UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                              Washington, DC 20549

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2005.

                                       OR

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

For the transition period from ____________ to ____________

Commission file number 0-20028


                            VALENCE TECHNOLOGY, INC.
             (Exact Name of Registrant as Specified in Its Charter)


            DELAWARE                                          77-0214673
(State or Other Jurisdiction of                            (I.R.S. Employer
 Incorporation or Organization)                           Identification No.)


     6504 BRIDGE POINT PARKWAY,
           AUSTIN, TEXAS                                         78730
(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


Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                    Yes x No

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

                                    Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

      Common Stock, $0.001 par value                    89,486,770
                (Class)                       (Outstanding at August 5, 2005)

<PAGE>

                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES


                                    FORM 10-Q

                       FOR THE QUARTER ENDED JUNE 30, 2005


<TABLE>
<CAPTION>
                                                                 INDEX

                                                                                                                   Pages
<S>             <C>                                                                                                 <C>
PART I.       FINANCIAL INFORMATION

   Item 1.    Financial Statements (Unaudited):

              Condensed Consolidated Balance Sheets as of
              June 30, 2005 and March 31, 2005.........................................................................3

              Condensed Consolidated Statements of Operations and
              Comprehensive Loss for Each of the Three-Month Periods
              Ended June 30, 2005 and June 30, 2004....................................................................4

              Condensed Consolidated Statements of Cash Flows for Each of the Three-
              Month Periods Ended June 30, 2005 and June 30, 2004......................................................5

              Notes to Condensed Consolidated Financial Statements.....................................................6

   Item 2.    Management's Discussion and Analysis of Financial
              Condition and Results of Operations.....................................................................15

   Item 3.    Quantitative and Qualitative Disclosures about Market Risk..............................................35

   Item 4.    Controls and Procedures.................................................................................35


PART II.      OTHER INFORMATION

   Item 1.    Legal Proceedings.......................................................................................36

   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.............................................36

   Item 3.    Defaults upon Senior Securities.........................................................................36

   Item 4.    Submission of Matters to a Vote of Security Holders.....................................................36

   Item 5.    Other Information.......................................................................................36

   Item 6.    Exhibits and Reports on Form 8-K........................................................................36

SIGNATURE     ........................................................................................................37

</TABLE>


                                                                2
<PAGE>




                         Part I - FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS (UNAUDITED)

                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
               (in thousands, except share and per share amounts)
                                   (unaudited)


<TABLE>
<CAPTION>

                                                                                 June 30, 2005            March 31, 2005
                                                                           ---------------------    ----------------------
<S>                                                                           <C>                       <C>
ASSETS
Current assets:
 Cash and cash equivalents                                                              $ 3,092                   $ 2,500
Trade receivables, net of allowance of $392 and $115
 as of June 30, 2005 and March 31, 2005                                                   1,979                     1,464
Inventory                                                                                 4,189                     2,564
Prepaid and other current assets                                                          1,347                       920
                                                                           ---------------------    ----------------------
   Total current assets                                                                  10,607                     7,448

Property, plant and equipment, net                                                        2,741                     2,383
Intellectual property, net                                                                  371                       400
                                                                           ---------------------    ----------------------
   Total assets                                                                        $ 13,719                  $ 10,231
                                                                           =====================    ======================

LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
 Bridge loan from stockholder                                                           $ 2,500                       $ -
 Accounts payable                                                                         6,023                     3,251
 Accrued expenses                                                                         3,784                     4,607
 Deferred revenue                                                                         1,129                     1,241
                                                                           ---------------------    ----------------------
  Total current liabilities                                                              13,436                     9,099

Long-term interest                                                                       13,276                    12,536
Long-term debt to stockholder                                                            34,832                    34,656
                                                                           ---------------------    ----------------------
  Total liabilities                                                                      61,544                    56,291
                                                                           ---------------------    ----------------------


Redeemable convertible preferred stock, $0.001 par value,
 authorized, issued and outstanding 861 shares at
 June 30, 2005, liquidation value $8,610                                                  8,592                     8,582
                                                                           ---------------------    ----------------------

Commitments and contingencies

Stockholders' equity (deficit):
Common stock, $0.001 par value, 200,000,000 shares authorized;
   89,448,306 and  87,061,639 shares issues and outstanding, respectively                    89                        87
Additional paid-in capital                                                              421,873                   415,745
Deferred compensation                                                                       (76)                      (89)
Notes receivable from stockholder                                                        (4,953)                   (5,164)
Accumulated deficit                                                                    (469,514)                 (461,328)
Accumulated other comprehensive loss                                                     (3,836)                   (3,893)
                                                                           ---------------------    ----------------------
  Total stockholders' deficit                                                           (56,417)                  (54,642)
                                                                           ---------------------    ----------------------

  Total liabililities, preferred stock and stockholders' deficit                       $ 13,719                  $ 10,231
                                                                           =====================    ======================

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

</TABLE>


                                                      3
<PAGE>

<TABLE>
<CAPTION>

                                      VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                       CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                                        (in thousands, except per share amounts)
                                                      (unaudited)


                                                                          Three Months Ended June 30
                                                             ----------------------     --------------------
                                                                       2005                    2004
                                                             ----------------------     --------------------
Revenue:
<S>                                                          <C>                        <C>
  Licensing and royalty revenue                              $               144        $             73
  Battery and system sales                                                 3,261                   2,764
         Total revenues                                                    3,405                   2,837
                                                             $-------------------       $----------------
Cost of sales:                                                             5,327                   3,923
                                                              -------------------        ----------------
Gross profit (loss)                                                       (1,922)                 (1,086)

  Research and product development                                         1,692                   1,899
  Marketing                                                                  723                   1,331
  General and administrative                                               3,370                   3,412
  (Gain)/Loss or disposal of assets                                         (615)                      -
  Depreciation and amortization                                             (168)                    273
                                                              -------------------       -----------------
         Total costs and expenses                                          5,338                   6,915
                                                              -------------------       -----------------
Operating loss                                                            (7,260)                 (8,001)
Interest and other income                                                     92                      96
Interest and other expense                                                  (975)                 (1,053)
                                                              -------------------       -----------------
Net loss                                                                  (8,143)                 (8,958)
Dividends on preferred stock                                                  43                      43
Preferred stock accretion                                                     10                     218
                                                              -------------------       -----------------
Net loss available to common stockholders                     $           (8,196)       $         (9,219)
                                                              ===================       =================

Other comprehensive loss:
 Net loss                                                     $           (8,143)       $         (8,958)
Change in foreign currency translation adjustments                            57                      50
                                                              -------------------        ----------------
 Comprehensive loss                                           $           (8,086)       $         (8,908)
                                                              ===================        ================

Net loss per share available to common stockholders           $            (0.09)       $          (0.12)
                                                              ===================        ================

Shares used in computing net loss per share available to                  88,389                  76,941
  common stockholders, basic and diluted
                                                             ====================        ================


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


</TABLE>



                                                  4
<PAGE>



                            VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                         CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                         (in thousands)
                                           (unaudited)

<TABLE>
<CAPTION>

Cash flows from operating activities:                                            2005                      2004
                                                                     -------------------          -----------------
<S>                                                                    <C>                        <C>
  Net loss                                                             $     (8,143)              $          (8,958)
Adjustments to reconcile net loss to net cash
   used in operating activities:
Depreciation and amortization                                                   168                             273
Gain on sale of property, plant & equipment                                    (615)                              -
Accretion of debt discount and other                                            229                             177
Interest income on stockholder note receivable                                  (70)                            (93)
Deferred compensation expense                                                    13                            (188)
Changes in operating and other assets and
  liabilities:
      Trade receivables                                                        (515)                           (183)
      Inventory                                                              (1,625)                           (166)
      Other current assets                                                     (435)                             18
      Accounts payable                                                        2,774                           1,360
      Accrued expenses and long-term interest                                   (39)                            469
      Deferred revenue                                                         (112)                           (450)
                                                                     -------------------          -----------------
         Net cash used in operating activities                               (8,370)                         (7,741)
                                                                     -------------------          -----------------
Cash flows from investing activities:
      Effect of deconsolidation of joint venture                                  -                            (913)
      Purchases of property, plant & equipment                                 (606)                           (171)
      Proceeds from sale of property, plant &
      equipment                                                                 622                               -
                                                                     -------------------          -----------------
         Net cash used in investing activities                                   16                          (1,084)
                                                                     -------------------          -----------------
Cash flows from financing activities:
      Proceeds from stockholder loan                                          2,500                               -
      Payment of long-term debt                                                   -                            (157)
      Dividends paid                                                            (43)                            (43)
      Interest received on stockholder note receivable                          281                             301
      Proceeds from stock option exercises                                      191                             231
      Proceeds from issuance of common stock,
        net of issuance costs                                                 5,991                           8,993
                                                                     -------------------          -----------------
          Net cash provided by financing activities                           8,920                           9,325
                                                                     -------------------          -----------------
Effect of foreign exchange rates on cash
     and cash equivalents                                                        26                              32
                                                                     -------------------          -----------------
Increase in cash and cash equivalents                                           592                             532
Cash and cash equivalents, beginning of period                                2,500                           2,692
                                                                     -------------------          -----------------
     Cash and cash equivalents, end of period                         $       3,092                $          3,224



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



                                          5


<PAGE>





                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 2005
                                   (Unaudited)

1.   INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:

     These interim condensed consolidated financial statements are unaudited but
     reflect, in the opinion of management, all normal recurring adjustments
     necessary to present fairly the financial position of Valence Technology,
     Inc. and its subsidiaries (the "Company") as of June 30, 2005, its
     consolidated results of operations for each of the three-month periods
     ended June 30, 2005 and June 30, 2004, and the consolidated cash flows for
     each of the three-month periods ended June 30, 2005 and June 30, 2004.
     Because all the disclosures required by generally accepted accounting
     principles are not included, these interim condensed consolidated financial
     statements should be read in conjunction with the audited financial
     statements and notes thereto in the Company's Annual Report on Form 10-K as
     of and for the year ended March 31, 2005. The results for the three-month
     period ended June 30, 2005 are not necessarily indicative of the results to
     be expected for the entire fiscal year ending March 31, 2006. The year-end
     condensed consolidated balance sheet data as of March 31, 2005 was derived
     from audited financial statements, but does not include all disclosures
     required by generally accepted accounting principles.

2.   BUSINESS AND BUSINESS STRATEGY:

     Valence Technology, Inc. (with its subsidiaries, the "Company") was founded
     in 1989 and has commercialized the industry's first phosphate-based
     lithium-ion technology. The Company's mission is to drive the wide adoption
     of high-performance, safe, low-cost energy storage systems by drawing on
     the numerous benefits of its latest battery technology, the extensive
     experience of its management team, and the significant market opportunity
     available to it.

     In February 2002, the Company unveiled its Saphion(R) technology, a
     lithium-ion technology which utilizes a phosphate-based cathode material.
     The Company believes that Saphion(R) technology addresses the major
     weaknesses of existing technology while offering a solution that is
     competitive in cost and performance. The Company believes that by
     incorporating a phosphate-based cathode material, its Saphion(R) technology
     is able to offer greater thermal and electrochemical stability than
     traditional lithium-ion technologies, which will facilitate its adoption in
     large application markets not traditionally served by lithium-ion batteries
     such as motive power, vehicular, portable appliances, telecommunications,
     and utility back-up systems. Currently, the Company offers its Saphion(R)
     technology in both cylindrical and polymer construction and have initiated
     the design of a prismatic cell.

     The Company's business plan and strategy focuses on the generation of
     revenue from product sales, while minimizing costs through a manufacturing
     plan that utilizes partnerships with contract manufacturers and internal
     manufacturing efforts through its newly-formed Wholly Foreign-Owned
     Enterprises ("WFOE's") in China. These WFOE's initiated operations in late
     fiscal 2005. The market for Saphion(R) technology will be developed by
     offering existing and new solutions that differentiate the Company's
     products and its customers' products in both the large-format and
     small-format markets through the Company's own product launches, such as
     the N-Charge(TM) Power System, K-Charge(TM) Power System, and U-Charge(TM)
     Power System, and through products designed by others. In addition, the
     Company expects to continue to pursue a licensing strategy as our
     Saphion(R) technology receives greater market acceptance.

     On July 13, 2005 the Company appointed James R. Akridge to succeed Stephan
     Godevais as its Chief Executive Officer. On August 3, the Company appointed
     Mr. Ackridge to succeed Mr. Godevais as its president. Mr. Godevais
     continues to act as an advisor to the Company.

3.   LIQUIDITY AND CAPITAL RESOURCES:

     At June 30, 2005, the Company's principal sources of liquidity were cash
     and cash equivalents of $3.1 million and $17.5 million remaining on a $20.0
     million funding commitment made by Mr. Carl Berg, a director and principal
     stockholder, on June 13, 2005. On June 30, 2005 the Company drew down $2.5
     million on this commitment in the form of a bridge loan. On July 13, 2005
     the Company secured a $20 million loan from a third party finance company,
     the full amount of which has been drawn down. Under the terms of the loan
     agreement, which is guaranteed by Mr. Berg, interest will be payable
     monthly and the entire principal balance will be payable on July 13, 2010.
     The loan will bear interest at the greater of 6.75% or LIBOR plus 4.0%. In
     connection with the loan the



                                       6
<PAGE>


     Company purchased a rate cap agreement to protect against fluctuations in
     LIBOR for the full amount of the loan for three years. The Company utilized
     $2.5 million of this loan to repay the June 30, 2005 draw from Mr. Berg.

     At June 30, 2005, the Company had $4.3 million of Series C-1 Convertible
     Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock
     outstanding. The Series C-1 Convertible Preferred Stock and Series C-2
     Convertible Preferred Stock are convertible into common stock at $4.00 per
     share and are redeemable on December 15, 2005 (subject to an early right of
     redemption in the case of the Series C-2 Convertible Preferred Stock during
     the 30 days following September 15, 2005). Applicable provisions of
     Delaware corporate law restrict the Company's ability to redeem the
     preferred stock. If the Company does not redeem the shares of Series C-1
     when required by their terms, the conversion price will be reduced to an
     amount equal to 95% of the lowest closing bid price of the Company's common
     stock during the three days ending on and including the conversion date. On
     July 11, 2005, Riverview Group LLC, the holders of all of the Series C-2,
     exercised its optional right of redemption on the $4.3 million of Series
     C-2 held by them. On July 14, 2005 the Company assigned its rights to
     purchase the Series C-2 to Berg & Berg, LLC, an affiliate of Carl Berg, a
     director and principal stockholder. Pursuant to the assignment, Berg & Berg
     has agreed that failure of the Company to redeem the stock on the maturity
     date shall not constitute a default under the Series C-2 certificate of
     designations and has waived the accrual of any default interest applicable
     in such circumstance. Berg & Berg has also agreed that in the event the
     Company does not redeem the shares of Series C-2 when required by their
     terms, the conversion price will be the lower of $4.00 or the closing price
     of the Company's common stock on the conversion date, provided that the
     conversion price can be no lower than $2.96, the closing bid price of the
     Company's common stock on July 13, 2005.

     The Company's current forecast assumes product sales for the second and
     third fiscal quarters of 2006 of between $4.5 - $5.5 million. The Company
     also anticipates further cash benefits from continued reductions in
     operating expenses and manufacturing costs, offset by small increases to
     capital expenditures associated with continuing efforts in China.

     The Company's cash requirements may vary materially from those now planned
     because of changes in our operations, including the failure to achieve
     expected revenues, greater than expected expenses, changes in OEM
     relationships, market conditions, the failure to timely realize our product
     development goals, and other adverse developments. These events could have
     a negative impact on our available liquidity sources during the next 12
     months.

