<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
[Mark One]

   [ x ]        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                    For the Fiscal Year Ended March 31, 2004

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

                        Commission File Number: 000-6377

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

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

1875 North Shoreline Boulevard, Mountain View, CA             94043-1601
-------------------------------------------------             ----------
(Address of principal executive offices)                      (Zip Code)

                                 (650) 969-7277
                                 --------------
              (Registrant's telephone number, including area code)

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

        None                                                     None
--------------------                                    ----------------------
(Title of each class                                    (Name of each exchange
   so registered)                                        on which registered)

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

                          Common Stock, $.01 Par Value
                          ----------------------------
                                (Title of 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 Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. [x] Yes [ ] No

Indicate by check mark 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]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [x] Yes [ ] No

Based on the last trade price of the Company's Common Stock on The Nasdaq Stock
Market on June 10, 2004, the aggregate market value of the voting stock held by
non-affiliates of the registrant is approximately $141,000,000.

 Number of outstanding shares of Common Stock, $.01 par value, at June 10, 2004:
                                   11,410,064

                    DOCUMENTS INCORPORATED BY REFERENCE: NONE

<PAGE>
<TABLE>
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                                                              PART I
                                                                                                                            Page
                                                                                                                            ----
<S>        <C>                                                                                                              <C>
Item 1.    Business.......................................................................................................     3
           Forward-Looking Statements.....................................................................................     3
               General Development of Business............................................................................     4
               Financial Information about Segments.......................................................................     6
               Narrative Description of Business..........................................................................     6
                  LaserCard(R)Optical Memory Cards.........................................................................    6
                     Optical Data Storage.................................................................................     6
                     The Drexon(R)Laser Recording Medium...................................................................    6
                     LaserCard Digital Governance Applications............................................................     6
                     Reading and Writing Optical Memory Cards.............................................................     8
                     Data Storage Capacity................................................................................     8
                     LaserCard Prerecording...............................................................................     8
                     LaserCard Durability.................................................................................     8
                     LaserCard Security Features and Capabilities.........................................................     9
                     International Standards for Optical Memory Cards.....................................................    11
                     LaserCard Manufacturing..............................................................................    11
                     Raw Materials........................................................................................    11
                     Subsidiaries and Marketing Organization .............................................................    12
                     Card Product Evolution...............................................................................    13
                     APIs and Application Software........................................................................    13
                     LaserCard Read/Write Drives; Manufacturing and Parts/Components......................................    14
                     LaserCard Biometric ID Verification System...........................................................    14
                     Other Advanced-Technology Cards......................................................................    15
                     Peripheral Equipment.................................................................................    15
                  Licensing...............................................................................................    15
                  Competition.............................................................................................    16
                  Other Matters...........................................................................................    17
                     Research and Engineering Expenses....................................................................    17
                     Patents and Trademarks...............................................................................    18
                     Employees............................................................................................    18
                     Dependence on Government Subcontracts through a Sole Contractor......................................    19
                     Backlog..............................................................................................    19
                     Financial Information about Geographic Areas.........................................................    19
                  Factors that May Affect Future Operating Results........................................................    20
Item 2.    Properties.....................................................................................................    26
Item 3.    Legal Proceedings..............................................................................................    26
Item 4.    Submission of Matters to a Vote of Security Holders............................................................    26

                                                             PART II

Item 5.    Market for the Registrant's Common Stock and Related Stockholder Matters.......................................    27
Item 6.    Selected Financial Data........................................................................................    28
Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations..........................    29
               Critical Accounting Policies...............................................................................    30
               Results of Operations--Fiscal 2004 Compared with Fiscal 2003 and Fiscal 2002................................   31
               Liquidity and Capital Resources............................................................................    37
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk.....................................................    41
Item 8.    Consolidated Financial Statements and Supplementary Data.......................................................    42
               Reports of Independent Registered Public Accounting Firms..................................................    42
               Consolidated Financial Statements..........................................................................    44
               Notes to Consolidated Financial Statements.................................................................    48
               Quarterly Financial Information (Unaudited)................................................................    66
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...........................    67
Item 9A.   Controls and Procedures........................................................................................    67

                                                             PART III

Item 10.   Directors and Executive Officers of the Registrant.............................................................    68
Item 11.   Executive Compensation.........................................................................................    69
Item 12.   Security Ownership of Certain Beneficial Owners and Management.................................................    71
Item 13.   Certain Relationships and Related Transactions.................................................................    73

                                                             PART IV

Item 14.   Principal Accountant Fees and Services.........................................................................    74
Item 15.   Exhibits, Financial Statement Schedule, and Reports on Form 8-K................................................    75
Signatures................................................................................................................    88
</TABLE>


                                                                2
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                                    PART I

ITEM 1.    BUSINESS

        FORWARD-LOOKING STATEMENTS. All statements contained in this report that
are not historical facts are forward-looking statements. The forward-looking
statements in this report are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. They are not historical facts
or guarantees of future performance or events. Rather, they are based on current
expectations, estimates, beliefs, assumptions, and goals and objectives and are
subject to uncertainties that are difficult to predict. As a result, the
Company's actual results may differ materially from the statements made. Often
such statements can be identified by their use of words such as "may," "will,"
"intends," "plans," "believes," "anticipates," "visualizes," "expects," and
"estimates." Forward-looking statements made in this report include statements
as to current and potential market segments, customers, and applications for and
deployment of the products of the Company; statements as to the business
benefits to the Company as a result of the March 2004 acquisition of two German
companies--including increased revenue potential, card production capacity and
product flexibility; statements as to the advantages of, potential income from,
and duties to be performed under the sale of a second-source card manufacturing
license; statements as to the Global Investments Group (GIG) license for
second-source card production in Slovenia, including future scheduled payments
and royalties, targeted startup date and production capacity, and that the
Company will sell equipment to GIG, provide GIG with installation support, and
have on-site personnel; production quantities, delivery rates and expected
delivery schedule, backlog, and revenue recognition for Company products for
U.S. or foreign government programs; statements as to potential deployment and
use of the Company's products in the Department of Homeland Security (DHS) U.S.
Visitor and Immigration Status Indication Technology (US-VISIT) program;
expectations as to the new sheet-lamination production facilities and the
short-term effect on gross margins; uncertainties associated with achieving
adequate production capacity for sheet-lamination process cards to meet order
requirements and delivery schedules; anticipated continued use of the Company's
products by the governments of the United States, Canada, and Italy; reliance on
value-added resellers and system integrators to generate sales, perform customer
system integration, develop application software, test products, and work with
governments to implement card programs; the Company's efforts to recruit new
value-added resellers (VARs); the need for, expected success of, and potential
benefits from the Company's research and engineering efforts, including
developing new or enhanced card capabilities, software products,
production-model read-only drives, or drives with advanced security features or
lower manufacturing costs; whether introduction of new drives will increase
sales, and the effects of read/write drive prices and sales volume on gross
profits or gross margins from read/write drive sales; the Company's belief that
the read/write drive inventory is reflected at its net realizable value; belief
that there is a market for both designs of its read/write drives to support and
expand optical card sales and that the read/write drive inventory on hand will
be ordered by customers; expectations regarding revenues, margins, capital
resources, and capital expenditures and investments, and the Company's deferred
tax asset and related valuation allowance; anticipated reductions of federal tax
cash payments due to current Company tax benefits; statements as to expected
card delivery volumes, estimates of optical card production capacity, expected
card yields therefrom, the Company's ability to expand production capacity, and
the Company's plans and expectations regarding the growth and associated capital
costs of such capacity; estimates that revenues will be sufficient to generate
cash from operating activities over the next 12 months despite expected
quarterly fluctuations; expectations regarding market growth, product demand,
and the continuation of current programs; potential expansion or implementation
of government programs utilizing optical memory cards, including without
limitation, those in Senegal, India, an Saudi Arabia, and the timing of the
award of any prime contracts for such programs; and the Company's plans,
objectives, and expected future economic performance.

        These forward-looking statements are based upon the Company's
assumptions about and assessment of the future, which may or may not prove true,
and involve a number of risks and uncertainties including, but not limited to,
whether there is a market for cards for homeland security in the U.S. and
abroad, and if so whether such market will utilize optical memory cards as
opposed to other technology; customer concentration and reliance on continued
U.S. and Italian government business; risks associated with doing business in
and with foreign countries; whether the Company can successfully integrate and
operate its recently acquired German subsidiaries; whether the Company will be
successful in assisting GIG with factory startup and training; whether GIG will
have the financial wherewithal to make its required payments to the Company and
to operate the facility; whether the facility will efficiently produce high
quality optical memory cards in volume; whether GIG will be able to procure and
satisfy customers so that it owes and pays royalties; and whether GIG will
encounter unexpected delays in constructing and staffing the facility;


                                       3
<PAGE>

lengthy sales cycles and changes in and dependence on government policy-making;
reliance on value-added resellers and system integrators to generate sales,
perform customer system integration, develop application software, integrate
optical card systems with other technologies, test products, and work with
governments to implement card programs; risks and difficulties associated with
development, manufacture, and deployment of optical cards, drives, and systems;
the impact of litigation or governmental or regulatory proceedings; the ability
of the Company or its customers to initiate and develop new programs utilizing
the Company's card products; risks and difficulties associated with development,
manufacture, and deployment of optical cards, drives, and systems; potential
manufacturing difficulties and complications associated with increasing
manufacturing capacity of cards and drives, implementing new manufacturing
processes, and outsourcing manufacturing; the Company's ability to produce and
sell read/write drives in volume; the unpredictability of customer demand for
products and customer issuance and release of corresponding orders; government
rights to withhold order releases, reduce the quantities released, and extend
shipment dates; whether the Company receives a fixed payment schedule and/or a
schedule, notification, or plan for shipments out of the government-funded vault
located on the Company's premises, enabling the Company to recognize revenues on
cards delivered to the vault instead of when cards later are shipped from the
vault; the impact of technological advances, general economic trends, and
competitive products; and the possibility that optical memory cards will not be
purchased for the full implementation of card programs in Italy, Saudi Arabia,
India, and Senegal or for DHS programs in the U.S., or will not be selected for
other government programs in the U.S. and abroad, including the US-VISIT
program; the risks set forth in the section entitled "Factors That May Affect
Future Operating Results" and elsewhere in this report; and other risks detailed
from time to time in the Company's SEC filings. These forward-looking statements
speak only as to the date of this report, and, except as required by law, the
Company undertakes no obligation to publicly release updates or revisions to
these statements whether as a result of new information, future events, or
otherwise.

        TRADEMARKS. LaserCard(R) and Drexon(R) are the Company's registered
trademarks. Smart/OpticalTM card, LaserCard(R) ConciergeCardTM, OptiChipTM, and
LaserBadgeTM are the Company's trademarks. The Company may also refer to
trademarks of other corporations and organizations in this document.

GENERAL DEVELOPMENT OF BUSINESS

        Headquartered in Mountain View, California, Drexler Technology
Corporation develops, manufactures, and markets optical data storage products
and systems featuring LaserCard(R) optical memory cards and chip-ready
Smart/Optical(TM) cards. Drexler-made LaserCard(R) optical memory cards are used
for digital governance applications such as immigration, border crossing visas,
cargo manifests, motor vehicle registration, multi-biometric identification (ID)
cards, and other digital read/write card applications. LaserCard Systems
Corporation (LSC), a wholly owned subsidiary of Drexler Technology Corporation,
makes optical card read/write drives, develops optical card software, and
markets optical cards, read/write drives, and related systems. Challenge Card
Design Plastikkarten GmbH of Rastede, Germany (CCD), and cards & more GmbH of
Ratingen, Germany (C&M) became wholly owned subsidiaries of Drexler Technology
on March 31, 2004. CCD manufactures advanced-technology cards, and C&M markets
CCD cards and system solutions worldwide and is a representative for various
thermal card printers in Europe, the Middle East, and Africa.

        Drexler Technology Corporation was incorporated under the laws of the
State of California on July 23, 1968, and was reincorporated as a Delaware
corporation on June 24, 1987. The Company's mailing address and executive
offices are located at 1875 North Shoreline Boulevard, Mountain View, California
94043, and the telephone number is (650) 969-7277. Throughout this report, the
"Company," "we," and "us" refer to Drexler Technology Corporation and
subsidiaries, unless otherwise indicated.

        The Company's annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and all amendments to those reports can be
obtained free of charge after such material is electronically filed with or
furnished to the Securities and Exchange Commission (SEC). These documents are
available as soon as reasonably practicable using the hypertext link to the
SEC's website via the Company's website, www.drexlertechnology.com. They also
may be obtained directly from the SEC's website,
www.sec.gov/edgar/searchedgar/companysearch.html under CIK code 30140. In
addition, these documents and the Company's "Code of Ethics and Business Conduct
for Employees, Officers, and Directors" are posted on the Company's website.


                                       4
<PAGE>

        The LaserCard optical memory card is an updatable, laser recordable,
computer readable, credit-card sized, data storage card--invented, patented,
developed, and manufactured by the Company. It contains a reflective stripe of
laser-recording material called Drexon(R), a Company invention. Along with its
ability to record, update, and store up to 4.1 megabytes of digital data (2.86
megabytes of user data), this unique card offers multiple data-security
features, can be carried in a wallet, and is highly resistant to counterfeiting
and data tampering. This makes the LaserCard ideal for portable, recordable,
secure, cumulative data storage and cardholder identification.

        The Company's product line primarily consists of LaserCard optical
memory cards, optical card read/write drives, optical card systems, chip-ready
hybrid Smart/Optical(TM) cards, and other advanced-technology cards. The Company
also sells optical card-related software and third-party peripherals, including
fingerprint sensor units, digital video cameras, and thermal card printers. The
Company's LaserCard products are sold mainly through value-added reseller (VAR)
companies and card-distribution licensees, with primary target markets being
domestic and foreign government programs, particularly for secure identification
cards. Company revenues also include fees from the occasional sale of patent and
know-how licenses.

        Originally a supplier of photomasks to the semiconductor industry, the
Company transitioned its business into optical memory cards over a number of
years of research, product development, production engineering, marketing, and
licensing. After several years of moderate-sized orders, the breakthrough order
for LaserCard optical memory cards came in February 1997 in the form of a $7.1
million order for Permanent Resident Cards (Green Cards) under a subcontract
where the United States Immigration and Naturalization Service (INS) was the
ultimate customer. This initial order was followed by a series of additional
multi-million-dollar order releases under subcontracts for INS Green Cards and
for U.S. Department of State "Laser Visa" Border Crossing Cards (BCCs). In June
2000, the Company was awarded a U.S. government subcontract to supply Green
Cards and Laser Visa BCCs over a period of up to five years. Under this
five-year subcontract, successive order releases totaling $41 million have been
received by the Company as of March 31, 2004. In early 2003, the INS became part
of the newly formed U.S. Department of Homeland Security (DHS), which is now the
ultimate customer under the Company's subcontract for Green Cards and Laser Visa
Border Crossing Cards.

        In addition, the U.S. Department of Defense has employed the LaserCard
since 1993 in its Automated Manifest System, now used for both Army and Marine
military cargo shipments. Through March 31, 2004, the Company has recorded
revenues of over $81 million on LaserCard optical memory cards sold for U.S.
government programs.

        In mid-2002, the Canadian government began issuing the Company's optical
memory cards as the new Canadian "Maple Leaf" Permanent Resident Card.

        Applications for the LaserCard include the following:

        o       United States Permanent Resident Card (Green Card)
        o       United States Department of State Laser Visa Border Crossing
                Card (BCC)
        o       United States Department of Defense Automated Manifest System
                Card
        o       Government of Canada "Maple Leaf" Permanent Resident Card
        o       Italian national ID card for citizens
        o       Saudi Arabian ID card
        o       Other developing programs involving banking, medical record
                cards, and vehicle registration cards

        On March 31, 2004, the Company successfully completed the acquisition of
two related German card companies, Challenge Card Design Plastikkarten GmbH of
Rastede, Germany, and cards & more GmbH of Ratingen, Germany, including their
sales operations in the USA and Korea. These acquisitions provide the Company
with a strong card manufacturing base to serve the European, Middle Eastern,
African, and Asian markets, supplementing the Company's newly expanded
manufacturing operations in California. While future operating results of these
German companies will be consolidated into the Company's financial statements
for future periods, the historic results of CCD and C&M have not been included
in the financial statements for fiscal 2004 and prior periods, although the
consolidated balance sheet as of March 31, 2004 reflects the acquisition of
these two companies.


                                       5
<PAGE>

        Effective April 3, 2004, the Company sold a royalty-bearing,
second-source card-manufacturing license to the Global Investments Group, for
optical memory card manufacturing in Slovenia. This agreement provides for
payments to the Company of $29 million over the 20-year term of the license
(consisting of a five-year training support package, followed by an ongoing
support phase for an additional 15 years). Additionally, the Company is to sell
approximately $12 million worth of the required manufacturing equipment and
provide installation support for the licensee's new facility to achieve a
targeted initial manufacturing capacity of 10 million optical cards annually.
The Company has received the initial $5 million of payments called for in the
agreements, consisting of a partial payment for the equipment of $500,000 as of
March 31, 2004 and $4.5 million subsequent to March 31, 2004. Start up of the
Global Investments Group facility is planned for early 2005.

        For a discussion of the risk factors related to the Company's business
operations, see the "Forward-Looking Statements" narrative at the beginning of
this report, the "Factors That May Affect Future Operating Results" at the end
of this section, and the "Management's Discussion and Analysis of Financial
Condition" contained in Item 7.

FINANCIAL INFORMATION ABOUT SEGMENTS

        The Company's two reportable segments are: (1) optical memory cards and
(2) optical memory card drives, maintenance, and related accessories ("optical
card drives"). The segments were determined based on the information used by the
chief operating decision maker. The segments reported are not strategic business
units which offer unrelated products and services, rather these reportable
segments utilize compatible technology and are marketed jointly. See "Segment
Reporting" in Note 4 in Item 8, "Consolidated Financial Statements and
Supplementary Data," for additional industry segment information.

NARRATIVE DESCRIPTION OF BUSINESS

LASERCARD(R)OPTICAL MEMORY CARDS

OPTICAL DATA STORAGE

        Optical data storage systems use a beam of laser light to write and read
information. This information is stored digitally in a binary code of "1" or "0"
bits that are represented by either the presence or absence of a physical "spot"
on the recording surface. The difference in reflectivity between the background
surface and the individual spot is measured by a light-sensing device and
converted into an electrical signal. These signals are then translated by a
microprocessor into text, graphics, sound, and pictures (which can include
facial images and other biometric identifiers). Using optical data storage, a
large amount of data can be stored on a relatively small surface area since the
digital data spots are microscopic in size.

THE DREXON(R) LASER RECORDING MEDIUM

        The Drexon(R) laser recording medium was invented and patented by the
Company for optical data storage. It consists of a thin, organic film or
colloidal matrix that contains a thin layer of microscopic silver particles.
Using proprietary and patented processes, the Drexon material is produced by
chemical conversion of photographic emulsions, creating a reflective recording
surface. As described under "Prerecording," Drexon allows data to be recorded
using a laser and/or prerecorded using photolithography.

        The Drexon medium is DRAW (direct-read-after-write). DRAW media permit
data to be read immediately after laser recording--for instantaneous checking of
information. Data can be laser written onto the Drexon material at any time
(immediately, or even over a period of years) but data can be written in a
specific location on the medium only once (write once). After an area is
recorded, firmware prevents that same location from being overwritten with new
data. Obsolete data can be ignored by the system but remains permanently stored
on the Drexon optical card as an audit trail of all changes. New or revised
information is recorded in a new location. Through these procedures, the card is
easily updatable.

        Thus, although the Drexon material is not physically erasable like
magnetic storage media, Drexon can be corrected and updated at any time and has
the important audit trail feature that magnetic media do not have. Data can


                                       6
<PAGE>

be read at any time (read many times), allowing access to newly recorded data
and to the audit trail. The permanent audit trail inhibits data tampering and is
of fundamental importance for high security identification card applications.

        To form LaserCard optical memory cards, the Drexon laser recording
material is encapsulated within layers of polycarbonate plastic (laminated using
electron-beam equipment) and then die cut into card shape. The resulting
LaserCard conforms to international card standards for size, thickness, and
flexibility. Currently, the average wholesale price to VARs per card is under $5
when the cards are ordered in hundreds of thousands, and even lower in cost when
larger quantities of basic cards are ordered.

LASERCARD DIGITAL GOVERNANCE APPLICATIONS

        To date, the most widespread use of LaserCard technology has been in
programs involving digital governance, defined as facilitating or expediting the
process of governing by documenting the grant of certain rights to citizens
and/or non-citizen permanent residents. The counterfeit- and tamper-resistant
cards are consumable products because they typically are replaced periodically.
The following are examples of digital governance cards:

        o       The current U.S. Green Card, or Permanent Resident Card, made by
                the Company and issued by the Department of Homeland Security,
                evidences that a foreign worker is approved to reside and be
                employed in the United States.

        o       The current Laser Visa Border Crossing Card, made by the Company
                and issued by the United States Department of State, permits
                Mexican citizens to visit and shop in the United States (within
                25 miles of the U.S. border) for up to 72 hours.

        o       The current Canadian "Maple Leaf" Permanent Resident Card, made
                by the Company, has been issued by the Government of Canada
                since mid-2002 to confirm Canadian permanent resident status and
                as a safe proof of status document for permanent residents
                re-entering Canada by commercial carrier after international
                travel (http://www.cic.gc.ca/english/pr-card/prc-about.html).

        o       The electronic national ID card application in Italy, now in
                Phase 2, identifies the holder as a citizen and confers upon the
                holder the rights and privileges to which a citizen is entitled.
                An Italian permanent resident card for non-citizens may also be
                implemented.

        o       In a planned program for the Kingdom of Saudi Arabia, the
                LaserCard would be used as a secure personal identification
                card. The Company has sold read/write drives for installation of
                the infrastructure required for card issuance, and also has
                shipped small quantities of optical memory cards for testing and
                sample purposes.

        o       For a secure banking project under the auspices of Societe
                Nationale La Poste, the national Post Office of Senegal, Africa,
                the LaserCard is planned to be issued to transient workers who
                often bank at remote branches which are not on-line in real time
                with each other.

        o       In a newly launched motor vehicle registration program in the
                State of Delhi, India, the Smart/Optical LaserCard would be used
                for storing the payment of road tax, vehicle registration,
                insurance, violations, and vehicle fitness. The State of Gujarat
                has reportedly issued up to 200,000 such optical cards based
                registrations to date, and the State of Maharastra has a planned
                Smart/Optical card program as well.

        o       The U.S. Department of Defense uses the LaserCard as a paperless
                cargo manifest in its Automated Manifest System for governing
                and facilitating the shipment of military cargo to Army and
                Marine deployments.


                                       7
<PAGE>

READING AND WRITING OPTICAL MEMORY CARDS

        The optical card read/write drive contains a low-power, semiconductor
diode laser for writing (10.0 milliwatts) and reading (0.5 milliwatts) of data.
The read/write drive is connected to a personal computer as an external data
storage peripheral. Information is recorded when the read/write drive pulses the
laser beam through the upper clear layer of the card, forming microscopically
small spots in linear tracks on the Drexon material. The recorded spots
represent digital data, which can be read by the computer system using an
optical card reader or reader/writer peripheral.

DATA STORAGE CAPACITY

        A byte is a unit of computer storage--the amount of memory needed to
store a single number or letter. A kilobyte is 1,024 bytes. A megabyte is 1,024
kilobytes (or 1,024 x 1,024 bytes = 1,048,576 bytes). The data storage capacity
of the standard LaserCard is 4,100 kilobytes, or 4.1 megabytes, explained as
follows. The LaserCard's data storage capacity is determined by the spot size,
track pitch, and width of the Drexon optical stripe used in the card. The
standard spot size is 2.5 microns and the standard track pitch is 12 microns. A
micron is 1/1,000 of a millimeter, or about 1/75 the width of a human hair. (The
smallest size spot the human eye can see is about 20 microns.) Two card products
conforming to international standards are manufactured by the Company: a
16-millimeter stripe LaserCard (1.5 megabyte capacity) and a 35-millimeter
stripe LaserCard (4.1 megabyte capacity). The LaserCard itself is the size of a
conventional credit card.

        A significant portion of the LaserCard's total data capacity is used for
an error detection and correction, or EDAC, algorithm. EDAC is routinely used in
various data storage and transfer methods to compensate for data errors
resulting from transmission errors, surface scratches above the recording
material, or contamination such as dust or fingerprints. EDAC is automatically
added to data written onto the LaserCard, to achieve written data error rates of
less than one in a trillion.

        The resulting data storage capacities are 2.86 megabytes of "user"
capacity for the standard 4.1 megabyte LaserCard and 1.1 megabytes of "user"
capacity for the 1.5 megabyte LaserCard. The 16-millimeter stripe LaserCard with
1.1 megabytes of user capacity can be employed in conjunction with a
microcontroller/microprocessor chip to create a hybrid smart card, which the
Company calls a Smart/Optical(TM) card.

        The amount of data that can be stored on the LaserCard varies depending
upon the type of digital file, file compression algorithm, formatting
parameters, and data encoding sector size. Typically, a 2.86 megabyte LaserCard
can store more than 1,200 digital text pages or 200 scanned text pages. If the
LaserCard is used in a transaction-based application, more than 35,000
transactions could be recorded. The 2.86 megabyte LaserCard has approximately
one hundred times the storage capacity of a 32-kilobyte integrated circuit (IC)
smart card and over 10,000 times the capacity of a magnetic-stripe card.

LASERCARD PRERECORDING

        Another feature of the LaserCard is its recordability both during and
after the card manufacturing process. Since photographic film is the base
material from which Drexon is made, photolithography is used during the
manufacturing process to prerecord optical digital data, graphics, and
formatting such as tracks and other indicia, while the film is still
photosensitive. Later, after the film is chemically processed to become Drexon
media and is made into cards, data can be laser recorded or updated at any
time--even over a period of years.

LASERCARD DURABILITY

        Unlike most other types of digital storage media, the LaserCard can be
manufactured to withstand temperatures of 100 degrees Centigrade (212 degrees
Fahrenheit) for extended periods. Additionally, its ability to withstand flexure
exceeds that of conventional credit cards and far surpasses chip cards. Because
the Drexon material is a nonvolatile data storage medium, it is not vulnerable
to data loss or damage when exposed to X rays, static electricity, application
of voltage, or other electromagnetic interference.


                                       8
<PAGE>

        Testing has indicated that, when protected by an appropriate envelope,
the LaserCard is not normally damaged by the usual dust particles, grime, and
scratches common to other types of cards carried in a wallet environment. The
ISO/DELA Standard (discussed below) uses a pit center data detection scheme for
the highest reliability in reading and writing, coupled with a powerful EDAC
code to maximize the life of the LaserCard.

        The longest running LaserCard program is the U.S. Department of Defense
"Automated Manifest" card (since 1993).

LASERCARD SECURITY FEATURES AND CAPABILITIES

        The level of data security used with the LaserCard would depend upon the
type of application. Very high security features are required for
government-issued ID cards, visas, immigrant work permits, licenses or permits,
and for the protection of confidential information such as medical records and
other personal data. The LaserCard's high storage capacity accommodates the use
of multiple, nonerasable, security safeguards in addition to holding all of the
user data and an audit trail. These security measures include eye readable and
computer readable security features to enhance data security, confidentiality,
and resistance to counterfeiting and data tampering.

        The LaserCard is a multiple-security-feature, digital identity card
solution that offers customers the capability of utilizing all or any
combination of the following security features on the same card:

        o       It can be upgraded time and again to deter data tampering and
                high-tech counterfeiters.

        o       It can store PC-readable (digitized) text and multiple
                biometrics-face photographs, signatures, fingerprints, hand
                scans, iris or retina scans, and other biometrics
                (simultaneously).

        o       It can permanently contain an "audit trail" of all digital data
                recorded on the card-even data that is thought to be "erased" by
                the user.

        o       It can utilize a patented process of uniquely laser-engraving an
                eye-readable image of the cardholder's face, biographic data,
                signature, document number, and card expiration date.

        o       It can have a unique, laser-engraved, sequential identification
                number.

        o       It can store precise, high-resolution microimages during the
                card manufacturing process-for example, images of all U.S.
                presidents and all state flags (which the Company does for
                Department of State and Department of Homeland Security cards).

        o       It can store digital certificates, digital signatures, and
                public and private cryptographic keys based upon public key
                infrastructure for use with the Internet, intranets, or
                extranets for verifying identity.

        o       It can contain an optically variable device for card
                authentication.

        BIOMETRICS, DIGITIZED PHOTOS, PINS, AND DEDICATED SYSTEMS. Various
computer-readable security safeguards that can be used with the LaserCard
include multiple biometric identifiers on the same card-such as digitized iris
or retina scans, signatures, fingerprints, and hand geometries; digitized color
photographs; biographic data; and one or more personal identification numbers
(PINs). Combinations of these and other security features can be recorded onto
the card when it is initialized by the card issuer, for later authentication of
the card when it is in actual use. Also, the Company can factory-prerecord
dedicated interface codes onto the card's embedded optical memory stripe so that
cards without these codes will not function in dedicated equipment, or vice
versa.

        With its multi-biometric data capability, the LaserCard's 2.8 megabyte
(2,800 kilobyte) storage capacity exceeds the requirements needed for the
following multi-biometric ID standards:

        o       U.S. National Institute of Standards and Technology (NIST)
                February 11, 2003 requirements for two fingerprints (10
                kilobytes each) and a 10-kilobyte facial image (total of 30
                kilobytes) of data storage.


                                       9
<PAGE>

        o       The International Biometrics group recommends the capture of
                iris, face, and fingerprint biometrics from visa applicants.

        o       The International Commercial Aviation Organization (ICAO)
                recommends 10 fingerprints, face, and iris biometrics, requiring
                about 250 kilobytes of data storage.

