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 December 31, 2006.

                                       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.)


           12201 TECHNOLOGY BOULEVARD, SUITE 150,
                       AUSTIN, TEXAS                           78727
         (Address of Principal Executive Offices)            (Zip Code)

                                 (512) 527-2900
              (Registrant's Telephone Number, Including Area Code)

Former Name, Former Address and Former Fiscal year, if Changed Since Last Report

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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):

Large accelerated filer  [X]  Accelerated filer  [ ]  Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).

                                 Yes [ ] No [X]

     Common Stock, $0.001 par value                      104,347,897
              (Class)                         (Outstanding at February 2, 2007)


<PAGE>

                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES


                                    FORM 10-Q

                     FOR THE QUARTER ENDED DECEMBER 31, 2006



<TABLE>
<CAPTION>
<S>           <C>                                                                                               <C>
                                              INDEX

                                                                                                                 PAGES

PART I.       FINANCIAL INFORMATION

     Item 1.  Financial Statements (Unaudited):

              Condensed Consolidated Balance Sheets as of

              December 31, 2006 and March 31, 2006................................................................1

              Condensed Consolidated Statements of Operations and
              Comprehensive Loss for Each of the Three- and Nine- Month Periods
              Ended December 31, 2006 and December 31, 2005.......................................................2

              Condensed Consolidated Statements of Cash Flows for
              the Nine- Month Periods Ended
              December 31, 2006 and December 31, 2005.............................................................3

              Notes to Condensed Consolidated Financial Statements................................................4

     Item 2.  Management's Discussion and Analysis of Financial
              Condition and Results of Operations................................................................17

     Item 3.  Quantitative and Qualitative Disclosures about Market Risk.........................................37

     Item 4.  Controls and Procedures............................................................................38


PART II.      OTHER INFORMATION

     Item 1.  Legal Proceedings..................................................................................39

     Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds........................................39

     Item 3.  Defaults upon Senior Securities....................................................................39

     Item 4.  Submission of Matters to a Vote of Security Holders................................................39

     Item 5.  Other Information..................................................................................39

     Item 6.  Exhibits ..........................................................................................39

SIGNATURE     ...................................................................................................41

</TABLE>

                                       i
<PAGE>


                         PART I - FINANCIAL INFORMATION

ITEM 1.         FINANCIAL STATEMENTS (UNAUDITED)

                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                               December 31, 2006             March 31, 2006
                                                                          ---------------------------    ----------------------
<S>                                                                          <C>                        <C>
Assets
Current assets:
   Cash and cash equivalents                                                          $       1,880              $        612
   Trade receivables, net of allowance of $113 and $99, respectively                          2,261                     2,376
   Inventory                                                                                  8,399                     2,738
   Prepaid and other current assets                                                           2,123                     2,566
                                                                          ---------------------------    ----------------------
Total current assets                                                                         14,663                     8,292
Property, plant and equipment, net                                                            3,449                     3,052
Intellectual property, net                                                                      200                       288
                                                                          ---------------------------    ----------------------
Total assets                                                                          $      18,312              $     11,632
                                                                          ===========================    ======================