     Currently, the Company does not have sufficient sales and gross profit to
     generate the cash flows required to meet its operating and capital needs.
     As a consequence, one of the Company's primary objectives has been to
     reduce expenses and overhead which limits the resources available to the
     development and commercialization of the Company's technology. The
     Company's limited financial resources could materially affect the ability,
     and the pace at which, the Company is able to commercially exploit its
     Saphion(R) technology, as well as other factors described under the Section
     "Risk Factors."

4.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     REVENUE RECOGNITION:

     Revenues are generated from sales of products including batteries and
     battery systems, and from licensing fees and royalties per technology
     license agreements. Product sales are recognized when all of the following
     criteria are met: persuasive evidence of an arrangement exists, delivery
     has occurred, seller's price to the buyer is fixed and determinable, and
     collectibility is reasonably assured. Product shipments that are not
     recognized as revenue during the period shipped, primarily product
     shipments to resellers that are subject to right of return, are recorded as
     deferred revenue and reflected as a liability on the Company's balance
     sheet. For reseller shipments where revenue recognition is deferred, the
     Company records revenue based upon resellers' supplied reporting of sales
     to end customers or upon their inventory reporting. For direct customers,
     the Company estimates a return percentage based upon its historical
     experience. The Company reviews this estimate on a quarterly basis. From
     time to time, the Company provides sales incentives in the form of rebates
     and other price adjustments; these are recorded as reductions to revenue as
     incurred. Licensing fees are recognized as revenue upon completion of an
     executed agreement and delivery of licensed information, if there are no
     significant remaining vendor obligations and collection of the related
     receivable is reasonably assured. Royalty revenues are recognized upon
     licensee revenue reporting and when collectibility is reasonably assured.



                                       7
<PAGE>


     IMPAIRMENT OF LONG-LIVED ASSETS:

     The Company performs a review of long-lived tangible and intangible assets
     for impairment whenever events or changes in circumstances indicate that
     the carrying amount of an asset may not be recoverable. Recoverability of
     these assets is measured by comparison of their carrying amounts to future
     undiscounted cash flows that the assets are expected to generate. If
     long-lived assets are considered to be impaired, the impairment to be
     recognized equals the amount by which the carrying value of the assets
     exceeds its fair value and is recorded in the period the determination was
     made.

     EXIT COSTS:

     The Company recognizes liabilities for costs associated with exit or
     disposal activities at fair value in the period during which the liability
     is incurred. Costs associated with exit or disposal activities are included
     in restructuring charges.

     STOCK-BASED COMPENSATION:

     The Company accounts for equity instruments issued to non-employees in
     accordance with the provisions of SFAS No. 123 ("SFAS 123"), "Accounting
     for Stock-Based Compensation," as amended by SFAS No. 148 ("SFAS 148"),
     "Accounting for Stock-Based Compensation - Transition and Disclosure - an
     Amendment of FASB Statement No. 123", and consensus of the Emerging Issues
     Task Force No. 96-18, "Accounting for Equity Instruments with Variable
     Terms That Are Issued for Consideration Other Than Employee Services." The
     Company accounts for stock-based employee compensation arrangements in
     accordance with the provisions of Accounting Principles Board Opinion No.
     25 ("APB No. 25"), "Accounting for Stock Issued to Employees" and complies
     with the disclosure provisions of SFAS 123, as amended by SFAS 148. Had
     compensation expense for the stock plans been determined based on the fair
     value at the grant date for options granted in the first three months of
     fiscal 2006 and 2005 consistent with the provisions of SFAS 123, as amended
     by SFAS 148, the pro forma net loss would have been reported as follows (in
     thousands):


</TABLE>

<TABLE>
<CAPTION>
                                                                                Three Months Ended
                                                                                      June 30,
                                                                       -----------------------------------
                                                                                2005            2004
                                                                       -----------------   ---------------
<S>                                                                      <C>               <C>
Net loss available to common stockholders - as reported                  $     (8,196)     $   (9,219)
Add: stock-based compensation expense, net of related taxes                      (580)           (903)
                                                                       -----------------   ---------------
Net loss available to common stockholders - pro forma                          (8,776)        (10,122)
Net loss available to common stockholders per share - as reported               (0.09)          (0.12)
Net loss available to common stockholders, basic and diluted, pro forma         (0.10)          (0.13)

</TABLE>

     The fair value of each option grant is estimated at the date of grant using
     the Black-Scholes pricing model with the following weighted average
     assumptions for grants in the first three months of fiscal 2006 and 2005:


                                              2006                2005
                                        ---------------      --------------
        Risk-free interest rate             3.72%               3.81%
        Expected life                       5.00 years          5.00 years
        Volatility                         93.31%             106.15%




     RECENT ACCOUNTING PRONOUNCEMENTS:

         In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
     CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO.
     51, which addresses consolidation by business enterprises of variable
     interest entities ("VIEs") either: (1) that do not have sufficient equity
     investment at risk to permit the entity to finance its activities without
     additional subordinated financial



                                       8
<PAGE>



     support, or (2) in which the equity investors lack an essential
     characteristic of a controlling financial interest. In December 2003, the
     FASB completed deliberations of proposed modifications to FIN 46 (Revised
     Interpretations) resulting in multiple effective dates based on the nature
     as well as the creation date of the VIE. VIEs created after January 31,
     2003, but prior to January 1, 2004, may be accounted for either based on
     the original interpretation or the Revised Interpretations. However, the
     Revised Interpretations must be applied no later than the first quarter of
     fiscal year 2004. VIEs created after January 1, 2004 must be accounted for
     under the Revised Interpretations. The adoption of these deferred
     provisions in 2004 had no effect on the Company's financial position,
     results of operations or cash flows.

          In November 2004, the FASB issued SFAS No. 151, INVENTORY COSTS, AN
     AMENDMENT OF ARB NO. 43, CHAPTER 4. The standard requires that abnormal
     amounts of idle capacity and spoilage costs should be excluded from the
     cost of inventory and expensed when incurred. The provision is effective
     for fiscal periods beginning after June 15, 2005. The Company does not
     expect the adoption of this standard to have a material effect on its
     financial position, results of operations or cash flows.

          In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF
     NONMONETARY ASSETS, AN AMENDMENT OF APB NO. 29, ACCOUNTING FOR NONMONETARY
     TRANSACTIONS. SFAS No. 153 requires exchanges of productive assets to be
     accounted for at fair value, rather than at carryover basis, unless (1)
     neither the asset received nor the asset surrendered has a fair value that
     is determinable within reasonable limits or (2) the transactions lack
     commercial substance. SFAS No. 153 is effective for nonmonetary asset
     exchanges occurring in fiscal periods beginning after June 15, 2005. The
     Company does not expect the adoption of this standard to have a material
     effect on its financial position, results of operations or cash flows.

          In December 2004, the FASB released its final revised standard, SFAS
     No. 123R, SHARE-BASED PAYMENT. SFAS No. 123R requires that an entity
     measure the cost of equity based service awards using the grant-date fair
     value of the award. That cost will be recognized over the period during
     which an employee is required to provide service in exchange for the award
     or the vesting period. No compensation cost is recognized for equity
     instruments for which employees do not render the requisite service. An
     entity will initially measure the cost of liability based service awards
     using its current fair value; the fair value of that award will be
     re-measured subsequently at each reporting date through the settlement
     date. Changes in fair value during the requisite service period will be
     recognized as compensation cost over that period. Adoption of SFAS No. 123R
     is required for fiscal periods beginning after June 15, 2005. As such, SFAS
     No. 123R is not effective until our fiscal 2007. The Company is evaluating
     SFAS 123R and believes that it will likely have a material effect on its
     financial position and results of operations when placed into effect.

          On May 30, 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND
     ERROR CORRECTIONS, a replacement of APB Opinion No. 20 and FASB Statement
     No. 3, which changes the requirements for the accounting and reporting of a
     change in accounting principle. The standard applies to all voluntary
     changes in accounting principle as well as to changes required by an
     accounting pronouncement that does not include specific transition
     provisions. SFAS No. 154 is effective for accounting changes and
     corrections of errors made in fiscal years beginning after December 15,
     2005. The Company does not expect the adoption of this standard to have a
     material effect on its financial position, results of operations or cash
     flows.

     NET LOSS PER SHARE:

     Net loss per share is computed by dividing the net loss available to common
     stockholders by the weighted average shares of common stock outstanding
     during the period. The dilutive effect of the options and warrants to
     purchase common stock are excluded from the computation of diluted net loss
     per share, since their effect is antidilutive. The antidilutive instruments
     excluded from the diluted net loss per share computation for the
     three-month periods ended June 30, 2005 and June 30, 2004 were as follows:



<TABLE>
<CAPTION>
                                                                               Three Months Ended
                                                                                    June 30
                                                                          2005                   2004
                                                                    -------------------------------------
<S>                                                                    <C>                    <C>
Shares reserved for conversion of Series C preferred stock             2,152,500              2,026,000
Common Stock options                                                  11,051,798              8,812,000
Warrants to purchase common stock                                      1,889,315              2,469,000
                                                                    -------------------------------------
                                                                      15,093,613             13,307,000


</TABLE>



5.   EQUITY FINANCING:

     On April 27, 2005, the Company drew down $3.0 million from its equity line
     of credit with Mr. Carl Berg. Under the terms of the equity commitment, the
     Company issued West Coast Venture Capital, Inc., an affiliate of Mr. Berg,
     1,251,042 shares of its restricted common stock at the average closing bid
     price of the stock for the five days prior to the purchase date.

     On May 26, 2005, the Company drew down $2.0 million from its equity line of
     credit with Mr. Carl Berg. Under the terms of the equity commitment, the
     Company issued West Coast Venture Capital, Inc., an affiliate of Mr. Berg,



                                       9
<PAGE>


     645,577 shares of its restricted common stock at the average closing bid
     price of the stock for the five days prior to the purchase date.

     On June 15, 2005, the Company drew down $1.0 million from its equity line
     of credit with Mr. Carl Berg. Under the terms of the equity commitment, the
     Company issued West Coast Venture Capital, Inc., an affiliate of Mr. Berg,
     329,380 shares of its restricted common stock at the average closing bid
     price of the stock for the five days prior to the purchase date. This
     represented the final draw on the June 2004 $20 million equity financing
     commitment.

6.   INVENTORY:

     Inventory consisted of the following (in thousands) at:


                                     June 30, 2005      March 31, 2005
                                   ----------------     --------------
        Raw materials               $        1,109      $         464
        Work in process                      2,307                880
        Finished goods                         773              1,220
                                   ----------------     --------------
                                    $        4,189      $       2,564
                                   ================     ==============




7.   PROPERTY, PLANT AND EQUIPMENT, NET:

     Property, plant and equipment, net of accumulated depreciation and
     impairment consisted of the following (in thousands) at:


                                       June 30, 2005            March 31, 2005
                                    ------------------     ---------------------
Building and land                    $              -      $               -
Leasehold improvements                            474                    456
Machinery and equipment                         6,180                  7,678
Office and computer equipment                   1,372                  1,237
Construction in progress                            -                     64
                                    ------------------     ---------------------
   Total cost                                   8,026                  9,436
Less:  accumulated deprecation                 (5,232)                (5,191)
Less:  impairment                                 (53)                (1,862)
                                    ------------------     ---------------------
   Total cost, net of depreciation   $          2,741      $           2,383
                                    ==================     =====================


8.   INTELLECTUAL PROPERTY:

     Intellectual property consisting of stacked battery construction technology
     acquired from Telcordia Technologies, Inc. in December 2000 is amortized
     over the remaining five years of its useful life. Intellectual property,
     net of accumulated amortization and impairment, consisted of the following
     (in thousands) at:



                                       10
<PAGE>


<TABLE>
<CAPTION>

                                                                 June 30, 2005          March 31, 2005
                                                         ----------------------   ---------------------
<S>                                                       <C>                     <C>
        Intellectual property before impairment                       $ 13,602                $ 13,602
        Less: accumulated amortization                                  (4,736)                 (4,708)
        Less: Impairment                                                (8,494)                 (8,494)
                                                         ----------------------   ---------------------
        Intellectual property, net                                    $    371                $    400
                                                         ======================   =====================


</TABLE>


     Amortization expense for each of the three-month periods ended June 30,
     2005 and 2004 was approximately $29,000. Amortization expense for the
     remaining nine months of fiscal 2006 will be $85,000, and will be $114,000
     in fiscal years 2007 and 2008, and $58,000 for fiscal 2009.

9.   DEBT:

        (in thousands)                  June 30, 2005          March 31, 2005
                                    --------------------     -----------------
        2001 Loan balance                     $20,000               $20,000
        1998 Loan balance                      14,950                14,950
        Bridge Loan                             2,500                     0
        Unaccreted debt discount                 (118)                 (294)
                                    --------------------     -----------------
        Balance                               $37,332               $34,656
                                    ====================     =================



     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
     advance the Company funds of up to $20 million between the date of the
     agreement and December 31, 2003. Interest on the 2001 Loan accrues at 8.0%
     per annum, payable from time to time. On July 13, 2005, Berg & Berg agreed
     to extend the maturity date for the loan principal and interest from
     September 30, 2006 to September 30, 2008 and the Company granted to Berg &
     Berg a 90-day option, effective October 1, 2006, to require that interest
     will accrue on the loan as compound interest. On November 8, 2002, the
     Company and Berg & Berg amended an affirmative covenant in the agreement to
     acknowledge The Nasdaq SmallCap Market as an acceptable market for the
     listing of the Company's common stock. As of June 30, 2005, accrued
     interest on the loan totaled $5.49 million, which is included in long-term
     interest. In conjunction with the 2001 Loan, Berg & Berg received a warrant
     to purchase 1,402,743 shares of the Company's common stock at the price of
     $3.208 per share. The warrant was exercisable beginning on the date it was
     issued and on July 13, 2005 the expiration date of the warrants was
     extended to September 30, 2008. The fair value assigned to these warrants,
     totaling approximately $2.768 million, has been reflected as additional
     consideration for the debt financing, recorded as a discount on the debt
     and accreted as interest expense over the life of the loan. The warrants
     were valued using the Black-Scholes valuation method using the assumptions
     of a life of 47 months, 100% volatility, and a risk free rate of 5.5%.
     Through June 30, 2005, a total of approximately $2.65 million has been
     accreted and included as interest expense. The amounts charged to interest
     expense on the outstanding balance of the loan for each of the three-month
     periods ended June 30, 2005 and 2004 was $404,000. Interest payments on the
     loan are currently being deferred, and are recorded as long-term interest.

     In July 1998, the Company entered into an amended loan agreement ("1998
     Loan") with Berg & Berg that allows the Company to borrow, prepay and
     re-borrow up to $10 million 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 million. As of June 30, 2005, the
     Company had an outstanding balance of $14.95 million under the 1998 Loan
     agreement. The loan bears interest at one percent over the lender's
     borrowing rate (approximately 9.0% at June 30, 2005). On July 13, 2005, the
     parties agreed to extend the loan's maturity date from September 30, 2006
     to September 30, 2008 and the Company granted to Berg & Berg a 90-day
     option, effective October 1, 2006, to require that interest will accrue on
     the loan as compound interest. On November 8, 2002, the Company and Berg &
     Berg amended an affirmative covenant in the agreement to acknowledge The
     Nasdaq SmallCap Market as an acceptable market for the listing of the
     Company's common stock. As of June 30, 2005, accrued interest on the loan
     totaled $7.785 million, which is included in long term interest. In fiscal
     1999, the Company issued warrants to purchase 594,031 shares of common
     stock to Berg & Berg in conjunction with the 1998 Loan agreement, as
     amended. The warrants expired on June 16, 2004. The amount charged to
     interest expense for each of the three-month periods ended June 30, 2005
     and 2004 was $335,000. Interest payments on the loan are currently being
     deferred, and are recorded as long-term interest.


