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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

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

                  FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998

                                       OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

        FOR THE TRANSITION PERIOD FROM _______________ TO _______________

                        COMMISSION FILE NUMBER 000-22625

                             LASER POWER CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                   DELAWARE                                95-3423358
        (State or other jurisdiction of                   (IRS Employer
        incorporation or organization)                 Identification No.)

            12777 HIGH BLUFF DRIVE                            92130
             SAN DIEGO, CALIFORNIA                         (Zip Code)
   (Address of principal executive offices)

       Registrant's telephone number, including area code: (619) 755-0700

        Securities registered pursuant to Section 12(b) of the Act: NONE

          Securities registered pursuant to Section 12(g) of the Act:

                          COMMON STOCK, $.001 PAR VALUE
                              (Title of each class)

   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 and 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. Yes [X] No [ ]

   Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

   The approximate aggregate market value of the Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock reported on the NASDAQ National Market System was $8,253,000 as of
December 1, 1998.*

   The number of shares of Common Stock outstanding was 8,398,455 as of December
1, 1998.


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                       DOCUMENTS INCORPORATED BY REFERENCE

                        (TO THE EXTENT INDICATED HEREIN)

   Registrant's Definitive Proxy Statement to be filed with the Securities and
Exchange Commission (the "Commission") pursuant to Regulation 14A in connection
with the 1999 Annual Meeting of Stockholders to be held February 5, 1999 (the
"1999 Annual Meeting") is incorporated herein by reference into Part III of this
Report.

   Certain exhibits filed with the Registrant's Registration Statement on Form
SB-2 (Registration No. 333-24421), as amended, and the Registrant's Registration
Statement on Form S-4 (No. 333-43415), as amended, are incorporated herein by
reference into Part IV of this Report.

------------
*   Excludes 3,509,408 shares of Common Stock held by directors and officers and
    stockholders whose beneficial ownership exceeds ten percent of the shares
    outstanding on December 1, 1998. Exclusion of shares held by any person
    should not be construed to indicate that such person possesses the power,
    direct or indirect, to direct or cause the direction of the management or
    policies of the Registrant, or that such person is controlled by or under
    common control with the Registrant.

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   This Annual Report on Form 10-K contains certain forward-looking statements,
and the actual results for Laser Power Corporation ("Laser Power" or the
"Company") may differ materially from those discussed here. Additional
information concerning factors that could cause such a difference can be found
in this Annual Report on Form 10-K in Part I, Item 1 under the caption "Certain
Risk Factors Related to the Company's Business" and elsewhere throughout this
Annual Report.

                                     PART I

ITEM 1.  BUSINESS

   Laser Power designs, manufactures and markets high performance lasers and
optics for industrial, medical and military applications. The Company's laser
optics products are sold to laser system OEMs and end users as original and
replacement components in high power CO2 and other lasers. The Company's
infrared optics products are sold primarily to the U.S. government and its prime
contractors for use in night vision and thermal imaging and guidance systems.
The Company's proprietary microlasers are designed for use in certain medical,
entertainment, projection display and other applications.

   The Company's laser optics customers use high power CO2 lasers in a variety
of industrial processing applications, such as sheet metal cutting, automobile
body welding, surface hardening for engine components and scribing and drilling
delicate ceramic circuits. The Company also sells high performance laser optics
to medical equipment OEMs for lower power CO2 lasers used in certain
therapeutic and cosmetic procedures, including surgery and skin wrinkle removal.
In addition, the Company has developed very low absorption thin film coatings
for laser optics for various government programs.

   The Company's infrared optics products are primarily windows, window
assemblies and domes. Windows and window assemblies are utilized in thermal
imaging systems which provide night vision, target acquisition and designation
and low altitude navigation capabilities. These systems are installed in various
platforms including ground vehicles, helicopters and fixed-wing aircraft. Domes
are utilized as a protective cover and infrared filter for various infrared
guided missiles. Missile sizes range from smaller, man-portable designs to
larger designs mounted on ground vehicles, helicopters and fixed-wing aircraft.

   The Company's core competencies in the manufacture of laser optics and
infrared optics lie in its surface finishing processes and thin film coatings,
and in the growth of a key material used in most of its infrared windows. The
Company believes that its expertise in these areas provides it with a
significant competitive advantage.

   The Company also conducts contract research in the development and
applications of advanced solid state lasers. Sponsors of contract research
include various agencies and departments of the U.S. government, as well as
commercial entities.

   The Company has leveraged its expertise in thin film coatings, surface
finishing and solid state lasers to develop proprietary microlasers that are
excited or "pumped" by diode lasers. These microlasers have significant size
advantages and are generally 100 times more energy efficient than conventional
gas and solid state lasers. Further, they have longer estimated lifetimes than
conventional lamp pumped solid state and gas lasers. Mircrolasers are currently
being sold to OEMs and end users as replacements for gas lasers in certain
medical equipment and laser light show applications. In addition, the Company
has sold small quantities of microlasers for use as research devices and for
evaluation and demonstration purposes for cable TV, sensor and projection
display applications. The Company believes that microlasers can replace other
lasers in additional medical equipment and in other applications.

INDUSTRY AND MARKET OVERVIEW

   LASER TECHNOLOGY

   The use of lasers in industrial and medical applications continues to grow
and to expand into new areas. High power CO2 lasers are widely used in
industrial applications, such as welding automobile bodies, scribing delicate
ceramic circuits and sheet metal cutting. CO2 lasers offer greater quality,
speed, flexibility and automation than conventional cutting and welding
technologies. Lower power CO2 lasers and argon-ion and solid-state lasers are
used in various medical procedures, including surgical, dermatology and
ophthalmology applications. Surgical laser procedures reduce blood loss and
post-operative pain compared to other procedures.





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   The precision optics which collect, form, reflect and transmit the laser beam
are crucial to a laser's function. In gas lasers, the lasing medium is encased
in a tube with optics at either end. These internal optics may direct the beam
from one tube to another, may turn the beam back on itself to further energize
the lasing medium or may allow part of the beam to exit the tube while turning
the rest of the beam back on itself. Conventional solid state lasers are similar
except that the tube is replaced by a laser crystal rod. In addition to the
internal optics, a number of external optics may be used to deliver the beam for
its intended application. These external optics may include mirrors, beam
splitters, focusing lenses and other special function optics. The number of
optics used in a laser system can be as many as 15 in a high power CO2 laser
system. Since optics wear and become contaminated during operation, they must be
replaced routinely. Sales of optics as replacement parts represent the majority
of the laser optics market.

   Lasers employing a semiconductor medium (diode lasers) are used in printers,
compact disk players and telecommunications equipment. Diode lasers can also be
used to excite or "pump" solid state lasers. Solid state lasers, which employ
crystals as the lasing medium and are energized by light from lamps, are used in
various industrial, medical and biotechnology applications. Recently, laser
engineers have developed small, highly efficient solid state lasers that are
energized by diode lasers (diode pumped solid state lasers or "DPSSLs"). Because
of their small size and high efficiency, DPSSLs may address many of the
applications currently served by other lasers and may create new applications.
Microlasers are miniature DPSSLs.

   The Company believes that because of their small size and high efficiency,
microlasers may replace gas, semiconductor and other solid state lasers in many
applications as well as enable new applications. For example, the Company's
microlasers are being used or evaluated as replacements for gas and solid state
lasers in dermatology and ophthalmology applications and for laser light shows.
Microlasers may also be used as replacements for semiconductor lasers and
laser/amplifier combinations in broadband communications applications such as
cable television ("CATV") and dense wavelength division multiplexing ("DWDM").
In addition, microlasers can be used in fiber optic sensor systems. Finally, the
Company believes that microlasers may enable the development of commercial solid
state laser projection systems for use in flight simulators, large meeting
venues, video walls and, ultimately, electronic cinema.

   INFRARED SENSOR TECHNOLOGY

   Utilization of infrared sensors continues to grow in a variety of military
and aerospace applications. Fielded systems range from small, personal use
devices such as range finders and night vision goggles to sophisticated airborne
and space-based imaging and targeting systems. Although the number of platforms
which employ these sophisticated systems continues to decrease, increased focus
on improved performance through major system upgrades to existing platforms is
expected to sustain this market. As sensor and signal processing technologies
evolve, infrared based technology is expected to gain wider acceptance for
commercial applications.

   Infrared optics are critical to the performance of infrared sensor systems.
The typical infrared sensor system utilizes an optic which acts as a window to
the environment external to the sensor package, such as a flat window or a dome,
and one or more internal optics. External thin film coatings and surfaces of
windows and domes degrade through exposure to the outside environment, and where
practical, these optics are periodically refurbished or replaced. Refurbishment
and replacement of damaged windows represents an important component of the
Company's infrared optics business.


PRODUCTS AND PRODUCTS UNDER DEVELOPMENT

   LASER OPTICS PRODUCTS

   The Company produces optics, including total reflectors, output couplers,
beam splitters and lenses, for use in high power industrial, medical, scientific
and military lasers. The Company's expertise in the area of surface finishing
and, in particular, thin film coatings, is critical to producing high
performance laser optics. In general, the performance of an optic is primarily
dependent on the quality of the thin film coating. Thin film coatings include
various reflective coatings for mirrors and transmissive and partially
transmissive coatings for lenses, beam splitters and output couplers. The
Company believes that the high quality of its thin film coatings and its
commitment to customer service enhance its reputation as a supplier of high
power and technically advanced laser optics.





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   CO2 Laser Optics. Reliable operation of high power CO2 lasers requires
high quality, low absorption optics. The Company supplies substantially all
types of optics used in CO2 lasers and laser systems. Such optics fall broadly
into two categories: transmissive and reflective optics.

   Zinc selenide is the substrate material of choice for high power CO2 laser
transmissive optics such as lenses, output couplers and beam splitters because
of its low absorption of laser energy. Generally, zinc selenide optics with low
absorption thin film coatings are able to handle up to three kilowatts of power.
As laser power increases to the multi-kilowatt range, reflective optics replace
transmissive optics in certain applications.

   Reflective optics (such as folding mirrors, phase shifting mirrors, beam
bending mirrors and focusing mirrors) utilize a highly reflective substrate,
such as copper or silicon. Silicon optics are fabricated by conventional
polishing processes, while copper optics are usually fabricated by single-point
diamond turning, a process which involves cutting by gem quality diamonds to
create a mirror finish. The Company is a leader in the use of single-point
diamond turning methods to produce both standard optics and those with
complicated surfaces such as aspheres, parabolas and hyperbolas, which are used
with higher power CO2 lasers. The Company's fabrication and thin film coating
technologies have earned Laser Power a reputation as a leading manufacturer of
laser optics.

   The Company supplies optics to high power CO2 laser and laser system
manufacturers and to the aftermarket as replacement parts. Because CO2 laser
optics wear or become contaminated, every new laser installed increases the
market for replacement optics. In order to meet this growing aftermarket demand,
the Company provides same day shipment of critical replacement optics for most
high power CO2 lasers.

   Other Laser Optics. In addition to CO2 laser optics, the Company provides
optics for a variety of industrial and military lasers operating at different
wavelengths.

   Military Products. The Company has developed thin film coatings for optics
utilized in ongoing U.S. government programs to develop laser weapons for
missile defense. The Company has developed very low absorption thin film
coatings for uncooled optics, which are critical to a space-based laser for
defense against long range ballistic missiles. The Company has also developed
thin film coatings for use in ground-based and airborne laser defense systems
for use against shorter range missiles.

   The technology used to produce coatings for optics for these lasers is
derived from technology used by the Company for CO2 laser optics. The Company
believes that participation in these military programs fosters continued
improvement in its optics technology for commercial applications.

   INFRARED OPTICS PRODUCTS

   The Company produces optics for use in infrared systems for night vision
imaging and navigation applications, principally for use by the U.S. government.
These products include monolithic and segmented windows and window assemblies,
focusing optics and missile domes. In addition, the Company provides thin film
design and coating services to customers for military and commercial infrared
applications. Performance of infrared optics is highly dependent on the
durability and optical performance of the thin film coatings applied to the
polished surfaces of the optics. The Company believes that the high quality of
its thin film coatings, along with its in-house capability for growth of
germanium substrates and expertise in high speed fabrication and polishing
provide it with significant competitive advantages.

   Germanium Windows. The substrate material utilized in optics for a
significant number of infrared systems is germanium. Depending upon the
operating environment, germanium windows may be heated through a metallic grid
applied to the surface of the optic. Windows manufactured by the Company are
utilized in a variety of platforms including the M1 tank and Bradley fighting
vehicle, the AA-64 Apache helicopter, and B-52 and tactical fixed-wing aircraft.
Applications include electronic viewing, night vision, target acquisition and
designation, and low altitude navigation and targeting. The Company supplies
optics during production phases of sensor programs, and provides post-production
repair, refurbishment and replacement services. The Company believes it is the
principal supplier of heated germanium windows for infrared systems utilized by
the U.S. government.





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   Other Windows. The Company also supplies windows fabricated from materials
other than germanium, such as silicon and zinc sulfide. These products are
manufactured utilizing the same fabrication and thin film coating processes as
are germanium windows. Typically, these products are sold in substantially lower
volumes than germanium windows.

   Missile Domes. The Company manufactures domes for the U.S. Army's Javelin
missile (a shoulder launched infrared guided anti-tank missile), and is
currently in the development or pre-production phase of other U.S. government
missile programs. Missile domes are mounted on the tip of infrared guided
missiles as a protective cover for the underlying sensor system. These optics
are designed to optimize the performance of the sensor system while
accommodating the size and weight limitations of the missile. The resultant dome
shape is difficult to fabricate in a cost-effective manner utilizing
conventional fabrication techniques. The Company has developed and automated
high speed fabrication and polishing processes which it believes will enable it
to become a leading supplier of missile domes.

   MICROLASER PRODUCTS

   The Company has developed proprietary microlasers, which are miniature
DPSSLs. The miniaturization is accomplished by reducing the size of the solid
state material to millimeter or sub-millimeter dimensions and replacing end
mirrors with complex thin film coatings applied to the polished ends of the
laser crystals. Microlasers have significant size advantages over gas and other
lasers. In addition, microlasers are generally 100 times more energy efficient
than gas lasers because they consume less electricity in creating their optical
output and require less cooling. Microlasers also have longer estimated
lifetimes than gas lasers.

   Green Microlasers. The Company's green microlaser has size and energy
efficiency advantages over gas lasers used in certain applications. The Company
currently sells green microlasers for medical (dermatology), entertainment and
projection display applications. Green microlasers are the Company's highest
unit sales volume microlaser product.

   Blue Microlasers. The Company believes that its blue microlaser is the only
high power all solid state compact blue laser in existence. The blue microlaser
is being developed primarily for microlaser based projection display
applications, for which limited quantities have been sold.

   Microlaser Based Displays. The Company has developed prototype projectors
using its green and blue microlasers with commercially available red diode
lasers to produce high quality images. The Company believes that microlaser
based projectors may produce higher resolution and more colors than commercially
available liquid crystal projectors. Further, microlaser light sources have
longer estimated lifetimes compared to conventional light sources. The Company
expects that microlaser based projectors may provide advantages in a number of
applications, including entertainment displays, flight simulators, process and
system control room displays, portable large venue projectors, videowalls and
electronic cinema.

   The Company has been awarded several government contracts to develop advanced
multi-beam, direct write microlaser projector technology, for which the Company
retains commercial rights. Such direct write technology will impress video
information directly on the microlaser beams. The beam will write the image
directly onto a screen similar to the way an electron beam writes a television
image, except that multiple lines will be written simultaneously, which may
enable super high resolution up to 5,000 by 4,000 pixels. The Company has been
issued a U.S. patent covering such technology and has filed applications seeking
additional patent protection. Since the beam from red diode lasers is not
suitable for use in direct write projection systems, the Company would need to
develop a red microlaser as a replacement. The Company has discontinued
development of a red microlaser. There can be no assurance that the Company will
resume development of a red microlaser, or if it is unable to develop such a
microlaser, that it will be able to acquire the rights to a suitable red laser
technology at a commercially reasonable cost, if at all.

   1550 nm Microlaser. Distributed feedback ("DFB") diode lasers emitting at
1550 nm wavelength are used in the telecommunications industry to transmit
signals through fiber optic cables. Such lasers are gaining widespread
acceptance in upgrades and new installations of CATV and other
telecommunications systems worldwide. The Company has developed and sold





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evaluation units of a 1550 nm microlaser which has better operating performance
and is capable of generating higher power than DFB lasers. If this technology is
adopted by transmitter manufacturers, CATV fiber optic systems employing 1550 nm
microlasers would not require amplification to the same extent as DFB lasers and
would deliver a higher quality, lower noise signal to the receiver. The Company
believes that its 1550 nm microlaser will provide a price/performance advantage
over DFB laser technology.