Liabilities and Stockholders' Deficit
Current liabilities:
   Convertible notes payable to stockholder                                           $           -              $      6,000
   Accounts payable                                                                           3,178                     1,599
   Accrued expenses                                                                           3,829                     4,479
   Deferred revenue                                                                             224                       464
                                                                          ---------------------------    ----------------------
Total current liabilities                                                                     7,231                    12,542
Long-term interest payable to stockholder                                                    17,743                    15,580
Long-term debt, net of debt discount                                                         18,364                    17,942
Long-term debt to stockholder, net of debt discount                                          33,722                    33,170
                                                                          ---------------------------    ----------------------
Total liabilities                                                                            77,060                    79,234
                                                                          ---------------------------    ----------------------
Commitments and contingencies                                                                     -                         -
Redeemable convertible preferred stock, $0.001 par value, 1,000 shares
authorized, 861 issued and outstanding as of December 31, 2006 and
March 31, 2006, liquidation value $8,610                                                      8,610                     8,610
Stockholders' deficit:
   Common stock, $0.001 par value, 200,000,000 shares authorized; 102,939,645
   and 89,883,539 shares outstanding as of December 31,
   2006 and March 31, 2006                                                                      103                        90
   Additional paid-in capital                                                               452,046                   426,745
   Notes receivable from stockholder                                                         (5,164)                   (5,164)
   Accumulated deficit                                                                     (510,611)                 (494,224)
   Accumulated other comprehensive loss                                                      (3,732)                   (3,659)
                                                                          ---------------------------    ----------------------
Total stockholders' deficit                                                                 (67,358)                  (76,212)
                                                                          ---------------------------    ----------------------
Total liabilities, preferred stock and stockholders' deficit                          $      18,312             $      11,632
                                                                          ===========================    ======================
         The accompanying notes are an integral part of these condensed
consolidated financial statements.

</TABLE>

                                       1
<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                      Nine Months Ended
                                                             December 31,                           December 31,
                                                 ------------------------------------    -----------------------------------
                                                       2006                2005                2006                2005
                                                 ------------------    --------------    ------------------    -------------
<S>                                                    <C>                 <C>                <C>                 <C>
Revenue:
     Battery and system sales                          $    2,085          $  4,565           $    11,261         $ 13,171
     Licensing and royalty revenue                            233               254                   601              571
                                                 ------------------    --------------    ------------------    -------------
Total revenues                                              2,318             4,819                11,862           13,742

Cost of sales                                               2,782             5,971                11,224           18,642
                                                 ------------------    --------------    ------------------    -------------
Gross margin profit (loss)                                   (464)           (1,152)                  638           (4,900)
Operating expenses:
     Research and product development                         911             1,185                 2,800            3,961
     Marketing                                                663               420                 1,639            1,661
     General and administrative                             1,885             2,554                 6,285            9,019
     Share based compensation                                 426                 -                 1,132                -
     Depreciation and amortization                            193               178                   599              528
     (Gain) /loss on disposal of assets                       (84)               11                   (82)            (611)
     Asset impairment charge                                    -               170                     -              170
     Contract settlement charges                                -                 -                    24                -
                                                 ------------------    --------------    ------------------    -------------
Total operating expenses                                    3,994             4,518                12,397           14,728
                                                 ------------------    --------------    ------------------    -------------

Operating loss                                             (4,458)           (5,670)              (11,759)         (19,628)
Interest and other income                                     348               138                   696              425
Interest expense                                           (1,809)           (1,524)               (5,195)          (3,996)
                                                 ------------------    --------------    ------------------    -------------
Net loss                                                   (5,919)           (7,056)              (16,258)         (23,199)
Dividends on preferred stock                                   43                43                   130              130
Preferred stock accretion                                       -                 7                     -               28
                                                 ------------------    --------------    ------------------    -------------
Net loss available to common stockholders,
     basic and diluted                                $    (5,962)         $ (7,106)          $   (16,388)       $ (23,357)
                                                 ==================    ==============    ==================    =============
Other comprehensive loss:
     Net loss                                         $    (5,919)         $ (7,056)          $   (16,258)       $ (23,199)
     Change in foreign currency translation
     adjustments                                              (62)               36                   (73)             226
                                                 ------------------    --------------    ------------------    -------------
Comprehensive loss                                    $    (5,981)         $ (7,020)          $   (16,331)       $ (22,973)
                                                 ==================    ==============    ==================    =============
Net loss per share available to common
     stockholders                                     $     (0.06)         $  (0.08)          $     (0.17)       $   (0.26)
                                                 ==================    ==============    ==================    =============
Shares used in computing net loss per share
     available to common stockholders, basic
     and diluted.                                         101,801            89,715                 98,053          89,223
                                                 ==================    ==============    ==================    =============

