<PAGE>   1
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

[Mark One]                          FORM 10-K

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

                    For the Fiscal Year Ended March 31, 1997

                                       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: 0-6377

                         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.)


1077 Independence Avenue, Mountain View, CA                         94043-1601
--------------------------------------------                      --------------
    (Address of principal executive offices)                        (Zip Code)

                                 (415) 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]

Based on the last trade price of the Company's Common Stock on The Nasdaq Stock
Market on June 19, 1997, the aggregate market value of the voting stock held by
non-affiliates of the registrant is approximately $80,044,000.

Number of outstanding shares of Common Stock, $.01 par value, at June 19, 1997:
9,212,066

                      DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement related to Registrant's 1997 Annual Stockholders
Meeting are incorporated by reference into Part III of this report.



<PAGE>   2

                                TABLE OF CONTENTS
<TABLE>
<CAPTION>

                                                        PART I                                             Page
                                                        ------                                             ----
<S>           <C>                                                                                            <C>
Item 1.       Business
                     General Development of Business...................................................       3
                     Financial Information about Industry Segments.....................................       4
                     Narrative Description of Business.................................................       4
                        LaserCard(R) Optical Memory Cards
                            Optical Data Storage.......................................................       4
                            The Drexon(R) Medium.......................................................       4
                            LaserCard Features.........................................................       4
                            Markets....................................................................       5
                            Writing and Reading........................................................       5
                            Card Storage Capacity......................................................       6
                            Prerecording...............................................................       6
                            Card Durability............................................................       6
                            Card Security..............................................................       7
                            International Standards....................................................       7
                        LaserCard Products
                            Card Manufacture...........................................................       8
                            Product Evolution..........................................................       8
                            Marketing and Technical Support............................................       9
                            System Software............................................................       9
                            The Role of VARs in Application Software...................................      10
                            Reader/Writers.............................................................      10
                            Other Peripherals..........................................................      11
                        Licensing
                            Basic Licenses and Upgrades................................................      11
                            Card Distribution Licenses.................................................      11
                            Card Manufacturing Licenses................................................      12
                        Competition
                            Competing Technologies.....................................................      12
                            Competing Optical Memory Cards.............................................      13
                        Other Matters
                            Research and Engineering...................................................      13
                            Patents and Trademarks.....................................................      14
                            Environment................................................................      14
                            Employees..................................................................      14
                        Risk Factors...................................................................      14
                        Forward-Looking Statements.....................................................      14
Item 2.       Properties    ...........................................................................      17
Item 3.       Legal Proceedings........................................................................      17
Item 4.       Submission of Matters to a Vote of Security Holders......................................      17

                                     PART II

Item 5.       Market for Registrant's Common Stock and Related Stockholder Matters.....................      18
Item 6.       Selected Financial Data..................................................................      19
Item 7.       Management's Discussion and Analysis of Financial Condition and Results of Operations....      20
Item 8.       Financial Statements and Supplementary Data
                     Report of Independent Public Accountants..........................................      24
                     Consolidated Financial Statements and Footnotes...................................      25
                     Quarterly Financial Information (Unaudited).......................................      36
Item 9.       Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....      37

                                    PART III

Item 10.      Directors and Executive Officers of Registrant...........................................      37
Item 11.      Executive Compensation...................................................................      37
Item 12.      Security Ownership of Certain Beneficial Owners and Management...........................      37
Item 13.      Certain Relationships and Related Transactions...........................................      37

                                     PART IV

Item 14.      Exhibits, Financial Statement Schedules, and Reports on Form 8-K.........................      38

</TABLE>


                                       -2-
<PAGE>   3

                                     PART I

ITEM 1.                 BUSINESS

(a)    General Development of Business

       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 September 17, 1987. Drexler Technology and its wholly owned
subsidiary, LaserCard Systems Corporation, (the "Company") develop, manufacture,
and market optical data storage products used with personal computers for
information recording, storage, and retrieval.

       The Company's product line consists of LaserCard(R) optical memory cards,
optical card data systems, and related system software. The Company's customers
are mainly value-added reseller (VAR) companies throughout the world that
develop commercial applications for LaserCard products. The target markets
include consumer, business, and government applications for portable,
recordable, secure, cumulative record cards. These applications include tamper-
resistant ID cards, healthcare cards, access cards/tickets, warranty/maintenance
records, and cargo manifests. The Company's revenues also include license fees
from the occasional sale of nonexclusive licenses and/or royalties under such
licenses.

       The history of the Company's optical data products business began while
the Company was a supplier of consumable products to the semiconductor industry.
Initially and for many years, the Company sold photomasks, photochemicals, and
emulsion-coated glass photoplates for integrated circuit production. During
experiments with glass photoplates as a possible data storage material, Company
personnel made discoveries which led to the development of a laser recording
medium (trademarked Drexon(R)) which is comprised of pure silver metal particles
suspended in a matrix. Later experiments with Drexon on a flexible substrate led
to the invention and patenting by the Company of a credit-card sized optical
memory card (trademarked LaserCard(R)) containing a reflective stripe of Drexon
material. The optical memory card is a laser-recordable, computer readable,
nonvolatile, data storage card. It offers multiple security features, can be
carried in a wallet, and stores over 4 megabytes of digital data.

       Over time, the Company's focus shifted to optical memory card product
development, manufacturing, marketing, and licensing, and the Company sold the
assets of two of its three semiconductor-related product lines. In 1991, the
Company began marketing optical memory card products through its subsidiary,
LaserCard Systems Corporation (LSC), which launched a value-added reseller
program for worldwide marketing and distribution of optical cards and card
systems. This program led to small commercial card sales by several VARs by
1993. Also in 1993, the last semiconductor-related product line was
discontinued, and optical memory card products became the Company's sole product
line. Meanwhile, the Company had established a card manufacturing facility with
a designed production capacity of up to 25 million optical cards per year,
depending upon card type and color-printing specifications. (For an explanation
of card production capacity, see Management's Discussion and Analysis.)

       By the end of calendar year 1996, orders were at levels of 5,000 to
100,000 cards per order, and VAR companies were marketing the LaserCard
internationally. However, the Company had not yet entered into long-term supply
agreements with any of its customers and did not have a consistent, large
backlog of orders. On February 19, 1997, the Company received a $7.1 million
order for 2 million optical memory cards to be used as "green cards" and "border
crossing cards" by the U.S. Immigration and Naturalization Service (INS), with
delivery scheduled from July of 1997 through May of 1998.

   Current commercial applications for the LaserCard include:

    -- INS immigration "green cards"      -- Laser eye surgery setup/key cards 
    -- INS border crossing cards          -- Shopping logs/secure entry cards  
    -- Other tamper-resistant ID cards    -- Secure soccer season tickets      
    -- Medical records cards              -- Military cargo manifests          
    -- Medical image storage cards        -- Vehicle repair/warranty cards     



                                       3
<PAGE>   4

(b)    Financial Information about Industry Segments

       Item 8, Consolidated Financial Statements and Supplementary Data,
contains industry segment information.

(c)    Narrative Description of Business

LASERCARD(R) OPTICAL MEMORY CARDS

Optical Data Storage

       Optical data storage systems use light to write and read information.
This information generally 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,
thereby, is converted into an electrical signal. These signals are then
translated by a microprocessor into text, graphics, voice, or pictures. A major
feature of optical data storage systems is that large amounts of data can be
stored on a relatively small media surface area since the data spots are
microscopic in size and tightly compacted.

       A read/write optical data storage system is comprised of a medium onto
which digital information is recorded using a laser, equipment which writes and
reads the digital information (a "reader/writer"), system software, and
application software. The Company does not manufacture reader/writers but
purchases them from a licensed supplier and resells them to customers. The
Company develops system software and customers develop the application-specific
software. The Company produces and sells its data storage medium in the form of
laser-recordable, optical memory cards.

       The general advantages of optical card storage systems over magnetic or
semiconductor memories typically include high storage capacity, durability, low
cost per bit stored, and resistance to accidental erasure or data degradation by
magnetic fields. Magnetic and most semiconductor media are updatable and
erasable. The Company's optical cards are not erasable but are updatable and
correctable. Permanent data storage is desired for a number of uses--such as ID,
medical, access, and cargo manifest cards. The Company believes that updatable,
nonerasable optical memory cards will constitute an important segment of the
market for portable data storage.

The Drexon(R) 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 which contains a thin layer of silver particles. Using
proprietary and patented processes, the Drexon medium is produced by chemical
conversion of photographic emulsions. This creates a gold-colored, mirror-like,
reflective recording surface. As explained under "Prerecording," Drexon allows
data to be prerecorded by photolithography and recorded by laser.

       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. The Drexon medium also is classified as WORM (write- once,
read-many times). WORM means that data can be laser written and read at any
time, but once an area is recorded, that same area may not be overwritten with
new data. Data can be added to the Drexon medium over a period of days, weeks,
or years. Using software, previously recorded data can be modified, corrected,
or updated. Obsolete data is ignored by the system but remains permanently
stored on the Drexon material as an audit trail of all data. (See "Card
Security.") Because Drexon is a nonvolatile (nonerasable) storage medium, it is
not vulnerable to data loss or damage when exposed to electronic signals or
magnetic fields.

LaserCard Features

       The LaserCard optical memory card is constructed of three layers of
electron-beam laminated polycarbonate plastic, with the Drexon laser-recording
material bonded within the center of the laminate. The LaserCard is the size,
shape, and thickness of a standard credit card so that it can be carried in the
wallet. The typical wholesale price to VARs is $4 to $5 per card when the
LaserCard is ordered in the thousands.



                                       4
<PAGE>   5

       Some of the significant features and benefits of the LaserCard are:

--Permanent/nonvolatile, recordable, updatable
--Low cost per card
--Compact and durable card construction--suitable for wallet environment 
--High data storage capacity for its credit-card size 
--Off-line or on-line capability 
--High difficulty of forging, counterfeiting, tampering 
--Audit trail of all data and updates 
--Computer-readable (digital) security options--such as biometric identifiers, 
  user codes, photographs, data encryption, digital data interleaved within 
  images
--Visible, card initialization security options--thermally printed text,
  photograph, and images; optical watermark with laser-recorded "embedded
  holograms" of custom micro-images
--Visible, factory-printed security options--emblems, logos, watermarks
--Optional add-on of other technologies--integrated circuit (IC) chip,
  magnetic stripe, RF taggants, conventional hologram, signature panel,
  OCR, bar code

Markets

       The LaserCard is designed primarily for carrying useful, time-saving,
cost-saving, or life-saving data in the wallet and for sequentially recording
and storing information in a secure, permanent mode. It is targeted toward the
following types of information systems:

--     Data recording and transaction systems--for medical records and health
       cards, warranty/service records, cargo manifests, other databases, and
       transaction security

--     Identification systems--for secure tickets and entry passes, immigration
       cards (e.g., INS "green cards" and border crossing cards), and other
       tamper-resistant ID cards

--     Image storage systems--for medical images such as MRI (magnetic resonance
       imaging) studies, CT (computed tomography) scans, X-rays; and for
       document images, photographs, and graphics

Writing and Reading

       A low-power, semiconductor-diode laser is used to write information onto
the LaserCard. The laser is about the size of a thumbtack and is housed inside
an optical card reader/writer. The LaserCard is inserted into a slot in the
reader/writer, which is connected to a personal computer. Information is
recorded by focusing a laser beam through the upper clear layer of the card and
forming microscopically small spots onto the embedded optical stripe, so that
recorded information is protected deep inside the card structure. The recorded
spots represent digital data, the language of computers.

       Since the reader/writer is connected to a personal computer, data can be
entered onto the card from the computer's memory or by using the computer's
keyboard. Equipment such as fax machines, medical imaging devices, document
scanners, or even other data storage media also can transfer data, through a
personal computer, onto the card. Information stored on the optical card is read
back using the same reader/writer or a compatible unit. Data read from the card
can be printed, displayed on a computer monitor, or used to operate a system.
LaserCard systems can be used with data communication networks and also with
stand-alone computers.

       System software enables the user to write, read, delete, correct, and
update data as if the LaserCard were a floppy disk. However, unlike a floppy
disk, which allows rerecording directly over erased data, the LaserCard
maintains both old and new data, thus providing a permanent, verifiable, audit
trail.




                                       5
<PAGE>   6

Card Storage Capacity

       The amount of information that can be stored on the LaserCard is
dependent upon such factors as data density and compression, reader/writer
design, and spot size. Spot size is measured in 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.) The size of spot used is determined
by the card format and the configuration of the reader/writer. A spot size of
2.25 microns is used for the Conlux LC-305 reader/writer currently sold by the
Company.

       A portion of the card's storage capacity is used for the error detection
and correction code (EDAC), a method routinely used throughout the computer
industry to compensate for errors from physical damage to data files. Data-
storage capacity also is determined by data compression and the type of data
encoding technique used. Thus, the storage capacity of the optical card varies
based on the type of data stored, EDAC, spot size, data compression, encoding
technique, reader/writer configuration, and format.

