Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**(Mark One)**
| **x**      | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                             |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                         |
| ** ** | **For the  quarterly period ended September 30, 2008**                                                                                                        |
| ** ** | ** **                                                                                                                                                         |
| ** ** | **Or**                                                                                                                                                             |
| ** ** | ** **                                                                                                                                                         |
| **o**      | **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: 0-20028**

 

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**VALENCETECHNOLOGY, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **77-0214673**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

| **12303 Technology Blvd., Suite 950, Austin, Texas** | ** ** | **78727**  |
|-----------------------------------------------------------|------------|------------|
| (Address of principal executive offices)                  |       | (Zip Code) |

 

**(512) 527-2900**

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year,if changed since last report)

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.     x  Yes     o  No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definitions of “accelerated filer”, “largeaccelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one)

 
| Large Accelerated Filer              | o      | Accelerated Filer                   | x |
|------------------------------------------------|--------|-------------------------------------|---|
| Non-Accelerated Filer                     | o      | Smaller Reporting Company | o |
| (Do not check if a smaller  reporting company) |   |

 

Indicate by check markwhether the registrant is a Shell Company (as defined in Rule 12b-2 of theExchange Act).o   Yes     x   No

 

APPLICABLEONLY TO CORPORATE ISSUERS:

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

Thenumber of shares of common stock, par value of $0.001 per share, outstanding atOctober 31, 2008 was 120,134,982.

 

 

 

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Tableof Contents

 

VALENCETECHNOLOGY, INC.

FORM 10-Q

INDEX

 
| PART I – FINANCIAL INFORMATION                                                                                                                               |   |   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|                                                                                                                                                                   |   |   |   |
| Item 1. Financial Statements  (Unaudited):                                                                                                                        |   |   |   |
|                                                                                                                                                                   |   |   |   |
| Condensed Consolidated Balance Sheets as of  September 30, 2008 and March 31, 2008                                                                           |   | 1      |   |
| Condensed Consolidated Statements of  Operations and Comprehensive Loss for the Three and Six Month Periods Ended  September 30, 2008 and September 30, 2007 |   | 2      |   |
| Condensed Consolidated Statements of Cash  Flows for the Six Month Periods Ended September 30, 2008 and  September 30, 2007                                  |   | 3      |   |
| Notes to  Condensed Consolidated Financial Statements                                                                                                                  |   | 4      |   |
|                                                                                                                                                                   |   |   |   |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                                              |   | 14     |   |
|                                                                                                                                                                   |   |   |   |
| Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                                                                               |   | 23     |   |
|                                                                                                                                                                   |   |   |   |
| Item 4.  Controls and Procedures                                                                                                                                  |   | 23     |   |
|                                                                                                                                                                   |   |   |   |
| PART II – OTHER INFORMATION                                                                                                                                  |   |   |   |
|                                                                                                                                                                   |   |   |   |
| Item 1. Legal Proceedings                                                                                                                                         |   | 24     |   |
|                                                                                                                                                                   |   |   |   |
| Item 1A. Risk Factors                                                                                                                                             |   | 24     |   |
|                                                                                                                                                                   |   |   |   |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.                                                                                             |   | 25     |   |
|                                                                                                                                                                   |   |   |   |
| Item 3.  Defaults Upon Senior Securities.                                                                                                                         |   | 25     |   |
|                                                                                                                                                                   |   |   |   |
| Item 4.  Submission of Matters to a Vote of Security Holders.                                                                                                     |   | 25     |   |
|                                                                                                                                                                   |   |   |   |
| Item 5. Other Information.                                                                                                                                        |   | 25     |   |
|                                                                                                                                                                   |   |   |   |
| Item 6. Exhibits.                                                                                                                                                 |   | 26     |   |
|                                                                                                                                                                   |   |   |   |
| Signatures and Certifications                                                                                                                                          |   | 27     |   |

 

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Table of Contents

 

**PART I– FINANCIAL INFORMATION**

 

**ITEM 1.****           F****INANCIAL STATEMENTS(UNAUDITED)**

 

**Valence Technology, Inc.**

**Condensed Consolidated Balance Sheets**

(inthousands, except share amounts)

 
| ** **                                                                                                                                                                                                                                              | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                              | ** ** | **2008**               | ** ** | **2008**           | ** ** |
| ** **                                                                                                                                                                                                                                              | ** ** | **(unaudited)**        | ** ** | ** **         | ** ** |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| ASSETS                                                                                                                                                                                                                                                  |       |                   |       |               |       |
| Current assets:                                                                                                                                                                                                                                         |       |                   |       |               |       |
| Cash and cash equivalents                                                                                                                                                                                                                               |       | $                      | 3,185      |               | $          | 2,616 |   |
| Trade receivables, net of allowance of $169  and $123, respectively                                                                                                                                                                                     |       | 3,562                  |       | 7,208              |       |
| Inventory, net                                                                                                                                                                                                                                          |       | 11,477                 |       | 8,904              |       |
| Receivable from stockholder                                                                                                                                                                                                                             |       | 5,517                  |       | —             |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                               |       | 5,359                  |       | 3,283              |       |
| Total current assets                                                                                                                                                                                                                                    |       | 29,100                 |       | 22,011             |       |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Property, plant and equipment, net                                                                                                                                                                                                                      |       | 6,086                  |       | 5,090              |       |
| Intellectual property, net                                                                                                                                                                                                                              |       | —                 |       | 57                 |       |
| Total assets                                                                                                                                                                                                                                            |       | $                      | 35,186     |               | $          | 27,158 |   |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| LIABILITIES, PREFERRED STOCK AND  STOCKHOLDERS’ DEFICIT                                                                                                                                                                                            |       |                   |       |               |       |
| Current liabilities:                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Accounts payable                                                                                                                                                                                                                                        |       | $                      | 2,957      |               | $          | 4,214 |   |
| Accrued expenses                                                                                                                                                                                                                                        |       | 6,290                  |       | 5,755              |       |
| Deferred revenue                                                                                                                                                                                                                                        |       | 1,079                  |       | 756                |       |
| Short term notes payable                                                                                                                                                                                                                                |       | 3,042                  |       | —             |       |
| Current portion of long-term debt                                                                                                                                                                                                                       |       | 76                     |       | 86                 |       |
| Total current liabilities                                                                                                                                                                                                                               |       | 13,444                 |       | 10,811             |       |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Long-term interest payable to stockholder                                                                                                                                                                                                               |       | 22,935                 |       | 21,447             |       |
| Long-term debt, net of debt discount                                                                                                                                                                                                                    |       | 19,205                 |       | 18,964             |       |
| Long-term debt to stockholder, net of debt  discount                                                                                                                                                                                                    |       | 34,704                 |       | 34,643             |       |
| Other long-term liabilities                                                                                                                                                                                                                             |       | 92                     |       | —             |       |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Commitments and contingencies                                                                                                                                                                                                                           |       |                   |       |               |       |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Preferred stock:                                                                                                                                                                                                                                        |       |                   |       |               |       |
| Redeemable convertible preferred stock,  $0.001 par value, 10,000,000 shares authorized,  861 shares issued and outstanding as of September 30, 2008 and  March 31, 2008,  liquidation value $8,610                                           |       | 8,610                  |       | 8,610              |       |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Stockholders’ deficit:                                                                                                                                                                                                                             |       |                   |       |               |       |
| Common stock, $0.001 par value, 200,000,000  shares authorized, 121,929,926 shares issued and 120,126,782 shares  outstanding as of September 30, 2008 and 117,439,248 shares issued and  115,636,104 shares outstanding as of March 31, 2008 |       | 122                    |       | 117                |       |
| Additional paid-in-capital                                                                                                                                                                                                                              |       | 492,610                |       | 477,657            |       |
| Treasury shares, 1,803,144 at cost                                                                                                                                                                                                                      |       | (5,164                 | )          | (5,164             | )          |
| Accumulated deficit                                                                                                                                                                                                                                     |       | (548,049               | )          | (536,260           | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                    |       | (3,323                 | )          | (3,667             | )          |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Total stockholders’ deficit                                                                                                                                                                                                                        |       | (63,804                | )          | (67,317            | )          |
|                                                                                                                                                                                                                                                    |       |                   |       |               |       |
| Total liabilities, preferred stock and  stockholders’ deficit                                                                                                                                                                                      |       | $                      | 35,186     |               | $          | 27,158 |   |

 

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

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**Valence Technology, Inc.**

**Condensed Consolidated Statements of Operations andComprehensive Loss**

 

(inthousands)

(*Unaudited*)

 
| ** **                                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Month Ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                                                                       | ** ** | **September 30,**           | ** ** | **September 30,**        | ** ** |
| ** **                                                                                       | ** ** | **2008**                         | ** ** | **2007**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Revenue:                                                                                         |       |                             |       |                          |       |   |   |   |   |
| Battery and system sales                                                                         |       | $                                | 5,114      |                          | $          | 5,372 |   | $ | 16,000 |   | $ | 9,340 |   |
| Licensing and royalty revenue                                                                    |       | 702                              |       | 180                           |       | 806 |   | 265 |   |
| Total revenues                                                                                   |       | 5,816                            |       | 5,552                         |       | 16,806 |   | 9,605 |   |
| Cost of sales (1)                                                                                |       | 5,987                            |       | 4,889                         |       | 17,003 |   | 8,416 |   |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Gross margin / (loss)                                                                            |       | (171                             | )          | 663                           |       | (197 | ) | 1,189 |   |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Operating expenses:                                                                              |       |                             |       |                          |       |   |   |   |   |
| Research and product development (1)                                                             |       | 1,190                            |       | 947                           |       | 2,349 |   | 1,765 |   |
| Marketing (1)                                                                                    |       | 695                              |       | 494                           |       | 1,501 |   | 983 |   |
| General and administrative (1)                                                                   |       | 2,443                            |       | 2,395                         |       | 4,968 |   | 4,396 |   |
| Depreciation and amortization                                                                    |       | 510                              |       | 280                           |       | 647 |   | 453 |   |
| (Gain) / loss on disposal of assets                                                              |       | 7                                |       | (15                           | )          | 1 |   | 6 |   |
| Total operating expenses                                                                         |       | 4,845                            |       | 4,101                         |       | 9,466 |   | 7,603 |   |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Operating loss                                                                                   |       | (5,016                           | )          | (3,438                        | )          | (9,663 | ) | (6,414 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Foreign exchange gain                                                                            |       | 149                              |       | 162                           |       | 619 |   | 350 |   |
| Interest and other income                                                                        |       | 8                                |       | 10                            |       | 12 |   | 17 |   |
| Interest and other expense                                                                       |       | (1,323                           | )          | (1,563                        | )          | (2,673 | ) | (3,119 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Net loss                                                                                         |       | $                                | (6,182     | )                             | $          | (4,829 | ) | $ | (11,705 | ) | $ | (9,166 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Dividends on preferred stock                                                                     |       | (43                              | )          | (43                           | )          | (86 | ) | (86 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Net loss available to common stockholders,  basic and diluted                                    |       | $                                | (6,225     | )                             | $          | (4,872 | ) | $ | (11,791 | ) | $ | (9,252 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Other comprehensive loss:                                                                        |       |                             |       |                          |       |   |   |   |   |
| Net loss                                                                                         |       | $                                | (6,182     | )                             | $          | (4,829 | ) | $ | (11,705 | ) | $ | (9,166 | ) |
| Change in foreign currency translation  adjustments                                              |       | 228                              |       | (156                          | )          | 345 |   | (223 | ) |
| Comprehensive loss                                                                               |       | $                                | (5,954     | )                             | $          | (4,985 | ) | $ | (11,360 | ) | $ | (9,389 | ) |
|                                                                                             |       |                             |       |                          |       |   |   |   |   |
| Net loss per share available to common  stockholders, basic and diluted                          |       | $                                | (0.05      | )                             | $          | (0.04 | ) | $ | (0.10 | ) | $ | (0.08 | ) |
| Shares used in computing net loss per share  available to common stockholders, basic and diluted |       | 117,204                          |       | 111,189                       |       | 116,802 |   | 109,803 |   |

 

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| (1)  Includes share-based compensation  as follows: |   |   |   |   |   |   |   |   |   |
|----------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Cost of sales                                            |   | $      | (15    | )      | $      | — |   | $      | (6     | ) | $ | — |   |
| Research and product development                         |   | 86     |   | 65     |   | 144    |   | 130    |   |
| Marketing                                                |   | 123    |   | 63     |   | 245    |   | 126    |   |
| General and administrative                               |   | 270    |   | 323    |   | 655    |   | 645    |   |
| Total share-based compensation                           |   | $      | 464    |   | $      | 451    |   | $      | 1,038  |   | $ | 901 |   |

 

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

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**Valence Technology, Inc.**

