The following discussion and analysis of our financial condition, results of operations and critical accounting policies should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto for the fiscal year ended March 31, 2009, included in the 2009 Form 10-K.

FORWARD-LOOKING STATEMENTS

All statements contained in this report that are not historical facts are forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are not facts or guarantees of future performance or events. Rather, they are based on current expectations, estimates, beliefs, assumptions, and goals and objectives and are subject to risks and uncertainties that are difficult to predict. As a result, our actual results may differ materially from the statements made. Often such forward-looking statements can be identified by their use of words such as "may," "will," "intends," "plans," "believes," "anticipates," "visualizes," "expects," "estimates," or similar language. Forward-looking statements made in this report include but are not limited to statements regarding our beliefs as to current and potential market segments, customers, and applications for and deployment of our products; the advantages of, potential income from, and duties to be performed under the sale of a second-source card manufacturing license to GIG/Prevent Global; our expectations as to the continuation, production quantities, delivery rates and requested and actual delivery schedule, backlog, revenue, margins, and profit for our products for U.S. or foreign government ID card programs; plans to increase card production capacity for anticipated increases in orders including possibly $1.4 million in capital equipment and leasehold improvements through March 31, 2010; our expectation of negative gross profit from the drive, system and enabling services market; the need for, expected success of, expense and potential benefits from our research and development efforts; estimates that revenues and advance payments will be sufficient to generate cash from operating activities during fiscal 2010 and fund our actual capital expenditures despite expected quarterly fluctuations; our projected liquidity in light of the issues surrounding our investments in auction rate securities ("ARS") and our ability to secure more contracts; and our belief as to the credit quality of our ARS and the changes in the fair value of these securities and our belief that the Put Option will not significantly impact our future earnings.

These forward-looking statements are based upon our assumptions about and assessment of the future, which may or may not prove true, and involve a number of risks and uncertainties including, but not limited to, whether there is a market for cards for homeland security in the U.S. and abroad, and if so, whether such market will utilize optical memory cards ("OMCs") as opposed to other technologies; significant customer concentration and reliance on continued U.S., Saudi Arabian, Angolan, and Italian government business; risks associated with doing business in and with foreign countries; whether we will be successful in assisting GIG/Prevent Global with factory startup and training; whether GIG/Prevent Global will obtain the financial resources to make the balance of its required payments to us and to operate the facility and the results of our recently filed litigation in the UK regarding the proper counterparty to the GIG/Prevent agreements and any counterclaims related thereto; whether the facility will efficiently produce high quality OMCs in volume and that meet our standards; lengthy sales cycles and changes in and dependence on government policy-making; reliance on value-added resellers and system integrators to generate sales, perform customer system integration, develop application software, integrate optical card systems with other technologies, test products, and work with governments to implement card programs; potential manufacturing difficulties and complications associated with increasing manufacturing capacity of cards and drives, implementing new manufacturing processes, and outsourcing manufacturing; our ability to produce and sell read/write drives in volume; the unpredictability of customer demand for products and customer issuance and release of corresponding orders; the possibility that OMCs will not be purchased for the full implementation of card programs in Italy, the Kingdom of Saudi Arabia, Angola, and India, or for Department of Homeland Security ("DHS") programs in the U.S., or will not be selected for other government programs in the U.S. and abroad; whether UBS AG will purchase our ARS, and the risks set forth in the section entitled "Risk Factors" and elsewhere in this report and our other SEC filings. These forward-looking statements speak only as of the date of this report, and, except as required by law, we undertake no obligation to publicly release updates or revisions to these statements whether as a result of new information, future events, or otherwise.

CRITICAL ACCOUNTING POLICIES

The preparation of condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, income taxes, restructurings, pensions and other post-retirement benefits, stock-based compensation, warranty costs, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are those policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. We believe our critical accounting policies include our policies regarding revenue recognition, allowances for doubtful accounts, inventory valuation, business combinations, value of long-lived assets, including intangibles, employee compensation and benefits, restructuring activities, gains or losses on dispositions and income taxes. For a more detailed discussion of our critical accounting policies, please refer to the 2009 Form 10-K.