       A byte is a unit of computer storage--the amount of memory needed to
store a single number or letter. A megabyte is one million bytes; a kilobyte is
one thousand bytes. The standard LaserCard has a total data capacity of 4.1
megabytes and, after EDAC, a user data capacity of 2.86 megabytes. This
represents about 350 times the storage capacity of an 8 kilobyte IC chip card
and over 2,800 times the capacity of the standard 1 kilobyte IC chip card.
Magnetic stripes are capable of holding 0.2 to 0.9 kilobytes--which is less than
 .03% of a standard LaserCard. A special 6.6 megabyte capacity LaserCard (4.2
megabytes of user data capacity) has been used by a customer for storing medical
MRI images. Regardless of its capacity, the LaserCard is identical in size to a
credit card.

Prerecording

       Another feature of the LaserCard is its recordability both during the
card manufacturing process and afterward. During card manufacture, since
photographic film is used to make the Drexon medium, photolithography is used to
prerecord optical digital data and formatting while the film is still
photosensitive. After the film is processed to become Drexon and made into
cards, data can be laser recorded at any time--over a period of years (for
example, a health history) or over a period of minutes (for example, a set of
medical MRI studies).

       To perform card prerecording or preformatting, the data pattern is
printed repeatedly, end to end, onto a strip of photographic film. This film is
spliced into a master loop, then inserted into a photolithographic machine.
There, a light source accomplishes "printing with light" by exposing the loop's
images onto long lengths of film at the rate of about 300 feet per minute. These
lengths of film, after chemical conversion and physical development into Drexon,
are laminated between polycarbonate sheets and cut into cards. On the finished
cards, the data pattern has low reflec- tivity and the background is more
reflective. The Drexon material's ability to be prerecorded is utilized not only
for preformatting the LaserCard but also to add security features such as
special codes, micro-line printing of text, watermarks, graphics, emblems, etc.
If desired, a LaserCard could be completely prerecorded with data during
manufacture.

Card Durability

       Although recordable and updatable, the LaserCard is not a volatile
(erasable) memory and therefore is unaffected by static electricity, application
of voltage, or other electromagnetic interference. Furthermore, the LaserCard's
ability to withstand flexure exceeds that of conventional credit cards. And,
unlike other types of storage media, the LaserCard can be manufactured to
withstand temperatures of 100 degrees C (212 degrees F) for extended periods.
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 any type of card in a wallet environment. Furthermore, the
ISO/DELA Standard 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.

       Commercial LaserCard applications are underway, a number of field
trials/pilot programs have been started, and extensive product evaluations have
been successfully completed. However, the LaserCard has only undergone limited
commercial use. The longest running commercial LaserCard programs have been the
U.S. Department of Defense "Automated Manifest System" (since 1993) and the VISX
eye surgery system VisionKey(R) card (since 1992).



                                       6
<PAGE>   7

Card Security

       The level of data security used with the LaserCard will depend on the
application. Storing automobile maintenance records requires little or no data
security, whereas very high security features can be employed to protect
confidential information such as medical records and other personal data. The
LaserCard has enough memory to hold multiple, nonerasable, security safeguards
in addition to all of the application data and an audit trail. The LaserCard can
offer various eye-readable and computer-readable security features to enhance
counterfeit-resistance, data security, and confidentiality.

       Using photolithography, eye-readable micro-images can be factory
prerecorded onto the LaserCard's optical stripe as deterrents against
counterfeiting--for example, complex optical watermarks, emblems, seals, and
logos. Later, using digital ID technology and commercially available thermal
printers, visual data and images such as the cardholder's name and address, a
face photograph (in full color or black and white), description, signature, or
other information can be printed directly onto the back of the LaserCard when
the card is initialized (issued). In addition, various other security options
that can be added to the LaserCard include RF taggants, conventional holograms,
signature panels, bar codes, and optical character recognition (OCR), and the
like.

       For maximum counterfeit-resistance, the LaserCard also uniquely offers
embedded personalized "holograms" which are visual micro-images (typically the
face photograph, name, signature, number, etc., relating to the specific card or
cardholder). Laser recorded onto the card's interior reflective layer (the
optical stripe), these embedded personalized "holograms" cannot be erased or
changed because the optical stripe is nonerasable and cannot be removed without
destruction of the card. The "holograms" require no field equipment to be
visible. The "holograms" are an unalterable visual validation of the same
cardholder-specific images and data that are thermally printed elsewhere on the
card. They also offer an even more powerful weapon against counterfeiting: The
"hologram" itself can contain a computer- readable, interleaved digital file
that validates the card personalization data.

       Various computer-readable security safeguards that can be used with
optical memory cards include digitized color photographs; biometric identifiers
such as digitized signatures, fingerprints, and hand geometries; extensive
biographic data; and one or more PINs (personal identification numbers).
Combinations of these and other security features can be recorded on the card
when it is initialized by the card issuer, for later authentication of the card
when it is in actual use. The Company can factory prerecord dedicated
card/equipment digital interface codes onto the cards' embedded storage stripe
during the card production process, so that unauthorized cards will not function
in dedicated equipment, or vice versa.

       If desired, data storage on the LaserCard can be segmented according to
confidentiality level (for example, patient records separated from insurance
information or pharmacy records) so that access to each area of the optical card
can be controlled separately. In addition, the software industry has developed
products to protect computer-based data against unauthorized access; these
software products and other techniques can be used with the LaserCard as well.
For applications that warrant cryptography, all data can be recorded using data
encryption algorithms.

       Because the LaserCard contains nonvolatile, WORM memory that cannot be
physically erased, it can hold a complete audit trail of data, changes, updates,
and deletions. This can be achieved through software--to allow access to
previously recorded files and, if desired, to record all attempts to access data
from the LaserCard.

International Standards

       Standardization of optical memory cards allows interchange of the digital
information encoded on the cards and facilitates compatibility among optical
card systems. The Company is actively involved in optical memory card standards
in the United States and internationally. The standard format under which the
Company's optical memory cards operate is called the "DELA Standard" format.
Shown below is the current status of optical card standards activities under
ISO/IEC (the International Organization for Standardization/International
Electrotechnical Committee) and under ANSI (the American National Standards
Institute):



                                       7
<PAGE>   8

--     ISO/IEC 11693 describes the general characteristics of optical memory
       cards. This approved international standard was published in 1994.

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

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

--     ISO/IEC 11694-3 describes the optical properties and characteristics of
       the card and provides technical specifications which allow interchange.
       This approved international standard was published in 1996.

--     ISO/IEC 11694-4 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.

--     In the USA, ANSI has adopted all of these ISO Standards as ANSI/ISO
       Standards.

       The LaserCard optical memory card system, featuring the DELA Standard
format, complies with all documents listed above. (For additional information,
see "Competition.") To date, the majority of optical cards sold in the world
marketplace have been DELA Standard cards.

LASERCARD PRODUCTS

Card Manufacture

       Optical memory cards are manufactured in Mountain View, California. As
explained in "Management's Discussion and Analysis," the Company's card
manufacturing facility is designed for a production capacity of 25 million
optical cards per year, depending upon type of card and color-printing
requirements. In fiscal 1997, the Company manufactured and sold about 456,000
optical memory cards, primarily for commercial card orders, and made additional
quantities of marketing sample cards.

       The ability to produce optical memory cards in high volume in the
Company's optical card manufacturing facility will be dependent upon maintaining
sources of supply of certain materials meeting the requirements for quality,
quantity, and price. Such materials include special photographic films which are
commercially available solely from the Eastman Kodak Company, of the United
States. The Company believes that Kodak will continue to supply such
photographic films to the Company on a satisfactory basis. Plastic films used in
optical card production are available from one supplier in the United States and
from multiple foreign suppliers. Processing chemicals, inks, bonding adhesives,
and packaging materials are obtained from various U.S. and foreign suppliers.

       To ensure adequacy of raw material supplies, the Company attempts to
establish ongoing relationships with principal suppliers and maintains
information about alternate suppliers. The Company stocks reasonable inventory
levels of raw materials that are consistent with current expected demand,
order-to-shipment lead times, and minimum order quantities. To enable the
Company to plan raw material inventory levels, the Company's quotations to
potential customers generally are based upon certain advance payments to the
Company.

Product Evolution

       The Company continues to upgrade its optical memory card products. It has
been able to adjust optical card production to meet evolving international
standards and to add signature panels, sequential serial numbers, or magnetic
stripes to optical cards for specific applications. Bar codes, conventional
holograms and laser-recorded "embedded holograms" are other examples of add-ons
that may be of interest to customers or potential customers. Also, "chip ready"
optical memory cards can be purchased from the Company, for insertion of IC
chips to create what the Company has termed "Smart/Optical(TM)" cards. The
Company expects its products to continue to evolve to meet changing market needs
or create new markets for optical cards.



                                       8
<PAGE>   9

Marketing and Technical Support

       LaserCard Systems Corporation (LSC), a wholly owned subsidiary of Drexler
Technology Corporation, markets the Company's products primarily through an
international VAR network. VARs may add value in the form of services,
application-specific software, personal computers, or other peripherals, and
then resell these products, integrated into systems, for end-user customers in
their geographic regions.

       LaserCard marketing offices are located in Mountain View, California;
Paris, France; and Zurich, Switzerland. In addition, general management and
technical personnel work closely with the Company's marketing staff. The main
objective of the marketing organization is to attract and qualify new VARs and
provide customer support and products to the VARs, thus generating revenues from
the sale of optical card products domestically and internationally.

       During fiscal 1997, the Company sold LaserCard products to approximately
50 customers located in nine states and 26 foreign countries. Outside of the
United States, sales of the Company's LaserCard products and licenses in fiscal
1997, 1996, and 1995 were 35%, 42%, and 71%, respectively, of net sales. The
Company believes that international markets will continue to be an important
source of license revenue and product sales. Substantially all foreign product
sales were made through the VAR network, whereas licensing activity is conducted
directly by the Company.

       Under nonexclusive distribution agreements with LSC, the VARs purchase
the Company's optical cards, LSC's system software, optical memory card
reader/writers made by a licensee of the Company, and other peripherals. LSC
also provides customer technical support related to optical memory card system
integration, software, sales, and maintenance. This technical support is
provided by a staff of administrative, software, and engineering professionals.

System Software

       System software controls or facilitates the basic operations and
read/write functions of optical memory card reader/writers so that they can
interface directly with Pentium(R) and x86 personal computers (Pcs). LSC
develops LaserCard-related system software such as device drivers, file system
DLLs (dynamic link libraries), and custom software utility tools to enhance
reader/writer integration. In addition, LSC provides software for demonstrating
archival, medical, and security concepts involving the LaserCard, and
software-development tools for related peripherals. LSC does not develop
application software other than demonstration software. (Also see "The Role of
VARs in Application Software.") The Company continues to upgrade its system
software capabilities.

       Windows(R)/DOS Device Driver. A device driver is system software that
translates operating system commands so that the reader/writer emulates a floppy
disk drive. LaserCard device drivers save VARs and their customers considerable
custom software development time because existing application software can be
modified easily to work with the LaserCard. LSC's first device driver was a DOS
(disk operating system) device driver for using LaserCard- equipped personal
computers under the DOS platform and with Windows.

       Windows NT(R) Device Driver. During fiscal 1996, the LSC software staff
completed the Windows NT device driver. This device driver allows the Company's
optical memory card to be used with computer networks under Windows NT, a widely
used network operating system.

       LSC's Windows NT device driver offers these features:

--     Provides compatibility between device drivers--files written to the
       LaserCard using the DOS/Windows driver are compatible with Windows NT
       driver, and vice versa

--     Enables use of LaserCard with network software sold by Microsoft, Novell,
       and others

--     Supports multi-tasking applications and background reader/writer
       operation

--     Facilitates the first-ever connectivity of optical card reader/writers to
       multiple hardware platforms (such as Intel x86, DEC Alpha, IBM Power PC)

--     Functions with application software programs designed to work with
       Windows 95 or Windows NT



                                       9
<PAGE>   10

       SCSI Driver/Adapter. System software available from LSC also includes
SCSI (small computer system interface) host adapters and DOS device drivers,
which consist of a software data format (driver) and a hardware add-on
(adapter). SCSI drivers/adapters are used for the interchange of data among
different types of ISO/DELA Standard optical card reader/writers.

       LaserCard File System (LCFS) Software. Optical card applications can be
developed using LSC's LaserCard File System DLL for additional security and to
optimize the LaserCard's WORM recording medium without the constraints of a DOS
or Windows file structure. The LCFS is not part of an operating system (as
device drivers are) so access to the card is available only from the application
that created the card or from a related application. In fiscal 1996, LSC
completed development of LCFS for Windows 3.1. Versions for use with Windows NT
and Windows 95 were completed in June 1997.

       The following are features of the LaserCard File System DLL:

--     Enables use of the LaserCard with database management systems from
       Microsoft, Oracle, Sybase, and others

--     Permits writing of LaserCard application programs under software
       languages such as Visual Basic, C++, and others

--     Generates up to 16 partitions for highly secure, password-protected,
       multiple-application cards

--     Enables LaserCard file format to be operating-system independent

--     Supports multiple sector size recording to optimize data capacity


The Role of VARs in Application Software

       As described above, the Company's software consists of optical memory
card device drivers and interface software, file systems, software development
tools, and application demonstration programs. However, the Company does not
develop commercial application software but instead relies on VARs or their
customers to do so. 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
(such as storing a health record). In this role, VARs may integrate optical card
products into existing software, write new application software for specific
programs, or license software from other VARs of the Company. VARs have written
optical card application software programs for certain applications, and other
application software development is underway by VARs and their customers.