        RADIO FREQUENCY (RF) CAPABILITY ON OPTICAL CARDS. The Company has
co-developed and markets a new type of smart card that combines a contactless RF
chip and optical memory technology to support biometric identification. The
contactless portion of the new hybrid card contains a computer chip and radio
antenna; the hybrid card is read automatically-no touching or inserting of the
card is needed. The contactless technology permits the card to be read in
approximately 100 milliseconds, allowing people and/or cars to approach a gate,
having their status verified against border security databases. The LaserCard's
optical memory stripe provides counterfeit resistance, automatic card
authentication, and high capacity secure storage for multiple biometric images.
The LaserCard system allows the rapid off-line verification of biometrics. For
facilitation applications, such as land border entry or registered traveler
programs, data from the optical memory can be downloaded to the contactless chip
to activate specific services and privileges for local use.

        DATA SEGMENTATION, SECURITY SOFTWARE, AND ENCRYPTION. If desired, data
storage on the LaserCard can be segmented by type of information stored (for
example, patient records separated from insurance information or pharmacy
records) so that access to each type of data can be controlled separately.
Further, for applications that warrant cryptography, all data can be recorded
onto the LaserCard using data encryption algorithms. The Company's hybrid,
chip-ready Smart/ Optical card-with a microprocessor and over 1 megabyte of
updatable optical memory-can be used to store digital signatures, digital
certificates, and cryptographic keys such as public key infrastructure for
Internet e-commerce, as well as multi-application programs and software
upgrades.

        AUDIT TRAIL. Because the LaserCard contains an updatable, nonvolatile
WORM memory (write-once, read-many times) that is recorded permanently, the card
can hold a complete audit trail of data, changes, updates, and deletions. This
can be achieved using software--to allow access to previously recorded files
and, if desired, to record all attempts to access data from the LaserCard.

        MATCHING, EYE READABLE IMAGES. The LaserCard uniquely offers this key
security feature for maximum counterfeit-resistance. Cardholder-specific
information (typically, the cardholder's face photograph, name, signature,
number, or other identifying information) can be laser-engraved onto the card's
reflective stripe (through the card's protective transparent polycarbonate
layer). These "embedded hologram" visual images provide an ultra-secure,
matching reference to the identical cardholder-specific image thermally printed
elsewhere on the card. These permanent, eye readable images are recorded when
the card is issued, using a specially programmed, standard optical card
read/write drive. The U.S. Department of Homeland Security, U.S. Department of
State, and the governments of Canada, Italy, and Saudi Arabia all use this
visual image technology with the Company's cards. For checking of cards at the
United States/Mexico border, the eye-readable, laser-engraved images facilitate
the immigration inspectors' job of visually verifying cards if automated
verification systems are not available.

        OPTICALLY VARIABLE DEVICES (OVDS). An OVD is a security feature that has
the characteristic of a changeable optical appearance depending on angle or
wavelength of reflected light. OVDs are key elements of many secure document
designs. The LaserCard optical media can contain OVD features integrated into
the media itself, which raises the counterfeit deterrence of the card.

        MICROPRINTING, THERMAL PRINTING, AND OTHER SECURITY ADD-ONS. Using
photolithography, microimages (readable with magnifiers) can be factory
prerecorded onto the LaserCard's optical stripe as further deterrents against
counterfeiting. Examples include complex optical watermarks, emblems, seals, and
logos. Later, using digital identification technology and commercially available
thermal printers, visual data and images can be thermally printed directly onto
the back of the LaserCard at the time the card is initialized (i.e., during card
issuance). Visual data could include the cardholder's name and address, a face
photograph (in full color or black and white), signature, or other information.
Various other security options that can be added to the LaserCard include
conventional holograms, OCR-B (optical character recognition), bar codes, serial
numbers, etc.


                                       10
<PAGE>

INTERNATIONAL STANDARDS FOR OPTICAL MEMORY CARDS

        Standardization of optical memory cards allows interchange of the
digital information encoded on the cards and facilitates compatibility among
optical memory card systems. The Company participates in optical card standards
activities in the United States and internationally. The standard format base
design under which the Company's optical memory cards operate is called the DELA
Standard (so named by the Drexler European Licensees Association). Shown below
is the current status of optical memory card standards under ISO/IEC (the
International Organization for Standardization/International Electrotechnical
Committee) and ANSI (the American National Standards Institute). The LaserCard
optical memory card system, based upon the DELA Standard format, complies with
all of the documents listed.

        o       ISO/IEC 11693 (2000) describes the general characteristics of
                optical memory cards. This approved international standard was
                first published in 1994.

        o       ISO/IEC 11694-1 (2000) describes the physical characteristics of
                the card, such as height, width, thickness, etc. This approved
                international standard was first published in 1994.

        o       ISO/IEC 11694-2 (2000) describes the dimensions and location of
                the accessible area--the area on the card where data
                writing/reading occurs. This approved international standard was
                first published in 1995.

        o       ISO/IEC 11694-3 (2001) describes the optical properties and
                characteristics of the card and provides the technical
                specifications which allow interchange. This approved
                international standard was published in 1995.

        o       ISO/IEC 11694-4 (2001) describes the logical data structure on
                the card and defines the method of writing and reading card
                data. This approved international standard was published in
                1996.

        o       In the United States, ANSI has adopted all of the above ISO
                Standards as ANSI/ISO Standards.

LASERCARD MANUFACTURING

        The Company's LaserCard optical memory card manufacturing operations are
located in Mountain View, California, and Rastede, Germany. The Company produces
optical memory cards using its established, roll-lamination process or a newer,
sheet-lamination process. The sheet-lamination process is currently more labor
intensive than its roll-lamination process but allows the use of high security
offset printing and other special features, resulting in a premium card. The
Company has an annual production capacity of 10 to 12 million roll-process cards
and approximately 5 million sheet-process cards. The optical memory card
manufacturing facilities permit incremental expansion of production capacity.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" regarding card production capacity.

        In addition, the fiscal 2004 acquisition of Challenge Card Design
Plastikkarten GmbH of Rastede, Germany, provides the Company with a card
manufacturing base to serve the European, Middle Eastern, African, and Asian
markets, supplementing the Company's card manufacturing operations in
California, which were recently expanded by moving certain operations to a newly
leased facility. CCD has a manufacturing capacity of up to 20 million of its
non-optical cards per year. The Company is in the process of enhancing the
existing CCD factory in order that finished optical cards may be manufactured in
Germany. This will enable CCD to manufacture cards featuring four of the key ID
card technologies (optical memory, contact IC chip, contactless RF ID, and
magnetic stripe) either singly or in combination, along with other high-security
features.

RAW MATERIALS

        To maintain adequate raw material supplies for the manufacture of
optical memory cards, the Company attempts to establish ongoing relationships
with principal suppliers and obtains information about alternate suppliers. The
Company maintains raw materials inventory levels that take into account current
expected demand, order-to-delivery


                                       11
<PAGE>

lead times, supplier production cycles, and minimum order quantities. To enable
the Company to plan raw material inventory levels, quotes to potential customers
generally provide for certain advance payments upon placing purchase orders with
the Company. If the Company is unable to buy raw materials in sufficient
quantities and on a timely basis, it would not be able to deliver products to
customers on time.

        The raw materials used in the manufacture of optical memory cards are
available from one or more qualified suppliers. Such materials include plastic
films used in optical memory card production, which are available from one
supplier in the U.S. and from multiple foreign suppliers. Processing chemicals,
inks, and bonding adhesives are obtained from various U.S. and foreign
suppliers. Certain photographic films are commercially available solely from
Eastman Kodak Company, of the United States. No assurance can be given that
Kodak will continue to supply such photographic films on a satisfactory basis
and in sufficient quantities, especially in light of its recent announcement
that it is reducing its emphasis on emulsion-based photographic films. If Kodak
were to discontinue manufacturing the film from which the Drexon optical stripe
is made, the Company would endeavor to establish an alternate supplier for such
film, although the purchase price could increase and reliability and quality
could decrease from a new supplier. Considering that the U.S. government is a
major end-user of optical memory cards, the Company anticipates that an
alternate supplier of such film could be established and qualified; however, no
assurance can be given that there will be adequate demand to attract a second
source for such film. In addition, an alternate supplier could encounter
technical issues in producing the film as there may be know-how and
manufacturing expertise which Kodak has developed over the years which an
alternate supplier may have difficulty to replicate. The Company has
pre-purchased a long-term supply of the film used to produce mastering loops for
prerecording cards. With regard to the film from which the Drexon optical stripe
is made, the Company currently has an order which Kodak has accepted with
deliveries scheduled through December, 2004. If Kodak announced that it was no
longer going to sell film, the Company would request that Kodak provide a
last-buy opportunity, which the Company would plan to take maximum advantage of,
although no assurance can be given that Kodak would provide such an opportunity.
The Company has film on hand plus on order that it believes would provide an
adequate supply to meet anticipated demand until the Company could locate and
begin volume purchases of film from a second source.

SUBSIDIARIES AND MARKETING ORGANIZATION

        LASERCARD SYSTEMS CORPORATION (LSC). LSC, a wholly owned subsidiary of
Drexler Technology Corporation, markets the Company's products, primarily
through value-added resellers (VARs) and licensees of the Company in the United
States and other countries. To its VARs and licensees, the Company makes
available for sale optical memory cards, optical card read/write drives and
software, and third-party peripherals. VARs/licensees may add value in the form
of services, application-specific software, personal computers, or other
peripherals, and then resell these products as integrated systems. Sales to the
United States government and foreign governments are made indirectly through
VARs and licensees. For example, products are sold indirectly to ultimate use
customers such as the U.S. Department of State, U.S. Department of Defense, U.S.
Department of Homeland Security, and the government of Canada, through a VAR
that is a government subcontractor.

        For fiscal 2004, the Company sold LaserCard products to approximately 26
direct customers in 4 states and 16 foreign countries. Revenues by geographic
region are shown in Note 4 of the "Notes to Consolidated Financial Statements"
in Item 8, "Consolidated Financial Statements and Supplementary Data."
Substantially all foreign product sales have been made through VARs and
licensees. The Company believes that international markets will be an important
source of product sales and license revenue in the future.

        LaserCard marketing operations are conducted through the Company's
offices in California, New York, and now in Germany. In addition, the LaserCard
Systems website (www.lasercard.com) supports worldwide marketing activities. The
Company's marketing staff, general management, and technical personnel work
closely with customers and provide pre-sales technical support to assist VARs
and licensees.

        EUROPEAN OPERATIONS. The Company's newly acquired Germany subsidiaries,
Challenge Card Design and cards & more, will provide the marketing base for most
of Europe, Middle East, and Africa (EMEA), and also maintain a sales office in
Korea. These acquisitions give the Company an established position in the
European Union in the advanced-technology card market. CCD and C&M have become
recognized leaders in Europe as providers of advanced contactless card
solutions, primarily in the consumer, event, and access control sectors. C&M
will be heading the Company's European marketing effort in coordination with
LaserCard Systems Corporation.


                                       12
<PAGE>

        The addition of the CCD card manufacturing plant in Rastede will add
significant capacity and product flexibility to the Company's product line. With
expertise in contactless IC technology and high resolution security printing,
the European factory base will position the Company to move into new market
areas. The European marketing base, along with the optical card manufacturing
capability planned for the new operation in Germany, are intended to accelerate
European acceptance of the use of optical memory products in EU government and
business solutions.

        The cards & more subsidiary will continue to serve and support its
existing customer base for advanced-technology cards and thermal printers, while
adding new resources to build the optical memory card business throughout the
EMEA region. In expanding its European presence, the Company intends to focus
principally on biometric ID solutions for national and regional governments, as
well as promoting optical cards in commercial and industrial markets which can
benefit from the large data capacity and robust security that optical cards
offer.

        MARKETING OBJECTIVES. In addition to expected continuation of its
current business involving U.S. Green Cards, U.S. Laser Visa BCCs, U.S. military
Automated Manifest System cards, Canadian Permanent Resident Cards, and the
electronic national ID card for citizens of Italy, the Company's marketing
objectives include card applications in the United States and abroad, such as:

        o       US-VISIT system (previously called the U.S. Entry-Exit system)
        o       Canadian Citizens' ID card
        o       Italian permanent resident card for non-citizens
        o       Identification card for Saudi Arabia
        o       Motor vehicle registration card for several states in India
        o       Multi-application cards plus other ID and banking card
                applications

CARD PRODUCT EVOLUTION

        The Company continues to add features to its optical memory card
products, making them much more than simple, digital data storage devices. The
Company has enhanced its optical memory card manufacturing capabilities to meet
evolving international standards and, for some applications, to provide special
features, if specified; for example: security printing, sequential serial
numbers, bar coded data, laser-engraved eye-readable images, signature panels,
magnetic stripes, OVD (optically variable device) security diffraction pattern,
and OptiChip small form factor optical media. In addition, "chip ready" optical
memory cards can be purchased from the Company, for insertion of IC chips to
create hybrid Smart/Optical cards. The Company intends to continue its research
and development efforts to evolve its products and services to meet changing
market needs or to create new markets for advanced-technology cards.

        In addition, Company personnel and the newly acquired CCD-C&M European
operations have worked together for the past four years to co-develop advanced
secure optical card solutions for customers such as the Canadian and Italian
government optical card programs.

APIS AND APPLICATION SOFTWARE

        The Company believes that its proprietary optical memory card
Application Programming Interface (API) and software development capabilities
play a key role in developing LaserCard applications and markets. However, API
and application software sales have not been a significant portion of revenues
thus far. To date, the Company's software development has been completed
concurrent with the establishment of technological feasibility and, accordingly,
all software development costs have been charged to research and engineering
expense in the accompanying statements of income.

        APIS. As part of its read/write drive and system sales, LSC includes a
comprehensive set of APIs in order for its customers to develop optical card
applications. An API is a set of routines, protocols, and tools used by
programmers for building software applications. LaserCard-related APIs control
or facilitate the basic operations and read/write functions of optical memory
card drives so that they can interface directly with personal computers. LSC
develops LaserCard-related APIs such as device drivers, file system DLLs
(dynamic link libraries), and custom software tools to enhance read/write drive
integration.


                                       13
<PAGE>

        CUSTOM APPLICATIONS. LSC also offers contract services for purchase by
customers that require custom programming in the development and integration of
their LaserCard applications. LSC also makes available for purchase by
customers, software for demonstrating data storage, medical, and security
concepts involving the LaserCard, software-development tools for related
peripherals, and a card issuance application software package.

        APPLICATION SOFTWARE. End-user application software is an important
factor in developing commercial markets for optical memory cards because it
directs computers to do specific tasks related to the customer's end-user
application for the LaserCard. Typically, the Company's VARs and/or their
customers develop software for specific end-user applications. In this role,
VARs may integrate optical card products into existing software products, write
new application software for specific optical memory card programs, or license
software from other VARs. Several VARs have written optical card software
programs for applications. LSC markets a BadgeMaker card personalization and
issuing application used for card issuance and data management, and a Biometric
ID Verification System application (discussed below).

LASERCARD READ/WRITE DRIVES; MANUFACTURING AND PARTS/COMPONENTS

        Optical memory cards are used in conjunction with a card read/write
device (drive) that connects to a personal computer. The price, performance, and
availability of read/write drives are factors in the commercialization of
optical cards. The Company maintains read/write drive manufacturing operations
in its Mountain View, California facilities. The Company has introduced a new
version of a read/write drive and is targeting design changes to allowing
further reductions in the drive selling price.

        To maintain adequacy of parts and components for the manufacture of
read/write drives, the Company attempts to establish ongoing relationships with
principal suppliers and obtains information about alternate suppliers. If the
Company is unable to buy parts and components in sufficient quantities and on a
timely basis, it would not be able to deliver products to customers on time. The
Company purchases read/write drive parts for its anticipated read/write drive
demand, taking into consideration the order-to-delivery lead times of vendors
and the economic purchase order quantity for such parts. For read/write drives,
the optical recording head for the current drive is a Company-specific part
obtained from one supplier; Audio-Technica Corp., of Japan.

        Prior to fiscal 2002, the Company had been selling read/write drives for
less than three thousand dollars per unit in quantities of six or more, and
these units generally include interface software/device drivers. In fiscal 2002,
the Company reduced the selling price for these read/write drives by 20% for
typical purchase quantities in an effort to develop a broader market and
customer base for LaserCard optical memory cards. Since fiscal 2002, there has
not been a further reduced selling price for these read/write drives. However,
in fiscal 2004, the Company introduced a new drive with a 25% reduction in price
for typical quantities as compared with the previous model. Current and target
applications for the Company's LaserCard typically require a small number of
drives relative to the number of cards purchased.

LASERCARD BIOMETRIC ID VERIFICATION SYSTEM

        LSC has developed a LaserCard Biometric ID Verification System that can
quickly confirm validity of optical memory card biometric ID cards, read and
display digitally stored photographs and other digital data from the cards, and
biometrically verify the cardholders' live-scanned fingerprints with the
fingerprint templates stored on the cards at time of card issuance.

        During the fiscal 2004 third quarter, the Company received an order for
and delivered 1,000 optical memory card read/write drives and biometric
verification system software for a Department of Homeland Security program.
These 1,000 drives and software systems are being deployed by the DHS at U.S.
borders, to enable the DHS to read the encoded data on more than 16 million
Green Cards and Border Crossing Cards previously manufactured by the Company and
issued by the U.S. government since 1998.

        LSC also is marketing the LaserCard Biometric ID Verification System as
a "concept" package, meaning that software which performs the same functions
(but not usable with U.S. government cards) is available in customized form to
other customers for government, industrial, and commercial applications.


                                       14
<PAGE>

OTHER ADVANCED-TECHNOLOGY CARDS

        Acquired by the Company on March 31, 2004, Challenge Card Design
Plastikkarten GmbH and cards & more GmbH are recognized leaders in Europe as
providers of advanced contactless card solutions, primarily in the consumer,
event, and access control sectors. CCD has the production capacity to
manufacture up to 20 million advanced-technology cards per year--including
contact IC chip cards, contactless RF ID cards, and magnetic stripe cards--while
C&M markets CCD cards and system solutions worldwide.

PERIPHERAL EQUIPMENT

        The sale of third-party peripheral equipment and systems has not
contributed materially to the Company's revenues to date. However, the following
peripherals are purchased and re-sold by the Company to facilitate customer
application development:

        o       Fingerprint sensor units to capture fingerprints for storage
                onto the LaserCard as a template and as a high-resolution image.

        o       Digital video cameras for capturing and storing computer
                readable photos in color.

        o       Thermal printers for printing on plastic cards.

LICENSING

        From 1983 through March 31, 2004, the Company generated a total of
approximately $40 million in license fee revenues under nonexclusive patent
license agreements related to optical memory card manufacture, equipment for
using the cards, optical data storage, card distribution, and other aspects of
the Company's technologies. These licenses included two $10 million,
nonexclusive, royalty bearing, patent licenses for optical memory card
manufacture, although the Company believes that the licensees are not
manufacturing or selling such cards at this time. The first such license was
sold in fiscal 1989 to Canon Inc. The second was sold in fiscal 1991 to Optical
Memory Card Business Corporation (OMCBC), a joint venture formed by four
Japanese companies (three of the Company's read/write drive equipment licensees
and Dai Nippon Printing Co., Ltd.). On July 1, 2002, the joint venture's license
was fully assumed by Dai Nippon Printing.

        Effective April 3, 2004, the Company sold a third card-manufacturing
license to the Global Investments Group, based in Auckland, New Zealand, for
card manufacturing in Slovenia. This agreement provides for payments to the
Company of $29 million for the license over the 20-year term of the license
(including a five-year training support package, followed by an ongoing support
phase for an additional 15 years). Additionally, the Company is to sell
approximately $12 million worth of the required manufacturing equipment and
installation support for the new facility to provide a targeted initial
manufacturing capacity of 10 million optical cards annually. Options to increase
capacity to 30 million cards per year are provided. The Company has received the
initial $5 million of payments called for in the agreements, consisting of a
partial payment for the equipment of $500,000 as of March 31, 2004 and $4.5
million subsequent to March 31, 2004. In addition to the $41 million from the
GIG transaction, Global Investments Group is to pay the Company royalties for
each card produced under the license. The territories covered by the license
include most of the European Union and eastern European regions. The Global
Investments Group has exclusive marketing rights in certain territories, with
performance goals to maintain these rights. The Company will assign personnel on
site during the license term to assist with quality, security, and operational
procedures, with a mutual goal that the facility and the cards made there
conform to the Company's standards. Start up of the Global Investments Group
facility is planned for early 2005. Payments under this license will be
recognized as revenue over the term of the arrangement beginning when operation
of the factory commences. The Company also retains rights to utilize up to 20%
of the new facility capacity as backup and capacity buffer to augment its own
card manufacturing facilities. The granting of this license to GIG is expected
to create a second source supplier of optical memory cards for existing and
prospective customers who may request multiple sources for cards.


                                       15
<PAGE>

        Also from time to time, the Company has offered nonexclusive, royalty
bearing licenses for optical card read/write drive manufacture, for assembly of
read/write drives from kits, for optical card finishing using Company-supplied
materials, and for card manufacturing. In the past, the Company also offered
card distribution licenses to create distributors, in selected regions of the
world, that can buy cards wholesale from the Company at prices lower than those
charged to VARs. The Company conducts its licensing efforts on a selective
basis. The timing, number, type, and magnitude of future license sales, if any,
cannot be predicted or inferred from past events. There is no assurance that any
of the Company's patent licensing efforts will be successful.

        License revenues for fiscal 2004, 2003, and 2002 are detailed in the
"Management's Discussion and Analysis" section of this report, under the heading
"License Fees and Other Revenues."

COMPETITION

        The Company's primary competition is other card products. Competitive
factors among the various card technologies include system/card portability,
interoperability, price-performance ratio of cards and associated equipment,
durability, environmental tolerance, and card security. The Company believes its
optical memory cards offer key technological and security advantages. The
current price of optical card read/write drives is a competitive disadvantage to
the Company in some markets because alternative technologies typically have
lower priced drives. However, when the cost of drives and a large number of
cards is factored together, the Company's optical memory card technology can
offer competitive pricing compared with its closest competitor, high capacity IC
cards, especially when the very high cost of Public Key encryption is factored
into the cost of an IC card system.

        Other card technologies that compete with optical memory cards include
integrated circuit (IC) cards, 2-dimensional bar code cards and symbology cards,
CD-read only cards and recordable cards, and RF (radio frequency) cards. The
financial and marketing resources of some of the competing companies are greater
than the Company's resources. The Company believes that the LaserCard's storage
capacity, read/write capability, price-performance ratio, rugged card
construction and flexibility, optional technology add-ons, ability to store
audit trails, and resistance to counterfeiting and tampering make the LaserCard
optical memory card a viable choice for a variety of digital card applications.

        In addition, centralized on-line databases combined with wide-area
networks may limit the penetration of optical memory cards in certain
applications, and are a form of competition.

        IC CARDS. The LaserCard competes primarily with cards that contain an
integrated circuit (IC) microprocessor and memory. Known as "smart cards," "IC
cards," or "chip cards," their prices and performance vary widely. The IC card
uses a much lower cost read/write drive than is currently used with an optical
card, whereas a typical smart card containing a 32-kilobyte IC and a
microprocessor is typically more than the cost of the Company's 2,800 kilobyte
optical memory card. The IC card is more vulnerable to tampering and can be more
easily damaged in everyday use, whereas the Company's card construction and the
use of polycarbonate plastic make the LaserCard more rugged. For multi-function
applications, the Company currently offers "chip ready" optical cards to which
an IC can be added to create a hybrid smart card, called a Smart/Optical(TM)
card. Companies that manufacture IC cards of various types and storage
capacities include Gemplus, SchlumbergerSema, Sharp, Orga Card Systems, Oberthur
Card Systems, and others.

        OTHER CARD PRODUCTS. Read/write magnetic-stripe cards and read-only
memory cards such as 2-dimensional bar code cards and symbology cards are lower
priced and compete with the Company's read/write optical memory cards for
certain markets, such as identification cards. However, the Company's cards have
significantly higher storage capacity and offer unique security features to
deter counterfeiting and data tampering. Commercial magnetic-stripe cards are
relatively easy to duplicate and, because they are erasable and rerecordable,
are highly susceptible to unauthorized erasure and alteration. Two-dimensional
bar codes on cards and other symbology cards store relatively small amounts of
data compared to the LaserCard and are not recordable/updatable after they are
issued. Moreover, alternative technologies--such as magnetic stripes, IC chips,
radio frequency (RF) circuitry, and bar codes/symbology--can be incorporated
into the Company's optical memory cards, thereby adding additional performance
features to the LaserCard. In 2000, a small company announced it was developing
a 5 megabyte magnetic card. However, the Company believes that magnetic-based
cards (which are easily erasable) may not have


                                       16
<PAGE>

the security and audit trail features required for government ID cards or
medical record cards. Experimental card technologies probably are under
development at other companies.

        There also are high capacity, high cost storage cartridges called PCMCIA
(Personal Computer Memory Card Industry Association) cards, or PC cards, that
are used in personal computer applications, for example, data-storage devices
for portable computers. Because they are structurally rigid, thick, and
significantly higher in cost, PC cards are not considered competitive with the
LaserCard for low cost, wallet-card applications.

        OTHER OPTICAL MEMORY CARDS AND EQUIPMENT. As described in the
"Licensing," section, the Company previously licensed its card patents to two
Japanese companies, Canon Inc. and Dai Nippon Printing, which the Company
believes are not manufacturing or selling such cards at this time. In addition,
in April 2004, the Company sold a card manufacturing license to a New Zealand
company for the manufacture of optical memory cards in Slovenia. Under these
royalty-bearing licenses, the licensees have the right to manufacture and sell
optical memory cards in competition with the LaserCard. Dai Nippon Printing Co.,
Ltd., did not report any optical card sales for calendar year 2002, and Canon
Inc. has not reported any such sales since 1999. The newly licensed Slovenian
operation under the Global Investments Group license is not yet capable of
manufacturing optical cards, but is expected to become a second-source for the
Company's cards over time. Global Investments Group could become a competitor in
certain Western European countries; however, exclusivity provisions of the
license preclude competition in certain markets. For example, the Company is
prohibited from competing in certain Eastern European countries, and Global
Investments Group is prohibited from competing in certain Western European
countries and in some other territories.

        As to optical card drives, both Canon and Japan-based Olympus Optical
Co. (an equipment licensee of the Company) have in the past produced their own
optical card drives, although they are not believed to be doing so currently.
Canon and Olympus have not reported any optical card drive sales since mid-2000.
A United States company, BSI2000 (a LaserCard VAR), has unveiled a proprietary
low-cost reader for optical cards, according to an April 28, 2004 news release
published by BSI 2000. It is described as a small, wall-mounted unit able to
scan and identify fingerprints that match biometric data embedded in optical
identity cards. BSI said it expects to have the unit ready for the marketplace
by early fall 2004. The Company cannot verify the actual status of this
announced product.

        The Company's LaserCard utilizes the ISO/DELA card format developed by
the Company in conjunction with a group of its licensees. Canon's optical memory
card used the ISO/SIOC format developed by Canon. Dai Nippon Printing is
believed to be capable of manufacturing both types of cards. Although both card
formats meet the ISO Standard, the Company's ISO/DELA format and the Canon
ISO/SIOC format are not functionally compatible. Olympus Optical has
manufactured and sold ISO/SIOC read/write drives and nonstandard format drives
and is capable of producing an optical card read-only drive. If the production
of ISO/SIOC cards and/or equipment were to resume by Dai Nippon Printing, Canon,
or Olympus, the Company believes that it currently offers competitive advantages
in areas such as system integration, APIs/software, customer support services,
and as the only company that manufactures both optical memory cards and
read/write drives.

        During the past several years, prerecorded read-only optical cards
functioning with CD players have been used as high-data capacity, 1.2-millimeter
thick, "business cards" containing computer-readable data such as promotional
materials. In 2000, Philips, Sony, and Taiyo Yuden announced a
customer-recordable version of these thick, rigid data cards based upon the
widely used CD-recordable format; however, they do not meet the ISO Standards
for either credit cards or identification cards. Also in 2000, it became known
that a small company is developing a high-data capacity, ultraviolet-laser
recordable, read-only, optical memory disk and optical memory card that would be
read with a second laser operating in the visible or near-infrared wavelength.
That company's news releases imply a primary focus on disks.

OTHER MATTERS

RESEARCH AND ENGINEERING EXPENSES

        Research and engineering expenses were $2,620,000 for fiscal 2004;
$2,818,000 for fiscal 2003; and $3,045,000 for fiscal 2002. The Company is
continuing its efforts to develop new optical memory card features, including
the insertion of contactless chips with radio frequency (RF) capability, optical
memory card read/write drives, read-only


                                       17
<PAGE>

drives (readers), OptiChip small form factor optical media, and software
products in an effort to provide new products that can stimulate optical memory
card sales growth. For example, the Company has developed a prototype of a
LaserCard handheld reader. The Company anticipates that these ongoing research
and engineering efforts will result in new or enhanced card capabilities,
production-model read-only drives, or drives with advanced security features and
lower manufacturing costs; however, there is no assurance that such product
development efforts will be successful. These factors are important for the
Company's existing and future optical memory card markets. Also see Item 7,
"Management's Discussion and Analysis."