   Dense wavelength division multiplexing allows multiple laser beams with
different wavelengths to be launched into a single optical fiber. DWDM has been
rapidly embraced by long-haul carriers for digital transmission because of
significant cost and time savings over laying additional fiber optic cable. In
addition, the Regional Bell Operating Companies ("RBOCs") and CATV operators are
beginning to use DWDM increasingly as the technology advances, cost of equipment
decreases and digital transmission becomes more popular for local traffic. The
Company believes that its 1550 nm microlaser could be developed for use in DWDM
applications and is seeking a strategic partner to develop this potential.

STRATEGY

   The Company's strategy is to expand its current precision optics business and
to leverage its core expertise in high performance laser optics, low absorption
thin film coatings and solid state lasers to become a world leader in the
manufacture, marketing and sale of microlasers and microlaser based products.
Key aspects of the Company's strategy include:

   Continue To Grow High Performance CO2 Laser Optics Business

   The Company's core competencies in the design and manufacture of high
performance laser optics, including its polishing and diamond turning processes
and thin film coatings, have made Laser Power one of the leading suppliers of
such components, especially for high power CO2 lasers. The Company's strategy
is to continually improve quality and customer service while lowering production
costs. The Company believes it is well positioned to meet more stringent
requirements for optics used in higher power CO2 lasers because of its
proprietary and state-of-the-art technologies.

   Expand Markets For High Performance Optics Products

   The Company believes that its technologies have applications in markets not
currently served by the Company. The Company plans to use its technology base
developed for CO2 laser optics and microlaser crystal polishing and thin film
coating to produce certain optics for neodymium-YAG lasers and visible lasers.
The Company also plans to enter other non-CO2 infrared markets using CO2
coatings.

   Increase Margins On Optics Products

   The Company has a multifaceted strategy to reduce costs and increase margins
on its optics products. To reduce costs, the Company is consolidating its laser
and infrared optics operations and is increasing the use of automation which
will reduce labor costs and improve yields on certain manufacturing processes.
To increase margins, the Company plans to intensify its sales efforts on higher
margin products and to serve high performance, high margin niches in such
markets as the emerging high power neodymium-YAG laser market.

   Market Microlasers For Existing Medical and Other Applications

   The Company currently is shipping green microlasers for use in medical,
entertainment and projection display applications. The Company intends to
exploit the superior size and energy efficiency characteristics of its
microlasers to replace existing gas and solid state lasers utilized in
applications and markets that are not currently addressed by the Company's
microlaser products.

   Market 1550 nm Microlasers for CATV and Sensor Applications

   The Company has developed a high power, low noise 1550 nm microlaser that it
believes will provide substantial performance and cost advantages over 1550 nm
DFB lasers used in certain existing CATV transmission systems. In addition, the
1550 nm microlaser is expected to provide substantial performance improvement
over existing technologies in certain sensor applications, such as underwater
oil exploration. The Company shipped evaluation units of its first 1550 nm laser
product in the





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second quarter of fiscal 1998 and continues to develop production units pending
acceptance of the 1550 nm microlaser technology by its targeted customer base.

   Develop And Market Microlasers For High End Projection Display Applications

   The Company has developed blue and green microlasers which, when packaged
with red diode lasers, can be arrayed together as the light source for a
high end display projector. The Company believes that microlaser based
projectors will have significant performance and size advantages over existing
high end lamp based and CRT based projectors.

   Supplement Product Development Activities Through Contract Funding

   The Company will opportunistically secure research contracts that will
enhance and advance its products under development. The Company has spent
approximately $15 million on microlaser development and related display
technology programs, substantially all of which was paid for through joint
ventures with strategic partners. See "Research and Development."

   Expand Capabilities Through Strategic Alliances And Acquisitions

   Through alliances with other companies, Laser Power has enhanced its high
performance laser optics technologies, broadened its research activities and
developed its microlaser technology. The Company believes that similar
relationships with leading companies in the medical equipment, CATV, sensor,
high end projection display and telecommunications industries will facilitate
its entry into those markets. In addition, the Company will continue to identify
and, if possible, acquire technologies or other companies that complement its
current technologies.

SALES AND MARKETING

   As of December 1, 1998, Laser Power employed 19 persons in sales and
marketing at sales offices in the United States and Belgium. The Company
promotes its products to OEM and end user customers through a multi-faceted
program which includes trade journal advertising, catalog distribution, direct
mail promotion, field sales presentations, technical seminars, trade show
exhibits and direct telemarketing. The Company sells its products through its
direct sales force in the United States and Belgium and through its distributors
in the rest of the world.

RESEARCH AND DEVELOPMENT

   The Company believes that its future success depends in large part on its
ability to complete products under development, to continue to enhance its
existing products and manufacturing processes and to develop new products. As of
December 1, 1998, the Company had 45 employees performing research and
development in the United States and Belgium. The Company spent $5.8 million,
$6.2 million and $6.1 million during fiscal years 1996, 1997 and 1998,
respectively, on research and development. The sources of such funds included
contracts with customers and strategic partners as well as internal Company
funds.

   The Company continues to develop its 1550 nm microlaser for sensor and
broadband communications applications and its blue microlaser for projection
display applications. Also, the Company continues laser projection display
development under several U.S. government and commercial research contracts. The
Company intends to strengthen its competitive position for all microlaser
applications by developing higher power microlasers and lower cost component and
sub-assembly designs. In addition, the Company is developing proprietary
automated manufacturing processes for optics fabrication and polishing to lower
costs and provide a more flexible manufacturing environment.

   The successful completion of development activities and the transition to
manufacture and sale of any resultant products is dependent on a number of
factors, including determination of demand and appropriate product design,
length of development period, development of appropriate manufacturing
processes, product performance and sales and marketing. There can be no
assurance that the 1550 nm microlaser, blue microlaser or any of the other
products or improvements under development will be successfully developed, or
that new products developed by the Company will be commercially available or
achieve market acceptance. See "Products Under Development" and "Certain Risk
Factors Related to the Company's Business - Development Risks Relating to
Microlaser Technologies."





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MANUFACTURING

   The Company manufactures high performance optics, microlasers and related
components. Some materials and components are available only from single
suppliers.

   The Company manufactures optics at its San Diego, California, Temecula,
California and Mexico facilities. Thorium fluoride, zinc selenide, zinc sulfide
and germanium are important to the manufacture of optics. The Company purchases
all of its thorium fluoride for use in its low absorption thin film coating
processes from Cerac Incorporated ("Cerac"), which the Company believes is the
sole source for high quality thorium fluoride. Any interruption or cessation of
supply by Cerac would have a material adverse effect on the Company's business,
financial condition and results of operations.

   In the case of zinc selenide and zinc sulfide, critical raw materials in a
significant percentage of the Company's optics products, the Company currently
relies principally on one supplier, the Advanced Materials Division of Morton
International, Inc. ("Morton"). To date, the Company has not experienced any
material difficulties in the quantity or the quality of the zinc selenide and
zinc sulfide delivered. If any such problem arises in the future, the Company
would have to seek an alternate supplier. However, there can be no assurance
that the Company would be able to secure sufficient inventory of zinc selenide
and zinc sulfide to produce sufficient product to meet its customers' needs. A
transition to alternate arrangements would involve additional costs and delays
in production.

   Germanium is mined as a byproduct of zinc mining. Germanium and refined
germanium are available through a limited number of suppliers worldwide. Because
of its status as a byproduct, availability of germanium is linked to the effects
of supply and demand for zinc. Germanium also has other uses such as in solar
panels used in space vehicles and satellites and in certain radar systems.
Changes in demand for and supply of germanium have resulted in significant
fluctuations in price in the past. While the Company attempts to structure its
contracts to protect it from the effects of price increases, there can be no
assurance that future price increases will not materially affect the
profitability of the Company's products which utilize germanium.

   The manufacture of optics is capital intensive. Future manufacturing capacity
requirements may require substantial investment in equipment and facilities. See
"Certain Risk Factors Related to the Company's Business -- Fluctuation in
Quarterly Performance."

   The Company's microlasers are assembled from component parts at the Company's
San Diego facility. The Company purchases component parts for its microlasers,
including laser crystals, nonlinear crystals, and semiconductor diode lasers,
from various sources around the world. The Company believes its suppliers can
supply the components in the quantities, with the quality and at the prices
required by the Company for volume production of the Company's microlaser
products and products under development. However, none of the Company's
suppliers of microlaser component parts has experience in supplying these
components with the Company's specifications at the increased volumes that the
Company needs to achieve its growth goals. In addition, certain future
applications require substantially lower cost components. The Company does not
have long term or volume purchase agreements with any of its suppliers and
currently purchases components on a purchase order basis. See "Certain Risk
Factors Related to the Company's Business -- Limited Microlaser Manufacturing
Experience; Scale-up Risk."

   Moreover, the Company has no experience in producing microlasers other than
in low level production quantities. The Company continues to increase its
manufacturing capability to polish and coat volume quantities of microlaser and
nonlinear crystals and to perform the required complex assembly steps. Future
increases in its manufacturing capabilities could require significant scale-up
expenditures and additions to the Company's facilities. See "Certain Risk
Factors Related to the Company's Business -- Limited Microlaser Manufacturing
Experience; Scale-Up Risk."

PATENTS AND PROPRIETARY RIGHTS

   As of December 1, 1998, Laser Power's patent portfolio included four patents
issued by the U.S. Patent and Trademark Office ("USPTO") and one patent granted
by the European Patent Office (the "EPO"), subsequently filed in five European
countries. The Company has received Notices of Allowability on four of its
patent applications pending with the USPTO and has eight other patent
applications pending. Two patent applications have been filed in several foreign
jurisdictions and the Company has been granted licenses to two patent
applications owned by Proxima and filed with the USPTO. Many of the Company's
pending patent applications relate to microlaser technology. The two pending
U.S. patent applications licensed from Proxima cover certain aspects of
microlaser display technology.





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   Because of lesser protection afforded by and the high cost of pursuing
patents in certain foreign jurisdictions, the Company has elected not to seek
patent protection for certain of its inventions covered by its U.S. patents in
foreign jurisdictions. Nevertheless, the Company intends to selectively pursue
foreign patent filings where the cost of and protection afforded by such
patents, if issued, are justified. However, the Company in general believes
that, in certain cases, obtaining foreign patents may be much less useful than
obtaining domestic patents because of differences in patent laws and costs of
patent enforcement, and further believes that the protection provided by foreign
patents, if obtained, and any other foreign intellectual proprietary protection
may be weaker than that provided domestically.

   Laser Power's continued success will depend in part on its ability to obtain
patent protection for its products and processes, and to operate without
infringing the proprietary rights of third parties. There can be no assurance
that patent applications filed by Laser Power will result in patents being
issued, that the claims of such patents will offer significant protection of the
Company's technology, or that any patents issued to or licensed by Laser Power
will not be challenged, narrowed, invalidated or circumvented. The Company may
also be subject to legal proceedings that result in the revocation of patent
rights previously owned by or licensed to Laser Power, as a result of which the
Company may be required to obtain licenses from others to continue to develop,
test or commercialize its products. There can be no assurance that Laser Power
will be able to obtain such licenses on acceptable terms, if at all.

   In addition, there may be pending or issued patents held by parties not
affiliated with Laser Power that relate to the technology utilized by Laser
Power. As a result, Laser Power may need to acquire licenses to, assert
infringement of, or contest the validity of, such patents or other similar
patents which may be issued. Laser Power could incur substantial costs in
defending itself against patent infringement claims, interference proceedings,
opposition proceedings or other challenges to its patent rights made by third
parties, or in bringing such proceedings or enforcing any patent rights of its
own.

   The patent positions of optic, laser component and laser manufacturing
companies, including the Company, are generally uncertain and involve complex
legal and factual questions. As a result, these industries have a history of
patent litigation and will likely continue to have patent litigation concerning
their technologies. A number of optic, laser component and laser manufacturing
companies maintain and continue to develop patent positions that could prevent
Laser Power from using technology covered by these patents. The commercial
success of the Company depends in part on not infringing patents. Any action
against the Company or its collaborative partners claiming damages or seeking to
enjoin commercial activities relating to the affected products and processes
could, in addition to subjecting the Company to potential liability for damages,
require the Company or its collaborative partners to obtain a license to
continue to develop, manufacture or market the affected products and processes.
There can be no assurances that the Company or its collaborative partners would
prevail in any such action or that any license (including licenses proposed by
third parties) required would be made available on commercially acceptable
terms, if at all. If the Company becomes involved in such litigation, it could
consume a substantial portion of the Company's managerial and financial
resources, which could have material adverse effect on the Company's business,
financial condition and results of operations.

   The Company has acquired from ATx Telecom Systems, Inc. ("ATx Telecom") a
license to a Stanford University ("Stanford") owned patent covering certain
technology used in the Company's blue microlaser. During fiscal year 1996, The
Company received a letter from a competitor claiming that the Company's license
was transferred improperly by Stanford and ATx Telecom. While the Company
believes that such license was properly transferred, there can be no assurance
that the Company's license would not be challenged. In such an event, there can
be no assurance that the Company would be able to obtain a replacement license
on favorable terms, if at all. Failure to obtain such a license could result in
a material adverse effect to the Company's business, financial condition and
results of operations.

   The Company is aware of patents held by other laser companies that may relate
to the Company's microlaser technology. The Company does not believe it
infringes any valid claims of such laser companies' patents or believes that it
has adequate design-arounds if it is held to be infringing. Nevertheless, for
certain cost or strategic reasons, the Company believes it may be advantageous
to enter into license agreements with such laser companies. However, there can
be no assurance that the Company will obtain the licenses on favorable terms, if
at all. If it is determined that the patents held by these other laser companies
do cover the Company's technology, the Company's inability to obtain licenses
for such technology could have a material adverse effect on the Company's
business, financial condition and results of operations.

   The Company has developed certain of its proprietary technology pursuant to
development contracts, including contracts with





                                       10
<PAGE>   11

federal government agencies. Under standard provisions in government contracts,
the government may retain certain rights in technology developed under such
contracts. In addition, the Company has granted significant rights to the other
parties under such contracts. The Company's strategy is to continue to develop a
significant portion of its proprietary technology pursuant to funding received
from development contracts. There can be no assurance that the Company will be
able to continue to obtain funding for the development of its proprietary
technology, or that, if received, the Company will obtain rights to such
technology sufficient to permit the Company to develop and market new products
or to prevent third parties from using such technology to compete with the
Company.

   In addition to patent protection, Laser Power also relies on copyright
protection, trade secrets, know-how, continuing technological innovation and
licensing opportunities to expand and bolster its competitive position. In an
effort to maintain the confidentiality and ownership of trade secrets and
proprietary information, the Company requires employees, consultants and certain
collaborators to execute confidentiality and invention assignment agreements
upon commencement of a relationship with the Company. These agreements are
intended to enable the Company to protect its proprietary information by
controlling the disclosure and use of technology to which it has rights and
provide for ownership by the Company of proprietary technology developed at the
Company or with the Company's resources. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's trade
secrets or other confidential information in the event of unauthorized use or
disclosure of such information or that adequate remedies would exist in the
event of such unauthorized use or disclosure. The loss or exposure of trade
secrets possessed by Laser Power could have a material adverse effect on the
Company's business, financial condition and results of operations.

   The Company's academic collaborators have certain rights to publish data and
information in which the Company has rights. There is considerable pressure on
academic institutions to publish discoveries in the high technology and physics
fields. There can be no assurance that such publication would not adversely
affect the Company's ability to obtain patent protection for certain
technologies in which it may have a commercial interest.

COMPETITION

   The industries in which the Company sells its products are highly
competitive. Laser Power's competitive position depends upon a number of
factors, including the price and performance of its products, the level of
customer service, the quality of its manufacturing processes, the compatibility
of its products with existing laser and infrared systems and Laser Power's
ability to participate in the growth of emerging technologies, such as
microlasers and their application to industries already served by gas and solid
state lasers. In the laser optics market, Laser Power primarily competes with
II-VI, Inc. ("II-VI"), Coherent, Inc. ("Coherent") and Sumitomo Electric
Industries, Ltd. II-VI produces its own supply of zinc selenide. The Company
uses zinc selenide as the substrate for 40% to 50% of the CO2 laser optics
sold by the Company and purchases this raw material from Morton. In the infrared
optics market, the Company primarily competes with in-house optical fabrication
and thin film coating capabilities of major prime contractors, such as Raytheon
Corporation.