                                       11
<PAGE>


     On June 30, 2005 the Company drew down $2.5 million from a new $20 million
     funding commitment with Mr. Berg entered into on June 13, 2005. This draw
     took the form of a bridge loan, which was repaid in full by the Company on
     July 13, 2005, including interest at an annual rate of 5.0%.

     On July 13, 2005 the Company secured a $20.0 million loan from a third
     party finance company, the full amount of which has been drawn down. Under
     the terms of the loan agreement, which is guaranteed by Mr. Berg, interest
     will be payable monthly and the entire principal balance will be payable on
     July 13, 2010. The loan will bear interest at the greater of 6.75% or LIBOR
     plus 4.0%. In connection with the loan the Company purchased a rate cap
     agreement to protect against fluctuations in LIBOR for the full amount of
     the loan for three years. The Company utilized $2.5 million of this loan to
     repay the June 30, 2005 draw from Mr. Berg. In connection with the loan
     both the third party financing company and Mr. Berg received warrants to
     purchase 600,000 shares of the Company's common stock at a price of $3.20
     per share.

10.  COMMITMENTS AND CONTINGENCIES:

     WARRANTIES:

     The Company has established a warranty reserve in connection with the sale
     of N-Charge(TM) Power Systems covering a 12-month warranty period during
     which the Company would provide a replacement unit to any customer
     returning a purchased product because of a product performance issue. The
     Company has also established a warranty reserve in relation to the sale of
     its K-Charge(TM) Power Systems and its U-Charge(TM) Power Systems. In
     addition, the Company has established a reserve for its 30-day right of
     return policy under which a direct customer may return a purchased
     N-Charge(TM) Power System. The Company has estimated its right of return
     liability as 5.0% of the previous month's direct N-Charge(TM) Power System
     sales. The total warranty liability as of June 30, 2005 is $1.067 million.

     Product warranty liabilities for the three-month period ended June 30, 2005
     and the year ended March 31, 2005 are as follows (in thousands):


                                     June 30, 2005         March 31, 2005
                                 ---------------------  ---------------------
        Beginning balance         $      1,067             $      490
        Less: claims                      (362)                  (695)
        Less: returns                       (7)                   (33)
        Plus: accruals                     369                  1,305
                                 --------------------------------------------
        Ending balance            $      1,067             $    1,067
                                 ============================================


     LITIGATION:

     The Company is subject to various claims and litigation in the normal
     course of business. Any contingent liabilities are recorded on a gross
     basis if probable and estimable. In the opinion of management, all pending
     legal matters are either covered by insurance or, in not insured, will not
     have a material adverse impact on the Company's consolidated financial
     statements.

11.  REDEEMABLE CONVERTIBLE PREFERRED STOCK:

     On June 2, 2003, the Company issued 1,000 shares of Series C Convertible
     Preferred Stock and warrants to purchase the Company's common stock for
     $10,000 per share, raising net proceeds of $9.416 million. On January 22,
     2004, the holder of the Series C Convertible Preferred Stock converted 139
     of its 1,000 shares with the principal amount of $1.39 million, including
     accrued and unpaid dividends, into 327,453 shares of the Company's common
     stock at the conversion price of $4.25 per share. On November 30, 2004, the
     Company entered into an amendment and exchange agreement to exchange all of
     the outstanding 861 shares of the Company's Series C Convertible Preferred
     Stock, representing $8.6 million of principal. The Series C Convertible
     Preferred Stock was exchanged for 431 shares of Series C-1 Convertible
     Preferred Stock, with a stated value of $4.3 million, and 430 shares of
     Series C-2 Convertible Preferred Stock, with a stated value of $4.3
     million. Under the terms of the Series C-1 Convertible Preferred Stock and
     Series C-2 Convertible Preferred Stock, the preferred stock is convertible
     into common stock at $4.00 per share, carry a 2% annual dividend rate,
     payable quarterly in cash or shares of common stock, and are redeemable on
     December 15, 2005. The new series of preferred stock are identical in all
     respects except that the holder of the Series C-2 Convertible Preferred
     Stock will have the right to require the Company to redeem the Series C-2
     Convertible



                                       12
<PAGE>


     Preferred Stock at any time during the 30 days following June 15, 2005 and
     September 15, 2005. The Company has the right to convert the preferred
     stock if the average of the volume weighted average price of the Company's
     common stock for a ten-day trading period is at or above $6.38 per share.
     Applicable provisions of Delaware corporate law restrict the Company's
     ability to redeem the preferred stock. If the Company does not redeem the
     shares of Series C-1 when required by their terms, the conversion price
     will be reduced to an amount equal to 95% of the lowest closing bid price
     of the Company's common stock during the three days ending on and including
     the conversion date. On July 11, 2005, Riverview Group LLC, the holder of
     all the Series C-2, exercised its optional right of redemption on the $4.3
     million of Series C-2 held by them. On July 14, 2005 the Company assigned
     its right to purchase the Series C-2 to Berg & Berg, an affiliate of Carl
     Berg, a director and principal stockholder. Pursuant to the assignment,
     Berg & Berg has agreed that the failure of the Company to redeem the stock
     on the maturity date shall not constitute a default under the Series C-2
     certificate of designations and has waived the accrual of any default
     interest applicable in such circumstance. Berg & Berg has also agreed that
     in the event the Company does not redeem the shares of Series C-2 when
     required by their terms, the conversion price will be the lower of $4.00 or
     the closing of the Company's common stock on the conversion date, provided
     that the conversion price can be no lower than $2.96, the closing bid price
     of the Company's common stock on July 13, 2005.

     In connection with the issue of the initial issuance of the Series C
     Convertible Preferred Stock, the Company issued to the Series C Convertible
     Preferred Stock holder a warrant to purchase 352,900 shares of the
     Company's common stock. The warrant is exercisable at a purchase price of
     $5.00 per share and expires in June 2008. The warrant was valued using the
     Black-Scholes valuation model. The warrant was recorded to additional paid
     in capital at its relative fair value to the Series C Convertible Preferred
     Stock.

12.  RELATED PARTY TRANSACTIONS:

     In June 2005, Mr. Carl Berg, a director and stockholder in the Company,
     agreed to provide an additional $20 million funding commitment. This
     funding commitment can take the form of debt or equity. On June 30, 2005,
     the Company drew down $2.5 million of this commitment. This draw took the
     form of a bridge loan at a 5.0% annual interest rate and was repaid with
     proceeds from the July 2005 debt offering Mr. Berg's commitment can be
     reduced by the amount of net proceeds received from a debt or equity
     transaction. As of the date of this report, Mr. Berg has not requested that
     his commitment be reduced.

     In June 2004, Mr. Carl Berg, a director and stockholder in the Company,
     agreed to provide an additional $20 million backup equity funding
     commitment. This additional funding commitment came in the form of an
     equity line of credit and allowed the Company to request Mr. Berg to
     purchase shares of common stock from time to time at the average closing
     bid price of the stock for the five days prior to the purchase date. As of
     June 30, 2005, the Company has drawn down the full amount of this
     commitment.

     On January 1, 1998, the Company granted Mr. Lev Dawson, the Company's then
     Chairman of the Board, Chief Executive Officer and President, an incentive
     stock option to purchase 39,506 shares, which was granted pursuant to the
     Company's 1990 Plan (the "1990 Plan"). Also, the Company granted Mr. Dawson
     an option to purchase 660,494 shares pursuant to the Company's 1990 Plan,
     and an option to purchase 300,000 shares was granted outside of any equity
     plan of the Company, neither of which were incentive stock options (the
     "Nonstatutory Options"). The exercise price of all three options is $5.0625
     per share, the fair market value on the date of the grant. The Compensation
     Committee of the Company approved the early exercise of the Nonstatutory
     Options on March 5, 1998. The options permitted exercise by cash, shares,
     full-recourse notes or non-recourse notes secured by independent
     collateral. The Nonstatutory Options were exercised on March 5, 1998 with
     non-recourse promissory notes in the amounts of $3,343,750 ("Dawson Note
     One") and $1,518,750 ("Dawson Note Two") (collectively, the "Dawson Notes")
     secured by the shares acquired upon exercise plus 842,650 shares previously
     held by Mr. Dawson. As of June 30, 2005, principal and interest amounts of
     $3.406 million and $1.547 million were outstanding under Dawson Note One
     and Dawson Note Two, respectively, and under each of the Dawson Notes,
     interest from the issuance date accrues on unpaid principal at the rate of
     5.77% per annum, or at the maximum rate permissible by law, whichever is
     less.

     In accordance with the Dawson Notes, interest is payable annually in
     arrears and has been paid through March 4, 2005.

13.  SEGMENT AND GEOGRAPHIC INFORMATION:

     The Company's chief operating decision maker is its Chief Executive
     Officer, who reviews operating results to make decisions about resource
     allocation and to assess performance. The Company's chief operating
     decision maker views results of operations of a single operating segment,
     the development and marketing of the


                                       13
<PAGE>


     Company's Saphion(R) technology. The Company's Chief Executive Officer has
     organized the Company functionally to develop, market and manufacture
     Saphion(R) products.

     Long-lived asset information by geographic area at June 30, 2005 and March
     31, 2005 is as follows (in thousands):


                                 June 30, 2005           March 31, 2005
                            ---------------------    -------------------
        United States           $            904         $         $987
        International                      2,208                  1,796
                            ---------------------    -------------------
        Total                   $          3,112         $        2,783
                            =====================    ===================


     Revenues by geographic area for the three-month periods ended June 30, 2005
     and June 30, 2004 are as follows (in thousands):

                                    Three Months Ended June 30,
                              ----------------------------------------
                                       2005               2004
                              -------------------  -------------------
        United States                     $3,207               $2,633
        International                        198                  204
                              -------------------  -------------------
        Total                             $3,405               $2,837
                              ===================  ===================


14.  SUBSEQUENT EVENTS:

     On July 13, 2005 the Company secured a $20 million loan from a third party
     financing company, the full amount of which has been drawn down. Under the
     terms of the loan agreement, which is guaranteed by Mr. Berg, interest will
     be payable monthly and the entire principal balance will be payable on July
     13, 2010. The loan will bear interest at the greater of 6.75% and LIBOR
     plus 4.0%. In connection with the loan the Company purchased a rate cap
     agreement to protect against fluctuations in LIBOR for the full amount of
     the loan for three years.



                                       14
<PAGE>


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

THIS REPORT CONTAINS STATEMENTS THAT CONSTITUTE "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, AND SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED. THE WORDS
"EXPECT," "ESTIMATE," "ANTICIPATE," "PREDICT," "BELIEVE" AND SIMILAR EXPRESSIONS
AND VARIATIONS THEREOF ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS APPEAR IN A NUMBER OF PLACES IN THE REPORT AND INCLUDE
STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF VALENCE
TECHNOLOGY, INC., TO WHICH WE REFER IN THIS REPORT AS VALENCE, WE OR US, OUR
DIRECTORS OR OFFICERS WITH RESPECT TO, AMONG OTHER THINGS, (A) TRENDS AFFECTING
OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS, (B) OUR PRODUCT DEVELOPMENT
STRATEGIES, (C) TRENDS AFFECTING OUR MANUFACTURING CAPABILITIES; (D) TRENDS
AFFECTING THE COMMERCIAL ACCEPTABILITY OF OUR PRODUCTS, AND (E) OUR BUSINESS AND
GROWTH STRATEGIES. YOU ARE CAUTIONED NOT TO PUT UNDUE RELIANCE ON
FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS ARE 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
OTHER, DISCUSSED IN THE SECTIONS - "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "RISK FACTORS." THE FOLLOWING
DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND
RELATED NOTES, WHICH ARE A PART OF THIS REPORT OR INCORPORATED BY REFERENCE TO
OUR REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, TO WHICH WE REFER
IN THE REPORT AS THE COMMISSION. WE UNDERTAKE NO OBLIGATION TO PUBLICLY REVISE
THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT ARISE
AFTER THE DATE HEREOF. THE RESULTS FOR THE THREE-MONTH PERIOD ENDED JUNE 30,
2005 ARE NOT NECESSARILY INDICATIVE OF THE RESULTS TO BE EXPECTED FOR THE ENTIRE
FISCAL YEAR ENDING MARCH 31, 2006.

OVERVIEW

We have commercialized the first phosphate-based lithium-ion technology and have
brought to market several products utilizing this technology. Our mission is to
drive the wide adoption of high-performance, safe, low-cost energy storage
systems by drawing on the numerous benefits of our latest battery technology,
Saphion(R), the extensive experience of our management team and the significant
market opportunity available to us. The introduction of lithium-ion technology
to the market was the result of consumer demand for high-energy, small battery
solutions to power portable electronic devices. The battery industry,
consequently, focused on high-energy solutions at the expense of safety.
Additionally, because of safety concerns, lithium-ion technology has been
limited in adoption to small-format applications, such as notebook computers,
cell phones and personal digital assistant devices. Our Saphion(R) technology, a
phosphate-based cathode material, addresses the need for a safe lithium-ion
solution, especially in large-format applications.

Our business plan and strategy focus on the generation of revenue from a
combination of product sales and licensing activities, while minimizing costs
through a manufacturing plan that utilizes partnerships with contract
manufacturers, and internal manufacturing efforts through our Wholly
Foreign-Owned Enterprises (WFOE's) in China. These WFOE's initiated operations
in late fiscal 2005. We plan to drive the adoption of our Saphion(R) technology
by offering existing and new solutions that differentiate our own products and
customers' products in both the large-format and small-format markets. In
addition, we will seek to expand the fields of use of our Saphion(R) technology
through the licensing of our intellectual property related to our battery
chemistries and manufacturing processes.

To date, we have achieved the following successes in implementing our business
plan:

     o    Proven the feasibility of our technology;

     o    Launched new Saphion(R) technology-based products, including our
          N-Charge(TM) Power System family and our K-Charge(TM) Power System,
          which meet market needs of a large customer base, and introduced our
          U-Charge(TM) Power System family of products, which is intended to be
          a direct replacement for existing lead acid battery solutions in the
          market today and serve emerging motive applications;

     o    Demonstrated capability for high volume production.

     o    Established relationships with top tier customers across many of the
          target market for our products, while continuing to build our brand
          awareness in multiple channels;

     o    Closed and sold our high-cost manufacturing facility in Northern
          Ireland and established key manufacturing partnerships in Asia to
          facilitate low-cost, quality production;



                                       15
<PAGE>



     o    Signed an agreement granting Tyco Electronics Power Systems, Inc. the
          exclusive right to resell under its private-labeled ELiTE RK brand,
          our K-Charge (TM) Power System to its telecommunications and utility
          customers for a period of three years.

     o    Began shipping in volume our long-range battery packs using our
          Saphion(R) technology for use in Segway LLC's human transporter.

     o    Established volume production of cathode powder and power systems in
          our two WFOE's in Suzhou, China.

     o    Launched a phosphate-based Lithium-ion power cell. Batteries designed
          with power cells can be discharged and charged more quickly than
          batteries designed with energy cells. This makes them ideal for
          applications that require powerful bursts rather than slow discharges
          of energy, such as portable appliances and future generations of
          hybrid and electric vehicles. Our new Saphion(R) power cell offers
          significant cycling, weight and longevity benefits over
          Nickel-Metal-Hydride (NiMH) and Nickel Cadmium (NiCad) battery
          technologies.

     o    Completed design of a U-Charge(TM) Power System and fuel gauge
          designed specifically for the electric wheelchair market. This new
          product is expected to be available in the third quarter of fiscal
          2006.