PATENTS AND TRADEMARKS

        OPTICAL DATA STORAGE. As of March 31, 2004, the Company owned
approximately 30 U.S. patents relating to optical data storage (including
optical storage media, optical cards, formats, equipment, systems, software, the
utilization of optical storage media, and e-commerce technology), and other U.S.
and foreign patent applications have been filed. Approximately 40 counterpart
patents of certain U.S. patents are issued in various foreign countries.
However, the Company owns certain U.S. patents as to which foreign counterparts
have either not been filed or the examination process has been terminated
without issuance of the foreign patents. From time to time, the Company elects
to allow some of its U.S. or foreign patents to expire when maintenance fees
become due, if the patents are deemed no longer relevant. In addition, the
Company protects as trade secrets some refinements to the Drexon medium and
cards and know-how related to card production. Also, the Company's know-how and
experience in volume card production, system development and software
capabilities, brand-name recognition within its card markets, and
dominant-supplier status for optical-memory cards are of far greater importance
than the Company's patents. Therefore, at this time, the Company believes that
its patent portfolio is helpful but is no longer essential for maintaining the
LaserCard's market position.

        The Company's U.S. patents have expiration dates ranging from 2004 to
2020, with the majority expiring during the first part of this period.
Counterpart patents in foreign countries also expire during this period, usually
about two to three years after the U.S. patent expires. Under the OMCBC/Dai
Nippon Printing license agreement with the Company for manufacture of optical
memory cards, the obligation to pay royalties to the Company for use of the
licensed patents cards ceased on December 31, 2003. Canon's royalty obligations
in connection with its licenses to manufacture optical memory cards and reading
and writing equipment expire on December 31, 2008. Dai Nippon Printing Co.,
Ltd., did not report any optical card sales for calendar year 2002, and Canon
Inc. has not reported any such sales since 1999. Other read/write equipment
licenses sold by the Company provide for royalty payments to cease on the last
expiration date of the licensed patents. The license sold to the Global
Investments Group provides for royalty payments on optical memory card sales;
however, the Slovenian card manufacturing operation is not expected to commence
manufacturing cards until calendar year 2005. Royalty payments to the Company
from its licensees have not been significant to date.

        The Company cannot predict whether the expiration or invalidation of its
patents would result in the introduction of competitive products which would
affect its future revenues adversely. The Company presently intends to pursue
any infringement of its patents either by litigation, arbitration, or
negotiation. However, there can be no assurance that any of the Company's
patents will be sufficiently broad in scope to afford protection from products
with comparable characteristics that may be sold by competitors in the future.
There also can be no assurance that the validity of any patents actually granted
will not be challenged.

        LaserCard(R) and Drexon(R) are federally registered trademarks of
Drexler Technology Corporation. The Company believes that its LaserCard brand
name, trade name, and other trademarks are important assets in marketing optical
memory card products.

EMPLOYEES

        As of March 31, 2004, the Company and its U.S. subsidiaries employed 128
persons (including four executive officers). This workforce consisted of 103
persons in administration, marketing/sales, manufacturing, and research and
engineering, plus 25 temporary personnel mainly for quality assurance inspection
of cards. In addition, the two German subsidiaries acquired by the Company on
March 31, 2004 employed 76 personnel as of that date. None of the Company's
employees is represented by a labor union.


                                       18
<PAGE>

DEPENDENCE ON GOVERNMENT SUBCONTRACTS THROUGH SOLE CONTRACTORS

        The largest purchaser of LaserCard products is Anteon International
Corporation, a value-added reseller (VAR) of the Company. Anteon is the
government contractor for LaserCard product sales to the U.S. Department of
Homeland Security (DHS), U.S. Department of State (DOS), U.S. Department of
Defense (DOD), and the government of Canada. Under government contracts with
Anteon, the DHS purchases U.S. Permanent Resident Cards (Green Cards) and DOS
"Laser Visa" Border Crossing Cards (BCCs); the DOD purchases Automated Manifest
System cards; and the Canadian government purchases Permanent Resident Cards.
Encompassing all of these programs, the Company's product sales to Anteon
represented 72% of total revenues for fiscal 2004; 94% of total revenues for
fiscal 2003; and 81% of total revenues for fiscal 2002. However, since the
ultimate customers are national governments, the Company is not dependent upon
any one specific contractor for continued revenues from these programs. Although
not anticipated, if Anteon were to discontinue its participation as contractor,
other qualified contractors could be utilized by those governments for
purchasing our products, although the process of doing so could cause program
delays.

        U.S. government subcontract release orders for DHS Green Cards and DOS
Laser Visa BCCs represented approximately 44% of the Company's revenue for
fiscal 2004; 82% of revenues for fiscal year 2003; and 75% of revenues for
fiscal 2002. The percentage declined during fiscal 2004 as U.S. government
orders decreased more than the Company had anticipated due to delays in the
government approving artwork reflecting the advent of the Department of Homeland
Security, and the U.S. governments' desire to reduce inventory levels, while at
the same time orders of cards from foreign governments increased as planned over
prior years' levels. The U.S. government's agreement with the above VAR expires
on May 25, 2005. There can be no assurance that the U.S. government will enter
into a new contract with the VAR to continue to purchase the Company's cards, in
which case one of the Company's major sources of revenues would be eliminated.

        During fiscal 2004, 22% of the Company's revenues were derived from
sales of cards for the government of Italy for its national ID card program,
Carta d'Identita Elettronica (CIE), now in Phase 2, early-stage implementation.
Card orders under this program are channeled to the Company through a
value-added reseller, Laser Memory Card SRL, of Rome, Italy. The most recent CIE
card order was in May 2004, for $3.3 million. According to Italian government
sources, the distribution of this new national ID card has started in a number
of the 56 Italian communities scheduled to be activated under the program during
2004. The government's publicly stated plan to issue up to two million cards
this year would put Italy at the forefront of European countries in terms of
providing citizens with secure, durable ID documents. However, if this program
were to be discontinued or interrupted by the Italian government, the Company
would lose one of its significant sources of optical memory card revenues.

BACKLOG

        As of March 31, 2004, the backlog for LaserCard optical memory cards
totaled $4.1 million, compared with a backlog of approximately $1.9 million for
fiscal 2003 and $16.4 million for fiscal 2002. Order backlog as of March 31,
2004 includes orders for the following programs: Green Cards for the U.S.
Department of Homeland Security, Italian government national ID cards (CIE
cards), and Canadian government Permanent Resident Cards. Backlog is subject to
fluctuation due to having few customers and the timing of orders. The Company
has no backlog for read/write drives.

        In addition, the backlog for Challenge Card Design Plastikkarten GmbH
and cards & more GmbH products and services totaled 2.1 million euros
(approximately $2.6 million) as of March 31, 2004.

FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

        Financial information about geographic areas is described in Note 4 to
Item 8, "Consolidated Financial Statements and Supplementary Data."


                                       19
<PAGE>

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

        OUR CURRENT AND FUTURE EXPECTED REVENUES ARE DERIVED FROM A SMALL NUMBER
OF ULTIMATE CUSTOMERS SO THAT THE LOSS OF OR REDUCTIONS IN PURCHASES BY ANY ONE
ULTIMATE CUSTOMER COULD MATERIALLY REDUCE OUR REVENUES AND LEAD TO LOSSES.
During fiscal 2004 and each of the previous two fiscal years, we have derived
more than 90% of our revenues from four programs-two U.S. government programs
and two foreign government programs. Due to the lengthy sales cycles, we believe
that these programs, with perhaps the addition of one or two other foreign
programs, will be the basis for a substantial majority of our revenues in the
near-term. The loss of or reductions in purchases by any one customer due to
program cutbacks, competition, or other reasons would materially reduce our
revenue base. Our U.S. government subcontract expires on May 25, 2005. There is
no assurance that a follow-on contract will be issued by the U.S. government
upon expiration of the current contract. Annual or quarterly losses would occur
if there are material reductions, gaps or delays in card orders from our largest
U.S. or foreign government programs or if such programs were to be reduced in
scope, delayed, canceled, or not extended and not replaced by other card orders
or other sources of income.

        WE HAVE INCURRED NET LOSSES DURING THE PAST FIVE QUARTERS AND MAY NOT BE
ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN
PROFITABILITY. As of March 31, 2004, we had an accumulated deficit of
$18,244,000. Although we operated profitably for the previous five years (fiscal
1999 through fiscal 2003), we have incurred significant losses in the past,
including in fiscal 1997 and 1998, and we incurred losses in fiscal 2004 due
primarily to delays in orders for our cards, and in the third fiscal quarter of
2004, by the increase in the valuation allowance we recorded against our
deferred tax assets. There can be no assurance that we will generate enough card
revenues in the near term or ever to become profitable. We are relying upon our
optical memory card technology to generate future product revenues, earnings,
and cash flows. If alternative technologies emerge or if we are otherwise unable
to compete, we may not be able to achieve or sustain profitability on a
quarterly or annual basis. Annual or quarterly losses would also occur if
increases in product revenues or license revenues do not keep pace with
increased marketing, research and engineering expenses and the depreciation and
amortization associated with capital expenditures.

        OUR PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE
U.S. AND ABROAD. Revenues during fiscal 2003 included sales of approximately
$21.5 million of U.S. government Green Cards and Laser Visa BCCs. Fiscal 2004
revenues included sales of approximately $5 million of cards for these
government programs, with annual sales in the near-term after fiscal 2005
expected to approximate the card personalization rate of the U.S. government,
which currently is approximately $9 million of cards per year ($6.6 million for
Green Cards and $2.4 million for Laser Visa BCCs). During fiscal 2005, we expect
our revenue from these programs to be less as we anticipate that the U.S.
government will draw down its excess inventory; and, as a worst case, we could
have almost no revenue if the inventory levels are drawn down substantially.
These revenue levels are less than the approximately $13 million level of
revenues we had previously expected to receive from these programs on an annual
basis. We believe that in order for our overall card revenues during fiscal 2005
to return to their fiscal 2003 levels, we will need significant additional
orders from new and other existing programs to supplement the revenue, currently
expected to be less than $6 million, from the U.S. Green Cards and Laser Visa
BCCs. Optical memory card digital governance programs that are emerging programs
or prospective applications in various countries include identification cards
for Italy and Saudi Arabia; motor vehicle registration cards in India; and
several new U.S. government ID card programs due to the increasing need for
enhanced U.S. border security. In the United States, the US-VISIT program, the
TWIC (Transportation Worker Identification Credential) program, and the proposed
Registered Flier program are possible market opportunities for secure
identification using optical memory cards. However, there is no assurance that
our products will be selected for any of these programs. In particular, we are
uncertain whether we will be chosen as a US-VISIT subcontractor directly or
through a VAR teaming partner with Accenture, which was announced as the prime
contractor for the full implementation of this program on June 1, 2004. Since
governmental card programs typically rely on government policy-making, which in
turn is subject to technical requirements, budget approvals, and political
considerations, there is no assurance that the US-VISIT program will be
implemented as expected or that it will include optical cards in its solution.

        From Italy, we received orders in July 2003, December 2003, and May 2004
valued at $2.4 million, $3.8 million, and $3.3 million, respectively, for Phase
2 of the Italian CIE card program and we anticipate receiving orders during


                                       20
<PAGE>

FY 2005 for one of Italy's new programs, the Permesso di Soggiorno Elettronico
(PSE) card. There is no assurance that the foregoing government programs will be
continued or implemented as anticipated or that the U.S. government will select
our cards for its new homeland security programs.

        ONE VALUE ADDED RESELLER IS THE CONTRACTOR FOR OUR U.S. AND CANADIAN
GOVERNMENT CUSTOMERS AND ANOTHER VAR PURCHASES CARDS FROM US FOR THE ITALIAN
NATIONAL ID CARD PROGRAM. HAVING TO REPLACE EITHER OF THESE VARS COULD INTERRUPT
OUR U.S., CANADIAN, OR ITALIAN GOVERNMENT BUSINESS. AND, IF OUR VARS LOSE THEIR
GOVERNMENT BUSINESS, OUR REVENUES WOULD LIKEWISE DECLINE MATERIALLY. The largest
purchaser of LaserCard products is Anteon International Corporation, one of our
value-added resellers (VARs). Anteon is the government contractor for LaserCard
product sales to the U.S. Department of Homeland Security, U.S. Department of
State, U.S. Department of Defense, and the government of Canada. Under
government contracts with Anteon, the DHS purchases U.S. Green Cards and DOS
Laser Visa BCCs; the DOD purchases Automated Manifest System cards; and the
Canadian government purchases Permanent Resident Cards. Encompassing all of
these programs, our product sales to Anteon represented 72% of total revenues
for fiscal 2004 ended March 31, 2004; 94% of total revenues for fiscal 2003
ended March 31, 2003; and 81% of total revenues for fiscal 2002 ended March 31,
2002. However, since the ultimate customers are national governments, we are not
dependent upon any one specific contractor for continued revenues from these
programs. Although not anticipated, if Anteon were to discontinue its
participation as contractor, other qualified contractors could be utilized by
those governments for purchasing our products, although the process of doing so
could cause program delays. Concerning Italy, during fiscal 2004, 22% of the
Company's revenues were derived from sales of cards and read/write drives for
the government of Italy for its CIE card program. Card orders under this program
are channeled to the Company through a value-added reseller, Laser Memory Card
SRL, of Rome, Italy. According to Italian government sources, the distribution
of this new national ID card has started in a number of the 56 Italian
communities scheduled to be activated under the program during 2004. The
government's publicly stated plan is to issue up to two million CIE cards this
year. However, if this program were to be discontinued or interrupted by the
Italian government, the Company would lose one of its significant sources of
optical memory card revenues.

        ONE OF OUR LARGER ULTIMATE CUSTOMERS, THE U.S. GOVERNMENT, HAS THE RIGHT
TO DELAY ITS ORDERS OR COULD CHANGE ITS TECHNOLOGY DECISIONS, WHICH WOULD RESULT
IN ORDER DELAYS OR LOSSES. Under U.S. government procurement regulations, the
government reserves certain rights, such as the right to withhold releases, to
reduce the quantities released, extend delivery dates, reduce the rate at which
cards are issued, and cancel all or part of its unfulfilled purchase orders. Our
U.S. government card deliveries depend upon the issuance of corresponding order
releases by the government to its prime contractor and, in turn, to us, and we
believe that these orders will continue in accordance with our government
subcontract. Losses would occur if either of our largest U.S. government
programs were to be delayed, canceled, or not extended and not be replaced by
other card orders or other sources of income, or if the government were to
change its technology decisions, or if increases in product revenues or licenses
do not keep pace with increased marketing, research and engineering, and
depreciation on capital equipment. For example, the latest order of cards under
our U.S. government subcontract, $2.6 million worth of optical memory cards for
the newly enhanced Green Cards, called for deliveries from December 2003 through
May 2004. As a result, we experienced a gap in production of several months,
which significantly affected operating results for fiscal 2004. The delay in the
U.S. government's order was the result of waiting for a change to the design of
the DHS artwork that is included on the cards as a result of the formation of
the Department of Homeland Security, and was exacerbated by its desire to reduce
its inventory levels. Any future excess inventory held by the U.S. government
for example due to delayed funding or a slower than anticipated program rollout,
or any future changes to the design of the cards may result in future gaps in
orders or production which may negatively impact our operating results.

        U.S. government subcontract release orders for DHS Green Cards and DOS
Laser Visa BCCs represented approximately 44% of the Company's revenue for
fiscal 2004; 82% of revenues for fiscal year 2003; and 75% of revenues for
fiscal 2002 The percentage declined during the first nine months of fiscal 2004
as U.S. government orders decreased more than we had anticipated, due to delays
in the government approving artwork reflecting the advent of the Department of
Homeland Security, and the U.S. governments' desire to reduce inventory levels,
while at the same time orders of cards from foreign governments increased as
planned over prior years' levels. The U.S. government's agreement with our VAR
expires on May 25, 2005. There can be no assurance that the U.S. government


                                       21
<PAGE>

will enter into a new contract with our VAR or renew its current contract to
purchase our cards, in which case one of our major sources of revenues would be
eliminated.

        There is no assurance of continuing read/write drive orders from the
U.S. government. The recent order of 1,000 drive units for use by the U.S.
government with our Biometric Verification System application software may not
result in similar orders in the future. The system performance, including
biometric verification speed, accuracy, and card reading performance may not
meet government objectives for further system expansion. There is no assurance
that the government will have budgeted sufficient funds to expand the system to
its full potential or that the Company will be successful in winning any new
U.S. government procurements for similar systems or application software.

        SINCE THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LONG AND
UNPREDICTABLE, WE HAVE DIFFICULTY PREDICTING FUTURE REVENUE GROWTH. Initial
product sales to VARs for their use or use by their ultimate customers are
generally in small quantities, for evaluation purposes and trial programs.
Obtaining substantial, follow-on orders from these customers usually involves a
lengthy sales cycle, requiring marketing and technical time and expense with no
guarantee that substantial orders will result. This long sales cycle results in
uncertainties in predicting operating results, particularly on a quarterly
basis. In addition, since our major marketing programs involve the U.S.
government and various foreign governments and quasi-governmental organizations,
additional uncertainties and extended sales cycles can result. Factors which
increase the length of the sales cycle include government regulations, bidding
procedures, budget cycles, and other government procurement procedures, as well
as changes in governmental policy-making.

        THE TIMING OF OUR U.S. GOVERNMENT REVENUES IS NOT UNDER OUR CONTROL AND
CANNOT BE PREDICTED BECAUSE WE DO NOT RECOGNIZE REVENUE UNTIL CARDS ARE SHIPPED
OUT OF A VAULT OR WE RECEIVE A FIXED SHIPMENT SCHEDULE FROM THE GOVERNMENT. We
recognize revenue from product sales when the following criteria are met: (a)
persuasive evidence of an arrangement exists; (b) delivery has occurred; (c) the
fee is fixed or determinable; and (d) collectibility is reasonably assured.

        Our U.S. government subcontract requires delivery of cards to a secure,
government-funded vault built on our premises. Deliveries are made into the
vault on a fixed schedule specified by the government or one of its specified
agents. When the cards are delivered to the vault, all title and risks of
ownership are transferred to the government. At the time of delivery, the prime
contractor is invoiced, with payment due within thirty days. The contract does
not provide for any return provisions other than for warranty. We recognize
revenue when the cards are delivered into the vault because we have fulfilled
our contractual obligations and the earnings process is complete. However, if we
do not receive such a shipment schedule, revenue is not recognized until the
cards are shipped from the vault. In addition, revenue recognition for future
deliveries into the vault would be affected if the U.S. government cancels the
shipment schedule. As a result, our revenues may fluctuate from period to period
if we do not continue to obtain shipment schedules under this subcontract or if
the shipment schedules are cancelled. We would no longer recognize revenue when
cards are delivered to the vault, but instead such revenue recognition would be
delayed until the cards are shipped from the vault to the U.S. government.

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


                                       22
<PAGE>

        IF WE ARE UNABLE TO BUY RAW MATERIALS IN SUFFICIENT QUANTITIES AND ON A
TIMELY BASIS, WE WILL NOT BE ABLE TO DELIVER PRODUCTS TO CUSTOMERS ON TIME. AS A
RESULT, WE COULD LOSE CUSTOMERS, AND REVENUES COULD DECLINE. We depend on sole
source and limited source suppliers for optical card raw materials. Such
materials include plastic films used in optical memory card production, which
are available from one supplier in the U.S. and from multiple foreign suppliers.
Processing chemicals, inks, and bonding adhesives are obtained from various U.S.
and foreign suppliers. Certain photographic films are commercially available
solely from Eastman Kodak Company, of the United States. No assurance can be
given that Kodak will continue to supply such photographic films on a
satisfactory basis and in sufficient quantities, especially in light of its
announcement that it is reducing its emphasis on emulsion-based films. If Kodak
were to discontinue manufacturing the film from which the Drexon optical stripe
is made, we would endeavor to establish an alternate supplier for such film,
although the purchase price could increase and reliability and quality could
decrease from a new supplier. Considering that the U.S. government is a major
end-user of our optical memory cards, we anticipate that an alternate supplier
of these films could be established and qualified; however, no assurance can be
given that there will be adequate demand to attract a second source. In
addition, an alternate supplier could encounter technical issues in producing
the film as there may be know-how and manufacturing expertise which Kodak has
developed over the years which an alternate supplier may have difficulty to
replicate. We have pre-purchased a long-term supply of the film used to produce
mastering loops for prerecording cards. With regard to the film from which the
Drexon optical stripe is made, we currently have an order which Kodak has
accepted with deliveries scheduled through September, 2004. If Kodak announced
that it was no longer going to sell film, we would request that Kodak provide us
with a last-buy opportunity which we would plan to take maximum advantage of,
although no assurance can be given that Kodak would provide us with such an
opportunity. We have film on hand plus on order that we believe would provide us
with an adequate supply to meet anticipated demand until we could locate and
begin volume purchases from a second source.

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

        IF WE ARE UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO
MANUFACTURE AND ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS.
Prior to fiscal 2002, we had been selling read/write drives for less than three
thousand dollars per unit in quantities of six or more, and these units
generally include our interface software/device drivers. In fiscal 2002, we
reduced the selling price by 20% for these read/write drives for typical
purchase quantities in an effort to develop a broader market and customer base
for LaserCard optical memory cards. Since fiscal 2002, there has not been a
further reduced selling price for these read/write drives. However, in fiscal
2004, we introduced a new drive with a 25% reduction in price for typical
quantities as compared with the previous model. We believe the price of our
drives is competitive in applications requiring a large number of cards per each
drive, because the relatively low cost for our cards offsets the high cost per
drive when compared with our major competition, IC card systems. In addition, we
have undertaken a product development program for a hand-held read-only drive,
which we believe would increase our prospects for winning future business.
However, there can be no assurance that our development program will be
successful, that production of any new design will occur in the near term, or
that significantly lower manufacturing costs or increased sales will result.

        IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE DATA CARD
INDUSTRY AND IN THE INFORMATION TECHNOLOGY INDUSTRY GENERALLY, WE MAY NOT BE
ABLE TO EFFECTIVELY COMPETE FOR FUTURE BUSINESS. The information technology
industry is characterized by rapidly changing technology and continuing product
evolution. The future success and growth of our business will


                                       23
<PAGE>

require the ability to maintain and enhance the technological capabilities of
the LaserCard product line. There can be no assurance that the Company's
products currently sold or under development will remain competitive or provide
sustained revenue growth.

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

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

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


                                       24
<PAGE>

        WE ARE SUBJECT TO RISKS ASSOCIATED WITH CHANGES IN FOREIGN CURRENCY
EXCHANGE RATES. Most of the manufacturing process of the LaserCard products that
we sell in Italy takes place in Europe. The prices charged to us by the European
manufacturer for products are denominated in euros, the currency used in much of
Europe. However, when we sell our finished products to the Italian government,
the prices that we charge are denominated in United States dollars. Also, as of
March 31, 2004, the Company had debt relating to the acquisition of Challenge
Card Design Plastikkarten GmbH and cards & more GmbH, of Germany, in the amount
of 2.9 million euros. Accordingly, we are subject to exposure if the exchange
rate for euros increases in relation to the United States dollar. As of March
31, 2004, we had not entered into a forward exchange contract to hedge against
or potentially minimize the foreign currency exchange risk.

        WE HAVE RECENTLY ACQUIRED TWO CARD COMPANIES LOCATED IN GERMANY AND MAY
ENCOUNTER DIFFICULTIES IN INTEGRATING THEM INTO OUR BUSINESS. We may encounter
unforeseen difficulties in managing Challenge Card Design GmbH and cards & more
GmbH, in which case we may not obtain some of the hoped-for benefits of these
acquisitions, such as expanded manufacturing capacity and establishment of a
significant European presence. Integration of these acquired companies may
result in problems related to integration of technology, management, personnel,
or products. If we fail to successfully integrate these acquisitions or if they
fail to perform as we anticipated, our operations and business could be harmed.
Likewise, if the due diligence and audit of these operations performed by third
parties on our behalf was inadequate or flawed, we could later discover
unforeseen financial or business liabilities. Additionally, in the future we may
evaluate other acquisition opportunities that could provide additional product
or services offerings or technologies. Any recent or future acquisition could
result in difficulties assimilating acquired operations and products, diversion
of capital and management's attention away from other business issues and
opportunities and may result in an expense if goodwill is impaired or other
intangible assets acquired are subsequently determined to be impaired.

      WE RECENTLY SOLD A SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL
INVESTMENTS GROUP (GLOBAL), UNDER WHICH WE WILL PROVIDE CERTAIN FACTORY SET-UP
AND TRAINING SERVICES. IF WE ARE NOT SUCCESSFUL OR IF GLOBAL IS UNABLE TO
FINANCE THIS OPERATION, THE SECOND-SOURCE SUPPLY OF OPTICAL CARDS WILL NOT
MATERIALIZE. IF WE AND GLOBAL ARE SUCCESSFUL, THE SECOND-SOURCE WILL COMPETE
WITH US FOR BUSINESS. If Global is not successful, but current and potential
customers require a second source of optical memory cards ( which is a common
business practice) they could decide to use alternate technology cards, such as
chip cards, that have multiple-source suppliers. We are planning to sell to
Global approximately $12 million worth of the required manufacturing equipment
and installation support for its new card manufacturing facility in Slovenia, to
provide a targeted initial manufacturing capacity of 10 million optical cards
annually. If successful, this will supply a second source for optical memory
cards. We will also be assigning personnel to be on site during the license term
to assist with quality, security, and operational procedures, with a mutual goal
that the facility and the cards made in Slovenia conform to our standards. If
cards are not produced in conformance with our quality standards, the reputation
and marketability of optical memory card technology could be damaged. If the
factory does not become operational and produce quality cards in high volume, or
if Global Investments Group is unable to raise sufficient capital to equip and
operate this facility, we would not obtain the hoped-for benefits--including
ongoing royalties, sales of raw materials to Global, expansion of the European
market, and a bona fide second source for optical memory cards. On the other
hand, if and when the factory is successfully manufacturing the cards in high
volume, it will compete against us for business in certain territories, which
could reduce our potential card revenues if the market does not expand.

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

        OUR CALIFORNIA FACILITIES ARE LOCATED IN AN EARTHQUAKE ZONE AND THESE
OPERATIONS COULD BE INTERRUPTED IN THE EVENT OF AN EARTHQUAKE, FIRE, OR OTHER
DISASTER. Our card manufacturing, corporate headquarters, and drive assembly
operations, administrative, and


                                       25
<PAGE>

product development activities are located near major earthquake fault lines. In
the event of a major earthquake, we could experience business interruptions,
destruction of facilities and/or loss of life, all of which could materially
adversely affect us. Likewise, fires, floods, or other events could similarly
disrupt our operations and interrupt our business.

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

ITEM 2.    PROPERTIES

        As of March 31, 2004, approximately 75,000 square feet of floor space
are leased by the Company for card manufacturing, read/write drive production,
administration, sales, and research and engineering, in three buildings located
in Mountain View, California. These facilities have a current total annualized
rental of approximately $960,000 on leases that expire on various dates from
July 2005 to May 2014. One 27,000-square foot building is used for optical
memory card production; one 43,000 square-foot building is used for optical card
production, read/write drive production, administration, sales, and research and
engineering; and one 5,000 square-foot building is used for administration. By
mutual agreement with the lessor, on November 1, 2003, the lease on the
27,000-square-foot building was modified and extended through October 2013. The
original lease had a remaining term through May 2006 with lease payments
totaling $2,083,000. The modified lease calls for payments totaling $1,293,000
over the same period. The Company also leases a small marketing office in New
York. In Europe, the Company leases a portion of a building in Ratingen,
Germany, and a building in Rastede, Germany totaling approximately 15,000 square
feet, for card manufacturing, administration, sales, and research and
engineering, for a total annualized rental of 239,000 euros on leases that
expire on dates from February 2009 to August 2009. Also, the Company owns land
and a building in Rastede, Germany, valued at approximately 660,000 euros, that
is used in non-optical card production. Management believes these leased and
owned facilities to be satisfactory for its present operations. Upon expiration
of the leases, management believes that these or other suitable buildings will
be able to be leased on a reasonable basis.

ITEM 3.    LEGAL PROCEEDINGS

        There are no material pending legal proceedings to which the Company is
a party or of which its property is a subject. In the Rawe litigation previously
described in prior filings, it was determined that the Company's products were
not included in the laser system which allegedly harmed Mr. Rawe, and Mr. Rawe's
counsel has notified counsel for the Company's insurance company that Mr. Rawe
has agreed to dismiss with prejudice his claim against the Company's subsidiary,
LaserCard Systems Corporation.

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

        There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 2004.


                                       26
<PAGE>

                                     PART II

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

        The Company's only class of common stock, $.01 par value, is traded on
The Nasdaq Stock Market(R) under the symbol DRXR and is quoted in THE WALL
STREET JOURNAL and other newspapers. The table below sets forth the high and low
trade prices for the Company's common stock (rounded to two decimal points) as
reported by Nasdaq during the fiscal periods indicated.


                       QUARTERLY STOCK PRICES (UNAUDITED)

                                  Fiscal 2003                  Fiscal 2004

                            High Trade   Low Trade       High Trade   Low Trade
                            ----------   ---------       ----------   ---------

          First Quarter      $  30.30     $ 16.61         $  22.25     $ 13.03
          Second Quarter        22.00       12.03            20.84       14.00
          Third Quarter         21.50       12.01            17.14       13.00
          Fourth Quarter        15.95       11.61            16.95       12.46


        As of March 31, 2004, there were approximately 912 holders of record of
the Company's common stock. The total number of stockholders is believed by the
Company to be several thousand higher since many holders' shares are listed
under their brokerage firms' names.

        The Company has never paid cash dividends on its common stock. The
Company anticipates that for the foreseeable future, it will retain any earnings
for use and reinvestment in its business.

        The Company did not repurchase any of its outstanding shares or other
securities during its fiscal quarter ended March 31, 2004.


