
        Total
        net other income for the three months ended June 30, 2007 was $241,000,
        consisting of $239,000 of interest income and $17,000 of miscellaneous other
        income, partially offset by interest and other expenses of $15,000. Total
        net
        other income for the first three months ended June 30, 2006 was $206,000
        including $252,000 of interest and other income, partially offset by interest
        expense of $46,000.
  *Income
        Taxes.* We
        recorded an income tax benefit of approximately $16,000 for the three months
        ended June 30, 2007, due to our foreign subsidiary’s loss that is expected to be
        refunded in its jurisdiction. For the three months ended June 30, 2006, we
        recorded an income tax benefit, net of $6,000 consisting of a tax benefit
        in the
        amount of $52,000 primarily due to our foreign subsidiary’s loss that is
        expected to be refunded in its jurisdiction, and a U.S. income tax expense
        of
        $46,000.
  27
  LIQUIDITY
        AND CAPITAL RESOURCES
 
 The
        following table summarizes cash, cash equivalents and investments as of June
        30,
        2007 and March 31, 2007 (in thousands):
 June
                    30,
                
                March
                    31,2007
                
                2007Cash
                    and cash equivalents
                
                $
                1,991
                
                $
                3,026Cash,
                    cash equivalents and short-term investments
                
                $
                17,591
                
                $
                20,526
 
 The
        following table displays the sources and uses of cash by activity (in
        thousands):
  Three
                    Months EndedJune
                    30,2007
                
                2006Net
                    cash provided by (used in) operating activities
                
                $
                (2,735
                )
                $
                340Net
                    cash provided by investing activities
                
                $
                1,628
                
                $
                532Net
                    cash provided by financing activities
                
                $
                106
                
                $
                751
 
 Cash
        used
        in operations of $2.7 million during the three months ended June 30, 2007
        consisted of $1.1 million used due to the net loss, net of non-cash items,
        a
        $1.0 million decrease in accounts payable and accrued liabilities, a decrease
        of
        $0.5 million in advance payments from customers, and $0.1 million due to
        changes
        in other working capital items. Cash provided by operations of $0.3 million
        during the three months ended June 30, 2006 consisted of $1.5 million provided
        by the net income, net of non-cash items, a $2.5 million decrease in accounts
        payable and accrued liabilities, a $0.4 million increase in advance payments
        from customers, and $0.9 million increase in other working capital
        items.
 
 Net
        cash
        provided by investing activities of $1.6 million during the three months
        ended
        June 30, 2007, was due to $1.9 million from net proceeds of maturity of
        investments, partially offset by capital and patent expenditures of
        approximately $0.3 million. Net cash provided by investing activities of
        $0.5
        million during the three months ended June 30, 2006, consisted of a net provided
        from investments of $1.6 million less capital equipment expenditures of $1
        million.
 
 Net
        cash
        provided by financing activities during the three months ended June 30, 2007
        was
        $0.1 million, which primarily consisted of net proceeds from the sale of
        common
        stock under our employee stock plans. Net cash provided by financing activities
        during the three months ended June 30, 2006 was $0.8 million, which primarily
        consisted of net proceeds from the sale of common stock under our employee
        stock
        plans.
 
 We
        believe that the estimated level of revenues and customer advance payments
        over
        the next twelve 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 our largest U.S. government programs were to be delayed, reduced,
        canceled, or not extended or; if the Italian CIE card program does not grow
        as
        planned internally, and if these programs are not replaced by other card
        orders
        or other sources of income, or if increases in product revenues or licenses
        do
        not keep pace with increased marketing and R&D and capital
        expenditures.
 
 We
        have
        not established a line of credit. We may negotiate a line of credit, although
        no
        assurance can be made that such financing would be available on favorable
        terms
        or at all, if needed.
  28
  As
        a
        result of our net loss for the three months ended June 30, 2007, our accumulated
        deficit increased from $38.7 million to $41.0 million. Upon adoption of FIN
        No.
        48, the Company recognized a cumulative effect adjustment of $61,000, decreasing
        its income tax liability for unrecognized tax benefits, and decreasing the
        March
        31, 2007 accumulated deficit balance. Stockholders’ equity decreased to $20.9
        million from $22.6 million as a result of the net loss partially offset by
        the
        the cumulative effect upon adoption of FIN 48 and issuance of common stock
        under
        our employee stock plans.
 