**Condensed Consolidated Statements of Cash Flows**

 

(inthousands)

(*Unaudited*)

 
| ** **                                                                  | ** ** | **Six Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| ** **                                                                  | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                       |       |                                               |       |   |   |
| Net loss                                                                    |       | $                                                  | (11,705    | ) | $ | (9,166 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities:    |       |                                               |       |   |   |
| Depreciation and amortization                                               |       | 1,230                                              |       | 485 |   |
| Loss on disposal of assets                                                  |       | 1                                                  |       | 6 |   |
| Bad debt expense                                                            |       | 47                                                 |       | 53 |   |
| Accretion of debt discount and other                                        |       | 1,779                                              |       | 609 |   |
| Share-based compensation                                                    |       | 1,038                                              |       | 901 |   |
| Changes in operating assets and  liabilities:                               |       |                                               |       |   |   |
| Trade receivable                                                            |       | 3,599                                              |       | 439 |   |
| Inventory                                                                   |       | (2,573                                             | )          | 996 |   |
| Prepaid and other current assets                                            |       | (7,593                                             | )          | (433 | ) |
| Accounts payable                                                            |       | (1,258                                             | )          | (987 | ) |
| Accrued expenses and long-term interest                                     |       | 543                                                |       | 2,135 |   |
| Deferred revenue                                                            |       | 324                                                |       | 89 |   |
|                                                                        |       |                                               |       |   |   |
| Net cash used in operating activities                                       |       | (14,568                                            | )          | (4,873 | ) |
|                                                                        |       |                                               |       |   |   |
| Cash flows from investing activities:                                       |       |                                               |       |   |   |
| Purchases of property, plant and equipment                                  |       | (3,084                                             | )          | (555 | ) |
| Proceeds from disposal of property, plant  and equipment                    |       | 1,029                                              |       | — |   |
|                                                                        |       |                                               |       |   |   |
| Net cash used in investing activities                                       |       | (2,055                                             | )          | (555 | ) |
|                                                                        |       |                                               |       |   |   |
| Cash flows from financing activities:                                       |       |                                               |       |   |   |
| Proceeds from short term loans                                              |       | 7,542                                              |       | — |   |
| Proceeds from stock option exercises                                        |       | 740                                                |       | — |   |
| Proceeds from issuance of common stock and  warrants, net of issuance costs |       | 8,679                                              |       | 7,000 |   |
|                                                                        |       |                                               |       |   |   |
| Net cash provided by financing activities                                   |       | 16,961                                             |       | 7,000 |   |
|                                                                        |       |                                               |       |   |   |
| Effect of foreign exchange rates on cash  and cash equivalents              |       | 231                                                |       | (223 | ) |
|                                                                        |       |                                               |       |   |   |
| Increase in cash and cash equivalents                                       |       | 569                                                |       | 1,349 |   |
| Cash and cash equivalents, beginning of  period                             |       | 2,616                                              |       | 1,168 |   |
| Cash and cash equivalents, end of period                                    |       | $                                                  | 3,185      |   | $ | 2,517 |   |
|                                                                        |       |                                               |       |   |   |
| Supplemental information:                                                   |       |                                               |       |   |   |
| Note payable contributed for exercise of  common stock warrants             |       | $                                                  | 4,500      |   | $ | — |   |
| Acquisition of treasury stock from  shareholder                             |       | $                                                  | —     |   | $ | 5,164 |   |
| Interest paid                                                               |       | $                                                  | 696        |   | $ | 958 |   |

 

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

 

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**Valence Technology, Inc.**

**Notes to Condensed Consolidated Financial Statements**

**September 30, 2008**

*(Unaudited)*

 

**1.**                     **INTERIM CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS:**

 

These interim condensedconsolidated financial statements are unaudited but reflect, in the opinion ofmanagement, all normal recurring adjustments necessary to present fairly thefinancial position of Valence Technology, Inc. and its subsidiaries (“Valence”or the “Company”) as of September 30,2008, its consolidated results of operations for each of the three and sixmonth periods ended September 30,2008 and September 30,2007, and the consolidated cash flows for the six month periods ended September 30, 2008 and September 30, 2007. Because allthe disclosures required by accounting principles generally accepted in theUnited States are not included, these interim condensed consolidated financialstatements should be read in conjunction with the audited financial statementsand notes thereto in the Company’s Annual Report on Form 10-K as of andfor the year ended March 31, 2008. The results for the three and six monthperiod ended September 30, 2008 are not necessarily indicative of theresults to be expected for the entire fiscal year ending March 31, 2009.The year-end condensed consolidated balance sheet data as of March 31,2008 was derived from audited financial statements, but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates.

 

**2.**                     **BUSINESS AND BUSINESSSTRATEGY:**

 

TheCompany was founded in 1989 and has commercialized the industry’s first lithiumphosphate technology. Valence develops, manufactures and sells high-energypower systems utilizing its proprietary phosphate-based lithium ion technologyfor diverse applications, with special emphasis on portable appliances andfuture generations of hybrid and electric vehicles.  The Company’s objective is to promote thewide adoption of high-performance, safe, long cycle life, environmentallyfriendly, low-cost energy storage systems. To accomplish its objectives andaddress the significant market opportunity it believes is available to it, theCompany utilizes the numerous benefits of its latest energy storage technology,deep intellectual property portfolio and extensive experience of its managementteam.

 

TheCompany is now in development of its third generation of lithium phosphate energystorage systems, which are expected to be commercially available in the secondquarter of calendar 2009. The Company’s third generation of lithium ionproducts feature its safe, long-life lithium phosphate technology whichutilizes a phosphate-based cathode material. The Company believes that theadvanced functionality and programmability of its third generation energystorage systems are well suited for electric vehicle (EV), plug-in hybridelectric vehicle (PHEV) and similar applications. The Company’s thirdgeneration lithium phosphate energy storage systems address the safety andlimited life weaknesses of other lithium technologies while offering a solutionthat is competitive in cost and performance. The Company believes that itsthird generation energy storage systems offer design and performancecapabilities that will facilitate adoption in automotive, industrial, UPS,telecommunications, aerospace and military markets not traditionally served byother lithium ion solutions.

 

The Company’s business plan and strategy focus on the generation ofrevenue from product sales, while minimizing costs through partnerships withcontract manufacturers and internal manufacturing efforts through the Company’stwo wholly-owned subsidiaries in China. These subsidiaries initiated operations in latefiscal 2005. Valence expects to develop target markets through the sales of ourthird generation lithium phosphate energy storage systems and custom lithiumphosphate energy storage systems based on programmable EpochTMCommand and Control Logic. In addition, Valence expects to pursue a licensingstrategy to supply the lithium phosphate sector with advanced Valence materialand components, including lithium phosphate cathode materials to fulfill othermanufacturers’ needs.

 

The Company has the followingsubsidiaries:

 

Valence Technology (Nevada), Inc.,Valence Technology Cayman Islands Inc., Valence Technology N.V., ValenceTechnology International, Inc., Valence Technology B.V., ValenceTechnology (Suzhou) Co., Ltd., and Valence Energy-Tech (Suzhou) Co., Ltd.

 

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**GoingConcern:**

 

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern, which contemplates the realization of assetsand satisfaction of liabilities in the normal course of business. The Companyhas incurred operating losses each year since its inception in 1989 and had an accumulateddeficit of $548.0 million as of September 30, 2008. For the three and sixmonth periods ended September 30, 2008, the Company sustained net lossesavailable to common stockholders of $6.2 and $11.8 million, respectively. Forthe three and six month periods ended September 30, 2007, the Companysustained net losses available to common stockholders of $4.9 and $9.3 million,respectively. These factors, among others, indicate that the Company may beunable to continue as a going concern for a reasonable period of time. TheCompany’s ability to continue as a going concern is contingent upon its abilityto meet its liquidity requirements. If the Company is unable to arrange fordebt or equity financing on favorable terms or at all the Company’s ability tocontinue as a going concern is uncertain. These financial statements do notgive effect to any adjustments to the amounts and classifications of assets andliabilities which might be necessary should the Company be unable to continueas a going concern.

 

**Liquidityand Capital Resources:**

 

At September 30, 2008,the Company’s principal sources of liquidity were cash and cash equivalents of$3.2 million. The Company expects that its sources of liquidity will not besufficient for the remaining fiscal year. The Company anticipates product salesand royalties during fiscal 2009 will be insufficient to cover the Company’soperating expenses. Management depends upon their ability to periodicallyarrange for additional equity or debt financing to meet the Company’s liquidityrequirements. Unless the Company’s product sales are greater than managementcurrently forecasts or there are other changes to the business plan, theCompany will need to arrange for additional financing within the next three tosix months to fund operating and capital needs. This financing could take theform of debt or equity. Given the Company’s historical operating results andthe amount of the Company’s existing debt, as well as the other factors, theCompany may not be able to arrange for debt or equity financing from thirdparties on favorable terms or at all.

 

The Company’s cashrequirements may vary materially from those now planned because of changes inthe Company’s operations including the failure to achieve expected revenues,greater than expected expenses, changes in OEM relationships, marketconditions, the failure to timely realize the Company’s product developmentgoals, and other adverse developments. These events could have a negativeimpact on the Company’s available liquidity sources during the remainder of thefiscal year.

 

**3.**                     **SUMMARY OF SIGNIFICANTACCOUNTING POLICIES:**

 

**RevenueRecognition:**

 

Revenues are generated fromsales of products including batteries and battery systems, and from licensingfees and royalties pursuant to technology license agreements. Product sales arerecognized when all of the following criteria are met: persuasive evidence ofan arrangement exists, delivery has occurred, seller’s price to the buyer isfixed and determinable, and ability to collect is reasonably assured. For somesales to customers in foreign jurisdictions where retention of title is neededto perfect a security interest, the Company retains title to products shipped,similar to a lien under the U.S. Uniform Commercial Code. For these sales, allother revenue recognition criteria are met for these shipments and neither thecustomer nor the Company can rescind the transaction. Accordingly, the Companyrecognizes this revenue when the product is shipped. Product shipments that arenot recognized as revenue during the period shipped, primarily productshipments to resellers that are subject to right of return, are recorded asdeferred revenue and reflected as a liability on the Company’s balance sheet.Products shipped to resellers with right of return are included in finishedgoods inventory as the Company retains title to the products. For resellershipments where revenue recognition is deferred, the Company records revenueand relieves inventory based upon the reseller-supplied reporting of sales toits end customers or its inventory reporting. For direct customers, the Companyestimates a return rate percentage based upon the Company’s historicalexperience. From time to time the Company provides sales incentives in the formof rebates or other price adjustments; these are generally recorded asreductions to revenue on the latter of the date the related revenue isrecognized or at the time the rebate or sales incentive is offered. Perpetuallicensing fees are recognized as revenue upon completion of an executedagreement and delivery of licensed information, if there are no significantremaining vendor obligations and collection of the related receivable isreasonably assured. Royalty revenues are recognized upon licensee revenuereporting and when collection is reasonably assured.

 

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**Use of Estimates:**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theU.S. requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements, as well as therevenues and expenses for the period. The Company has made significantestimates in determining the allowance for bad debt, the amount of inventoryreserves and inventory overhead absorption, warranty liabilities, andshare-based compensation. Actual results could differ from those estimates.

 

**Recent Accounting Pronouncements:**

 

In September 2006, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) 157, *“FairValue Measurements”*. This standard defines fair value, establishes aframework for measuring fair value in accounting principles generally acceptedin the United States of America, and expands disclosure about fair valuemeasurements. This pronouncement applies under other accounting standards thatrequire or permit fair value measurements. Accordingly, this statement does notrequire any new fair value measurement. This statement is effective for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. However, SFAS 157 is amended by Financial Statement Position (“FSP”)FAS 157-1, *“Application of FASB Statement157 to FASB Statement 13 and Other Accounting Pronouncements That Address FairValue Measurements for Purposes of Lease Classification or Measurement underStatement 13”*, which excludes from the scope of this provisionarrangements accounted for under SFAS 13, “Accounting for Leases”. SFAS 157 isalso amended by FSP FAS 157-2 “Effective Date of FASB Statement No. 157”,which delays the effective date of SFAS 157 for all nonfinancial assets andnonfinancial liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis (at least annually).This FSP partially defers the effective date of Statement 157 to fiscal yearsbeginning after November 15, 2008, and interim periods within those fiscalyears for items within the scope of this FSP. SFAS 157 is also amended by FSPFAS 157-3, *Determining the Fair Value of a Financial AssetWhen the Market for That Asset is Not Active*, which clarifies theapplication of SFAS 157 in a market that is not active and provides an exampleto illustrate key considerations in determining the fair value of a financialasset when the market for that financial asset is not active. We adopted SFAS157 on April 1, 2008, except as it applies to those nonfinancial assetsand nonfinancial liabilities as noted in FSP FAS 157-2. The partial adoption ofSFAS 157 did not have a material impact on the Company’s consolidated financialposition or results of operations.