                                       27
<PAGE>

ITEM 6.    SELECTED FINANCIAL DATA

        The following selected consolidated financial information as of and for
each of the five years in the period ended March 31 is derived from the
consolidated financial statements of the Company. This financial data should be
read in conjunction with the consolidated financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing in Item 7 of this report.

<TABLE>
<CAPTION>
                                            DREXLER TECHNOLOGY CORPORATION

                               FIVE-YEAR SUMMARY OF CONSOLIDATED FINANCIAL INFORMATION
                                       Fiscal Years Ended March 31, 2000 - 2004
                                       (In thousands, except per share amounts)


OPERATIONS DATA                                      2000(1)       2001(1)         2002          2003         2004
                                                     ----          ----            ----          ----         ----
<S>                                                  <C>           <C>           <C>           <C>          <C>
   Revenues                                          $ 15,443      $ 24,906      $ 20,889      $ 26,331     $ 16,963
   Cost of product sales                                8,668        12,199        10,652        13,906       13,157
   Selling, general, and administrative expenses        3,996         4,134         5,165         6,202        6,700
   Research and engineering expenses                    1,299         2,370         3,045         2,818        2,620
   Interest and other income, net                         388           612           386           397          176
                                                     --------      --------      --------      --------     --------
   Income (loss) before income taxes                    1,868         6,815         2,413         3,802       (5,338)
   Income tax (benefit) provision                      (2,919)       (1,097)       (2,786)        1,520        7,089
                                                     --------      --------      --------      --------     --------
   Net income (loss)                                 $  4,787      $  7,912      $  5,199      $  2,282     $(12,427)
                                                     ========      ========      ========      ========     ========

   Net income (loss) per share:
       Basic                                         $    .49      $    .80      $    .52      $    .22     $  (1.15)
                                                     ========      ========      ========      ========     ========
       Diluted                                       $    .48      $    .76      $    .50      $    .21     $  (1.15)
                                                     ========      ========      ========      ========     ========

   Weighted average number of common
         and common equivalent shares:
       Basic                                            9,812         9,897         9,961        10,356       10,761
       Diluted                                          9,935        10,446        10,468        10,842       10,761

BALANCE SHEET DATA
   Current assets                                    $ 14,489      $ 18,333      $ 28,118      $ 21,192     $ 23,294
   Current liabilities                                  8,305         7,324         7,501         3,620       11,271
   Total assets                                        24,362        30,137        40,713        40,463       49,835
   Long-term liabilities                                   --            --            --            --        2,878
   Stockholders' equity                                16,057        22,813        32,337        36,843       35,686
</TABLE>

(1)     As more fully described in the Company's Report on Form 8-K dated May
        15, 2002, the financial statements for fiscal 2000 and 2001 were
        restated due to changes in the timing of revenue recognition of
        LaserCard optical memory cards that have been delivered into a secure,
        government-funded vault built for the government on Company premises to
        comply with security regulations under the subcontract.


                                       28
<PAGE>

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
           FINANCIAL CONDITION

        The following discussion and analysis of the Company's financial
condition and results of operations should be read in conjunction with the
condensed consolidated financial statements and related notes included elsewhere
in this Form 10-K Report for the year ended March 31, 2004.

        FORWARD-LOOKING STATEMENTS. Please refer to the "Forward-Looking
Statements" section starting at page 3 of this report and the section entitled
"Factors that May Affect Future Operating Results" starting at page 20 of this
report.

CRITICAL ACCOUNTING POLICIES

        REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement, and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns. To date, actual warranty costs and returns activity have not
been material.

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

        License revenue, which may consist of up-front license fees and
long-term royalty payments, is recognized as revenue when earned. The
second-source card manufacturing license sold in April 2004 to Global
Investments Group provides for royalty payments to the Company for each card
produced during the 20-year term of the license agreement. This is a
multi-element arrangement as described in Emerging Issues Task Force (EITF)
Issue No. 00-21; revenue derived from the up-front payments will be recognized
from time to time over the term of the license. The cost of license revenue is
not material and is included in selling, general, and administrative expenses.

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

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


                                       29
<PAGE>

        Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. During fiscal 2002, the Company recorded a
tax benefit of $2,786,000, which included a $2,999,000 reduction to the
valuation allowance on its deferred tax assets, net of federal alternative
minimum taxes, based on management's assessment that such portion of its
deferred tax assets would more likely than not be realized. Due to the Company's
recent cumulative tax loss history for the three-year period ending March 31,
2004, income statement loss history over the past five quarters, and the
difficulty in forecasting the timing of future revenue as evidenced by the
deviations in achieved revenues from expected revenues during the past few
quarters and taking into account the newness of certain customer relationships,
the Company determined it was necessary to increase the valuation allowance
under SFAS No. 109 to the full amount of the deferred tax asset. As a result,
the Company has recorded a valuation allowance of $14.8 million as of March 31,
2004, which includes a charge to increase the valuation allowance against the
beginning of the year net deferred tax asset balance of $7,086,000 for the year
ended March 31, 2004, due to uncertainties related to the Company's ability to
utilize its deferred tax assets. In addition the Company recorded a valuation
allowance against its net deferred tax asset generated during fiscal 2004 in the
amount of $2,411,000.

        The Company's methodology for determining the realizability of its
deferred tax assets involves estimates of future taxable income; the estimated
impact of future stock option deductions; and the expiration dates and amounts
of net operating loss carryforwards. These estimates are based on near-term
projections and assumptions which management believes to be reasonable. For
recent prior periods, the Company had been estimating future taxable income from
its core business, which assumed on-going business under the U.S. government
subcontract for Permanent Resident Cards and Laser Visa Border Crossing Cards
and the Canadian government's Permanent Resident Card program, as well as
estimated operating expenses to support that level of business, as offset by the
estimated impact of future stock option deductions. The Company went back to
estimating future taxable income based upon its expectations for the current and
next three years because this past core business has not proven to be as stable
as the Company had believed it to be and because this past core business is
expected to represent an increasingly smaller part of the business. This is
because the Company expects revenues from these U.S. programs to stabilize at
revenue levels lower than had been expected in the past and because the Company
expects new foreign business, which has fluctuated considerably quarter to
quarter, to comprise a larger portion of the core business. The Company has had
difficulty in the past, and expects to have continued difficulty in the future,
in reliably forecasting its foreign business and the revenue to be received from
it. This, in combination with the anticipated three-year cumulative tax loss for
the period ended March 31, 2004, has resulted in the Company basing its
estimates of future income for these purposes to booked orders only. As
circumstances change, the Company may in the future be able to revert back to
estimating future revenue based upon its forecast revenues rather than only
using booked orders, although the Company cannot say when this will occur.

        In concluding that a valuation allowance was required, the Company
considered both the positive and negative evidence regarding its ability to
generate sufficient future taxable income to realize its deferred tax assets.
Positive evidence included having achieved profitability for financial reporting
purposes from fiscal 1999 through fiscal year 2003. Other positive evidence
included (1) the level of sales and business experienced under the contract with
the Canadian government's Permanent Resident Card program; (2) prospects in
Italy and Saudi Arabia for national identification card programs; (3) the
heightened interest in border security initiatives following the events of
September 11, 2001; and (4) expected future orders. Negative evidence included
(1) the Company's reliance on a limited number of customers for a substantial
portion of its business; (2) the uncertainty in timing of anticipated orders
from customers; (3) the impact of future stock option deductions on taxable
income; and (4) recent experience of net operating loss carryforwards expiring
unused; (5) the loss for the fourth quarter of fiscal 2003 and the losses in
fiscal 2004; and (6) the prospect of three years' cumulative tax net operating
losses. In weighing the positive and negative evidence above, the Company
considered the "more likely than not" criteria pursuant to SFAS No. 109 as well
as the risk factors related to its future business described under the
subheadings: "Dependence on VARs and on a Limited Number of Customers," "Lengthy
Sales Cycles," "Technological Change," and "Competition" as noted in the section
entitled "Factors That May Affect Future Operating Results." As described above,
the Company concluded that the negative evidence outweighed the positive
evidence and as a result increased the valuation allowance to be equal to the
full amount of the deferred tax asset as of March 31, 2004.

        In the event that actual results differ from these estimates or that
these estimates are adjusted in future periods, the


                                       30
<PAGE>

Company may need to adjust the amount of the valuation allowance based on future
determinations of whether it is more likely than not that some or all of its
deferred tax assets will be realized. A decrease in the valuation allowance
would be recorded as an income tax benefit or a reduction of income tax expense
or a credit to stockholders' equity. The Company's net operating losses
available to reduce future taxable income expire on various dates from fiscal
2005 through fiscal 2024. To the extent that the Company generates taxable
income in jurisdictions where the deferred tax asset relates to net operating
losses that have been offset by a full valuation allowance, the utilization of
these net operating losses would result in the reversal of the related valuation
allowance in the Company's results of operations. The Company would need
$8,226,000 of income on its federal income tax return to avoid the expiration of
$2,797,000 of the deferred tax asset now set to expire in fiscal 2005.

        INVENTORIES. The Company values its inventory at the lower of the actual
cost to purchase and/or manufacture the inventory or the current estimated
market value of the inventory. Management regularly reviews inventory quantities
on hand and records a provision for excess and obsolete inventory based
primarily on forecasts of product demand. Demand for read/write drives can
fluctuate significantly. In order to obtain favorable pricing, purchases of
certain read/write drive parts are made in quantities that exceed the historical
annual sales rate of drives. The Company purchases read/write drive parts for
its anticipated read/write drive demand and takes into consideration the
order-to-delivery lead times of vendors and the economic purchase order quantity
for such parts.

        Management's analysis of the carrying value of card and read/write drive
inventory is performed on a quarterly basis. With respect to inventory carrying
values, the Company follows the principles articulated in Accounting Research
Bulletin 43, Chapter 4, "Inventory Pricing," paragraphs 5 through 7 and 10 and
other authoritative guidance (SAB 100) as it relates to determining the
appropriate cost basis of inventory and determining whether firm, noncancelable
purchase commitments should be accrued as a loss if forecasted demand is not
sufficient to utilize all such committed inventory purchases. As part of the
Company's quarterly excess/obsolete analysis, management also determines whether
lower of cost or market adjustments (i.e., where selling prices less certain
costs are not sufficient to recover inventory carrying values) are warranted;
during fiscal 2004, the Company has not recorded any significant lower of cost
or market adjustments. In those instances where the Company has recorded charges
for excess and obsolete inventory, management ensures that such new cost basis
is reflected in the statement of operations if that inventory is subsequently
sold. The Company's inventory reserves are based upon the lower of cost or
market for slow moving or obsolete items. As a result, the Company believes a
10% increase or decrease of sales would not have a material impact on such
reserves.

RESULTS OF OPERATIONS--FISCAL 2004 COMPARED WITH FISCAL 2003 AND FISCAL 2002

Overview

        Drexler Technology Corporation is headquartered in Mountain View,
California. The Company makes and markets high-security, durable plastic,
LaserCard optical memory cards and associated computerized read/write drives
primarily for use in digital governance programs by the US and foreign
governments. The counterfeit- and tamper-resistant cards are consumable products
because they typically are replaced when the cards expire. The largest purchaser
of LaserCard products is Anteon International Corporation, a value-added
reseller (VAR) of the Company. Anteon is the government contractor for LaserCard
product sales to the U.S. Department of Homeland Security (DHS), U.S. Department
of State (DOS), U.S. Department of Defense (DOD), and the government of Canada.
Under government contracts with Anteon, the DHS purchases U.S. Permanent
Resident Cards (Green Cards) and DOS "Laser Visa" Border Crossing Cards (BCCs);
the DOD purchases Automated Manifest System cards; and the Canadian government
purchases Permanent Resident Cards. Encompassing all of these programs, the
Company's product sales to Anteon represented 72% of total revenues for fiscal
2004 ended March 31, 2004; 94% of total revenues for fiscal 2003 ended March 31,
2003; and 81% of total revenues for fiscal 2002 ended March 31, 2002.


                                       31
<PAGE>

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

                                                                 Fiscal Year
                                                             2002   2003   2004
                                                             ----   ----   ----

         United States Green Cards and Laser Visa BCCs        75%    82%    44%
         Canadian Permanent Resident Cards                     3%    10%    25%
         Italian Carta d'Identita Elettronica (CIE) Cards      4%    --     22%

        For the government of Italy, the Company has received orders for CIE
cards (Carta d'Identita Elettronica) and anticipates orders for a new program
for the PSE cards (Permesso di Soggiorno Elettronico). As of March 31, 2004, the
Company has a backlog in the amount of $2.8 million for CIE cards scheduled for
delivery through May 2004 for Phase 2 of this program. According to program
descriptions released by the Italian government, CIE card orders could
potentially reach 8 to 10 million cards per year if Phase 3 is fully
implemented.

        Production of U.S. Laser Visa Border Crossing Cards (BCCs) and U.S.
Permanent Resident Cards (Green Cards) for the U.S. Department of Homeland
Security (DHS) was delayed at the beginning of fiscal 2004 while new artwork for
the cards was being designed by DHS. The artwork change for Laser Visa BCCs was
completed in July 2003, and on July 14, 2003, the Company announced receipt of
an optical memory card order valued at approximately $2 million for Laser Visa
BCCs. The new order called for card production to start immediately and to be
completed within four months. The artwork change for Green Cards resulted in an
order announced by the Company on December 19, 2003, valued at approximately
$2.6 million, calling for deliveries through May 2004. The Company has not
received a follow-on order for either Laser Visa BCCs or Green Cards. As of
March 31, 2004, between its own on-site inventory and the inventory it owns and
maintains in their vault on Company premises, the U.S. government has
inventories of Laser Visa BCCs and Green Cards which would last approximately 20
and 12 months, respectively, at the U.S. government's current
card-personalization rates.

        Optical memory card revenues for fiscal 2004 included approximately $4.8
million in sales of U.S. Green Cards and Laser Visa BCCs. This is less than the
approximately $13 million level of revenues the Company had previously expected
to receive from these programs on an annual basis. Optical memory card revenues
for these two programs were approximately $21.2 million for fiscal 2003 and
$15.6 million for fiscal 2002. The Company anticipates that fiscal 2005 optical
memory card revenues for these two programs will not exceed $6 million. The U.S.
government is currently personalizing cards at an $9 million annualized run
rate. The value is based upon the Company's selling price of cards to Anteon.
The Company believes that annual revenues under these two programs will
approximate the U.S. government personalization rate over time, subject to
fluctuations in the level of inventory deemed appropriate by the U.S.
government.

        The Company has established sheet-lamination production facilities to
make Canadian Permanent Resident Cards, Italian National ID cards, and cards for
other potential programs. This process is currently more labor intensive than
its roll-lamination process but allows the use of high security offset printing
and other special features, resulting in a premium card. To date, gross margins
on the Canadian sheet-process cards have been less than 40%. The Company
believes that over time it will be able to improve margins on cards made by the
sheet-lamination process, through automation and yield improvements. In
addition, roll-lamination card gross margins have been hampered by low sales and
production volume.

        Potential applications for LaserCard optical memory card digital
governance programs include identification cards in several countries, motor
vehicle registration cards in India, and the expansion of current U.S.
government ID card programs due to the perceived increasing need for enhanced
U.S. border security. During the fiscal 2004 third quarter, the Company received
an order for and delivered 1,000 optical memory card read/write drives and
biometric verification system software for a Department of Homeland Security
program. These 1,000 drives and software systems are being deployed by the DHS
at U.S. borders, to enable the DHS to read the encoded data on more than 16
million Green Cards and Border Crossing Cards previously manufactured by the
Company and issued by the U.S. government since 1998. Potential U.S. government
ID programs include the U.S. Visitor and Immigration Status Indication
Technology (US-VISIT) program. The Company is uncertain whether it will be
chosen as a US-VISIT subcontractor directly or through a VAR teaming partner
with Accenture, which was


                                       32
<PAGE>

announced as the prime contractor for the full implementation of this program on
June 1, 2004. Since governmental card programs typically rely on government
policy-making, which in turn is subject to technical requirements, budget
approvals, and political considerations, there is no assurance that the US-VISIT
program will be implemented as expected or that it will include optical cards in
its solution.

        In addition to using its own marketing staff, the Company utilizes VAR
companies and card distribution licensees for the development of markets and
applications for LaserCard products. Product sales to VARs and licensees consist
primarily of the Company's optical memory cards and optical card read/write
drives. The Company also offers for sale, its customized software applications
and add-on peripherals made by other companies (such as equipment for adding a
digitized photo, fingerprint, hand template, or signature to the cards). The
VARs/licensees may add application software, personal computers, and other
peripherals, and then resell these products integrated into data systems. The
Company is continuing its efforts to recruit new VARs and eliminate
nonproductive VARs.

        The Company's current five-year U.S. government subcontract for Green
Cards and Laser Visa BCCs was announced in June 2000 and will expire on May 25,
2005. This subcontract was received by the Company through Anteon, a LaserCard
VAR that is a U.S. government prime contractor, under a competitively bid,
government procurement contract. There is no assurance that a follow-on contract
will be issued by the DHS upon expiration of the current contract, especially
given the advent of the US-VISIT program.

        In 2002, the Company was awarded a subcontract for production of
Canada's new Permanent Resident Cards. Shipments began in fiscal 2003 and have
totaled $6.7 million as of March 31, 2004. Including an order received in April
2004, the Company's backlog at that time of $2.4 million called for deliveries
through January 2005.

        In March 2004, the Company quoted on a tender issued by the Kingdom of
Saudi Arabia for three million cards and 220 read/write drives for a secure
personal identification card program. The products would be delivered over a
one-year period after contract issuance. The Company previously sold 120
read/write drives for this program, most of which were shipped in the fiscal
2004 second quarter, for installation of the infrastructure required for card
issuance, and also has shipped small quantities of optical memory cards for
testing and sample purposes. The first-phase contract allows for the procurement
of 300,000 cards, the balance of which may be purchased after testing is
complete. The second-phase contract is expected to be awarded to one of the
prime contractors in July 2004; however, there is no assurance that the contract
will be issued, that the Company would be the selected vendor, or that the
Company will receive additional orders for this program under any contract that
may ultimately be issued by the Saudi Arabian government.

        On March 31, 2004, the Company successfully concluded the acquisition of
two related German card companies, Challenge Card Design Plastikkarten GmbH of
Rastede, Germany, and cards & more GmbH of Ratingen, Germany, including their
sales operations in the United States and Korea. These acquisitions provide the
Company with a card manufacturing base to serve the European, Middle Eastern,
African, and Asian markets, supplementing the Company's newly expanded
manufacturing operations in California.

        Effective April 3, 2004, the Company sold a second-source
card-manufacturing license to the Global Investments Group, based in Auckland,
New Zealand, for card manufacturing in Slovenia. This agreement provides for
payments to the Company of $29 million for the license over the 20-year term of
the license (consisting of a five-year training support package, followed by an
ongoing support phase for an additional 15 years). Additionally, the Company is
to sell approximately $12 million worth of the required manufacturing equipment
and installation support for the new facility to provide a targeted initial
manufacturing capacity of 10 million optical cards annually. The Company has
received the initial $5 million of payments called for in the agreements,
consisting of a partial payment for the equipment of $500,000 as of March 31,
2004 and $4.5 million subsequent to March 31, 2004. Global Investments Group is
to pay the Company royalties for each card produced during the 20-year term of
the license agreement. Start up of the Global Investments Group facility is
planned for early 2005. Revenue will be allocated over the remaining term of the
agreement beginning when operation of the factory commences.

        As more fully described under "Liquidity and Capital Resources," in
December 2003, the Company raised approximately $9.4 million in an equity
private placement, net of expenses. The Company sold 791,172 shares of common
stock at $12.76, nine-month options to purchase 122,292 shares of common stock
at $16.51, and five-year warrants to purchase 174,057 shares of common stock at
$17.26.


                                       33
<PAGE>

        Kodak, the Company's sole-source supplier of raw material for its
optical memory card media, announced that it is reducing its emphasis on
emulsion based films. If Kodak were to discontinue manufacturing the raw
material from which the Company's optical memory card media is made, the Company
would order the maximum amount of final-run stock for use while endeavoring to
establish an alternate supplier for such raw material, although the purchase
price could increase from a new supplier. The Company has purchased a long-term
supply of the raw material to make mastering loops and believes it has on hand
an adequate supply of media raw material on hand and on order to meet
anticipated demand.

        The Company plans to invest approximately $11 million in additional
capital equipment and leasehold improvement expenditures in fiscal 2005, as more
fully discussed under "Liquidity and Capital Resources." In this regard, the
Company has entered into ten-year leases for two buildings in Mountain View,
California, totaling 69,000 square feet, with average annual lease payments
totaling $1.1 million combined. One lease is a renegotiation of the lease for an
existing leased building and the other lease, signed on January 29, 2004, is for
additional space. Rent expense is recorded at the average of the rent payments
over the term of the lease. When the lease payments increase over the lease
term, the result is recorded as an accrued liability (deferred rent). At the
time the renegotiated lease was signed, there was $139,000 of deferred rent
associated with the original lease. This amount is being amortized on a
straight-line basis over the ten-year term of the new lease. The Company
occupied the newly leased building in April 2004. The Company will move out of a
smaller building in mid-2004. This has resulted in the acceleration of certain
leasehold improvement amortization costs for the period from November 2003
through May 2004, and in the recognition of approximately $300,000 of additional
leasehold amortization expense through that period. Fiscal 2004 amortization
expense for leasehold improvements was $367,000.

Revenues

        For the 2004 fiscal year ended March 31, 2004 the Company's total
revenues were $16,963,000 compared with $26,331,000 for fiscal 2003 and
$20,889,000 for fiscal 2002.

        PRODUCT REVENUES. The Company's product revenues consist of sales of
optical memory cards, optical card read/write drives, drive accessories,
maintenance, peripherals, and other miscellaneous items to approximately 26
customers in four states and 16 foreign countries. Product revenues were
$16,963,000 for fiscal 2004; $25,221,000 for fiscal 2003; and $19,562,000 for
fiscal 2002. The changes in product revenues over these periods were due
primarily to the sale of optical memory cards for the U.S. government's Laser
Visa BCC and Green Card programs. Optical memory card revenues for these
programs were $4.8 million for fiscal 2004; $21.2 million for fiscal 2003; and
$15.6 million for fiscal 2002. The Company anticipates that fiscal 2005 revenues
will not exceed $6 million for these two programs. Therefore, additional orders
from new and existing programs are needed to increase revenues to pre-fiscal
2004 levels. Such programs could include those in India, Italy, Saudi Arabia,
Senegal, Costa Rica, and the United States.

        Revenue on optical memory cards totaled $13.4 million for fiscal 2004
compared with $24.2 million for fiscal 2003 and $18.2 million for fiscal 2002.
The decrease for fiscal 2004 mainly was due to lower unit volume of card sales.

        For fiscal 2004, revenue on read/write drives, drive service, and
related accessories totaled $3.4 million compared with $0.7 million for fiscal
2003 and $1.3 million for fiscal 2002. The increase for fiscal 2004 compared
with fiscal 2003 and fiscal 2002 was due to an increase in unit sales volume for
read/write drives and higher selling prices resulting from the inclusion of
biometric system software. The sales-volume increase for fiscal 2004 was
primarily the result of an order for and delivery of 1,000 optical memory card
read/write drives and biometric verification system software for a U.S.
Department of Homeland Security program. Read/write drives comprised 20% of
total revenues during fiscal 2004; 3% for fiscal 2003; and 6% for fiscal 2002.

        LICENSE FEES AND OTHER REVENUES. During fiscal 2002, the Company entered
into a read/write drive kits assembly license with a customer in Italy, which
generated license revenue of $119,000. The arrangement was structured whereby
the customer agreed to pay a contractually agreed upon fee in exchange for the
transfer of technical knowledge and know-how and training in the assembly of
read/write drives. The training period extended over 16


                                       34
<PAGE>

months, which is the period over which the Company recognized the fee as
revenue. Also in fiscal 2002, the Company recorded revenue of $1,206,000
realized on digital sound patent licenses sold to Sony Corporation and Dolby
Laboratories, Inc. The revenues were net of legal costs and third party
contingency (success) fees. There are no ongoing royalty payments. Fiscal 2003
license and other revenue included $875,000, representing the unamortized
portion of a $1,000,000 nonrefundable distribution license fee received in 2000
from a licensee in Asia that had committed to purchase a minimum number of
optical memory cards for a program in the licensee's country. The Company
recorded this fee as deferred revenue and has been amortizing it as revenue in
proportion to the actual card purchases by the licensee. During December 2002,
the Company determined that, due to the licensee's failure to meet the minimum
contractual purchase commitment, the licensee's distribution rights had become
unenforceable and that the licensee would no longer be acting as the sole card
supplier for that program. In addition, at that time the Company decided it
would no longer work with the licensee under the terms of the license agreement.
Since there were no further obligations, the Company recognized the remaining
$875,000 of revenue in the quarter ended December 31, 2002. Fiscal 2003 license
and other revenue also included $235,000 relating to a payment received in
January 2002 from a third party that was considering entering into a license
agreement with the Company; the Company originally recorded this payment as
deferred revenue. The third party had subsequently foregone its rights under
this agreement due to non-performance and, accordingly, the Company recognized
revenue on this arrangement in the fourth quarter of fiscal 2003.

        There were no license revenues for the 2004 fiscal year ended March 31,
2004. However, on April 16, 2004, the Company announced the sale of a
royalty-bearing, optical memory card manufacturing license to the Global
Investments Group, of New Zealand, for card manufacturing in Slovenia. The
license agreement provides for payments to the Company of $29 million for the
license (including a five-year training support package, followed by an ongoing
support phase for an additional 15 years). Additionally, the Company agreed to
sell approximately $12 million worth of the required manufacturing equipment and
installation support for the new facility to provide a targeted initial
manufacturing capacity of 10 million optical cards annually, with options to
increase capacity to 30 million cards per year. The Company to date has received
the initial $5 million of payments called for in the agreements, consisting of a
partial payment for the equipment of $500,000 as of March 31, 2004 and $4.5
million subsequent to March 31, 2004. These payments have been recorded in
deferred revenue and will be recognized as revenue over the term of the
arrangement beginning when operation of the factory commences.

Backlog

        As of March 31, 2004, the backlog for LaserCard optical memory cards
totaled $4.1 million, compared with a backlog of approximately $1.9 million for
fiscal 2003 and $16.4 million for fiscal 2002. Order backlog as of March 31,
2004 includes orders for the following programs: Green Cards for the U.S.
Department of Homeland Security, Italian government national ID cards (CIE
cards), and Canadian government Permanent Resident Cards. Backlog is subject to
fluctuation due to having few customers and the timing of orders. The Company
has no backlog for read/write drives.

        In addition, the backlog for Challenge Card Design Plastikkarten GmbH
and cards & more GmbH products and services totaled 2.1 million euros
(approximately $2.6 million) as of March 31, 2004.

Gross Margin

        Gross margin on product sales was 22% for fiscal 2004; 45% for fiscal
2003; and 46% for fiscal 2002. The overall gross profit declined $8,619,000, to
$3,806,000 for fiscal 2004 from $12,425,000 for fiscal 2003 and decreased
$6,431,000 from $10,237,000 for fiscal 2002. The decrease in gross margin on
product sales for fiscal 2004 compared with fiscal 2003 was due primarily to
lower volume of optical memory card sales. The decrease in gross margin on
product sales for fiscal 2003 compared with fiscal 2002 was due largely to (1)
the initial production of cards for the Canadian program under a new
manufacturing process initiated by the Company during fiscal 2003 and (2) the
larger negative gross margin on read/write drive sales, as discussed below.

        According to the license effective April 3, 2004 with Global Investments
Group, the Company will resell $12 million of card manufacturing equipment to
this licensee during fiscal 2005 and 2006. The Company expects to realize little
gross margin on this sale, which is largely a pass-through. The Company will
have little cost associated


                                       35
<PAGE>

with its Global Investments Group license revenue, therefore, its gross margin
will approximate its amortized revenue from the $29 million license fee. The $41
million in revenue and the associated costs will be amortized over the 20-year
term of the license.

        OPTICAL MEMORY CARDS. Prior to fiscal 2004, optical memory card gross
margins have approximated 50%. Optical memory card gross profit and margins can
vary significantly based on average selling price, sales and production volume,
mix of card types, production efficiency and yields, and changes in fixed costs.
The gross margin on optical memory cards declined to 26% for fiscal 2004
compared with 50% for fiscal 2003 and 52% for fiscal 2002. The declines for
fiscal 2004 were primarily due to low sales and production volume and the
corresponding underabsorption of fixed costs and the introduction of cards made
by a sheet-lamination process that currently have lower margins than cards made
by the roll-lamination process. The changes in gross profit for fiscal 2003 and
fiscal 2002 were mainly due to changes in sales volume.

        READ/WRITE DRIVES. In fiscal 2002, the Company reduced the selling price
for LaserCard read/write drives by 20% for typical purchase quantities in an
effort to develop a broader market and customer base for LaserCard optical
memory cards. Since fiscal 2002, there has not been a further reduced selling
price for these read/write drives. However, in fiscal 2004, the Company
introduced a new drive with a 25% reduction in price for typical quantities as
compared with the previous model. Current and target applications for the
Company's LaserCard typically require a small number of drives relative to the
number of cards purchased.