 We
        consider 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. We determine
        the
        length of our investments after considering our cash requirements and yields
        available for the type of investment considered by our Company. We determine
        the
        appropriate classification of debt and equity securities at the time of purchase
        and reevaluate the classification of investments as of each balance sheet
        date.
        As of June 30, 2007, we had $15.6 million classified as short-term investments
        and had no long-term investments, compared with $17.5 million classified
        as
        short-term investments and no long-term investments at March 31, 2007. All
        auction rate securities are accounted for as available-for-sale and all other
        interest-bearing securities are accounted for as held-to-maturity.
 
 We
        made
        capital equipment and leasehold improvement purchases of approximately $0.2
        million during thre three months ended June 30, 2007 compared with approximately
        $1.0 million during the three months ended June 30, 2006. We have an annual
        production capacity of 10 million roll-process cards in conjunction with
        approximately 9 million sheet-process cards depending upon the optimum mix
        of
        features. We plan to purchase additional production equipment in a series
        of
        steps when we deem appropriate based in part upon orders and forecasts. We
        may
        use cash on hand and cash generated from operations or debt financing to
        fund
        possible capital expenditures of possibly $8 million for equipment and leasehold
        improvements for card production, read/write drive tooling and assembly,
        and
        general support items as customer orders justify the investment. These
        expenditures could occur throughout the next twelve to eighteen
        months.
 
 There
        were no debt financing activities for the three months ended June 30, 2007
        and
        2006.
 
 OFF-BALANCE
        SHEET ARRANGEMENTS
 
 We
        have
        no off-balance sheet arrangement as of June 30, 2007 and March 31, 2007,
        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.
 
 RECENT
        ACCOUNTING PRONOUNCEMENTS
 
 Recent
        accounting pronouncements are disclosed in Note 1 of the notes to condensed
        consolidated financial statements.
 
 29
  **ITEM
        3.**  **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**
 
 *Interest
        Rate Risk.* We
        invest our cash, beyond that needed for daily operations, in high quality
        debt
        securities. In doing so, we seek primarily to preserve the value and liquidity
        of our capital and, secondarily, to safely earn income from these investments.
        To accomplish these goals, we invest 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 serviceso
              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, our 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 first quarter of fiscal year 2008 in
        our
        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 (in thousands):
 June
                    30, 2007Auction
                    rate securities
                
                $
                15,600Weighted
                    average yield
                
                
                5.32
                %Total
                    investments
                
                $
                15,600
 There
        were no long-term investments as of June 30, 2007.
 
 *Foreign
        Currency Exchange Rate Risk.* Our
        U.S.
        operations sell products in various international markets.  During the
        three months ended June 30, 2007, revenue by our German subsidiary of
        approximately $3.0 million was denominated in foreign currency.  In
        addition, some raw material purchases and purchased services are denominated
        in
        foreign currency. Cash provided by/used in CCD operating activities has been
        immaterial.
 
 We
        use
        short-term foreign exchange forward contracts to mitigate foreign currency
        risk
        associated primarily with inter-company receivables and payables, and loans
        receivable (denominated in Euros) to our 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 of 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
        loans
        receivable.  At June 30, 2007, we had a foreign exchange forward contract
        with a maturity of less than 30 days to purchase 2.3 million euros. The
        fair value of the forward contract was not material at June 30,
        2007.
 
 30
 
 
 **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.* There
        were no significant changes in our internal control over financial reporting
        that occurred during the three months ended June 30, 2007 ** that
        have
        materially affected, or are reasonably likely to materially affect, our internal
        control over financial reporting.
 
 **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 our 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,
        2007, and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the
        fiscal quarter ended December 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
        our
        three months ended June 30, 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 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.
  31
  WE
        INCURRED NET LOSSES DURING FOURTEEN OF THE PREVIOUS SEVENTEEN 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 from October 1, 2005, through June 30, 2006, we incurred a loss
        for our
        last four quarters and we had incurred losses as well for the ten quarters
        preceding the quarter ended October 1, 2005. Our loss for the quarter ended
        June
        30, 2007, was $2.4 million and for our fiscal year 2007 our loss was $12.4
        million, and we had an accumulated deficit of $41 million at June 30, 2007.
        There can be no assurance that we will generate enough 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.
 
 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
        CONTINUED OPERATING LOSSES. We believe 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 Italian governments’ CIE and PSE card programs were minimal in the three
        months ended June 30, 2007, but represented 21% of total revenue for the
        three
        months ended June 30, 2006. During fiscal year 2007, we increased card
        manufacturing capacity to meet the anticipated demand and we have expected
        a
        large order since the first quarter of fiscal year 2007. However, this order
        has
        not yet been placed and there can be no assurance that the order will be
        placed
        in the near-term or that demand will increase or be sustained as we anticipate.
        We would most likely incur losses if orders are further delayed, or if full
        implementation is canceled, not extended, or if the program is not implemented
        at the level foreseen or if the government was to change its technology decision
        and no longer use optical memory cards. While selected Italian cities have
        issued cards and tested the distributed card issuing process, full
        implementation is dependent upon regionalized and further decentralized 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.
 