 

In February 2007, theFASB issued SFAS 159, *“The Fair Value Optionfor Financial Assets and Financial Liabilities – including an amendment of FASBStatement 115”.* This standard permits an entity to measure manyfinancial instruments and certain other assets and liabilities at fair value onan instrument-by-instrument basis. This statement is effective for fiscal yearsbeginning after November 15, 2007. The Company adopted SFAS 159 on April 1,2008 as required. The adoption of SFAS 159 did not have a significant impact onthe Company’s financial position or results of operations as the Company didnot elect the fair value option for items within the scope of this statement.

 

In December 2007, theFASB issued SFAS 141(R), *“BusinessCombinations—a replacement of FASB Statement 141”*, whichsignificantly changes the principles and requirements for how the acquirer of abusiness recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, and any non-controlling interest inthe acquiree. The statement also provides guidance for recognizing andmeasuring the goodwill acquired in the business combination and determines whatinformation to disclose to enable users of the financial statements to evaluatethe nature and financial effects of the business combination. This statement iseffective prospectively, except for certain retrospective adjustments todeferred tax balances, for fiscal years beginning after December 15, 2008.The Company is currently evaluating the requirements of SFAS 141(R) andhave not yet determined the impact on the Company’s consolidated financialstatements.

 

In March 2008, the FASBissued SFAS 161, *“Disclosures aboutDerivative Instruments and Hedging Activities”*. This Statementchanges the disclosure requirements for derivative instruments and hedgingactivities. Entities are required to provide enhanced disclosures about (a) howand why an entity uses derivative instruments, (b) how derivativeinstruments and related hedged items are accounted for under Statement 133 andits related interpretations, and (c) how derivative instruments andrelated hedged items affect an entity’s financial position, financial performance,and cash flows. This statement is effective for fiscal years and interimperiods beginning after November 15, 2008. Early application isencouraged. The Company is currently evaluating the requirements of SFAS 161and have not yet determined the impact on the Company’s consolidated financialstatements.

 

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InApril 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, *Determination of the Useful Life of IntangibleAssets.* FSP FAS 142-3 amends the factors that should be consideredin developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under FASB Statement No. 142, *Goodwill and Other Intangible Assets.* FSPFAS 142-3 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and interim periods within those fiscalyears. Early adoption is prohibited. Based on its current operations, theCompany does not expect that the adoption of FSP FAS 142-3 will have a materialimpact on its financial position or results of operations.

 

In May 2008, the FASB issued SFAS No. 162, *The Hierarchy of Generally Accepted Accounting Principles*.SFAS 162 identifies the sources of accounting principles and the frameworkfor selecting the principles used in the preparation of financial statements ofnongovernmental entities that are presented in conformity with generallyaccepted accounting principles in the United States (the GAAP hierarchy).SFAS 162 will become effective 60 days following the SEC’s approvalof the Public Company Accounting Oversight Board amendments to AU Section 411,*The Meaning of Present Fairly in ConformityWith Generally Accepted Accounting Principles.* Based on its currentoperations, the Company does not expect that the adoption of SFAS 162 willhave a material impact on its financial position or results of operations.

 

**Net Lossper Share Available to Common Stockholders:**

 

Net loss per share iscomputed by dividing the net loss available to common stockholders by theweighted average shares of common stock outstanding during the period. Thedilutive effect of the options and warrants to purchase common stock areexcluded from the computation of diluted net loss per share, since their effectis antidilutive. The antidilutive instruments excluded from the diluted netloss per share computation for the three and six month periods ended September 30,2008 and September 30, 2007 were as follows:

 
| ** **                                                                             | ** ** | **Three Months Ended** | ** ** | **Six Month Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                                                             | ** ** | **September 30,**           | ** ** | **September 30,**        | ** ** |
| ** **                                                                             | ** ** | **2008**                         | ** ** | **2007**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                   |       |                             |       |                          |       |   |   |   |   |
| Shares reserved for conversion of  Series C-1 and Series C-2 preferred stock |       | 3,628,634                        |       | 3,628,634                     |       | 3,628,634 |   | 3,628,634 |   |
| Common stock options reserved                                                          |       | 7,345,093                        |       | 9,945,971                     |       | 7,345,093 |   | 9,945,971 |   |
| Warrants to purchase common stock                                                      |       | —                           |       | 2,955,643                     |       | — |   | 2,955,643 |   |
| Total                                                                                  |       | 10,973,727                       |       | 16,530,248                    |       | 10,973,727 |   | 16,530,248 |   |

 

The number of shares listedabove as reserved for conversion of Series C-1 and Series C-2preferred stock does not include shares related to accrued dividends that areconvertible at the election of the Company, subject to certain limitations. On September 30,2008, up to $517,000 in accrued dividends would be convertible into up to149,876 shares of common stock based on the closing sales price of $3.45 pershare on September 30, 2008.

 

**4.**                     **INVENTORY:**

 

Inventory consisted of thefollowing (in thousands) at:

 
| ** **      | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|-----------------|------------|--------------------------------------|------------|------------------------------|------------|
|            |       |                                 |       |                         |       |
| Raw materials   |       | $                                    | 2,739      |                         | $          | 1,485 |   |
| Work in process |       | 2,725                                |       | 4,140                        |       |
| Finished goods  |       | 6,013                                |       | 3,279                        |       |
| Total inventory |       | $                                    | 11,477     |                         | $          | 8,904 |   |

 

Included in inventory at September 30,2008 and March 31, 2008 were valuation allowances of $4.7 million and $2.0million to reduce their carrying values to the lower of cost or market.Management has valued overhead absorption related to work in process based onestimates of completion at September 30, 2008 and March 31, 2008.

 

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**5.**                     **PROPERTY, PLANT ANDEQUIPMENT:**

 

Property, plant andequipment, net of accumulated depreciation and impairment, consisted of thefollowing (in thousands) at:

 
| ** **                      | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
|                            |       |                                 |       |                         |       |
| Leasehold improvements          |       | $                                    | 1,167      |                         | $          | 1,141 |   |
| Machinery and equipment         |       | 6,467                                |       | 5,319                        |       |
| Office and computer equipment   |       | 1,635                                |       | 1,620                        |       |
| Construction in progress        |       | 1,112                                |       | 407                          |       |
| Total cost                      |       | 10,381                               |       | 8,487                        |       |
| Less: accumulated depreciation  |       | (3,906                               | )          | (3,387                       | )          |
| Less: impairment                |       | (389                                 | )          | (10                          | )          |
| Total cost, net of depreciation |       | $                                    | 6,086      |                         | $          | 5,090 |   |

 

**6.**                    **INTELLECTUAL PROPERTY:**

 

Intellectual propertyconsisting of stacked battery construction technology acquired from TelcordiaTechnologies, Inc. in December 2000 is amortized over its estimateduseful life. Intellectual property, net of accumulated amortization andimpairment, consisted of the following (in thousands) at:

 
| ** **                              | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
|                                    |       |                                 |       |                         |       |
| Intellectual property before impairment |       | $                                    | 13,602     |                         | $          | 13,602 |   |
| Less: accumulated amortization          |       | (5,108                               | )          | (5,051                       | )          |
| Less: impairment                        |       | (8,494                               | )          | (8,494                       | )          |
| Intellectual property, net              |       | $                                    | —     |                         | $          | 57 |   |

 

Amortization expense wasapproximately $28,000 and $20,000 for the three month periods ended September 30,2008 and September 30, 2007, respectively, and $57,000 and $58,000 for thesix month periods ended September 30, 2008 and 2007, respectively.

 

**7.**                     **LONG TERM DEBT:**

 
| **(in thousands)**            | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
|                               |       |                                 |       |                         |       |
| 2005 Loan balance                  |       | $                                    | 20,000     |                         | $          | 20,000 |   |
| Unaccreted debt discount           |       | (795                                 | )          | (1,036                       | )          |
| Balance                            |       | $                                    | 19,205     |                         | $          | 18,964 |   |
|                               |       |                                 |       |                         |       |
| 2001 Loan from stockholder balance |       | 20,000                               |       | $                            | 20,000     |   |
| 1998 Loan from stockholder balance |       | 14,950                               |       | 14,950                       |       |
| Unaccreted debt discount           |       | (246                                 | )          | (307                         | )          |
| Balance                            |       | $                                    | 34,704     |                         | $          | 34,643 |   |

 

On July 13, 2005, theCompany secured a $20.0 million loan (the “2005 Loan”) from SFT I, Inc.,the full amount of which has been drawn down. The loan is guaranteed by Mr. CarlBerg, chairman of the Board of Directors and the Company’s principalstockholder. The loan matures in a lump sum on July 13, 2010. Interest isdue monthly based on a floating interest rate. The interest rate is calculatedas the greater of 6.75% or the sum of LIBOR Rate, rounded to the nearest 1/16thof 1.0%, plus 4.0% (6.75% as of September 30, 2008). The loan may beprepaid during the period beginning on July 13, 2007 through July 12,2009, with a 1.0% prepayment premium, and on July 13, 2009 and thereafterwith no prepayment premium. As of September 30, 2008, no amounts have beenpaid on the loan.

 

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In connection with the loan,both SFT I, Inc. and Berg & Berg Enterprises, LLC (“Berg &Berg”), an affiliate of Mr. Berg, each received warrants to purchase600,000 shares of the Company’s common stock at a price of $2.74 per share, theclosing price of the Company’s common stock on July 12, 2005. The fairvalue assigned to these warrants, totaling approximately $2.0 million, has beenrecorded as a discount on the debt and will be accreted as interest expenseover the life of the loan. The warrants were valued using the Black-Scholesvaluation method using the assumptions of a life of 36 months, 96.45%volatility, and a risk-free rate of 3.88%. On April 24, 2008, Berg &Berg exercised its warrants by purchasing 600,000 shares of the Company’scommon stock for an aggregate purchase price of $1.6 million. In addition, SFTI, Inc. completed a cashless exercise of its warrants on June 4, 2008and June 27, 2008 and received a total 230,767 common stock shares uponcompletion of the cashless exercise. Also in connection with the loan, theCompany incurred a loan commitment fee and attorneys’ fees which, in additionto the interest rate cap agreement, have been recorded as a discount on the debtand will be accreted as interest expense over the life of the loan. Through September 30,2008, a total of approximately $1.6 million has been accreted and included asinterest expense. Interest payments on the loan are currently being paid on amonthly basis.

 

 In October 2001,the Company entered into a loan agreement (“2001 Loan”) with Berg &Berg. Under the terms of the agreement, Berg & Berg agreed to advancethe Company funds of up to $20.0 million between the date of the agreement and September 30,2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable from time totime. On July 13, 2005, Berg & Berg agreed to extend the maturitydate for the loan principal and interest from September 30, 2006 to September 30,2008. On June 12, 2008, the Company and Berg & Berg agreed tofurther extend the maturity date for the loan principal and interest from September 30,2008 to September 30, 2010.

 

In conjunction with the 2001Loan, Berg & Berg received a warrant to purchase 1,402,743 shares ofthe Company’s common stock at the price of $3.208 per share. These warrantswere exercised on September 30, 2008 when Berg & Berg surrendereda short term note payable of $4.5 million to the Company as exerciseconsideration. The fair value assigned to these warrants, totalingapproximately $5.1 million, has been reflected as additional consideration forthe debt financing, recorded as a discount on the debt and accreted as interestexpense over the life of the loan. The warrants were valued using the Black-Scholesmethod using the assumptions of a life of 47 months (extended to 84 months),100% volatility, and a risk-free rate of 5.5%. Through September 30, 2008,a total of $4.9 million has been accreted and included as interest expense. Theamounts charged to interest expense on the outstanding balance of the loan forthe three month periods ended September 30, 2008 and September 30,2007 were $409,000. The amounts charged to interest expense on the outstandingbalance of the loan for the six month periods ended September 30, 2008 andSeptember 30, 2007 were $813,000. Interest payments on the loan arecurrently being deferred, and are recorded as long-term interest. The accruedinterest amounts for the 2001 Loan were $10.8 million and $10.0 million as of September 30,2008 and March 31, 2008, respectively.

 

In July 1998, theCompany entered into an amended loan agreement (“1998 Loan”) with Berg &Berg that allows the Company to borrow, prepay and re-borrow up to $10.0million principal under a promissory note on a revolving basis. In November 2000,the 1998 Loan agreement was amended to increase the maximum amount to $15.0million. As of September 30, 2008, the Company had an outstanding balanceof $15.0 million under the 1998 Loan agreement. The loan bears interest at onepercent over lender’s borrowing rate (approximately 9.0 % at September 30,2008). On July 13, 2005, Berg & Berg agreed to extend thematurity date for the loan principal and interest from September 30, 2006to September 30, 2008. On June 12, 2008, the Company and Berg &Berg agreed to further extend the maturity date for the loan principal andinterest from September 30, 2008 to September 30, 2010. The accruedinterest amounts for the 1998 Loan were $12.2 million and $11.5 million as of September 30,2008 and March 31, 2008, respectively.