RESULTS OF OPERATIONS

Overview

Headquartered in Mountain View, California, we are, together with our subsidiaries, a leading provider of secure ID solutions to governments and commercial clients worldwide. Our wholly-owned German subsidiary, CCD, with offices in Rastede and Ratingen, Germany, manufactures and offers a wide range of high quality specialty cards, plus card personalization and ID management solutions under the CCD and Cards & More brands. We develop, manufacture, and integrate LaserCard® optical memory cards ("OMCs"), multi-technology cards, encoders, peripherals, smart and specialty cards, biometrics, and modular software. Our cards and systems are used in demanding applications, including citizen and foreign resident identification, government service delivery and facility access used in countries around the world, such as the United States, Germany, United Kingdom, Angola, Italy, India, Costa Rica and the Kingdom of Saudi Arabia.

The majority of our revenues are from sales of products and services through partners such as value added resellers ("VARs") and system integrators ("SIs") who generally have specific experience in the development of markets and applications for our products. We have sales staff located in California, the Washington D.C. area, Latin America and Germany.

The table below presents condensed consolidated revenues, excluding inter-company transactions, recorded by our U.S. and German operations (in thousands):

                           Three Months Ended           Six Months Ended         Three Months       Six Months
                             September 30,                September 30,                      Change
                           2009          2008          2009          2008        2009 vs 2008      2009 vs 2008
U.S. operations         $   11,986     $   9,539     $  25,109     $  16,629     $       2,447     $       8,480
German operations            3,730         3,928         6,915         7,560              (198 )            (645 )
                        $   15,716     $  13,467     $  32,024     $  24,189     $       2,249     $       7,835

Our revenues are derived mainly from advanced technology cards such as optical memory, contact, contactless and RFID cards, or multi-technology versions of these cards including optical memory and one or more other technologies, used in government identity programs, and from high quality specialty cards for applications such as major event badging and access control. The remainder of our revenues comes from equipment sales, the sale of enabling services, such as consulting, custom application development and the integration of ID management solutions, and from knowledge transfer and licensing.

Our reseller partners generally add value in the form of system integration, installation, training, application software development and support services. We continue to recruit new VARs and SIs in strategically important markets.

Revenues recorded by our U.S. operations are generally derived from a small number of prime contractors serving government customers located throughout the world. Revenues recorded by our German operations are generally from a relatively large number of VARs serving commercial customers, including universities in Germany for student identification cards and organizers of sporting events for secure access cards.

OMCs are our proprietary product for which we hold 19 U.S. patents. In addition, we have years of know-how in the manufacture and use of cards, encoding devices, read/write drives, systems, enabling services and software. This provides a basis for highly leveraged contribution margins in the OMC segment. Therefore, our strategy is to sell all card technologies with a goal to upgrade programs to optical memory when possible.

We sell encoders and read/write drives at near direct manufacturing cost to enable sales of OMCs. We experience negative gross profits for our drives, systems and enabling services segment when equipment volume does not allow for the contribution necessary to cover fixed costs and we do not have sizable contribution from enabling services. Even at higher volume, the gross profit margin on encoders and read/write drives will probably not exceed 10%.

We provide enabling services as a strategy to promote card sales. Examples include the furnishing of equipment, application software, integration, and installation, training and support services for a card issuance system for the Kingdom of Saudi Arabia national ID card program, and a complete data collection, database, and card issuing system for the Costa Rica Foreign Resident ID Card program.

We believe the major near term growth potential for our OMCs is in government-sponsored identification programs in several targeted geographies. Since governmental card programs typically rely on policy-making, which in turn is subject to technical requirements, budget approvals, and political considerations, there is no assurance that these programs will be implemented as expected, or that they will include optical cards or our products.