 THE
        U.S.
        GOVERNMENT, ONE OF OUR TWO LARGEST ULTIMATE CUSTOMERS, HAS THE RIGHT TO DELAY
        ITS ORDERS OR COULD CHANGE ITS TECHNOLOGY DECISIONS, WHICH WOULD RESULT IN
        ORDER
        DELAYS AND POSSIBLY IN OPERATING LOSSES. During the three months ended June
        30,
        2007 revenues included sales of approximately $2.7 million of Green Cards
        and
        Laser Visa BCCs, and comprised 35% of our total revenue. Our fiscal year
        2007
        revenues included sales of approximately $7.4 million of Green Cards and
        Laser
        Visa BCCs, and comprised 23% of our total revenue. We expect these revenues
        to
        continue at approximately $10 million annually ($8 million for Green Cards
        and
        $2 million for Laser Visa BCCs) if the U.S. government continues to use our
        cards in these programs, continues to personalize cards at that rate and
        continues to maintain an inventory level equal to six-months of usage. On
        April
        2, 2007, we announced a subcontract with General Dynamics Information Technology
        (GDIT) for the manufacture and supply of Green Cards and Laser Visas. The
        subcontract is for an initial 12-month period with optional extensions up
        to a
        total of five years. The first purchase order received under the subcontract
        calls for delivery of $5.9 million in Green Cards and Laser Visas over the
        period from March through September 2007. 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 one or both of these 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 Laser Visa Border Crossing Cards, intends to introduce Radio
        Frequency Identification (RFID) technology into 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
        Laser Visa orders if this technology change occurs as projected. 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 GDIT,
        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.
  32
  OUR
        PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE U.S.
        OR
        ABROAD OR IF THE ITALIAN NATIONAL ID PROGRAM IS NOT IMPLEMENTED AS ANTICIPATED.
        Although the U.S. government subcontract has been renewed, we do not expect
        future growth from the U.S. Green Card and Laser Visa BCC programs as we
        expect
        future revenue to average $10 million annually, in line with last year’s
        issuance rates. There were minimal revenues recorded from these programs
        in the
        three months ended June 30, 2007. We had revenues from Italian CIE and PSE
        cards
        of about $2.3 million during the three months ended June 30, 2006. During
        full
        implementation, we expect our revenues from the Italian 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 drivers license card in South Africa, and sports logbook
        cards. There can be no assurance that we will receive sizable future orders
        for
        any of these programs, nor 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. 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.
 
 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 may invest up to $8 million of capital expenditures during
        the
        next twelve to eighteen months assuming certain business developments. However,
        since customer demand is difficult to predict, we may be unable to ramp up
        our
        production quickly enough to fill new customer orders in a timely fashion.
        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 and 2007.
        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.
  33
  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
        SOME OF WHICH IS MORE THAN 20 YEARS OLD. Unless and until Prevent Global
        (Prevent), (previously 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 using a proprietary manufacturing process,
        with our German subsidiary capable of performing a few key steps in certain
        instances. There is no assurance that the Prevent facility, if and when
        operational, will be an acceptable second source to some of our key government
        accounts. 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 currently have on hand and on order enough inventory of film
        to
        produce cards for orders projected over the next nine to fifteen months.
        If
        Kodak announced that it was no longer going to sell film, we would request
        that
        Kodak provide us with a last-buy opportunity which we would plan to take
        maximum
        advantage of, although no assurance can be given that Kodak would provide
        us
        with such an opportunity. We have film on hand plus on order that we believe
        would provide us with an adequate supply to meet anticipated demand until
        we
        could locate and begin volume purchases from a second source.
 
 AN
        INTERRUPTION IN THE SUPPLY OF READ/WRITE DRIVE PARTS OR DIFFICULTIES ENCOUNTERED
        IN READ/WRITE DRIVE ASSEMBLY COULD CAUSE A DELAY IN DELIVERIES OF DRIVES
        AND
        OPTICAL MEMORY CARDS AND A POSSIBLE LOSS OF SALES, WHICH WOULD ADVERSELY
        AFFECT
        OUR OPERATING RESULTS. Several major components of our read/write drives
        are
        designed specifically for our read/write drive. For example, the optical
        recording head for the current drive is a part obtained from one supplier;
        and
        at current production volumes, it is not economical to have more than one
        supplier for this custom component. The ability to produce read/write drives
        in
        high-volume production, if required, will be dependent upon maintaining or
        developing sources of supply of components that meet our requirements for
        high
        volume, quality, and cost. In addition, we could encounter quality control
        or
        other production problems at high-volume production of read/write drives.
        We are
        also investing in research and development in an effort to develop new drive
        products.
 