 

All of the Company’s assetsare pledged as collateral under the 2001 Loan and the 1998 Loan to stockholder.

 

**8.**                     **COMMITMENTS ANDCONTINGENCIES:**

 

**Warranties:**

 

The Company has establisheda warranty reserve in connection with the sale of N-Charge® Power Systemscovering a 12-month warranty period during which the Company would refund thefull value to any customers returning a purchased product because of a productperformance issue. The Company has also established a warranty reserve inrelation to the sale of U-Charge® Power Systems, and other large-format powersystems. The total warranty liability was $1.3 million and $1.2 million as of September 30,2008 and March 31, 2008, respectively.

 

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**Litigation:**

 

On January 31, 2007,Valence filed a claim against Phostech Lithium Inc. in the Federal Court inCanada (Valence Technology, Inc. v. Phostech Lithium Inc. Court File No. T-219-07)alleging infringement of Valence Canadian Patent 2,395,115. Subsequently, on April 2,2007, Valence filed an amended claim alleging infringement of its CanadianPatents 2,483,918 and 2,466,366. The action is in the discovery phase. TheCompany is seeking monetary damages and injunctive relief for the acts ofPhostech in manufacturing, using and selling phosphate cathode material thatinfringes the asserted Valence Canadian patents.

 

On February 14, 2006,Hydro-Quebec filed an action against the Company in the United States DistrictCourt for the Western District of Texas (Hydro-Quebec v. Valence Technology,Civil Action No. A06CA111). In its amended complaint filed April 13,2006, Hydro-Quebec alleges that Saphion® I Technology, thetechnology utilized in all of the Company’s commercial products, infringes U.S.Patent Nos. 5,910,382 and 6,514,640 exclusively licensed to Hydro-Quebec.Hydro-Quebec’s complaint seeks injunctive relief and monetary damages. Theaction is in the initial pleading state and the Company has filed a responsedenying the allegations in the amended complaint. The action has been stayed bythe Court pending a final determination of reexaminations of the two patents bythe USPTO.

 

The Company is subject to,from time to time, various claims and litigation in the normal course ofbusiness. In the Company’s opinion, all pending legal matters will not have amaterial adverse impact on its consolidated financial statements.

 

**9.**                     **REDEEMABLE CONVERTIBLEPREFERRED STOCK:**

 

On June 2, 2003, theCompany issued 1,000 shares of Series C Convertible Preferred Stock andwarrants to purchase the Company’s common stock for $10,000 per share, raisingnet proceeds of $9.416 million. On January 22, 2004, the holder of the Series CConvertible Preferred Stock converted 139 of its 1,000 shares with theprincipal amount of $1.39 million, including accrued and unpaid dividends, into327,453 shares of the Company’s common stock at the conversion price of $4.25per share. On November 30, 2004, the Company entered into an amendment andexchange agreement to exchange all outstanding 861 shares of the Company’s Series CConvertible Preferred Stock, representing $8.6 million of principal. The Series CConvertible Preferred Stock was exchanged for 431 shares of Series C-1Convertible Preferred Stock, with a stated value of $4.3 million, and 430shares of Series C-2 Convertible Preferred Stock, with a stated value of$4.3 million. When issued, the Series C-1 Convertible Preferred Stock and Series C-2Convertible Preferred Stock were convertible into common stock at $4.00 pershare. Each series carries a 2% annual dividend rate, payable quarterly in cashor shares of common stock, and were redeemable on December 15, 2005. TheCompany has the right to convert the preferred stock if the average of thedollar-volume weighted average price of the Company’s common stock for aten-day trading period is at or above $6.38 per share. If the preferred sharesare not redeemed in accordance with their terms, the holder of the preferredstock shall have the option to require the Company to convert all or part ofthe redeemed shares at a price of 95% of the lowest closing bid price of theCompany’s common stock during the three days ending on and including theconversion date. The preferred shares are currently outstanding and subject toredemption or conversion at the holder’s discretion.

 

Pursuant to assignmentagreements entered into between the Company and Berg & BergEnterprises, LLC on July 14, 2005 and December 14, 2005, Berg &Berg purchased all of the outstanding Series C-1 Convertible PreferredStock and Series C-2 Convertible Preferred Stock from its original holder.Pursuant to the terms of the assignment agreement, Berg & Berg agreedthat the failure of the Company to redeem the preferred stock on December 15,2005 did not constitute a default under the certificate of designations and haswaived the accrual of any default interest applicable in such circumstance. Inexchange, the Company has agreed (i) that the Series C-1 ConvertiblePreferred Stock may be converted, at any time, into the Company’s common stockat the lower of $4.00 per share or the closing bid price of the Company’scommon stock on December 13, 2005 ($1.98) and (ii) that the Series C-2Convertible Preferred Stock may be converted, at any time, into the Company’scommon stock at the lower of $4.00 per share or the closing bid price of theCompany’s common stock on July 13, 2005 ($2.96). Berg & Berg hasagreed to allow dividends to accrue on the preferred stock. At September 302008, $517,000 in preferred stock dividends had accrued.

 

In connection with the issueof the original issuance of the Series C Convertible Preferred Stock, in June 2003,the Company issued to the Series C Convertible Preferred Stock originalholder a warrant to purchase 352,900 shares of the Company’s common stock. Thewarrant, which expired on June 2, 2008, had a purchase price of $5.00 pershare. The warrant was valued using the Black-Scholes valuation model. Thewarrant was recorded to additional paid in capital at its relative fair valueto the Series C Convertible Preferred Stock at $933,000. Accretion to theremaining redemption value of $8.61 million was recorded over theeighteen-month period of the Series C Convertible Preferred Stock ending December 2,2004.

 

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**10.**                 **SHARE-BASED COMPENSATION:**

 

In February 1996, theBoard of Directors adopted a stock plan for outside Directors (the “1996Non-Employee Director’s Stock Option Plan”). The 1996 plan expired in February of2006 and as of September 30, 2008 no shares are available to be grantedunder this plan.

 

In January 2000, theBoard of Directors adopted the 2000 Stock Option Plan (the “2000 Plan”). Underthe 2000 Plan, the Company may grant incentive stock options to employees andnon-statutory stock options to non-employee members of the Board of Directorsand consultants. Options are to be granted at a price not less than fair marketvalue on the date of grant. In the case of an incentive stock option granted toan employee who owns stock possessing more than 10% of the total combinedvoting power of all classes of stock of the Company or any affiliate, theoption is to be granted at a price not less than 110% of the fair market valueon the date of grant. The options are exercisable as determined by the Board ofDirectors, generally over a four-year period. The options expire no later thanten years from the date of grant. Unvested options are canceled and returned tothe 2000 Plan upon an employee’s termination. Vested options, not exercised withinthree months of termination, also are canceled and returned to the 2000 Plan.During the first six months of fiscal 2009, 302,200 shares were granted underthis plan. At September 30, 2008, the Company had 829,403 shares availablefor grant under the 2000 Plan.

 

When options are exercisedthe Company issues new shares to the grantee.

 

Aggregate option activity isas follows (shares in thousands):

 
| ** **                         | ** ** | **Outstanding Options** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Number of**           | ** ** | **Weighted  Average** | ** ** |
| ** **                         | ** ** | **Shares**                   | ** ** | **Exercise Price** | ** ** |
| Balance at March 31, 2008     |       | 6,688                        |       | $ | 2.97 |   |
| Granted                            |       | 302                          |       | 3.56 |   |
| Exercised                          |       | (338                         | )          | 2.19 |   |
| Cancelled                          |       | (573                         | )          | 6.01 |   |
| Balance at September 30, 2008 |       | 6,079                        |       | $ | 2.73 |   |

 

The following tablesummarizes information about fixed stock options outstanding at September 30,2008 (shares in thousands):

 
| **Options Oustanding**   | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | ** **              | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **              | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **              | ** ** | **Remaining** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Number**              | ** ** | **Contractual  Life** | ** ** | **Average  Exercise** | ** ** | **Number** | ** ** | **Average  Exercise** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**         | ** ** | **(years)** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $ 0.63 - $1.99      |       | 4,194                   |       | 8.14 |   | $ | 1.55 |   | 487 |   | $ | 1.45 |   |
| $ 1.99 - $4.62      |       | 1,237                   |       | 6.72 |   | 3.20 |   | 672 |   | 3.44 |   |
| $ 4.62 - $10.06     |       | 586                     |       | 1.26 |   | 7.20 |   | 584 |   | 7.21 |   |
| $ 10.06 - $15.75    |       | 10                      |       | 1.99 |   | 13.84 |   | 10 |   | 13.84 |   |
| $ 15.75 - $23.56    |       | —                  |       | — |   | — |   | — |   | — |   |
| $ 23.56 - $34.62    |       | 52                      |       | 1.38 |   | 34.11 |   | 52 |   | 34.11 |   |
| $ 0.63 - $34.62     |       | 6,079                   |       | 7.12 |   | $ | 2.73 |   | 1,805 |   | $ | 5.07 |   |

 

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Compensation expense forstock plans has been determined based on the fair value at the grant date foroptions granted in the current fiscal year. For the three months ended September 30,2008 and September 30, 2007, $464,000 and $451,000 of share-basedcompensation expense has been included in operating expenses in the condensedconsolidated statements of operations and comprehensive loss. For the sixmonths ended September 30, 2008 and September 30, 2007, $1,038,000and $901,000 of share-based compensation expense has been included in operatingexpenses in the condensed consolidated statements of operations andcomprehensive loss. The aggregate intrinsic value of options exercisable at September 30,2008 is $1.1 million. There were 337,668 options exercised during the six monthperiod ended September 30, 2008.

 

As of September 30,2008 the Company had a total of $4.2 million in compensation costs related toshare-based compensation to recognize over a remaining service period of 1.9years for non-vested options. The fair value of each option grant is estimatedat the date of grant using the Black-Scholes pricing model with the followingweighted average assumptions for grants in fiscal years 2009 and 2008:

 
| ** **                               | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| Weighted average risk-free interest rate |       | 3.26                                 | %          | 4.27                         | %          |
| Average expected life in years           |       | 5.9 years                            |       | 5.9 years                    |       |
| Average expected volatility              |       | 82.07                                | %          | 80.49                        | %          |
| Dividend yield                           |       | None                                 |       | None                         |       |

 

**11.**                  **RELATED PARTY TRANSACTIONS:**

 

On September 30, 2008, Berg & Bergexercised a warrant for the purchase of 1.4 million shares of common stock. Aspayment of the $4.5 million exercise price of the warrant, Berg & Bergsurrendered certain promissory notes issued on September 26 ($1.0 millionin principal and approximately $1,000 in accrued interest), September 18($1.0 million in principal and approximately $3,000 in accrued interest) and July 23,2008 ($2.5 million in principal and approximately $38,000 in accrued interest).The surrendered promissory notes were the second, third and fourth workingcapital loan installments made pursuant to an agreement between the Company andBerg & Berg whereby Berg & Berg agreed to provide up to $10.0million in interim working capital loans from time to time in order tosupplement the Company’s working capital and other financial needs. The Companyhas up to $2.5 million in principal amount of working capital loans remainingunder the agreement as of September 30, 2008.

 

On September 5, 2008, the Company and Berg &Berg amended certain promissory notes dated June 26 and July 23(which has since been repaid in part and re-issued, as described below) tochange the dates that the promissory notes are payable from September 15,2008 to November 15, 2008.

 

On July 23, 2008, Berg & Berg advancedto the Company $3.0 million as a loan to be used to cover working capitalrequirements.  In connection therewith,the Company executed a promissory note (the “$3.0 Million Promissory Note”) inthe aggregate principal amount of $3.0 million in favor of Berg &Berg.  The $3.0 Million Promissory Notewas surrendered in part as payment of the arrant exercise price describedabove.  Because the total amount of the$3.0 Million Promissory Note was not paid in full, a new promissory note wasissued to Berg & Berg in the principal amount of $542,000 whichcontinues to bear interest at a rate of 8.0% per annum and which continues tobe payable on November 15, 2008.

 

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**12.**                 **SEGMENT AND GEOGRAPHICINFORMATION:**

 

The Company’s chiefoperating decision maker is its Chief Executive Officer, who reviews operatingresults to make decisions about resource allocation and to assess performance.The Company’s chief operating decision maker views results of operations of asingle operating segment, the development and marketing of the Company’slithium phosphate technology. The Company’s Chief Executive Officer hasorganized the Company functionally to develop, market and manufacture lithiumphosphate products.