        For fiscal 2004, the Company had a gross profit on read/write drive
sales, including biometric system software, of approximately $410,000 and a
gross margin of 12% compared with a negative gross profit on read/write drive
sales of approximately $890,000 for fiscal 2003 and $640,000 for fiscal 2002.
Read/write drive gross profits increased by $525,000 in fiscal 2004 due to the
inclusion of biometric system software on a per-drive basis on the 1,000 drive
DHS purchase. During fiscal 2003, the Company wrote off read/write drive
inventory totaling approximately $300,000. Read/write drive gross profit and
margins can vary significantly based upon sales and production volume, changes
in fixed costs, and the inclusion of optional features and software licenses on
a per-drive basis. Prior to receipt of the comparatively large read/write drive
order from the U.S. government in the third quarter of fiscal 2004, read/write
drive gross profits had been negative, inclusive of fixed overhead costs, due to
low sales volume. The Company anticipates that quarterly negative gross profits
will recur in the future unless sales volume is sufficient to cover fixed costs.
Also, unless per drive system software licenses are included in future orders,
the Company believes that margins will be below 10% when sales volume is
sufficient to result in positive gross profit.

Income and Expenses

        SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). SG&A expenses were
$6,700,000 for fiscal 2004; $6,202,000 for fiscal 2003; and $5,165,000 for
fiscal 2002. The increase for fiscal 2004 compared with fiscal 2003 was
primarily due to a $231,000 increase in insurance premiums and an increase of
$360,000 in legal and accounting fees. The increase for fiscal 2003 compared
with fiscal 2002 included approximately $507,000 for increased marketing and
selling expenditures, an increase of $273,000 in general and administrative
expenditures, an increase of $177,000 for insurance expenditures, and an
increase of $132,000 for legal and accounting services. SG&A expenses for fiscal
2004 were higher than fiscal 2003 levels, mainly due to increases in accounting
and legal fees primarily related to due diligence for the acquisition of two
companies in Germany and increased costs of being a public company. The Company
believes that SG&A expenses for fiscal 2005 will be higher than fiscal 2004
levels, mainly due to integration of the acquired companies, increases in
marketing and selling expenses, and the cost of compliance with internal control
auditing mandated by Section 404 of the Sarbanes-Oxley Act.

        RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card features and structures, including
various sheet-lamination card structures, the insertion of contactless chips
with radio frequency (RF) capability, OptiChip(TM), OVD (optically variable
device) products, and associated media development; enhanced optical memory card
read/write drives and read-only drives (readers); and new software products in
an effort to provide new products that can stimulate optical memory card sales
growth. For example, the Company recently has developed a prototype of a
LaserCard handheld reader. The Company anticipates that these ongoing research
and engineering efforts will result in new or enhanced card capabilities,
production-model read-only drives, or drives with advanced security features and
lower manufacturing costs; however, there is no assurance that such product
development efforts will be successful. These features are important for the
Company's existing and


                                       36
<PAGE>

future optical memory card markets. Total R&E expenses were $2,620,000 for
fiscal 2004; $2,818,000 for fiscal 2003; and $3,045,000 for fiscal 2002. The
decrease in R&E spending for fiscal 2004 compared with fiscal 2003 is mainly due
to the completion of the design for a new read/write drive model and a $98,000
reduction related to the completion last year of the amortization of design
technology transfer costs. The $227,000 decrease for fiscal 2003 compared with
2002 is mainly due to a reduction in purchased services and prototype
expenditures. Increases in R&E expenses are anticipated for fiscal 2005 for
development of production-model read-only drives, optical memory card media
development, and other card and hardware related programs.

        OTHER INCOME AND EXPENSE. Total net other income for fiscal 2004 was
$176,000, consisting of $269,000 of interest income, offset by $93,000 of
expense recorded to mark-to-market the fair value of common stock options and
warrants issued in December 2003. Total other income was $397,000 of interest
income for fiscal 2003 and $386,000 of interest income for fiscal 2002. The
decrease in interest income for fiscal 2004 compared with fiscal 2003 was
primarily due to the decline in interest rates.

        INCOME TAXES. The Company recorded an income tax expense of $7,089,000
for fiscal 2004. For fiscal 2003, the income tax expense was $1,520,000, for an
effective tax rate of 40%; and for fiscal 2002, the income tax benefit was
$2,786,000. The Company's income tax expense for fiscal 2004 was due to
increasing the valuation allowance to be equal to the remaining balance of the
Company's deferred tax asset. This income tax expense is not a cash item and
does not mean that the Company owes income taxes, but rather that it no longer
can demonstrate that in the future it will likely be able to utilize the tax
benefits of previously generated net operating losses. The methodology for
determining the realizability of its deferred tax asset is a critical accounting
policy as described under the heading "Critical Accounting Policies" and in the
Company's SEC filings. In summary, this methodology considers positive and
negative evidence regarding the Company's ability to generate sufficient future
taxable income to realize its deferred tax assets. Due to the Company's recent
cumulative tax loss history especially as forecast for the three-year period
ending March 31, 2004, income statement loss history over the five quarters
ended March 31, 2004, and the difficulty in forecasting the timing of future
revenue which could lead to positive income on its financial statements and
taxable income as evidenced by the deviations in achieved revenues from expected
revenues during the past few quarters and taking into account the newness of
certain customer relationships, the Company determined it was necessary to
increase the valuation allowance under SFAS No. 109 to the full amount of the
deferred tax asset because its estimated future revenue taking into account only
booked orders would not generate sufficient taxable income to realize any of its
deferred tax assets. If the Company has taxable income in the future, any
unexpired net operating loss income tax carry-forward amounts will be utilized
to reduce otherwise required income tax payments, and future tax expense, up to
the full amount of the deferred tax asset which is currently $14.8 million. As
of March 31, 2002, the Company had recognized all prior tax benefits for income
statement purposes. The income tax benefit for fiscal 2002 included a credit of
$2,999,000 due to the change in the valuation allowance relating to the federal
deferred tax asset, net of federal alternative minimum taxes, partially offset
by $213,000 for state tax expense. Most of the subsequent $8.6 million of income
tax expense has resulted from increasing the valuation allowance to be equal to
the deferred tax assets. In future years, unless the valuation is reduced,
should the Company be profitable for income tax purposes, the Company will
utilize the deferred tax asset to reduce the income tax it would otherwise owe,
meaning that its effective tax rate will be zero. The Company has $2.8 million
of deferred tax assets that expire in 2005 to the extent they are not utilized
to reduce income tax which would be due should the Company have profits on its
income tax return. To the extent that the Global Investments Group license
agreement generates taxable income and the Company is in an overall taxable
income position the Company would be able to reduce the valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

        As of March 31, 2004, the Company had cash, cash equivalents, and
short-term investments of $12,669,000 and a current ratio of 2.1 to 1. The
Company also had $8,246,000 in long-term investments with original maturities
from one year to two and one-half years. Cash, short-term investments, and
long-term investments were $20,915,000 at March 31, 2004 and $17,015,000 at
March 31, 2003.

        Net cash used in operating activities was $2,000 for fiscal 2004
compared with net cash used in operating activities of $64,000 for fiscal 2003
and net cash provided by operating activities of $4,369,000 for fiscal 2002. The
decrease in cash provided by operating activities from fiscal 2002 to fiscal
2003 is largely due to changes in advance payments from customers and deferred
revenue.


                                       37
<PAGE>

        Cash increased during fiscal 2004 due to the proceeds from an equity
private placement of common stock, as described below. Cash will fluctuate based
upon the timing of advance payments from customers relative to shipments and the
timing of inventory purchases and subsequent manufacture and sale of products.

        The Company believes that the estimated level of revenues and advance
payments over the next 12 months will be sufficient to generate cash from
operating activities over the same period. However, quarterly fluctuations are
expected. Operating cash flow could be negatively impacted to a significant
degree if either of the Company's largest U.S. government programs were to be
further delayed, reduced, canceled, or not extended, if the Italian CIE card
program does not grow as planned internally, and if these programs are not
replaced by other card orders or other sources of income, or if increases in
product revenues or licenses do not keep pace with increased marketing and R&E
expenditures.

        The Company has not established a line of credit and has no current
plans to do so. The two acquired German companies each have existing lines of
credit with their banks. The Company may negotiate a line of credit if and when
it becomes appropriate, although no assurance can be made that such financing
would be available on favorable terms or at all, if needed.

        As a result of the $12,427,000 net loss recorded for fiscal 2004, the
Company's accumulated deficit increased to $18,244,000. Stockholders' equity
decreased to $35,686,000 as a result of the net loss recorded that was offset by
$11,173,000 in additions to equity due to the sale of stock through stock plans
during fiscal 2004 and the proceeds of a private placement of common stock, as
described below.

        Net cash used for investing activities was $5,144,000 for fiscal 2004;
$4,151,000 for fiscal 2003, and $6,319,000 for fiscal 2002. These amounts
include $3,089,000 in connection with the purchase of two German companies,
Challenge Card Design Plastikkarten GmbH and cards & more GmbH, in fiscal 2004;
purchases and maturities of liquid investments; purchases of property and
equipment of $3,996,000 for fiscal 2004; $2,468,000 for fiscal 2003; and
$1,723,000 for fiscal 2002; and acquisitions of patents and other intangibles of
$93,000 for fiscal 2004; $307,000 for fiscal 2003; and $98,000 for fiscal 2002.

        The Company considers all highly liquid investments, consisting
primarily of commercial paper, taxable notes, and U.S. government bonds, with
original or remaining maturities of three months or less at the date of
purchase, to be cash equivalents. All investments with original or remaining
maturities of more than three months but not more than one year at the date of
purchase, are classified as short-term. Investments with original or remaining
maturities of more than one year at the date of purchase are classified as
long-term. The Company determines the length of its investments after
considering its cash requirements and yields available for the type of
investment considered by the Company. Management also determines the appropriate
classification of debt and equity securities at the time of purchase and
reevaluates the classification of investments as of each balance sheet date. As
of March 31, 2004 the Company had $9,227,000 classified as short-term and
long-term investments, compared with $11,261,000 at March 31, 2003. All
marketable securities were accounted for as held-to-maturity.

        The Company made capital equipment and leasehold improvement purchases
of approximately $4 million during fiscal 2004 compared with $2.5 million during
fiscal 2003 and approximately $1.7 million during fiscal 2002. The Company's
current card capacity, assuming optimal card type mix, is estimated at
approximately 16 million cards per year. The Company plans to purchase
additional production equipment in a series of steps when deemed appropriate by
the Company. The Company is also increasing production capacity for cards with
new structures used by the Canadian and Italian programs. In addition to
investment used for expansion, the Company expects to make additional capital
expenditures for cost savings, quality improvements, and other purposes. The
Company plans to use cash on hand and cash generated from operations to fund
capital expenditures of approximately $11 million during fiscal 2005 for
equipment and leasehold improvements for card production, read/write drive
tooling and assembly, and general support items.

        On March 31, 2004, the Company completed its acquisition of two related
German card companies, Challenge Card Design Plastikkarten GmbH of Rastede,
Germany, and cards & more GmbH of Ratingen, Germany (collectively, the Acquired
German Entities), including their sales operations in the United States and
Korea. The Company


                                       38
<PAGE>

purchased the shares of the Acquired German Entities from their five
shareholders (the Shareholders) and purchased assets of the United States sales
operation from a partnership comprised of the Shareholders. In the acquisition
transaction, the Company agreed to assume approximately 0.5 million euros of
debt and to pay approximately 4.75 million euros in cash, consisting of
approximately 2.25 million euros payable at closing and the remaining
approximately 2.5 million euros payable in five equal annual installments for
the business and certain assets. The agreement specified that the purchase price
be adjusted based upon other assets purchased and additional liabilities
assumed. This resulted in a reduction in the purchase price of approximately 0.4
million euros as of March 31, 2004. The present value of the net total purchase
price is $5.5 million. This purchase price was determined by negotiation between
the Company and the Shareholders, taking into account such matters as the value
of the tangible assets and the going concern value of the business operations of
the Acquired German Entities. Four of the Shareholders entered into new
employment agreements with the Acquired German Entities while the fifth
Shareholder, who is resident in the US, entered into an employment agreement
with registrant. In addition to salaries, these employment agreements provide
for commission based upon the future results of operations of the Acquired
German Entities, which could be as much as 3.75 million euros over the next five
years. The Company used a portion of its available cash to fund the acquisition.
The Shareholders had no previous material relationship with the Company or its
affiliate or subsidiaries, although the Company did substantial business with
the Acquired German Entities during recent years. One of the Acquired German
Entities owns a plant in Rastede, Germany together with associated equipment
which it has used to manufacture plastic cards featuring contactless IC chip
technology and high resolution printing. The Company intends to continue to use
the facility and equipment to produce such cards as well as to enhance the
facility to produce LaserCard optical memory cards in Germany. This will enable
CCD to manufacture cards featuring four of the key ID card technologies (optical
memory, contact IC chip, contactless RF ID, and magnetic stripe) either singly
or in combination, along with other high-security features.

        Net cash provided by financing activities was $11,080,000 for fiscal
2004; $1,776,000 for fiscal 2003; and $3,922,000 for fiscal 2002. Fiscal 2004
financing activities consisted of proceeds from the equity private placement
described below. Proceeds on sales of common stock through the Company's
stock-option and stock-purchase plans were $1,691,000 for fiscal 2004;
$1,776,000 for fiscal 2003; and $4,097,000 for fiscal 2002.

        The Company received net proceeds of $9,389,000 (net of fees and
expenses) from the issuance and sale in December 2003 of 791,172 shares of
common stock, options to purchase 122,292 shares of common stock, and warrants
to purchase 174,057 shares of common stock for an aggregate purchase price of
$10,095,332 in a private placement. The purchase price of the common stock was
$12.76 per share, which was a 15% discount from the five-day average price as of
December 23, 2003. The options have an exercise price of $16.51 per share and a
nine-month life. The warrants have an exercise price of $17.26 per share and a
life of five years. The options and warrants were valued at $245,000 and
$984,000, respectively, based on a Black-Scholes calculation as of December 23,
2003 and pursuant to the provisions of EITF Issue No. 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock," (EITF 00-19) were recorded at those values in long-term
liabilities. The balance of the net proceeds was accounted for as additional
paid in capital. Under EITF 00-19, the Company marks-to-market the fair value of
the options and warrants at the end of each accounting period. At the end of the
fiscal 2004 third quarter, this resulted in options and warrants valued at
$195,000 and $916,000, respectively. The decrease in valuation of the options
and warrants between December 23, 2003 and the quarter end of $118,000 was
recorded as other income in the accompanying Condensed Consolidated Statement of
Operations and resulted from a decrease in the Company's stock price. On
February 6, 2004, the Company and the investors entered into an amendment to
their original agreement that resulted in the reclassification of the options
and warrants to equity. The amendment clarified that the options and warrants
granted in the financing may be exercised at a time when a registration
statement covering the resale of the underlying shares is not effective or
available and that in such instance the Company would deliver to the investors
shares of common stock whose resale is not currently registered. On the
effective date of the amendment, the options and warrants were reclassified to
equity as additional paid-in-capital. As a result of the increase in value of
the options and warrants from the closing date to the amendment date, due to
increases in the Company's stock price, the Company recognized an expense of
$211,000, which is included in other expense in the Condensed Consolidated
Statement of Operations in the fourth quarter of fiscal 2004.

        On January 23, 2004, the Company filed an S-3 Registration Statement
with the Securities and Exchange Commission covering the resale of the common
stock issued and issuable in such financing. The Securities and Exchange
Commission declared the registration statement effective on April 28, 2004. The
Company is subject to certain indemnity provisions included in the stock
purchase agreement entered into as part of the financing associated


                                       39
<PAGE>

with this registration. Morgan Keegan & Company, Inc. acted as the Company's
exclusive placement agent for this transaction. The Company used approximately
$3 million of the net proceeds from this private placement in connection with
the purchase of CCD and C&M and presently intends to use the balance of such
proceeds (1) to purchase capital equipment and make leasehold improvements to
further expand the Company's LaserCard optical memory card production capacity,
(2) for additional payments in connection with the purchase of CCD and C&M, and
(3) for general corporate purposes.

        During fiscal 2001, the Company commenced a share repurchase program
under which up to 200,000 shares of common stock could be purchased by the
Company from time to time in Nasdaq Stock Market transactions in an aggregate
amount not exceeding $3 million. During the first quarter of fiscal 2002, the
Company used cash of $175,000 for this purpose and has since terminated this
program without further activity.

        There were no debt financing activities for fiscal 2004, 2003, or 2002.
The Company acquired bank debt in the amount of $1,394,000 in the fiscal 2004
acquisition of Challenge Card Design Plastikkarten GmbH and cards & more GmbH,
of Germany. In addition, the net present value of future payments on this
acquisition is $2,150,000 on this transaction.

        The following table provides a summary of the effect on liquidity and
cash flows from the Company's contractual obligations as of March 31, 2004 (in
thousands):

<TABLE>
<CAPTION>

                                                                          Fiscal Year
                                                                                                   2010 and
                                          2005        2006        2007        2008        2009    Thereafter     Total
                                          ----        ----        ----        ----        ----    ----------     -----
<S>                                     <C>         <C>         <C>         <C>         <C>         <C>         <C>
Contractual obligations:
    Debt obligations                    $ 1,166     $   792     $   640     $   487     $   459     $    --     $ 3,544
    Noncancellable operating leases       1,374       1,218       1,138       1,086       1,048       6,800      12,664
    Noncancelable purchase orders         2,921          --          --          --          --          --       2,921
                                        -------     -------     -------     -------     -------     -------     -------
         Total                          $ 5,461     $ 2,010     $ 1,778     $ 1,573     $ 1,507     $ 6,800     $19,129
                                        =======     =======     =======     =======     =======     =======     =======
</TABLE>

        The Company has also entered into employment agreements with certain
Shareholders of the Acquired German Entities that provide for commissions based
upon the results of operations of the acquired entities, which could be as much
as 3.75 million euros over the next five years and have not been reflected in
the table above.


                                       40
<PAGE>

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

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

        o       Commercial paper rated A1/P1 or debt instruments rated AAA, as
                rated by the major rating services
        o       Can readily be sold for cash

        There were no material changes during the fourth quarter of fiscal 2004
to the Company's exposure to market risk for changes in interest rates.

        FOREIGN CURRENCY EXCHANGE RATE RISK. The Company sells products in
various international markets. All of these sales are denominated in U.S.
dollars. However, some raw material and purchased services are denominated in
euros. Also, as of March 31, 2004, the Company had debt relating to the
acquisition of Challenge Card Design Plastikkarten GmbH and cards & more GmbH,
of Germany, in the amount of 2.9 million euros. Accordingly, the Company is
subject to exposure if the exchange rate for euros increases in relation to U.S.
dollars. As of March 31, 2004, the Company had not entered into a forward
exchange contract to hedge against or potentially minimize the foreign currency
exchange risk.


                                       41
<PAGE>

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors and Stockholders
Drexler Technology Corporation:

        We have audited the accompanying consolidated balance sheet of Drexler
Technology Corporation and subsidiaries as of March 31, 2004, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.

        We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 Drexler
Technology Corporation and subsidiaries as of March 31, 2004, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.


/s/ KPMG LLP
Mountain View, California
June 9, 2004


                                       42
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
of Drexler Technology Corporation:

        In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Drexler Technology Corporation and its subsidiaries at March 31, 2003, and the
results of their operations and their cash flows for each of the two years in
the period ended March 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. 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
conducted our audits of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.


/s/ PricewaterhouseCoopers LLP
San Jose, California
April 28, 2003, except for
Note 4, as to which the date is January 22, 2004


                                       43
<PAGE>
<TABLE>
<CAPTION>

                           DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                     CONSOLIDATED BALANCE SHEETS
                                  March 31, 2003 and March 31, 2004
                         (In thousands, except share and per share amounts)


                                                                             2003             2004
                                                                             ----             ----
                                               ASSETS
<S>                                                                       <C>              <C>
Current assets:
   Cash and cash equivalents                                              $  5,754         $ 11,688
   Short-term investments                                                    4,363              981
   Accounts receivable, net of allowances of $90 at March 31, 2003
      and $296 at March 31, 2004                                             1,659            2,550
   Inventories                                                               5,711            6,799
   Deferred tax assets, net                                                  2,689               --
   Prepaid and other current assets                                          1,016            1,276
                                                                          --------         --------
      Total current assets                                                  21,192           23,294
                                                                          --------         --------

Property and equipment, at cost                                             23,204           27,609
   Less--accumulated depreciation and amortization                         (15,795)         (16,079)
                                                                          --------         --------
      Property and equipment, net                                            7,409           11,530

Long-term investments                                                        6,898            8,246
Equipment held for resale                                                       --            2,419
Patents and other intangibles, net                                             567              978
Deferred tax assets, net                                                     4,397               --
Goodwill                                                                        --            3,321
Other non-current assets                                                        --               47
                                                                          --------         --------
           Total assets                                                   $ 40,463         $ 49,835
                                                                          ========         ========

                                LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable                                                       $  1,085         $  4,249
   Accrued liabilities                                                       1,434            2,035
   Deferred tax liability                                                       --              608
   Advance payments from customers                                           1,096            3,102
   Deferred revenue                                                              5              111
   Bank borrowings                                                              --              726
   Current portion of long-term debt                                            --              440
                                                                          --------         --------
      Total current liabilities                                              3,620           11,271
                                                                          --------         --------

Long-term debt, net of current portion                                          --            2,378
Advance payments from customers                                                 --              500
                                                                          --------         --------
           Total liabilities                                              $  3,620         $ 14,149
                                                                          --------         --------

Commitments and contingencies (Note 7)

Stockholders' equity:
     Preferred stock, $.01 par value:
      Authorized--2,000,000 shares
      Issued--none                                                              --               --
   Common stock, $.01 par value:
      Authorized--30,000,000 shares
      Issued and outstanding--10,443,192 shares at March 31, 2003
           and 11,399,764 shares at March 31, 2004                             104              114
   Additional paid-in capital                                               42,556           53,816
   Accumulated deficit                                                      (5,817)         (18,244)
                                                                          --------         --------
           Total stockholders' equity                                       36,843           35,686
                                                                          --------         --------

               Total liabilities and stockholders' equity                 $ 40,463         $ 49,835
                                                                          ========         ========


       The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>


                                                 44
<PAGE>
<TABLE>
<CAPTION>

                          DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                               CONSOLIDATED STATEMENTS OF OPERATIONS
                         Fiscal Years Ended March 31, 2002, 2003, and 2004
                             (In thousands, except per share amounts)


                                                          2002             2003            2004
                                                          ----             ----            ----
<S>                                                     <C>              <C>             <C>
Revenues:
    Product sales                                       $ 19,562         $ 25,221        $ 16,963
    License and other revenue                              1,327            1,110              --
                                                        --------         --------        --------
         Total revenues                                   20,889           26,331          16,963
                                                        --------         --------        --------

Cost of product sales                                     10,652           13,906          13,157
                                                        --------         --------        --------

       Gross profit                                       10,237           12,425           3,806
                                                        --------         --------        --------

Operating expenses:
    Selling, general and administrative expenses           5,165            6,202           6,700
    Research and engineering expenses                      3,045            2,818           2,620
                                                        --------         --------        --------
       Total operating expenses                            8,210            9,020           9,320
                                                        --------         --------        --------

          Operating income (loss)                          2,027            3,405          (5,514)
                                                        --------         --------        --------

Other income, net                                            386              397             176
                                                        --------         --------        --------

          Income (loss) before income taxes                2,413            3,802          (5,338)

Income tax (benefit) expense                              (2,786)           1,520           7,089
                                                        --------         --------        --------

          Net income (loss)                             $  5,199         $  2,282        $(12,427)
                                                        ========         ========        ========

Net income (loss) per share:
          Basic                                         $    .52         $    .22           (1.15)
                                                        ========         ========        ========
          Diluted                                       $    .50         $    .21        $  (1.15)
                                                        ========         ========        ========

Weighted-average shares used in
   computing net income (loss) per share:
          Basic                                            9,961           10,356          10,761
          Diluted                                         10,468           10,842          10,761


      The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>


                                                45
<PAGE>
<TABLE>
<CAPTION>

                                    DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                   Fiscal Years Ended March 31, 2002, 2003, and 2004
                                                     (In thousands)


                                                                     Additional
                                                Common Stock           Paid-in     Treasury     Accumulated
                                             Shares       Amount       Capital       Stock        Deficit        Total
                                             ------       ------       -------       -----        -------        -----
<S>                                            <C>       <C>          <C>          <C>           <C>           <C>
Balance, March 31, 2001                        9,951     $     99     $ 37,852     $ (1,840)     $(13,298)     $ 22,813
    Shares purchased through an
       open market repurchase program             --           --           --         (175)           --          (175)
    Shares issued under stock option
       and stock purchase plans                  290            3        2,079        2,015            --         4,097
    Income tax benefit arising from
       stock options                              --           --          307           --            --           307
    Compensation related to
       stock plan activity                        --           --           96           --            --            96
    Net income                                    --           --           --           --         5,199         5,199
                                            --------     --------     --------     --------      --------      --------

Balance, March 31, 2002                       10,241          102       40,334           --        (8,099)       32,337
    Shares issued under stock option
       and stock purchase plans                  202            2        1,774           --            --         1,776
    Income tax benefit arising from
       stock options                              --           --          356           --            --           356
    Compensation related to
       stock plan activity                        --           --           92           --            --            92
    Net income                                    --           --           --           --         2,282         2,282
                                            --------     --------     --------     --------      --------      --------

Balance, March 31, 2003                       10,443     $    104     $ 42,556     $     --      $ (5,817)     $ 36,843
    Shares, warrants, and options
       sold in private placement,
       net of $706 in issuance costs
       and $93 for change in fair value
       of common stock warrants
       and options                               791            8        9,474           --            --         9,482
    Shares issued under stock option
       and stock purchase plans                  166            2        1,689           --            --         1,691
    Compensation related to
       stock plan activity                        --           --           97           --            --            97
    Net loss                                      --           --           --           --       (12,427)      (12,427)
                                            --------     --------     --------     --------      --------      --------

Balance, March 31, 2004                       11,400     $    114     $ 53,816           --      $(18,244)     $ 35,686
                                            ========     ========     ========     ========      ========      ========


                 The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>


                                                           46
<PAGE>
<TABLE>
<CAPTION>

                                      DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                           CONSOLIDATED STATEMENTS OF CASH FLOWS
                                     Fiscal Years Ended March 31, 2002, 2003, and 2004
                                                       (In thousands)


                                                                                  2002             2003             2004
                                                                                  ----             ----             ----
<S>                                                                             <C>              <C>              <C>
Cash flows from operating activities:
   Net income (loss)                                                            $  5,199         $  2,282         $(12,427)
     Adjustments to reconcile net income (loss) to net cash
           provided by (used in) operating activities:
        Depreciation and amortization                                              1,556            1,829            2,123
        Provision for (recovery of) doubtful accounts receivable                     (14)              11                1
        Provision for excess and obsolete inventory                                  276              425               97
        Recovery of product return reserve                                          (127)              --               --
        Decrease (increase) in deferred income tax assets                         (3,484)           1,326            7,086
        Stock-based compensation                                                      96               92
                                                                                                                        97
        Tax benefit relating to the exercise of stock options                        307              356               --
        Loss associated with increase in fair value of
           common stock warrants and options                                          --               --               93
     Changes in operating assets and liabilities, net of assets acquired
           and liabilities assumed in business combination:
        Decrease (increase) in accounts receivable                                  (240)             (11)             346
        Increase in inventories                                                     (368)          (1,163)          (1,476)
        Decrease (increase) in other assets                                          116             (455)              63
        Increase (decrease) in accounts payable and accrued liabilities              (45)             664            2,305
        Increase (decrease) in deferred revenue                                     (179)          (3,965)             106
        Increase (decrease) in advance payments from customers                     1,276           (1,455)           1,584
                                                                                --------         --------         --------

           Net cash provided by (used in) operating activities                     4,369              (64)              (2)
                                                                                --------         --------         --------

Cash flows from investing activities:
     Purchases of property and equipment                                          (1,723)          (2,468)          (3,996)
     Acquisition of patents and other intangibles                                    (98)            (307)             (93)
     Purchases of investments                                                    (13,964)         (16,453)         (10,013)
     Proceeds from maturities of investments                                       9,466           15,077           12,047
     Purchase of Challenge Card Design and
        cards & more, net of $12 cash acquired                                        --               --           (3,089)
                                                                                --------         --------         --------

           Net cash used in investing activities                                  (6,319)          (4,151)          (5,144)
                                                                                --------         --------         --------

Cash flows from financing activities:
        Proceeds from sale of common stock through stock plans                     4,097            1,776            1,691
        Cash used to purchase common stock through an open market
           repurchase program                                                       (175)              --               --
        Net proceeds from sale of common stock, options and
           warrants through private placement                                         --               --            9,389
                                                                                --------         --------         --------
           Net cash provided by financing activities                               3,922            1,776           11,080
                                                                                --------         --------         --------
           Net increase (decrease) in cash and cash equivalents                    1,972           (2,439)           5,934
Cash and cash equivalents:
     Beginning of period                                                           6,221            8,193            5,754
                                                                                --------         --------         --------
     End of period                                                              $  8,193         $  5,754         $ 11,688
                                                                                ========         ========         ========
Supplemental disclosures--cash payments for:
     Income taxes                                                               $    182         $     --         $     --
                                                                                ========         ========         ========


                 The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>


                                                            47
<PAGE>

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.      ORGANIZATION AND OPERATIONS

        Drexler Technology Corporation and its wholly owned subsidiaries,
LaserCard Systems Corporation, Challenge Card Design Plastikkarten GmbH, and
cards & more GmbH (the "Company") develop, manufacture, and integrate
LaserCard(R) optical memory cards other advanced-technology cards, optical card
drives, and card systems and peripherals. Challenge Card Design Plastikkarten
GmbH and cards & more GmbH were acquired by Drexler Technology on March 31,
2004. Through fiscal 2004, the Company's customers are mainly value-added
reseller (VAR) companies and licensees, in the United States and other
countries, that develop commercial applications for LaserCard products. Target
markets for these products include government and commercial applications for
portable, recordable, secure, identification cards and other unitary-record
cards. Applications include U.S. immigration Green Cards and Laser Visa Border
Crossing Cards, U.S. military cargo manifests, Canadian Permanent Resident
Cards, Italian national ID cards, biometric IDs, and other wallet-card
applications. Challenge Card Design Plastikkarten GmbH and cards & more GmbH
supply other advanced-technology cards for various applications, card printers,
and systems integration for gate-keeping and ticketing. The Company has two
additional subsidiaries that are dormant, Precision Photoglass, Inc., and
Microfab Systems Corporation.