   With regard to the Company's microlaser based products and products under
development, the Company faces competition from gas, solid state and DFB laser
manufacturers who already service the various markets the microlasers are
intended to address as well as from lamp manufacturers who are developing lamps
with extended lives for projection display. Competitive factors in the market
for microlaser applications include price, product performance and reliability,
strong customer support and service, customer relationships and the breadth of
product line. In these markets, the Company faces competition from companies
that have substantially greater financial, engineering, research, development,
manufacturing, marketing, service and support resources, greater name
recognition than the Company and long standing customer relationships.
Specifically, the Company believes that its main competitors for its products
and products under development will be Spectra-Physics Lasers, Inc., Coherent,
Uniphase Corporation, Lightwave Electronics Corporation, LiCONiX, Light
Solutions Corporation, Omnichrome Corporation and Edinburgh Instruments Ltd.
With respect to 1550 nm microlasers and microlaser transmitters for supply to
OEMs, the Company believes its competitors will include Harmonic Lightwaves,
Inc., Ortel Corporation, Synchronous Group, Inc., Uniphase Corporation, SDL,
Inc., ATx Telecom, Scientific-Atlanta, Inc., Fujitsu Compound Semiconductor,
Inc., Lucent Technologies Inc. and NORTEL, Ltd.

Other broadband communications equipment suppliers as well as other laser
companies who may develop microlaser based products which compete directly with
the Company's microlaser based products may also enter this market.





                                       11
<PAGE>   12
ENVIRONMENTAL, HEALTH AND SAFETY MATTERS

   The Company uses or generates certain hazardous substances in its research
and manufacturing facilities. The Company believes that its handling and
disposal of such substances is in material compliance with applicable local,
state and federal environmental, safety and health regulations at each operating
location. The Company invests substantially in proper protective equipment,
process controls and specialized training to minimize risks to employees,
surrounding communities and the environment due to the presence and handling of
such hazardous substances. The Company conducts monthly workplace monitoring
regarding such substances. When exposure problems or potential problems have
been indicated, corrective actions have been implemented and re-occurrence has
been minimal or non-existent. The Company does not carry environmental
impairment insurance.

   The Company uses a low level radioactive material called thorium fluoride to
manufacture low absorption thin film coatings. The use, storage and disposal of
this material is governed by the State of California which last inspected and
licensed the Company's facilities and procedures in February 1996. All thorium
fluoride bearing by-products are collected and disposed of at an appropriately
licensed facility.

   The generation, use, collection, storage and disposal of all other hazardous
by-products resulting from the Company's manufacturing of its products and
research and development of new products, such as suspended solids containing
heavy metals or airborne particulates, are believed by the Company to be in
material compliance with local, state and federal regulations. The Company
believes that it possesses all of the permits and licenses required for
operation. Although the Company is not aware of any material environmental,
safety and health problems in its properties or processes, there can be no
assurance that problems will not develop in the future which would have a
material adverse effect on the Company.

BACKLOG

   With the exception of contracts with the U.S. government and its prime
contractors, most customer orders for optics are from stock or for deliveries
within one to two months. Backlog of optics was $13.8 million at September 30,
1998, consisting primarily of backlog for infrared optics. Backlog of research
contracts fluctuates based on the timing of contract awards and was $1.8 million
at September 30, 1998. Backlog of microlaser orders reflects the early stage of
this product line and was $1.8 million at September 30, 1998.

EMPLOYEES

   As of December 1, 1998, the Company had 238 full time and 5 part time
employees in the United States and 32 full time employees in its foreign
subsidiaries. Of the Company's United States employees, 16 were engaged in
marketing, sales and related customer-support services, 43 in research and
development and 184 in operations, administration and finance. None of the
Company's employees is represented by a labor union or covered by a collective
bargaining agreement. The Company has not experienced any work stoppages and
considers its relations with its employees to be good.

EXECUTIVE OFFICERS OF THE REGISTRANT

   The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
          NAME             AGE                     POSITION
          ----             ---                     --------
<S>                         <C>  <C>
Dick Sharman............    64   Chief Executive Officer and Director

Paul P. Wickman, Jr.....    49   Senior Vice  President  and Chief  Financial Officer

Thomas J. Brawley.......    57   President, Precision Optics Group

Dean T. Hodges, Ph.D....    54   President, Microlasers Division

Douglas H. Tanimoto, Ph.D   58   President, Research Division and Director
</TABLE>

   Dick Sharman has served as Chief Executive Officer of the Company since
December 1998 and as a director of the Company since February 1998. Mr. Sharman
has served as Chairman of the Board, President and Chief Executive Officer of
EMI from 1993 until February 1998 and as Chairman of the Board of its wholly
owned subsidiary, Exotic Materials, Inc., from 1988 until February 1998. From
1988 until June 1996, and again from June 1997 until November 1997, Mr. Sharman
served as President and Chief





                                       12
<PAGE>   13

Executive Officer of Exotic. Mr. Sharman received an A.A. in Electronics from
Orange Coast College.

   Paul P. Wickman, Jr. has served as Senior Vice President and Chief Financial
Officer of the Company since September 1992. From 1982 to 1992, he served as
Group Vice President, Finance, and Controller of The Titan Corporation, a
diversified high technology company. Mr. Wickman received a B.S. in Accounting
from San Diego State University and is a Certified Public Accountant.

   Thomas J. Brawley has served as President of the Precision Optics Group since
June 1998 and as President and Chief Executive Officer of Exotic since November
1997. From July 1990 to September 1997, Mr. Brawley was employed by Optical
Coating Laboratories, Inc., serving in various operations and sales and
marketing management positions for its Commercial Products Division and its
Asian Business Ventures. Mr. Brawley received a B.A. from San Diego State
University and an M.B.A. from San Jose State University.

   Dean T. Hodges, Ph.D. has served as President of the Microlasers Division
since March 1996. Dr. Hodges served as President of the Optics Division from
March 1994 to March 1996. From 1984 to March 1994, Dr. Hodges served as Senior
Vice President of Newport Corporation, a manufacturer of instruments for the
laser and optics industries. Dr. Hodges received a B.S. in mathematics and
physics from Humboldt State College and a Ph.D. in Applied Physics from Cornell
University.

   Douglas H. Tanimoto, Ph.D. has served as President of the Research Division
since 1988 and has served as a director of the Company since 1984. Dr. Tanimoto
served as President of the Optics Division from 1986 to 1988. Dr. Tanimoto
received a B.A. from the University of California, Berkeley and an M.S. and Ph.D
in Physics from the University of Oregon.

CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS

   In addition to those risks identified elsewhere in this Annual Report on Form
10-K, the Company's business and results of operations are subject to other
risks, including the following risk factors:

HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT

   The Company has incurred operating losses in the past and, at September 30,
1998, had an accumulated deficit of $8.2 million. The development, sales,
marketing and support of new products will require continued substantial
expenditures for the foreseeable future, which could result in additional
operating losses. The Company has funded a substantial portion of its product
development efforts through development contracts. Any failure by the Company to
maintain its external funding sources could result in increased operating
losses. There can be no assurance that the Company will maintain its external
funding sources or be profitable in the future or that present capital and any
funds provided by operations will be sufficient to fund the Company's future
capital requirements.

DEVELOPMENT RISKS RELATING TO MICROLASER TECHNOLOGIES

   The Company has devoted substantial resources to developing its microlasers
and future microlaser based products. To date, sales of the Company's
microlasers have been limited to low level production quantities and evaluation
units. Other microlasers and microlaser based products are still in the early
stages of development. There can be no assurance that the Company's microlasers
will be successfully designed into customers' products or that the Company's
microlasers will achieve widespread market acceptance. There also can be no
assurance that the Company will successfully develop additional microlasers or
microlaser based products or that any of the Company's products under
development will achieve commercial sales volumes. The Company believes that it
will be necessary to continue to reduce the cost of manufacturing and to broaden
the variety of wavelengths provided by its microlasers to achieve commercial
acceptance. If the Company is unable to successfully gain market acceptance of
its microlasers and microlaser based products, its business, operating results
and financial condition will be materially and adversely affected.

DEPENDENCE ON NEW PRODUCTS AND PROCESSES

   To meet its strategic objectives, the Company must continue to develop,
manufacture and market new products, develop new processes and improve its
existing processes. As a result, the Company expects to continue to make
significant investments in





                                       13
<PAGE>   14

research and development and to consider from time to time the strategic
acquisition of businesses, products, or technologies complementary to the
Company's business. The success of the Company in developing, introducing and
selling new and enhanced products depends upon a variety of factors, including
product selection, timely and efficient completion of product design and
development, timely and efficient implementation of manufacturing and assembly
processes, effective sales and marketing and product performance in the field.
There can be no assurance that the Company will be able to develop and introduce
new products or enhancements to its existing products and processes in a manner
that satisfies customer needs or achieves market acceptance. The failure to do
so would have a material adverse effect on the Company's business, financial
condition and results of operations.

LIMITED MICROLASER MANUFACTURING EXPERIENCE; SCALE-UP RISK

   The Company has no experience in producing microlasers other than in low
level production quantities. The Company's microlasers are assembled from
component parts at the Company's San Diego facility. The Company purchases
component parts for its microlasers, including laser crystals, nonlinear
crystals and diode lasers, from various sources around the world. However, none
of the Company's suppliers of microlaser component parts has experience in
supplying components with the Company's specifications at increased volumes. The
Company does not have long term or volume purchase agreements with any of its
suppliers and currently purchases components on a purchase order basis. There
can be no assurance that these suppliers will be able to provide components to
the Company in the quantities, with the quality or at the prices necessary for
production quantities of the Company's products and products under development.
Future increases in the Company's manufacturing capacity to polish and coat
crystals and to perform the required complex assembly steps could require
significant scale-up expenditures and additions to the Company's facilities. In
the event the Company is unable to locate sufficient sources of microlaser
component parts, or is unable to expand its manufacturing capacity to produce
microlasers and microlaser based products, the Company will not be able to
manufacture its products on commercially reasonable terms, if at all, which
would have a material adverse effect on the Company's business, financial
condition and results of operations.

LIMITED MICROLASER SALES, MARKETING AND DISTRIBUTION EXPERIENCE

   The Company has only limited experience marketing and selling its
microlasers, and does not have experience marketing and selling such products in
large quantities. The Company sells its microlasers and microlaser based
products through a direct sales force in North America and a direct sales force
and distributors in Europe. In Asia, the Company intends to sell its microlasers
and microlaser based products primarily through agreements with distributors or
representatives, although the Company has not entered into any such agreements
or arrangements to date. To the extent that the Company enters into distribution
or representation arrangements for the sale of its microlasers and microlaser
based products, the Company will be dependent upon the efforts of third parties.
There can be no assurance that the Company will be able to build a direct sales
force or marketing organization for microlasers or microlaser based products,
that establishing such a direct sales force or marketing organization will be
cost effective, or that the Company's sales and marketing efforts will be
successful. There can be no assurance that the Company will be able to enter
into agreements with distributors or representation arrangements on a timely
basis, if at all, or that such distributors or representatives will devote
adequate resources to selling the Company's microlasers and microlaser based
products. Failure to build an effective sales and marketing organization or to
establish effective distribution or representation arrangements for the
Company's microlaser products would have a material adverse effect on the
Company's business, financial condition and results of operations.

FUTURE CAPITAL REQUIREMENTS

   Although the Company believes that its existing cash balances and available
lines of credit will be sufficient to meet its capital requirements for at least
the next 12 months, the Company may seek additional equity or debt financing to
compete effectively in the markets it serves. The timing and amount of the
Company's capital requirements cannot be precisely determined at this time and
will depend on a number of factors, including the demand for the Company's
products and products under development. There can be no assurance that such
additional financing will be available when needed, or, if available, will be on
terms satisfactory to the Company. If additional funds are raised by issuing
equity securities, further dilution to the then existing stockholders will
result.





                                       14
<PAGE>   15

FLUCTUATION IN QUARTERLY PERFORMANCE

   The Company has experienced and expects to continue to experience significant
fluctuations in its quarterly results. The Company may incur significant losses
in the future due to product design, development, manufacturing and marketing
expenditures, especially in connection with its microlasers and microlaser based
products. If significant variations were to occur between forecasts and actual
orders with respect to its optics businesses or microlasers and microlaser based
products, the Company may not be able to reduce its expenses proportionately and
in a timely manner, and operating results could be adversely affected. Such
variations have occurred in the past and could occur again in the future as a
result of increases in development expenditures for proposed new products,
product introductions by competitors, changes in customer ordering patterns and
other factors. In addition, the Company's ability to fill orders in a timely and
responsive manner is dependent upon maintaining adequate manufacturing capacity
and significant inventories of raw material and finished optics for replacement
orders. The Company has experienced capacity constraints in the past which have
resulted in delays in order fulfillment and reduced gross margins. Future delays
in order fulfillment could lead to declines in product sales. If product sales
or prices were to decline substantially, inventory writedowns could occur. Price
reductions or increases in material costs could also have an adverse effect on
the Company's business, financial condition and results of operations.

RISKS ASSOCIATED WITH INTERNATIONAL SALES

   International sales accounted for approximately 34% and 41% of the Company's
total revenues in the fiscal years ended August 31, 1996 and 1997, respectively,
and 39% of the Company's total revenues in the fiscal year ended September 30,
1998, and the Company expects that international sales will continue to account
for a substantial portion of total revenues. The Company may continue to expand
its operations outside of the United States and to enter additional
international markets, both of which will require significant management
attention and financial resources. International sales are subject to inherent
risks, including unexpected changes in regulatory requirements, tariffs and
other trade barriers, political and economic instability in foreign markets,
difficulties in staffing and management and integration of foreign operations,
longer payment cycles, greater difficulty in accounts receivable collection,
currency fluctuations and potentially adverse tax consequences. Since
substantially all of the Company's foreign sales are denominated in U.S.
dollars, the Company's products may also become less price competitive in
countries in which local currencies decline in value relative to the U.S.
dollar. The Company's business and operating results may also be materially and
adversely affected by lower sales levels which typically occur during the summer
months and the calendar year end in Europe and certain other overseas markets.
The sales of many of the Company's OEM customers are dependent on international
sales, which increases the Company's exposure to the risks associated with
international sales.

ENVIRONMENTAL, HEALTH AND SAFETY CONCERNS

   The Company is subject to a variety of federal, state and local governmental
regulations related to the storage, use and disposal of hazardous materials used
by the Company in connection with the manufacture of optics. Both the
governmental regulations and the costs associated with complying with such
regulations are subject to change in the future. There can be no assurance that
any such change will not have a material adverse effect on the Company's
business, financial condition and results of operations. The Company makes
investments in protective equipment, and continually reviews and monitors
process controls, manufacturing procedures and training to minimize the risks to
employees, surrounding communities and the environment due to the presence and
handling of such hazardous materials. The failure to properly handle such
materials could lead to harmful exposure to employees or to the improper
discharge of hazardous materials. Since the Company does not carry environmental
impairment insurance, such a failure could result in a material adverse effect
on the Company's business, financial condition and results of operations.

VOLATILITY OF STOCK PRICE

   Until recently, there has been no public market for the Common Stock, and
there can be no assurance that an active public market for the Common Stock will
develop or be sustained. The trading price of the Common Stock could be subject
to significant fluctuations in response to variations in quarterly operating
results, the gain or loss of significant orders, changes in earning estimates by
analysts, announcements of technological innovations or new products by the
Company or its competitors, general conditions in the optics and laser
industries and other events or factors. In addition, the stock market in general
has experienced extreme price and volume fluctuations that have affected the
market price for many companies in industries similar or related to that of the
Company and that have been unrelated to the operating performance of those
companies. These market fluctuations may materially and adversely affect the
market price of the Common Stock.