 

Long-lived asset informationby geographic area is as follows (in thousands):

 
| ** **    | ** ** | **September ****30, 2008** | ** ** | **March 31, 2008** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------|------------|
| United States |       | $                                    | 328        |                         | $          | 340 |   |
| International |       | 5,758                                |       | 4,807                        |       |
| Total         |       | $                                    | 6,086      |                         | $          | 5,147 |   |

 

Revenues by geographic areaare as follows (in thousands):

 
| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Month Ended** | ** ** |
|---------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **    | ** ** | **September 30,**           | ** ** | **September 30,**        | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|          |       |                             |       |                          |       |   |   |   |   |
| United States |       | $                                | 4,044      |                          | $          | 5,202 |   | $ | 9,894 |   | $ | 9,073 |   |
| International |       | 1,772                            |       | 350                           |       | 6,912 |   | 532 |   |
| Total         |       | $                                | 5,816      |                          | $          | 5,552 |   | $ | 16,806 |   | $ | 9,605 |   |

 

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| **ITEM  2.** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|--------------|-------------------------------------------------------------------------------------------------|

 

This Report containsstatements that constitute “forward-looking statements” within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, and Section 27A of theSecurities Act of 1933, as amended. The words “may,” “will,” “expect,” “intend,”“estimate,” “continue,” “anticipate,” “predict,” “believe” and similarexpressions and variations thereof are intended to identify forward-lookingstatements. These statements appear in a number of places in the Report andinclude statements regarding the intent, belief or current expectations ofValence Technology, Inc., to which we refer in this Report as the “Company,”“we” or “us,” our directors or officers with respect to, among other things:

 
| · | trends affecting  our financial condition or results of operations; |
|--------|---------------------------------------------------------------------|
| · | our product  development strategies;                                |
| · | trends affecting  our manufacturing capabilities;                   |
| · | trends affecting  the commercial acceptability of our products; and |
| · | our business and  growth strategies.                                |

 

You are cautioned not toput undue reliance on forward-looking statements. Forward-looking statementsare not guarantees of future performance and involve risks and uncertainties,and actual results may differ materially from those projected in this Report,for the reasons, among others, discussed in the sections — “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and “RiskFactors.” Factors that could cause actual results to differ materially includethose discussed under “Cautionary Statements and Risk Factors,” which include,but are not limited to the following:

 
| · | our ability to  develop and market products that compete effectively in targeted market  segments;                                                                    |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | market  acceptance of our current and future products;                                                                                                                |
| · | our ability to  meet customer demand;                                                                                                                                 |
| · | our ability to  perform our obligations under our loan agreements;                                                                                                    |
| · | a loss of one of  our key customers;                                                                                                                                  |
| · | our ability to  implement our long-term business strategy that will be profitable and/or generate  sufficient cash flow;                                              |
| · | the ability of  our vendors to provide conforming materials for our products on a timely  basis;                                                                      |
| · | the loss of any  of our key executive officers;                                                                                                                       |
| · | our ability to  manage our foreign manufacturing and development operations;                                                                                          |
| · | international  business risks;                                                                                                                                        |
| · | our ability to  attract and retain skilled personnel;                                                                                                                 |
| · | our ability to  protect and enforce our current and future intellectual property;                                                                                     |
| · | international  business risks;                                                                                                                                        |
| · | our need for  additional, dilutive financing or future acquisitions; and                                                                                              |
| · | future economic,  business and regulatory conditions, as well as the fluctuations in the price  of commodities such as oil, which may affect demand for our products. |

 

**Webelieve that it is important to communicate our future expectations toinvestors. However, there may be events in the future that we are not able toaccurately predict or control. The factors discussed under “Risk Factors” inthis Report, as well as any cautionary language in this Report or any of ourother reports or filings, including our Annual Report on Form 10-K,provide examples of risks, uncertainties and events that may cause our actualresults to differ materially from the expectations we described in ourforward-looking statements.**

 

**Thefollowing discussion should be read in conjunction with our financialstatements and related notes, which are a part of this Report or incorporatedby reference to our reports filed with the Securities and Exchange Commission,to which we refer in this Report as the Commission. We undertake no obligationto publicly revise these forward-looking statements to reflect events orcircumstances that arise after the date hereof. The results for the three andsix month period ended September 30, 2008 are not necessarily indicative ofthe results to be expected for the entire fiscal year ending March 31,2009 or any other period.**

 

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**Overview**

 

We were founded in1989 and have commercialized the industry’s first lithium phosphate technology.We develop, manufacture and sell high-energy power systems utilizing ourproprietary phosphate-based lithium ion technology for diverse applications,with special emphasis on portable appliances and future generations of hybridand electric vehicles. Our mission is to promote the wide adoption ofhigh-performance, safe, long cycle life, environmentally friendly, low-costenergy storage systems. To address the significant market opportunity webelieve is available, we utilize the numerous benefits of our latest energystorage technology, deep intellectual property portfolio and the extensiveexperience of our management team.

 

We are now indevelopment of our third generation of lithium phosphate energy storage systems,which are expected to be commercially available in the second quarter ofcalendar 2009. Our third generation of lithium ion products feature our safe,long-life lithium phosphate technology which utilizes a phosphate-based cathodematerial. We believe that the advanced functionality and programmability of ourthird generation energy storage systems are well suited for electric vehicle(EV), plug-in hybrid electric vehicle (PHEV) and similar applications. Ourthird generation lithium phosphate energy storage systems address the safetyand limited life weaknesses of other lithium technologies while offering asolution that is competitive in cost and performance. We believe that our thirdgeneration energy storage systems offer design and performance capabilitiesthat will facilitate adoption in automotive, industrial, UPS,telecommunications, aerospace and military markets not traditionally served byother lithium ion solutions.

 

**Strategy**

 

Our business planand strategy focus on the generation of revenue from product sales, whileminimizing costs through partnerships with contract manufacturers and internalmanufacturing efforts through our two wholly-owned subsidiaries in China. Thesesubsidiaries initiated operations in late fiscal 2005. We expect to developtarget markets through the sales of our third generation lithium phosphateenergy storage systems and custom lithium phosphate energy storage systemsbased on programmable EpochTM Command and Control Logic. Inaddition, we expect to pursue a licensing strategy to supply the lithiumphosphate sector with advanced Valence material and components, includinglithium phosphate cathode materials to fulfill other manufacturers’ needs.

 

Key elements of ourbusiness strategy include:

 

·                  *Develop and market differentiatedbattery solutions for a wide array of applications that leverage the advantagesof our technology.*Our product development and marketing efforts are focused on large-formatbattery solutions, such as our third generation lithium phosphate energystorage systems and U-Charge® Power System and other custom batterysolutions that feature advanced performance and technological advantages. Theseproducts are targeted for a broad range of applications in the motive, powerand consumer appliance, telecommunication and utility industries and as asubstitute for certain applications using lead acid batteries.

 

·                  *Manufacturing high-quality,cost-competitive products using a combination of Company owned and contractmanufacturing facilities*. Our products are manufactured in China, using both internal andcontract manufacturing resources. Our company-owned China facility includes twoplants; one manufactures our advanced lithium phosphate materials with ourpatented carbothermal process while the second manufactures our advancedstandard large-format packs such as U-Charge® and custom packs suchas Segway. We have arrangements with contract manufacturers for cellproduction. We believe this manufacturing strategy will allow us to directlycontrol our intellectual property and operations management as well as deliverhigh-quality products that meet the needs of a broad range of customers andapplications.

 

Our businessstrategy is being implemented in three phases, each building on the previousone:

 

·                  Initial Phase: The initial phase of our strategy, nowcomplete, focused on the first generation of our technology in our patentedpolymer construction. During this phase, we introduced the N-Charge®Power System which has been sold through national and regional retailers,top-tier computer manufacturers and national resellers.  We have discontinued the sale of our N-Charge®products.

 

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·                  Second Phase: The second phase of our businessstrategy is nearly complete. Throughout this phase our cell development hasfocused on commercializing a cylindrical Lithium Phosphate cell and advancedthird generation Energy Source Storage System. This third generation ofproducts is designed for motive applications such as hybrid and electricvehicles, scooters and wheelchairs and has the same dimensions as the mostpopular lead acid batteries but with significant increases in performancerelated to safety, energy cycle life and weight.

 

·                  Third Phase: The third phase of our business strategywill entail the development and commercialization of our patented LithiumVanadium Phosphate (LVP) and Lithium Vanadium Fluorophosphate (LVPF) cathodematerials into large-format, high capacity prismatic cells. These materialsoffer superior performance with additional energy storage and higher voltagecapabilities for the automotive, industrial, UPS, aerospace,telecommunications, military and other sectors.

 

Our businessheadquarters is in Austin, Texas. Our materialsresearch and development center is in Las Vegas, Nevada. Our European sales andOEM manufacturing support center is in Mallusk, Northern Ireland. Ourmanufacturing and product development center is in Suzhou, China.  We have the following subsidiaries:  Valence Technology (Nevada), Inc.,Valence Technology Cayman Islands, Inc., Valence Technology N.V., ValenceTechnology International, Inc., Valence Technology B.V., ValenceTechnology (Suzhou) Co., Ltd., and Valence Energy-Tech (Suzhou) Co., Ltd.

 

**GoingConcern**

 

As a result of ourlimited cash resources and history of operating losses there is substantialdoubt about our ability to continue as a going concern. Except for theremaining $2.5 million available under the Berg & Berg $10.0 millionworking capital loan discussed in the Notes to Condensed Consolidated FinancialStatements, Note 11, Related Party Transactions, we presently have no furthercommitments for financing by our Chairman Carl Berg and/or his affiliates orany other source. If we are unable to obtain financing from Mr. Berg orothers on terms acceptable to us, or at all, we may be forced to cease alloperations and liquidate our assets. Our cash requirements may vary materiallyfrom those now planned because of changes in our operations, including thefailure to achieve expected revenues, greater than expected expenses, changesin OEM relationships, market conditions, the failure to timely realize ourproduct development goals, and other adverse developments. These events couldhave a negative impact on our available liquidity sources during fiscal 2009.

 

**Basis ofPresentation, Critical Accounting Policies and Estimates**

 

We prepare our condensedconsolidated financial statements in conformity with generally acceptedaccounting principles in the United States. The preparation of our financialstatements requires us to make estimates and assumptions that affect reportedamounts. We believe our most critical accounting policies and estimates relateto revenue recognition. Our accounting policies are described in the Notes toCondensed Consolidated Financial Statements, Note 3, Summary of SignificantAccounting Policies. The following further describes the methods andassumptions we use in our critical accounting policies and estimates:

 

***Revenue Recognition***

 

We generate revenues fromsales of products including batteries and battery systems, and from licensingfees and royalties pursuant to technology license agreements. Product sales arerecognized when all of the following criteria are met: persuasive evidence ofan arrangement exists, delivery has occurred, seller’s price to the buyer isfixed and determinable, and collection is reasonably assured. For some sales tocustomers in foreign jurisdictions where retention of title is needed toperfect a security interest, we retain title to products shipped, similar to alien under the U.S. Uniform Commercial Code. For these sales, all other revenuerecognition criteria is met for these shipments and neither we nor the customercan rescind the transaction. Accordingly, we recognize this revenue when theproduct is shipped. Product shipments that are not recognized as revenue duringthe period shipped, primarily product shipments to resellers that are subjectto right of return, are recorded as deferred revenue and reflected as aliability on our balance sheet. Products shipped with right of return areincluded in finished goods inventory as we retain title to the products. Forreseller shipments where revenue recognition is deferred, we record revenue andrelieve inventory based upon the reseller-supplied reporting of sales to theirend customers or their inventory reporting. For direct customers, we estimate areturn rate percentage based upon our historical experience. From time to time weprovide sales incentives in the form of rebates or other priceadjustments.  These are generallyrecorded as reductions to revenue on the latter of the date the related revenueis recognized or at the time the rebate or sales incentive is offered. Licensingfees are recognized as revenue upon completion of an executed agreement anddelivery of licensed information, if there are no significant remaining vendorobligations and collection of the related receivable is reasonably assured.Royalty revenues are recognized upon licensee revenue reporting and whencollection is reasonably assured.