 IF
        WE ARE
        UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO MANUFACTURE
        AND
        ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS. The price of
        our
        read/write drive product line ranges from $1,800 to approximately $2,500
        depending on features and quantity purchased. We believe the price of our
        drives
        is competitive in applications requiring a large number of cards per drive,
        because the relatively low cost for our cards offsets the high cost per drive
        when compared with our major competition, IC card systems. In addition, we
        have
        undertaken a product development program for a portable read-only drive that
        has
        been sampled in limited quantities at prices less than $1,000, which we believe
        would increase our prospects for winning future business. However, there
        can be
        no assurance that our development program will be successful, that volume
        production of any new design will occur in the near term, or that significantly
        lower manufacturing costs or increased sales will result.
  34
  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 OpticalProximityTM
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 SECURE ID CARD INDUSTRY AND
        IN
        THE INFORMATION TECHNOLOGY INDUSTRY GENERALLY, WE MAY NOT BE ABLE TO EFFECTIVELY
        COMPETE FOR FUTURE BUSINESS. The secure ID 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 our 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 our 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. We
        sell
        to VARs and system integrators who in turn sell solutions to the 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 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. We work to train the integrators to avoid such
        situations, but cannot control their work. Also, we can step in to demonstrate
        how to successfully implement an optical memory card issuing system. We plan
        to
        continue to offer this support then transition the card issuing process to
        local
        resources once the program is running successfully.
  35
  OUR
        OPTICAL MEMORY CARDS HAVE A COMPLEX STRUCTURE THAT REQUIRES A HIGH DEGREE
        OF
        TECHNICAL KNOWLEDGE AND EXPERIENCE TO MEET INCREASINGLY STRINGENT PERFORMANCE
        REQUIREMENTS.  WE HAVE AND COULD IN THE FUTURE AGREE TO CERTAIN
        CHARACTERISTICS BEYOND THOSE REQUIRED IN INDEPENDENTLY PUBLISHED
        STANDARDS.  THIS COULD INCREASE OUR COST OF MANUFACTURING CARDS OR RESULT
        IN ACCEPTING RETURNS OR GIVING CREDITS TO THE CUSTOMER.  MANY CUSTOMERS
        MAINTAIN SIGNIFICANT ADVANCE INVENTORY WHICH INCREASES THIS RISK. There can
        be
        no assurance that we will be able to meet customers’ quality or standards
        requirements consistently.  This could lead to high manufacturing costs due
        to low product yields or unexpected product returns.  We employ a rigorous
        quality control procedure, are ISO 9000 certified and we strive to deliver
        product that meets published standards and customer expectations.  Even so,
        we can not give assurance that our products will meet customer expectations
        in
        all cases.  We have in the past, and may in the future, replace product
        held by the customer or give credit for products previously
        delivered.
 
 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.
  36
  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.
        The losses on foreign currency exchange for both fiscal year 2007 and the
        three
        months ended June 30, 2007 were immaterial. As of June 30, 2007, 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 payables and receivables.
 
 WE
        SOLD A
        SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL INVESTMENTS GROUP (GIG)
        THAT
        WAS SUBSEQUENTLY TRANSFERRED TO PREVENT GLOBAL (PREVENT), UNDER WHICH WE
        WILL
        PROVIDE CERTAIN FACTORY SET-UP AND TRAINING SERVICES. IF WE ARE NOT SUCCESSFUL
        OR IF PREVENT IS UNABLE TO FINANCE THIS OPERATION, THE SECOND-SOURCE SUPPLY
        OF
        OPTICAL CARDS WILL NOT MATERIALIZE. IF WE AND PREVENT ARE SUCCESSFUL, THE
        SECOND-SOURCE WILL COMPETE WITH US FOR BUSINESS. We will be obligated to
        deliver
        the required manufacturing equipment and installation support to Prevent
        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 Prevent
        is successful, Prevent would become a second source for optical memory cards.
        We
        will also be assigning personnel to be on site during the license term, if
        such
        option is elected by Prevent, 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 Prevent 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 Prevent, expansion of the European market, and a bona fide second
        source for optical memory cards. On the other hand, if and when the factory
        is
        successfully manufacturing the cards in high volume, it will compete against
        us
        for business in certain territories, which could reduce our potential card
        revenues if the market does not expand. Revenue will be recognized over the
        remaining term of the agreement beginning when the equipment has been accepted
        and training completed, which date is dependent on Prevent providing a facility
        in Slovenia. We could incur greater expenses than we anticipate for the purchase
        and installation of the required manufacturing equipment thereby reducing
        cash
        and anticipated profits. If Prevent is not successful, but current and potential
        customers require a second source of optical memory cards (which is a common
        business practice) they could decide to use alternate technology cards, such
        as
        chip cards, that have multiple-source suppliers.
 