                                       15
<PAGE>   16

ITEM 2.  PROPERTIES

   The Company leases a facility of approximately 44,000 square feet in San
Diego, California which is used for its headquarters and laser optics,
microlaser, and contract research operations. This facility is leased through
December 31, 2001 and may be purchased pursuant to an option which may be
exercised at the expiration of the lease with a purchase price equal to the
prevailing market value of the property. The Company also leases a facility in
Temecula, California of approximately 60,000 square feet under a lease agreement
which provides for an initial term expiring in June 2007. In addition to the
initial lease term, the lease provides for two additional five-year terms which
are exercisable at the Company's option. The Company has an option to purchase
the Temecula facility at its fair market value at the time the option is
exercised. The Company also leases facilities in Plymouth, Michigan, Tijuana,
Mexico and Gent, Belgium, consisting of approximately 1,000, 4,600 and 3,900
square feet, respectively. The leases on the Michigan and Mexico facilities are
month to month, and the lease on the Belgium facility expires in December 1999.
The Company believes that its leased properties are adequately covered by
insurance. The Company believes that its facilities are adequate for its current
and projected needs and that additional space will be available as needed.

ITEM 3.  LEGAL PROCEEDINGS

   The Company is not a party to any material litigation.

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

   No matters were submitted to a vote of security holders during the quarter
ended September 30, 1998.

PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
         STOCKHOLDER MATTERS

   (a) The Company's Common Stock was first traded on June 19, 1997 on the
Nasdaq National Market under the symbol LPWR. The following table sets forth,
for the periods indicated, the high and low sales prices per share of the Common
Stock as reported on the Nasdaq National Market:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31, 1997        HIGH     LOW
                                         ----     ---
<S>                                     <C>       <C>
Fourth Quarter.......................   7 3/8     5 1/2

FISCAL YEAR ENDED SEPTEMBER 30, 1998

First Quarter........................   9 3/4     5 3/8
Second Quarter.......................   8 7/8     4 5/16
Third Quarter........................   5 5/32    3 1/8
Fourth Quarter.......................   4 1/2     1 1/8
</TABLE>

   The Company had approximately 130 stockholders of record of its Common Stock
as of September 30, 1998. This number does not reflect the number of beneficial
holders of the Company's Common Stock, which the Company believes to be in
excess of 800 holders. The Company has never paid any cash dividends on its
Common Stock and does not anticipate paying cash dividends in the foreseeable
future. The Company's credit agreements restrict the payment of cash dividends.

   (b) On June 18, 1997, the Company's Form SB-2 registration statement (File
no. 333-24421) was declared effective by the Securities and Exchange Commission.
The registration statement, as amended, covered the offering of 1,650,000 shares
of the Company's Common Stock, $.001 par value. The offering commenced on June
19, 1997 and the sale to the public of 1,650,000 shares of Common Stock at $5.50
per share was completed on June 24, 1997 for an aggregate price of $9,075,000.
The registration statement covered an additional 247,500 shares of Common Stock
that the underwriters had the option to purchase solely to cover
over-allotments. The managing underwriters for the offering were Cruttenden Roth
Incorporated and L.H. Friend, Weinress, Frankson & Presson, Inc. On August 6,
1997, the underwriters exercised their option to purchase all 247,500 additional
shares of Common Stock. A total of 1,897,500 shares of Common Stock were sold in
the offering at an aggregate price of $10,436,250. All of the shares sold in the
offering were sold by the Company.





                                       16
<PAGE>   17

   Expenses incurred by the Company through September 30, 1998 in connection
with the issuance and distribution of Common Stock in the offering included
underwriting discounts, commissions and allowances of $965,353 and other
expenses of $1,365,566. Total offering expenses of $2,330,919 resulted in net
offering proceeds to the Company of $8,105,331. No expenses were paid to
directors, officers or affiliates of the Company or 10% owners of any class of
equity securities of the Company.

   Of the net offering proceeds to the Company of $8,105,331, through September
30, 1998 approximately $700,000 had been used for repayment of certain term
loans and amounts outstanding under its line of credit with Wells Fargo Bank
N.A., approximately $200,000 had been used for the mandatory repayment of
certain term loans owed to Proxima, approximately $1,000,000 had been used for
general corporate purposes, approximately $1,100,000 had been used for
acquisition related costs, approximately $3,400,000 had been used for the
purchase of certain machinery and equipment, approximately $500,000 had been
used for facilities expansion and improvements and approximately $1,200,000 had
been used for enhancement of internal research and development capabilities. No
payments were made to directors, officers or affiliates of the company or 10%
owners of any class of equity securities of the Company, other than compensation
payments to officers of the Company.

ITEM 6.  SELECTED FINANCIAL DATA

   The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's Consolidated Financial Statements
and the Notes thereto included elsewhere in this Annual Report on Form 10-K.

<TABLE>
<CAPTION>
                                                                                       ONE MONTH
                                                     YEAR ENDED AUGUST 31,                ENDED       YEAR ENDED
                                        ---------------------------------------------- SEPTEMBER 30, SEPTEMBER 30,
                                          1994         1995         1996        1997        1997         1998
                                        --------     --------     --------    -------- ------------- -------------
<S>                                     <C>          <C>          <C>         <C>         <C>          <C>     
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Revenues:
Product sales ......................    $ 16,822     $ 19,140     $ 25,789    $ 29,396    $  2,531     $ 31,069
Contract research and development ..       1,727        2,714        3,713       6,156         449        3,494
                                        --------     --------     --------    --------    --------     --------
    Total revenues .................      18,549       21,854       29,502      35,552       2,980       34,563
Cost of revenues:
Product sales ......................      11,526       13,444       17,476      20,078       1,559       23,366
Contract research and development ..       1,308        2,059        2,942       4,849         382        3,328
                                        --------     --------     --------    --------    --------     --------
    Total cost of revenues .........      12,834       15,503       20,418      24,927       1,941       26,694
Gross profit:
Product sales ......................       5,296        5,696        8,313       9,318         972        7,703
Contract research and development ..         419          655          771       1,307          67          165
                                        --------     --------     --------    --------    --------     --------
    Total gross profit .............       5,715        6,351        9,084      10,625       1,039        7,869
Income (loss) from operations ......        (309)      (1,375)         531       2,876          66       (6,477)
Net income (loss) before
  extraordinary items ..............    $   (701)    $ (1,837)    $     55    $  2,275         (74)    $ (7,032)
Net income (loss) ..................        (701)      (1,837)         174       2,275         (74)      (7,032)

Diluted earnings (loss) per share(1)    $   (.18)    $   (.38)    $    .03    $    .32    $   (.01)    $   (.85)
Average common shares
  outstanding - Diluted (1) ........       3,926        4,791        6,573       7,196       8,099        8,266
</TABLE>

<TABLE>
<CAPTION>
                                                                                       
                                                           AUGUST 31,                  
                                        ----------------------------------------------   SEPTEMBER 30,
                                          1994         1995         1996        1997         1998
                                        --------     --------     --------    --------  -------------
<S>                                     <C>          <C>          <C>         <C>         <C>     
CONSOLIDATED BALANCE SHEETS DATA:
Cash and cash equivalents ...........   $  1,778     $    834     $  1,508    $  8,253    $  2,412
Working capital .....................      3,919        4,715        6,417      14,787       5,304
Total assets ........................     13,319       14,639       17,565      29,073      25,401
Long-term debt,
   net of current portion ...........      3,155        2,923        2,640       3,230         287
Subordinated convertible debentures..      1,660        1,660        1,660       1,660       1,660
Total stockholders' equity ..........      4,475        5,808        7,922      17,682      11,233
</TABLE>

---------------
(1)  See Note 1 of Notes to Consolidated Financial Statements for a description
     of the computation of net income (loss) per share and the number of shares
     used in the per share calculation.



                                       17
<PAGE>   18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
        RESULTS OF OPERATIONS

   The following discussion contains forward-looking statements that involve
risks and uncertainties. Laser Power's actual results could differ materially
from those discussed here. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the sections
entitled "Certain Risk Factors Related to the Company's Business" as well as
those discussed elsewhere in this Form 10-K.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO THE FISCAL YEAR ENDED
AUGUST 31, 1997

   Revenues. For the fiscal year ended September 30, 1998, product sales were
$31.1 million compared to $29.4 million for fiscal 1997, an increase of $1.7
million or 6%. Contract research and development revenues were $3.5 million for
fiscal 1998 compared to $6.2 million for fiscal 1997, a decrease of $2.7 million
or 44%. The increase in product sales was due primarily to increased shipments
of infrared optics on long-term production contracts and to initial volume
shipments of microlasers, partially offset by reduced shipments of laser optics
attributed to the Asian economic crisis and to increased competition elsewhere.
The decrease in contract research and development revenues was primarily due to
reduced funding for microlaser based display development for commercial and
government customers and for thin film coating development for military laser
optics.

   The Company's ability to increase product sales for fiscal 1999 is dependent
on successful consolidation of optics operations, increased manufacturing
capacity for anticipated customer requirements for infrared optics, recovery of
laser optics markets and response to competition in those markets, and
successful marketing and production of microlasers. Contract research and
development revenues are expected to increase due to work performed commencing
in October 1998 on a subcontract to develop the capability for coating large
optics.

   Gross Profit. Gross profit on product sales was $7.7 million in fiscal 1998
compared to $9.3 million in fiscal 1997, a decrease of $1.6 million or 17%.
Gross profit on research and development revenues was $.2 million in fiscal 1998
compared to $1.3 million in fiscal 1997, a decrease of $1.1 million or 85%.
Gross margin on product sales was 25% in fiscal 1998 compared to 32% in fiscal
1997. The decrease in gross margin was due to a product mix shift to lower
margin laser and infrared optics, reduced fixed cost absorption on production of
laser optics and reduced average selling prices for laser optics in certain
markets, partially offset by a reduction in the negative impact on gross margin
from ramp-up in microlaser manufacturing. Gross margin on contract research and
development revenues was 5% in fiscal 1998 compared to 21% in fiscal 1997. The
decrease in gross margin is due to lower absorption of fixed costs related to
reduced contract activity and to contract overruns on certain microlaser based
display development contracts.

   Internal Research and Development Expense. Internal research and development
expense was $2.8 million in fiscal 1998 compared to $1.4 million in fiscal 1997,
an increase of $1.4 million or 100%. The increase was due to development of
microlaser manufacturing processes and the transition of funding for certain
microlaser development efforts from contract sources to internal sources. As a
percentage of sales, the Company does not expect internal research and
development expense to increase significantly in the near term. In the long
term, increases and decreases as a percentage of sales are less predictable and
depend on a number of factors, including the Company's ability to obtain
contract funding for development of key technologies.

   Selling, General and Administrative Expense. Selling, general and
administrative expense was $7.8 million in fiscal 1998 compared to $6.4 million
in fiscal 1997, an increase of $1.4 million or 22%. The increase was primarily
due to the additional expense associated with being a publicly-held corporation
and to increased marketing and sales expense for microlasers. The Company
anticipates that these expenses will continue to increase to enable the sales
and marketing activities and information systems infrastructure necessary to
support the Company's long-term growth objectives. However, as a percentage of
sales, these expenses are expected to remain constant or increase moderately.





                                       18
<PAGE>   19

   Interest Expense. Net interest expense was $306,000 in fiscal 1998 compared
to $417,000 in fiscal 1997, a decrease of $111,000 or 27%. The decrease was due
primarily to lower average borrowings during fiscal 1998. Interest expense is
expected to increase in the near term due to higher average borrowings used to
fund capital additions and to use of cash to fund manufacturing ramp-up of
microlasers and consolidation of optics operations.

   Income Taxes. Income taxes were $249,000 in fiscal 1998 compared to $185,000
in fiscal 1997, an increase of $64,000 or 35%. The increase was due to increased
taxable income of EMI for periods prior to the merger. The Company has
substantial federal and state tax operating loss carryforwards available for
future periods. The availability of these carryforwards may be limited by the
application of rules relating to a change in control as a result of the merger
with EMI and the completion of the IPO in August 1997.

FISCAL YEAR ENDED AUGUST 31, 1997 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1996

   Revenues. For the fiscal year ended August 31, 1997, product sales were $29.4
million compared to $25.8 million for fiscal 1996, an increase of $3.6 million
or 14%. Contract research and development revenues were $6.2 million for fiscal
1997 compared to $3.7 million for fiscal 1996, an increase of $2.5 million or
66%. The increase in product sales was due primarily to increased demand for
laser optics for new lasers and as replacement parts in installed lasers, and to
increased shipments of infrared optics on long-term production contracts.
Initial shipments of microlasers were not significant. The increase in contract
research and development revenues was primarily due to work performed on a
commercial microlaser display development contract.

   Gross Profit. Gross profit on product sales was $9.3 million in fiscal 1997
compared to $8.3 million in fiscal 1996, an increase of $1.0 million or 12%.
Gross profit on research and development revenues was $1.3 million in fiscal
1997 compared to $.8 million in fiscal 1996, an increase of $.5 million or 63%.
Gross margin on product sales was 32% in fiscal 1997 and fiscal 1996. Decreased
gross margins on sales of laser optics due to manufacturing inefficiencies and
reduced selling prices were offset by increased gross margins on sales of
infrared optics due to increased manufacturing volumes. Gross margin on contract
research and development revenues was 21% for both fiscal 1997 and fiscal 1996.

   Internal Research and Development Expense. Internal research and development
expense was $1.4 million in fiscal 1997 compared to $2.9 million in fiscal 1996,
a decrease of $1.5 million or 52%. The decrease was due to the transition of
funding for certain microlaser development efforts from internal sources to
contract sources.

   Selling, General and Administrative Expense. Selling, general and
administrative expense was $6.4 million in fiscal 1997 compared to $5.7 million
in fiscal 1996, an increase of $.7 million or 12%. Expense decreased as a
percentage of revenues as absolute spending increased at a slower rate than the
growth in revenues.

   Interest Expense. Net interest expense was $417,000 in fiscal 1997 compared
to $453,000 in fiscal 1996, a decrease of $36,000 or 8%. The decrease was due
primarily to income from investment of the net proceeds of the Company's initial
public offering ("IPO"), partially offset by increased borrowings for capital
investments.

   Income Taxes. Income taxes were $185,000 in fiscal 1997 compared to $22,000
in fiscal 1996, an increase of $163,000 or 741%. The increase was due to
increased taxable income. The Company's effective tax rate in fiscal 1997 was
reduced substantially by the utilization of federal and state tax net operating
loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

   The Company completed its IPO in June 1997, raising approximately $8.1
million, net of offering costs. Prior to the IPO, the Company satisfied its
liquidity requirements primarily from cash generated from operating activities
and the net proceeds of private sales of preferred and common stock and, to a
lesser extent, from issuance of subordinated debentures and capital equipment
leasing and bank debt.

   During 1998, the Company was not in compliance with several of its bank
covenants and a waiver was obtained for the year ended September 30, 1998.
The Company is currently in the process of renegotiating its credit agreements,
including amending its covenant provisions and expects to be in compliance with
the amended covenants for the year ending September 30, 1999. At December
23, 1998, because the Company's new credit agreements were not in place, the
term debt was reclassified to current and upon completing the credit agreements
the same term debt will be reclassified to long term.

   Cash used in operating activities was $3.7 million in fiscal 1998 compared to
cash provided by operating activities of $2.2 million and $.1 million in fiscal
1997 and 1996, respectively. The primary reasons for the use of cash were
operating losses incurred due to increased internal funding of research and
development and manufacturing start-up of microlasers, reduced gross margins for
laser optics, inventory investments for optics and microlasers, and expenses
related to the merger with EMI and subsequent integration activities.





                                       19
<PAGE>   20

   Cash used in investing activities was $4.0 million in fiscal 1998 compared to
$3.6 million and $1.2 million in fiscal 1997 and 1996, respectively. The
increase is primarily due to additions to plant and equipment to increase
capacity and automation for manufacture of optics products and to enable
manufacturing of microlaser products. The Company expects capital equipment
investment to be lower in the near term.

   Cash provided by financing activities was $1.9 million in fiscal 1998
compared to $8.6 million and $1.7 million for fiscal 1997 and 1996,
respectively. For fiscal 1998, the primary sources of financing were bank
borrowings and exercise of stock options. For fiscal 1997, the primary source of
financing was the IPO. For fiscal 1996, the primary source of financing was the
private sale of preferred stock. The Company had no amount outstanding under its
bank line of credit at November 30, 1998.

   The Company believes that its current cash balance together with other
sources of liquidity will satisfy its cash requirements for at least the next
twelve months.

Y2000

   Many older computer software programs refer to years in terms of their last
two digits only. Such programs may interpret the year 2000 to mean the year 1900
instead. If not corrected, these programs could cause date-related transaction
failures. This problem is often referred to as the "Year 2000" issue.