 

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**Resultsof Operations**

 

The following table setsforth, for the periods indicated, the percentages of net sales represented bycertain items reflected in our condensed consolidated statements of operations:

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | **Six Month Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                    | ** ** | **September 30,**           | ** ** | **September 30,**        | ** ** |
| ** **                    | ** ** | **2008**                         | ** ** | **2007**                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                          |       |                             |       |                          |       |   |   |   |   |
| Battery and systems sales     |       | 88                               | %          | 97                            | %          | 95 | % | 97 | % |
| Licensing and royalty revenue |       | 12                               | %          | 3                             | %          | 5 | % | 3 | % |
| Total revenues                |       | 100                              | %          | 100                           | %          | 100 | % | 100 | % |
|                          |       |                             |       |                          |       |   |   |   |   |
| Gross margin profit (loss)    |       | (3                               | )%         | 12                            | %          | (1 | )% | 12 | % |
| Operating expenses            |       | 83                               | %          | 74                            | %          | 56 | % | 79 | % |
| Operating loss                |       | (86                              | )%         | (62                           | )%         | (57 | )% | (67 | )% |
| Net loss                      |       | (106                             | )%         | (87                           | )%         | (70 | )% | (95 | )% |

 

***Revenues and Gross Margin***

 

*Batteryand System Sales*.Battery and system sales totaled $5.1 and $16.0 million for the three and sixmonths ended September 30, 2008, respectively, as compared to $5.4 and$9.3 million for the three and six months ended September 30, 2007,respectively. The year to date increase in revenues was primarily due to firstquarter fiscal 2009 sales to a new customer, Tanfield, of $4.2 million, as wellas an increase in sales to Segway of $1.6 million in the first quarter (secondquarter Segway sales remained flat at $3.4 million compared to $3.5 million inthe same period last year). We had $1.1 million and $756,000 in deferredrevenue on our balance sheet at September 30, 2008 and March 31,2008, respectively, primarily related to sales shipping in the end of thequarter. Tanfield sales accounted for 0% and 26% of our product sales for thethree and six months ending September 30, 2008 and 0% of our product salesfor the three and six months ended September 30, 2007. Tanfield revisedtheir strategy to expect significantly lower growth than previously forecasted.We halted shipments to Tanfield in June and how much, if any, futurerevenues we may receive from sales to Tanfield is uncertain.  Segway sales accounted for 67% and 47% of ourtotal product sales for the three and six months ended September 30, 2008and 64% for the three and six months ended September 30, 2007. We expectsales of the large-format battery system to increase during fiscal 2009, due tothe fulfillment of our current back orders and sales agreements; however, weexpect sales of the N-Charge® Power System to be reduced in fiscal 2009 as wehave discontinued the product. The large-format battery system sales represent31% and 18% of our total revenue for the second fiscal quarter in 2009 and2008, respectively and 49% and 16% of our total revenue for the first sixmonths of fiscal 2009 and 2008, respectively. The growth in large-formatbattery systems sales are due to the increase in demand in alternative energysolutions driven by the rising costs of fossil fuels.

 

*Licensingand Royalty Revenue*.Licensing and royalty revenues relate to revenue from licensing agreements forour battery construction technology. Fiscal second quarter 2009 licensing androyalty revenue was $702,000 compared with $180,000 for the same quarter infiscal 2008. Licensing and royalty revenue for the first six months of fiscal2009 and 2008 was $806,000 and $265,000, respectively. Licensing and royaltyrevenue increased in the current fiscal quarter primarily due to concluding alicense amendment with Varta AG as well as our existing license agreement withAmperex Technology Limited, which makes on-going royalty payments as sales aremade using our technology. We expect to continue to pursue a licensing strategyas our lithium phosphate technology receives greater market acceptance. Weexpect licensing and royalty revenues to fluctuate as new agreements areexecuted and existing agreements are fulfilled.

 

*GrossMargin*. Grossmargin as a percentage of revenue was (3)% and (1)% for the three and sixmonths ending September 30, 2008, as compared to 12% for both the threeand six months ended September 30, 2007. Management revised certainestimates regarding inventory reserves, thereby increasing cost of goods soldby $284,000 and $2.7 million for the three and six months ended September 30,2008, respectively. Inventory reserves were increased by $1.0 million anddecreased by $2.0 million for the three and six months ended September 30,2007, respectively. The majority of the reserve adjustment for the three andsix month periods ended September 30, 2008, was related to thediscontinuation of the N-Charge product line. We reduced the $2.1 millioncarrying value of our N-Charge® inventory to its net realizable value, whichwas estimated at $0.6 million as of June 30, 2008 and $0 as of September 30,2008.

 

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***Operating Expenses***

 

The following tablepresents the change in operating expenses from 2007 to 2008 for the three andsix months ending September 30th of those years:

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | **Six Month Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                    | ** ** | **September 30,**           | ** ** | **September 30,**        | ** ** |
| ** **                    | ** ** | **Increase /  (Decrease)**  | ** ** | **% Change**             | ** ** | **Increase /  (Decrease)** | ** ** | **% Change** | ** ** |
|                          |       |                             |       |                          |       |   |   |   |   |
| Research and development      |       | $                                | 243        |                          | 26         | % | $ | 584 |   | 33 | % |
| Marketing                     |       | 201                              |       | 41                            | %          | 518 |   | 53 | % |
| General and administrative    |       | 48                               |       | 2                             | %          | 572 |   | 13 | % |
| Depreciation and amortization |       | 230                              |       | 82                            | %          | 194 |   | 43 | % |
| Loss on disposal of assets    |       | 22                               |       | (147                          | )%         | (5 | ) | (83 | )% |
| Total operating expenses      |       | $                                | 744        |                          | 18         | % | $ | 1,863 |   | 25 | % |

 

During the three and sixmonths ending September 30, 2008, total operating expenses were 83% and56% of revenue, respectively, compared to 74% and 79% of revenue during thesame periods last year.  The dollarincrease is primarily due to increased numbers of employees, travel expenses,product testing, and reporting fees. Total operating expenses as a percentageof revenue for the six months ended September 30, 2008 compared to the sixmonths ended September 30, 2007 decreased because the increases inrevenues for these periods outpaced the increases in expenses.

 

*Researchand Product Development.* Research and product development expenses consist primarily ofpersonnel, equipment and materials to support our efforts to develop batterychemistry and products, as well as to improve our manufacturing processes.Research and product development expenses increased by $243,000, or 26%, to$1.2 million for the three months ending September 30, 2008 from $947,000for the three months ending September 30, 2007. Research and productdevelopment expenses increased by $584,000, or 33%, to $2.3 million for the sixmonths ending September 30, 2008 from $1.8 million for the six monthsending September 30, 2007.  Theincrease in research and development expenses is the result of increasedexpenses related to the development of our third generation lithium phosphateenergy storage systems. Engineering and design fees related to third -partyconsulting services increased by $60,000 and $164,000 for the three and sixmonths ending September 30, 2008, respectively from the same periods lastyear.  For the three and six months endedSeptember 30, 2008, salary expenses increased by $140,000 and $293,000,respectively, primarily due to the hiring of two application engineers in thefirst fiscal quarter 2009 and three application engineers in the second fiscalquarter 2009, in addition to standard annual salary increases for currentemployees. Expenses related to components, parts and software used in testingour products increased by $147,000 and $306,000 during the three and six monthsended September 30, 2008, respectively, from the same periods in 2007.Testing increased by $6,000 and $198,000 for the three and six months ended September 30,2008, respectively, compared to these same periods in 2007. Customer relations,including travel expenses, increased by $40,000 and $99,000 for the three andsix months ended September 30, 2008, respectively, compared to theseperiods in 2007. During the three and six months ending September 30,2008,approximately $86,000 and $144,000 of share-based compensation was allocated toresearch and development expenses as compared to $65,000 and $130,000 in thethree and six months ending September 30, 2007, respectively. We expectresearch and development expenses to increase as we create and develop newproducts.

 

*Marketing*. Marketing expenses consist primarily ofcosts related to sales and marketing personnel, public relations andpromotional materials. Marketing expenses of $695,000 in the three monthsending September 30, 2008 were $201,000, or 41%, higher than the $494,000for the three months ending September 30, 2007. Marketing expenses of $1.5million in the first six months ending September 30, 2008 were $518,000,or 53%, higher than the $ 983,000 for the six months ending September 30,2007. During the three and six months ending September 30, 2008,approximately $123,000 and $245,000, respectively, of share-based compensationwas allocated to marketing expenses as compared to $63,000 and $126,000 in thethree and six months, respectively, ending September 30, 2007, an increaseof $60,000 and $119,000, respectively. Salary expenses increased by $171,000and $205,000 in the three and six months ending September 30, 2008compared to the same periods in fiscal 2007 primarily due to standard annualsalary increases for current employees and hiring two additional marketingstaff in second fiscal quarter 2009. Expenses related to software used inmarketing increased $32,000 for the six months ended September 30, 2008compared to this period in fiscal 2007. Three month software numbers remainedrelatively flat from period to period. We expect marketing expenses to increasemoderately as we focus on growing our revenue for the remainder of fiscal year2009.

 

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*General and Administrative*. General and administrative expensesconsist primarily of salaries, share-based compensation and other related costsfor finance, human resources, facilities, accounting, information technology,legal, and corporate-related expenses. General and administrative expensesremained flat at $2.4 million for the three months ending September 30,2008 and 2007.  These expenses totaled$5.0 million and $4.4 million for the six months ended September 30, 2008and 2007, respectively, or an 13% increase. Audit expenses, consulting fees,and annual report expenses for our SEC filings increased by $334,000 for thesix months ended September 30, 2008 compared to this period in 2007.Bonuses and severance pay increased by $52,000 for the six months ended September 30,2008 from the same period in fiscal 2007. Software expenses increased by$101,000 due to the purchase of certain Axapta user licenses during the sixmonths ended September 30, 2008 compared to software expenses for thisperiod in 2007.  Facility costs andtravel for customer relations both increased by $56,000 for the six monthsended September 30, 2008 compared to this period in 2007. General andadministrative expenses included $270,000 and $323,000 of share-basedcompensation expense for the second fiscal quarter of 2009 and 2008,respectively, a decrease of $53,000. Share-based compensation was $655,000 and$645,000 for the first six months ended September 30, 2008 and 2007,respectively.

 

*Depreciationand Amortization*.Depreciation and amortization expenses were $510,000 and $280,000 for thesecond quarters of fiscal 2009 and 2008, respectively, or an 82% increase.These expenses were $647,000 and $453,000 for the six months ended September 30,2008 and 2007, respectively, or a 43% increase. This increase was due to the$379,000 impairment charge taken against fixed assets considered obsoleteduring the three months ended September 30, 2008. This increase was partiallyoffset by a decrease due to depreciable assets purchased in prior yearsbecoming fully depreciated.

 

 **Liquidity and Capital Resources**

 

***Liquidity***

 

At September 30,2008, our principal source of liquidity was cash and cash equivalents of $3.2million. We do not expect our cash and cash equivalents will be sufficient tofund our operating and capital needs for the next twelve months following September 30,2008 nor do we anticipate product sales during the remainder of fiscal 2009will be sufficient to cover our operating expenses. Historically, we haverelied upon management’s ability to periodically arrange for additional equityor debt financing to meet our liquidity requirements. Unless our product salesare greater than management currently forecasts or there are other changes toour business plan, we will need to arrange for additional financing to fundoperating and capital needs. This financing could take the form of debt orequity. Given our historical operating results and the amount of our existingdebt, as well as the other factors, we may not be able to arrange for debt orequity financing on favorable terms or at all.

 

Our cash requirements mayvary materially from those now planned because of changes in our operationsincluding the failure to achieve expected revenues, greater than expectedexpenses, changes in OEM relationships, changes in market conditions, thefailure to timely realize our product development goals, and other adversedevelopments. These events could have a negative impact on our availableliquidity sources during the remainder of the fiscal year.

 

The following tablesummarizes our statement of cash flows for the six months ended September 30,2008 and 2007:

 
| ** **                                            | ** ** | **Six Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **(dollars in thousands)**                  | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Net cash flows provided by (used in):                 |       |                                                   |       |   |   |
| Operating activities                                  |       | $                                                      | (14,568    | ) | $ | (4,873 | ) |
| Investing activities                                  |       | (2,055                                                 | )          | (555 | ) |
| Financing activities                                  |       | 16,961                                                 |       | 7,000 |   |
| Effect of foreign exchange rates                      |       | 231                                                    |       | (223 | ) |
| Net (decrease) increase in cash and cash  equivalents |       | $                                                      | 569        |   | $ | 1,349 |   |

 

Our use of cash fromoperations the first six months of fiscal 2009 and fiscal 2008 was $14.6million and $4.9 million, respectively. The cash used for operating activitiesduring the first six months of fiscal 2009 was primarily for operating lossesand working capital. Cash used for operating losses in the first six months offiscal 2009 increased from the same period of fiscal 2008 by $9.7 millionprimarily from the impact of increases in operating expenses as described abovein the section titled “Operating Expenses.”

 

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In the first six monthsof fiscal 2009, we had a net decrease in cash used in investing activities of$1.5 million, as compared to the first six months of fiscal 2008. Cash used ininvesting activities during the first six months of fiscal 2009 relates topurchases of equipment domestically and in China.