        The Company is subject to certain risks including, but not limited to,
competition from substitute products and larger companies and dependence on
certain suppliers and customers. The Company's U.S. government subcontract
expires on May 25, 2005.

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated
financial statements include the accounts of Drexler Technology Corporation and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

        USE OF ESTIMATES. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
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.

        FISCAL PERIOD. For purposes of presentation, the Company labels its
annual accounting period end as March 31 and its quarterly accounting period
ends as June 30, September 30, and December 31. The Company, in fact, operates
and reports based on quarterly periods ending on the Friday closest to month
end. Fiscal 2002 ended on March 29, 2002; fiscal 2003 ended on March 28, 2003;
and fiscal 2004 ended on April 2, 2004.

        CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS, AND LONG-TERM
INVESTMENTS. The Company considers all highly liquid investments, consisting
primarily of commercial paper, taxable notes, and U.S. government bonds, with
maturities of three months or less at the date of purchase, to be cash
equivalents. Cash equivalents as of March 31, 2003 and March 31, 2004 were
$4,396,000 and $9,400,000, respectively. All investments with original or
remaining maturities at date of purchase of more than three months and up to one
year are classified as short-term investments. All investments with original or
remaining maturities at date of purchase greater than one year are classified as
long-term investments. Management determines the appropriate classification of
debt and equity securities at the time of purchase and reevaluates the
classification of investments as of each balance sheet date.

        All short-term and long-term investments are classified as held to
maturity and are stated in the balance sheet at amortized cost. As investments
are classified as held to maturity, no unrealized gains or losses are recorded.
The carrying amounts of individual held to maturity securities are reviewed at
the balance sheet date for potential impairment. As of March 31, 2003 and March
31, 2004, the Company has determined that an impairment which was


                                       48
<PAGE>

"other than temporary" has not occurred. The carrying amounts of short-term and
long-term investments at March 31 are (in thousands):

                                                            2003            2004
                                                            ----            ----
Short-term investments:
   U.S. government and agency obligations              $      401     $       --
   Certificates of deposit                                  3,962            981
                                                       ----------     ----------
      Total short-term investments                          4,363            981
                                                       ----------     ----------

Long-term investments:
   U.S. government and agency obligations                   6,500          7,300
   Certificates of deposit                                    398            946
                                                       ----------     ----------
      Total long-term investments                           6,898          8,246
                                                       ----------     ----------
           Total investments                           $   11,261     $    9,227
                                                       ==========     ==========

        Scheduled maturities of held-to-maturity investments at March 31 are (in
thousands):

                                                                            2004
                                                                            ----

Up to one year                                                        $      981
After one year through five years                                          8,246
                                                                      ----------
                                                                      $    9,227

        FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of the
Company's financial instruments including cash and cash equivalents, short-term
investments, accounts receivable, accounts payable and accrued liabilities,
approximate their fair values due to their short maturities. The fair value of
long-term investments was $6,910,000 at March 31, 2003 and $8,269,000 at March
31, 2004.

        INVENTORIES. Inventories are stated at the lower of cost or market, with
cost determined on a first-in, first-out basis and market based on the lower of
cost or estimated realizable value. The components of inventories as of March 31
are (in thousands):

                                                            2003            2004
                                                            ----            ----

Raw materials                                          $    3,234     $    3,243
Work-in-process                                               220          1,651
Finished goods                                              2,257          1,905
                                                       ----------     ----------
                                                       $    5,711     $    6,799
                                                       ==========     ==========

        The Company recorded charges to write down excess and obsolete inventory
of $276,000 for fiscal 2002; $425,000 for fiscal 2003; and $97,000 for fiscal
2004.

        PROPERTY AND EQUIPMENT, NET. The components of property and equipment as
of March 31 are (in thousands):

                                                            2003            2004
                                                            ----            ----

Building and land                                      $       --     $      811
Equipment and furniture                                    19,200         21,754
Construction in progress, including
   purchased equipment                                      1,323          2,338
Leasehold improvements                                      2,681          2,706
                                                       ----------     ----------
                                                       $   23,204     $   27,609
                                                       ==========     ==========


                                       49
<PAGE>

        Property and equipment are recorded at cost. Depreciation is provided
over the estimated useful lives (four to seven years) of equipment and furniture
using the double-declining balance and straight-line methods. Leasehold
improvements are amortized over the shorter of the life of the asset or the life
of the lease using the straight-line method. Depreciation and leasehold
amortization expense for fiscal 2002, 2003, and 2004 was $1,192,000; $1,477,000;
and $1,922,000, respectively.

        GOODWILL AND INTANGIBLE ASSETS. Goodwill represents the excess of the
purchase price over the fair value of identifiable net tangible and intangible
assets acquired in a business combination. In accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," the Company does not amortize goodwill.
Instead, the Company evaluates goodwill for impairment annually in the fourth
quarter and whenever events or changes in circumstances indicate that it is more
likely than not that an impairment loss has been incurred. Goodwill is assigned
to reporting units, which are operating segments as defined by our current
segment reporting structure. As of March 31, 2004, the Company has one reporting
unit that contains goodwill. Acquisition-related intangible assets other than
goodwill include backlog, which is amortized on a straight-line basis over its
estimated useful life of six months; and brand, which has an indefinite useful
life. Legal expenses incurred in connection with patents are capitalized and
amortized over the estimated remaining useful lives of the patents of six to
seventeen years.

        Definite life intangible assets capitalized and accumulated amortization
as of March 31 are as follows (in thousands):

                                                            2003           2004
                                                            ----           ----

Patent expenditures                                   $    3,089     $    3,172
Technology transfer expenditures                             545            545
Backlog                                                       --             29
Other                                                         --             10
                                                      ----------     ----------
    Total patent and other intangible expenditures         3,634          3,756
                                                      ----------     ----------

Patent accumulated amortization                           (2,638)        (2,810)
Technology transfer accumulated amortization                (429)          (455)
Other                                                         --             (3)
                                                      ----------     ----------
    Accumulated amortization                              (3,067)        (3,268)
                                                      ----------     ----------

        Patents and other intangibles, net            $      567     $      488
                                                      ==========     ==========

        The weighted average remaining amortization periods as of March 31 are
as follows:

                                                            2003           2004
                                                            ----           ----

Backlog                                                       --      0.5 years
Patents                                                4.4 years      4.8 years
Technology transfer                                    2.7 years      3.2 years
     Total                                             3.8 years      4.2 years


                                       50
<PAGE>

        Amortization expense on intangible assets for fiscal 2002, 2003, and
2004 was $364,000; $352,000; and $201,000, respectively. There were no amounts
relating to goodwill or intangibles assets no longer being amortized included in
these amounts. The estimated amortization expense for the next five years is as
follows (in thousands):

                                   Fiscal Year
                                       2005                 $   147
                                       2006                     112
                                       2007                      97
                                       2008                      62
                                       2009                      41
                                                            -------
                                          Total             $   459
                                                            =======

        Intangible assets capitalized that would not be amortized as of March 31
are as follows (in thousands):

                                                            2003           2004
                                                            ----           ----

Brand                                                    $    --        $   490
Goodwill                                                      --          3,321
                                                         -------        -------
   Total                                                 $    --        $ 3,811
                                                         =======        =======

        ASSESSMENT OF IMPAIRMENT OF TANGIBLE AND INTANGIBLE LONG-LIVED ASSETS.
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," the Company assesses the impairment of long-lived assets
whenever events or changes in circumstances indicate that their carrying value
may not be recoverable from the estimated future cash flows expected to result
from their use and eventual disposition. The Company's long-lived assets subject
to this evaluation include property, plant and equipment, and amortizable
intangible assets. If the Company's estimate of future undiscounted net cash
flows is insufficient to recover the carrying value of the assets over the
estimated useful life, the Company will record an impairment loss in the amount
by which the carrying value of the assets exceeds the fair value. If assets are
determined to be recoverable but the useful lives are shorter than originally
estimated, the Company depreciates or amortizes the net book value of the asset
over the newly determined remaining useful lives. To date, the Company has not
needed to record any impairment losses on long-lived assets.

        ACCRUED LIABILITIES. The components of accrued liabilities as of March
31 are (in thousands):

                                                            2003           2004
                                                            ----           ----

Accrued payroll and fringe benefits                      $   605        $ 1,107
Other accrued liabilities                                    829            928
                                                         -------        -------
   Total                                                 $ 1,434        $ 2,035
                                                         =======        =======

        SOFTWARE DEVELOPMENT COSTS. Development costs incurred in the research
and development of new software products are expensed as incurred until
technological feasibility in the form of a working model has been established.
To date, the Company's software development has been completed concurrent with
the establishment of technological feasibility and, accordingly, all software
development costs have been charged to research and engineering expenses in the
accompanying consolidated statements of operations.

        ADVANCE PAYMENTS FROM CUSTOMERS. The Company customarily receives
advance payments on orders placed by its customers. The advance payments are
recorded as a liability on the balance sheet until the related orders are
shipped.

        REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement, and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns. Product sales primarily consist of card sales and sales of
read/write drives.


                                       51
<PAGE>

        The Company's U.S. government subcontract requires delivery into a
secure, government-funded vault located on Company premises. Shipments are made
from the vault on a shipment schedule provided by the prime contractor, which is
subject to revision, but not cancellation, at the option of the prime
contractor. At the time the cards are delivered into the vault, title to the
cards is transferred to the government and all risks of ownership are
transferred as well. The prime contractor is invoiced, with payment due within
thirty days, and the contract does not contain any return (other than for
warranty) or cancellation provisions. Pursuant to the provisions of Staff
Accounting Bulletin No. 104 (SAB 104), revenue is recognized on delivery into
the vault as the Company has fulfilled its contractual obligations and the
earnings process is complete. If the Company does not receive a shipment
schedule, revenue is deferred and recognized upon shipment from the vault.

        The Company applies the provisions of Statement of Position (SOP) No.
97-2, "Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" to all transactions involving the sale of software products.
Revenue from the license of the Company's software products is recognized when
persuasive evidence of an arrangement exists, the software product has been
delivered, the fee is fixed or determinable, and collectibility is reasonably
assured, and, if applicable, upon acceptance when acceptance criteria are
specified or upon expiration of the acceptance period.

        License revenue, which may consist of up-front license fees and
long-term royalty payments, is recognized as revenue when earned. The cost of
license revenue is not material and is included in selling, general and
administrative expenses. The Company entered into a read/write drive kits
assembly license with a customer in Italy which generated license revenue of
$119,000 during fiscal 2002. The arrangement was structured whereby the customer
agreed to pay the Company a contractually agreed upon fee in exchange for the
transfer of technical knowledge and know-how and training in the assembly of
read/write-drives. The training period extended over 16 months, which is the
period over which the Company recognized the fee as revenue. The Company
recorded revenue of $1,206,000 in fiscal 2002 relating to digital sound patent
licenses sold to Sony Corporation and Dolby Laboratories, Inc. The revenues were
net of legal costs and third party contingency (success) fees. There are no
ongoing royalty payments or continuing obligations. License revenue in the
amount of $875,000 for fiscal 2003 represents the unamortized portion of a
$1,000,000 nonrefundable distribution license fee received in 2000 from a
licensee in Asia that had committed to purchase a minimum number of optical
memory cards for a program in the licensee's country. The Company recorded this
fee as deferred revenue and had been amortizing it as revenue in proportion to
actual card purchases by the licensee. During the quarter ended December 31,
2002, the Company determined that, due to the licensee's failure to meet the
minimum contractual purchase commitment, the licensee's distribution rights had
become unenforceable and that the licensee would no longer be acting as the card
supplier for that program. Fiscal 2003 license revenue also included $235,000
relating to a payment received in January 2002 from a third party that was
considering entering into a license agreement with the Company; the Company
originally recorded this payment as deferred revenue. The third party had
subsequently foregone its rights under this agreement due to non-performance and
accordingly, the Company recognized revenue on this arrangement in the fourth
quarter of fiscal 2003. There was no license revenue for the fiscal year ended
March 31, 2004.

        Effective April 3, 2004, subsequent to year end, the Company sold a
card-manufacturing license to the Global Investments Group, based in Auckland,
New Zealand, for card manufacturing in Slovenia. This agreement provides for
payments to the Company of $29 million for the license over the 20-year term of
the license (including a five-year training support package, followed by an
ongoing support phase for an additional 15 years). Additionally, the Company is
to sell approximately $12 million worth of the required manufacturing equipment
and installation support for the new facility to provide a targeted initial
manufacturing capacity of 10 million optical cards annually. As of March 31,
2004 the Company had $2,419,000 of this equipment classified as equipment held
for resale on its balance sheet. Options to increase capacity to 30 million
cards per year are provided. The Company has received the initial $5 million of
payments called for in the agreements, consisting of a partial payment for the
equipment of $500,000 as of March 31, 2004 and $4.5 million subsequent to March
31, 2004. In addition to the $41 million discussed above, Global Investments
Group is to pay the Company royalties for each card produced under the license.
The territories covered by the license include most of the European Union and
eastern European regions. The Global Investments Group has exclusive marketing
rights in certain territories, with performance goals to maintain these rights.
The Company will assign personnel on site during the license term to assist with
quality, security, and operational procedures, with a mutual goal that the
facility and the cards made there conform to the Company's standards. Start up


                                       52
<PAGE>

of the Global Investments Group facility is planned for early 2005. Revenue
under this license will be allocated over the remaining term of the agreement
beginning when operation of the factory commences. The Company also retains
rights to utilize up to 20% of the new facility capacity as backup and capacity
buffer to augment its own card manufacturing facilities in Mountain View,
California. The granting of this license to GIG establishes a second source
supplier of optical memory cards for existing and prospective customers who may
request multiple sources for cards. The Company does not expect to record
material license revenues under this agreement prior to fiscal 2006.

        RESEARCH AND ENGINEERING EXPENSES. Costs related to research, design and
development of products are charged to research and engineering expense as
incurred.

        STOCK-BASED COMPENSATION. On December 31, 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure,"
which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent
disclosures about the effects of stock-based compensation, which the Company
adopted for the year ended March 31, 2003. The Company accounts for its
stock-based compensation plans using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Compensation cost for stock options, if any, is measured by the
excess of the quoted market price of the Company's stock at the date of grant
over the amount an employee must pay to acquire the stock. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair-value based method of accounting for stock-based
employee compensation plans. Had compensation expense for the Plans been
determined consistent with SFAS No. 123, the Company's net income (loss) and
basic and diluted net income (loss) per share would have decreased to the
following pro forma amounts (dollars, in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                                              Fiscal Year

                                                                                2002              2003             2004
                                                                                ----              ----             ----
<S>                                                                          <C>              <C>               <C>
Net income (loss), as reported                                                $  5,199         $    2,282        $(12,427)

Add:  Stock-based employee compensation expense included in
    reported net income (loss), net of related tax effects                          91                 55              97

Deduct: total stock-based employee compensation determined under
    Fair-value based method for all awards, net of related tax effects          (2,336)            (1,408)         (1,925)
                                                                              --------         ----------        --------
Pro forma net income (loss)                                                   $  2,954         $      929        $(14,255)
                                                                              ========         ==========        ========

Basic net income (loss) per common share:
    As reported                                                               $     52         $      .22        $  (1.15)
                                                                              ========         ==========        ========
    Pro forma                                                                 $    .30         $      .09        $  (1.32)
                                                                              ========         ==========        ========

Diluted net income (loss) per common share:
    As reported                                                               $    .50         $      .21        $  (1.15)
                                                                              ========         ==========        ========
    Pro forma                                                                 $    .28         $      .09        $  (1.32)
                                                                              ========         ==========        ========

Shares used in computing basic and diluted pro forma
       net income (loss) per share:
    Basic                                                                        9,961             10,356          10,761
                                                                              ========         ==========        ========
    Diluted                                                                     10,468             10,842          10,761
                                                                              ========         ==========        ========
</TABLE>


                                       53
<PAGE>

        The Company computed the fair value of each option grant on the date of
grant using the Black-Scholes option valuation model with the following
assumptions:

<TABLE>
<CAPTION>
                                                                     Fiscal Year

                                                     2002                2003                2004
                                                     ----                ----                ----
<S>                                                  <C>                 <C>                 <C>
Risk-free interest rate                              5%                  2.67% to 4.99%      2.74% to 3.85%
Average expected life of option                      6 to 8 years        5 to 8 years        5 to 8 years
Dividend yield                                       0%                  0%                  0%
Volatility of common stock                           50%                 50%                 48% to 50%
Weighted average fair value of option grants         $7.54               $8.59               $8.35
</TABLE>

        COMPREHENSIVE INCOME (LOSS). Under SFAS No. 130, "Reporting
Comprehensive Income," comprehensive income (loss) is defined as the changes in
equity of an enterprise except those resulting from stockholders' transactions.
For the fiscal years ended March 31, 2002, 2003, and 2004, comprehensive income
(loss) equaled net income (loss).

        RECENT ACCOUNTING PRONOUNCEMENTS.

        In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables"
(EITF 00-21). EITF 00-21 provides guidance on how to account for arrangements
that involve the delivery or performance of multiple products, services and/or
rights to use assets. The provisions of EITF 00-21 apply to revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. The adoption of
this standard did not have a material impact on the Company's financial position
or results of operations.

        In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). FIN 46 addresses
consolidation by business enterprises of variable interest entities. Under that
interpretation, certain entities known as Variable Interest Entities (VIEs) must
be consolidated by the primary beneficiary of the entity. The primary
beneficiary is generally defined as having the majority of the risks and rewards
arising from the VIE. For VIEs in which a significant (but not majority)
variable interest is held, certain disclosures are required. In December 2003,
the FASB revised FIN 46, delaying the effective dates for certain entities
created before February 1, 2003, and making other amendments to clarify
application of the guidance. For potential variable interest entities other than
any Special Purpose Entities (SPEs), the revised FIN 46 (FIN 46R) is now
required to be applied no later than the end of the first fiscal year or interim
reporting period ending after March 15, 2004. The original guidance under FIN 46
is still applicable, however, at the end of the first interim or annual
reporting period ending after December 15, 2003 for all SPEs created prior to
February 1, 2003. FIN 46R may be applied prospectively with a cumulative effect
adjustment as of the date it is first applied, or by restating previously issued
financial statements with a cumulative-effect adjustment as of the beginning of
the first year restated. FIN 46R also requires certain disclosures of an
entity's relationship with variable interest entities. The Company will adopt
FIN 46R for non-SPE entities in the quarter ended June 30, 2005. The adoption of
this standard will not have an impact on the Company's financial position or
results of operations.

        In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of SFAS No. 149 did not have an impact on the Company's financial
position or results of operations.

        In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities and equity. It
requires companies to classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective


                                       54
<PAGE>

beginning with the third quarter of fiscal 2004. The adoption of SFAS No. 150
did not have an impact on the Company's financial position and results of
operations.

        In July 2003, the EITF reached a consensus on Issue No. 03-5,
"Applicability of AICPA Statement of Position 97-2 (SOP 97-2) to Non-Software
Deliverables" (EITF 03-5). The consensus was reached that SOP 97-2 is applicable
to non-software deliverables if they are included in an arrangement that
contains software that is essential to the non-software deliverables'
functionality. This consensus is to be applied to Company's financial year
beginning after October 1, 2003. The Company has not yet evaluated the impact
that EITF 03-5 will have on its financial position or results of operations.

        In November 2003, the EITF reached consensus on EITF Issue No. 03-1,
"The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments" (EITF 03-1). EITF 03-1 requires disclosures concerning unrealized
losses related to investments in debt and marketable equity securities that are
accounted for under SFAS No. 115. Disclosures include the length of time
investments have been in a loss position and discussion pertaining to the nature
of the impairment. The adoption of EITF Issue 03-1 did not have an impact on the
Company's financial position or results of operations.

        In December 2003, the SEC issued SAB 104, which supercedes SAB 101,
"Revenue Recognition in Financial Statements." The primary purpose of SAB 104 is
to rescind the accounting guidance contained in SAB 101 related to multiple
element revenue arrangements, which was superceded as a result of the issuance
of EITF 00-21. The adoption of SAB 104 did not have an impact on the Company's
financial position or results of operations.

        RECLASSIFICATIONS. Certain reclassifications were made to the prior year
financial data to conform with the current year presentation.

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

3.      NET INCOME (LOSS) PER SHARE

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

        The reconciliation of the denominators of the basic and diluted net
income (loss) per share computation for the fiscal years ended March 31, 2002,
2003, and 2004 is shown in the following table (in thousands, except per share
data):


                                       55
<PAGE>
<TABLE>
<CAPTION>

                                                                                 Fiscal Year

                                                                     2002            2003            2004
                                                                     ----            ----            ----

<S>                                                                <C>             <C>             <C>
Net income (loss)                                                  $  5,199        $  2,282        $(12,427)
                                                                   ========        ========        ========

Basic net income (loss) per share:
    Weighted average common shares outstanding                        9,961          10,356          10,761
                                                                   --------        --------        --------
Basic net income (loss) per share                                  $    .52        $    .22        $  (1.15)
                                                                   ========        ========        ========

Diluted net income (loss) per share:
    Weighted average common shares outstanding                        9,961          10,356          10,761
    Weighted average common shares from stock option grants             507             486            --
                                                                   --------        --------        --------
    Weighted average common shares and common stock
       equivalents outstanding                                       10,468          10,842          10,761
                                                                   --------        --------        --------
Diluted net income (loss) per share                                $    .50        $    .21        $  (1.15)
                                                                   ========        ========        ========
</TABLE>

        Stock options having an exercise price greater than the average market
value for profitable periods are excluded from the calculation of diluted net
income per share, as their effect would be antidilutive. Therefore, stock
options to purchase 280,950 and 168,000 shares were excluded from the
calculation of diluted net income per share for the years ended March 31, 2002
and 2003, respectively. As the effect of common stock equivalents would be
antidilutive since the Company incurred a loss, all stock options and warrants
were excluded from the calculation of diluted net loss per share for the fiscal
year ended March 31, 2004.

4.      SEGMENTS

        SEGMENT REPORTING. Prior to the second fiscal quarter of 2004, the
Company reported its results as a single reportable segment. During the second
fiscal quarter of 2004, revenues increased for optical card drives and as a
result, the Company concluded that it had two reportable segments and began
reporting the results of each segment and other information pursuant to
Statement of Financial Accounting Standards No. 131, "Segment Reporting."
Segment financial data for the years ended March 31, 2002 and 2003 has been
restated to reflect these segments.

        The Company's two reportable segments are: (1) optical memory cards and
(2) optical memory card drives, maintenance, and related accessories ("optical
card drives"). The segments were determined based on the information used by the
chief operating decision maker. The segments reported are not strategic business
units which offer unrelated products and services, rather these reportable
segments utilize compatible technology and are marketed jointly.

        The accounting policies used to derive reportable segment results are
the same as those described in the "Summary of Significant Accounting Policies."
Resources are allocated to the segments in a manner that optimizes optical
memory card revenues as determined by the chief operating decision maker.
Segment revenues are comprised of sales to external customers. Segment gross
profit (loss) includes all segment revenues less the related cost of sales.
Fixed assets and inventory are not separately reported by segment to the chief
operating decision maker. Accounts receivable, cash, deferred income taxes,
prepaid expenses, certain fixed assets, and other assets are not separately
identifiable to segments. Therefore, the amount of assets by segment is not
meaningful. There are no inter-segment sales or transfers. All of the Company's
long-lived assets are attributable to the United States except for $3,195,000
that are attributable to Germany.

        The Company's chief operating decision maker is currently the Company's
Co-Chief Executive Officers, prior to which the Company's Chairman and Chief
Executive Officer was considered to be the chief operating decision maker. The
chief operating decision maker reviews financial information presented on a
consolidated basis that is accompanied by disaggregated information about
revenues and gross profit (loss) by segment.


                                       56
<PAGE>

        The table below presents information for optical memory cards and
optical card drives for the fiscal years ended March 31, 2002, 2003, and 2004
(in thousands):

                        Fiscal Year Ended March 31, 2002

                               Optical       Optical
                               Memory          Card           Segment
                                Cards         Drives           Total
                                -----         ------           -----

Revenue                        $18,201        $ 1,279         $19,480
Cost of sales                    8,717          1,918          10,635
Gross profit (loss)              9,484           (639)          8,845
Depreciation and
   amortization expense            798             61             859


                        Fiscal Year Ended March 31, 2003

                               Optical       Optical
                               Memory          Card           Segment
                                Cards         Drives           Total
                                -----         ------           -----

Revenue                        $24,247        $   693         $24,940
Cost of sales                   12,120          1,579          13,699
Gross profit (loss)             12,127           (886)         11,241
Depreciation and
   amortization expense            995             81           1,076


                        Fiscal Year Ended March 31, 2004

                               Optical       Optical
                               Memory          Card           Segment
                                Cards         Drives           Total
                                -----         ------           -----

Revenue                        $13,379        $ 3,448        $16,827
Cost of sales                    9,965          3,039         13,004
Gross profit                     3,414            409          3,823
Depreciation and
   amortization expense          1,207            179          1,386

        The following is a reconciliation of segment results to amounts included
in the Company's consolidated financial statements for the fiscal years ended
March 31, 2002, 2003, and 2004 (in thousands):

                        Fiscal Year Ended March 31, 2002

                               Segment
                                Total        Other (a)         Total
                                -----        -----

Revenue                        $19,480        $ 1,409        $20,889
Cost of sales                   10,635             17         10,652
Gross profit                     8,845          1,392         10,237
Depreciation and
   amortization expense            859            697          1,556


                                       57
<PAGE>

                        Fiscal Year Ended March 31, 2003

                               Segment
                                Total        Other (a)         Total
                                -----        -----

Revenue                        $24,940        $ 1,391        $26,331
Cost of sales                   13,699            207         13,906
Gross profit                    11,241          1,184         12,425
Depreciation and
   amortization expense          1,076            753          1,829


                        Fiscal Year Ended March 31, 2004

                               Segment
                                Total        Other (a)         Total
                                -----        -----

Revenue                        $16,827        $   136         $16,963
Cost of sales                   13,004            153          13,157
Gross profit (loss)              3,823            (17)          3,806
Depreciation and
   amortization expense          1,386            737           2,123


(a)     Other revenue consists primarily of license revenue. Other cost of sales
        and depreciation and amortization expense represents corporate and other
        costs not directly associated with segment activities.

        SALES BY GEOGRAPHIC REGION. Sales by geographic region are generally
determined based upon the ship-to address on the invoice. Revenues by geographic
region are as follows (in thousands):

                                                    Fiscal Year

                                         2002             2003              2004
                                         ----             ----              ----

United States                      $   18,832       $   22,205        $    8,461
Canada                                    606            2,764             4,177
Italy                                     729              334             3,720
Middle East and Africa                     12               33               478
Asia                                      580              887                39
Rest of world                             130              108                88
                                   ----------       ----------        ----------
                                   $   20,889       $   26,331        $   16,963
                                   ==========       ==========        ==========

        Sales to customers outside the United States are denominated in U.S.
dollars.

        MAJOR CUSTOMERS. One customer accounted for 81% of revenues for fiscal
2002, 94% of revenues for fiscal 2003, and 72% of revenues for fiscal 2004.
Another customer accounted for 22% of revenues for fiscal 2004. The revenue from
these customers was attributable to both the optical memory card and the optical
card drive segments. No other customer accounted for more than 10% of revenues
during the periods.

        One United States customer comprised 99% of accounts receivable at March
31, 2003. Two customers comprised 53% and 46%, respectively, of accounts
receivable at March 31, 2004.


                                       58
<PAGE>

5.      RELATED-PARTY TRANSACTIONS

        On October 21, 2001, the Company entered into a one-year agreement with
Wexler & Walker Public Policy Associates, a unit of Hill and Knowlton, Inc.,
("Wexler") to be lobbyists on behalf of the Company. The Chairman of Wexler is
Robert S. Walker, a brother of director Walter F. Walker. In October 2002, the
agreement was extended for the period October 1, 2002 through September 2003 or
until terminated upon seven days' notice. The extended agreement provided for a
monthly retainer of $10,000, and there currently is a purchase order dated
December 11, 2003, valid through September 30, 2004 with the same terms and
conditions of the previous agreement. The Company paid $24,245 to Wexler during
fiscal 2002; $82,985 during fiscal 2003; and $151,147 during the fiscal 2004.
There were no significant amounts due to Wexler as of March 31, 2003 or 2004.

6.      COMMON STOCK

        STOCK OPTION PLAN. The Company has one stock option plan (the Stock
Option Plan) under which 2,133,455 shares of common stock have been reserved as
of March 31, 2004, consisting of 1,909,059 shares for stock options already
granted and 224,396 shares for stock options not yet granted. In addition, as of
March 31, 2004, 120,000 shares of stock have been reserved outside of the
Company's Stock Option Plan, for stock options issued under Nasdaq Rule No.
4350(i)(1)(A), in connection with the CCD-C&M acquisition. As an inducement to
join the Company, each of six key employees of the acquired companies were
granted non-statutory stock options with a term of five years to purchase 20,000
common shares.