Reader/Writers

       Under a royalty-bearing license purchased from the Company, commercial
quantities of ISO/DELA Standard format card reader/writers are available from
Nippon Conlux Co., Ltd. ("Conlux"). This supplier (a public company listed on
the First Section of the Tokyo Stock Exchange) sells reader/writers to the
Company under a nonexclusive distribution agreement. The Company incorporates
the Conlux reader/writers into systems for sale to customers. The Company sells
reader/writers for a few thousand dollars per unit, and these units generally
include the Company's device driver software. In principle, price reductions due
to production economies of scale, volume price breaks on components, and other
volume manufacturing cost savings can be achieved when production shifts from
small-scale to large-scale volumes. Also, the yen/dollar exchange rate affects
the price of reader/writers, since they are purchased in Japanese yen. Upon
request, Conlux provides quotations to the Company for various volume quantities
of reader/writers for potential customer programs and has quoted substantially
lower prices for a very high volume potential application. The Company can give
no assurance that any such quotations will result in high-volume orders for
Conlux reader/writers or that a cumulative increase in orders would result in
larger-scale production or that correspondingly lower prices would result. A
significant decrease in the price of reader/writers would have a positive impact
on the development of the market for optical cards. (Also see Risk Factors,
"Reader/Writer Availability.")




                                       10
<PAGE>   11

Other Peripherals

       LSC also purchases and resells the following application-specific
peripherals, adding LSC-authored software- development tools:

--     Electronic digital camera with video capture board for storing
       computer-readable, color photos

--     Thermal card printers for printing eye-readable photo, logos, and text in
       black and white or color (using consumable printing ribbons)

--     Digital biometric identity verification systems (hand geometry,
       fingerprint, and signature verification systems) for comparing a unique
       biometric identifier stored on the LaserCard with that of the card user

LICENSING

       The Company has developed a portfolio of United States and foreign
patents which have generated significant revenues in the form of license
agreements related to optical memory cards and equipment for using the cards.
The Company's patent licensing program is directed mainly toward licensing the
manufacture of optical card reader/writers and, in a few special cases,
manufacture of the optical cards themselves. The Company presently offers
nonexclusive, royalty-bearing licenses for optical memory card reader/writer
manufacture and for card manufacture. Also offered are nonexclusive licenses for
optical memory card distribution. These create licensed card distributors in
regions of the world, that can buy cards wholesale from the Company at prices
lower than are charged to VARs. The Company's royalty-bearing, reader/writer
manufacturing licenses include optical memory card distribution rights and, in
some cases, license upgrades for rights to additional patents. The Company
estimates that approximately eight licensees are involved in some aspect of the
optical memory card industry--such as reader/writer manufacture, optical memory
card manufacture, market development, standards, software development, or system
integration.

       Initial license fees charged by the Company for its licenses vary based
on the rights and benefits of each license. License fees are unconditional and
nonrefundable and no significant obligations remain unfulfilled by the Company
under the licenses. The Company will continue its licensing efforts on a
selective basis, although the timing, number, type, and magnitude of future
license sales, if any, cannot be predicted.

Basic Licenses and Upgrades

       The Company has sold limited-term, nonexclusive, basic licenses to over
25 companies worldwide. Each such license involved a one-time license payment
and no royalties. The basic license included certain technical know-how,
information, and nonexclusive licenses under certain patents, owned by the
Company, involving equipment for reading and writing optical memory cards. Some
of these licenses include card distribution rights for the purchase of optical
memory cards, for use or resale, at the Company's most favorable pricing. The
Company also has sold five nonexclusive, royalty-bearing license upgrades
related to equipment for reading and writing optical memory cards. The upgrade
extends the term of the basic license and covers equipment patents issued to the
Company after the date limits of the original basic license agreements. No basic
licenses or upgrades have been sold since 1989.

Card Distribution Licenses

       In fiscal 1995, the Company sold a nonexclusive, royalty-free, optical
memory card distribution license for a one-time payment of $1 million to a
Korean firm that initially was a VAR of the Company. A card distribution license
entitles the licensee to purchase optical memory cards from the Company at the
most favorable pricing, for use or resale. Card prices to licensed distributors
are typically 10% to 15% below VAR pricing for optical cards having similar data
capacity, printing complexity, formatting complexity, specifications,
tolerances, quality, quantity, and delivery times. No similar licenses were sold
in fiscal 1997; however, in fiscal 1996 a $200,000 fee payment was received
toward the purchase of an optical memory card distribution license in
conjunction with a trademark license.




                                       11
<PAGE>   12

Card Manufacturing Licenses

       Two nonexclusive, royalty-bearing, patent licenses have been sold by the
Company for optical card manufacture--one in fiscal 1989 and one in fiscal 1991.
The fee for each card manufacturing license was $10 million plus long-term,
periodic royalty payments to the Company. The 1989 license sale was to Canon
Inc., which previously also had purchased a basic license from the Company. The
1991 optical card manufacturing license was sold to Optical Memory Card Business
Corporation ("OMCBC"), a Japanese company formed by Dai Nippon Printing Co.,
Ltd. and three reader/writer equipment licensees of the Company--Nippon Conlux
Co., Ltd., Olympus Optical Co., Ltd., and Omron Corporation. As described under
"Competition," OMCBC is a second source (alternate) supplier for optical memory
cards compatible with the Company's cards. The Company may consider the sale of
additional such licenses, but the future sale or timing of any licenses cannot
be predicted or inferred from past events.

COMPETITION

       Producers of data storage media and devices continually strive for
optimal form factors, larger data storage capacities, durability, security,
higher performance, and lower cost. The Company believes optical memory cards
offer advantages in certain of these categories--most notably as a combination
of a small, secure, portable, durable form factor with a large data storage
capacity relative to its size and price.

Competing Technologies

       Depending on the application, optical cards compete with other data
storage cards in addition to other established products that are used for the
storage and transfer of digital information. Since the optical card is not
widely commercialized, some potential customers may choose to employ
technologies that have been in use longer. However, the Company believes that
the LaserCard's high storage capacity, performance/cost ratio, rugged card
construction, ability to store an audit trail, counterfeit resistance, and
tamper resistance make it a viable choice for a number of card applications.
Examples include health history cards, high security ID/access card systems,
warranty/maintenance cards, cargo manifest cards, and medical image storage
cards.

       IC Cards. The LaserCard competes in some applications with cards that
contain an integrated circuit (IC) memory and/or a microprocessor. They are
known as "smart cards" or "IC cards" or "chip cards." They are susceptible to
damage by electrical discharges and also can be more vulnerable to unauthorized
access and duplication. The IC card can be more easily damaged in everyday use,
whereas the Company's card construction and production processes make the
LaserCard more rugged. An 8-kilobyte IC card can store about 1% of the amount of
data storable on a LaserCard. (See "Card Storage Capacity" for memory
comparisons.) IC card prices and performance vary widely. The IC card uses a
much lower cost reader/ writer than is used with an optical card, whereas a
typical smart card containing an 8- kilobyte IC and a microprocessor is higher
priced than the Company's 4.1 megabyte optical memory card.

       Because of their low priced reader/writer, IC cards containing an
8-kilobyte IC and a microprocessor are very competitive, particularly in the
markets for financial transaction systems. The IC card has a greater installed
base outside the U.S.A. (it was invented five years before the LaserCard) and
low-storage capacity IC cards are currently used as payphone cards and
point-of-sale cards, particularly in Europe. Low-storage capacity cards for
payphones and for debit/cash card systems (recently introduced to the U.S.
banking industry) are not markets for the Company's cards. However, for secure
electronic commerce applications and some patient record applications, the
Company offers "chip ready" optical memory cards to which an IC can be added
(called Smart/Optical cards).

       Other Competing Products. While not functionally similar to optical
memory cards there are other commercial data storage products that are sometimes
thought of as competitive to the Company's products. They include floppy disks,
magnetic-stripe cards, cards containing 2-dimensional bar codes or other visual
patterns, read/write optical disks, magneto-optical recording media, and CD-ROM
disks. Magnetic-stripe cards are highly susceptible to unauthorized use,
duplication, erasure, and alteration. Cards that store limited amounts of data
using 2-dimensional bar codes or other visual patterns can be utilized as
identification cards; however, data cannot be added to these types of cards once
they are initialized. There also are high capacity, high cost storage cards
called PCMCIA (Personal Computer Memory Card Industry Association) cards that
are used with personal computers as a substitute for magnetic disk drives. These




                                       12
<PAGE>   13

PCMCIA cards are very high cost relative to the Company's optical memory cards
and generally are not considered directly competitive with the LaserCard. In
addition, in countries such as the United States and Japan, where the
telecommunications infrastructure is extensive and low cost, it is possible that
centralized data bases and wide-area networks may limit the penetration of
optical memory cards into some potential markets.

Competing Optical Memory Cards

       Two Japanese firms, Optical Memory Card Business Corporation (OMCBC) and
Canon Inc., are selling optical cards. Dai Nippon Printing Co., Ltd. (the
principal owner of OMCBC) produces ISO/DELA format cards and Canon format cards,
called the SIOC format. The Company manufactures ISO/DELA format cards.

       The DELA format and SIOC format are not functionally compatible with one
another. DELA and SIOC format cards both meet the ISO Standard but differ from
each other with respect to recording modulation method, error correction code,
and efficiency of sector sizes. The Company believes that the ISO/DELA format
offers performance advantages over the ISO/SIOC format, particularly when the
optical card is subjected to dirt particles or becomes scratched. The Company
also believes that, through its LaserCard Systems subsidiary, it currently
offers competitive advantages in areas such as system integration, interface
software, and customer technical support for a variety of card applications and
markets.

       Optical card reader/writers made by Conlux use the ISO/DELA format.
Canon-produced reader/writers use the ISO/SIOC format. Olympus Optical Co., of
Japan, is capable of producing reader/writers compatible with DELA, SIOC, or its
own proprietary format but is not known to be selling ISO/DELA format
reader/writers at this time. At least several times as many ISO/DELA cards have
been manufactured and sold than Canon ISO/SIOC format cards. Nevertheless,
ISO/SIOC format cards and reader/writers have been sold in competition with
Company products, although in smaller quantities so far. The Company expects
that if Canon or Olympus continue their marketing and product improvement
programs for optical card systems, they should be able to obtain materially
sizable card and equipment orders.

        The Company anticipates that many optical card programs will be
dedicated applications for defined user groups and that the optical memory card
formats will co-exist. Although the Company's world-wide market share for
optical memory cards in 1997 should exceed that of its competitors, singly and
collectively, it is possible that the Com- pany's market share could decrease
over time. This is because the size, name recognition, and resources for
marketing of Canon, Olympus, and Dai Nippon Printing are considerably greater
than the Company's.

       Additional entrants into the optical card industry could expand the
overall size of the market and also could result in licensing opportunities for
the Company. In the past, a number of firms have disclosed the development of
alternative optical cards, including Asahi Chemical, Optical Recording
Corporation, Polaroid, Sony, and Toppan Printing. However, the Company is not
aware of any current optical memory card-related commercial activities by these
firms.

OTHER MATTERS

Research and Engineering

       In fiscal years 1997, 1996, and 1995, research and engineering expenses
approximated $938,000, $1,092,000, and $1,860,000, respectively. These expenses
primarily consist of the majority of operating costs and depreciation and
amortization expenses on the optical card facility. The manufacturing facility
is used both for engineering and card manufacturing. Therefore, facility costs
(depreciation expense, building lease payments, and other costs) are allocated
between manufacturing and engineering based on the level of manufacturing
activity.

Patents and Trademarks

       As of March 31, 1997, the Company owned approximately 50 U.S. patents
relating to optical data storage (including media, optical cards, formats,
equipment, systems, and the utilization of optical storage media). Counterparts
of



                                       13
<PAGE>   14

certain U.S. patents have been issued as patents in a number of foreign
countries, and the Company has applied for additional foreign patents
corresponding to U.S. patent applications. However, the Company owns certain
U.S. patents as to which foreign counterparts have either not been filed or the
prosecution has been terminated without issuance of the foreign patents. Also,
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 to its patents, the Company has chosen to protect
as trade secrets, rather than by patents, some refinements to the Drexon medium
and cards and knowhow related to their manufacture.

       The Company presently intends to pursue any infringement of its patents.
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. In 1992, the claims of three of the Company's issued U.S. patents
successfully passed re-examination proceedings in the U.S. Patent and Trademark
Office (USPTO) after a two-year review by the USPTO's Board of Patent Appeals
and Interferences. (Also see Risk Factors, "Patent Protection.")

       The Company believes that several of its optical data storage patents
also apply to the motion picture industry in connection with reading optical
digital sound signals from digital data stored directly on motion picture film.
Therefore, the Company has been attempting to license the patents or to sell two
U.S. patents for this purpose. However, there is no assurance that such efforts
will be successful. 

       "Drexon" and "LaserCard" are federally registered trademarks of Drexler
Technology Corporation.

Environment

       Compliance with federal, state, and local laws and regulations involving
the protection of the environment did not have and is not expected to have a
material effect on the Company's capital expenditures, earnings, or competitive
position. The Company is a voluntary participant in the U.S. Environmental
Protection Agency's "Green Lights" program, under which most of the Company's
lighting systems have been upgraded for energy efficiency.