Our financial results for the three-month period ended June 30, 2005 were
consistent with our expected progress in our business. First quarter of fiscal
2006 revenue was in line with our expectations at $3.4 million, an increase of
20.0% from the first quarter of fiscal year 2005 of $2.8 million and an increase
of 43.8% from the fourth quarter of the fiscal 2005 of $2.4 million. Gross
margin loss was (56%) for the first quarter of fiscal 2006, compared with (38%)
for the first quarter of fiscal 2005. During the first quarter of fiscal 2006,
we continued our efforts to transition our manufacturing and other operations to
our WFOE's in China, which became operational in late fiscal 2005. To support
the continual efforts in China and help manage potential delays in product
transitions and receiving customer purchase orders, on June 13, 2005 we have
received an additional $20 million funding commitment from Carl Berg, a director
and principal stockholder, to cover our fiscal 2006 cash requirements. As of
June 30, 2005, $2.5 million had been drawn down in the form of a bridge loan and
$17.5 million remained under the commitment. This bridge loan was repaid with
proceeds from the July debt offering. The remaining commitment can be reduced if
funds to support operational needs are received from other debt or equity
financing arrangements. As of the date of this report, Mr. Berg has not
requested that his commitment be reduced. On July 13, 2005 the Company secured a
$20 million loan from a third party financing company, the full amount of which
has been drawn down. From the proceeds of this loan we repaid the $2.5 million
amount drawn on Mr. Berg's line.

Our business headquarters are located in Austin, Texas, our research and
development centers are in Henderson, Nevada and Oxford, England, and our
European sales and OEM manufacturing support center is in Mallusk, Northern
Ireland and our manufacturing and product development centers are in Suzhou and
Shanghai, China.

BASIS OF PRESENTATION, CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We prepare our condensed consolidated financial statements in conformity with
generally accepted accounting principles in the United States. The preparation
of our financial statements requires us to make estimates and assumptions that
affect reported amounts. We believe our most critical accounting policies and
estimates relate to revenue recognition, impairment of long-lived assets, and
exit costs. Our accounting policies are described in the Notes to Condensed
Consolidated Financial Statements, Note 4, Summary of Significant Accounting
Policies. The following further describes the methods and assumptions we use in
our critical accounting policies and estimates:



                                       16
<PAGE>


REVENUE RECOGNITION

We generate revenues from sales of products including batteries and battery
systems, and from licensing fees and royalties per technology license
agreements. Product sales are recognized when all of the following criteria are
met: persuasive evidence of an arrangement exists, delivery has occurred,
seller's price to the buyer is fixed and determinable, and collectibility is
reasonably assured. Product shipments that are not recognized as revenue during
the period shipped, primarily product shipments to resellers that are subject to
right of return, are recorded as deferred revenue and reflected as a liability
on our balance sheet. For reseller shipments where revenue recognition is
deferred, we record revenue based upon the reseller-supplied reporting of sales
to their end customers or their inventory reporting. For direct customers, we
estimate a return rate percentage based upon our historical experience. We
review this estimate on a quarterly basis. From time to time we provide sales
incentives in the form of rebates or other price adjustments; these are recorded
as reductions to revenue as incurred. Licensing fees are recognized as revenue
upon completion of an executed agreement and delivery of licensed information,
if there are no significant remaining vendor obligations and collection of the
related receivable is reasonably assured. Royalty revenues are recognized upon
licensee revenue reporting and when collectibility is reasonably assured.

IMPAIRMENT OF LONG-LIVED ASSETS

We perform a review of long-lived tangible and intangible assets for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of these assets is measured by
comparison of their carrying amounts to future undiscounted cash flows that the
assets are expected to generate. If long-lived assets are considered to be
impaired, the impairment to be recognized equals the amount by which the
carrying value of the assets exceeds its fair value and is recorded in the
period the determination was made. The estimated cash flows used in our
impairment analyses reflect our assumptions about average selling prices,
royalties, sales volumes, product costs, operating costs (including costs
associated with our manufacturing transition to China), disposal costs, and
market conditions. These assumptions are sometimes subjective and may require us
to make estimates of matters that are uncertain. Additionally, we use
probability-weighted scenarios to incorporate the impact of alternative
outcomes, where applicable.

RESULTS OF OPERATIONS

The following table summarizes the results of our operations for the three
months ended June 30, 2005 and 2004 (the three months ended for each period may
also be referred to as the first quarter of the respective fiscal year):



<TABLE>
<CAPTION>

                                   ---------------------------------------------------------------
                                           June 30, 2005                   June 30,2004
                                   ---------------------------------------------------------------
(dollars in thousands)                     % of Revenue                    % of Revenue
<S>                                     <C>               <C>          <C>                <C>
Licensing and royalty revenue           $     144              4%        $     73              3%
Battery and system sales                    3,261             96%           2,764             97%
                                   ---------------------------------------------------------------
Total revenues                              3,405            100%           2,837            100%
Gross profit (loss)                        (1,922)           -56%          (1,086)           -38%
Operating expenses                          5,338            157%           6,915            244%
Operating loss                             (7,260)          -213%          (8,001)          -282%
                                   ---------------------------------------------------------------
Net loss                                $  (8,143)          -239%        $ (8,958)          -316%
                                   ===============================================================

</TABLE>


REVENUES AND GROSS MARGIN

BATTERY AND SYSTEM SALES: Battery and system sales increased by $497,000, or
18.0%, to $3.261 million in the first quarter of fiscal 2006 from $2.764 million
in the first quarter of fiscal 2005. The increase in battery and system sales
was primarily the result of sales of the Segway battery pack and other U-Charge
(TM) products. Overall, we saw a 580% increase in large-format orders in the
first quarter of fiscal 2006 compared to the fourth quarter of fiscal 2005.
These systems comprised 38% of our total revenue for the three months ended June
30, 2005 versus 8% for the three months ended June 30, 2004. However, due to the
high cost of doing business in the retail channel in connection with our
N-Charge (TM) products and our desire to focus on our Saphion(R) technology, we
have decided to cease sales of N-Charge products through our retail channels.
Product shipments to resellers that are subject to right of return and monies
received for exclusivity of future obligations are recorded on the balance sheet
as deferred revenue. We had $1.129 million in deferred revenue on our balance
sheet at June 30, 2005.



                                       17
<PAGE>


LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for our technology. Fiscal first quarter 2006
licensing and royalty revenue was $144,000 compared with $73,000 for the same
quarter in fiscal 2005. Licensing and royalty revenue was primarily from our
license agreement with Amperex Technology Limited (ATL), which makes on-going
royalty payments as sales are made using our technology. We expect to continue
to pursue a licensing strategy as our Saphion(R) technology receives greater
market acceptance.

GROSS MARGIN (LOSS): Gross margin (loss) as a percentage of revenue was (56%)
for the first quarter of fiscal 2006 as compared to (38%) in the first quarter
of fiscal 2005. We maintained a negative gross margin on our sales in all
periods because of insufficient production and sales volumes to facilitate the
coverage of our indirect and fixed manufacturing operating costs. Gross margins
were impacted by the ramp-up cost of the Segway product as well as the
manufacturing transition to China. We have successfully transitioned our battery
manufacturing and N-Charge(TM) product assembly operations to contract
manufacturers in Asia and as well as our manufacturing and product development
operations to our newly-established WFOE's in Suzhou, China. We expect cost of
sales to continue to decrease as a percentage of sales as production volumes
continue to increase, as we continue to implement our lower-cost manufacturing
strategy, and as we launch higher-margin products.

OPERATING EXPENSES

The following table summarizes operating expenses for the three-month periods
ended June 30, 2005 and 2004:


<TABLE>
<CAPTION>
                                                Three Months Ended June 30
                                        --------------------------------------------
                                                            Increase/
(Dollars in thousands                     2005     2004    (Decrease)      %Change
                                        --------------------------------------------
<S>                                      <C>      <C>          <C>            <C>
Research and product development         1,692    1,899        (207)         -11%
Marketing                                  723    1,330        (607)         -46%
General and administrative               3,370    3,412         (42)          -1%
Depreciation and amortization              168      273        (105)          -38%
(Gain)/Loss on disposal of assets         (615)       -        (615)            -
Total operating expenses                 5,338    6,914      (1,576)          -23%
Percentage of revenues                     157%     244%

</TABLE>



During the first quarter of fiscal 2006, operating expenses were 157% of revenue
and were 244% of revenue in the same quarter last year. The decrease is a result
of increased revenues and our focus on expense reductions during the quarter,
offset by increases in general and administrative expenses related to compliance
with the Sarbanes-Oxley Act of 2002 and our relocation of manufacturing and
development operations to China, as well as by our gain on the sale of our
Mallusk, Northern Ireland facility.

RESEARCH AND PRODUCT DEVELOPMENT. Research and product development expenses
consist primarily of personnel, equipment and materials to support our efforts
to develop battery chemistry and products, as well as to improve our
manufacturing processes. Research and product development expenses decreased by
$207,000, or 11%, to $1.692 million for the first quarter of fiscal 2006 from
$1.899 million for the first quarter of fiscal 2005. The decrease in research
and development expenses is the result of cessation of process development work
in our Northern Ireland facility, as well as reduced temporary staff and
consulting expenses and materials usage in our Henderson, Nevada facility.

MARKETING. Marketing expenses consist primarily of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses of $723,000 in the first quarter of fiscal 2006 were $607,000 lower
than the comparable period of fiscal 2005. The decrease in marketing expenses in
the three-month period ended June 30, 2005 over the comparable period in fiscal
2005 was the result of reduced spending for lead generation, consulting related
to European market development, and reduced media advertising expenditures. We
expect marketing expenses to grow as we expand and develop our channels, launch
additional Saphion(R) products, and continue our branding efforts.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other related costs for finance, human resources,
facilities, accounting, information technology, legal, and corporate-related
expenses, including our China initiatives. General and administrative expenses
totaled $3.370 million and $3.412 million for the first fiscal quarters of 2006
and 2005, respectively. General and administrative expense decreases
attributable to the closing of our Northern Ireland were offset by increases
caused by our ongoing relocation and establishment of manufacturing and
development operations to China.



                                       18
<PAGE>

GAIN ON SALE OF ASSETS: Gains on sales of the facility and production and
development equipment from our former Mallusk, Northern Ireland facility were
$615,000 in the first quarter of fiscal 2006. The majority of the gain is
related to the sale of our Northern Ireland facility property and equipment
completed in April, 2005. Additionally, we determined that some equipment was
not required in our manufacturing and development operations in Suzhou, China,
and was sold for fair value.

DEPRECIATION AND AMORTIZATION

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were
$168,000 and $273,000 for the first quarters of fiscal 2006 and 2005,
respectively. The decrease in depreciation resulted from the sale of assets in
our Northern Ireland facility in the third quarter of fiscal 2005, the impact of
the impairment charges to intellectual property and property, plant, and
equipment and the impact of the sale of our Henderson, Nevada facility.

LIQUIDITY AND CAPITAL RESOURCES

LIQUIDITY

At June 30, 2005, the Company's principal sources of liquidity were cash and
cash equivalents of $3.1 million and $17.5 million remaining on a new $20.0
million funding commitment made by Mr. Carl Berg, a director and principal
stockholder, on June 13, 2005. On June 30, 2005 the Company drew down $2.5
million on this commitment in the form of a bridge loan. On July 13, 2005 the
Company secured a $20.0 million loan from a third party finance company, the
full amount of which has been drawn down. Under the terms of the loan agreement,
which is guaranteed by Mr. Berg, interest will be payable monthly and the entire
principal balance will be payable on July 13, 2010. The loan will bear interest
at the greater of 6.75% or LIBOR plus 4.0%. In connection with the loan the
Company purchased a rate cap agreement to protect against fluctuations in LIBOR
for the full amount of the loan for three years. The Company utilized $2.5
million of this loan to repay the June 30, 2005 draw from Mr. Berg.

At June 30, 2005, the Company had $4.3 million of Series C-1 Convertible
Preferred Stock and $4.3 million of Series C-2 Convertible Preferred Stock
outstanding. The Series C-1 Convertible Preferred Stock and Series C-2
Convertible Preferred Stock are convertible into common stock at $4.00 per share
and are redeemable on December 15, 2005 (subject to an early right of redemption
in the case of the Series C-2 Convertible Preferred Stock during the 30 days
following September 15, 2005). Applicable provisions of Delaware corporate law
restrict our ability to redeem the preferred stock. If we do not redeem the
shares of Series C-1 when required by their terms, the conversion price will be
reduced to an amount equal to 95% of the lowest closing bid price of our common
stock during the three days ending on and including the conversion date. On July
11, 2005, Riverview Group LLC, the holders of all of the Series C-2, exercised
its optional right of redemption on the $4.3 million of Series C-2 held by them.
On July 14, 2005 the Company assigned its rights to purchase the Series C-2 to
Berg & Berg, LLC, an affiliate of Carl Berg, who is a director and principal
stockholder of the Company. Pursuant to the assignment, Berg & Berg has agreed
that failure of the Company to redeem the stock on the maturity date shall not
constitute a default under the Series C-2 certificate of designations and has
waived the accrual of any default interest applicable in such circumstance. Berg
& Berg pursuant to the assignment dated July 14, 2005, as amended on August 8,
2005, has also agreed that in the event the Company does not redeem the shares
of Series C-2 when required by their terms, the conversion price will be the
lower of $4.00 or the closing price of the Company's common stock on the
conversion date, provided that the conversion price can be no lower than $2.96,
the closing bid price of the Company's common stock on July 13, 2005.

Our current forecast assumes product sales for the second and third fiscal
quarters of 2006 of between $4.5 - $5.5. million. We also anticipate further
cash benefits from continued reductions in operating expenses and manufacturing
costs, offset by small increases to capital expenditures associated with
continuing efforts in China.

Our cash requirements may vary materially from those now planned because of
changes in our operations, including the failure to achieve expected revenues,
greater than expected expenses, changes in OEM relationships, market conditions,
the failure to timely realize our product development goals, and other adverse
developments. These events could have a negative impact on our available
liquidity sources during the next 12 months.

Currently, we do not have sufficient sales and gross profit to generate the cash
flows required to meet our operating and capital needs. As a consequence, one of
our primary objectives has been to reduce expenses and overhead and thus
limiting the resources available to the development and commercialization of our
technology. Our limited financial resources could materially affect our ability,
and the pace at which, we are able to commercially exploit our Saphion(R)
technology, as well as other factors described under the section "Risk Factors."

The following table summarizes our statement of cash flows for the three months
ended June 30, 2005 and 2004:


                                       19
<PAGE>



<TABLE>
<CAPTION>
                                                             Three Months Ended June 30,
                                                       ----------------------------------------
<S>                                                    <C>                      <C>
        (Dollars in thousands)                                2005                     2004
                                                       ---------------           --------------
        Net cash flows provided by (used in):
        Operating activities                               $  (8,370)               $  (7,741)
        Investing activities                                      16                   (1,084)
        Financing activities                                   8,920                    9,325
        Effect of foreign exchange rates                          26                       32
                                                       ---------------           --------------
        Net increase in cash and cash equivalents          $     592                $     532
                                                       ===============           ==============

</TABLE>


Our use of cash from operations the first three months of fiscal 2006 and fiscal
2005 was $8.4 million and $7.7 million, respectively. The cash used for
operating activities during the first three months of our fiscal 2006 operating
activities was primarily for operating losses and working capital. Cash use for
operating losses in the first three months of fiscal 2006 was lower than the
same period of fiscal 2005 by $1.5 million. Cash used for working capital in the
first three months of fiscal 2006 was greater than cash used for working capital
in the first three months of fiscal 2005 by $2.2 million primarily to support
purchases of inventory for increased production.