 

We obtained cash from financing activities in the amounts of $17.0million and $7.0 million during the first six months of fiscal 2009 and 2008,respectively. The financing activities in the first six months of fiscal 2009were short term loans made to us by Berg & Berg for working capitalrequirements in the total amount of $7.5 million pursuant to an agreementwhereby Berg & Berg agreed to provide for up to $10.0 million ininterim working capital loans from time to time in order for Berg &Berg and/or certain of its affiliates to supplement our working capital andother financial needs. TheCompany has an additional $2.5 million in principal amount of working capitalloans remaining under the agreement as of September 30, 2008.  In addition Berg & Berg exercisedcertain warrants by paying us the $1.6 million exercise price and bysurrendering certain of the principal and interest outstanding under promissorynotes related to the short-term loans discussed above aggregating $4.5 million.The remaining $3.0 million in short-term promissory notes bear interest at arate of 8.0% per annum and are payable on November 15, 2008.  Financing activities in the first six monthsof fiscal 2009 also include $8.7 million in issuances of common stock in salesto private investors and $0.7 million for the exercise of stock options.

 

On June 26,2008, Berg & Berg advanced us $2.5 million as a loan to be used tocover working capital requirements. Subsequently, we entered into an agreement whereby Berg & Bergagreed to provide for up to $10.0 million in such interim working capital loansfrom time to time in order for Berg & Berg and/or certain of itsaffiliates to supplement our working capital and other financial needs.  In connection therewith, on July 2,2008, we executed a promissory note (the “$2.5 Million Promissory Note”) inaggregate principal amount of $2.5 million in favor of Berg & Berg forthe initial advance.  The $2.5 MillionPromissory Note was originally payable on September 15, 2008 and bearsinterest at a rate of 8.0% per annum.  OnSeptember 5, 2008, the Company and Berg & Berg amended the $2.5Million Promissory Note to change the date the note is payable from September 15,2008 to November 15, 2008.

 

On January 14, 2008, we filed a Form S-3 RegistrationStatement with the SEC utilizing a “shelf” registration process.  On January 22, 2008, the Form S-3Registration was declared effective by the SEC. Pursuant to this “shelf”registration statement, we may sell debt or equity securities described in theaccompanying prospectus in one or more offerings up to a total public offeringprice of $50.0 million.  We believe thatthis shelf registration statement provides us additional flexibility withregards to potential financings that we may undertake when market conditionspermit or our financial condition may require.

 

On February 22, 2008, we entered into an At Market Issuance SalesAgreement with Wm. Smith & Co., as sales agent (the “Sales Agent”).  Concurrent with entering into this At MarketIssuance Sales Agreement, we provided notice of termination of the ControlledEquity Offering Sales Agreement dated April 13, 2006 that we previouslyentered into with Cantor Fitzgerald & Co.

 

In accordance with terms of the At Market Issuance Sales Agreement, wemay issue and sell up to 5,000,000 shares of common stock in a series oftransactions over time as we may direct through the Sales Agent.  Sales of shares may be made in privatelynegotiated transactions and/or any other method permitted by law, includingsales deemed to be an “at the market” offering as defined in Rule 415under the Securities Act of 1933, which includes sales made directly on theNASDAQ Capital Market, the existing trading market for our common stock, orsales made to or through a market maker other than on an exchange.  The Sales Agent will make all sales on a bestefforts basis using commercially reasonable efforts consistent with its normaltrading and sales practices, on mutually agreed terms between the Sales Agentand us. Unless we and the Sales Agent agree to a lesser amount with respect tocertain persons or classes of persons, the compensation to the Sales Agent forsales of common stock sold pursuant to the Agreement will be 6.0% of the grossproceeds of the sales price per share.

 

During the first six months of fiscal 2009, we sold 1.9 million shareswith proceeds net of commissions of $7.0 million under the At Market IssuanceSales Agreement. Of this $7.0 million, approximately $5.5 million was not receiveduntil after September 30, 2008 and is therefore classified as a receivablefrom stockholder and not cash on the condensed consolidated balance sheet. Asof the date of this Report, we have made no further decisions as to whether orwhen we may seek to make additional sales under the At Market Issuance SalesAgreement. To date, we have sold a total of 2.9 million of the 5.0 millionshares available for sale under the terms of the At Market Issuance SalesAgreement.

 

As a result of the above,we had a net increase in cash and cash equivalents of $569,000 during the firstsix months of fiscal 2009.

 

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As a result of ourlimited cash resources and history of operating losses, our auditors haveexpressed in their report on our consolidated financial statements, included inour audited March 31, 2008 consolidated financial statements, that thereis substantial doubt about our ability to continue as a going concern. Exceptfor the remaining $2.5 million available under the Berg & Berg $10.0million working capital loan discussed in the Notes to Condensed ConsolidatedFinancial Statements, Note 11, Related Party Transactions, we presently have no further commitments forfinancing by Mr. Carl Berg, chairman of our Board of Directors and ourprincipal shareholder, and/or his affiliates, or from any other source. If weare unable to obtain financing from Mr. Berg and/or his affiliates, orothers on terms acceptable to us, or at all, we may be forced to cease alloperations and liquidate our assets. Our cash requirements may vary materiallyfrom those now planned because of changes in our operations, including thefailure to achieve expected revenues, greater than expected expenses, changesin OEM relationships, market conditions, the failure to timely realize ourproduct development goals, and other adverse developments. These events couldhave a negative impact on our available liquidity sources. We intend to improveour liquidity by continued monitoring and reduction of manufacturing, facilityand administrative costs. However, there can be no assurance that these effortswill be successful or that the anticipated benefits would be realized in thenear term.

 

***Capital Commitments and Debt***

 

At September 30,2008, we had commitments for capital expenditures for the next 12 months ofapproximately $163,000 relating to manufacturing equipment. We may requireadditional capital expenditures in order to meet greater demand levels for ourproducts than are currently anticipated and/or to support our operations inChina.

 

Our cash obligations forshort-term, long-term debt and interest, gross of unaccreted discount,consisted of the following:

 
| **(Dollars in thousands)**                     | ** ** | **September ****30,  2008** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| 1998 long-term debt to Berg & Berg              |       | $                                | 14,950     |   |
| 2001 long-term debt to Berg & Berg              |       | 20,000                           |       |
| 2005 long-term debt to third-party                       |       | 20,000                           |       |
| 2008 short-term debt to Berg & Berg             |       | 3,042                            |       |
| Interest on short and long-term debt                     |       | 22,935                           |       |
| Current portion of interest on short and long-term  debt |       | 137                              |       |
| Total                                                    |       | $                                | 81,064     |   |

 

Repayment obligations ofshort-term and long-term debt principal as of September 30, 2008 are:

 
| ** **                           | ** ** | **Fiscal year** | ** ** |
|--------------------------------------|------------|----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2009**             | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|                                 |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Principal repayment                  |       | $                    | 3,042      |   | $ | — |   | $ | 54,950 |   | $ | — |   | $ | — |   | $ | — |   | $ | 57,992 |   |
|                                      |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At September 30, 2008, theredemption obligation for our Series C-1 Convertible Preferred Stock and Series C-2Convertible Preferred Stock, all of which is currently held by Berg &Berg, is $8.6 million, plus accrued dividends, which as of September 30, 2008totaled $517,000.  The preferred sharesare currently subject to redemption or conversion at the holder’sdiscretion.  We do not have sufficientresources to effect this redemption; however, Berg & Berg has agreedthat our failure to redeem the Series C-1 Convertible Preferred Stock andthe Series C-2 Convertible Preferred Stock does not constitute a defaultunder the certificate of designations for either the Series C-1Convertible Preferred Stock or the Series C-2 Convertible Preferred Stockand has waived the accrual of any default interest applicable.  Berg & Berg also has agreed to deferthe payment of dividends on the Series C-1 Convertible Preferred Stock andSeries C-2 Convertible Preferred Stock. According to our agreement with Berg & Berg, dividends willcontinue to accrue (without interest) on the Series C-1 ConvertiblePreferred Stock and the Series C-2 Convertible Preferred Stock accordingto the terms of the applicable certificates of designation; and such dividendsare not payable until such time as the parties mutually agree, or uponredemption or conversion in accordance with the terms of the applicablecertificates of designation.  We have nopresent intention to pay dividends on this preferred stock, including theaccrued dividends.  The Series C-1Convertible Preferred Stock may be converted, at any time, into shares of ourcommon stock at the lower of $4.00 or the closing price of our common stock onthe conversion date, provided the conversion price can be no lower than $1.98,the closing price of the common stock on December 13, 2005.  The Series C-2 Convertible PreferredStock may be converted, at any time, into shares of our common stock at thelower of $4.00 or the closing price of our common stock on the conversion date,provided the conversion price can be no lower than $2.96, the closing bid priceof our common stock on July 13, 2005.

 

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If cash flow fromoperations is not adequate to meet our debt obligations, or to supportinventory, capital equipment or other working capital needs, we will berequired to seek additional debt or equity financing. There can be no assurancethat we could obtain the additional financing or that such financing will notbe substantially dilutive to current shareholders.

 

***Inflation***

 

Historically, ouroperations have not been materially affected by inflation. However, ouroperations may be affected by inflation in the future.

 

***Tabular Disclosure of Contractual Obligations***

 

The following table setsforth, as of September 30, 2008 our scheduled principal, interest andother contractual annual cash obligations due for each of the periods indicatedbelow (in thousands):

 
| ** **                                | ** ** | **Payment Due by Period** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | ** **                               | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **                                | ** ** | **Total**                                | ** ** | **One Year** | ** ** | **1-2 Years** | ** ** | **3-5 Years** | ** ** | **5 Years** | ** ** |
| Contractual obligations:             |       |                                     |       |   |   |   |   |   |   |   |   |
| Short term notes payable                  |       | $                                        | 3,103      |   | $ | 3,103 |   | $ | — |   | $ | — |   | $ | — |   |
| Long-term debt obligations                |       | 77,961                                   |       | 76 |   | 77,885 |   | — |   | — |   |
| Operating lease obligations               |       | 2,242                                    |       | 599 |   | 884 |   | 759 |   | — |   |
| Purchase obligations                      |       | 9,247                                    |       | 9,247 |   | — |   | — |   | — |   |
| Redemption of convertible preferred stock |       | 9,127                                    |       | 9,127 |   | — |   | — |   | — |   |
|                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Total                                     |       | $                                        | 101,680    |   | $ | 22,152 |   | $ | 78,769 |   | $ | 759 |   | $ | — |   |

 

The terms of thecertificates of designation for the series C-1 preferred stock and the Series C-2 preferredstock initially provided that the deadline for redemption was December 15,2005. Pursuant to assignment agreements entered into between us and Berg &Berg, Berg & Berg waived the requirement that the Series C-1preferred stock and Series C-2 preferred stock be redeemed on this date. There currentlyare no redemption deadlines, but the preferred shares are subject to redemptionor conversion at the holder’s discretion. As set forth above, although dividends are not due,they are continuing to accrue (currently $517,000 as of September 30,2008). The total above for Redemption of Convertible Preferred Stock includesaccrued dividends.

 

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**ITEM 3.**                                                     **QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We considered theprovisions of Financial Reporting Release No. 48, “*Disclosuresof Accounting Policies for Derivative Financial Instruments and DerivativeCommodity Instruments, and Disclosures of Quantitative and QualitativeInformation about Market Risk Inherent in Derivative Commodity Instruments*.”On July 13, 2005, in connection with a $20.0 million loan agreement with athird party finance company with an adjustable interest rate equal to thegreater of 6.75% or the sum of the LIBOR rate plus 4.0% (6.75% at September 30,2008), we entered into a rate cap agreement which caps the LIBOR rate at 5.5%(On October 10, 2008, the most recent adjustment date, the LIBOR rate was4.19%) In addition, we are exposed to financial market risks, including changesin foreign currency exchange rates and interest rates.

 

We also have long-termdebt in the form of two loans from a stockholder, which mature in September 2010,and one loan from a third party finance company which matures in July 2010.The first loan from the stockholder has an adjustable rate of interest at 1.0%above the lender’s borrowing rate (9.0% at September 30, 2008) and thesecond loan from the stockholder has a fixed interest rate of 8.0%. The loanfrom the third party finance company has a monthly floating interest rate asdescribed above. Each 0.25% increase in interest on the adjustable rate loanwould increase our annual interest expense by approximately $87,000. The tablebelow presents principal amounts by fiscal year for our long-term andshort-term debt:

** **
| **(dollars in thousands)** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Liabilities:                         |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Fixed rate debt                      |       | $        | 3,042      |     | —     |     | $          | 20,000   |       | —   |       | —         |       | —    |       | $ | 23,042 |   |
| Variable rate debt                   |       | —   |       | —   |       | $        | 34,950     |     | —     |     | —     |           | —     |      | $          | 34,950 |   |
|                                      |            |          |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |

 

Based on borrowing ratescurrently available to us for loans with similar terms, the carrying value ofour debt obligations approximates fair value.