Employees

       As of March 31, 1997, the Company and its subsidiaries employed 44
persons (including four executive officers). This workforce consisted of
approximately 39 persons in administration, marketing/sales, manufacturing, and
research and engineering, plus approximately five temporary personnel mainly for
quality assurance inspection of cards. None of the Company's employees is
represented by a labor union.

RISK FACTORS

       Early Stage of Product Commercialization. The Company has invested
considerable resources in the development of optical memory cards and related
equipment and system software. These products entered the commercial stage
through the Company's VAR (value-added-reseller) network, which was initially
launched in 1991; and, in 1993, optical memory card products became the
Company's sole product line. During fiscal 1997, the Company sold 456,000
optical memory cards, related equipment, and system software through its
subsidiary, LaserCard Systems Corporation, to approximately 50 customers located
in nine states and 26 foreign countries. The Company currently makes and sells
optical cards in varying quantities, with orders typically ranging from 5,000 to
100,000 cards per order. The largest single order to date is a recent order from
the INS in the amount of $7.1 million for 2 million cards to be delivered
through May 1998. This order provides the largest component of the Company's
currently anticipated card production. As is the case in all U.S. government
procurement, the government reserves the right to change specifications, delay
deliveries, and cancel all or part of the order. Also, the Company could
encounter equipment, raw material, quality control, or other production problems
under high-volume production of this magnitude. In addition, the Company does
not have the technology or resources to manufacture certain materials used in
the manufacture of optical memory cards; accordingly, its ability to produce the
cards will be dependent upon maintaining sources of supply of such materials
meeting its requirements for quality and quantity. High-volume orders for
optical memory cards require the VAR companies to develop customers and
applications, or to obtain significant follow-on orders from customers whose
programs are already underway. The frequency and size of such orders cannot be
predicted.



                                       14
<PAGE>   15

       Unpredictable License Revenues. Historically, revenues from fees for
patent and distribution licenses have been an important part of the Company's
revenues, profits and financing. The Company is actively pursuing efforts to
generate additional license revenues. However, the Company's license sales are
sporadic and unpredictable as to timing and type of license.

       Liquidity; Limited Capital Resources. At the fiscal 1997 level of product
sales, the Company did not generate net cash from operations after expenses. To
fund its operations, the Company requires either additional financing, sales of
additional patent and distribution licenses, or a substantial increase in the
level of orders for optical memory cards. Based on current raw material costs
and other expense calculations, the Company estimates that it will break even on
cash flow if it achieves annual sales in the range of 1.6 million to 1.8 million
optical memory cards, depending on the margins on sales of related hardware.
Generally, the Company's products are made to custom specifications which are
specific to each customer, end user, or application, and the Company obtains
advance payments, in whole or in part, from customers at the time of accepting
an order. Therefore, the Company believes that, although working capital
requirements should grow in proportion to increased product order and shipment
levels, the advance payments will reduce the need for working capital financing.
However, the Company has not established a line of credit, and no assurance can
be made that negotiations to obtain a line of credit will be successful should
it become necessary to establish one. Since the third quarter of fiscal year
1995, the Company has generated cash through the sale of common stock, a
single-payment license fee on the sale of an optical memory card distribution
license to an overseas VAR, the receipt of a license upgrade fee payment, and an
advance payment under the INS card order. There can be no assurance that the
Company will be able to meet its future cash needs on a favorable basis. (Also
see Management's Discussion and Analysis, "Liquidity.")

       Historical Losses. As of March 31, 1997, the Company had an accumulated
deficit of $27,548,000 and has operated at a loss during the last five years.
The Company anticipates that its financial performance will improve due to
anticipated increases in sales of optical cards and related products, except for
possible quarterly fluctuations. However, if increased commercialization is
delayed and the Company does not realize such increased sales, its losses will
continue, except in the event of sporadic sales of licenses. The Company is
relying upon its optical card technology to generate future product revenues,
earnings and cash flow when order volumes reach material levels. Until
commercialization increases, the Company is dependent upon other sources of
income, such as license fees, which cannot be predicted as to timing or dollar
amount. Delays in customers' development of optical card based programs and
corresponding commercialization of the Company's optical cards and related
products, combined with an absence of additional license sales or other
revenues, could extend continuing losses and result in the need for additional
financing.

       Reader/Writer Availability. Optical card reader/writer availability is
essential for the viability and growth of the optical memory card business.
Nippon Conlux Co., Ltd. ("Conlux"), a Japanese company, is currently the only
supplier in commercial quantities of reader/writer equipment for DELA-standard
format cards, the type manufactured by the Company and a licensed second-source
card manufacturer. DELA Standard format cards comprise the majority of optical
memory cards sold in the world marketplace to date. Two other licensees of the
Company have the capability to produce reader/writers compatible with the
Company's optical memory cards, but are not manufacturing them at this time. If
Conlux were to curtail manufacture of reader/writers, the Company would allocate
its incoming shipments of such devices among incoming orders from established
customers. Conlux has not developed its own optical memory card and is not known
to be doing so. Its customers continue to rely on cards manufactured by the
Company or, particularly with respect to Japanese customers, by Optical Memory
Card Business Corporation ("OMCBC"), a Japanese licensee of the Company, of
which Conlux is a minority owner. The Company sells Conlux reader/writers for a
few thousand dollars per unit, and these units generally include the Company's
device-driver software. The Company expects card-related revenues to increase
more rapidly if card reader/writers are produced and sold in volume at lower
prices than at present. However, the Company can give no assurance that
increased production will occur in the near term or that high-volume sales and
correspondingly lower prices will result. Furthermore, the yen/dollar exchange
rate affects the price of reader/writers, since they are purchased in Japanese
yen. In addition, if market demand increases sharply over a short period of
time, an initial shortage of reader/writers could result. (Also see
"Reader/Writers.")

       Nasdaq Listing. Currently the Company's common stock is traded on the
Nasdaq National Market System of NASD (National Association of Securities
Dealers). In 1994, this listing was briefly subject to an exception from
ordinary National Market System requirements, under which the Company was
required to, and did successfully,



                                       15
<PAGE>   16

implement a plan to maintain its net tangible assets at a minimum of $4,000,000.
The Company's net tangible assets also fell below that level during the fourth
quarter of fiscal 1995, but were restored during the first quarter of fiscal
1996 without action by NASD. If the Company's net tangible assets should fall
below $4,000,000, and if the NASD does not allow another exception, the common
stock would then be traded on the Nasdaq Small Cap Market, rather than the
National Market System, with some possible reduction of market interest and
liquidity. As of March 31, 1997, the Company's net tangible assets (as defined
by NASD for this purpose) were $4,059,000.

       Stock Price Volatility. The price of the Company's common stock is
subject to significant volatility due to fluctuations in revenues, earnings,
capitalization, liquidity, press coverage, and financial market interest. Some
of these factors may be exacerbated because the Company operates solely in the
optical memory card products industry, which is in the early stages of
commercialization.

       Competition. The Company's products compete with those of OMCBC and
Canon, two of its Japanese licensees, who also sell optical cards under
royalty-bearing licenses from the Company. Canon has introduced an optical card
under its own standard, called "SIOC." The Company's DELA format and the Canon
SIOC format are not functionally compatible, although both card formats meet the
ISO Standard. The Company believes that the ISO/DELA format offers performance
advantages over the ISO/SIOC format in terms of flexibility and durability, as
well as competitive advantages in system integration, device drivers/interface
software, and customer support for a variety of applications and markets. At
least several times as many ISO/DELA cards have been manufactured and sold than
Canon ISO/SIOC format cards. OMCBC produces optical cards using the ISO/SIOC
format, as well as cards using the ISO/DELA format, and cards conforming to a
third format, created by Olympus Optical Co., another licensee of the Company,
for its own reader/writers. The Company's current worldwide market share for
optical memory cards exceeds that of its competitors. However, the Company
expects several of its Japanese licensees to sell ISO/SIOC format cards and
reader writers, and believes that if Canon and Olympus continue their card
marketing programs, they should begin to obtain material orders for cards and
equipment. The Company anticipates that insofar as many optical card programs
will be dedicated applications for defined groups of users, various types of
optical cards will coexist. However, the size, trade name recognition, and
marketing and development resources of Canon, Olympus, and Dai Nippon Printing
Co. (the principal owner of OMCBC) are substantially greater than those of the
Company. (See "Competition" elsewhere in this report.)

       Competing Technological Advances. The Company also competes in certain
applications with other portable data storage products, particularly chip
(integrated circuit/microprocessor or "IC") cards. IC cards which store three or
four pages of text compete directly with optical memory cards in applications
where the limited storage capacity of IC cards and higher cost per card, but
lower cost per reader/writer, will suffice. The advantages of the optical memory
card in storage capacity, durability, and low cost, make it better suited for
potentially sizable applications, such as for patient records in health care and
for national identification card systems. However, the IC card has a greater
installed base worldwide at present, mainly as prepaid telephone cards. For
applications with relatively low storage capacity, such as electronic
banking/credit/debit cards, the Company expects IC cards to be used instead of
optical memory cards. (Also see "Competition" elsewhere in this report.) In
addition, in countries such as the United States and Japan, where the
telecommunications infrastructure is extensive and low cost, it is possible that
centralized data bases and wide-area networks may limit the penetration of
optical memory cards into some potential markets.

       Patent Protection. The Company's U.S. patents have expiration dates
ranging from 2002 to 2012, with the majority expiring during the first half of
this period. Counterpart patents in foreign countries also expire during that
period. Under its license agreement with the Company for manufacture of optical
memory cards, OMCBC's obligation to pay royalties to the Company for use of the
licensed patents ceases 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. Other royalty-bearing licenses
sold by the Company related to equipment for reading and writing optical cards
provide for royalty payments to cease on the last expiration date of the
licensed patents. The Company is unable to determine whether there would be a
material, adverse effect on royalties in the event of expiration or
unenforceability of its patents, because the Company's royalty revenues are not
significant at this time. The Company also 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 is not
aware of any optical memory card products which otherwise would infringe its
patents in countries where the Company might have difficulty enforcing its
patents or has no patent protection. (Also see "Patents and Trademarks.")



                                       16
<PAGE>   17

       International Sales and Operations. The Company does not believe that
there are substantial risks inherent in its international business as compared
to its domestic business, with the exception of export/import regulations
pertaining to doing business in specific countries. Sales of its products and
licenses outside the United States in the 1997, 1996, and 1995 fiscal years have
comprised 35%, 42%, and 71% of net sales, respectively. The Company believes
that international sales will be an important component of its sales growth
potential.

FORWARD-LOOKING STATEMENTS

       Certain statements made above relating to plans, objectives, and economic
performance go beyond historical information and may provide an indication of
future results. To that extent, they are forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
each is subject to factors that could cause actual results to differ from those
in the forward-looking statement. Such factors are described above and in the
Management's Discussion and Analysis section of this Form 10-K.

ITEM 2. PROPERTIES

       As of March 31, 1997, approximately 32,000 square feet of floor space are
leased by the Company for production, administration, sales, and research and
engineering, in two buildings located in Mountain View, California. These
facilities have a current total annualized rental of approximately $364,000. The
Company also leases a small marketing office in France. Management believes
these leased facilities to be satisfactory for its present operations. Upon
expiration of the leases, management believes that these or other suitable
facilities will be able to be leased on a reasonable basis.

ITEM 3. LEGAL PROCEEDINGS

       On September 28, 1995, the Company filed a complaint against LeRoy A.
Pesch, Genus Technology Corporation, LAPESCH & Company, and Genus Technology,
N.V., in Santa Clara County California Superior Court, to collect an $800,000
balance due under an upgrade license agreement entered into between the Company
and Genus Technology Corporation. The other defendants are guarantors and/or
co-obligors.

       On November 29, 1995, the defendants answered by denying the allegations
of the complaint and asserting as a cross-complaint that defendant Genus
Technology N.V. was wrongly denied the right to purchase 400,000 shares of the
Company's common stock at a purchase price of $5.75 per share. On January 16,
1996, the parties entered into a stipulation to submit all issues raised in this
litigation to binding arbitration before the American Arbitration Association.
On May 20, 1996, Dr. Pesch filed a Chapter 11 bankruptcy petition, thereby
effecting an automatic stay of the arbitration proceedings as to Dr. Pesch (but
not as to the other defendants).

       On August 28, 1996, the Arbitrator entered an award holding that the
defendants, other than Dr. Pesch, are liable in the amount of $800,000, plus
costs and 10% ongoing interest, and that these defendants are not entitled to
any offset, reduction in award, or affirmative relief based on the
cross-complaint. On December 19, 1996, the Superior Court confirmed the
arbitration award and issued a judgment based thereon.

       On September 6, 1996, Dr. Pesch's bankruptcy proceedings were dismissed
without discharge of his debts. Accordingly, on January 13, 1997, the Superior
Court issued a judgment against Dr. Pesch in the amount of $800,000, plus costs
and 10% ongoing interest.

       There can be no assurance that the Company will be successful in
collecting on its judgments. No portion of the approximately $1,000,000 balance
due is recorded in the Company's financial statements.

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 1997.



                                       17
<PAGE>   18

                                     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(SM) 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 (rounded to the nearest one-eighth) for the Company's common stock as
reported by Nasdaq during the fiscal periods indicated.