   The Company recognizes the need to ensure that the Year 2000 issue will not
impact its operations. The Company does not believe that it has a material
exposure to the Year 2000 issue with respect to its own products. The Company
intends to ensure that its information systems are Year 2000 ready by
consolidation of information storage and processing on systems that have already
been determined to be Year 2000 ready. The Company has identified critical
operations dependent on microprocessors that might be impacted by the Year 2000
issue and is working with vendors to implement the necessary corrective action.
The Company also has developed plans to survey critical suppliers and customers
to determine the status of their Year 2000 readiness programs. To date, the 
Company's expenditures on such corrective actions and surveys have not been 
material and the Company does not expect to incur material costs in the future 
related to addressing the Year 2000 issue. Although the Company does not 
believe that it has a material exposure to the Year 2000 issue with respect to 
its own products, there can be no assurance that failure of the Company to
complete consolidation of its information storage and processing on Year 2000
ready systems, to implement corrective action for microprocessor software which
supports critical operations, or of its critical suppliers and customers to
adequately address the Year 2000 issue in a timely fashion, will not result in a
material adverse effect on the Company's business, financial condition or
operating results. The Company has not yet developed a contingency plan in the 
event its business or operations are materially adversely affected by the Year 
2000 issue.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   The Company's market risk disclosures pursuant to item 7A. are not material
and are therefore not required.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   The financial statements and supplementary data of the Company required by
this item are filed as exhibits hereto, are listed under Item 14(a)(1) and (2),
and are incorporated herein by reference.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

    None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   The information required by this item with respect to directors of the
Company is incorporated by reference to Registrant's Definitive Proxy Statement
to be filed with the Commission pursuant to Regulation 14A in connection with
the 1999 Annual Meeting (the "Proxy Statement") under the headings "Nominees"
and "Directors." The information required by this section with respect to
Executive Officers is set forth under Part I, Item 1, "Business--Executive
Officers of the Registrant."

ITEM 11. EXECUTIVE COMPENSATION

   The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Executive





                                       20
<PAGE>   21

Compensation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Security Ownership of Certain Beneficial
Owners and Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Certain Transactions."

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) (1)  Index to Consolidated Financial Statements:

   The consolidated financial statements required by this item are submitted in
   a separate section beginning on page 24 of this Annual Report on Form 10-K.

<TABLE>
          <S>                                                                                     <C>
          Report of Ernst & Young LLP, Independent Auditors.....................................  25
          Report of McGladrey & Pullen LLP, Independent Auditors................................  26
              Consolidated  Balance  Sheets at September 30, 1998 and August 31, 1997...........  27
              Consolidated Statements of Operations for the years ended
                  September 30, 1998,  August 31, 1997,  August 31, 1996 and the
                  one month ended September 30, 1997............................................  28
              Consolidated  Statements of Stockholders' Equity for the years ended
                  September 30, 1998, August 31, 1997, August 31, 1996 and the
                  one month ended September 30, 1997............................................  29
              Consolidated Statements of Cash Flows for the years ended
                  September 30, 1998, August 31, 1997, August 31, 1996 and the
                  one month ended September 30, 1997............................................  30
              Notes to Consolidated Financial Statements........................................  31
</TABLE>

   (2) All schedules have been omitted because they are not applicable or
       required, or the information required to be set forth therein is included
       in the Financial Statements or notes thereto.

(b) The Registrant filed no reports on Form 8-K during the fourth quarter of the
    fiscal year ended September 30, 1998.

(c) Exhibits

<TABLE>
<CAPTION>
       EXHIBIT         EXHIBIT
       FOOTNOTE        NUMBER                   DESCRIPTION
       --------        -------                  -----------
       <S>             <C>       <C>
         (1)            3.1      Registrant's Amended and Restated Certificate of Incorporation

         (1)            3.2      Registrant's Amended and Restated Bylaws

         (1)            4.4      Form of Common Stock Certificate of Registrant

         (1)           10.1      Form of Indemnity  Agreement  entered into between  Registrant  and its
                                 directors and executive officers

         (1)(3)        10.2      Registrant's  Second  Amended and Restated  1981 Stock Option Plan (the
                                 "1981 Plan")

         (1)           10.3      Incentive Stock Option Agreement Under Registrant's 1981 Plan
</TABLE>


                                       21
<PAGE>   22

<TABLE>
<CAPTION>
       EXHIBIT        EXHIBIT
       FOOTNOTE       NUMBER                   DESCRIPTION
       --------       -------                  -----------
       <S>            <C>        <C>
         (1)(3)       10.4       Registrant's 1993 Stock Option Plan (the "1993 Plan")

         (1)          10.5       Form of Incentive Stock Option Agreement under the 1993 Plan

         (1)          10.6       Form of Nonstatutory Stock Option Agreement under the 1993 Plan

         (1)(3)       10.7       Registrant's 1997 Equity Incentive Plan (the "1997 Plan")

         (1)          10.8       Form of Incentive Stock Option Agreement under the 1997 Plan

         (1)          10.9       Form of Nonstatutory Stock Option Agreement under the 1997 Plan

         (1)(3)       10.10      Registrant's Employee Stock Purchase Plan

         (1)          10.11      Form of Warrant  issued by Registrant in favor of certain  directors of
                                 Registrant and attached schedule

         (1)(2)       10.12      Cooperative   Development   and  License   Agreement   between  Proxima
                                 Corporation and Registrant dated January 11, 1994

         (1)          10.13      Registration  Rights Agreement between  Registrant,  Union Miniere Inc.
                                 and Proxima Corporation dated June 9, 1997

         (1)(2)       10.14      Assignment  Agreement between Registrant and ATx Telecom Systems,  Inc.
                                 dated September 30, 1996

         (1)          10.15      Credit Agreement  between  Registrant and Wells Fargo dated January 29,
                                 1997

         (1)          10.16      Form of Employment Agreement and attached schedule

         (1)          10.17      Consulting  Agreement  dated  December 1, 1996 between  Registrant  and
                                 Arthur P. Minich

         (1)          10.18      Lease dated August 30, 1984 between the  Registrant  and Highlands Park
                                 Partnership and amendments thereto

         (1)(2)       10.19      Development  and   Manufacturing   Agreement  for  RGB  Lasers  between
                                 Registrant and LDT GmbH & Co. dated July 1, 1996

         (4)          10.20      Building  Lease  dated  October 25,  1991,  as amended  between  Exotic
                                 Materials, Inc. and Reisung Enterprises, Inc.
         (4)          10.21      Unsecured Subordinated  Installment Note dated October 31, 1996 between
                                 Exotic Materials, Inc. and Vitec Group US Holdings, Inc.

         (4)          10.22      Employment  Agreement between Exotic  Materials,  Inc. and Dick Sharman
                                 dated December 5, 1997.

         (4)          10.23      Employment Agreement between Exotic Materials,  Inc. and Robert N. Haro
                                 dated December 5, 1997.

         (4)          10.24      Employment  Agreement  between  Exotic  Materials,  Inc.  and Thomas J.
                                 Brawley dated December 24, 1997.
</TABLE>


                                       22
<PAGE>   23

<TABLE>
<CAPTION>
       EXHIBIT         EXHIBIT
       FOOTNOTE        NUMBER                   DESCRIPTION
       --------        -------                  -----------
       <S>             <C>       <C>
         (5)           10.25     Second  Amendment,  Third  Amendment  and  Fourth  Amendment  to Credit
                                 Agreement  dated  January 31, 1997  between the Company and Wells Fargo
                                 Bank and related promissory notes and security agreements

         (1)           21.1      Subsidiaries of the Registrant

                       23.1      Consent of Ernst & Young LLP, Independent Auditors

                       24.1      Power of Attorney. Reference is made to page 44

                       27.1      Financial Data Schedule
</TABLE>

------------

(1) Filed as an exhibit to the Registrant's Registration Statement on Form SB-2
    (No. 333-24421) or amendments thereto and incorporated herein by reference.

(2) Certain confidential portions deleted pursuant to Order Granting Application
    Under the Securities Act of 1933, as amended, and Rule 406 thereunder
    respecting Confidential Treatment dated June 12, 1997.

(3) Indicates management or compensatory plan or arrangement required to be
    identified pursuant to item 14(a)(3).

(4) Filed as an exhibit to Registrant's Registration Statement on Form S-4 (No.
    333-43415) or amendments thereto and incorporated herein by reference.

(5) Filed as an exhibit to Registrant's quarterly report on Form 10-Q for the
    quarter ending June 30, 1998 and incorporated herein by reference.
























                                       23

<PAGE>   24

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<S>                                                                                     <C>
Report of Ernst & Young LLP, Independent Auditors.....................................  25

Report of McGladrey & Pullen LLP, Independent Auditors................................  26

    Consolidated  Balance  Sheets at September 30, 1998 and August 31, 1997...........  27

    Consolidated Statements of Operations for the years ended
        September 30, 1998,  August 31, 1997,  August 31, 1996 and the
        one month ended September 30, 1997............................................  28

    Consolidated  Statements of Stockholders' Equity for the years ended
        September 30, 1998, August 31, 1997, August 31, 1996 and the
        one month ended September 30, 1997............................................  29

    Consolidated Statements of Cash Flows for the years ended
        September 30, 1998, August 31, 1997, August 31, 1996 and the
        one month ended September 30, 1997............................................  30

    Notes to Consolidated Financial Statements........................................  31
</TABLE>


























                                       24

<PAGE>   25

                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors and Stockholders


Laser Power Corporation

   We have audited the accompanying consolidated balance sheets of Laser Power
Corporation at September 30, 1998 and August 31, 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the years ended September 30, 1998, August 31, 1997 and August 31, 1996,
and the one month ended September 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of EMI Acquisition Corp., a wholly-owned subsidiary, which
statements reflect 36% of total revenues for the year ended August 31, 1996.
Those statements were audited by other auditors whose report has been furnished
to us, and our report, insofar as it relates to data included for EMI
Acquisition Corp. is based solely on the report of the other auditors.

   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.

   In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Laser Power Corporation at September 30,
1998 and August 30, 1997, and the consolidated results of its operations and its
cash flows for the years ended September 30, 1998, August 31, 1997, August 31,
1996, and the one month ended September 30, 1997, in conformity with generally
accepted accounting principles.




                                             ERNST & YOUNG LLP


San Diego, California
December 4, 1998
except for Note 3, as to which 
the date is December 23, 1998



















                                       25

<PAGE>   26
                         REPORT OF INDEPENDENT AUDITORS



To the Board of Directors
EMI Acquisition Corp.
Murrieta, California


     We have audited the consolidated balance sheet of EMI Acquisition Corp. and
subsidiary as of December 31, 1996, and the related consolidated statements of
operations, shareholders' equity, and cash flows for the year then ended (not
presented separately herein). These financial statements are the responsibility
of EMI Acquisition Corp.'s management. Our responsibility is to express an
opinion on these financial statements based on our audit.

     We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of EMI
Acquisition Corp. and subsidiary as of December 31, 1996, and the results of
their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.


                                        McGLADREY & PULLEN, LLP

Anaheim, California
November 14, 1997

                                        26
<PAGE>   27


                             LASER POWER CORPORATION

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,        AUGUST 31,
                                                                    1998               1997
                                                                ------------       ------------
<S>                                                             <C>                <C>         
ASSETS
Current assets:
    Cash and cash equivalents ............................      $  2,412,327       $  8,252,501
    Restricted cash ......................................         1,000,000                 --
    Accounts receivable, net .............................         5,659,719          6,807,147
    Inventories, net .....................................         6,873,478          5,474,692
    Other current assets .................................           547,096            518,261
                                                                ------------       ------------
      Total current assets ...............................        16,492,620         21,052,601
Property and equipment, net ..............................         8,088,298          7,079,829
Intangibles and other assets, net ........................           820,371            940,461
                                                                ------------       ------------
      Total assets .......................................      $ 25,401,289       $ 29,072,891
                                                                ============       ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable .....................................      $  2,233,758       $  2,687,244
    Accrued compensation and related expenses ............         1,305,077          1,715,703
    Other current liabilities ............................         3,221,988          1,416,815
    Current portion of long-term debt ....................         4,427,811            446,300
                                                                ------------       ------------
      Total current liabilities...........................        11,188,634          6,266,062

Long-term liabilities ....................................         1,032,472            234,795
Long-term debt ...........................................           286,838          3,230,164
Subordinated convertible debentures ......................         1,660,000          1,660,000

Commitments and contingencies

Stockholders' equity:
    Common stock, par value $.001:
      Authorized -- 15,000,000 shares
      Issued and outstanding 8,398,455 shares in 1998, and
        8,073,742 shares in 1997 .........................             8,398              8,074
    Additional paid-in capital ...........................        19,416,298         18,542,773
    Foreign currency translation adjustment ..............           (39,047)           (50,576)
    Accumulated deficit ..................................        (8,152,304)          (818,401)
                                                                ------------       ------------
      Total stockholders' equity .........................        11,233,345         17,681,870
                                                                ------------       ------------
      Total liabilities and stockholders' equity .........      $ 25,401,289       $ 29,072,891
                                                                ============       ============
</TABLE>


                             See accompanying notes.





                                       27
<PAGE>   28

                             LASER POWER CORPORATION

                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                ONE MONTH                  YEAR ENDED
                                                YEAR ENDED         ENDED         ----------------------------
                                               SEPTEMBER 30,    SEPTEMBER 30,     AUGUST 31,      AUGUST 31,
                                                    1998             1997            1997            1996
                                               ------------     ------------     ------------    ------------
<S>                                            <C>              <C>              <C>             <C>         
Revenues:
   Product sales ..........................    $ 31,069,431     $  2,531,442     $ 29,395,711    $ 25,789,384
   Contract research and development ......       3,493,271          448,592        6,155,794       3,712,967
                                               ------------     ------------     ------------    ------------
           Total revenues .................      34,562,702        2,980,034       35,551,505      29,502,351
Costs and expenses:
   Cost of product sales ..................      23,366,110        1,559,496       20,077,950      17,475,928
   Contract research and development ......       3,328,359          381,998        4,849,183       2,941,947
   Internal research and development ......       2,799,748          173,633        1,377,176       2,859,727
   Selling, general and administrative ....       7,767,074          798,891        6,370,703       5,694,112
   Merger and integration .................       3,778,000               --               --              --
                                               ------------     ------------     ------------    ------------
           Total  costs and expenses ......      41,039,291        2,914,018       32,675,012      28,971,714
                                               ------------     ------------     ------------    ------------
Income (loss) from operations .............      (6,476,589)          66,016        2,876,493         530,637
Interest expense, net .....................         306,381            9,774          416,519         453,300
                                               ------------     ------------     ------------    ------------
Income (loss) before income taxes .........      (6,782,970)          56,242        2,459,974          77,337
Income taxes ..............................         248,642          129,800          184,758          22,281
                                               ------------     ------------     ------------    ------------
Net income (loss) before extraordinary item      (7,031,612)         (73,558)       2,275,216          55,056
Gain on early extinguishment of debt ......              --               --               --         118,679
                                               ------------     ------------     ------------    ------------
Net Income (loss) .........................    $ (7,031,612)    $    (73,558)    $  2,275,216    $    173,735
                                               ============     ============     ============    ============

Basic earnings (loss) per share:
   Before extraordinary item ..............    $       (.85)    $       (.01)    $        .41    $        .02
   Extraordinary item .....................              --               --               --             .02
                                               ------------     ------------     ------------    ------------
   Net income (loss) per share ............    $       (.85)    $       (.01)    $        .41    $        .04
                                               ============     ============     ============    ============
Diluted earnings (loss) per share:
   Before extraordinary item ..............    $       (.85)    $       (.01)    $        .32    $        .01
   Extraordinary item .....................              --               --               --             .02
                                               ------------     ------------     ------------    ------------
   Net income (loss) per share ............    $       (.85)    $       (.01)    $        .32    $        .03
                                               ============     ============     ============    ============
Average common shares outstanding:
   Basic ..................................       8,266,000        8,099,000        5,592,000       4,900,000
                                               ============     ============     ============    ============
   Diluted ................................       8,266,000        8,099,000        7,196,000       6,573,000
                                               ============     ============     ============    ============
</TABLE>


                             See accompanying notes.