        The Company's Stock Option Plan provides that stock options may be
granted to employees, officers, directors and consultants of the Company and
that option prices may be no less than 100% of the fair market value of the
shares at the date of grant. No options were granted to consultants during
fiscal 2002, 2003, or 2004. The Board of Directors specifies the term of options
and the vesting schedule for exercise of options. The option term cannot exceed
ten years (except that incentive stock options granted to a principal
shareholder cannot exceed five years).

        The following table lists Stock Option Plan activity from March 31, 2001
through March 31, 2004:


                                 Options                             Weighted
                                Available        Outstanding          Average
                                for Grant          Options        Exercise Price
                                ---------          -------        --------------

Balance March 31, 2001           276,220          2,028,100         $   11.49
    Authorized                   300,000                 --
    Granted                     (345,500)           345,500         $   13.82
    Exercised                         --           (416,618)        $    9.52
    Expired                       83,251            (83,251)        $   13.86
                                                 ----------         ---------
Balance March 31, 2002           313,971          1,873,731         $   12.25
                                                 ----------         ---------
    Authorized                   275,000                 --
    Granted                     (394,000)           394,000         $   16.03
    Exercised                         --           (184,100)        $    8.67
    Expired                       23,833            (23,833)        $   16.11
                                                 ----------         ---------
Balance March 31, 2003           218,804          2,059,798         $   13.25
                                                 ----------         ---------
    Granted                      (35,000)           155,000         $   14.43
    Exercised                       --             (145,147)        $   10.34
    Expired                       40,592            (40,592)        $   15.12
                                                 ----------         ---------
Balance March 31, 2004           224,396          2,029,059         $   13.51
                                                 ==========         =========


                                       59
<PAGE>

        The following table summarizes information about stock options
outstanding at March 31, 2004:

<TABLE>
<CAPTION>
                                     Options Outstanding                            Options Exercisable
                     ----------------------------------------------------     --------------------------------
                         Number        Weighted-Average       Weighted-           Number          Weighted-
     Range of        Outstanding at       Remaining            Average        Exercisable at       Average
 Exercise Prices     March 31, 2004    Contractual Life    Exercise Price     March 31, 2004    Exercise Price
 ---------------     --------------    ----------------    --------------     --------------    --------------
<S>                       <C>              <C>                <C>                  <C>             <C>
$ 7.04  -  $10.75         252,233          4.1 years          $   9.42             252,233         $  9.42
$10.91  -  $12.69         559,001          4.0 years          $  11.77             530,867         $ 11.76
$13.06  -  $15.56         800,725          7.2 years          $  13.95             410,823         $ 13.96
$16.47  -  $22.75         417,100          7.3 years          $  17.46             236,750         $ 17.14
                       ----------                                               ----------
          Totals        2,029,059                                                1,430,673
                       ==========                                               ==========
</TABLE>

        EMPLOYEE STOCK PURCHASE PLAN. The Company has an Employee Stock Purchase
Plan (Stock Purchase Plan), under which 64,208 shares are reserved as of March
31, 2004 for future purchases by employees. Under the Stock Purchase Plan,
eligible employees may designate from 2% to 6% of their compensation to be
withheld for the purchase of shares of common stock at 67% of a trailing average
price. The differential between fair market value and the average price of the
shares sold under the Stock Purchase Plan is charged to operations as a
compensation expense and is taxed to the employee as income. Under the Stock
Purchase Plan, employees purchased 12,942 shares for fiscal 2002; 18,405 shares
for fiscal 2003; and 20,253 shares for fiscal 2004. The average purchase price
per share was $10.52 for fiscal 2002; $9.74 for fiscal 2003; and $9.38 for
fiscal 2004. The weighted average market price per share for shares purchased
was $17.97 for fiscal 2002; $14.76 for fiscal 2003; and $14.19 for fiscal 2004.

7.   COMMITMENTS AND CONTINGENCIES

     The Company occupies its buildings under various operating leases. Rent
expense relating to these buildings was approximately $1,169,000 for fiscal
2002; $1,186,000 for fiscal 2003; and approximately $1,102,000 for fiscal 2004.
As of March 31, 2004, future minimum rental payments relating to these leases
are (in thousands):

                            Fiscal Year
                                2005              $    1,374
                                2006                   1,218
                                2007                   1,138
                                2008                   1,086
                                2009                   1,048
                                Thereafter             6,800
                                                  ----------
                                    Total         $   12,664

        By mutual agreement with the lessor, on November 1, 2003, a lease on a
27,000-square-foot building was modified and extended through October 2013. The
original lease had a remaining term through May 2006 with lease payments
totaling $2,083,000. The modified lease calls for payments totaling $1,293,000
over the same period. Rent expense is recorded at the average of the rent
payments over the term of the lease. At the time the renegotiated lease was
signed, there was $139,000 of deferred rent associated with the original lease.
This amount is being amortized on a straight-line basis over the ten-year term
of the modified lease.

        In the normal course of business, the Company is subject to various
claims and assertions. In the opinion of management, the ultimate disposition of
such claims and assertions will not have a material adverse impact on the
financial position of the Company.


                                       60
<PAGE>

8.      INCOME TAXES

        The provision (benefit) for income taxes for fiscal 2002, 2003, and
fiscal 2004 consists of the following (in thousands):

                                                        Fiscal Year

                                           2002            2003           2004
                                           ----            ----           ----
Current:
    Federal                             $    49         $   261        $  --
    State                                   213              98              3
                                        -------         -------        -------
                                            262             359              3
                                        -------         -------        -------
Deferred:
    Federal                              (3,048)          1,161          6,552
    State                                  --              --              534
                                        -------         -------        -------
                                         (3,048)          1,161          7,086

Income tax expense (benefit)            $(2,786)        $ 1,520        $ 7,089
                                        =======         =======        =======

        The Company's effective tax rate differs from the statutory rate as
follows:

                                                        Fiscal Year

                                           2002            2003           2004
                                           ----            ----           ----
Tax reconciliation:
    Federal statutory rate                   34%             34%           (34%)
    State tax, net of federal benefit         6%              6%             0%
Change in valuation allowance              (159%)            --            166%
                                        -------         -------        -------
                                           (119%)            40%           132%
                                        =======         =======        =======

        The major components of the net deferred tax asset/(liability) as of
March 31 are as follows (in thousands):

                                                               Fiscal Year

                                                           2003           2004
                                                           ----           ----
Deferred tax asset:
  Net operating loss carryforwards:
    Federal                                             $10,311        $12,252
    Foreign                                                  --             32
  Tax credits                                               537            662
  Reserves and accruals not currently
    deductible for tax purposes                             964          1,032
  Depreciation                                              574            787
  Other                                                     107            141
                                                        -------        -------
       Total deferred tax asset                          12,493         14,906
  Valuation allowance                                    (5,254)       (14,751)
       Net deferred tax asset                             7,239            155
                                                        -------        -------
Deferred tax liability:
    German operations                                        --           (640)
    Capitalized patent costs                               (153)          (123)
                                                        -------        -------
       Total deferred tax liability                        (153)          (763)
                                                        -------        -------
Net deferred tax asset/(liability)                      $ 7,086        $  (608)
                                                        =======        =======


        The fiscal 2004 acquisition of Challenge Card Design GmbH and cards &
more GmbH resulted in a deferred tax liability of $608,000.

        The Company analyzes its deferred tax assets with regard to potential
realization. The Company has established a full valuation allowance on its
deferred tax assets because management could not conclude that it was more
likely than not that such deferred tax assets would be realized. The Company's
methodology for determining the realizability of its deferred tax assets
involves estimates of future taxable income; the estimated impact of future
stock option deductions; and the expiration dates and amounts of net operating
loss carryforwards. These estimates are based on near-term projections and
assumptions which management believes to be reasonable. For recent prior
periods, the


                                       61
<PAGE>

Company had been estimating future taxable income from its core business, which
assumed on-going business under the U.S. government subcontract for Permanent
Resident Cards and Laser Visa Border Crossing Cards and the Canadian
government's Permanent Resident Card program, as well as estimated operating
expenses to support that level of business, as offset by the estimated impact of
future stock option deductions. The Company subsequently went back to estimating
future taxable income based upon its expectations for the current and next three
years because this past core business has not proven to be as stable as the
Company had believed it to be and because this past core business is expected to
represent an increasingly smaller part of the business. The Company expects
revenues from these U.S. programs to stabilize at revenue levels lower than had
been expected in the past and expects new foreign business, which has fluctuated
considerably quarter to quarter, to comprise a larger portion of the core
business. The Company has had difficulty in the past, and expects to have
continued difficulty in the future, in reliably forecasting its foreign business
and the revenue to be received from it. This, in combination with the three-year
cumulative tax loss for the period ended March 31, 2004, has resulted in the
Company basing its estimates of future income for these purposes to orders in
backlog at the end of each reporting period. As circumstances change, the
Company may in the future be able to estimate its future revenue based upon our
forecast revenues rather than only using booked orders, although the Company
cannot say if or when this will occur.

        In the event that actual results differ from these estimates or that
these estimates are adjusted in future periods, the Company may need to adjust
the amount of the valuation allowance based on future determinations of whether
it is more likely than not that some or all of its deferred tax assets will be
realized. A decrease in the valuation allowance would be recorded as an income
tax benefit or a reduction of income tax expense or a credit to stockholders'
equity. The Company's net operating losses available to reduce future taxable
income expire on various dates from fiscal 2005 through fiscal 2024. To the
extent that the Company generates taxable income in jurisdictions where the
deferred tax asset relates to net operating losses that have been offset by a
full valuation allowance, the utilization of these net operating losses would
result in the reversal of the related valuation allowance in the Company's
results of operations. The Company would need $8,226,000 of income on its
federal income tax return to avoid the expiration of $2,797,000 of the deferred
tax asset now set to expire in fiscal 2005.

        Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. During fiscal 2002, the Company recorded a
tax benefit of $2,786,000, which included a $2,999,000 reduction to the
valuation allowance on its deferred tax assets, net of federal alternative
minimum taxes, based on management's assessment that such portion of its
deferred tax assets would more likely than not be realized. Due to the Company's
recent cumulative tax loss history for the three-year period ending March 31,
2004, income statement loss history over the past five quarters, and the
difficulty in forecasting the timing of future revenue as evidenced by the
deviations in achieved revenues from expected revenues during the past few
quarters and taking into account the newness of certain customer relationships,
the Company determined it was necessary to increase the valuation allowance
under SFAS No. 109 to the full amount of the deferred tax asset. As a result,
the Company has recorded a valuation allowance of $14.8 million as of March 31,
2004, which includes a charge to increase the valuation allowance against the
beginning of the year net deferred tax asset balance of $7,086,000 for the year
ended March 31, 2004, due to uncertainties related to the Company's ability to
utilize its deferred tax assets. In addition the Company recorded a valuation
allowance against its net deferred tax asset generated during fiscal 2004 in the
amount of $2,411,000.

        The Company's federal net operating loss carryforwards as of March 31,
2004 of $36,040,000 will expire at various dates from 2005 through 2024, if not
utilized. The tax effect of this amount is reflected above as federal net
operating loss carryforwards totaling $12,252,000. Of this amount, $5,811,000,
representing tax benefits relating to stock-based compensation programs, will be
credited to stockholders' equity to the extent the Company concludes that it is
more likely than not that this amount will be realized. Tax credits in the
amount of $312,000 for alternative minimum taxes have no expiration. Other tax
credits in the amount of $350,000 will expire on various dates from 2013 through
2022, if not utilized.

9.      ISSUANCE OF STOCK, OPTIONS, AND WARRANTS

        In December 2003, the Company issued and sold 791,172 shares of common
stock, options to purchase 122,292 shares of common stock, and warrants to
purchase 174,057 shares of common stock for an aggregate purchase price of
$10,095,332 in a private placement. The Company received net proceeds of
$9,389,000 (net of fees and expenses). The


                                       62
<PAGE>

purchase price of the common stock was $12.76 per share, which was at a 15%
discount from the five-day average price as of December 23, 2003. The options
have an exercise price of $16.51 per share and a nine-month life. The warrants
have an exercise price of $17.26 per share and a life of five years. The options
and warrants were valued at $245,000 and $984,000, respectively, based on a
Black-Scholes calculation as of December 23, 2003 and pursuant to the provisions
of EITF Issue No. 00-19, "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock," (EITF 00-19)
were recorded at those values in short-term and long-term liabilities. The
balance of the net proceeds was accounted for as additional paid-in capital.
Under EITF 00-19, the Company marks-to-market the fair value of the options and
warrants at the end of each accounting period. At March 31, 2004, this resulted
in options and warrants valued at $195,000 and $916,000, respectively. The
decrease in the valuation of the options and warrants, between December 23, 2003
and March 31, 2004, of $118,000 was recorded as other income in the accompanying
consolidated statements of operations and resulted from a decrease in the
Company's stock price. On February 6, 2004, the Company and the investors
entered into an amendment to their original agreement, that resulted in the
reclassification of the options and warrants to equity. The amendment clarified
that the options and warrants granted in the financing may be exercised at a
time when a registration statement covering the resale of the underlying share
is not effective or available and that in such instance the Company would
deliver to the investors shares of common stock whose resale is not currently
registered. On the effective date of the amendment, the option and warrant value
was reclassified to equity as additional paid-in capital. As a result of the
increase in the value of the options and warrants from the closing date to the
amendment date due to increases in the Company's stock price, the Company
recognized an expense of $211,000 which is included in other expense in the
consolidated statements of operations for the fourth quarter of fiscal 2004. The
Company is subject to certain indemnity provisions included in the stock
purchase agreement entered into as part of the financing in connection with its
registration of the resale of the common stock issued and issuable in the
financing. Morgan Keegan & Company, Inc. acted as the Company's placement agent
for this transaction and was granted warrants to purchase 15,824 shares of
common stock.

10.     ACQUISITION

        On March 31, 2004, the Company completed its acquisition of 100% of two
related German card companies, Challenge Card Design Plastikkarten GmbH of
Rastede, Germany, and cards & more GmbH of Ratingen, Germany (collectively, the
Acquired German Entities), including their sales operations in the USA and
Korea. The Company purchased the shares of the Acquired German Entities from
their five shareholders (the Shareholders) and purchased the intangible assets
of the USA sales operation from a partnership comprised of the Shareholders. In
the acquisition transaction, the Company agreed to assume approximately 0.5
million euros of debt and to pay approximately 4.75 million euros in cash,
consisting of approximately 2.25 million euros payable at closing and the
remaining approximately 2.5 million euros payable in five equal annual
installments for the business and certain assets. The agreement specified that
the purchase price be adjusted based upon other assets purchased and additional
liabilities assumed. This resulted in a reduction in the purchase price of
approximately 0.4 million euros as of March 31, 2004. This purchase price was
determined by negotiation between the Company and the Shareholders, taking into
account such matters as the value of the tangible assets and the going concern
value of the business operations of the Acquired German Entities. Four of the
Shareholders entered into new employment agreements with the Acquired German
Entities while the fifth Shareholder, who is resident in the US, entered into an
employment agreement with registrant. In addition to salaries, these employment
agreements provide for commission based upon the results of operations of the
Acquired German Entities which could be as much as 3.75 million euros over the
next five years. The Company used a portion of its available cash to fund the
acquisition. The Shareholders had no previous material relationship with the
Company or its affiliate or subsidiaries, although the Company did substantial
business with the Acquired German Entities during recent years. One of the
Acquired German Entities owns a plant in Rastede, Germany together with
associated equipment which it has used to manufacture plastic cards featuring
contactless IC chip technology and high resolution printing. The Company intends
to continue to use the facility and equipment to produce such cards as well as
to enhance the facility to produce LaserCard optical memory cards.

        The primary reasons for the acquisition were to provide the Company with
(1) a strong card manufacturing base to serve the European, Middle Eastern,
African, and Asian markets; (2) additional production capacity of up to 20
million advanced-technology cards per year; (3) an expanded product line;
namely, contact IC chip cards, contactless RF ID cards, magnetic stripe cards,
and color thermal printers for printing on cards; and (4) future cooperation in
developing and marketing advanced, secure optical card solutions.


                                       63
<PAGE>

        Goodwill is derived when the purchase price is greater than the value of
the tangible and intangible assets acquired less the liabilities assumed.
Factors that contributed to a purchase price that resulted in goodwill were (1)
the assembled workforce, in particular the managing directors of the acquired
companies; (2) the proximity of the managing directors to the target customer
base; and (3) the ability of the managing directors to use their skills and
specific know-how to enhance the Company's product offerings in the advanced
technology card marketplace. Goodwill resulting from the purchase price
allocation in the amount of $3,321,000 was recorded as a result of the
acquisition. None is expected to be deductible for income tax purposes.

        An intangible asset for backlog in the amount of $29,000 was recorded as
a result of the acquisition. This will be amortized as the backlog is shipped,
which period is estimated at six months. There were no other amortizable
intangible assets recorded.

        The results of operations of the acquired entities from the acquisition
date to year end have not been included in the Company's 2004 operating results,
as the acquisition occurred at the end of the Company's fiscal year, and the
acquired entities' results during this period were not material. The cost of the
acquired entities totaled $5,251,000, comprised of $3,101,000 paid up-front plus
future payments specified in the purchase agreement with a net present value of
$2,150,000.

        The total purchase price of $5,251,000 has been allocated to the net
assets acquired based on estimated fair values as follows (in thousands):

           Current assets                                    $ 4,577
           Property and equipment                              2,094
           Goodwill and other intangibles                      3,840
                                                             -------
                Total assets acquired                         10,511
                                                             =======

           Current liabilities                                (4,891)
           Long-term debt                                       (369)
                                                             -------
                Total liabilities assumed                     (5,260)
                                                             =======

           Net assets acquired                               $ 5,251
                                                             =======

           Cash paid                                           3,101

           Future payments accrued                             2,150
                                                             -------

                Total purchase price                         $ 5,251
                                                             =======

        Pro-forma financial information for the impact of the acquisition on the
Company's consolidated results of operations has not been presented as the
Acquired German Entities were foreign entities who did not prepare financial
statements in accordance with United States Generally Accepted Accounting
Principles (U.S. GAAP). Reported revenues, excluding sales to the Company, for
fiscal 2002 and 2003 for the entities on a local GAAP basis were $8,654,000 and
$8,580,000, respectively. On a similar local GAAP basis, which management
believes does not materially differ from U.S. GAAP, results of operations of the
acquired entities would not be material to the Company's consolidated results of
operations.


                                       64
<PAGE>

11.     DEBT

        Debt at March 31 consisted of the following (in thousands):

                                                                       2004
                                                                       ----

Unsecured promissory notes at 7.5% - 10%                            $    726
Notes secured by equipment at 4.04% - 7.4%                               668
Notes secured by acquired companies at 6% discount rate                2,150
                                                                    --------
     Total debt                                                        3,544
Less current portion of long-term debt and bank borrowings             1,166
                                                                    --------
     Long-term debt                                                 $  2,378
                                                                    ========

        All debt is denominated in euros (2,883,000 euros equals $3,544,000 as
of March 31, 2004) and is related to the acquisition of Challenge Card Design
GmbH and cards & more GmbH. Managing Directors of cards & more GmbH have
personally guaranteed $188,000 of the unsecured promissory notes. In connection
with the acquisition, the Company has agreed to take actions to eliminate this
guarantee and anticipates to liquidate the unsecured promissory notes and notes
secured by equipment during fiscal 2005.

        Interest on the promissory notes is variable and based on a margin over
the Bundesbank discount rate. Notes secured by equipment are collateralized by
the underlying equipment. Under the terms of the agreements, principal and
interest are due monthly over original maturity periods that range from five to
twelve years. The notes are due on dates ranging from December 2004 through
January 2007 and contain certain covenant and default provisions that require
the Company to provide financial statements on an annual basis. At March 31,
2004 the Company was in compliance with all covenants under the agreements.

        Debt in the amount of $2,150,000 arising from the acquisition of
Challenge Card Design GmbH and cards & more GmbH is payable to the Managing
Directors of the acquired companies and is payable annually at twelve-month
anniversaries of the purchase agreement subject to certain deductions that
relate to the purchased assets and assumed liabilities.

        The outstanding debt obligations mature in future fiscal years as
follows (in thousands):

           Fiscal Year                             Total Debt

               2005                                 $   1,166
               2006                                       792
               2007                                       640
               2008                                       487
               2009                                       459
                                                    ---------
                  Total                             $   3,544
                                                    =========

        The credit lines at banks associated with the acquired German companies
totaled 910,000 euros ($1,119,000 as of March 31, 2004). A portion of these
notes are personally guaranteed by the Managing Directors of cards & more GmbH.
The Company has agreed to take actions to remove this guarantee during fiscal
2005.


                                       65
<PAGE>
<TABLE>
<CAPTION>
                                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
                                    (In thousands, except per share amounts)


                                           1st Quarter      2nd Quarter        3rd Quarter          4th Quarter
                                           -----------      -----------        -----------          -----------

<S>                                         <C>              <C>                 <C>                 <C>
Fiscal 2003:
   Product sales                            $  6,588         $  9,493            $  4,490            $  4,650
   License and other revenue                      --               --                 875                 235
   Total revenues                              6,588            9,493               5,365               4,885
   Cost of product sales                       3,285            5,095               2,580               2,946
   Net income (loss)                             659            1,375                 397                (149)
   Net income (loss) per share:
       Basic                                $    .06         $    .13            $    .04            $   (.01)
       Diluted                              $    .06         $    .13            $    .04            $   (.01)
   Weighted average number of common
       and common equivalent shares:
       Basic                                  10,300           10,314              10,376              10,433
       Diluted                                11,117           10,764              10,788              10,433

Fiscal 2004:
   Product sales                            $  2,446         $  2,708            $  5,467            $  6,342
   License and other revenue                      --               --                  --                  --
   Total revenues                              2,446            2,708               5,467               6,342
   Cost of product sales                       2,556            2,526               3,905               4,170
   Net loss                                   (1,456)          (1,744)             (8,864)               (363)
   Net loss per share:
       Basic                                $   (.14)        $   (.17)           $   (.83)           $   (.03)
       Diluted                              $   (.14)        $   (.17)           $   (.83)           $   (.03)
   Weighted average number of common
       and common equivalent shares:
       Basic                                  10,478           10,553              10,631              11,381
       Diluted                                10,478           10,553              10,631              11,381
</TABLE>

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

(1)     During the second quarter of fiscal 2003, for the first time, the
        Company received a fixed schedule for shipments out of a secure,
        government-funded vault built on Company premises. Revenue on all of the
        2.17 million cards located in the vault was recognized upon the receipt
        of such fixed shipment schedule. Had the Company not received this fixed
        schedule, revenues for the fiscal 2003 second quarter would have been
        based only on shipment of cards out of the vault, as in the past, which
        would have reduced revenue by approximately $6.9 million for the three
        months ended September 30, 2002.


                                       66
<PAGE>

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

Not applicable.


ITEM 9A.   CONTROLS AND PROCEDURES

        EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's
principal executive officers and principal financial officer have evaluated the
Company's disclosure controls and procedures (as defined in Exchange Act Rules
13a-14(c) and 15d-14(c)) as of the end of the period covered by this Form 10-K
and have determined that they are reasonable taking into account the totality of
the circumstances.

        CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
significant changes in the Company's internal control over financial reporting
that occurred during the period covered by this Form 10-K that have materially
affected, or are reasonably likely to materially affect, such control.


                                       67
<PAGE>

                                    PART III
                                    --------

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

A.      DIRECTORS AND EXECUTIVE OFFICERS

<TABLE>
<CAPTION>
                                       Officer or
                                        Director
      Name                      Age      Since       Position with Registrant and, If Different, Principal Occupation
      ----                      ---      -----       ----------------------------------------------------------------
<S>                             <C>      <C>         <C>
Jerome Drexler                  76       1968        Chairman of the Board of Directors of Drexler Technology
                                                     Corporation and its wholly owned subsidiary, LaserCard Systems
                                                     Corporation (LSC). Previously was Chief Executive Officer of
                                                     Drexler Technology Corporation (1968-September 2003) and LSC
                                                     (1989-September 2003).

Richard M. Haddock              52       1997        Director (since 2001) and Co-Chief Executive Officer (since
                                                     September 2003) of Drexler Technology Corporation and LaserCard
                                                     Systems Corporation (LSC). President (since 1989) of LSC.
                                                     Previously was President and Chief Operating Officer of Drexler
                                                     Technology (1997-2003) and Chief Operating Officer of LSC
                                                     (1989-2003).

Christopher J. Dyball           53       1992        Director (since 2001) and Co-Chief Executive Officer (since
                                                     September 2003) of Drexler Technology Corporation and its wholly
                                                     owned subsidiary, LaserCard Systems Corporation (LSC). Assistant
                                                     Treasurer (since 1998) of Drexler Technology and LSC. Previously
                                                     was Executive Vice President and General Manager, Card
                                                     Manufacturing, of Drexler Technology Corporation (1992-2003).

Steven G. Larson               54        1987        Vice President of Finance, Treasurer, and Assistant Secretary of
                                                     Drexler Technology Corporation and its wholly owned subsidiary,
                                                     LaserCard Systems Corporation.

Arthur H. Hausman              80        1981        Director. Private investor. Retired Chairman, President, and
                                                     Chief Executive Officer of Ampex Corporation (manufacturer of
                                                     professional audio-video systems, data/memory products, and
                                                     magnetic tape). Director of California Amplifier, Inc.
                                                     (low-noise amplifiers).

Dan Maydan                     68        1998        Director. President Emeritus (since April 2003), Director (since
                                                     1992), and former President (December 1993 to April 2003) of
                                                     Applied Materials, Inc. (semiconductor manufacturing equipment).
                                                     Director of Electronics for Imaging, Inc. (software). Member of
                                                     the National Academy of Engineering.

William E. McKenna             84        1970        Director. Private investor. Director of WMS Industries, Inc.
                                                     (coin-operated video and other games). Certified Public Accountant
                                                     (New York and California).

Walter F. Walker               49        1999        Director. President, CEO, and Director (since 2001) of The
                                                     Basketball Club of Seattle, LLC, which owns the Seattle Sonics &
                                                     Storm Basketball teams (NBA and WNBA basketball); formerly
                                                     President (since 1994) of Seattle SuperSonics NBA basketball team.
                                                     Previously, was President (in 1994) of Walker Capital, Inc. (money
                                                     management firm) and Vice President (from 1987 to 1994) of Goldman
                                                     Sachs & Co. (investment banking firm). Director of Advanced Digital
                                                     Information Corporation (archival and backup data-storage
                                                     peripherals). National Trustee of Boys & Girls Clubs of America.
                                                     Member of the Institute of Chartered Financial Analysts (CFAs).
</TABLE>

        It is anticipated that each of the remaining directors and executive
officers will continue in his position, although there is no understanding or
arrangement to that effect. Each director holds office until the next annual
meeting of stockholders and until such director's successor is elected and
qualified. However, any of the above directors or executive officers could
resign, and any of the officers could be replaced or removed by the Board of
Directors at any time. There are no family relationships among any directors or
executive officers of the Company.


                                       68
<PAGE>

B.      SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

        Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors, executive officers, and beneficial owners of
more than 10% of the Company's common stock to file with the Securities and
Exchange Commission (SEC) initial reports of ownership and reports of changes in
ownership of common stock and other equity securities of the Company. The
Company typically files these reports on behalf of its directors and officers,
based on information provided by them. The Company believes, based on its review
of Forms 3, 4, 5, if any, and periodic written representations from reporting
persons, that all other officers, directors, and holders of more than 10% of the
Company's common stock complied with all Section 16(a) filing requirements for
the 2004 fiscal year. The Company's website at www.drexlertechnology.com
contains copies of the fiscal 2004 and subsequent filings of Forms 3, 4, and 5
related to beneficial ownership by the Company's directors and executive
officers, and the SEC's EDGAR database website at
www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=30140&owner=only contains
this information as soon as it is posted by the SEC.

C.      AUDIT COMMITTEE FINANCIAL EXPERT

        The Audit Committee of our Board of Directors contains at least one
"audit committee financial expert." The name of the Audit Committee financial
expert is William E. McKenna, and the Board of Directors has determined that he
is "independent" as that term is defined Item 7(d)(3)(iv) of Section 14A of the
Securities and Exchange Act, as amended (the "Exchange Act").

D.      CODE OF ETHICS

        The Company has adopted a code of ethics that applies to all Company
employees. A copy of this code of ethics is accessible free of charge on the
Company's Internet website for investor relations (www.drexlertechnology.com).
Information contained on the Company's website is not part of this report.

ITEM 11.   EXECUTIVE COMPENSATION

A.      COMPENSATION OF EXECUTIVE OFFICERS

        The Summary Compensation table below discloses the total compensation
paid to each of the Company's four executive officers for the three fiscal years
ended March 31, 2004, for services rendered in all capacities to the Company and
its subsidiaries.

<TABLE>
<CAPTION>
                                               SUMMARY COMPENSATION TABLE

                                                 Annual Compensation        Long-Term Compensation
                                                 -------------------        ----------------------
                                  Fiscal                                     Securities Underlying        All Other
Name and Principal Position        Year        Salary ($)      Bonus ($)       Option Grants (#)       Compensation(1)
---------------------------        ----        ----------      ---------       -----------------       ---------------

<S>                                <C>         <C>             <C>               <C>                    <C>
Jerome Drexler                     2004        $  251,947          --                     --                    --
  Chairman of the Board            2003           245,405          --                     --                    --
                                   2002           237,972          --                     --                    --

Richard M. Haddock                 2004        $  318,176          --                     --              $     --
  Co-Chief Executive Officer       2003           282,158          --                 50,000                 6,250
  (since September 1, 2003)        2002           263,645          --                 30,000                 5,437

Christopher J. Dyball              2004        $  314,408          --                     --              $     --
  Co-Chief Executive Officer       2003           263,109          --                 50,000                 6,250
  (since September 1, 2003)        2002           256,763          --                 30,000                 5,437

Steven G. Larson                   2004        $  250,150          --                     --              $     --
  Vice President of Finance        2003           217,217          --                 35,000                 6,123
  and Treasurer                    2002           207,810          --                 12,000                 5,437
</TABLE>
---------------------

(1)     Represents the Company's matching contribution on behalf of these
        individuals in the Company's 401(k) Plan.