<TABLE>
<CAPTION>

    Quarterly Stock Data (Unaudited)          1st         2nd       3rd           4th
    --------------------------------          ---         ---       ---           ---
    <S>                                    <C>  <C>    <C> <C>    <C>          <C>  <C>

                                           (High and Low Trade Prices by Fiscal Quarter)
    Fiscal 1996
         High..........................     8  1/4      13  3/4    16           15   3/4
         Low...........................     5            6  1/4    10           11
    Fiscal 1997
         High..........................    18  1/2      16  3/8    14   1/4     14   1/4
         Low...........................    12            9  7/8    10            9   1/4

</TABLE>

         On March 31, 1997, there were approximately 1,338 holders of record of
the Company's common stock. The Company has never paid cash dividends on its
common stock. The Company anticipates that for the foreseeable future it would
retain any earnings for use and reinvestment in its business.



                                       18
<PAGE>   19

ITEM 6.  SELECTED FINANCIAL DATA

       The following selected consolidated financial data for, and as of the end
of, each of the years in the five-year period ended March 31, 1997, are derived
from the consolidated financial statements of the Company. The 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 elsewhere herein.


                   FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION
                    Fiscal Years Ended March 31, 1993 - 1997
                    (In thousands, except per share amounts)


<TABLE>
<CAPTION>


Operations Data                                     1993         1994         1995         1996        1997
---------------                                     ----         ----         ----         ----        ----
<S>                                               <C>          <C>          <C>          <C>          <C>    

Revenues:
    Product sales ...........................     $ 1,197      $ 1,819      $ 2,141      $ 5,059      $ 3,510
    License fees and royalties ..............          21           19        1,025          236           19
                                                  -------      -------      -------      -------      -------
    Total revenues ..........................       1,218        1,838        3,166        5,295        3,529
                                                  -------      -------      -------      -------      -------
Cost of product sales .......................         831        1,180        1,511        3,659        2,388
Selling, general, and administrative expenses       1,836        1,925        2,023        2,400        2,602
Research and engineering expenses ...........       2,284        2,202        1,860        1,092          938
Other income ................................        --            713            4          202           22
Interest income .............................          83           24           35           78           50
Interest expense ............................           4            4            7            8            8
                                                  -------      -------      -------      -------      -------
Loss from continuing operations .............      (3,654)      (2,736)      (2,196)      (1,584)      (2,335)
Income (loss) from discontinued operations ..         (76)         (90)          22         --           --
                                                  -------      -------      -------      -------      -------
Net loss ....................................     $(3,730)     $(2,826)     $(2,174)     $(1,584)     $(2,335)
                                                  =======      =======      =======      =======      ========
Loss per share:
    Continuing operations ...................     $  (.50)     $  (.36)     $  (.27)     $  (.18)     $  (.26)
    Discontinued operations .................        (.01)        (.01)        --           --           --
                                                  -------      -------      -------      -------      -------
Net loss per share ..........................     $  (.51)     $  (.37)     $  (.27)     $  (.18)     $  (.26)
                                                  =======      =======      =======      =======      ========
Weighted average common shares ..............       7,264        7,581        8,161        8,692        9,006



Balance Sheet Data                                   1993         1994         1995         1996        1997
------------------                                   ----         ----         ----         ----        ----


Current assets ..............................     $ 1,549      $ 2,733      $ 1,873      $ 3,782      $ 4,588
Current liabilities .........................         639        1,154          995        2,044        3,030
Total assets ................................       5,403        5,856        4,531        6,371        7,089
Long-term obligations .......................        --           --           --           --           --
Stockholders' equity ........................       4,764        4,702        3,536        4,327        4,059

</TABLE>



                                       19
<PAGE>   20

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

RESULTS OF OPERATIONS--FISCAL 1997 AS COMPARED WITH FISCAL 1996 AND 1995

Revenues

       The Company's total revenues for fiscal 1997 were $3,529,000 as compared
with $5,295,000 for fiscal 1996 and $3,166,000 for fiscal 1995.

       Product Sales. Sales of LaserCard(R) optical memory cards and related
products to value-added resellers (VARs), licensees, and end-user customers were
$3,510,000 for fiscal 1997 versus $5,059,000 for fiscal 1996 and $2,141,000 for
fiscal 1995. The difference between fiscal 1997 and fiscal 1996 was due mainly
to an order from the U.S. Department of Defense (DoD) for 537 reader/writer
units in fiscal 1996 versus 83 units for that customer in fiscal 1997, for an
ongoing DoD program. Total reader/writer sales were 390 units in fiscal 1997,
879 units in fiscal 1996, and 313 units in fiscal 1995. Optical memory card
sales in fiscal 1997, 1996, and 1995 were 456,000, 420,000, and 150,000 cards,
respectively. The Company received a $7.1 million order in February 1997 for 2
million optical memory cards for the U.S. Immigration and Naturalization Service
(INS). Deliveries are scheduled to begin in July of 1997 and are expected to
average approximately 200,000 cards per month thereafter.

       Applications for the Company's optical memory card products currently in
use by customers include: medical data applications in the United States;
several programs in Italy, including a secure soccer-season ticket; two programs
in the Philippines--an admission pass/retail purchase log at a duty-free
shopping zone and a vehicle warranty and maintenance records card; and U.S.
government-related programs--the DoD's cargo manifest card and the U.S.
Immigration and Naturalization Service's "border crossing card" and "green
card."

       The Company sold LaserCard products in fiscal 1997 to approximately 50
customers in 9 states and 26 foreign countries. For the development of
commercial markets and applications for its products, the Company utilizes VAR
companies as part of its marketing and distribution program for LaserCard
products. Sales to VARs include the Company's optical memory cards, the
Company's system software, optical card reader/writers made by a licensee of the
Company, 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 may add application software, personal computers, and other
peripherals, and then resell these products, integrated into data systems, for
end-user customers.

       There were 23 new VARs in fiscal 1997 compared with 17 in fiscal 1996 and
30 in fiscal 1995. All new VARs purchase initial systems including optical cards
and equipment. However, there can be no assurances that any new or existing VAR
company in any country will be successful in its markets or field trials or that
it will place follow-on orders with the Company for additional quantities of
cards and systems. In order to upgrade its VAR customer base to increase the
probability of success, the Company will continue its efforts to recruit new
VARs and eliminate nonproductive ones. The Company provides marketing leads,
customer technical support, and system software to assist VARs.

       Software is an important factor in developing the commercial markets for
optical memory cards. The Company's system software consists of optical card
interface software/device drivers, file systems, software development tools, and
demonstration software. The Company does not provide software for specific
applications, but instead depends on its VARs to integrate optical card products
into existing software products, write new application software for specific
optical card programs, or license software from other VARs. Several VARs have
written optical card software programs for applications such as automobile
warranty and maintenance records, cargo manifesting, digital optical key
systems, admissions/ID, data logging systems, and various medical-related
applications such as medical image storage and health history cards. Other
application software development is underway by VARs and their customers.



                                       20
<PAGE>   21

       Optical memory cards are used in conjunction with card reader/writer
equipment connected to personal computers and accessed in the same manner as
floppy disk drives. Such reader/writers are incorporated into LaserCard systems
sold to VARs and other customers of the Company. The price, performance, and
availability of such reader/writers are factors in the commercialization of
optical cards. The Company sells reader/writers for a few thousand dollars per
unit, and these units generally include the Company's interface software/device
drivers.

       The Company does not manufacture card reader/writers but instead
continues to purchase such equipment from a Japanese licensee, Nippon Conlux
Co., Ltd., currently the Company's sole supplier of reader/writers. The
Company's inventory level for reader/writers fluctuates based on the timing of
purchases and sales and is typically approximately 50 to 75 units. The Company
can give no assurance that increased production of card reader/writers will
occur in the near term or that high-volume sales and correspondingly lower
prices will result. If market demand increases sharply over a short period of
time, an initial shortage of reader/writers could result. Also, an interruption
or change in the supply of reader/writers could cause a delay in product
shipments and a possible loss of sales, which would adversely affect operating
results.

       Licenses. There were no licenses sold in fiscal 1997, as compared with
one license in fiscal 1996 for $200,000, and one license for $1,000,000 in
fiscal 1995. The license fee payments were received in the respective fiscal
periods. The fiscal 1996 license agreement included a trademark license and a
LaserCard distribution license payment. The fiscal 1995 license agreement was
for a LaserCard distribution license sold to a Korean VAR of the Company.

       License fees received by the Company are unconditional and nonrefundable,
and no significant obligations remain unfulfilled by the Company under any of
its licenses. The Company is actively pursuing its efforts to generate
additional license revenues; however, license sales by the Company are sporadic
and unpredictable as to timing and type of license. The magnitude of future
license revenues, if any, cannot be predicted or inferred from past events.

       Royalties. Royalty revenues were $19,000 for fiscal 1997, $36,000 for
fiscal 1996, and $25,000 for fiscal 1995. Although royalty revenues have not
reached material amounts, the Company does anticipate future royalty income on a
long-term, continuing basis from among two royalty-bearing optical memory card
manufacturing licenses and several royalty-bearing, equipment-license upgrades
previously sold. The Company cannot predict whether or when equipment or card
sales by its licensees will result in material royalties to the Company.
Therefore, the Company is not relying on royalty income and does not expect it
to be a significant factor in the near term.

       Backlog. The Company received a $7.1 million order in February 1997 for 2
million optical memory cards for the U.S. Immigration and Naturalization
Service. Deliveries are scheduled to begin in July of 1997 and are expected to
average approximately 200,000 cards per month thereafter.

       Margins. The gross margin on product sales for fiscal 1997 was 32% as
compared with 28% for fiscal 1996 and 29% for fiscal 1995. The increase in
fiscal 1997 as compared with fiscal 1996 is due mainly to an increase in the
average selling price of optical memory cards. The decrease in fiscal 1996 as
compared with 1995 is due mainly to a decrease in the average selling price of
optical cards, partially offset by a lower per-card cost. This is a result of a
greater portion of fiscal 1996 optical card sales being lower-priced cards with
fewer features than cards sold the previous fiscal year. The gross margin on
optical memory card sales will fluctuate based upon type and volume of cards
sold. As card manufacturing for commercial orders increases, the Company's
optical memory card manufacturing facility is used less for the purposes of
research and engineering. Therefore, more of the manufacturing facility costs
(depreciation expense, building lease payments, and other costs) are allocated
to cost of card manufacturing, and less of these costs are charged to research
and engineering. For fiscal 1997, fiscal 1996, and fiscal 1995, the Company
allocated 42%, 47%, and 17%, respectively, of the facility expenses to card
manufacturing for commercial orders and marketing samples. When the Company
reaches a production level of approximately 1.5 million cards per year for
commercial orders, the cost allocation percentages should become relatively
fixed, with essentially all of the card manufacturing facility costs allocated
to cost of product sales. The facility expenses will then become a fixed cost
component of product sales and should decrease on a per-card basis as production
volumes increase above 1.5 million cards per year.



                                       21
<PAGE>   22

Income and Expenses

       Selling, General, and Administrative Expenses (SG&A). Fiscal year 1997
SG&A expenses were $2,602,000 as compared with $2,400,000 and $2,023,000,
respectively, for fiscal 1996 and 1995. The majority of the increase for the
fiscal 1997 versus fiscal 1996 is attributable to increased payroll and
marketing expenses. The $377,000 increase for fiscal 1996 versus fiscal 1995 is
due mainly to a $100,000 increase in payroll expenses, a $112,000 increase in
marketing expenses, including trade shows and travel, and a $73,000 increase in
legal expenses. SG&A spending is expected to continue at current levels for the
short term. If certain financial goals are achieved, the Company's plans include
increased marketing and customer technical support activity.

       Research and Engineering Expenses. Research and engineering expenses were
$938,000 for fiscal 1997 as compared with $1,092,000 for fiscal 1996 and
$1,860,000 for fiscal 1995. The optical memory card facility is used for both
engineering and manufacturing. Therefore, the facility costs (depreciation
expense, building lease payments, and other costs) are allocated between
manufacturing and engineering based upon the level of manufacturing activity.
Depreciation and amortization expenses charged to research and engineering was
$274,000 for fiscal 1997 compared with $238,000 for fiscal 1996 and $603,000 for
fiscal 1995. The difference between fiscal 1996 and 1995 was due mainly to a
change on October 1, 1994 in the estimated useful lives of the optical card
manufacturing equipment.

         The Company continues to undertake ongoing research and engineering
project activities. However, reported research and engineering expenses are
expected to continue to decrease as optical card production increases and card
manufacturing resources are allocated to card production to a greater degree
than at present. The Company believes that the reduction in card manufacturing
facility expenses allocated to research and engineering will not have a negative
effect on its optical card business since appropriate research and engineering
projects are continuing. It also is possible that future projects may require
increased spending as the optical card industry grows.

       Other Income and Expense. Other income for fiscal 1997 was $64,000 as
compared with $272,000 for fiscal 1996 and $32,000 for fiscal 1995. Other income
for the fiscal 1997 included a $22,000 gain on foreign currency exchange; there
was no income of this type for fiscal 1996 or fiscal 1995. During the first
quarter of fiscal 1996, the Company received a $200,000 nonrefundable deposit
toward a license agreement. The license agreement was not consummated and the
deposit was forfeited by the licensee. The income from the forfeiture of the
deposit is recorded as other income in fiscal 1996. There was no income of this
type for fiscal 1997 or for fiscal 1995.