 

**ITEM 4.****                                                    ****CONTROLS AND PROCEDURES**

 

The term “disclosurecontrols and procedures” refers to the controls and other procedures of acompany that are designed to ensure that information required to be disclosedby the company in the reports that it files under the Securities Exchange Actof 1934 (“Exchange Act”) is recorded, processed, summarized and reported,within required time periods. Disclosure controls and procedures, include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed in the reports the Company files or submits under theExchange Act is accumulated and communicated to our management, including ourChief Executive Officer and Principal Financial Officer as appropriate to allowtimely decisions regarding required disclosure. Our management, with theparticipation of our Chief Executive Officer and Principal Financial Officer,carried out an evaluation of the effectiveness of our disclosure controls andprocedures pursuant to Exchange Act Rule 13a-15(b) for the periodcovered by this Report.

 

Based on this evaluation,the Chief Executive Officer and Principal Financial Officer has concluded that,as of September 30, 2008, our disclosure controls and procedures areeffective in timely alerting him to material information required to beincluded in our periodic reports with the Commission.  Subsequent to thedate of his evaluation, there have been no significant changes in our internalcontrols or in other factors that could significantly affect these controls.

 

On July 23, 2008,Galen H. Fischer resigned from his position as Chief Financial Officer. Due tocompensating controls, there were no changes in our internal controls duringthe six months of fiscal 2009 that have materially affected, or are reasonablylikely to materially affect, our internal controls over financial reporting.

 

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**PART II- OTHER INFORMATION**

 

**ITEM 1.**                                                     **LEGAL PROCEEDINGS**

 

On January 31, 2007,we filed a claim against Phostech Lithium Inc. in the Federal Court in Canada(Valence Technology, Inc. v. Phostech Lithium Inc. Court File No. T-219-07)alleging infringement of Valence Canadian Patent 2,395,115. Subsequently, on April 2,2007, we filed an amended claim alleging infringement of its Canadian Patents2,483,918 and 2,466,366. The action is in the discovery phase. We are seekingmonetary damages and injunctive relief for the acts of Phostech inmanufacturing, using and selling phosphate cathode material that infringes theasserted Valence Canadian Patents.

 

On February 14,2006, Hydro-Quebec filed an action against us in the United States DistrictCourt for the Western District of Texas (Hydro-Quebec v. Valence Technology,Civil Action No. A06CA111). In its amended complaint filed April 13,2006, Hydro-Quebec alleges that Saphion ® I Technology, thetechnology utilized in all of our commercial products, infringes U.S. PatentNos. 5,910,382 and 6,514,640 exclusively licensed to Hydro-Quebec. Hydro-Quebec’scomplaint seeks injunctive relief and monetary damages. The action is in theinitial pleading state and we have filed a response denying the allegations inthe amended complaint. The action has been stayed by the Court pending a finaldetermination of reexaminations of the two patents by the USPTO.

 

We are subject, from timeto time, to various claims and litigation in the normal course of business. Inour opinion, all pending legal matters will not have a material adverse impacton our consolidated financial statements.

 

**ITEM 1A.**               **RISKFACTORS**

 

In addition to the riskfactors included in Item 1A of our Annual Report on Form 10-K for our fiscalyear ending March 31, 2008, filed with the Commission on June 16,2008, the following additional and/or updated risk factors are applicable:

 

**Thedemand for batteries in the transportation and other markets may depend on thecontinuation of current trends resulting from dependence on fossil fuels.**

 

We believe that much ofthe present and projected demand for advanced batteries in the transportationand other markets results from increases in the cost of oil, the dependency ofthe United States on oil from unstable or hostile countries, governmentregulations and economic incentives promoting fuel efficiency and alternateforms of energy, as well as the belief that climate change results in part fromthe burning of fossil fuels. If the cost of oil decreases significantly andover a substantial time period, the outlook for the long-term supply of oil tothe United States improves, the government eliminates or modifies itsregulations or economic incentives related to fuel efficiency and alternateforms of energy, or if there is a change in the perception that the burning offossil fuels negatively impacts the environment, the demand for our batteriescould be reduced, and our business and revenue may be harmed.

 

**Adversebusiness or financial conditions affecting the automotive industry may have amaterial adverse effect on our development and marketing partners and ourbattery business.**

 

We are seeking to enterinto certain agreements with certain automotive manufacturers and tier 1suppliers regarding their PHEV and EV development efforts. Certain of thesemanufacturers and suppliers have in recent years experienced static or reducedrevenues, increased costs, net losses, loss of market share, labor issues andother business and financial challenges. Adverse business or financialconditions affecting individual automotive manufacturers or tier 1 suppliers orthe automotive industry generally, including potential bankruptcies, as well asmarket disruption that could result from future consolidation in the automotiveindustry, could have a material adverse effect on our business. Automotivemanufacturers may discontinue or delay their planned introduction of PHEVs orEVs as a result of adverse changes in their financial condition or otherfactors. Automotive manufacturers may also seek alternative battery systemsfrom other suppliers which may be more cost-effective or require fewermodifications in standard manufacturing processes than our products. We mayalso experience delays or losses with respect to the collection of payments duefrom customers in the automotive industry experiencing financial difficulties.

 

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**Generaleconomic conditions, including concerns regarding a potential global recessionand credit constraints, or unfavorable economic conditions in a particularregion, business or industry sector, may lead our customers to delay or foregotechnology investments and could have other impacts, any of which couldadversely affect our business, financial condition, operating results and cashflow.**

 

Recent disruption in theglobal credit markets, failures or material business deterioration ofinvestment banks, commercial banks and other intermediaries in the UnitedStates and elsewhere around the world, and significant reductions in assetvalues across businesses, households and individuals, combined with otherfinancial and economic indicators, raise significant concerns of a potentialglobal recession. If these conditions continue or worsen, they may result inreduced demand for products utilizing our advanced battery technology anddifficulties in obtaining financing, which may adversely affect our business.  Risks we might face could include:

 

·                                          potential declines in revenues due toreduced orders or other factors caused by economic challenges faced by ourcustomers and prospective customers;

 

·                                          potential adverse impacts on ourcustomers’ ability to pay, when due, amounts payable to us and relatedincreases in our cost of capital associated with any increased working capitalor borrowing needs we may have if this occurs, or to collect amounts payable tous in full (or at all) if any of our customers fail or seek protection underapplicable bankruptcy or insolvency laws;

 

·                                          potential adverse impacts on our abilityto access credit and other financing sources (and the cost thereof) beyond theapproved credit lines we have.  This mayimpact our ability to finance future acquisitions or significant capitalexpenditures relating to new products; and

 

·                                          lengthening sales cycles and/or delayedor cancelled decisions to purchase our products an/or our technology.

 

Any such impacts couldadversely affect our business, financial condition, operating results and cashflow. Such a general slowdown or recession in the global economy may alsomaterially impact the global banking system including individual institutionsas well as a particular business or industry sector, which could cause furtherconsolidations or failures in such a sector. These adverse financial eventscould also result in further government intervention in the United States andworld markets. Any of these results could impact the manner in which we areable to conduct business including within a particular industry sector ormarket and could adversely affect our business, financial condition, operatingresults and cash flow or cash position.

 

**ITEM 2.****                                                    ****UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3.****                                                    ****DEFAULTS UPON SENIORSECURITIES**

 

None.

 

**ITEM 4.****                                                    ****SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

None.

 

**ITEM 5.****                                                    ****OTHER INFORMATION**

 

None.

 

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**ITEM 6.**   **EXHIBITS**

 
| **EXHIBIT NO.** | ** ** | ** **                                                                                                                                                                                                                                                                                                                            |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                  |
| 3.1             |       | Second Restated  Certificate of Incorporation of the Company (incorporated by reference to the  exhibit so described in the Company’s Registration Statement on Form S-1  (File No. 33-46765), as amended, filed with the SEC on March 27,  1992)                                                                 |
| 3.2             |       | Amendment to the Second  Restated Certificate of Incorporation of the Company (incorporated by the  reference to the exhibit so described in the Company’s Schedule 14A filed  with the SEC on January 28, 2000)                                                                                                            |
| 3.3             |       | Fourth Amended and  Restated Bylaws of the Company (incorporated by reference to the exhibit so  described in the Company’s Current Report on Form 8-K filed with the SEC  on January 22, 2008)                                                                                                                        |
| 4.1             |       | Certificate of  Designations, Preferences and Rights of Series C-1 Convertible Preferred  Stock (incorporated by reference to the exhibit so described in the Company’s  current Report on Form 8-K dated November 30, 2004, filed with the  SEC on December 1, 2004)                                        |
| 4.2             |       | Certificate of  Designations, Preferences and Rights of Series C-2 Convertible Preferred  Stock (incorporated by reference to the exhibit so described in the Company’s  current Report on Form 8-K dated November 30, 2004, filed with the  SEC on December 1, 2004)                                        |
| 4.3             |       | Letter Agreement, dated  December 21, 2007 by and between Valence Technology, Inc. and  Berg & Berg Enterprises, LLC (incorporated by reference to the  exhibit so described in the Company’s quarterly Report on Form 10-Q  dated February 11, 2008, filed with the SEC on February 11, 2008) |
| 31.1            |       | Certification of Robert  L. Kanode, Principal Executive Officer, pursuant to Rule 13a-14 and  15d-14 of the Securities Exchange Act of 1934.                                                                                                                                                                                     |
| 31.2            |       | Certification of Robert  L. Kanode, Principal Financial Officer, pursuant to Rule 13a-14 and  15d-14 of the Securities Exchange Act of 1934                                                                                                                                                                                      |
| 32.1            |       | Certification of Robert  L. Kanode, Principal Executive Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                |
| 32.2            |       | Certification of Robert  L. Kanode, Principal Financial Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereto dulyauthorized.

 

VALENCETECHNOLOGY, INC.

 
| Date:  November 10, 2008 | By:    | /s/ Robert L. Kanode                            |
|-------------------------------|--------|----------------------------------------------------------------|
|                          |   | Robert L. Kanode                                               |
|                          |   | President and  Chief Executive Officer                         |
|                          |   | (Principal  Executive Officer and Principal Financial Officer) |

 

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EXHIBIT INDEX

 
| **EXHIBIT  NO.** | ** ** | ** **                                                                                                                                                                                                                                                                                                                             |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                                   |
| 3.1              |       | Second Restated  Certificate of Incorporation of the Company (incorporated by reference to the  exhibit so described in the Company’s Registration Statement on Form S-1  (File No. 33-46765), as amended, filed with the SEC on March 27,  1992)                                                                  |
| 3.2              |       | Amendment to the  Second Restated Certificate of Incorporation of the Company (incorporated by  the reference to the exhibit so described in the Company’s Schedule 14A filed  with the SEC on January 28, 2000)                                                                                                             |
| 3.3              |       | Fourth Amended  and Restated Bylaws of the Company (incorporated by reference to the exhibit  so described in the Company’s Current Report on Form 8-K filed with the  SEC on January 22, 2008)                                                                                                                         |
| 4.1              |       | Certificate of  Designations, Preferences and Rights of Series C-1 Convertible Preferred  Stock (incorporated by reference to the exhibit so described in the Company’s  current Report on Form 8-K dated November 30, 2004, filed with the  SEC on December 1, 2004)                                         |
| 4.2              |       | Certificate of  Designations, Preferences and Rights of Series C-2 Convertible Preferred  Stock (incorporated by reference to the exhibit so described in the Company’s  current Report on Form 8-K dated November 30, 2004, filed with the  SEC on December 1, 2004)                                         |
| 4.3              |       | Letter  Agreement, dated December 21, 2007 by and between Valence  Technology, Inc. and Berg & Berg Enterprises, LLC (incorporated  by reference to the exhibit so described in the Company’s quarterly Report on  Form 10-Q dated February 11, 2008, filed with the SEC on  February 11, 2008) |
| 31.1             |       | Certification of  Robert L. Kanode, Principal Executive Officer, pursuant to Rule 13a-14  and 15d-14 of the Securities Exchange Act of 1934.                                                                                                                                                                                      |
| 31.2             |       | Certification of  Robert L. Kanode, Principal Financial Officer, pursuant to Rule 13a-14  and 15d-14 of the Securities Exchange Act of 1934                                                                                                                                                                                       |
| 32.1             |       | Certification of  Robert L. Kanode, Principal Executive Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                 |
| 32.2             |       | Certification of  Robert L. Kanode, Principal Financial Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                 |

 

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