                                       69
<PAGE>

STOCK OPTION GRANTS TO EXECUTIVE OFFICERS

        There were no stock options granted to the Company's four executive
officers under the Company's Stock Option Plan during the 2004 fiscal year ended
March 31, 2004.

AGGREGATED OPTION EXERCISES AND OPTIONS HELD BY EXECUTIVE OFFICERS

        The following table sets forth the value of options exercised by the
Company's executive officers during the fiscal year ended March 31, 2004, and
remaining options held at fiscal year end.

<TABLE>
<CAPTION>
                                     AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                                            AND FISCAL YEAR-END OPTION VALUES

                                                              Number of Securities
                                 Shares                      Underlying Unexercised             Value of Unexercised
                                Acquired                           Options at                 In-the-Money Options at
                                   on         Value           Fiscal Year-End (#)              Fiscal Year-End ($)(2)
                                Exercise     Realized         -------------------              ----------------------
         Name                      (#)        ($)(1)       Exercisable  Unexercisable        Exercisable  Unexercisable
         ----                      ---        ------       -----------  -------------        -----------  -------------
<S>                             <C>         <C>              <C>            <C>                <C>            <C>
   Jerome Drexler                   --            --         155,000            --             $261,248           --
   Richard Haddock              18,000      $121,823         201,500        60,000             $264,154       $3,750
   Christopher Dyball               --            --         187,700        60,000             $236,460       $3,750
   Steven Larson                    --            --         132,417        37,250             $116,207       $1,500
</TABLE>

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

(1)     Market value of underlying securities (based on the fair market value of
        the Company's common stock on The Nasdaq Stock Market) at the time of
        their exercise, minus the exercise price.

(2)     Market value of securities underlying in-the-money options at fiscal
        year end (based on $13.375 per share, the average market price of the
        Company's common stock on The Nasdaq Stock Market on the last day of the
        Company's fiscal year) minus the exercise price.

B.      COMPENSATION OF DIRECTORS

        During the first four months of fiscal 2004, each director received a
fee of $1,200 per month for serving as a director, the standard fee in effect
since July 1995. On August 6, 2004, due to the increased corporate governance
responsibilities and oversight required of the Audit Committee and the Board of
Directors in light of regulatory and legislative changes, the monthly fee for
each person serving as director was increased to $1,500 per month. In addition,
the Board determined that Audit Committee members will be paid an additional
$5,000 per year, prorated over 12 months, except for the Chairman of the Audit
Committee, who will be paid an additional $10,000 per year, prorated over 12
months. The Company also reimburses reasonable out-of-pocket expenses incurred
by directors performing services for the Company.

        The Company's Stock Option Plan provides for the automatic grant of an
option to purchase 15,000 shares of the Company's common stock on the date any
person first becomes a director. These grants to newly elected directors have
become exercisable in cumulative increments of one-fourth (1/4) each at the end
of 12 months, 24 months, 36 months, and 48 months from the date of grant. The
Stock Option Plan further provides that on the date of the Company's annual
meeting, each non-employee director who has been a director of the Company for
the preceding six-month period and who is re-elected at the annual meeting, is
automatically granted an option to purchase 6,000 shares of the Company's common
stock. The option share grants to the re-elected directors are exercisable in
full at the time of grant. The exercise price for options granted to newly
elected directors and re-elected directors is the fair market value of the
Company's common stock on the date of grant.


                                       70
<PAGE>

C.      EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL
        ARRANGEMENTS

        None of the Company's executive officers has employment or severance
arrangements with the Company. Under the terms of the Stock Option Plan, the
Board of Directors and/or Stock Option Committee retains discretion, subject to
certain limits, to modify the terms of outstanding options. In the event of a
merger or sale of assets or like event, the Board of Directors is empowered to
make appropriate adjustments to options under the Stock Option Plan. The Board
of Directors has adopted guidelines specifying the following as adjustments that
it would consider appropriate upon the occurrence of such an event:

        o       permitting optionees no less than 30 days to exercise the vested
                portion of their options;

        o       having the successor corporation either (a) issue to optionees
                replacement options for the unvested portions of options, or
                else (b) pay deferred compensation on the spread between the
                value of Company stock upon the occurrence of such event and the
                option exercise price at the time such unvested portion would
                have vested; and

        o       providing for vesting of 100% of the unvested portion for
                optionees employed by the Company for at least two years prior
                to such event if their employment is terminated within one year
                of such event by the successor corporation other than by
                resignation or for acts of moral turpitude.

D.      COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

        During fiscal 2004, none of the Company's executive officers served on
the board of directors of any entities whose directors or officers serve on the
Company's Compensation Committee. During fiscal 2004, Mr. McKenna and Dr. Maydan
served as members of the Compensation Committee, which is currently composed
entirely of two outside directors who are not officers or employees of the
Company. As presently established, the Compensation Committee approves the
salary of executive officers, including the Co-Chief Executive Officers, and
certain other employees.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The table below, based upon information supplied by the principal
stockholders, shows the name, address, number of shares held, nature of
ownership, and percentage of shares held as of March 31, 2004 by the persons or
entities known to the Company to own beneficially more than 5% of the
outstanding common stock. Applicable percentages are based on 11,399,764 shares
outstanding on March 31, 2004.


                 BENEFICIAL OWNERSHIP BY PRINCIPAL STOCKHOLDERS

                                                          Common      Percent of
     Name and Address of Beneficial Owner               Shares (1)     Class (2)
     ------------------------------------               ----------    ----------

Jerome Drexler, c/o Drexler Technology Corporation,     662,110 (3)      5.7%
1077 Independence Avenue, Mountain View, CA 94043

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

(1)     The stockholder named in this table has sole voting and investment power
        with respect to the shares indicated as beneficially owned, subject to
        community property laws, where applicable, and the information contained
        in the footnotes to this table.

(2)     For purposes of computing the percentage of outstanding shares held by
        each person or group of persons named above on a given date, shares
        which such person or group has the right to acquire within 60 days after
        such date are deemed to be outstanding, but are not deemed to be
        outstanding for the purposes of computing the percentage ownership of
        any other person.

(3)     Includes 155,000 shares purchasable by exercise of option within 60
        days. Does not include 7,700 shares owned by Mr. Drexler's wife, as to
        which shares Mr. Drexler disclaims any beneficial ownership. Includes
        7,700 shares held by The Drexler Foundation, the assets of which are
        perpetually dedicated to charity. The power to vote and to dispose of
        the shares held by The Drexler Foundation is shared by the Foundation's
        directors, consisting of Mr. Drexler and his wife. Mr. Drexler disclaims
        beneficial ownership with respect to these shares.


                                       71
<PAGE>

        The following table contains information as of March 31, 2004,
respecting the number of shares and percentage of the Company's common stock
beneficially owned by each of the Company's seven directors, by each executive
officer of the Company, and by all executive officers and directors as a group.
The address of each beneficial owner listed in the table is c/o Drexler
Technology Corporation, 1875 North Shoreline Boulevard, Mountain View,
California 94043. Applicable percentages are based on 11,399,764 shares
outstanding on March 31, 2004.

<TABLE>
<CAPTION>
               STOCK OWNERSHIP BY DIRECTORS AND EXECUTIVE OFFICERS

      Name                                       Common Shares (1)      Percent of Class (2)
      ----                                       -----------------      --------------------
<S>                                              <C>                    <C>
Jerome Drexler                                       662,110 (3)                5.7%
Christopher J. Dyball                                196,451 (4)                1.7%
Arthur H. Hausman                                     62,392 (5)                0.5%
Richard M. Haddock                                   210,650 (6)                1.8%
Steven G. Larson                                     135,572 (7)                1.2%
Dan Maydan                                            39,000 (8)                0.3%
William E. McKenna                                    89,483 (9)                0.8%
Walter F. Walker                                      69,250 (10)               0.6%
All executive officers and directors as a group    1,464,898 (11)              12.0%
</TABLE>

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

(1)     To the Company's knowledge, the persons named in the table have sole
        voting and investment power with respect to all shares of common stock
        shown as beneficially owned by them, subject to community property laws,
        where applicable, and the information contained in the footnotes to this
        table.

(2)     For purposes of computing the percentage of outstanding shares held by
        each person or group of persons named above on a given date, shares
        which such person or group has the right to acquire within 60 days after
        such date are deemed to be outstanding, but are not deemed to be
        outstanding for the purposes of computing the percentage ownership of
        any other person.

(3)     Includes 155,000 shares purchasable by exercise of option within 60
        days. Does not include 7,700 shares owned by Mr. Drexler's wife, as to
        which shares Mr. Drexler disclaims any beneficial ownership. Includes
        7,700 shares held by The Drexler Foundation, the assets of which are
        perpetually dedicated to charity. The power to vote and to dispose of
        the shares held by The Drexler Foundation is shared by the Foundation's
        directors, consisting of Mr. Drexler and his wife. Mr. Drexler disclaims
        beneficial ownership with respect to these shares.

(4)     Includes 187,700 shares purchasable by exercise of option within 60
        days.

(5)     Includes 42,000 shares purchasable by exercise of option within 60 days.

(6)     Includes 201,500 shares purchasable by exercise of option within 60
        days.

(7)     Includes 132,417 shares purchasable by exercise of option within 60
        days.

(8)     Includes 39,000 shares purchasable by exercise of option within 60 days.

(9)     Includes 54,000 shares purchasable by exercise of option within 60 days.

(10)    Includes 37,000 shares purchasable by exercise of option within 60 days.
        Does not include 1,000 shares owned by Mr. Walker's wife, as to which
        shares Mr. Walker disclaims any beneficial ownership.

(11)    Includes 848,617 shares purchasable by exercise of option within 60
        days.


                                       72
<PAGE>

                      EQUITY COMPENSATION PLAN INFORMATION

        The table below shows information as of March 31, 2004, with respect to
equity compensation plans under which equity securities of the Company are
authorized for issuance. The Company's equity compensation plans, consisting of
the Stock Option Plan and Employee Stock Purchase Plan, are approved by security
holders.

<TABLE>
<CAPTION>
                                  Number of Securities to Be      Weighted-Average           Number of Securities Remaining
                                    Issued upon Exercise of      Exercise Price of        Available for Future Issuance under
                                     Outstanding Options,       Outstanding Options,      Equity Compensation Plans (Excluding
         Plan Category               Warrants, and Rights       Warrants, and Rights       Securities Reflected in Column (a))
         -------------               --------------------       --------------------       -----------------------------------
                                              (a)                       (b)                               (c)
<S>                                        <C>                         <C>                            <C>
Equity compensation plans
approved by security holders               1,909,059                   $13.52                         288,604 (1)

Equity compensation plans
not approved by security
holders (Nasdaq
exemption Rule No.                           120,000                    13.36                               0
4350(i)(1)(A))
</TABLE>

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

(1)     Includes 64,208 shares reserved as of March 31, 2004 for future
        purchases by employees through payroll deductions under the Company's
        Employee Stock Purchase Plan, which is available to all regular
        employees who work a minimum of 30 hours per week and who have completed
        six months of employment with the Company.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        On October 21, 2001, the Company entered into a one-year agreement with
Wexler & Walker Public Policy Associates, a unit of Hill and Knowlton, Inc.,
("Wexler") to be lobbyists on behalf of the Company. The Chairman of Wexler is
Robert S. Walker, a brother of director Walter F. Walker. In October 2002, the
agreement was extended for the period October 1, 2002 through September 2003 or
until terminated upon seven days' notice. The extended agreement provided for a
monthly retainer of $10,000, and there currently is a purchase order dated
December 11, 2003, valid through September 30, 2004 with the same terms and
conditions of the previous agreement. The Company paid $24,245 to Wexler during
fiscal 2002; $82,985 during fiscal 2003; and $151,147 during the fiscal 2004.
There were no significant amounts due to Wexler as of March 31, 2003 or 2004.


                                       73
<PAGE>

ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

AUDIT AND NON-AUDIT FEES

        The following table shows the aggregate fees billed to the Company by
its previous independent accountants, PricewaterhouseCoopers LLP ("PwC") and its
current independent accountants, KPMG LLP ("KPMG"), for services related to
fiscal years 2003 and 2004.

<TABLE>
<CAPTION>
                                                               Fiscal 2003                              Fiscal 2004
                                                               -----------                              -----------

              Description of Fees                        PwC                 KPMG                 PwC                KPMG
              -------------------                        ---                 ----                 ---                ----
<S>                                                   <C>                   <C>                <C>                <C>
Audit fees related to annual financial
statements for fiscal 2004 and 2003 and
reviews of  financial statements included on
Form 10-K and Forms 10-Q, and other SEC
registration statements                               $ 314,450             $  0               $107,400 (1)       $ 391,060 (2)

Audit-related fees for audits of employee
benefit plans and due diligence services                      0                0                      0                   0

Tax consultation and tax compliance  services
                                                         16,500                0                      0              48,267 (3)
All other fees                                                0                0                      0                   0
</TABLE>

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

(1)     Includes PwC fees for review of the first quarter of fiscal 2004, $9,700
        for the transition from PwC to KPMG, and $82,700 for the S-8 and S-3
        registration statements filed in fiscal 2004.

(2)     Includes $144,260 for the fiscal 2004 nine-month audit and S-8 and S-3
        registration statements filed in fiscal 2004.

(3)     Includes $30,267 for tax consultation relating to the fiscal 2004
        acquisition of Challenge Card Design GmbH and cards & more GmbH.

        All audit and non-audit fees were approved by the Audit Committee. The
Company's policy on auditor independence does not permit the employment of its
independent auditor for material non-audit related services, except for the
following: services which are incidental and directly related to audit
activities, tax related activities and tax planning on behalf of the Company.
The Audit Committee considered whether the provision of services other than the
audit services is compatible with maintaining the auditors' independence.

PRE-APPROVAL POLICIES AND PROCEDURES

        It is the Company's policy that all non-audit services to be performed
by the Company's independent auditor be approved in advance by the Audit
Committee. The Company's policy on auditor independence requires that, prior to
engaging the independent auditor in any non-audit related activity other than
that specifically authorized by the Company's policy on auditor independence,
Company management report to the Audit Committee the nature of the proposed
activity, including the reasons why (i) it is necessary or beneficial to the
Company to use the independent auditor to engage in such activity, and (ii) the
steps being taken to ensure that the engagement of the independent auditor in
such activity will not, among other things, violate applicable laws or
regulations of the United States and applicable states, or the rules and
regulations of the Nasdaq Stock Market, on which the Company's securities are
listed. In order for the Company to engage the independent auditor in the
proposed activity, the Company must obtain Audit Committee approval.


                                       74
<PAGE>

                                     PART IV
                                     -------

ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(A)     LIST OF DOCUMENTS FILED AS PART OF THIS REPORT

        1.      The consolidated financial statements of the Company, filed
                herewith under Item 8, as follows:

                                                                           Page
                                       Description                        Number
                                       -----------                        ------

                (1)     Reports of Independent Registered Public
                        Accounting Firms                                    42

                (2)     Consolidated Balance Sheets at March 31, 2003
                        and March 31, 2004                                  44

                (3)     Consolidated Statements of Operations for
                        Fiscal Years 2002, 2003, and 2004                   45

                (4)     Consolidated Statements of Stockholders'
                        Equity for Fiscal Years 2002, 2003, and 2004        46

                (5)     Consolidated Statements of Cash Flows for
                        Fiscal Years 2002, 2003, and 2004                   47

                (6)     Notes to Consolidated Financial Statements          48

        2.      Financial Statement Schedules:

                The schedule supporting the Company's Consolidated Financial
                Statements, filed herewith under Item 14(d), as follows:

                Schedule                                                   Page
                 Number                Description                        Number
                 ------                -----------                        ------

                   --   Report of Independent Registered Public
                        Accounting Firms on Financial Statement Schedule    78

                   II   Valuation and Qualifying Accounts                   80

                Schedules not listed above are not applicable or not required,
                or the information required to be set forth therein is included
                in the consolidated financial statements or the notes thereto.

        3.      Exhibits:

                The Exhibits to this Report, filed herewith under Item 14(c) or
                incorporated by reference from other documents previously filed
                with the Securities and Exchange Commission, as follows:

                                                              Filed Herewith or
                Exhibit                                      Incorporated Herein
                Number                 Description             by Reference To
                ------                 -----------           -------------------

                  3.1   Amended and Restated Certificate     Exhibit 3.1.1 to
                        of Incorporation                     Report on Form 10-Q
                                                             for period ended
                                                             September 30, 2000

                  3.2.  Amended and Restated By-Laws         Exhibit 3.2 to
                                                             Report on Form 10-K
                                                             for fiscal year
                                                             ended March 31,
                                                             2002


                                       75
<PAGE>

                                                              Filed Herewith or
                Exhibit                                      Incorporated Herein
                Number                 Description             by Reference To
                ------                 -----------           -------------------

                 10.1   Building lease agreement with        Exhibit 10.1 to
                        Renault & Handley Employees          Report on Form 10-Q
                        Investment Co. for 2644-2648         for period ended
                        Bayshore Pkwy., Mountain View, CA    December 31, 2003

                 10.2   Building Lease Agreement with        Filed herewith as
                        Shoreline Park LLC for 1395          page 82.
                        Charleston Road, Mountain View, CA
                        (mailing address 1875 North
                        Shoreline Boulevard, Mountain View,
                        CA)

                 10.3*  Amended and Restated Stock Option    Exhibit 10.4.1 to
                        Plan                                 Report on Form 10-Q
                                                             for period ended
                                                             September 30, 2002

                 10.4   Patent License Agreement with        Exhibit 10.6 to
                        Nippon Conlux Co., Ltd.              Report on Form 10-K
                                                             for fiscal year
                                                             ended March 31,
                                                             1999

                 10.5   U.S. Government subcontract with     Exhibit 10.6 to
                        Information Spectrum Inc. (now       Report on Form 10-K
                        Anteon International) dated          for fiscal year
                        June 2, 2000                         ended March 31,
                                                             2001

                 10.6   Engagement Letter with Morgan        Exhibit 99.1 to
                        Keegan & Co., Inc. (as amended)      Report on Form 10-Q
                                                             for period ended
                                                             December 31, 2003

                 10.7   Stock and Warrant Purchase           Exhibit 99.2 to
                        Agreement (as amended)               Report on Form 10-Q
                                                             for period ended
                                                             December 31, 2003

                 10.8   Optical Card Manufacturing           Filed herewith as
                        License Agreement with Global        page 83.
                        Investments Group (portions
                        omitted pursuant to a request
                        for confidential treatment)

                 16.1   Letter re Change in Certifying       Exhibit 16 to
                        Accountants                          Report on Form 8-K
                                                             dated April 8, 2002

                 16.2   Letter re Change in Certifying       Exhibit 16.1 to
                        Accountants                          Report on Form 8-K
                                                             dated August 29,
                                                             2003

                 21     Subsidiaries of the Registrant       Filed herewith as
                                                             page 84.

                 23.1   Consent of Independent Registered    Filed herewith as
                        Public Accounting Firm (KPMG)        page 85.

                 23.2   Consent of Independent Registered    Filed herewith as
                        Public Accounting Firm               page 86.
                        (PricewaterhouseCoopers)

                 24     Power of attorney                    Filed herewith as
                                                             page 81.

                 31.1   Rule 13a-14(a) Certification of      Filed herewith as
                        Christopher J. Dyball,               page 87.
                        co-principal executive officer

                 31.2   Rule 13a-14(a) Certification of      Filed herewith as
                        Richard M. Haddock, co-principal     page 88.
                        executive officer


                                       76
<PAGE>

                                                              Filed Herewith or
                Exhibit                                      Incorporated Herein
                Number                 Description             by Reference To
                ------                 -----------           -------------------

                 31.3   Rule 13a-14(a) Certification of      Filed herewith as
                        Steven G. Larson, principal          page 89.
                        financial officer

                 32.1   Section 1350 Certification of        Filed herewith as
                        Christopher J. Dyball and Richard    page 90.
                        M. Haddock, co-chief executive
                        officers

                 32.2   Section 1350 Certification of        Filed herewith as
                        Steven G. Larson, chief financial    page 91.
                        officer


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

*Indicates management contract or compensatory plan or arrangement.


(B)     REPORTS ON FORM 8-K

        On January 23, 2004, the Company filed a Report on Form 8-K dated
January 23, 2004, which presented under Item 5 financial statements and
independent accountants' reports to reflect the change from those contained in
the Company's Form 10-K/A for the fiscal year ended March 31, 2003, to include
the segment reporting disclosure in Note 4 to the financial statements.

        On February 11, 2004, the Company filed a Report on Form 8-K dated
February 5, 2004, which reported under Item 12 the issuance of a press release
containing financial results for the fiscal 2004 third quarter ended December
31, 2003.

        On March 17, 2004, the Company filed a Report on Form 8-K dated March
16, 2004, which presented under Item 5 audited consolidated financial statements
as of and for the nine-month period ended December 31 2003, and as of March 31,
2003, and for the two years then ended, so that they could be incorporated into
the Company's then-pending Form S-3 Registration Statement.

(C)     EXHIBITS

        Exhibits 10.2, 10.8, 21, 23.1, 23.2, 24, 31.1, 31.2, 31.3, 32.1, and
32.2 are filed herewith.

(D)     FINANCIAL STATEMENT SCHEDULE

        Schedule II to the Company's consolidated financial statements is on
page 80.


                                       77
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                         ON FINANCIAL STATEMENT SCHEDULE




The Board of Directors and Stockholders
Drexler Technology Corporation:

        The audit referred to in our report dated June 9, 2004, included the
related financial statement schedule as of March 31, 2004, and for the year then
ended, included in this Annual Report on Form 10-K. The financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on the financial statement schedule based on our audit.
In our opinion, such financial statement schedule, when considered in relation
to the consolidated financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.



/s/ KPMG LLP
Mountain View, California
June 9, 2004


                                       78
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                         ON FINANCIAL STATEMENT SCHEDULE




To the Board of Directors
of Drexler Technology Corporation:

       Our audit of the consolidated financial statements of Drexler Technology
Corporation referred to in our report dated April 28, 2003, except for Note 4,
as to which the date is January 22, 2004, which report and consolidated
financial statements are included in this Annual Report on Form 10-K, also
included an audit of the financial statement schedule for Fiscal 2003 and Fiscal
2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial
statement schedule presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.



/s/ PricewaterhouseCoopers LLP
San Jose, California
April 28, 2003


                                       79
<PAGE>
<TABLE>
<CAPTION>

                                                                                                                      SCHEDULE II




                                         DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                                VALUATION AND QUALIFYING ACCOUNTS
                                    For the Fiscal Years Ended March 31, 2002, 2003, and 2004




                                     Balance at        Additions (Deletions)   Additions
                                     Beginning          Charged (Credited)     Charged to                            Balance at
       Description                   of Period          to Profit and Loss   Other Accounts       Deductions       End of Period
       -----------                   ---------          ------------------   --------------       ----------       -------------
<S>                                  <C>                <C>                  <C>                  <C>              <C>
Fiscal 2002:

    Product return reserve           $    234,000       $    (127,000)       $          --        $      7,000     $     100,000
                                     ============       =============        =============        ============     =============

    Deferred tax asset
       valuation allowance           $  8,408,000       $  (3,048,000)       $   1,499,000        $  1,541,000     $   5,318,000
                                     ============       =============        =============        ============     =============

Fiscal 2003:

    Product return reserve           $    100,000       $          --        $          --        $     10,000     $      90,000
                                     ============       =============        =============        ============     =============

    Deferred tax asset
       valuation allowance           $  5,318,000       $          --        $          --        $     64,000     $   5,254,000
                                     ============       =============        =============        ============     =============

Fiscal 2004:

    Product return reserve           $     90,000       $          --                   --        $      4,000     $      86,000
                                     ============       =============        =============        ============     =============

    Bad debt reserve                 $         --       $          --        $     210,000 (1)    $         --     $     210,000
                                     ============       =============        =============        ============     =============

    Deferred tax asset
       valuation allowance           $  5,254,000       $   8,940,000        $     557,000 (2)    $         --     $  14,751,000
                                     ============       =============        =============        ============     =============
</TABLE>

(1)     This represents the amount of bad debt reserve recorded against the
        accounts receivable of the acquired entities at the date of acquisition.

(2)     This amount relates to stock option deductions to be credited to
        additional paid-in capital when realized.


                                       80
<PAGE>

SIGNATURES

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

        Dated: June 15, 2004


        DREXLER TECHNOLOGY CORPORATION

By:  /s/ Christopher J. Dyball              By:   /s/ Richard M. Haddock
   -------------------------------             -------------------------------
        Christopher J. Dyball,                       Richard M. Haddock,
     Co-Chief Executive Officer                   Co-Chief Executive Officer

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Christopher J. Dyball, Richard M.
Haddock, and Steven G. Larson, and each of them, acting individually, as his
attorney-in-fact, each with full power of substitution and resubstitution, for
him and in his name, place and stead, in any and all capacities, to sign any and
all amendments to this Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully 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/ Christopher J. Dyball           Co-Chief Executive Officer                  June 15, 2004
--------------------------------    (Co-Principal Executive Officer)
Christopher J. Dyball


/s/ Richard M. Haddock              Co-Chief Executive Officer                  June 15, 2004
--------------------------------    (Co-Principal Executive Officer)
Richard M. Haddock


/s/ Steven G. Larson                Vice President of Finance and Treasurer     June 15, 2004
--------------------------------    (Principal Financial Officer and
Steven G. Larson                    Principal Accounting Officer)


/s/ Jerome Drexler                  Chairman of the Board of Directors          June 15, 2004
--------------------------------
Jerome Drexler


/s/ Arthur H. Hausman               Director                                    June 15, 2004
--------------------------------
Arthur H. Hausman


/s/ Dan Maydan                      Director                                    June 15, 2004
--------------------------------
Dan Maydan


/s/ William E. Mckenna              Director                                    June 15, 2004
--------------------------------
William E. McKenna


/s/ Walter F. Walker                Director                                    June 15, 2004
--------------------------------
Walter F. Walker
</TABLE>


                                       81
<PAGE>

                                INDEX TO EXHIBITS

                                  [ITEM 14(c)]
Exhibit
Number    Description
------    -----------

3.1       Amended and Restated Certificate of Incorporation; previously filed as
          Exhibit 3.1.1 to Report on Form 10-Q for period ended September 30,
          2000, and incorporated herein by reference

3.2       Amended and Restated By-Laws; previously filed as Exhibit 3.2. to
          Report on Form 10-K for fiscal year ended March 31, 2002, and
          incorporated herein by reference

10.1      Building lease agreement with Renault & Handley Employees Investment
          Co. for 2644-2648 Bayshore Parkway, Mountain View, CA; previously
          filed as Exhibit 10.1 to Report on Form 10-Q for period ending
          December 31, 2003, and incorporated herein by reference

10.2      Building lease agreement with Shoreline Park LLC for 1395 Charleston
          Road, Mountain View, CA (mailing address 1875 North Shoreline
          Boulevard, Mountain View, CA); filed herewith as page 82

10.3      Amended and Restated Stock Option Plan; previously filed as Exhibit
          10.4.1 to Report on Form 10-Q for period ended September 30, 2002, and
          incorporated herein by reference

10.4      Patent License Agreement with Nippon Conlux Co., Ltd.; previously
          filed as Exhibit 10.6 to Report on Form 10-K for fiscal year ended
          March 31, 1999, and incorporated herein by reference

10.5      U.S. Government subcontract with Information Spectrum Inc. (now Anteon
          International) dated June 2, 2000; previously filed as Exhibit 10.6 to
          Report on Form 10-K for fiscal year ended March 31, 2001, and
          incorporated herein by reference

10.6      Engagement Letter with Morgan Keegan & Co., Inc. (as amended);
          previously filed as Exhibit 99.1 to Report on Form 10-Q for period
          ended December 31, 2003

10.7      Stock and Warrant Purchase Agreement (as amended); previously filed as
          Exhibit 99.2 to Report on Form 10-Q for period ended December 31, 2003

10.8      Optical Card Manufacturing License Agreement with Global Investments
          Group (portions omitted pursuant to a request for confidential
          treatment); filed herewith as page 83

16.1      Letter re Change in Certifying Accountant; previously filed as Exhibit
          16 to Report on Form 8-K dated April 8, 2002

16.2      Letter re Change in Certifying Accountant; previously filed as Exhibit
          16.1 to Report on Form 8-K dated August 29, 2003

21        Subsidiaries of the Registrant; filed herewith as page 84

23.1      Consent of Independent Registered Public Accounting Firm (KPMG); filed
          herewith as page 85

23.2      Consent of Independent Registered Public Accounting Firm
          (PricewaterhouseCoopers); filed herewith as page 86

24        Power of Attorney; filed herewith as page 81

31.1      Rule 13a-14(a) Certification of Christopher J. Dyball, co-principal
          executive officer; filed herewith as page 87

<PAGE>

31.2      Rule 13a-14(a) Certification of Richard M. Haddock, co-principal
          executive officer; filed herewith as page 88

31.3      Rule 13a-14(a) Certification of Steven G. Larson, principal financial
          officer; filed herewith as page 89

32.1      Section 1350 Certification of Christopher J. Dyball and Richard M.
          Haddock, co-chief executive officers; filed herewith as page 90

32.2      Section 1350 Certification of Steven G. Larson, chief financial
          officer; filed herewith as page 91