       Interest income for fiscal 1997 was $50,000 as compared with $78,000 for
fiscal 1996 and $35,000 for fiscal 1995. The changes in interest income for each
year were due generally to changes in average invested funds. The Company's
interest expense on short-term loans was $8,000 for fiscal 1997, $8,000 for
fiscal 1996, and $7,000 for fiscal 1995.

       Discontinued Operations. During fiscal 1993, the Company discontinued its
emulsion photoplate operation because of the limited market for these products,
which was long anticipated by the Company. During fiscal 1995, the Company
completed settlement of its remaining commitments related to its discontinued
emulsion photoplate operation, at an amount lower than its accruals for these
items. Therefore, discontinued operations had income of $22,000 for fiscal 1995.
There was no income or loss from discontinued operations for fiscal 1996 or
fiscal 1997.

LIQUIDITY

       As of March 31, 1997, the Company had cash and cash equivalents of
$2,916,000 and a current ratio of 1.5 to 1. Net cash used for operating
activities was $813,000 for fiscal 1997 as compared with $940,000 during fiscal
1996 and $1,729,000 for fiscal 1995. As of March 31, 1997, the Company had no
long-term debt.

       The Company has not established a line of credit. Generally, the
Company's customers make advance payments, in whole or in part, at time of order
placement because the Company's optical memory cards are usually made to custom
specifications that are specific to each customer, end user, or application. The
Company believes that although working capital requirements should grow in
proportion to product shipment levels, the advance payments will reduce the need
for working capital financing. 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, if needed.



                                       22
<PAGE>   23

       At March 31, 1997, the Company had an accumulated deficit of $27,548,000
and, except for sporadic sales of licenses, has experienced quarterly losses.
Based on current raw-material costs and other expense calculations, the Company
estimates that it will break even on operations at annual sales of approximately
1.6 million to 1.8 million optical memory cards, depending on the margins on
sales of related hardware. Due to its large card order from the INS, the Company
expects its financial performance to improve.

       The Company's Total deferred income tax asset was $16,114,000 at March
31, 1997. If utilized, the Total deferred income tax asset would reduce future
tax expense and payments. Included are amounts derived from federal income tax
net operating losses that will expire at various dates from 2001 through 2012,
amounts from state income tax net operating losses that will expire at various
dates from 1998 through 2002, and amounts from tax credits that will expire from
2000 through 2004. The ability of the Company to utilize this deferred tax asset
is contingent upon generating sufficient income within the stated time periods.
In view of the uncertain value of this asset, the Company has recorded a full
valuation allowance against it; therefore, no part of the Total deferred tax
asset of $16,114,000 has been added to stockholders' equity on the Company's
balance sheet.

       The Company is planning to install $1,800,000 of capital equipment and
leasehold improvements in its card production facility during the fiscal year
ending March 31, 1998. These assets are for the production of new products and
for process improvements to increase yields, and will result in a production
capacity of 6 million cards annually. The Company currently estimates that an
additional $5 million in production equipment is required to reach the factory-
designed capacity of 25 million cards per year. Such equipment will be purchased
incrementally as commercial orders for optical memory cards justify increased
production capacity, estimated as follows: for 8 million cards annually, $1.2
million; for 10 million cards annually, an additional $1.3 million; and for 25
million cards annually, an additional $2.5 million. The Company may make
additional capital expenditures for cost savings and other purposes.

       During fiscal 1996, the Company had cash receipts, net of expenses, of
$446,000 from the private placement of 115,000 shares of its common stock.
During fiscal 1997, Company employees and consultants purchased from the Company
314,500 shares of registered common stock, at an average price of $6.48 per
share, through the exercise of stock options under the Company's 1991 Stock
Option Plan, which resulted in additional cash receipts to the Company of
$2,037,000. As of March 31, 1997, Company employees and consultants held
unexercised, vested, in-the-money options to purchase 606,767 shares of common
stock at exercise prices ranging from $4.25 to $9.06 per share, for an average
of $6.62 per share. These stock options, if exercised, would provide the Company
with cash in the amount of $4,016,000.

FORWARD-LOOKING STATEMENTS

       Certain statements made above relating to plans, objectives, and economic
performance go beyond historical information and may provide an indication of
future results. To that extent, they are forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
each is subject to factors that could cause actual results to differ from those
in the forward-looking statement. Such factors are described above and under
Risk Factors in this Form 10-K.



                                       23
<PAGE>   24

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND
        SUPPLEMENTARY DATA



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Drexler Technology Corporation:

We have audited the accompanying consolidated balance sheets of Drexler
Technology Corporation (a Delaware corporation) and subsidiaries as of March 31,
1996 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drexler Technology Corporation
and subsidiaries as of March 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1997, in conformity with generally accepted accounting principles.




                                                  /s/Arthur Andersen LLP

                                                ARTHUR ANDERSEN LLP


San Jose, California
April 21, 1997



                                       24
<PAGE>   25

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                             March 31, 1996 and 1997
               (In thousands, except share and per share amounts)

<TABLE>
<CAPTION>

                                                                                             1996              1997
                                                                                             ----              ----
<S>                                                                                     <C>               <C>       
                                     Assets
Current assets:
     Cash and cash equivalents ....................................................     $   2,094         $    2,916
     Accounts receivable...........................................................           667                615
     Inventories ..................................................................           864                852
     Other current assets. ........................................................           157                205
                                                                                        ---------          -----------
         Total current assets .....................................................         3,782              4,588
                                                                                        ---------          -----------
Property and equipment, at cost....................................................        13,067             13,404
     Less--accumulated depreciation and amortization ...............................      (11,460)           (11,790)
                                                                                        ---------          -----------
         Property and equipment, net...............................................         1,607              1,614

Patents, net      .................................................................           982                887
                                                                                        ---------          -----------
              Total assets.........................................................     $   6,371         $    7,089
                                                                                        ---------          -----------

                      Liabilities and Stockholders' Equity

Current liabilities:
     Accounts payable..............................................................     $   1,498         $      501
     Accrued payroll costs ........................................................           233                230
     Advance payments from customers...............................................           177              2,183
     Other accrued liabilities.....................................................           136                116
                                                                                        ---------          -----------
         Total current liabilities.................................................         2,044              3,030
                                                                                        ---------          -----------
Commitments (Note 7)
Stockholders' equity:
     Preferred stock, $.01 par value:
         Authorized--2,000,000 shares
         Outstanding--none..........................................................            --                 --
     Common stock, $.01 par value:
         Authorized--15,000,000 shares
         Outstanding--8,831,674 shares in 1996 and 9,150,416 shares in 1997.........            88                 91
Additional paid-in capital.........................................................        29,452              31,516
Accumulated deficit................................................................       (25,213)            (27,548)
         Total stockholders' equity................................................         4,327               4,059
                                                                                        ---------          -----------
              Total liabilities and stockholders' equity...........................     $   6,371         $     7,089
                                                                                        =========          ==========
</TABLE>


   The accompanying notes are an integral part of these financial statements.



                                       25
<PAGE>   26

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

            For the Fiscal Years Ended March 31, 1995, 1996, and 1997
                    (In thousands, except per share amounts)



<TABLE>
<CAPTION>

                                                                       1995            1996            1997
                                                                       ----            ----            ----
<S>                                                              <C>              <C>             <C>       

Revenues:
     Product sales...........................................    $   2,141        $   5,059       $    3,510
     License fees and royalties..............................        1,025              236               19
                                                                 ----------       ---------       -----------
         Total revenues......................................        3,166            5,295            3,529
                                                                 ----------       ---------       -----------
Costs and expenses:
     Cost of product sales...................................        1,511            3,659            2,388
     Selling, general, and administrative expenses...........        2,023            2,400            2,602
     Research and engineering expenses.......................        1,860            1,092              938
                                                                 ----------       ---------       -----------
         Total costs and expenses............................        5,394            7,151            5,928
                                                                 ----------       ---------       -----------

             Operating loss from continuing operations.......       (2,228)          (1,856)          (2,399)

Other income and expense:
     Other income............................................            4              202               22
     Interest income.........................................           35               78               50
     Interest expense........................................           (7)              (8)              (8)
                                                                 ----------       ---------       -----------
         Total other income, net.............................           32              272               64
                                                                 ----------       ---------       -----------
             Loss from continuing operations.................       (2,196)          (1,584)          (2,335)

Income from discontinued operations..........................           22               --               --
                                                                 ----------       ---------       -----------
             Net loss........................................    $  (2,174)       $  (1,584)          (2,335)
                                                                 ----------       ---------       -----------
Loss per share:
     Continuing operations ..................................    $    (.27)       $    (.18)      $     (.26)
     Discontinued operations.................................           --               --               --
                                                                 ----------       ---------       -----------
             Net loss........................................    $    (.27)       $    (.18)      $     (.26)
                                                                 ----------       ---------       -----------
Weighted average common shares...............................        8,161            8,692             9,006
                                                                 =========        =========        ==========
</TABLE>



   The accompanying notes are an integral part of these financial statements.



                                       26
<PAGE>   27

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

            For the Fiscal Years Ended March 31, 1995, 1996, and 1997
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>

                                                                           Additional
                                                       Common Stock          Paid-In     Accumulated
                                                    Shares      Amount       Capital       Deficit        Total
                                                    ------      ------       -------       -------        -----
<S>                                                 <C>             <C>      <C>          <C>             <C>  

Balance, March 31, 1994 ....................        8,104           81       26,076       (21,455)        4,702
     Shares issued under stock option
         and stock purchase plans ..........           17         --             78          --              78
     Compensation related to
         stock plan activity ...............         --           --              8          --               8
     Shares issued under private placement
         at $4.00 per share, net of issuance
         costs of $28 ......................          237            2          920          --             922
     Net loss ..............................         --           --           --          (2,174)       (2,174)
                                                   ------     --------       ------       -------        -------
Balance, March 31, 1995 ....................        8,358           83       27,082       (23,629)        3,536
     Shares issued under stock option
         and stock purchase plans ..........          359            4        1,914          --           1,918
     Compensation related to
         stock plan activity ...............         --           --             11          --              11
     Shares issued under private placement
         at $4.00 per share, net of issuance
         costs of $14 ......................          115            1          445          --             446
     Net loss ..............................         --           --           --          (1,584)       (1,584)
                                                   ------     --------       ------       -------        -------
Balance, March 31, 1996 ....................        8,832           88       29,452       (25,213)        4,327
     Shares issued under stock option
         and stock purchase plans ..........          318            3        2,064          --           2,067
     Compensation related to
         stock plan activity ...............         --           --             16          --              16
     Stock plan registration costs .........         --           --            (16)         --             (16)
     Net loss ..............................         --           --           --          (2,335)       (2,335)
                                                   ------     --------       ------       -------        -------

Balance, March 31, 1997 ....................        9,150     $     91     $ 31,516      $(27,548)     $  4,059
                                                   ======     ========     ========      ========      ========

</TABLE>


   The accompanying notes are an integral part of these financial statements.



                                       27
<PAGE>   28

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

            For the Fiscal Years Ended March 31, 1995, 1996, and 1997
                                 (In thousands)

<TABLE>
<CAPTION>


                                                                                       1995                1996           1997
                                                                                     ---------        ---------       ---------
<S>                                                                                  <C>              <C>             <C>      

Cash flows from operating activities:
    Net loss from continuing operations...........................................   $   (2,196)      $  (1,584)      $ (2,335)
    Adjustments to reconcile net loss to net cash used
             for operating activities:
         Income from discontinued operations......................................           22              --             --
         Depreciation and amortization............................................          800             449            504
         Provision for doubtful accounts receivable...............................            1               1             --
         Compensation on stock plan activity......................................            8              11             16
    Changes in operating assets and liabilities:
         (Increase) decrease in accounts receivable...............................           (6)           (570)            52
         (Increase) decrease in inventories.......................................         (191)           (278)            12
         Increase in other assets.................................................           (8)            (18)           (48)
         Increase (decrease) in accounts payable and accrued liabilities..........           35           1,102         (1,020)
         (Decrease) increase in advance payments from customers...................         (121)            (39)         2,006
         Decrease in liabilities related to discontinued operations...............          (73)            (14)            --
                                                                                     ----------       ---------       --------
             Net cash used for operating activities...............................       (1,729)           (940)          (813)
                                                                                     ----------       ---------       --------
Cash flows from investing activities:
    Purchase of property and equipment............................................         (252)           (313)          (343)
    Increase in patents...........................................................         (83)             (67)           (73)
                                                                                     ----------       ---------       --------
             Net cash used for investing activities...............................         (335)           (380)          (416)
                                                                                     ----------       ---------       --------
Cash flows from financing activities:
    Proceeds from sale of common stock, net of issuance costs.....................        1,000           2,364          2,051
                                                                                     ----------       ---------       --------
             Net cash provided by financing activities............................        1,000           2,364          2,051
                                                                                     ----------       ---------       --------
             Net (decrease) increase in cash and cash equivalents.................       (1,064)          1,044            822

Cash and cash equivalents:
    Beginning of year.............................................................        2,114           1,050          2,094
                                                                                     ----------       ---------       --------
    End of year...................................................................   $    1,050       $   2,094          2,916
                                                                                     ==========       =========       ========
Supplemental disclosures--cash payments for the following items are:
    Income taxes..................................................................   $        5       $       6       $      4
                                                                                     ==========       =========       ========
    Interest......................................................................   $        7       $       8       $      8
                                                                                     ==========       =========       ========
</TABLE>


   The accompanying notes are an integral part of these financial statements.