In the first three months of fiscal 2006, we received net cash from investing
activities of $16,000. The cash provided from investing activities during the
first three months of fiscal 2006 relates to the sale of property and equipment
from our Northern Ireland facility. These sales proceeds are offset by purchases
of equipment for our China manufacturing facilities and enterprise software.
Cash used in investing activities during the first three months of fiscal 2005
relates to the effect of deconsolidation of our China joint venture, as the
assets, liabilities, and operating results of the joint venture are no longer
being consolidated into our financial statements.

We obtained cash from financing activities of $8.9 million and $9.3 million
during the first three months of fiscal 2006 and 2005, respectively. The
financing activates in the first three months of fiscal 2006 included a $2.5
million bridge loan agreement with Berg & Berg and equity issuances totaling
$6.0 million to Berg & Berg under our equity line agreement.

As a result of the above, we had a net increase in cash and cash equivalents of
$592,000 during the first three months of fiscal 2006 and a net increase of
$532,000 for the first three months of fiscal 2005.

CAPITAL COMMITMENTS AND DEBT

At June 30, 2005, we had commitments for capital expenditures for the next 12
months of approximately $175,000 relating to the continuing implementation of
enterprise software and $305,000 for production equipment in our new
manufacturing facility in China. We anticipate that we will incur additional
capital expenses as we start up and expand our China operations. We may require
additional capital expenditures in order to meet greater demand levels for our
products than currently are anticipated.

Our cash obligations for short-term and long-term debt, gross of unaccreted
discount, consisted of:


        (Dollars in thousands)                        June 30, 2005
                                                  --------------------
        Loan from stockholder                          $        2,500
        1998 long-term debt to Berg & Berg                     14,950
        2001 long-term debt to Berg & Berg                     20,000
        Interest on long-term debt                             13,276
                                                  --------------------
        Total debt                                     $       50,726
                                                  ====================


                                       20
<PAGE>



Repayment obligations of short-term and long-term debt principal as of June 30,
2005 are:



<TABLE>
<CAPTION>
                                                        Fiscal year
                              --------------------------------------------------------------------------
<S>                           <C>      <C>       <C>       <C>       <C>       <C>            <C>
(Dollars in thousands)          2006     2007      2008      2009      2010     Thereafter      Total
                              -------- --------  -------  --------  ---------  -----------    ----------
Principal repayment           $2,500    $34,950       -         -         -              -     $ 37,450

</TABLE>



Subsequent to June 30, 2005, we repaid the $2.5 million due in fiscal 2006 with
proceeds from the July 13, 2005 debt arrangement, and Berg & Berg agreed to
extend the maturity of the 1998 and 2001 long-term debt due in fiscal 2007
(September 30, 2006) to fiscal 2009 (September 30, 2008).

If not converted to common stock prior to maturity, the redemption obligation
for the Series C-1 Convertible Preferred Stock and Series C-2 Convertible
Preferred Stock will be $8.6 million on December 15, 2005.

INFLATION

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

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table sets forth, as of June 30, 2005, our scheduled principal,
interest and other contractual annual cash obligations due for each of the
periods indicated below (in thousands):


<TABLE>
<CAPTION>

                                                                                        PAYMENT DUE BY PERIOD
                                                   -----------------------------------------------------------------------------
<S>                                                 <C>            <C>             <C>            <C>              <C>
Contractual Obligations                                Total         Less than One   1- 2 Years     3 - 5 Years     More than 5
                                                                        Year                                          Years
-------------------------------------------        -------------   -------------   -------------   -------------   -------------
Short- and long-term debt obligations                  $ 50,726       $       -        $ 50,726         $     -        $      -
Operating lease obligations                               1,696             467           1,064             165               -
Purchase obligations                                      3,248           3,248               -               -               -
Redemption of Converible Preferred Stock                  8,610           8,610               -               -               -
                                                   -------------   -------------   -------------   -------------   -------------
Total                                                  $ 64,280       $  12,325        $ 51,790         $   165        $      -
                                                   =============   =============   =============   =============   =============

</TABLE>



                                       21
<PAGE>


                     CAUTIONARY STATEMENTS AND RISK FACTORS

SEVERAL OF THE MATTERS DISCUSSED IN THIS REPORT CONTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. FACTORS ASSOCIATED WITH THE
FORWARD-LOOKING STATEMENTS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER FROM THOSE
PROJECTED OR FORECASTED IN THIS REPORT ARE INCLUDED IN THE STATEMENTS BELOW. IN
ADDITION TO OTHER INFORMATION CONTAINED IN THIS REPORT, YOU SHOULD CAREFULLY
CONSIDER THE FOLLOWING CAUTIONARY STATEMENTS AND RISK FACTORS. THE RISKS AND
UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY RISKS AND UNCERTAINTIES WE FACE.
ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE
CURRENTLY DEEM IMMATERIAL ALSO MAY IMPAIR OUR BUSINESS OPERATIONS. IF ANY OF THE
FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION, AND RESULTS
OF OPERATIONS COULD SUFFER. IN THAT EVENT, THE TRADING PRICE OF OUR COMMON STOCK
COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT IN OUR COMMON
STOCK. THE RISKS DISCUSSED BELOW ALSO INCLUDE FORWARD-LOOKING STATEMENTS AND OUR
ACTUAL RESULTS MAY DIFFER SUBSTANTIALLY FROM THOSE DISCUSSED IN THESE
FORWARD-LOOKING STATEMENTS.

                          RISKS RELATED TO OUR BUSINESS

WE MAY NEED TO RAISE ADDITIONAL DEBT OR EQUITY FINANCING TO EXECUTE OUR BUSINESS
PLAN.

At June 30, 2005, our principal sources of liquidity were cash and cash
equivalents of $3.1 million and $17.5 million remaining on a new $20.0 million
funding commitment made by Mr. Carl Berg, a director and principal stockholder,
on June 13, 2005. On June 30, 2005 we drew down $2.5 million on this commitment
in the form a bridge loan. On July 13, 2005 we secured a $20.0 million loan from
a third party finance company, the full amount of which has been drawn down.
Under the terms of the loan agreement, which is guaranteed by Mr. Berg, interest
will be payable monthly and the entire principal balance will be payable on July
12, 2010. The loan will bear interest at the greater of 6.75% or LIBOR plus
4.0%. We utilized $2.5 million to repay the June 30, 2005 draw from Mr. Berg. In
connection with the loan, we purchased a rate cap agreement to protect against
fluctuations in LIBOR for the full amount of the loan for three years.

At June 30, 2005, we had $4.3 million of Series C-1 Convertible Preferred Stock
and $4.3 million of Series C-2 Convertible Preferred Stock outstanding. The
Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred
Stock are convertible into common stock at $4.00 per share and are redeemable on
December 15, 2005 (subject to an early right of redemption in the case of the
Series C-2 Convertible Preferred Stock during the 30 days following September
15, 2005). Applicable provisions of Delaware corporate law restrict our ability
to redeem the preferred stock. If we do not redeem the shares of Series C-1 when
required by their terms, the conversion price will be reduced to an amount equal
to 95% of the lowest closing bid price of our common stock during the three days
ending on and including the conversion date. On July 11, 2005, Riverview Group
LLC, the holders of all of the Series C-2, exercised its optional right of
redemption on the $4.3 million of Series C-2 held by them. On July 14, 2005 we
assigned its rights to purchase the Series C-2 to Berg & Berg, LLC, an affiliate
of Carl Berg, who is a director and principal stockholder. Pursuant to the
assignment, Berg & Berg has agreed that our failure to redeem the stock on the
maturity date shall not constitute a default under the Series C-2 certificate of
designations and has waived the accrual of any default interest applicable in
such circumstance. Berg & Berg has also agreed that in the event we do not
redeem the shares of Series C-2 when required by their terms, the conversion
price will be the lower of $4.00 or the closing price of our common stock on the
conversion date, provided that the conversion price can be no lower than $2.96,
the closing bid price of our common stock on July 13, 2005.

Our current forecast assumes product sales for the second and third fiscal
quarters of 2006 of between $4.5 - $5.5 million. We also anticipates further
cash benefits from continued reductions in operating expenses and manufacturing
costs, offset by small increases to capital expenditures associated with
continuing efforts in China.

Our cash requirements may vary materially from those now planned because of
changes in our operations, including the failure to achieve expected revenues,
greater than expected expenses, changes in OEM relationships, market conditions,
the failure to timely realize our product development goals, and other adverse
developments. These events could have a negative impact on our available
liquidity sources during the next 12 months.



                                       22
<PAGE>

OUR LIMITED FINANCIAL RESOURCES COULD MATERIALLY AFFECT OUR BUSINESS, OUR
ABILITY TO COMMERCIALLY EXPLOIT OUR TECHNOLOGY AND OUR ABILITY TO RESPOND TO
UNANTICIPATED DEVELOPMENTS, AND COULD PLACE US AT A DISADVANTAGE TO OUR
COMPETITORS.

Currently, we do not have sufficient sales and gross profit to generate the cash
flows required to meet our operating and capital needs. As a consequence, one of
our primary objectives has been to reduce expenses and overhead thus limiting
the resources available for the development and commercialization of our
technology. Our limited financial resources could materially affect our ability,
and the pace at which we are able to commercially exploit our Saphion(R)
technology. For example, it could:

     o    limit the research and development resources we are able to commit to
          the further development of our technology and the development of
          products that can be commercially exploited in our marketplace;

     o    limit the sales and marketing resources that we are able to commit to
          the marketing of our technology;

     o    have an adverse impact on our ability to attract top-tier companies as
          our technology and marketing partners;

     o    have an adverse impact on our ability to employ and retain qualified
          employees with the skills and expertise necessary to implement our
          business plan;

     o    make us more vulnerable to failure to achieve our forecasted results,
          economic downturns, adverse industry conditions, and catastrophic
          external events;

     o    limit our ability to withstand competitive pressures and reduce our
          flexibility in planning for, or responding to, changing business and
          economic conditions; and

     o    place us at a competitive disadvantage to our competitors that have
          greater financial resources than we have.

WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT AND MAY NEVER ACHIEVE OR
SUSTAIN SIGNIFICANT REVENUES OR PROFITABILITY.

We have incurred operating losses each year since our inception in 1989 and had
an accumulated deficit of $469.5 million as of June 30, 2005. We have sustained
recurring losses related primarily to the research and development and marketing
of our products combined with the lack of sufficient sales to provide for these
needs. We anticipate that we will continue to incur operating losses and
negative cash flows during fiscal 2006. We may never achieve or sustain
sufficient revenues or profitability in the future.

IF WE CONTINUE TO EXPERIENCE SIGNIFICANT LOSSES WE MAY BE UNABLE TO MAINTAIN
SUFFICIENT LIQUIDITY TO PROVIDE FOR OUR OPERATING NEEDS.

We reported a net loss available to common stockholders of $8.196 million in the
three months ended June 30, 2005, a net loss available to common stockholders of
$32.2 million for the fiscal year ended March 31, 2005 and a net loss available
to common stockholders of $56.1 million for the fiscal year ended March 31,
2004. If we cannot achieve a competitive cost structure, achieve profitability
and access the capital markets on acceptable terms, we will be unable to fund
our obligations and sustain our operations.

OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE BEYOND THOSE CURRENTLY
ANTICIPATED.

We have planned for an increase in sales, and, if we experience sales in excess
of our plan, our working capital needs and capital expenditures would likely
increase from that currently anticipated. Our ability to meet this additional
customer demand would depend on our ability to arrange for additional equity or
debt financing since it is likely that cash flow from sales will lag behind
these increased working capital requirements.

OUR INDEBTEDNESS AND OTHER OBLIGATIONS ARE SUBSTANTIAL AND COULD MATERIALLY
AFFECT OUR BUSINESS AND OUR ABILITY TO INCUR ADDITIONAL DEBT TO FUND FUTURE
NEEDS.

We now have and will continue to have a significant amount of indebtedness and
other obligations. As of June 30, 2005, we had approximately $50.6 million of
total consolidated indebtedness and other obligations. On July 13, 2005 we
secured an additional 20.0 million loan with a third party finance company. Our
substantial indebtedness and other obligations could negatively impact our
operations in the future. For example, it could:


                                       23
<PAGE>


     o    limit our ability to obtain additional financing for working capital,
          capital expenditures, acquisitions and general corporate purposes;

     o    require us to dedicate a substantial portion of our cash flow from
          operations to the payment of principal of, and interest on, our
          indebtedness, thereby reducing the funds available to us for other
          purposes;

     o    make us more vulnerable to failure to achieve our forecasted results,
          economic downturns, adverse industry conditions or catastrophic
          external events, limit our ability to withstand competitive pressures
          and reduce our flexibility in planning for, or responding to, changing
          business and economic conditions; and

     o    place us at a competitive disadvantage to our competitors that have
          relatively less debt than we have.

ALL OF OUR ASSETS ARE PLEDGED AS COLLATERAL UNDER OUR LOAN AGREEMENTS. OUR
FAILURE TO MEET THE OBLIGATIONS UNDER OUR LOAN AGREEMENTS COULD RESULT IN
FORECLOSURE OF OUR ASSETS.

All of our assets are pledged as collateral under various loan agreements with
Mr. Carl Berg or related entities. If we fail to meet our obligations pursuant
to these loan agreements, Mr. Berg may declare all amounts borrowed from them to
be due and payable together with accrued and unpaid interest. If this were to
occur, we would not have the financial resources to repay our debt and these
lenders could proceed against our assets.

WE DEPEND ON A SMALL NUMBER OF CUSTOMERS FOR OUR REVENUES, AND OUR RESULTS OF
OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED IF WE WERE TO LOSE THE
BUSINESS OF ANY ONE OF THEM.

To date, our existing purchase orders in commercial quantities are from a
limited number of customers. During the first three months of fiscal 2006, one
customer, Segway, LLC, contributed approximately 31% of revenue while D&H
Distributors and PC Connection contributed approximately 17% and 14% of
revenue, respectively. We anticipate that sales of our products to a limited
number of key customers will continue to account for a significant portion of
our total revenues. We do not have long-term agreements with any of our
customers and do not expect to enter into any long-term agreements in the near
future. As a result, we face the substantial risk that one or more of the
following events could occur:

     o    reduction, delay or cancellation of orders from a customer;

     o    development by a customer of other sources of supply;

     o    selection by a customer of devices manufactured by one of our
          competitors for inclusion in future product generations ;

     o    loss of a customer or a disruption in our sales and distribution
          channels; or

     o    failure of a customer to make timely payment of our invoices.

If we were to lose one or more customers, or if we were to lose revenues due to
a customer's inability or refusal to continue to purchase our batteries, our
business, results of operations and financial condition could be harmed.

OUR BUSINESS WILL BE ADVERSELY AFFECTED IF OUR SAPHION(R) TECHNOLOGY BATTERIES
ARE NOT COMMERCIALLY ACCEPTED.