 WE
        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 CFO,
        or
        our failure to attract and retain other key personnel could disrupt operations
        and have a negative effect on employee productivity and morale, thus decreasing
        production and harming our financial results. In addition, the competition
        to
        attract, retain and motivate qualified personnel is intense.
 
 OUR
        CALIFORNIA FACILITIES ARE LOCATED IN AN EARTHQUAKE ZONE AND THESE OPERATIONS
        COULD BE INTERRUPTED IN THE EVENT OF AN EARTHQUAKE, FIRE, OR OTHER DISASTER.
        Our
        card manufacturing, corporate headquarters, and drive assembly operations,
        administrative, and product development activities are located near major
        earthquake fault lines. In the event of a major earthquake, we could experience
        business interruptions, destruction of facilities and/or loss of life, all
        of
        which could materially adversely affect us. Likewise, fires, floods, or other
        events could similarly disrupt our operations and interrupt our
        business.
  37
  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.
 
 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 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, 2007 and
        2006.
        Although our assessment, testing and evaluation resulted in our conclusion
        that
        as of March 31, 2007 and 2006, our internal controls over financial reporting
        were effective, we cannot predict the outcome of our testing in future periods.
        Because 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 our Company have been detected. If our internal controls
        are found to be ineffective in future periods, our reputation could be harmed.
        We may incur additional expenses and commitment of management’s time in
        connection with further evaluations, both of which could materially increase
        our
        operating expenses and accordingly reduce our net income.
 
 BEGINNING
        WITH OUR FISCAL YEAR 2007, WE WERE 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. The adoption of this accounting standard reduced our profitability
        as
        measured by generally accepted accounting principles (GAAP) due to our
        outstanding options and our current intention to continue to grant options
        in
        the future as an incentive and retention tool for our employees. This may
        adversely affect our stock price. For example, for the three months ended
        June
        30, 2007 and fiscal year 2007, we recognized approximately $0.4 million and
        $1.7
        million, respectively, of additional 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.
 
 38
  **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**
 
 Exhibit
                  No.
              
              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
                  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 C to Schedule 14A Proxy Statement for 2006 Annual Stockholders
                  Meeting filed with the SEC on August 11, 2006, 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**
  39
  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 reference10.12*
              
              Employee
                  Stock Purchase Plan, as Amended; previously filed as Appendix A
                  to amended
                  Schedule 14A Proxy Statement for 2007 Annual Stockholders Meeting
                  filed
                  with the SEC on August 3, 2007, and incorporated herein by
                  reference.31.1
              
              Rule
                  13a-14(a) Certification of Richard M. Haddock, chief executive
                  officer is
                  filed herewith.31.2
              
              Rule
                  13a-14(a) Certification of Steven G. Larson, chief financial officer
                  is
                  filed herewith.32.1
              
              Section
                  1350 Certification of Richard M. Haddock, chief executive officer
                  is filed
                  herewith.32.2
              
              Section
                  1350 Certification of Steven G. Larson, chief financial officer
                  is filed
                  herewith.
 
 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.










40
 
 
 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
              
              August
                  6, 2007Richard
                  M. Haddock/s/Steven
                  G. Larson
              
              Chief
                  Financial Officer
              
              August
                  6, 2007Steven
                  G. Larson
    
 
 41
 
 INDEX
        TO
        EXHIBITS
 
 [ITEM
        14(c)]
  ExhibitNumber
                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 C to Schedule 14A Proxy Statement for 2006 Annual Stockholders
                    Meeting filed with the SEC on August 11, 2006, 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 reference10.12*
                The
                    Employee Stock Purchase, as Amended; previously filed as Appendix
                    A to
                    Schedule 14A Proxy Statement for 2007 Annual Stockholders Meeting
                    filed
                    with the SEC on August 3, 2007, and incorporated herein by
                    reference.31.1
                Rule
                    13a-14(a) Certification of Richard M. Haddock, chief executive
                    officer is
                    filed herewith.31.2
                Rule
                    13a-14(a) Certification of Steven G. Larson, chief financial
                    officer is
                    filed herewith.32.1
                Section
                    1350 Certification of Richard M. Haddock, chief executive officer
                    is filed
                    herewith.
  42
  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.
    43