                                       28
<PAGE>   29

                 DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                 MARCH 31, 1997

1.    Organization and Operations

      Drexler Technology Corporation and its wholly owned subsidiary, LaserCard
Systems Corporation, (the "Company") develop, manufacture, and market optical
data storage products used with personal computers for information recording,
storage, and retrieval. The Company's customers are mainly value-added reseller
(VAR) companies throughout the world that develop commercial applications for
LaserCard(R) products. The Company's target markets include consumer, business,
and government applications for portable, recordable, unitary record cards.
These applications include healthcare, secure access, immigration/ID cards, and
vehicle maintenance cards.

      The Company is subject to certain risks including competition from
substitute products and larger companies, and the need for additional financing
through profitable operations or external financing, or both.

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.

      The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

      Fiscal Period

      For purposes of presentation, the Company has indicated its accounting
period as ending on March 31 and its interim quarterly periods as ending on the
corresponding month end. The Company, in fact, operates and reports quarterly
periods ending on the Friday closest to month end. Fiscal 1995, 1996, and 1997
were 52-week years.

      Cash and Cash Equivalents

      The Company considers all highly liquid investments, consisting primarily
of commercial paper, with original maturities of three months or less to be cash
equivalents.

      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
replacement cost or estimated realizable value.

      The components of inventories as of March 31 are (in thousands):

<TABLE>
<CAPTION>
                                                      1996          1997
                                                     ------       -------
<S>                                                 <C>           <C>    

Raw materials....................................   $  443        $   353
Work-in-process..................................       79            133
Finished goods...................................      164            288
Systems and components
   held for resale...............................      178             78
                                                    ------        --------
                                                    $  864        $   852
                                                    ======        ========
</TABLE>


                                       29



<PAGE>   30

      The Company currently buys all of its optical memory card reader/writers,
an important component of its systems, from one supplier. An interruption or
change in the supply of reader/writers could cause a delay in product shipments
and a possible loss of sales, which would adversely affect operating results.

      Property and Equipment

      The components of property and equipment as of March 31 are (in
thousands):

<TABLE>
<CAPTION>

                                                     1996        1997
                                                     ----        ----
<S>                                              <C>          <C>     
Equipment and furniture..........................  $11,285     $11,581
Leasehold improvements...........................    1,782       1,823
                                                   -------     -------
                                                   $13,067     $13,404
                                                   =======     =======

</TABLE>

      Depreciation is provided over the estimated useful lives (five to seven
years) of equipment and furniture using the double-declining balance and
straight-line methods. During fiscal 1995, the Company completed a review of its
fixed asset lives and determined that the actual lives for manufacturing
equipment, with a net book value of $1,320,000, were generally longer than the
estimated useful lives for depreciation purposes. Therefore, the Company
extended the estimated useful lives of its manufacturing equipment by five
years, effective October 1, 1994. In addition, the Company established a salvage
value of approximately $315,000 on this equipment. Leasehold improvements are
amortized over the shorter of the life of the asset or the life of the lease
using the straight-line method.

      Patent Costs

      Costs incurred in connection with patents are capitalized and amortized
over the estimated useful lives of the patents of 9 to 17 years.

      Gross patent expenditures capitalized and accumulated amortization as of
March 31 are as follows (in thousands):

<TABLE>
<CAPTION>
                                           1996           1997
                                           ----           ----
<S>                                     <C>            <C>     
Gross patent expenditures............   $  2,312       $  2,385
Accumulated amortization.............     (1,330)        (1,498)
                                        --------       --------
                                        $    982       $    887
                                        ========       ========
</TABLE>

      Software Development Costs

      Under the criteria set forth in Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed," capitalization of software development costs begins upon the
establishment of technological feasibility of the product, which the Company
defines as a beta version of the software. The period of time commencing when a
product achieves beta status and ending when a product is available for general
release is typically very short. Accordingly, amounts that could have been
capitalized under SFAS No. 86 after consideration of the above factors were
immaterial and, therefore, no software development costs have been capitalized
by the Company to date.

      Advance Payments from Customers

      The Company customarily receives advance payments on orders placed by its
customers. The advance payments are deferred until the related orders are
shipped. At March 31, 1997, approximately 99% of total advance payments related
to a contract with one customer.



                                       30
<PAGE>   31

      Revenue Recognition

      Product sales primarily consist of card sales and sales of reader/writers.
The Company generally recognizes revenue from product sales at the time of
shipment. Where appropriate, provision is made at that time for estimated
warranty costs.

      License revenues include front-end license fees and long-term royalty
payments. License fees are generally recognized as revenues when the license
agreement is signed. Long-term royalty payments are recognized as revenue when
realized.

      No licenses were sold in fiscal 1997; fiscal 1995 license revenue included
$1 million from the sale of an optical memory card distribution license, and
fiscal 1996 license revenue included $200,000 from an agreement comprised of a
trademark license and an installment payment toward a possible future license
for optical memory card distribution. Optical memory card distribution licenses
grant the right to purchase such cards at the Company's most favorable pricing.

      The cost of license revenue is not material and is included in selling,
general, and administrative expenses.

      Stock-Based Compensation

      Effective April 1, 1996, the Company adopted the disclosure provisions of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." In accordance with the provisions of SFAS No. 123, the Company
applies Accounting Principles Board Opinion (APBO) No. 25 and related
interpretations in accounting for its stock option plan. Note 6 to the
consolidated financial statements contains a summary of the pro forma effects on
reported net income and earnings per share for fiscal 1996 and 1997 based on the
fair value of the options granted at grant date as prescribed by SFAS No. 123.

      Long-Lived Assets

      In March 1995, the Financial Accounting Standards Board (FASB) issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS No. 121 requires that long-lived assets be
reviewed for impairment and, if necessary, an impairment loss be recorded
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. SFAS No. 121 is effective for fiscal year
1997. Adoption of SFAS No. 121 did not have a material effect on the financial
position or results of operations of the Company.

      FASB 128 Disclosure

      In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which simplifies the standards for computing earnings per share previously found
in APBO No. 15. SFAS No. 128 replaces the presentation of primary earnings per
share with a presentation of basic earnings per share, which excludes dilution.
SFAS No. 128 also requires dual presentation of basic and diluted earnings per
share on the face of the income statement for all entities with complex capital
structures and requires a reconciliation. Diluted earnings per share is computed
similarly to fully diluted earnings per share pursuant to APB No. 15. SFAS No.
128 must be adopted for financial statements issued for periods ending after
December 15, 1997, including interim periods; earlier application is not
permitted. SFAS No. 128 requires restatement of all prior-period earnings per
share data presented. The Company does not expect the adoption of SFAS No. 128
to have a material impact on its financial statements.

      Reclassifications

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



                                       31
<PAGE>   32

3.    Loss Per Share

      Loss per share has been computed based upon the weighted average number of
common shares outstanding.

4.    Major Customers and Export Sales

      The Company operates in one industry segment--the development,
manufacture, and sale of optical data products used for computer data storage.
Five customers each accounted for more than 10% of revenues for one or more
years during fiscal 1995, 1996, and 1997, as follows:

<TABLE>
<CAPTION>
                                         Fiscal Year
                                         -----------

                                   1995      1996      1997
                                   ----      ----      ----
   <S>                               <C>       <C>       <C>
   Customer A...................     16%       13%       35%
   Customer B...................     NA        39%       22%
   Customer C...................     NA        18%       14%
   Customer D...................     13%       NA        NA
   Customer E...................     32%       NA        NA

</TABLE>

  (NA = Not applicable, less than 10% of revenues.)


       At March 31, 1997, two substantial U.S. customers comprised 70% of total
accounts receivable. At March 31, 1996, two substantial U.S. customers comprised
96% of total accounts receivable, primarily for products sold under a U.S.
government subcontract.

      Revenues by region are as follows (in thousands):

<TABLE>
<CAPTION>
                                                   Fiscal Year
                                                   -----------
                                           1995         1996        1997
                                           ----         ----        ----
   <S>                                 <C>           <C>          <C>     
   United States....................     $  917        $3,083       $2,294
   Asia.............................      1,427         1,263          747
   Europe...........................        698           684          321
   Rest of world....................        124           265          167
                                         ------        ------       ------
                                         $3,166        $5,295       $3,529
                                         ======        ======       ======
</TABLE>

      Three foreign countries each accounted for more than 10% of revenues for
one or more years during fiscal 1995, 1996, and 1997, as follows: fiscal 1995 -
South Korea (34%), Czech Republic (14%); fiscal 1996 - Philippine Islands (19%);
and fiscal 1997 - Philippine Islands (14%).

5.    Discontinued Operations

      In the fourth quarter of fiscal 1993, the Company closed its Precision
Photoglass, Inc. subsidiary, which was a manufacturer of photoplates for the
semiconductor industry. The income from discontinued operations included in the
consolidated statements of operations contained herein for the fiscal year ended
March 31, 1995 was composed of a reduction in an expense reserve.



                                       32
<PAGE>   33

6.    Common Stock

      Stock Option Plan

      The Company has one stock option plan, the 1991 Stock Option Plan ("1991
Option Plan"), under which 1,401,020 shares of common stock are reserved as of
March 31, 1997. The Company accounts for this plan under APB Opinion No. 25;
accordingly, no compensation expense has been recognized in the consolidated
financial statements. SFAS No. 123 requires the disclosure of pro forma net loss
and loss per share as if the Company had adopted the fair value method as of the
beginning of fiscal 1996. Under the fair value method, compensation cost is
measured at the grant date based on the value of the award and is recognized
over the service period. Under SFAS No. 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing models. Such
models require subjective assumptions, including future stock price volatility
and estimated term.

      These calculations were made using the Black-Scholes option-pricing model
with the following weighted-average assumptions used for grants in fiscal 1996
and 1997: risk-free interest rate of 6%, expected lives of two to five years,
and expected volatility of 55%. The fair value of each option grant was
estimated on the date of grant. The calculations resulted in weighted average
fair values of $3.25 and $6.42, respectively, for options granted in fiscal 1996
and 1997, and pro forma net loss of $2,701,000 ($0.31 per share) for fiscal 1996
and $3,397,000 ($0.38 per share) for fiscal 1997.

      Because the SFAS No. 123 method of accounting had not been applied to
options granted prior to April 1, 1995, the resulting pro forma compensation
costs may not be representative of what such costs would be expected to be in
future years.

      The Company's 1991 Stock Option Plan provides that stock options may be
granted to employees, officers, 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. Options are exercisable, as determined by the Board of Directors,
during the term of the option, which cannot exceed ten years (except that the
option term cannot exceed five years in the case of incentive stock options
granted to a principal shareholder).

      The total option price paid for options exercised during fiscal 1995,
1996, and 1997 was $62,278, $1,893,609, and $2,036,559, respectively.

      The following table lists option activity in the Stock Option Plan which
has occurred since March 31, 1994.



                                       33
<PAGE>   34

                               Stock Option Table
                               ------------------
<TABLE>
<CAPTION>

                                         Options                   Weighted Average
                                       Available      Outstanding     Exercise
                                       for Grant       Options        Price              Per Share Price
                                       ---------       -------        -----              ---------------
<S>                                     <C>             <C>          <C>          <C>          <C>    
Balance March 31, 1994...........        109,820         922,950      $ 6.08       $ 3.375  --  $ 8.125
     Authorized..................        400,000              --         --
     Granted.....................        (93,100)         93,100      $ 4.73       $ 4.563  --  $ 6.813
     Exercised...................             --         (11,900)     $ 5.23       $ 4.94   --  $ 5.94
     Expired.....................          1,500          (1,500)     $ 6.50       $ 6.50
                                        --------       ---------
Balance March 31, 1995...........        418,220       1,002,650      $ 5.96       $ 3.375  --  $ 8.125
     Authorized..................        400,000              --
     Granted.....................       (530,400)        530,400      $ 7.63       $ 5.57   --  $12.313
     Exercised...................             --        (355,350)     $ 5.33       $ 3.375  --  $ 8.125
     Expired.....................          2,100          (2,100)     $ 6.81       $ 6.813
                                        --------       ---------
Balance March 31, 1996...........        289,920       1,175,600      $ 6.90       $ 4.25   --  $12.313
     Authorized..................        250,000              --          --
     Granted.....................       (356,880)        356,880      $ 3.14       $11.813  --  $16.313
     Exercised...................             --        (314,500)     $ 6.48       $ 5.69   --  $ 8.563
     Expired.....................          2,500          (2,500)     $ 7.41       $ 6.938  --  $ 8.125
                                        --------       ---------
Balance March 31, 1997...........        185,540       1,215,480      $ 8.84       $ 4.25   --  $16.313
                                        ========       =========

</TABLE>

      The following table summarizes information about stock options outstanding
at March 31, 1997:

<TABLE>
<CAPTION>
                                              Options Outstanding                               Options Exercisable
                                              -------------------                               -------------------
                              Number          Weighted-Average                               Number
     Range of               Outstanding            Remaining          Weighted-Average     Exercisable  Weighted-Average
Exercise Prices             At 3/31/97        Contractual Life          Exercise Price     At 3/31/97    Exercise Price
---------------             ----------        ----------------          --------------     ----------    --------------
<S>           <C>              <C>              <C>                     <C>               <C>               <C>   

$ 4.25  -     9.06             855,600          2.7 years               $   7.04          606,767           $ 6.62
$11.81  -    16.31             359,880          5.2 years               $  13.13           65,000           $13.18
                             ---------                                                    -------
      Totals                 1,215,480                                                    671,767
                             =========                                                    =======
</TABLE>

      Employee Stock Purchase Plan

      The Company has an Employee Stock Purchase Plan ("Stock Purchase Plan"),
under which 65,170 shares are reserved as of March 31, 1997. 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
fair market value. The 33% differential in the price of shares sold under the
Stock Purchase Plan is charged to operations as compensation. Under the Stock
Purchase Plan, employees purchased 4,673 shares in fiscal 1995; 3,295 shares in
fiscal 1996; and 4,242 shares in fiscal 1997, at an average purchase price per
share of $3.35, $7.00, and $7.49, respectively. The weighted average fair value
per share for shares purchased during fiscal 1995, 1996, and 1997 was $5.00,
$10.45, and $11.17, respectively.