                                       28
<PAGE>   29

                             LASER POWER CORPORATION

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

      YEARS ENDED SEPTEMBER 30, 1998, AUGUST 31, 1997, AUGUST 31, 1996 AND
                       ONE MONTH ENDED SEPTEMBER 30, 1997


<TABLE>
<CAPTION>
                                              CONVERTIBLE                                            
                                            PREFERRED STOCK                     COMMON STOCK         
                                    -----------------------------        --------------------------  
                                       SHARES           AMOUNT            SHARES          AMOUNT     
                                    ------------     ------------        ---------     ------------  
<S>                                 <C>              <C>                 <C>           <C>           
Balance at August 31, 1995 .....       1,143,196     $    142,899        4,821,026     $      4,822  
   Issuance of preferred stock .         467,695           58,462               --               --  
   Issuance of common stock ....              --               --          275,690              276  
   Repurchase of common stock ..              --               --          (47,457)             (49) 
   Foreign currency
    translation adjustment .....              --               --               --               --  
   Net loss ....................              --               --               --               --  
   Adjustment (Note 1) .........              --               --               --               --  
                                    ------------     ------------        ---------     ------------  
Balance at August 31, 1996 .....       1,610,891          201,361        5,049,259            5,049  
   Issuance of common stock ....              --               --           95,373               95  
   Issuance of common stock
    in conjunction with the
    initial  public offering
    at $5.50 per share .........              --               --        1,897,500            1,898  
   Conversion of preferred stock
    in  conjunction with the
    initial public offering ....      (1,610,891)        (201,361)       1,193,252            1,193  
   Repurchase of common stock ..              --               --         (161,642)            (161) 
   Foreign currency translation
    adjustment .................              --               --               --               --  
   Net income ..................              --               --               --               --  
                                    ------------     ------------        ---------     ------------  
Balance at August 31, 1997 .....              --               --        8,073,742            8,074  
   Transition period (Note 1) ..              --               --               --               --  
                                    ------------     ------------        ---------     ------------  
Balance at September 30, 1997 ..              --               --        8,073,742            8,074  
   Issuance of common stock
    for exercised options ......              --               --          291,142              291  
   Issuance of common stock
    for employee stock
    purchase plan ..............              --               --           33,571               33  
   Issuance of warrants for
    services ...................              --               --               --               --  
   Foreign currency
    translation adjustment .....              --               --               --               --  
   Net loss ....................              --               --               --               --  
                                    ------------     ------------        ---------     ------------  
Balance at September 30, 1998 ..    $         --     $         --        8,398,455     $      8,398  
                                    ============     ============     ============     ============  


<CAPTION>
                                                        FOREIGN
                                       ADDITIONAL       CURRENCY
                                         PAID-IN       TRANSLATION      ACCUMULATED
                                         CAPITAL        ADJUSTMENT         DEFICIT           TOTAL
                                      ------------     ------------     ------------     ------------
<S>                                   <C>              <C>              <C>              <C>           
Balance at August 31, 1995 .....      $  8,422,756     $    112,690     $ (3,194,055)    $  5,489,112
   Issuance of preferred stock .         1,812,318               --               --        1,870,780
   Issuance of common stock ....            63,127               --               --           63,403
   Repurchase of common stock ..            (8,197)              --               --           (8,246)
   Foreign currency
    translation adjustment .....                --           10,532               --           10,532
   Net loss ....................                --               --          173,735          173,735
   Adjustment (Note 1) .........                --               --          (73,297)         (73,297)
                                      ------------     ------------     ------------     ------------
Balance at August 31, 1996 .....        10,290,004          123,222       (3,093,617)       7,526,019
   Issuance of common stock ....           117,405               --               --          117,500
   Issuance of common stock
    in conjunction with the
    initial  public offering
    at $5.50 per share .........         8,121,868               --               --        8,123,766
   Conversion of preferred stock
    in  conjunction with the
    initial public offering ....           200,168               --               --               --
   Repurchase of common stock ..          (186,672)              --               --         (186,833)
   Foreign currency translation
    adjustment .................                --         (173,798)              --         (173,798)
   Net income ..................                --               --        2,275,216        2,275,216
                                      ------------     ------------     ------------     ------------
Balance at August 31, 1997 .....        18,542,773          (50,576)        (818,401)      17,681,870
   Transition period (Note 1) ..           (13,216)          13,385         (302,291)        (302,122)
                                      ------------     ------------     ------------     ------------
Balance at September 30, 1997 ..        18,529,557          (37,191)      (1,120,692)      17,379,748
   Issuance of common stock
    for exercised options ......           718,213               --               --          718,504
   Issuance of common stock
    for employee stock
    purchase plan ..............           111,528               --               --          111,561
   Issuance of warrants for
    services ...................            57,000               --               --           57,000
   Foreign currency
    translation adjustment .....                --           (1,856)              --           (1,856)
   Net loss ....................                --               --       (7,031,612)      (7,031,612)
                                      ------------     ------------     ------------     ------------
Balance at September 30, 1998 ..      $ 19,416,298     $    (39,047)    $ (8,152,304)    $ 11,233,345
                                      ============     ============     ============     ============
</TABLE>




                                       29
<PAGE>   30

                             LASER POWER CORPORATION

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                           ONE MONTH                YEAR ENDED
                                                           YEAR ENDED         ENDED        ---------------------------
                                                          SEPTEMBER 30,   SEPTEMBER 30,     AUGUST 31,      AUGUST 31,
                                                               1998            1997            1997            1996
                                                           -----------     -----------     -----------     -----------
<S>                                                        <C>             <C>             <C>             <C>        
OPERATING ACTIVITIES
Net income (loss) from operations .....................    $(7,031,612)    $   (73,558)    $ 2,275,216     $   173,735
Adjustment to income (loss) to account for
   overlapping periods (Note 1) .......................             --        (228,733)             --              --
Adjustments to reconcile net income (loss) to net
  cash provided by (used in) operating activities:
   Gain on early extinguishment .......................             --              --              --        (118,679)
   Depreciation and amortization ......................      1,898,584         115,187       1,328,990       1,150,744
   Loss on disposal of property and equipment and
    impairment of long-lived assets ...................      1,250,505              --              --          84,936
   Long-term liabilities ..............................        803,548          (5,871)        (70,452)        (70,452)
   Warrants issued for services .......................         57,000              --              --              --
   Changes in operating assets and liabilities:
    Restricted cash ...................................     (1,000,000)             --              --              --
    Accounts receivable ...............................        682,998         464,430      (1,339,149)     (1,597,010)
    Inventories .......................................     (1,130,161)       (268,625)     (1,220,625)       (564,970)
    Other current assets ..............................        (13,595)        (15,240)       (186,834)        (46,755)
    Accounts payable ..................................       (542,129)         88,659         638,878         339,078
    Accrued compensation and related expenses .........       (465,711)         55,085         537,926         426,586
    Other current liabilities .........................      1,764,328          40,829         260,169         369,322
                                                           -----------     -----------     -----------     -----------
   Net cash provided by (used in) operating activities      (3,726,245)        172,163       2,224,119         146,535

INVESTING ACTIVITIES
Additions to property and equipment ...................     (3,953,259)       (179,014)     (3,364,535)     (1,075,894)
Decrease in intangibles and other assets ..............         (6,615)         (2,238)       (193,126)       (109,889)
                                                           -----------     -----------     -----------     -----------
   Net cash used in investing activities ..............     (3,959,874)       (181,252)     (3,557,661)     (1,185,783)

FINANCING ACTIVITIES
Proceeds from borrowings ..............................      3,504,476              --       1,354,835         402,454
Payments on borrowings ................................     (2,435,446)        (30,845)       (801,623)       (618,429)
Net proceeds from issuance of stock in conjunction
  with initial public offering ........................             --              --       8,123,766              --
Net proceeds from issuance and repurchase of stock ....        830,065         (13,216)        (69,333)      1,929,128
                                                           -----------     -----------     -----------     -----------
   Net cash provided by (used in)  financing activities      1,899,095         (44,061)      8,607,645       1,713,153
                                                           -----------     -----------     -----------     -----------
Net increase (decrease) in cash and cash equivalents ..     (5,787,024)        (53,150)      7,274,103         673,905
Cash and cash equivalents at beginning of the period ..      8,199,351       8,252,501         978,398         834,319
                                                           -----------     -----------     -----------     -----------
Cash and cash equivalents at end of the period ........    $ 2,412,327     $ 8,199,351     $ 8,252,501     $ 1,508,224
                                                           ===========     ===========     ===========     ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest ..............    $   619,000     $    17,000     $   548,000     $   487,000
                                                           ===========     ===========     ===========     ===========
Cash paid during period for income taxes ..............    $   241,000     $        --     $    48,000     $    14,000
                                                           ===========     ===========     ===========     ===========
</TABLE>


                             See accompanying notes.





                                       30
<PAGE>   31

                             LASER POWER CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                               SEPTEMBER 30, 1998


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business and Basis of Presentation

   Laser Power Corporation ("Laser Power" or the "Company") designs,
manufactures and markets high performance optics and lasers for industrial,
medical and military applications. The Company's laser optics products are sold
to laser system OEMs and end users as original and replacement components in
high power CO2 and other lasers. The Company's infrared optics products are sold
to various government agencies and to prime contractors of these agencies, and
are used primarily in infrared imaging systems. The company also provides thin
film design and coating services for industrial and military applications. The
Company's proprietary miniature microlasers are designed for use in certain
medical, entertainment, projection display and other applications. The Company
also conducts contract research in the development and applications of advanced
solid state lasers.

   The accompanying consolidated financial statements present the financial
position, results of operations and cash flows of Laser Power Corporation (the
"Company") and its subsidiaries, EMI Acquisition Corp. ("EMI"), Laser Power
Optics de Mexico S.A. de C.V. ("Laser Power Mexico") and Radius Engineering N.V.
("Radius"). EMI operates through its subsidiary Exotic Materials, Inc. (doing
business as Exotic Electro-Optics - "Exotic"). Exotic manufactures infrared
optic products principally for the aerospace and defense markets in the United
States. Radius operates primarily as the European sales and distribution center
for the Company. Laser Power Mexico performs a portion of the laser optic
manufacturing and does not sell products to unaffiliated customers. All
significant inter-company accounts and transactions have been eliminated in
consolidation.


Change in Fiscal Year

   The Company changed its fiscal year end from August 31 to September 30
effective for the fiscal year ended September 30, 1998. The Consolidated
Statement of Operations and the Consolidated Statement of Cash Flows for the
one-month period ended September 30, 1997 are presented in the consolidated
financial statements. For comparative purposes, the Condensed Consolidated
Statement of Operations (unaudited) and the Condensed Consolidated Statement of
Cash Flows (unaudited) for the one-month period ended September 30, 1996, are as
follows:







                                       31
<PAGE>   32

                             LASER POWER CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)
                    (in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                                       ONE MONTH
                                                                         ENDED
                                                                      SEPTEMBER 30,
                                                                           1996
                                                                      -------------
<S>                                                                     <C>    
Revenues:
Product sales ...................................................       $ 1,928
Contract research and development ...............................           459
      Total revenues ............................................         2,387
Costs and expenses:
   Cost of product sales ........................................         1,340
   Contract research and development ............................           372
   Internal research and development ............................            89
   Selling, general and administrative ..........................           493
                                                                        -------
      Total costs and expenses ..................................         2,294
                                                                        -------
Income from operations ..........................................            93
Interest expense, net ...........................................            32
                                                                        -------
Income before income taxes ......................................            61
Income taxes ....................................................             1
                                                                        -------
Net income ......................................................       $    60
                                                                        =======

Basic earnings per share ........................................       $   .01
                                                                        =======
Diluted earnings per share ......................................       $   .01
                                                                        =======
Average common shares outstanding - Basic .....................           5,043
                                                                        =======
Average common shares - Diluted .................................         6,696
                                                                        =======
</TABLE>


                             LASER POWER CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                       ONE MONTH
                                                                         ENDED
                                                                      SEPTEMBER 30,
                                                                           1996
                                                                      -------------
<S>                                                                     <C>    

OPERATING ACTIVITIES

Net income ......................................................       $    60
Adjustments to reconcile net income to net cash
   provided by operating activities:
   Depreciation and amortization ................................           182
   Other ........................................................            (6)
   Changes in operating assets and liabilities ..................           126
                                                                        -------
      Net cash provided by operating activities .................           362

INVESTING ACTIVITIES

Additions to property and equipment .............................          (109)
Increase in intangibles and other assets ........................           (13)
                                                                        -------
   Net cash used in investing activities ........................          (122)

FINANCING ACTIVITIES

Payments on borrowings ..........................................           (31)
                                                                        -------
   Net cash (used in) financing activities ......................           (31)
                                                                        -------
Net increase in cash and cash equivalents .......................           209
Cash and cash equivalents at beginning of the period ............           978
                                                                        -------
Cash and cash equivalents at end of the period ..................       $ 1,187
                                                                        =======
</TABLE>




                                       32
<PAGE>   33

Acquisition of EMI

    In February 1998, the Company merged with EMI. The Company issued 2,021,178
shares of its common stock based on a 1.8511 ratio of exchange. The Company has
accounted for the merger as a pooling-of-interests; accordingly, the
consolidated financial statements for the periods prior to the merger have been
retroactively restated as if the combining companies had been combined for all
periods presented. The Company's August 31, 1997 and 1996 consolidated financial
statements include the EMI financial statements for the years ended September
30, 1997 and December 31, 1996, respectively.

    The consolidated results of operations of EMI for the three months ended
December 31, 1996 were utilized in both the 1997 and 1996 fiscal periods.
Summarized information for the three months ended December 31, 1996 is as
follows (unaudited, in thousands):

<TABLE>
              <S>                                                        <C>    
              Total revenues.............................................$ 3,122
              Operating expenses.........................................$ 2,697
              Income before extraordinary item...........................$   384
</TABLE>

    The consolidated financial statements for the year ended August 31, 1997
include the year ended September 30, 1997 for EMI. The consolidated financial
statements for the one month ended September 30, 1997 include EMI's net income
as follows:

<TABLE>
              <S>                                                        <C>    
              Laser Power.............................................$ (302,291)
              EMI.....................................................$  228,733
                                                                      ----------
              Net Loss................................................$  (73,558)
                                                                      ==========
</TABLE>


    Total revenues and net income (loss) of Laser Power and EMI for the periods
preceding the acquisition were as follows (in thousands):

<TABLE>
<CAPTION>
                                         Laser Power        EMI         Combined
                                         -----------      --------      --------

Five months ended February 28, 1998 (unaudited)

              <S>                          <C>            <C>           <C>     
              Total revenues ........      $  9,550       $  5,474      $ 15,024
              Net income (loss) .....      $ (2,213)      $    469      $ (1,744)

Year ended August 31, 1997

              Total revenues ........      $ 23,353       $ 12,199      $ 35,552
              Net income ............      $    754       $  1,521      $  2,275

Year ended August 31, 1997

              Total revenues ........      $ 18,907       $ 10,595      $ 29,502
              Extraordinary item, net
                of income taxes .....      $     --       $    119      $    119
              Net income (loss) .....      $ (1,231)      $  1,405      $    174
</TABLE>

    In order to properly state the accumulated deficit at August 31, 1996, a
transition adjustment of $73,297 was recorded. This amount is the net income for
the three months ended December 31, 1996 less the net income for the three
months ended December 31, 1995.

Merger and Integration Charge

   During 1998, the Company recorded a merger and integration charge of
approximately $3.8 million related to the Company's merger with EMI and plan to
move its laser optics operations from San Diego, California to Temecula,
California. This charge included approximately $1.0 million related to an
abandonment of a portion of the San Diego facilities lease, $1.3 million related
to impairment of long-lived assets, $.8 million for acquisition costs and $.7
million related to severance for 26 employees, including three senior officers.
The severance payments made, and applied against the merger and integration
accrual, total $.3 million as of September 30, 1998.





                                       33
<PAGE>   34

Revenues

   Product sales are recorded upon shipment. Revenue on long-term (generally
spanning more than twelve months) fixed price contracts is recognized utilizing
the units-of-delivery method of accounting. Under such method, revenues are
recognized as units are shipped. The costs attributable to units shipped are
based upon the actual cost of those units. Losses expected to be incurred on
long-term contracts in progress are charged to operations when identified.
Revenues from contract research and development involve both commercial and
governmental contracts and are recognized using the percentage-of-completion
method based on the ratio of costs incurred to date to total estimated costs.
Provisions are made to recognize any anticipated losses on contracts when losses
become evident.

   Total product revenues from government contracts and subcontracts were
$14,547,000, $12,485,000, and $10,468,000 in 1998, 1997 and 1996, respectively.
Total contract revenues from government contracts and subcontracts were
$2,401,000, $3,337,000, and $3,397,000 in 1998, 1997 and 1996, respectively.