We are researching and developing batteries based upon phosphate chemistry. Our
batteries are designed and manufactured as components for other companies and
end-user customers. Our success depends on the acceptance of our batteries and
the products using our batteries in their markets. Technical issues may arise
that may affect the acceptance of our products by our customers. Market
acceptance may also depend on a variety of other factors including educating the
target market regarding the benefits of our products. Market acceptance and
market share are also affected by the timing of market introduction of
competitive products. If our customers or we are unable to gain any significant
market acceptance for Saphion(R) technology-based batteries, our business will
be adversely affected. It is too early to determine if Saphion(R)
technology-based batteries will achieve significant market acceptance.



                                       24
<PAGE>


IF WE ARE UNABLE TO DEVELOP, MANUFACTURE AND MARKET PRODUCTS THAT GAIN WIDE
CUSTOMER ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The process of developing our products is complex, and failure to anticipate
customers' changing needs and to develop products that receive widespread
customer acceptance could significantly harm our results of operations. We must
make long-term investments and commit significant resources before knowing
whether our predictions will eventually result in products that the market will
accept. After a product is developed, we must be able to manufacture sufficient
volumes quickly and at low costs. To accomplish this, we must accurately
forecast volumes, mix of products and configurations that meet customer
requirements, and we may not succeed.

IF OUR PRODUCTS FAIL TO PERFORM AS EXPECTED, WE COULD LOSE EXISTING AND FUTURE
BUSINESS, AND OUR ABILITY TO DEVELOP, MARKET AND SELL OUR BATTERIES COULD BE
HARMED.

If our products, when introduced, do not perform as expected, our reputation
could be severely damaged, and we could lose existing or potential future
business. This performance failure may have the long-term effect of harming our
ability to develop, market, and sell our products.

OUR FAILURE TO COST-EFFECTIVELY MANUFACTURE OUR TECHNOLOGICALLY COMPLEX
BATTERIES IN COMMERCIAL QUANTITIES WHICH SATISFY OUR CUSTOMERS' PRODUCT
SPECIFICATIONS AND THEIR EXPECTATIONS FOR PRODUCT QUALITY AND DELIVERY COULD
DAMAGE OUR CUSTOMER RELATIONSHIPS AND RESULT IN SIGNIFICANT LOST BUSINESS
OPPORTUNITIES FOR US.

To be successful, we must cost-effectively manufacture commercial quantities of
our technologically complex batteries that meet customer specifications for
quality and timely delivery. To facilitate commercialization of our products, we
will need to further reduce our manufacturing costs, which we intend to do
through the effective utilization of manufacturing partners and continuous
improvement of our manufacturing and development operations in our wholly-owned
subsidiaries in China. We currently manufacture our batteries and assemble our
products in China and Taiwan. We intend to transition additional operations to
Asia over the course of fiscal 2006. We are dependent on the performance of our
manufacturing partners as well as our own manufacturing operations to
manufacture and deliver our products to our customers. If any of our
manufacturing partners or our own manufacturing operations are unable to
manufacture products in commercial quantities on a timely and cost-effective
basis, we could lose customers and adversely impact our ability to attract
future customers.

IN ADDITION TO BEING USED IN OUR OWN PRODUCT LINES, OUR BATTERY CELLS ARE
INTENDED TO BE INCORPORATED INTO OTHER PRODUCTS. IF WE DO NOT FORM EFFECTIVE
ARRANGEMENTS WITH OEMS TO COMMERCIALIZE THESE PRODUCTS, OUR PROFITABILITY COULD
BE IMPAIRED.

Our business strategy contemplates that we will be required to rely on
assistance from OEMs to gain market acceptance for our products. We therefore
will need to identify acceptable OEMs and enter into agreements with them. Once
we identify acceptable OEMs and enter into agreements with them, we will need to
meet these companies' requirements by developing and introducing new products
and enhanced or modified versions of our existing products on a timely basis.
OEMs often require unique configurations or custom designs for batteries, which
must be developed and integrated into their product well before the product is
launched. This development process not only requires substantial lead-time
between the commencement of design efforts for a customized power system and the
commencement of volume shipments of the power systems to the customer, but also
requires the cooperation and assistance of the OEMs for purposes of determining
the requirements for each specific application. We may have technical issues
that arise that may affect the acceptance of our products by OEMs. If we are
unable to design, develop, and introduce products that meet OEMs' requirements,
we may lose opportunities to enter into additional purchase orders and our
reputation may be damaged. As a result, we may not receive adequate assistance
from OEMs or pack assemblers to successfully commercialize our products, which
could impair our profitability.

FAILURE TO IMPLEMENT AN EFFECTIVE LICENSING BUSINESS STRATEGY WILL ADVERSELY
AFFECT OUR REVENUE, CASH FLOW, AND PROFITABILITY.

Our long-term business strategy anticipates achieving significant revenue from
the licensing of our intellectual property assets, such as our Saphion(R)
technology. We have not entered into any licensing agreements for our Saphion(R)
technology. Our future operating results could be adversely affected by a
variety of factors including:

     o    our ability to secure and maintain significant licensees of our
          proprietary technology;

     o    the extent to which our future licensees successfully incorporate our
          technology into their products;

     o    the acceptance of new or enhanced versions of our technology;

     o    the rate at which our licensees manufacture and distribute their
          products to OEMs; and



                                       25
<PAGE>

     o    our ability to secure one-time license fees and ongoing royalties for
          our technology from licensees.

Our future success will also depend on our ability to execute our licensing
operations simultaneously with our other business activities. If we fail to
substantially expand our licensing activities while maintaining our other
business activities, our results of operations and financial condition will be
adversely affected.

THE FACT THAT WE DEPEND ON A SOLE SOURCE SUPPLIER OR A LIMITED NUMBER OF
SUPPLIERS FOR KEY RAW MATERIALS MAY DELAY OUR PRODUCTION OF BATTERIES.

We depend on a sole source supplier or a limited number of suppliers for certain
key raw materials used in manufacturing and developing our power systems. We
generally purchase raw materials pursuant to purchase orders placed from time to
time and have no long-term contracts or other guaranteed supply arrangements
with our sole or limited source suppliers. As a result, our suppliers may not be
able to meet our requirements relative to specifications and volumes for key raw
materials, and we may not be able to locate alternative sources of supply at an
acceptable cost. In the past, we have experienced delays in product development
due to the delivery of nonconforming raw materials from our suppliers. If in the
future we are unable to obtain high quality raw materials in sufficient
quantities on competitive pricing terms and on a timely basis, it may delay
battery production, impede our ability to fulfill existing or future purchase
orders and harm our reputation and profitability.

WE HAVE FIVE KEY EXECUTIVES, THE LOSS OF ANY OF WHICH COULD HARM OUR BUSINESS.

Without qualified executives, we face the risk that we will not be able to
effectively run our business on a day-to-day basis or execute our long-term
business plan. We do not have key man life insurance policies with respect to
any of our key members of management.

OUR ONGOING MANUFACTURING AND DEVELOPMENT OPERATIONS IN CHINA ARE COMPLEX AND
HAVING THESE REMOTE OPERATIONS MAY DIVERT MANAGEMENT ATTENTION, LEAD TO
DISRUPTIONS IN OPERATIONS AND DELAY IMPLEMENTATION OF OUR BUSINESS STRATEGY.

We have relocated most of our manufacturing and development operations to China,
which has been a time-consuming and complicated process. These facilities became
operational in late fiscal 2005. The relocation of our operations continues to
require physically moving and setting up operations as well as ensuring that we
have adequate staffing, including administrative and executive personnel.. We
may not be able to find suitable employees in China. If the labor pool does not
have adequate resources, we may have to train personnel to perform necessary
functions for our manufacturing and development operations. Additionally, some
of our key employees, including executives, may choose not to remain employed
with us after the relocation. The occurrence of any of the foregoing events
affecting or resulting from our move could harm our business.

WE EXPECT TO SELL A SIGNIFICANT PORTION OF OUR PRODUCTS TO AND DERIVE A
SIGNIFICANT PORTION OF OUR LICENSING REVENUES FROM CUSTOMERS LOCATED OUTSIDE THE
UNITED STATES. FOREIGN GOVERNMENT REGULATIONS, CURRENCY FLUCTUATIONS AND
INCREASED COSTS ASSOCIATED WITH INTERNATIONAL SALES COULD MAKE OUR PRODUCTS AND
LICENSES UNAFFORDABLE IN FOREIGN MARKETS, WHICH WOULD REDUCE OUR FUTURE
PROFITABILITY.

We expect that international sales of our products and licenses, as well as
licensing royalties, represent a significant portion of our sales potential.
International business can be subject to many inherent risks that are difficult
or impossible for us to predict or control, including:

     o    changes in foreign government regulations and technical standards,
          including additional regulation of rechargeable batteries, technology,
          or the transport of lithium and phosphate, which may reduce or
          eliminate our ability to sell or license in certain markets;

     o    impositions by foreign governments of tariffs, quotas, and taxes on
          our batteries or our import of technology into their countries;

     o    requirements or preferences of foreign nations for domestic products
          could reduce demand for our batteries and our technology;

     o    fluctuations in currency exchange rates relative to the U. S. dollar
          could make our batteries and our technology unaffordable to foreign
          purchasers and licensees or more expensive compared to those of
          foreign manufacturers and licensors;



                                       26
<PAGE>


     o    longer payment cycles typically associated with international sales
          and potential difficulties in collecting accounts receivable, which
          may reduce the future profitability of foreign sales and royalties;

     o    import and export licensing requirements in Europe and other regions,
          including China, where we intend to conduct business, which may reduce
          or eliminate our ability to sell or license in certain markets; and

     o    political and economic instability in countries, including China,
          where we intend to conduct business, which may reduce the demand for
          our batteries and our technology or our ability to market our
          batteries and our technology in those countries.

These risks may increase our costs of doing business internationally and reduce
our sales and royalties or future profitability.

WE MAY NEED TO EXPAND OUR EMPLOYEE BASE AND OPERATIONS IN ORDER TO EFFECTIVELY
DISTRIBUTE OUR PRODUCTS COMMERCIALLY, WHICH MAY STRAIN OUR MANAGEMENT AND
RESOURCES AND COULD HARM OUR BUSINESS.

To implement our growth strategy successfully, we will have to increase our
staff in China, with personnel in manufacturing, engineering, sales, marketing,
and product support capabilities, as well as third party and direct distribution
channels. However, we face the risk that we may not be able to attract new
employees to sufficiently increase our staff or product support capabilities, or
that we will not be successful in our sales and marketing efforts. Failure in
any of these areas could impair our ability to execute our plans for growth and
adversely affect our future profitability.

COMPETITION FOR PERSONNEL, IN PARTICULAR FOR PRODUCT RESEARCH AND DEVELOPMENT
PERSONNEL, IS INTENSE, AND WE MAY HAVE DIFFICULTY ATTRACTING THE PERSONNEL
NECESSARY TO EFFECTIVELY OPERATE OUR BUSINESS.

We believe that our future success will depend in large part on our ability to
attract and retain highly skilled technical, managerial, and marketing personnel
who are familiar with and experienced in the battery industry. If we cannot
attract and retain experienced sales and marketing executives, we may not
achieve the visibility in the marketplace that we need to obtain purchase
orders, which would have the result of lowering our sales and earnings. We
compete in the market for personnel against numerous companies, including
larger, more established competitors who have significantly greater financial
resources than we do. We cannot assure you that we will be successful in
attracting and retaining the skilled personnel necessary to operate our business
effectively in the future.

INTERNATIONAL POLITICAL EVENTS AND THE THREAT OF ONGOING TERRORIST ACTIVITIES
COULD INTERRUPT MANUFACTURING OF OUR BATTERIES AND OUR PRODUCTS AT OUR OEM
FACILITIES OR OUR OWN FACILITIES AND CAUSE US TO LOSE SALES AND MARKETING
OPPORTUNITIES.

The terrorist attacks that took place in the United States on September 11,
2001, along with the U.S. military campaigns against terrorism in Iraq,
Afghanistan, and elsewhere, and continued violence in the Middle East have
created many economic and political uncertainties, some of which may materially
harm our business and revenues. International political instability resulting
from these events could temporarily or permanently disrupt our manufacturing of
our batteries and products at our OEM facilities or our own facilities in Asia
and elsewhere, and have an immediate adverse impact on our business. Since
September 11, 2001, some economic commentators have indicated that spending on
capital equipment of the type that use our batteries has been weaker than
spending in the economy as a whole, and many of our customers are in industries
that also are viewed as under-performing the overall economy, such as the
telecommunications, industrial, and utility industries. The long-term effects of
these events on our customers, the market for our common stock, the markets for
our products, and the U.S. economy as a whole are uncertain. Terrorist
activities could temporarily or permanently interrupt our manufacturing,
development, sales and marketing activities anywhere in the world. Any delays
also could cause us to lose sales and marketing opportunities, as potential
customers would find other vendors to meet their needs. The consequences of any
additional terrorist attacks, or any expanded armed conflicts are unpredictable,
and we may not be able to foresee events that could have an adverse effect on
our markets or our business.

IF WE ARE SUED ON A PRODUCT LIABILITY CLAIM, OUR INSURANCE POLICIES MAY NOT BE
SUFFICIENT.

Although we maintain general liability insurance and product liability
insurance, our insurance may not cover all potential types of product liability
claims to which manufacturers are exposed or may not be adequate to indemnify us
for all liability that may be imposed. Any imposition of liability that is not
covered by insurance or is in excess of our insurance coverage could harm our
business.



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<PAGE>


OUR PATENT APPLICATIONS MAY NOT RESULT IN ISSUED PATENTS, WHICH WOULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR ABILITY TO COMMERCIALLY EXPLOIT OUR PRODUCTS.

Patent applications in the United States are maintained in secrecy until the
patents issue or are published. Since publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries by
several months, we cannot be certain that we are the first creator of inventions
covered by pending patent applications or the first to file patent applications
on these inventions. We also cannot be certain that our pending patent
applications will result in issued patents or that any of our issued patents
will afford protection against a competitor. In addition, patent applications
filed in foreign countries are subject to laws, rules and procedures that differ
from those of the United States, and thus we cannot be certain that foreign
patent applications related to issued U.S. patents will issue. Furthermore, if
these patent applications issue, some foreign countries provide significantly
less effective patent enforcement that the United States.

The status of patents involves complex legal and factual questions and the
breadth of claims allowed is uncertain. Accordingly, we cannot be certain that
the patent applications that we file will result in patents being issued, or
that our patents and any patents that may be issued to us in the near future
will afford protection against competitors with similar technology. In addition,
patents issued to us may be infringed upon or designed around by others and
others may obtain patents that we need to license or design around, either of
which would increase costs and may adversely affect our operations.

IF WE CANNOT PROTECT OR ENFORCE OUR EXISTING INTELLECTUAL PROPERTY RIGHTS OR IF
OUR PENDING PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, WE MAY LOSE THE
ADVANTAGE OF OUR RESEARCH AND MANUFACTURING ACTIVITIES.

Our ability to compete successfully will depend on whether we can protect our
existing proprietary technology and manufacturing processes. We rely on a
combination of patent and trade secret protection, non-disclosure agreements and
cross-licensing agreements. These measures may not be adequate to safeguard the
proprietary technology underlying our batteries. Employees, consultants, and
other who participate in the development of our products may breach their
non-disclosure agreements with us, and we may not have adequate remedies in the
event of their breaches. In addition, our competitors may be able to develop
products that are equal or superior to our products without infringing on any of
our intellectual property rights. We currently manufacture and export some of
our products from China. The legal regime protecting intellectual property
rights in China is weak. Because the Chinese legal system in general and the
intellectual property regime in particular, are relatively weak, it is often
difficult to enforce intellectual property rights in China. In addition, there
are other countries where effective copyright, trademark and trade secret
protection may be unavailable or limited. Accordingly, we may not be able to
effectively protect our intellectual property rights outside of the United
States.