Our principal strategies for long-term revenue growth are to:

o Maintain, leverage and expand the existing OMC customer base of national and regional governments worldwide;

o Increase revenues by offering enabling services, such as consulting, custom software development, and the development of integrated secure ID solutions, which can include data capture, personalization, quality assurance and credential issuance modules; and

o Increase market share for specialized cards and associated ID management solutions, such as major event badging and access control and university student ID.

Currently our OMC segment revenues are mainly derived from the following programs; the U.S. DHS Green Card program, National ID Card programs for the Kingdom of Saudi Arabia and Angola, three state-level vehicle registration card programs in India, and a Foreign Resident ID Card program in Italy.

Revenues from the following government card programs are shown below as a percentage of total revenues:

                                                       Three Months Ended             Six Months Ended
                                                          September 30,                 September 30,
                                                     2009              2008          2009           2008
Angola National ID Card program                           30 %               -           15 %            -
U.S. Green Cards                                          23 %              20 %         27 %           18 %
Italian Government ID Card programs                       11 %               -            8 %            -
Vehicle Registration in India                              6 %              10 %          6 %           12 %
Kingdom of Saudi Arabia National ID Card program           6 %              22 %         20 %           20 %

We announced the following during the quarter ended September 30, 2009:

? The Government of Angola launched its new citizen ID card in October, 2009.
Issuance of the new optical security media-based credential began in Luanda and is scheduled to roll out to other provinces.

? Receipt of a purchase order for the supply of additional U.S. Permanent Resident Cards (Green Cards).

We may invest up to $1.4 million through March 31, 2010 in additional capital equipment and leasehold improvement expenditures for OMC and specialty card manufacturing and for other general purposes.

Revenues

Segment Revenues. Our total revenues consisted of sales in our three segments of
(1) OMCs and multi-technology cards (referred to herein as the OMC segment), (2) optical card drives, systems and enabling services, and (3) specialty cards and card printers, as well as other miscellaneous items. Total revenues for the three and six-month periods ended September 30, 2009 were $15.7 million and $32.0 million, respectively. Total revenues for the three and six-month periods ended September 30, 2008 were $13.5 million and $24.2 million, respectively.

The following table presents our condensed consolidated revenues by segment (in thousands, except for percentages):

                           Three Months Ended           Six Months Ended         Three Months       Six Months
                             September 30,                September 30,                      Change
                           2009          2008          2009          2008        2009 vs 2008      2009 vs 2008
Optical memory cards    $   11,885     $   8,632     $  24,249     $  14,536     $       3,253     $       9,713
% of total revenues             76 %          64 %          76 %          60 %              38 %              67 %

Optical cards drives,
systems and services            73           908           832         2,093              (835 )          (1,261 )
% of total revenues              0 %           7 %           3 %           9 %             -92 %             -60 %

Specialty cards and
card printers                3,758         3,927         6,943         7,560              (169 )            (617 )
% of total revenues             24 %          29 %          22 %          31 %              -4 %              -8 %
Total revenues          $   15,716     $  13,467     $  32,024     $  24,189     $       2,249     $       7,835

The following table presents our OMC revenues by major program (in thousands):

                           Three Months Ended            Six Months Ended          Three Months        Six Months
                              September 30,                September 30,                       Change
                           2009           2008          2009          2008         2009 vs 2008       2009 vs 2008
Angola National ID
Card program            $     4,400     $       -     $   4,444     $       -     $        4,400      $       4,444
U.S. Green Cards              3,534         2,656         8,592         4,273                878              4,319
Italian Government ID
Card programs                 1,665           522         2,703           542              1,143              2,161
Vehicle Registration
in India                        999         1,281         1,810         2,791               (282 )             (981 )
Kingdom of Saudi
Arabia National ID
Card program                    940         2,673         5,936         4,455             (1,733 )            1,481
Canadian Permanent
Resident Cards                  284         1,205           567         1,205               (921 )             (638 )
Foreign Resident ID
Card in Costa Rica                -             -             -           736                  -               (736 )
Other                            63           295           197           534               (232 )             (337 )
Total optical memory
card revenues           $    11,885     $   8,632     $  24,249     $  14,536     $        3,253      $       9,713
 % Change 2009 vs
2008                                                                                         38   %             67   %