7.    Commitments

      The Company occupies its facilities under various operating leases. The
rent expense relating to these facilities was approximately $363,000 in fiscal
1995, $369,000 in fiscal 1996, and $372,000 in fiscal 1997. As of March 31,
1997, future minimum rental payments relating to these leases are (in
thousands):



                                       34
<PAGE>   35

<TABLE>

         <S> <C>                                                   <C>    
         Fiscal Year
             1998...............................................   $   374
             1999...............................................       375
             2000...............................................       343
             2001...............................................        61
             2002...............................................         8
             Thereafter.........................................        32
                                                                   -------
                                                                   $ 1,193
                                                                   =======
</TABLE>

8. Income Taxes

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

<TABLE>
<CAPTION>

                                                     1996           1997
                                                     ----           ----
   <S>                                           <C>             <C>       
   Net operating losses:
      Federal..................................  $   13,065      $   14,432
      State....................................       1,089             813
   Tax credits.................................       1,109           1,109
   Reserves and accruals not currently
      deductible for tax purposes..............         144             145
   Depreciation................................         (86)            (14)
   Capitalized patent costs....................        (364)           (329)
   Other    ...................................          (4)            (42)
                                                 ----------      -----------
      Total deferred tax asset.................      14,953          16,114
   Valuation allowance.........................     (14,953)        (16,114)
                                                 ----------      -----------
   Net deferred tax asset......................  $       --      $       --
                                                 ==========      ===========

</TABLE>

      The Company has established a valuation allowance for the total deferred
tax asset, as it is uncertain that the deferred tax asset will be realized.

      The Company's federal net operating losses will expire at various dates
from 2001 through the year 2012. The Company's state net operating losses will
expire at various dates from 1998 through the year 2002. The tax credit
carryforwards will expire at various dates from 2000 through the year 2004.

9.    Other Income

      During the first quarter of fiscal 1996, the Company received a $200,000
nonrefundable deposit toward a license agreement. The license agreement was not
consummated and the deposit was forfeited by the licensee. The income from the
forfeiture of the deposit is recorded as other income in fiscal 1996.



                                       35
<PAGE>   36

                   QUARTERLY FINANCIAL INFORMATION (Unaudited)


       The unaudited quarterly results of operations of the Company for fiscal
1996 and fiscal 1997 are as follows (in thousands, except per share amounts):


<TABLE>
<CAPTION>

    Quarterly Financial Results (Unaudited)            1st           2nd             3rd         4th
    ---------------------------------------            ---           ---             ---         ---
    <S>                                               <C>            <C>            <C>          <C>    

                                                           (In Thousands, Except Per Share Data)
    Fiscal 1996

         Product sales.............................   $    762       $    785       $  1,582     $ 1,930
         License fees..............................        207             10              7          12
         Net loss..................................       (453)          (441)          (364)       (326)
         Loss per share............................   $   (.05)      $   (.05)      $   (.04)    $  (.04)

    Fiscal 1997

         Product sales.............................   $    609       $  1,013       $    813     $ 1,075
         License fees..............................          9              5              2           3
         Net loss..................................       (646)          (437)          (694)       (558)
         Loss per share............................   $   (.07)      $   (.05)      $   (.08)    $  (.06)

</TABLE>



                                       36
<PAGE>   37

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

          None.

                                    PART III

          Pursuant to Paragraph G(3) of the General Instructions for Form 10-K,
the information called for by Items 10, 11, and 12 under Part III of Form 10-K
is incorporated by reference from the Company's Proxy Statement to be filed with
the Commission in connection with the Company's 1997 Annual Meeting of
Stockholders (the "Proxy Statement").

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

          Information concerning directors and executive officers of the Company
is included in the Proxy Statement under the caption "Stock Ownership by
Directors and Officers" and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

          Information concerning executive compensation appears in the Company's
Proxy Statement, under the captions "Director Compensation," "Executive
Compensation," and "Compensation Committee Interlocks and Insider Participation"
and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
         MANAGEMENT

          Information concerning the security ownership of certain beneficial
owners and management appears in the Company's Proxy Statement under the
captions "Stock Ownership by Directors and Officers" and "Principal Stockholder"
and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          None.



                                       37
<PAGE>   38

                                     PART IV

ITEM 14. 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:

<TABLE>
<CAPTION>
                                                                         Page
                                                                         Number
                                                                         ------
              <S>       <C>                                                  <C>

              (1)       Report of Independent Public Accountants             24

              (2)       Consolidated Balance Sheets at March 31, 1996
                        and March 31, 1997                                   25

              (3)       Consolidated Statements of Operations for
                        Fiscal Years 1995, 1996, and 1997                    26

              (4)       Consolidated Statements of Stockholders' Equity
                        for Fiscal Years 1995, 1996, and 1997                27

              (5)       Consolidated Statements of Cash Flows for Fiscal
                        Years 1995, 1996, and 1997                           28

              (6)       Notes to Consolidated Financial Statements           29

</TABLE>

       2.     Financial Statement Schedules: None

              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:

<TABLE>
<CAPTION>
                        Exhibit                                                       Incorporated Herein
                        Number          Description                                   By Reference to
                        ------          -----------                                   ---------------
              <S>       <C>             <C>                                           <C>                 
              (1)       Exhibits 3.1, 3.2, 3.2.1, 3.2.2, and 3.2.3, Articles of
                        Incorporation and By-Laws of the Company, as follows:

                        3.1                                                           Articles of Incorporation  
                                                                                      Exhibit 3.1 to Report on
                                                                                      Form 10-Q for period
                                                                                      ended September 25, 1987

</TABLE>



                                       38
<PAGE>   39

<TABLE>
<CAPTION>
                        Exhibit                                                          Incorporated Herein
                        Number           Description                                     By Reference to
                        ------           -----------                                     ---------------
              <S>       <C>              <C>                                             <C>                 
                        3.2              By-Laws                                         Exhibit 3.2 to Report on
                                                                                         Form 10-Q for period
                                                                                         ended September 25, 1987

                        3.2.1            By-Law Amendment Adopted                        Exhibit 3.2.1 to Report on
                                         during Fiscal 1991                              Form 10-K for period
                                                                                         ended March 31, 1992

                        3.2.2            By-Law Amendments Adopted                       Exhibit 3.2.2 to Report on
                                         during Fiscal 1992                              Form 10-K for period
                                                                                         ended March 31, 1992

                        3.2.3            By-Law Amendment Adopted                        Exhibit 3.2.3 to Report on
                                         during Fiscal 1994                              Form 10-Q for period
                                                                                         ended September 30, 1993

                        3.2.4            By-Laws of the Company, as amended              Filed herewith
                                         through February 21, 1997

              (2)       Exhibits 10.1 through 10.6.4, Material Contracts, as follows:

                        10.1             Building Lease with                             Exhibit 10.1 to Report on
                                         Kimes Properties                                Form 10-K for fiscal year
                                                                                         ended March 31, 1993

                        10.1.2           Building Lease Extension                        Exhibit 10.1.2 to Report on
                                         with Kimes Properties                           Form 10-K for fiscal year
                                                                                         ended March 31, 1996

                        10.2             Building Lease with                             Exhibit 10.8 to Report on
                                         Renault & Handley                               Form 10-K for fiscal year
                                         Employees Investment Co.                        ended April 2, 1982

                        10.2.1           Building Lease Extensions                       Exhibit 10.10 to Report
                                         with Renault & Handley                          on Form 10-K for fiscal
                                         Employees Investment Co.                        year ended March 31, 1987

                        10.2.2           Building Lease Extensions                       Exhibit 10.3.2 to Report
                                         with Renault & Handley                          on Form 10-K for fiscal
                                         Employees Investment Co.                        year ended March 31, 1989

                        10.2.3           Building Lease Extensions                       Exhibit 10.2.3 to Report on
                                         with Renault & Handley                          Form 10-K for fiscal year
                                         Employees Investment Co.                        ended March 31, 1992

                        10.2.4           Building Lease Extensions                       Exhibit 10.2.4 to Report on
                                         with Renault & Handley                          Form 10-Q for period ended
                                         Employees Investment Co.                        September 30, 1994

</TABLE>


                                       39
<PAGE>   40

<TABLE>
<CAPTION>

                        Exhibit                                                             Incorporated Herein
                        Number                   Description                             By Reference to
                        ------                   -----------                             ---------------
              <S>       <C>              <C>                                             <C>                 
                        10.3            Optical Memory Card                              Exhibit 4 to Report on
                                        Manufacturing License                            Form 8-K dated
                                        with Canon Inc.                                  January 10, 1989
                                                                                       
                        10.4            Optical Memory Card Manufacturing                Exhibit 10.8 to Report on
                                        License with Optical Memory Card                 Form 10-K for fiscal year
                                        Business Corporation                             ended March 31, 1991
                                                                                       
                        10.5            Management Bonus Plan                            Exhibit 10.9 to Report on
                                                                                         Form 10-K for fiscal year
                                                                                         ended April 1, 1983
                                                                                       
                        10.6            1991 Stock Option Plan                           Exhibit 10.10 to Report
                                                                                         on Form 10-K for fiscal
                                                                                         year ended March 31, 1991
                                                                                       
                        10.6.1          Amended 1991 Stock Option Plan                   Exhibit 10.10.1 to Report
                                        Approved by Stockholders during                  on Form 10-Q for period
                                        Fiscal 1994                                      ended September 30, 1993
                                                                                       
                        10.6.2          Amended 1991 Stock Option Plan                   Exhibit 10.6.2 to Report
                                        Approved by Stockholders during                  on Form 10-K for period
                                        Fiscal 1995                                      ended March 31, 1995
                                                                                       
                        10.6.3          Amended 1991 Stock Option Plan                   Exhibit 10.1 to Report
                                        Approved by Stockholders during                  on Form 10-Q for period
                                        Fiscal 1996                                      ended September 30, 1995
                        
                        10.6.4          Amended 1991 Stock Option Plan                   Exhibit 10.1 to Report
                                        Approved by Stockholders during                  on Form 10-Q for period
                                        Fiscal 1997                                      ended September 30, 1996
                 
              (3)       22              Subsidiaries                                     Filed herewith
                                                                                       
              (4)       24              Consent of Experts and Counsel                   Filed herewith
                                                                                       
              (5)       27              Financial Data Schedule                          Filed herewith
</TABLE>


       Exhibits not listed above are not applicable to registrant.              

(b)    Reports on Form 8-K

       The Company did not file any Reports on Form 8-K during the quarter ended
March 31, 1997.

(c)  Exhibits

       Exhibits 3.2.4, 22, 24, and 27 are filed herewith.

(d)  Financial Statement Schedules

       None.



                                       40
<PAGE>   41

                                   SIGNATURES

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

            Dated:  June 25, 1997

                                     DREXLER TECHNOLOGY CORPORATION



                                     By  /s/Jerome Drexler
                                     ---------------------
                                     Jerome Drexler, Chairman and Chief 
                                     Executive Officer



            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/Jerome Drexler         Chairman of the Board of Directors       June 25, 1997
---------------------     and Chief Executive Officer   
Jerome Drexler            (Principal Executive Officer) 
                          


/s/Steven G. Larson       Vice President of Finance and Treasurer  June 25, 1997
---------------------     (Principal Financial Officer and  
Steven G. Larson          Principal Accounting Officer)     
                                                            
                         

/s/Arthur H. Hausman      Director                                 June 25, 1997
---------------------
Arthur H. Hausman



/s/William E. McKenna     Director                                 June 25, 1997
---------------------
William E. McKenna

</TABLE>


                                       41
<PAGE>   42

<TABLE>
<CAPTION>
                                                 EXHIBIT INDEX
                                                 ------------
                     
                        Exhibit                                                                                 
                        Number                   Description                             
                        ------                   -----------                             
                          <C>              <C>                                                            
                        3.2.4           By-Laws of Drexler Technology Corporation, 
                                        as amended
                 
                        22              Subsidiaries                                     
                                                                                       
                        24              Consent of Experts and Counsel                   
                                                                                  
                        27              Financial Data Schedule                          
</TABLE>