We have established a program for intellectual property documentation and
protection in order to safeguard our technology base. We intend to vigorously
pursue enforcement and defense of our patents and our other proprietary rights.
We could incur significant expenses in preserving our proprietary rights, and
these costs could harm our financial condition. We also are attempting to expand
our intellectual property rights through our applications for new patents. We
cannot be certain that our pending patent applications will result in issued
patents or that our issued patents will afford us protection against a
competitor. Our inability to protect our existing proprietary technologies or to
develop new proprietary technologies may substantially impair our financial
condition and results of operations.

INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BROUGHT AGAINST US COULD BE
TIME-CONSUMING AND EXPENSIVE TO DEFEND, AND IF ANY OF OUR PRODUCTS OR PROCESSES
IS FOUND TO BE INFRINGING, WE MAY NOT BE ABLE TO PROCURE LICENSES TO USE PATENTS
NECESSARY TO OUR BUSINESS AT REASONABLE TERMS, IF AT ALL.

In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. While we currently are
not engaged in any intellectual property litigation or proceedings, we may
become involved in these proceedings in the future. In the future we may be
subject to claims or inquiries regarding our alleged unauthorized use of a third
party's intellectual property. An adverse outcome in litigation could force us
to do one or more of the following:

     o    stop selling, incorporating, or using our products that use the
          challenged intellectual property;

     o    pay significant damages to third parties;

     o    obtain from the owner of the infringed intellectual property right a
          license to sell or use the relevant technology, which license may not
          be available on reasonable terms, or at all; or

     o    redesign those products or manufacturing processes that use the
          infringed technology, which may not be economically or technologically
          feasible.



                                       28
<PAGE>


Whether or not an intellectual property litigation claim is valid, the cost of
responding to it, in terms of legal fees and expenses and the diversion of
management resources, could be expensive and harm our business.

IN THE PAST WE HAVE SOLD OXIDE-BASED BATTERIES CONTAINING POTENTIALLY DANGEROUS
MATERIALS, WHICH COULD EXPOSE US TO PRODUCT LIABILITY CLAIMS.

In the event of a short circuit or other physical damage to an oxide-based
battery, a reaction may result with excess heat or a gas being generated and
released. If the heat or gas is not properly released, the battery may be
flammable or potentially explosive. We could, therefore, be exposed to possible
product liability litigation. In addition, our batteries incorporate potentially
dangerous materials, including lithium. It is possible that these materials may
require special handling or those safety problems may develop in the future. If
the amounts of active materials in our batteries are not properly balanced and
if the charge/discharge system is not properly managed, a dangerous situation
may result. Battery pack assemblers using batteries incorporating technology
similar to ours include special safety circuitry within the battery to prevent
such a dangerous condition. We expect that our customers will have to use a
similar type of circuitry in connection with their use of our oxide-based
products.

                  RISKS ASSOCIATED WITH DOING BUSINESS IN CHINA

SINCE OUR PRODUCTS ARE MANUFACTURED IN CHINA AND WE INTEND TO TRANSFER
ADDITIONAL OPERATIONS TO CHINA, WE FACE RISKS IF CHINA LOSES NORMAL TRADE
RELATIONS WITH THE UNITED STATES.

We manufacture and export products from China. Our products sold in the United
States are currently not subject to U.S. import duties. On September 19, 2000,
the U.S. Senate voted to permanently normalize trade with China, which provides
a favorable category of U.S. import duties. In addition, on December 11, 2001,
China was accepted into the World Trade Organization (WTO), a global
international organization that regulates international trade. As a result of
opposition to certain policies of the Chinese government and China's growing
trade surpluses with the United States, there has been, and in the future may
be, opposition to the extension of Normal Trade Relations, or NTR, status for
China. The loss of NTR status for China, changes in current tariff structures or
adoption in the United States of other trade policies adverse to China could
have an adverse effect on our business.

Furthermore, our business may be adversely affected by the diplomatic and
political relationships between the United States and China. These influences
may adversely affect our ability to operate in China. If the relationship
between the United States and China were to materially deteriorate, it could
negatively impact our ability to control our operations and relationships in
China, enforce any agreements we have with Chinese manufacturers or otherwise
deal with any assets or investments we may have in China.

BECAUSE THE CHINESE LEGAL SYSTEM IN GENERAL AND THE INTELLECTUAL PROPERTY REGIME
IN PARTICULAR, ARE RELATIVELY WEAK, WE MAY NOT BE ABLE TO ENFORCE INTELLECTUAL
PROPERTY RIGHTS IN CHINA AND ELSEWHERE.

We currently manufacture and export our products from China. The legal regime
protecting intellectual property right in China is weak. Because the Chinese
legal system in general and the intellectual property regime in particular, are
relatively weak, it is often difficult to enforce intellectual property rights
in China. In addition, there are other countries where effective copyright,
trademark and trade secret protection may be unavailable or limited.
Accordingly, we may not be able to effectively protect our intellectual property
rights outside of the United States.

ENFORCING AGREEMENTS AND LAWS IN CHINA IS DIFFICULT OR MAY BE IMPOSSIBLE AS
CHINA DOES NOT HAVE A COMPREHENSIVE SYSTEM OF LAWS.

We are dependent on our agreements with our Chinese manufacturing partners.
Enforcement of agreements may be sporadic and implementation and interpretation
of laws may be inconsistent. The Chinese judiciary is relatively inexperienced
in interpreting agreements and enforcing the laws, leading to a higher than
usual degree of uncertainty as to the outcome of any litigation. Even where
adequate law exists in China, it may be impossible to obtain swift and equitable
enforcement of the law, or to obtain enforcement of a judgment by a court of
another jurisdiction.

THE GOVERNMENT OF CHINA MAY CHANGE OR EVEN REVERSE ITS POLICIES OF PROMOTING
PRIVATE INDUSTRY AND FOREIGN INVESTMENT, IN WHICH CASE OUR ASSETS AND OPERATIONS
MAY BE AT RISK.


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<PAGE>


China is a socialist state, which since 1949 has been, and is expected to
continue to be, controlled by the Communist Party of China. Our existing and
planned operations in China are subject to the general risks of doing business
internationally and the specific risks related to the business, economic and
political conditions in China, which include the possibility that the central
government of China will change or even reverse its policies of promoting
private industry and foreign investment in China. Many of the current reforms
which support private business in China are unprecedented or experimental. Other
political, economic and social factors, such as political changes, changes in
the rates of economic growth, unemployment or inflation, or the disparities of
per capita wealth among citizens of China and between regions within China,
could also lead to further readjustment of the government's reform measures. It
is not possible to predict whether the Chinese government will continue to be as
supportive of private business in China, nor is it possible to predict how
future reforms will affect our business.

THE GOVERNMENT OF CHINA CONTINUES TO EXERCISE SUBSTANTIAL CONTROL OVER THE
CHINESE ECONOMY WHICH COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS.

The government of China has exercised and continues to exercise substantial
control over virtually every section of the Chinese economy through regulation
and state ownership. China's continued commitment to reform and the development
of a vital private sector in that country have, to some extent, limited the
practical effects of the control currently exercised by the government over
individual enterprises. However, the economy continues to be subject to
significant government controls which, if directed towards our business
activities, could have a significant adverse impact on us. For example, if the
government were to limit the number of foreign personnel who could work in the
country, or substantially increase taxes on foreign businesses or were to impose
any number of other possible types of limitations on our operations, the impact
would be significant.

CHANGES IN CHINA'S POLITICAL AND ECONOMIC POLICIES COULD HARM OUR BUSINESS.

The economy of China has historically been a planned economy subject to
governmental plans and quotas and has, in certain aspects, been transitioning to
a more market-oriented economy. Although we believe that the economic reform and
the macroeconomic measures adopted by the Chinese government have had a positive
effect on the economic development of China, we cannot predict the future
direction of these economic reforms or the effect these measures may have on our
business, financial position or results of operations. In addition, the Chinese
economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD. These
differences include:

     o    economic structure;

     o    level of government involvement in the economy;

     o    level of development;

     o    level of capital reinvestment;

     o    control of foreign exchange;

     o    currency valuation;

     o    methods of allocating resources; and

     o    balance of payments position.

As a result of these differences, our operations, including our current
manufacturing operations in China, may not develop in the same way or at the
same rate as might be expected if the Chinese economy were similar to the OECD
member countries.

BUSINESS PRACTICES IN CHINA MAY ENTAIL GREATER RISK AND DEPENDENCE UPON THE
PERSONAL RELATIONSHIPS OF SENIOR MANAGEMENT THAN IS COMMON IN NORTH AMERICA AND
THEREFORE SOME OF OUR AGREEMENTS WITH OTHER PARTIES IN CHINA COULD BE DIFFICULT
OR IMPOSSIBLE TO ENFORCE.

The business culture of China is, in some respects, different from the business
culture in Western countries and may present some difficulty for Western
investors reviewing contractual relationships among companies in China and
evaluating the merits of an investment. Personal relationships among business
principals of companies and business entities in China are very significant in
the business culture. In some cases, because so much reliance is based upon
personal relationships, written contracts among businesses in China may be less
detailed and specific than is commonly accepted for similar written agreements
in Western countries. In some cases, material terms of an understanding are not
contained in the written agreement but exist as oral agreements only. In other
cases, the terms of transactions which may involve material amounts of


                                       30
<PAGE>


money are not documented at all. In addition, in contrast to Western business
practices where a written agreement specifically defines the terms, rights and
obligations of the parties in a legally-binding and enforceable manner, the
parties to a written agreement in China may view that agreement more as a
starting point for an ongoing business relationship which will evolve and
require ongoing modification. As a result, written agreements in China may
appear to the Western reader to look more like outline agreements that precede a
formal written agreement. While these documents may appear incomplete or
unenforceable to a Western reader, the parties to the agreement in China may
feel that they have a more complete understanding than is apparent to someone
who is only reading the written agreement without having attended the
negotiations. As a result, contractual arrangements in China may be more
difficult to review and understand. Also, despite legal developments in China
over the past 20 years, adequate laws, comparable with Western standards, do not
exist in all areas and it is unclear how many of our business arrangements would
be interpreted or enforced by a court in China.

OUR OPERATIONS COULD BE MATERIALLY INTERRUPTED, AND WE MAY SUFFER A LARGE AMOUNT
OF LOSS, IN THE CASE OF FIRE, CASUALTY OR THEFT AT ONE OF OUR MANUFACTURING OR
OTHER FACILITIES.

Firefighting and disaster relief or assistance in China is substandard by
Western standards. Consistent with the common practice in China for companies of
our size and or the size of our business partners in China, neither we nor they,
to our knowledge, maintain fire, casualty, theft insurance or business
interruption insurance. In the event of any material damage to, or loss of, the
manufacturing plants where our products are or will be produced due to fire,
casualty, theft, severe weather, flood or other similar causes, we would be
forced to replace any assets lost in those disasters without the benefit of
insurance. Thus our financial position could be materially compromised or we
might have to cease doing business. Also, consistent with customary business
practices in China, we do not carry business interruption insurance.

THE SYSTEM OF TAXATION IN CHINA IS UNCERTAIN AND SUBJECT TO UNPREDICTABLE CHANGE
THAT COULD AFFECT OUR PROFITABILITY.

Many tax rules are not published in China and those that are published can be
ambiguous and contradictory, leaving a considerable amount of discretion to
local tax authorities. China currently offers tax and other preferential
incentives to encourage foreign investment. However, the country's tax regime is
undergoing review and we cannot assure you that such tax and other incentives
will continue to be made available. Currently, China levies a 10% withholding
tax on dividends received from Chinese-foreign joint ventures. If we enter into
a joint venture with a Chinese company as part of our strategy to reduce costs,
the joint venture may be considered a Chinese-foreign joint venture if the
majority of its equity interests are owned by a foreign shareholder. A temporary
exemption from this withholding tax has been granted to foreign investors.
However, there is no indication when this exemption will end.

IT IS UNCERTAIN WHETHER WE WILL BE ABLE TO RECOVER VALUE ADDED TAXES IMPOSED BY
THE CHINESE TAXING AUTHORITIES.

China's turnover tax system consists of value-added tax, consumption tax and
business tax. Export sales are exempted under VAT rules and an exporter who
incurs Value Added Tax (VAT) on purchase or manufacture of goods should be able
to claim a refund from Chinese tax authorities. However, due to a reduction in
the VAT export refund rate of some goods, exporters might bear part of the VAT
they incurred in conjunction with the exported goods. In 2003, changes to the
Chinese VAT system were announced affecting the recoverability of input VAT
beginning January 1, 2004. Our VAT expense will depend on the reaction of both
our suppliers and customers. Continued efforts by the Chinese government to
increase tax revenues could result in the revisions to tax laws or their
interpretation, which could increase our VAT and various tax liabilities.

ANY RECURRENCE OF SEVERE ACUTE RESPIRATORY SYNDROME, OR SARS, AVIARY FLU, OR
ANOTHER WIDESPREAD PUBLIC HEALTH PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS
AND RESULTS OF OPERATIONS.

A renewed outbreak of SARS, aviary flu, or another widespread public health
problem in China, where we have moved our manufacturing operations and may move
additional operations, could have a negative effect on our operations. Our
operations may be impacted by a number of health-related factors, including the
following:

     o    quarantines or closures of some of our manufacturing or other
          facilities which would severely disrupt our operations, or

     o    the sickness or death of key officers or employees of our
          manufacturing or other facilities.

Any of the foregoing events or other unforeseen consequences of public health
problems in China could adversely affect our business and results of operations.



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<PAGE>


OUR PRODUCTION AND SHIPPING CAPABILITIES COULD BE ADVERSELY AFFECTED BY ONGOING
TENSIONS BETWEEN THE CHINESE AND TAIWANESE GOVERNMENTS.

Key components of our products are manufactured in China and assembled in Taiwan
into end products or systems. In the event that Taiwan does not adopt a plan for
unifying with China, the Chinese government has threatened military action
against Taiwan. As of yet, Taiwan has not indicated that it intends to propose
or adopt a reunification plan. If an invasion by China were to occur, the
ability of our manufacturing and assembly partners could be adversely affected,
potentially limiting our production capabilities. An invasion could also lead to
sanctions or military action by the United States and/or European countries,
which could further adversely affect our business.

                       RISKS ASSOCIATED WITH OUR INDUSTRY

IF COMPETING TECHNOLOGIES THAT OUTPERFORM OUR BATTERIES WERE DEVELOPED AND
SUCCESSFULLY INTRODUCED, THEN OUR PRODUCTS MIGHT NOT BE ABLE TO COMPETE
EFFECTIVELY IN OUR TARGETED MARKET SEGMENTS.

Rapid and ongoing changes in technology and product standards could quickly
render our products less competitive or obsolete. Other companies who are
seeking to enhance traditional battery technologies, such as lead acid and
nickel cadmium, have recently introduced or are developing batteries based on
nickel metal-hydride, liquid lithium-ion and other emerging and potential
technologies. These competitors are engaged in significant development work on
these various battery systems, and we believe that much of this effort is
focused on achieving higher energy densities for low power applications such as
portable electronics. One or more new, higher energy rechargeable battery
technologies could be introduced which could be more directly competitive with,
or superior to, our technology. The capabilities of many of these competing
technologies have improved over the past several years. Competing technologies
that outperform our batteries could be developed and successfully introduced,
and as a result, there is a risk that our products may not be able to compete
effectively in our targeted market segments.