OMC revenues for the three-month period ended September 30, 2009 increased by $3.3 million or 38% over the three-month period ended September 30, 2008 due to the launch of Angola's national ID card program, increased shipments for U.S. Green Cards, and the Italian government's foreign resident card program partially offset by decreased shipments for the Vehicle Registration program in India, the Kingdom of Saudi Arabia's national ID card program and the phase-out of the Canadian permanent resident card program. OMC revenues for the six-month period ended September 30, 2009 increased by $9.7 million or 67% over the six-month period ended September 30, 2008 due to the launch of Angola's national ID card program, increased shipments of U.S. Green Cards, the Italian government's foreign resident card program, and the Kingdom of Saudi Arabia's national ID card program partially offset by decreased shipments for the Vehicle Registration program in India, Costa Rica's Foreign resident ID card program and the phase-out of the Canadian permanent resident card program. Program revenues fluctuate on a quarter to quarter basis. Therefore, increases and reductions in revenues by program do not necessarily correlate with longer term overall program demand.

Revenue in the drives, systems and services for the three-month period ended September 30, 2009 decreased by $0.8 million over the three-month period ended September 30, 2008 due to the supply in 2008 of parts to Ritel to manufacture encoders. The $1.3 million decrease in the six-month period ended September 30, 2009 as compared with the same period last year was due to enabling services revenue recorded in 2008 on an enabling services contract for the Costa Rica Foreign Resident Card program.

Specialty card and card printer revenues for the three-month period ended September 30, 2009 decreased by approximately $0.2 million or 4% as compared to three-month period ended September 30, 2008. Specialty card and card printer revenues for the six-month period ended September 30, 2009 decreased by approximately $0.6 million or 8% as compared to six-month period ended September 30, 2008. Both declines were largely due to the effect of the fluctuation on the foreign exchange rates between the U.S. dollar and Euro. When the U.S. dollar weakens against other currencies in which we transact business, particularly against Euro, generally sales and net income will be positively impacted. Conversely, when the U.S. dollar strengthens against other currencies in which we transact business, particularly against Euro, generally sales and net income will be negatively impacted. The weakening world economy will likely have a negative effect on revenue in some portions of the specialty cards and card printers segment.

Backlog

Some of our customers place orders for a period of several months to a year or more, and others place orders for immediate or fast turn delivery. Variations in order placement from a single customer can materially affect backlog. As a result, the relative size of our backlog has not been a reliable indicator of future revenue trends. Our backlog as of September 30, 2009 was $13.2 million for OMCs and $1 million for specialty cards and card printers as compared with our backlog as of March 31, 2009 for OMCs of $21.4 million and $1.2 million for specialty cards and card printers. There was no significant backlog for optical card drives, systems and enabling services as of September 30, 2009 or March 31, 2009.

Gross Profit

The following table presents our gross profit in absolute dollar amounts and
gross margin as a percentage of revenue by segment (in thousands, except for
percentages):

                           Three Months Ended             Six Months Ended         Three Months       Six Months
                              September 30,                September 30,                       Change
                           2009           2008           2009          2008        2009 vs 2008      2009 vs 2008
Optical memory cards    $    6,098      $   3,657     $   12,184     $   5,800     $       2,441     $       6,384
% of optical memory
card revenues                   51 %           42 %           50 %          40 %

Optical cards drives,
systems and services          (373 )         (218 )         (735 )          63              (155 )            (798 )
% of optical card
drive, systems
revenues                        NM             NM             NM             3 %