Cash and Cash Equivalents and Restricted Cash

    Cash and cash equivalents consist of cash and highly liquid investments with
maturities of three months or less when purchased.

    Restricted cash consists of a highly liquid investment with a maturity of
six months or less when purchased. The cash is restricted by a loan agreement
with a bank.

Inventories

   Inventories are stated at lower of cost (first-in, first-out) or market.
Market is based upon estimated net realizable value.


Depreciation and Amortization

   Machinery, equipment and office furniture are depreciated over their
estimated useful lives (3 to 15 years) on the straight-line method and leasehold
improvements are amortized over the useful life of the asset or the lease term,
whichever is less.

   Intangible assets consist primarily of goodwill, patents and licenses.
Goodwill is amortized over 20 years and patents and licenses (which are
primarily related to microlaser technology) are amortized over the shorter of
the estimated useful life or the legal life. Amortization of patents is
initiated when the related technology is ready for commercial release.

Use of Estimates

   The preparation of financial statements in conformity with 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.

Concentration of Credit Risk

   The Company primarily sells its products to industrial, entertainment, and
medical equipment companies, and to U.S. government agencies and their prime
contractors. Financial instruments that potentially subject the Company to
credit risk consist principally of cash equivalents and trade receivables. The
Company invests in a variety of financial instruments and limits exposure with
any one issuer. The Company performs periodic credit evaluations of its
customers and has not experienced significant losses with respect to its
accounts receivable. As of September 30, 1998, the carrying value of cash
equivalents and trade receivables approximated estimated fair value.





                                       34
<PAGE>   35

Impairment of Long-Lived Assets

   The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. The Company recorded $1,418,000 during the year ended September
30, 1998 related to the impairment of long-lived assets, resulting from merger
and integration of operations and review of its patent portfolio.

Accounting for Stock-Based Compensation

    As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company has
elected the current intrinsic value-based method and the pro forma effect of
using the fair value-based method to account for stock-based compensation in its
financial statements.

Net Income (Loss) Per Share

   Net income (loss) per share is computed using "Basic EPS" and "Diluted EPS"
as required by Statement of Financial Accounting Standards No. 128, Earnings per
Share ("SFAS 128"), which supersedes APB Opinion 15. Basic EPS includes no
dilution and is based on weighted-average common shares outstanding for the
period. Diluted EPS reflects the potential dilution of stock options,
convertible preferred stock and warrants to purchase common stock. For loss
periods, these common equivalent shares are excluded from the Diluted EPS
computation as their effect would be antidilutive.

New Accounting Standards

   In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"), and Statement of Financial Accounting Standards No. 131, Segment
Information ("SFAS 131"). Both of these standards are effective for fiscal years
beginning after December 15, 1997. SFAS 130 requires that all components of
comprehensive income, including net income, be reported in the financial
statements in the period in which they are recognized. Comprehensive income is
defined as the change in equity during a period from transactions and other
events and circumstances from non-owner sources. Net income and other
comprehensive income, including foreign currency translation adjustment, minimum
pension accrual, and unrealized gains and losses on investments shall be
reported, net of their related tax effect, to arrive at comprehensive income.
The Company intends to adopt SFAS 130 in fiscal 1999 and operating results of
prior periods will be reclassified.

   Historically, the Company has operated in one business segment; however, SFAS
131 redefines segments and in the future, the Company may also be required to
disclose certain financial information about operating segments, products and
services. The Company has not determined how operating segments will be defined
for disclosure purposes or which segments will meet the quantitative
requirements for disclosure. The adoption of the standard will have no impact on
the Company's future results of operations or financial position.





















                                       35
<PAGE>   36

2. SELECTED BALANCE SHEET DETAILS

<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30,       AUGUST 31,
                                                                       1998              1997
                                                                  ------------       ------------
              <S>                                                 <C>                <C>         
              Accounts receivable:
              Trade ........................................      $  5,779,286       $  6,491,015
              Revenue in excess of billings ................           293,116            605,086
                                                                  ------------       ------------
                                                                     6,072,402          7,096,101
              Reserves .....................................          (412,683)          (288,954)
                                                                  ------------       ------------
                                                                  $  5,659,719       $  6,807,147
                                                                  ============       ============
              Inventories:
              Raw materials ................................      $  2,670,421       $  2,121,475
              Work in progress .............................         3,524,880          2,849,674
              Finished goods ...............................         1,460,698            793,656
                                                                  ------------       ------------
                                                                     7,655,999          5,764,805
              Reserves .....................................          (782,521)          (290,113)
                                                                  ------------       ------------
                                                                  $  6,873,478       $  5,474,692
                                                                  ============       ============
              Property and equipment, at cost:
              Machinery and equipment ......................      $ 14,236,123       $ 12,138,595
              Leasehold improvements .......................           575,296          1,284,093
              Office furniture and equipment ...............         1,067,164            981,410
                                                                  ------------       ------------
                                                                    15,878,583         14,404,098
              Less accumulated depreciation and amortization        (7,790,285)        (7,324,269)
                                                                  ------------       ------------
                                                                  $  8,088,298       $  7,079,829
                                                                  ============       ============
              Intangibles and other assets:
              Goodwill in foreign subsidiary ...............      $    549,100       $    549,100
              Patents and licenses .........................           522,037            507,462
              Other ........................................           271,790            277,512
                                                                  ------------       ------------
                                                                  $  1,342,297       $  1,334,074
              Less accumulated amortization ................          (522,556)          (393,613)
                                                                  ------------       ------------
                                                                  $    820,371       $    940,461
                                                                  ============       ============
              Accrued compensation and related expenses:
              Accrued bonuses ..............................      $    165,856       $    768,767
              Other ........................................         1,139,221            946,936
                                                                  ------------       ------------
                                                                  $  1,305,077       $  1,715,703
                                                                  ============       ============
              Other current liabilities:
              Customer advances ............................      $  1,137,559            180,094
              Merger and integration .......................           669,744                 --
              Accrued income taxes .........................           109,891            325,978
              Other ........................................         1,304,794            910,743
                                                                  ------------       ------------
                                                                  $  3,221,988       $  1,416,815
                                                                  ============       ============
</TABLE>

3. LONG-TERM DEBT AND OTHER FINANCING AGREEMENTS

   In June 1998, the Company renewed a line of credit with a bank, subject to
maximum advances of $2,500,000 and at an annual interest rate of 1% above the
bank's prime rate (9.25% at September 30, 1998). The line of credit expires on
February 1, 1999, and there were no advances under the line of credit at
September 30, 1998. As part of the credit agreement, the Company has pledged a
$1 million certificate of deposit as collateral to the bank.

Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                     SEPTEMBER 30,    AUGUST 31,
                                                          1998           1997
                                                      ----------      ----------
              <S>                                     <C>             <C>       
              Promissory note ..................      $   57,058      $   75,000
              Term note payable to bank ........       2,814,877       1,319,626
              Note payable to Vitec ............              --       1,890,542
              Equipment line of credit from bank       1,504,466              --
              Other equipment financing ........         330,328         375,531
              Other ............................           7,920          15,765
                                                      ----------      ----------
                                                       4,714,649       3,676,464
              Less current portion .............       4,427,811         446,300
                                                      ----------      ----------
                                                      $  286,838      $3,230,164
                                                      ==========      ==========
</TABLE>





                                       36
<PAGE>   37

   The promissory note is payable in monthly installments of principal and
interest of $1,840 through September 2001. Borrowings under the promissory note
are secured by equipment and bear interest at 8.25% per annum.

   In conjunction with the acquisition of Exotic by EMI, Exotic issued a $2
million unsecured note payable to Vitec Group plc ("Vitec"). The Company fully
paid off the note in June, 1998.

   In July 1997, the Company fully paid off the prior term note payable to the
bank using proceeds from the initial public offering. In August 1997, the
Company converted its equipment line draws to a five-year term note payable to
the bank. In June 1998, the Company entered into a new term loan amounting to
$1.9 million to pay off the Vitec note.

   The combined current term notes payable to the bank are due in monthly
principal payments of $61,583 plus interest, with the final installment
consisting of all remaining unpaid principal due and payable in full no later
than August 1, 2002. The term notes bear interest ranging from 1.0% to 1.25%
above the bank's prime rate (9.25 to 9.50% at September 30, 1998.)

   In June 1998, the Company obtained a $2.0 million equipment line of credit at
1% above the bank's prime rate (9.25% at September 30, 1998). The balance
outstanding at February 1, 1999 will convert to a term loan, and the principal
payments will be paid over the following sixty months.

   All bank borrowings under the credit agreement are secured by accounts
receivable, inventory, intangibles, and property and equipment, and contain
restrictive covenants. Restrictive covenants include limitations on losses,
maintenance of minimum tangible net worth, debt to equity and cash flow ratios,
as well as restrictions on capital and lease expenditures, investment levels in
the Company's Belgium subsidiary, additional borrowings and payment of
dividends. During 1998, the Company was not in compliance with several
of these covenants and a waiver was obtained for the year ended September 
30, 1998. The Company is currently in the process of renegotiating its credit 
agreements, including amending its covenant provisions and expects to be in 
compliance with the amended covenants for the year ending September 30, 
1999. At December 23, 1998, because the Company's new credit agreements were 
not in place, the term debt was reclassified to current and upon completing 
the credit agreements the same term debt will be reclassified to long term.

   Other equipment financing agreements are payable in monthly installments of
principal and interest through March 2001. Borrowings under these financing
agreements are secured by specific equipment, with interest at rates ranging
from 9.7% to 10.7% at September 30, 1998.

   In November 1987, the Company obtained debt and equity financing from Union
Miniere ("Union"). The Company issued 483,333 shares of common stock for
$1,053,000 cash (net of stock issuance costs of $107,000) and subordinated
convertible debentures amounting to $1,340,000. In December 1988, the Company
issued an additional $320,000 of subordinated convertible debentures to Union.
In March 1997, the maturity date of the debentures was extended to November 2,
2000 and the conversion rate for which the debentures are convertible into
common stock was set at $4.625 per share (358,918 shares). The debentures are
subordinated to all bank borrowings and interest is payable semi-annually at an
annual rate equal to 1% above a bank's prime rate (9.25% at September 30, 1998)
subject to a minimum rate of 5 -1/2% and a maximum rate of the lesser of 11.5%
or the maximum rate permitted by law. The debentures provide for restrictive
covenants similar to those of the bank borrowings. At September 30, 1998, the
Company was not in compliance with one of these covenants; however, a waiver has
been obtained from Union.

   All subordinated convertible debentures and long-term debt of the Company
bear an adjustable interest rate and are carried at the principal value of the
liability, which approximates fair value. Principal maturities on the
subordinated convertible debentures and long-term debt for each of the years
ending subsequent to September 30, 1998 are as follows:

<TABLE>
               <S>                            <C>       
               1999.......................    $4,428,000
               2000.......................       151,000
               2001.......................       105,000
               2002.......................     1,688,000
               2003.......................         3,000
               Thereafter.................            -- 
                                              ----------
                                              $6,375,000
                                              ==========
</TABLE>





                                       37
<PAGE>   38


4.      INCOME TAXES

   Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The components of the
Company's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>

                                                        SEPTEMBER 30,       AUGUST 31,
                                                             1998              1997
                                                         -----------       -----------
              <S>                                        <C>               <C>        
              Deferred tax assets:
                Tax basis operating loss and credit
                  carryforwards ...................      $ 4,817,000       $ 2,303,000
                Other .............................          518,000           513,000
                                                         -----------       -----------
              Total deferred tax assets ...........        5,335,000         2,816,000
                                                         -----------       -----------
              Deferred tax liability:
                Depreciation ......................          (55,000)         (161,000)
                Intangibles .......................         (243,000)         (191,000)
                                                         -----------       -----------
              Total deferred tax liabilities ......         (298,000)         (352,000)
                                                         -----------       -----------
              Net deferred tax assets .............        5,037,000         2,464,000
              Valuation allowance .................       (5,037,000)       (2,464,000)
                                                         -----------       -----------
              Net deferred tax accounts ...........      $        --       $        --
                                                         ===========       ===========
</TABLE>

<TABLE>
<CAPTION>
                                                         ONE MONTH               YEAR ENDED
                                                           ENDED        --------------------------
                                        SEPTEMBER 30,   SEPTEMBER 30,    AUGUST 31,     AUGUST 31,
                                             1998            1997           1997           1996
                                         -----------     -----------    -----------    -----------
        <S>                              <C>             <C>            <C>            <C>         
        Pretax income (loss):
           United States ............    $(6,983,277)    $    46,970    $ 2,289,323    $   (28,594)
           Foreign ..................        200,307           9,272        170,651        105,931
                                         -----------     -----------    -----------    -----------
                                         $(6,782,970)    $    56,242    $ 2,459,974    $    77,337
                                         ===========     ===========    ===========    ===========
</TABLE>

    Significant components of the provision for income taxes are as follows:

<TABLE>
<CAPTION>
                                                         ONE MONTH               YEAR ENDED
                                                           ENDED        --------------------------
                                        SEPTEMBER 30,   SEPTEMBER 30,    AUGUST 31,     AUGUST 31,
                                             1998            1997           1997           1996
                                         -----------     -----------    -----------    -----------
        <S>                              <C>             <C>            <C>            <C>         
        Current:
           Federal ..................    $   177,000     $   121,500    $   139,500    $        --
           Foreign ..................             --              --         12,836             --
           State ....................         71,642          23,300         32,422         22,281
                                         -----------     -----------    -----------    -----------
        Total income tax provision ..    $   248,642     $   144,800    $   184,758    $    22,281
                                         ===========     ===========    ===========    ===========
</TABLE>

   A reconciliation of the effective tax rates and the statutory federal income
tax rate is as follows:

<TABLE>
<CAPTION>
                                                                   ONE MONTH               YEAR ENDED
                                                                     ENDED        --------------------------
                                                  SEPTEMBER 30,   SEPTEMBER 30,    AUGUST 31,     AUGUST 31,
                                                       1998            1997           1997           1996
                                                   -----------     -----------    -----------    -----------
        <S>                                             <C>           <C>            <C>       <C>         
        Tax at U.S. statutory rate ...............      (35.0)%        35.0%         35.0%          35.0%
        State income taxes, net of federal benefit         .7          26.9            .9           18.7
        Higher effective income taxes of other
           countries .............................         --                         (.5)            --
        Change in valuation allowance ............       38.0         235.5         (30.0)         (30.0)
        Other, net ...............................         .2         (39.9)          1.1            5.1
                                                        -----         -----         -----          ----- 
                                                          3.9%        257.5           6.5%          28.8%
                                                        =====         =====         =====          =====
</TABLE>

   At September 30, 1998, the Company has net operating loss carryforwards for
federal and California income tax purposes of approximately $11,917,000 and
$3,807,000, respectively, which may be applied against future taxable income.
These carryforwards will begin to expire in 2001 and 1999, respectively, unless
previously utilized.





                                       38
<PAGE>   39

   The Company also has investment tax credit, research and development credit,
targeted jobs tax credit, alternative minimum tax credit and California
manufacturers investment credit carryforwards at September 30, 1998 aggregating
approximately $275,000 These tax credit carryforwards will expire in 1999
through 2003 unless previously utilized.

   Due to the Tax Reform Act of 1986, the Company's ability to use the net
operating loss and tax credit carryforwards could be limited in the event of a
cumulative change in ownership of more than 50% occurring within a three year
period.

5. STOCKHOLDERS' EQUITY

Common Stock Warrants

   Periodically, the Company will issue warrants to purchase common stock to
outside directors and consultants in lieu of stock options. During the three
years ended September 30, 1998, 51,664 warrants at exercise prices ranging from
$4.50 to $4.94 per share were issued to outside directors and consultants which
are fully exercisable. Warrants to purchase 373,328 shares of common stock at
$3.00 to $7.33 per share are outstanding at September 30, 1998 including 185,000
warrants a price range of $7.15 to $7.33 per share issued to representatives of
the underwriters in conjunction with the initial public offering and for
periodic advisory services. During 1998, 200,000 warrants were exercised at a
$3.00 exercise price. The outstanding warrants expire from June 2002 to January
2008.