</TABLE>

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


                                       2
<PAGE>

<TABLE>
<CAPTION>
                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (Unaudited)

                                                                                      Nine Months Ended December 31,
                                                                            ---------------------------------------------------
                                                                                        2006                       2005
                                                                            -----------------------------    ------------------
<S>                                                                                           <C>                 <C>
Cash flows from operating activities:
Net loss                                                                                     $  (16,258)         $    (23,199)
Adjustments to reconcile net loss to net cash used in operating activities:
     Depreciation and amortization                                                                  599                   528
     Asset impairment charge                                                                          -                   170
     Gain/(loss) on disposal of property, plant, equipment                                          (82)                 (611)
     Accretion of debt discount and other                                                           913                   770
     Interest income on stockholder note receivable                                                   -                  (210)
     Deferred compensation expense                                                                    -                   172
     Share based compensation                                                                     1,132                     -
Changes in operating and other assets and liabilities:
     Trade receivables                                                                              115                (2,476)
     Inventory                                                                                   (5,661)               (2,608)
     Prepaid and other current assets                                                               443                (1,432)
     Accounts payable                                                                             1,579                   207
     Accrued expenses and long-term interest                                                      1,513                 2,022
     Deferred revenue                                                                               240                  (835)
                                                                            -----------------------------    ------------------
Net cash used in operating activities                                                           (15,467)              (27,502)
                                                                            -----------------------------    ------------------

Cash flows from investing activities:
     Purchases of property, plant & equipment                                                    (1,430)               (1,355)
     Proceeds from sale of property, plant & equipment                                               15                   611
                                                                            -----------------------------    ------------------
Net cash used in investing activities                                                            (1,415)                 (744)
                                                                            -----------------------------    ------------------

Cash flows from financing activities:
     Proceeds from note payable to stockholder                                                    5,000                 1,000
     Proceeds from long-term debt                                                                     -                19,639
     Dividends paid                                                                                   -                  (130)
     Interest received on stockholder note receivable                                                 -                   281
     Proceeds from stock option exercises                                                           245                   656
     Proceeds from issuance of common stock, net of issuance costs                               12,832                 5,906
                                                                            -----------------------------    ------------------
Net cash provided by financing activities                                                        18,077                27,352
                                                                            -----------------------------    ------------------
Effect of foreign exchange rates on cash
     and cash equivalents                                                                            73                   226
                                                                            -----------------------------    ------------------
Increase (decrease) in cash and cash equivalents                                                  1,268                  (668)
Cash and cash equivalents, beginning of period                                                      612                 2,500
                                                                            -----------------------------    ------------------
Cash and cash equivalents, end of period                                                 $        1,880            $    1,832
                                                                            =============================    ==================
Supplemental information:
     Conversion of notes payable to stockholder into common stock                                11,101                     -
     Interest paid                                                                       $        1,406            $        -

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

</TABLE>

                                       3
<PAGE>


                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2006
                                   (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 December 31, 2006, its consolidated
results of operations for each of the three-and nine-month periods ended
December 31, 2006 and December 31, 2005, and the consolidated cash flows for the
nine-month periods ended December 31, 2006 and December 31, 2005. 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,
2006. The results for the three- and nine-month periods ended December 31, 2006
are not necessarily indicative of the results to be expected for the entire
fiscal year ending March 31, 2007. The year-end condensed consolidated balance
sheet data as of March 31, 2006 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, marine, 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 wholly owned subsidiaries in China. These subsidiaries
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 and U-Charge(R) 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.