We have invested in research and development of next-generation technology in
energy solutions. If we are not successful in developing and commercially
exploiting new energy solutions based on new materials, or we experience delays
in the development and exploitation of new energy solutions, compared to our
competitors, our future growth and revenues will be adversely affected.

OUR PRINCIPAL COMPETITORS HAVE GREATER FINANCIAL AND MARKETING RESOURCES THAN WE
DO AND THEY MAY THEREFORE DEVELOP BATTERIES SIMILAR OR SUPERIOR TO OURS OR
OTHERWISE COMPETE MORE SUCCESSFULLY THAN WE DO.

Competition in the rechargeable battery industry is intense. The industry
consists of major domestic and international companies, most of which have
financial, technical, marketing, sales, manufacturing, distribution and other
resources substantially greater than ours. There is a risk that other companies
may develop batteries similar or superior to ours. In addition, many of these
companies have name recognition, established positions in the market, and
long-standing relationships with OEMs and other customers. We believe that our
primary competitors are existing suppliers of cylindrical lithium-ion, nickel
cadmium, nickel metal-hydride and in some cases, non-SLI lead-acid batteries.
These suppliers include Sanyo, Matsushita Industrial Co., Ltd. (Panasonic),
Sony, Toshiba, SAFT E-One Moli Energy as well as the numerous lead-acid
manufacturers throughout the world. Most of these companies are very large and
have substantial resources and market presence. We expect that we will compete
against manufacturers of other types of batteries in our targeted application
segments. There is also a risk that we may not be able to compete successfully
against manufacturers of other types of batteries in any of our targeted
applications.

LAWS REGULATING THE MANUFACTURE OR TRANSPORTATION OF BATTERIES MAY BE ENACTED
WHICH COULD RESULT IN A DELAY IN THE PRODUCTION OF OUR BATTERIES OR THE
IMPOSITION OF ADDITIONAL COSTS THAT COULD HARM OUR ABILITY TO BE PROFITABLE.

At the present time, international, federal, state, and local laws do not
directly regulate the storage, use, and disposal of the component parts of our
batteries. However, laws and regulations may be enacted in the future, which
could impose environmental, health and safety controls on the storage, use, and
disposal of certain chemicals and metals used in the manufacture of lithium
polymer batteries. Satisfying any future laws or regulations could require
significant time and resources from our technical staff and possible redesign
which may result in substantial expenditures and delays in the production of our
product, all of which could harm our business and reduce our future
profitability. The transportation of lithium and lithium-ion batteries is
regulated both internationally and domestically. Under the recently revised
United Nations recommendations and as adopted by the International Air Transport
Association (IATA), our N-Charge(TM) Power System (Model VNC-65) and
N-Charge(TM) Power System II are exempt from a Class 9 designation for
transportation, while our N-Charge(TM) Power System (Model VNC-130), our
K-Charge(TM) Power System, and U-Charge(TM) Power System currently fall within
the level such that they are not exempt and require a Class 9 designation for
transportation. The revised United


                                       32
<PAGE>


Nations recommendations are not U.S. law until such time as they are
incorporated into the Department of Transportation (DOT) Hazardous Material
Regulations. However, DOT has proposed new regulations harmonizing with the U.N.
guidelines. At present it is not known if or when the proposed regulations would
be adopted by the United States. While we fall under the equivalency levels for
the United States and comply with all safety packaging requirements worldwide,
future DOT or IATA regulations or enforcement policies could impose costly
transportation requirements. In addition, compliance with any new DOT or IATA
approval process could require significant time and resources from our technical
staff and, if redesign were necessary, could delay the introduction of new
products.

                  GENERAL RISKS ASSOCIATED WITH STOCK OWNERSHIP

CORPORATE INSIDERS OR THEIR AFFILIATES WILL BE ABLE TO EXERCISE SIGNIFICANT
CONTROL OVER MATTERS REQUIRING STOCKHOLDER APPROVAL THAT MIGHT NOT BE IN THE
BEST INTERESTS OF OUR STOCKHOLDERS AS A WHOLE.

As of July 29, 2005, our officers, directors and their affiliates as a group
beneficially owned approximately 40.3% of our outstanding common stock. Carl
Berg, one of our directors, beneficially owns approximately 42.9% of our
outstanding common stock. As a result, these stockholders will be able to
exercise significant control over all matters requiring stockholder approval,
including the election of directors and the approval of significant corporate
transactions, which could delay or prevent someone from acquiring or merging
with us. The interest of our officers and directors, when acting in their
capacity as stockholders, may lead them to:

     o    vote for election of directors who agree with the incumbent officers'
          or directors' preferred corporate policy; or

     o    oppose or support significant corporate transactions when these
          transactions further their interests as incumbent officers or
          directors, even if these interests diverge from their interests as
          stockholders per se and thus from the interests of other stockholders.

SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE MARKET PRICE OF OUR STOCK AND LIMIT THE PRICE THAT
POTENTIAL ACQUIRERS MAY BE WILLING TO PAY FOR OUR COMMON STOCK.

Our board of directors has the authority, without any action by the outside
stockholders, to issue additional shares of our preferred stock, which shares
may be given superior voting, liquidation, distribution and other rights as
compared to those of our common stock. The rights of the holders of our capital
stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
additional shares of preferred stock could have the effect of making it more
difficult for a third party to acquire a majority of our outstanding voting
stock. These provisions may have the effect of delaying, deferring or preventing
a change in control, may discourage bids for our common stock at a premium over
its market price, may decrease the market price, and may infringe upon the
voting and other rights of the holders of our common stock.

AT ANY GIVEN TIME WE MIGHT NOT MEET THE CONTINUED LISTING REQUIREMENTS OF THE
NASDAQ SMALLCAP MARKET.

Given the volatility of our stock and trends in the stock market in general, at
any given time we might not meet the continued listing requirements of The
Nasdaq SmallCap Market. Among other requirements, Nasdaq requires the minimum
bid price of a company's registered shares to be $1.00. On July 29, 2005, the
closing price of our common stock was $3.11. If we are not able to maintain the
requirements for continued listing on The Nasdaq SmallCap Market, it could have
a materially adverse effect on the price and liquidity of our common stock.

OUR STOCK PRICE IS VOLATILE, WHICH COULD RESULT IN A LOSS OF YOUR INVESTMENT.

The market price of our common stock has been and is likely to continue to be
highly volatile. Factors that may have a significant effect on the market price
of our common stock include the following:

     o    fluctuation in our operating results;

     o    announcements of technological innovations or new commercial products
          by us or our competitors;

     o    failure to achieve operating results projected by securities analysts;

     o    governmental regulation;

     o    developments in our patent or other proprietary rights or our
          competitors' developments



                                       33
<PAGE>



     o    our relationships with current or future collaborative partners; and

     o    other factors and events beyond our control.

In addition, the stock market in general has experienced extreme volatility that
often has been unrelated to the operating performance of particular companies.
These broad market and industry fluctuations may adversely affect the trading
price of our common stock, regardless of our actual operating performance.

As a result of this potential stock price volatility, investors may be unable to
sell their shares of our common stock at or above the cost of their purchase
prices. In addition, companies that have experienced volatility in the market
price of their stock have been the object of securities class action litigation.
If we were the subject of securities class action litigation, this could result
in substantial costs, a diversion of our management's attention and resources
and harm to our business and financial condition.

FUTURE SALES OF CURRENTLY OUTSTANDING SHARES COULD ADVERSELY AFFECT OUR STOCK
PRICE.

The market price of our common stock could drop as a result of sales of a large
number of shares in the market or in response to the perception that these sales
could occur. In addition, these sales might make it more difficult for us to
sell equity or equity-related securities in the future at a time and price that
we deem appropriate. We had outstanding 89,448,306 shares of common stock as of
June 30, 2005. In addition, at June 30, 2005, we had 12,941,113 shares of our
common stock reserved for issuance under warrants and stock option plans. In
connection with the potential conversion of the Series C-1 Convertible Preferred
Stock and Series C-2 Convertible Preferred Stock issued on December 1, 2004, we
expect that we may need to issue up to 2,152,500 shares of our common stock
(based on a conversion price of $4.00).

WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK, AND THEREFORE
STOCKHOLDERS WILL BE ABLE TO RECOVER THEIR INVESTMENT IN OUR COMMON STOCK, IF AT
ALL, ONLY BY SELLING THE SHARES OF OUR STOCK THAT THEY HOLD.

Some investors favor companies that pay dividends on common stock. We have never
declared or paid any cash dividends on our common stock. We currently intend to
retain any future earnings for funding growth and we do not anticipate paying
cash dividends on our common stock in the foreseeable future. Because we may not
pay dividends, a return on an investment in our stock likely depends on the
ability to sell our stock at a profit.

OUR BUSINESS IS SUBJECT TO CHANGING REGULATIONS RELATING TO CORPORATE GOVERNANCE
AND PUBLIC DISCLOSURE THAT HAS INCREASED BOTH OUR COSTS AND THE RISK OF
NONCOMPLIANCE.

Because our common stock is publicly traded, we are subject to certain rules and
regulations of federal, state and financial market exchange entities charged
with the protection of investors and the oversight of companies whose securities
are publicly traded. These entities, including the Public Company Accounting
Oversight Board, the Commission, and Nasdaq, have recently issued new
requirements and regulations and continue to develop additional regulations and
requirements in response to recent laws enacted by Congress, most notably
Section 404 of the Sarbanes-Oxley Act of 2002. Our efforts to comply with these
new regulations have resulted in, and are likely to continue to result in,
materially increased general and administrative expenses and a significant
diversion of management time and attention from revenue-generating and cost
reduction activities to compliance activities.

In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act
of 2002 and the related regulations regarding our required assessment of our
internal controls over financial reporting and our registered independent public
accounting firm's audit of that assessment has required, and continues to
require, the commitment of significant financial and managerial resources.
Although we believe that the ongoing review of our internal controls will enable
us to provide an assessment of our internal controls and our registered
independent public accounting firm to provide its audit opinion as of March 31,
2006 as required by Section 404 of the Sarbanes-Oxley Act of 2002, we cannot
assure you that these efforts will be completed on a timely and successful
basis.

Because these laws, regulations, and standards are subject to varying
interpretations, their application in practice may evolve over time as new
guidance becomes available. This evolution may result in continuing uncertainty
regarding compliance matters and additional costs necessitated by ongoing
revisions to our disclosure and governance practices.

In the event that our chief Executive Officer, Vice President of Finance, or
registered independent public accounting firm determine that our internal
controls over financial reporting are not effective as defined under Section 404
of the Sarbanes-


                                       34
<PAGE>


Oxley Act of 2002, there may be a material adverse impact in investor
perceptions and a decline in the market price of our stock.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We considered the provisions of Financial Reporting Release No. 48, "Disclosures
of Accounting Policies for Derivative Financial Instruments and Derivative
Commodity Instruments, and Disclosures of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Commodity Instruments." We
had no holdings of derivative financial or commodity instruments at June 30,
2005. However, we are exposed to financial market risks, including changes in
foreign currency exchange rates and interest rates.

We also have long-term debt in the form of two loans, which mature in September
2008, to a stockholder. The first loan has an adjustable rate of interest at 1%
above the lender's borrowing rate (9% at June 30, 2005) and the second loan has
a fixed interest rate of 8%. Each 0.25% increase in interest on the adjustable
rate loan would increase our annual interest expense by approximately $37,000.
The table below presents principal amounts by fiscal year for our long-term
debt:


<TABLE>
<CAPTION>
<S>                           <C>      <C>       <C>       <C>       <C>       <C>            <C>
                                2006     2007      2008      2009      2010     Thereafter      Total
                              -------- --------  -------  --------  ---------  -----------    ----------
                                                        (Dollars in thousands)
Liabilities
Fixed rate debt:               $    -    $20,000       -         -         -            -      $ 20,000
Variable rate debt:            $    -     14,950       -         -         -            -      $ 14,950
Bridge Loan                    $ 2,500                 -         -         -            -      $  2,500


</TABLE>


Based on borrowing rates currently available to us for loans with similar terms,
the carrying value of our debt obligations approximates fair value.

ITEM 4. CONTROLS AND PROCEDURES

We conducted an evaluation, under the supervision and with the participation of
our Principal Executive Officer and Principal Financial Officer, of the
effectiveness of our disclosures controls and procedures as of the end of the
first quarter of fiscal 2006. Based on this evaluation, our Principal Executive
Officer and Principal Financial Officer concluded that our disclosure controls
and procedures are effective in timely alerting them to material information
required to be included in our periodic reports with the Commission.

In accordance with the Commission's requirements, our Principal Executive
Officer and Principal Financial Officer note that there were no significant
changes in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.

During the last fiscal quarter, there have been no changes in our internal
control over financial reporting that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.

Our management, including our Principal Executive Officer and Principal
Financial Officer, does not expect that our disclosure controls or our internal
controls will prevent all error and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within our systems have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple errors or mistakes. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected.


                                       35
<PAGE>



                           PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to various claims and litigation in the normal course of
business. Any contingent liabilities are recorded on a gross basis if probable
and estimable. In our opinion, all pending legal matters are either covered by
insurance, or, if not insured, will not have a material adverse impact on our
condensed consolidated financial statements.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None, other than as previously reported in Current Reports on Form 8-K filed by
us with the Commission.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

EXHIBIT NO.

<TABLE>
<CAPTION>

<S>        <C>
4.1        Option Agreement, dated as of July 13, 2005, by and between Valence Technology, Inc. and
           James R. Akridge.

10.1       Letter Agreement, dated August 8, 2005, by and between Valence Technology, Inc. and Berg &
           Berg Enterprises, LLC.

31.1       Certification of James R. Akridge, Principal Executive Officer, pursuant to Rule 13a-14
           and 15d-14 of the Securities Exchange Act of 1934.

31.2       Certification of Kevin W. Mischnick, Principal Financial Officer, pursuant to Rule 13a-14
           and 15d-14 of the Securities Exchange Act of 1934

32.1       Certification of James R. Akridge, Principal Financial 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 Kevin W. Mischnick, Principal Financial Officer, pursuant to 18 U.S.C.
           Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
</TABLE>


                                       36
<PAGE>

                                    SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.

                             VALENCE TECHNOLOGY, INC.



Date: August 9, 2005         By:   /s/ James R. Akridge
                                   ---------------------------------------------
                                   James R. Akridge
                                   Chief Executive Officer (Principal Executive
                                   Officer)



                             By:   /s/ Kevin W. Mischnick
                                   ---------------------------------------------
                                   Kevin W. Mischnick
                                   Vice President of Finance and Assistant
                                   Secretary (Principal Financial and
                                   Accounting Officer)


                                       37
<PAGE>


<TABLE>
<CAPTION>
EXHIBIT INDEX

EXHIBIT NO.

<C>       <C>
4.1       Option Agreement, dated as of July 13, 2005, by and between Valence Technology, Inc. and
          James R. Akridge.

10.1      Letter Agreement, dated August 8, 2005, by and between Valence Technology, Inc. and Berg &
          Berg Enterprises, LLC.

31.1      Certification of James R. Akridge, Principal Executive Officer, pursuant to Rule 13a-14
          and 15d-14 of the Securities Exchange Act of 1934.

31.2      Certification of Kevin W. Mischnick, Principal Financial Officer, pursuant to Rule 13a-14
          and 15d-14 of the Securities Exchange Act of 1934

32.1      Certification of James R. Akridge, Principal Financial 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 Kevin W. Mischnick, Principal Financial Officer, pursuant to 18 U.S.C.
          Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

</TABLE>


                                       38