Stock Option Plans

   The Company's 1981 Stock Option Plan was approved by the Board of Directors
and stockholders in 1981, as amended (the "1981 Plan"). The Company's 1993 Stock
Option Plan (the "1993 Plan") was approved by the Board of Directors and
stockholders in September 1993. The exercise price of options granted were not
less than fair market value of the stock on the date of grant and the options
vest over a five year period commencing on the date of grant in annual
increments of twenty percent and are exercisable for a period of ten years after
the date of grant. The Board of Directors has terminated the 1981 and 1993 Plans
and no additional shares will be granted thereunder, but outstanding options
remain exercisable and continue to vest in accordance with their terms until
they terminate.


   On March 25, 1997, the Company adopted the 1997 Equity Incentive Plan (the
"1997 Plan"). The 1997 Plan provides for incentive stock options and stock
appreciation rights appurtenant thereto for employees (including officers and
employee directors), and nonstatutory stock options, stock appreciation rights
appurtenant thereto, stock bonuses and rights to purchase restricted stock for
employees (including officers and employee directors) and non-employee directors
and consultants. The 1997 Plan is administered by the Board of Directors, or a
Committee appointed by the Board, which determines the option awards to be
granted, including exercise prices, number of shares subject to the awards and
the exercisability thereof, provided that such terms comply with the provisions
of the plan.

   The term of stock options granted under the 1997 Plan may not exceed 10
years. The exercise price of options granted under the 1997 Plan is determined
by the Board of Directors, but in the case of an incentive stock option, cannot
be less than 100% of the fair market value of the common stock on the date of
grant and in the case of a non- statutory stock option, cannot be less than 85%
of the fair market value of the common stock on the date of grant. Options
granted under the plans vest at the rate specified in the option agreement. The
Board has authorized and reserved an aggregate of 1,000,000 shares of common
stock for issuance under the Plan.





                                       39
<PAGE>   40


The following table summarizes stock option and warrant activity:

<TABLE>
<CAPTION>
                                                                         WEIGHTED
                                                                         AVERAGE
                                                                         EXERCISE
                                              NUMBER OF     PRICE PER    PRICE PER
                                               SHARES         SHARE        SHARE
                                              ---------     ---------    ---------
        <S>                                   <C>           <C>           <C>   
        Outstanding at August 31, 1995 ..     1,179,010     $.22-4.50     $ 3.40
          Granted .......................       181,149      .56-4.50       3.47
          Exercised .....................            (6)         4.50       4.50
          Canceled ......................       (81,656)    3.00-4.50       3.46
                                              ---------     ---------     ------
        Outstanding at August 31, 1996 ..     1,278,497      .22-4.50       3.40
          Granted .......................       666,776     1.05-3.00       5.02
          Exercised .....................            --            --       --
          Canceled ......................       (35,329)    3.00-4.50       3.37
                                              ---------     ---------     ------
        Outstanding at August 31, 1997 ..     1,909,944      .22-7.15       3.97
          Granted .......................       502,000     3.25-7.33       4.39
          Exercised .....................      (243,880)     .22-3.00       2.67
          Canceled ......................      (275,524)    1.22-6.50       4.50
                                              ---------     ---------     ------
        Outstanding at September 30, 1998     1,892,540     $.56-7.33     $ 4.17
                                              =========     =========     ======
</TABLE>

   At September 30, 1998, the weighted-average exercise price of outstanding
stock options and warrants is $3.87 and $5.38, respectively, and 1,178,701
options and warrants are exercisable.

   Adjusted pro forma information regarding net income (loss) is required by
SFAS 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that statement. The fair
value for these options was estimated at the date of grant using the
Black-Scholes method for option pricing with the following weighted-average
assumptions: volatility of 0.559; risk-free interest rate range from 5.4% to
6.2%; dividend yield of 0%; and a weighted average expected life of the options
of 6 years. The Company's pro forma information is as follows:

<TABLE>
<CAPTION>
                                                                         YEAR ENDED
                                                        ------------------------------------------
                                                        SEPTEMBER 30,     AUGUST 31,    AUGUST 31,
                                                             1998            1997          1996
                                                        ------------     -----------    ----------
        <S>                                             <C>              <C>            <C>     
        Adjusted pro forma income (loss) ...........    $ (7,682,537)    $ 2,025,355    $ 78,314
        Adjusted pro forma diluted net income (loss)
            per share ..............................    $       (.92)    $       .28    $    .01
</TABLE>

Employee Stock Purchase Plan

   On March 25, 1997 the Company adopted the Employee Stock Purchase Plan (the
"Purchase Plan") covering an aggregate of 250,000 shares of common stock. The
Purchase Plan is intended to qualify as an employee stock purchase plan within
the meaning of Section 423 of the IRS Code. Under the Purchase Plan, the Board
has authorized participation by eligible employees, including officers, in
periodic offerings following the commencement of the Purchase Plan. The initial
offering under the Purchase Plan commenced on the closing of the Company's
initial public offering and terminated on February 28, 1998. Sequential
six-month offerings have occurred since that date. The Purchase Plan permits the
purchase of shares of common stock at the end of each offering period at 85% of
the lesser of the price of the common stock on the first day of the offering
period and the last day of the offering period. During 1998, 33,571 shares were
issued to employees under this Plan at an average price of $3.32 per share.





                                       40
<PAGE>   41

Shares Reserved for Future Issuance

   The following shares of common stock are reserved for future issuance at
September 30, 1998:

<TABLE>
        <S>                                                    <C>    
        Subordinated convertible debentures                      358,918
        Stock options:
          Granted and outstanding .......................      1,519,212
          Reserved for future grants ....................        660,310
        Warrants ........................................        373,328
        Stock Purchase Plan .............................        216,429
                                                               ---------
                                                               3,128,197
                                                               =========
</TABLE>


6.  EARNINGS PER SHARE

   The following table sets forth the computation of basic and diluted earnings
per share (in thousands):

<TABLE>
<CAPTION>
                                                                              YEAR ENDED
                                                              ---------------------------------------
                                                              SEPTEMBER 30,   AUGUST 31,   AUGUST 31,
                                                                   1998          1997         1996
                                                              -------------   ----------   ----------
        <S>                                                      <C>           <C>          <C>    
        Numerator:
          Net income (loss) before extraordinary items ....      $(7,032)      $ 2,275      $    55
          Extraordinary items .............................           --            --          119
                                                                 -------       -------      -------
          Numerator for basic and diluted earnings
             per share -- income (loss) available to common
             stockholders .................................      $(7,032)      $ 2,275      $   174
                                                                 =======       =======      =======
        Denominator:
          Denominator for basic earnings per
             share -- weighted-average shares .............        8,266         5,592        4,900
          Effect of dilutive securities:
             Stock options and warrants ...................           --           634          668
             Convertible preferred stock ..................           --           970        1,005
                                                                 -------       -------      -------
          Dilutive potential common shares ................           --         1,604        1,673
          Denominator for diluted earnings per
            share -- adjusted weighted-average
            shares and assumed conversions ................        8,266         7,196        6,573
                                                                 =======       =======      =======
        Basic earnings per share ..........................      $  (.85)      $   .41      $   .04
                                                                 =======       =======      =======
        Diluted earnings per share ........................      $  (.85)      $   .32      $   .03
                                                                 =======       =======      =======
</TABLE>







                                       41
<PAGE>   42

7. COMMITMENTS AND CONTINGENCIES

Lease Commitments

   The Company leases its operating, office and other facilities as well as
certain vehicles and equipment under non-cancellable operating leases. The
operating and office facilities leases contain escalation clauses and options
for renewal and extend through July, 2007.

   Future minimum rental payments (excluding common area maintenance charges)
required under the operating leases for each of the remaining fiscal years
ending subsequent to September 30, 1998 are as follows:

<TABLE>
        <S>                                         <C>       
        1999 .....................................  $1,210,000
        2000 .....................................   1,152,000
        2001 .....................................   1,049,000
        2002 .....................................     521,000
        2003 .....................................     346,000
        Thereafter ...............................   1,298,000
                                                    ----------
                                                    $5,576,000
                                                    ==========
</TABLE>

   Rent expense was $1,528,000, $1,063,000, and $1,282,000 for the years ended
September 30, 1998, August 31, 1997 and August 31, 1996, respectively.

Contingency

   The Company has a license to certain technology used in its blue microlaser.
During 1996, the Company received a letter from a third party claiming that the
Company's license was granted improperly by the licensor. While the Company
believes that such license was properly granted, there can be no assurance that
the Company's license would not be voided if subjected to a legal challenge. In
such an event, there can be no assurance that the Company would be able to
obtain a replacement license on favorable terms, if at all. Failure to obtain
such a license could result in a material adverse effect to the Company's
business, financial condition and results of operations.





                                       42
<PAGE>   43

8.      GEOGRAPHIC INFORMATION

   The Company operates in one business segment and designs, manufactures and
markets high performance optics and lasers for industrial, processing, medical,
aerospace and defense markets. No one customer accounted for more than 10% of
revenues in 1998, 1997 or 1996. Export sales from U.S. operations to
unaffiliated customers located principally in Europe and the Asia Pacific region
amounted to 29%, 34%, and 25% of total revenue in 1998, 1997 and 1996,
respectively.

   Information with respect to the Company's operations by significant
geographic area is set forth below. Transfers between geographic areas have been
shown at the agreed upon transfer price. All transactions denominated in foreign
currency have been translated at the average exchange rates during the period.

   The identifiable assets located in the United States include assets located
in Mexico, which are not considered significant.

<TABLE>
<CAPTION>
                                                              YEAR ENDED SEPTEMBER 30, 1998
                                              --------------------------------------------------------------
                                                 UNITED                                         CONSOLIDATED
                                                 STATES           EUROPE       ELIMINATIONS        TOTAL
                                              ------------     ------------    ------------     ------------
        <S>                                   <C>              <C>             <C>              <C>         
        Sales to unaffiliated customers ..    $ 30,206,550     $  4,356,152    $         --     $ 34,562,702
        Transfers between geographic areas       2,262,342               --      (2,262,342)              --
                                              ------------     ------------    ------------     ------------
        Total revenue ....................    $ 32,468,892     $  4,356,152    $ (2,262,342)    $ 34,562,702
                                              ============     ============    ============     ============
        Income (loss) before income taxes     $ (6,918,801)    $    200,307    $    (64,476)    $ (6,782,970)
                                              ============     ============    ============     ============
        Identifiable assets ..............    $ 24,853,962     $  2,387,980    $ (1,765,653)    $ 25,476,289
                                              ============     ============    ============     ============
</TABLE>

<TABLE>
<CAPTION>
                                                                 YEAR ENDED AUGUST 31, 1997
                                              --------------------------------------------------------------
                                                 UNITED                                         CONSOLIDATED
                                                 STATES           EUROPE       ELIMINATIONS        TOTAL
                                              ------------     ------------    ------------     ------------
        <S>                                   <C>              <C>             <C>              <C>         
        Sales to unaffiliated customers ..    $ 31,831,982     $  3,719,523    $         --     $ 35,551,505
        Transfers between geographic areas       1,391,125               --      (1,391,125)              --
                                              ------------     ------------    ------------     ------------
        Total revenue ....................    $ 33,223,107     $  3,719,523    $ (1,391,125)    $ 35,551,505
                                              ============     ============    ============     ============
        Income (loss) before income taxes     $  2,275,704     $    170,651    $     13,619     $  2,459,974
                                              ============     ============    ============     ============
        Identifiable assets ..............    $ 28,718,225     $  2,009,946    $ (1,655,280)    $ 29,072,891
                                              ============     ============    ============     ============
</TABLE>

<TABLE>
<CAPTION>
                                                                 YEAR ENDED AUGUST 31, 1996
                                              --------------------------------------------------------------
                                                 UNITED                                         CONSOLIDATED
                                                 STATES           EUROPE       ELIMINATIONS        TOTAL
                                              ------------     ------------    ------------     ------------
        <S>                                   <C>              <C>             <C>              <C>         
        Sales to unaffiliated customers ..    $ 26,057,328     $  3,445,023    $         --     $ 29,502,351
        Transfers between geographic areas       1,195,380               --      (1,195,380)              --
                                              ------------     ------------    ------------     ------------
        Total revenue ....................    $ 27,252,708     $  3,445,023    $ (1,195,380)    $ 29,502,351
                                              ============     ============    ============     ============
        Income (loss) before income taxes     $    (12,153)    $    105,931    $    (40,747)    $     77,337
                                              ============     ============    ============     ============
        Identifiable assets ..............    $ 17,658,158     $  1,994,440    $ (2,087,574)    $ 17,565,024
                                              ============     ============    ============     ============
</TABLE>

9. EMPLOYEE BENEFIT PLAN

   The Company has a defined contribution plan (the "Plan") covering
substantially all employees that have been employed for at least 90 days and
meet certain age requirements. Employees may contribute up to 16% of their
compensation per year (subject to a maximum limit by federal tax law). The
Company is obligated to make matching contributions equal to 50% of the
employee's contribution up to a maximum of 6% of the employee's compensation. At
the discretion of the Board of Directors, the Company may make additional
contributions. Prior to its merger with the Company, EMI had a defined
contribution plan with contributions based on a profit-sharing formula.
Subsequent to the merger, the EMI plan was terminated and participant balances
rolled over into the Company's plan. The Company's contributions charged to
operations, which include contributions to the EMI plan prior to its
termination, were $422,000, $140,000, and $194,000 for the years ended September
30, 1998, August 31, 1997 and August 31, 1996, respectively.






                                       43
<PAGE>   44




10.     AGREEMENT WITH PROXIMA CORPORATION

   The Company and Proxima have entered into a Cooperative Development and
License Agreement (the "Agreement") which provides for licensing of existing
technology and technologies being developed under the terms of the agreement.

   Included in internal research and development expenses in the accompanying
statements of operations is $1,630,000 spent in accordance with the Agreement in
1996. No amounts were spent during 1997 and 1998.


11.  SIGNIFICANT FOURTH QUARTER ADJUSTMENTS

   During the fourth quarter of fiscal 1998, the Company recorded approximately
$1.8 million in merger and integration costs (See Note 1). The Company also
recorded $.7 million to increase reserves, of which $.4 million relates to
inventories, $.2 million for other specific reserves and $.1 million for losses
on contracts. The increase in inventory reserves primarily relate to a redesign
of one of the Company's products, and warranty reserves and estimates of future
sales of certain optics products. The patent reserve relates to specific patents
the Company does not intend to pursue due to economic conditions. The reserve
for losses on contracts relates to losses the Company anticipates on certain of
its contracts.





























                                       44
<PAGE>   45


                                   SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of San Diego, County of
San Diego, State of California, on the 29th day of December, 1998.


                                        LASER POWER CORPORATION

                                        By  /s/ Paul P. Wickman
                                           ------------------------------------
                                                Paul P. Wickman, Jr.
                                                Senior Vice President and Chief
                                                Financial Officer

                                                        POWER OF ATTORNEY

   KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Dick Sharman and Paul P. Wickman, Jr., or any of
them, his attorney-in-fact, each with the power of substitution, for him in any
and all capacities, to sign any amendments to this Report, and to file the same,
with exhibits thereto and other documents in connections therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                  SIGNATURE                                  TITLE                            DATE
                  ---------                                  -----                            ----
<S>                                             <C>                                     <C>
     /s/        DICK SHARMAN                    Chief Executive Officer and Director    December 29, 1998
--------------------------------------------    (Principal Executive Officer)
                Dick Sharman

     /s/       PAUL P. WICKMAN                  Senior Vice President and Chief         December 29, 1998
--------------------------------------------    Financial Officer
            Paul P. Wickman, Jr.                (Principal Financial and
                                                Accounting Officer)

     /s/    ROBERT G. KLIMASEWSKI               Chairman of the Board                   December 29, 1998
--------------------------------------------
            Robert G. Klimasewski

     /s/     DOUGLAS H. TANIMOTO                Director                                December 29, 1998
--------------------------------------------
             Douglas H. Tanimoto, Ph.D.

     /s/     WILLIAM G. FREDRICK                Director                                December 29, 1998
--------------------------------------------
             William G. Fredrick

     /s/      RICHARD C. LAIRD                  Director                                December 29, 1998
--------------------------------------------
              Richard C. Laird

     /s/      KENNETH E. OLSON                  Director                                December 29, 1998
--------------------------------------------
              Kenneth E. Olson

     /s/       JOHN C. STISKA                   Director                                December 29, 1998
--------------------------------------------
               John C. Stiska

     /s/      ROBERT P. PERKINS                 Director                                December 29, 1998
--------------------------------------------
              Robert P. Perkins
</TABLE>






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