Specialty cards and
card printers                1,064          1,126          1,943         2,169               (62 )            (736 )
% of specialty cards
and card printers
revenues                        28 %           29 %           28 %          29 %
Total gross profit      $    6,789      $   4,565     $   13,392     $   8,032     $       2,224     $       5,360
% of total revenue              43 %           34 %           42 %          33 %

OMCs. OMC gross margin for the three-month period ended September 30, 2009 was 51% of OMC revenue as compared to 42% of OMC revenue for the three-month period ended September 30, 2008. This increase was due to the combined favorable impact of increased sales volume in several major ID card programs and production efficiencies partially offset by a $926,000 provision for obsolete inventory recorded in the quarter. OMC gross margin for the six-month ended September 30, 2009 was 50% of OMC revenue as compared to 40% of OMC revenue for the six-month period ended September 30, 2008 due largely to increased sales volume from the Angola National ID Card program and other card programs and a slightly higher average selling price partially offset by $1.1 million provision for obsolete inventory. OMC manufacturing depreciation and amortization expense was $440,000 and $420,000 for the three-month periods ended September 30, 2009 and 2008, respectively. OMC manufacturing depreciation and amortization expense was $911,000 and $841,000 for the six-month periods ended September 30, 2009 and 2008, respectively.

Drives, Systems and Enabling Services. Except for the quarter ended June 30, 2008, the drives, systems and enabling services gross profit has been negative over the past three years due to low sales volume and our policy to price drives close to direct manufacturing cost to promote card sales resulting in the inability to cover fixed overhead costs at current sales volumes. This segment also includes enabling services with revenue recognized during the six-month period ended September 30, 2008 from the Costa Rica Foreign Resident ID card program and none during the six-month period ended September 30, 2009 largely contributing to the significant decrease in gross margin. This segment also has lower margins than OMCs. This segment depreciation and amortization expense was approximately $28,000 and $46,000 for the three-month periods ended September 30, 2009 and 2008, respectively. For the six-month periods ended September 30, 2009 and 2008, this segment's depreciation and amortization expense was $58,000 and $93,000, respectively. We anticipate that drives, systems and enabling services negative gross margins will continue in the future unless equipment sales volume is sufficient to cover fixed costs or there is a material amount of enabling services revenue.

Specialty Cards and Card Printers. The gross margin on specialty cards and card printers was 28% of this segment's revenue for the three and six-month periods ended September 30, 2009. For the three and six-month periods ended September 30, 2008, the gross margin of this segment was 29%. Due to the current economic conditions, we anticipate pressure on selling prices for specialty cards and margins. This could lead to a decrease in margins in this segment unless offset by the continuation of increased revenues of the higher value printer and systems products. We anticipate that this segment's gross margin will be in the mid 20% range for the remainder of fiscal year 2010. This segment's manufacturing depreciation and amortization expense was approximately $39,000 and $91,000 for the three-month periods ended September 30, 2009 and 2008, respectively, and approximately $78,000 and $186,000 for the six-month periods ended September 30, 2009 and 2008, respectively. The decreases in depreciation in fiscal year 2010 as compared to fiscal year 2009 were due to the full depreciation of capital equipment on March 31, 2009 that was purchased in the acquisition of CCD on March 31, 2004.

Operating Expenses

The following table presents operating expenses (in thousands, except for
percentages):

                           Three Months Ended             Six Months Ended          Three Months       Six Months
                              September 30,                September 30,                        Change
                           2009           2008           2009          2008        2009 vs 2008       2009 vs 2008
Selling, general and
administrative
expenses                $    4,278      $   3,587     $    8,352     $   7,487     $          691     $         865
Percent of revenue              27 %           27 %           26 %          31 %
Percent of change
from prior year                                                                                19 %              12 %

Research and
development expenses    $      296      $     828     $      667     $   1,688     $         (532 )   $      (1,021 )
Percent of revenue               2 %            6 %            2 %           7 %
Percent of change
from prior year                                                                               -64 %             -60 %

. . .