3.   GOING CONCERN AND LIQUIDITY AND CAPITAL RESOURCES:

GOING CONCERN:

The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and satisfaction of

                                       4
<PAGE>


liabilities in the normal course of business. The Company has incurred operating
losses each year since its inception in 1989 and had an accumulated deficit of
$510.6 million as of December 31, 2006. For the nine-month period ended December
31, 2006 the Company has incurred a net loss available to common stockholders of
$16.4 million. For the years ended March 31, 2006 and 2005, the Company
sustained net losses of $32.9 and $32.2 million, respectively. These factors,
among others, indicate that the Company may be unable to continue as a going
concern for a reasonable period of time. The Company's ability to continue as a
going concern is contingent upon its ability to meet its liquidity requirements.
If the Company is unable to arrange for debt or equity financing on favorable
terms or at all the Company's ability to continue as a going concern is
uncertain. These financial statements do not give effect to any adjustments to
the amounts and classifications of assets and liabilities which might be
necessary should the Company be unable to continue as a going concern.

LIQUIDITY AND CAPITAL RESOURCES:

At December 31, 2006, the Company's principal sources of liquidity were cash and
cash equivalents of $1.88 million. The Company expects its sources of liquidity
will not be sufficient for the remaining fiscal year. The Company anticipates
product sales during fiscal 2007 from the N-Charge(TM) Power System and the
battery pack for Segway, Inc., which are subject to seasonal fluctuations and
from the sale of U-Charge(R) Power Systems will be insufficient to cover the
Company's operating expenses. Management depends upon the Company's ability to
periodically arrange for additional equity or debt financing to meet liquidity
requirements. Unless product sales are greater than management currently
forecasts or there are other changes to the business plan, the Company will need
to arrange for additional financing within the next three to six months to fund
operating and capital needs. This financing could take the form of debt or
equity. Given the historical operating results and the amount of our existing
debt, as well as the other factors, the Company may not be able to arrange for
debt or equity financing from third parties on favorable terms or at all.

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

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 sales to ultimate customers.
For direct customers, the Company estimates a return rate percentage based upon
its historical experience, reviewed on a quarterly basis. Customer rebates and
other price adjustments are recognized 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 sales of licensed products and when collectibility is
reasonably assured.

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


                                       5
<PAGE>


cash flows that the assets are expected to generate. If long-lived assets are
considered to be impaired, the impairment recognized equals the amount by which
the carrying value of the assets exceeds its fair value and is recorded in the
period the determination is made.

STOCK-BASED COMPENSATION:

Prior to April 1, 2006, the Company accounted for stock-based compensation under
the recognition and measurement provisions of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations, as permitted by Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation. No employee
compensation cost for stock options was recognized in the consolidated income
statements for periods prior to April 1, 2006, as all stock options granted had
an exercise price equal to the market value of the underlying common stock on
the date of grant. In December 2004, the FASB issued SFAS No. 123 (revised
2004), Share-Based Payment ("SFAS 123R"), which revises SFAS 123. SFAS 123R also
supersedes APB No. 25 and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R
eliminates the alternative to account for employee stock options under APB No.
25 and requires the fair value of all share-based payments to employees,
including the fair value of grants of employee stock options to be recognized in
the statement of operations, generally over the vesting period. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB")
No. 107, which provides additional implementation guidance for SFAS 123R. Among
other things, SAB 107 provides guidance on share-based payment valuations,
income statement classification and presentation, capitalization of costs and
related income tax accounting. SFAS 123R provides for adoption using either the
modified prospective or modified retrospective transition method. The Company
adopted SFAS 123R on April 1, 2006 using the modified prospective transition
method in which compensation cost is recognized beginning April 1, 2006 for all
share-based payments granted on or after that date and for awards granted to
employees prior to April 1, 2006 that remain unvested on that date. The Company
uses the Black-Scholes option pricing model to determine the fair value of stock
option awards. See Note 12 to the condensed consolidated financial statements
for disclosures required by SFAS 123R and related pronouncements.

RECENT ACCOUNTING PRONOUNCEMENTS:

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 inventory beginning April
1, 2006. The adoption of this standard did not have a material effect on the
Company's 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 beginning April 1, 2006. The adoption of this
standard did not have a material effect on the Company's financial position,
results of operations or cash flows.

In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations ("FIN 47"). FIN 47 clarifies that an
entity must record a liability for a "conditional" asset retirement obligation
if the fair value of the obligation can be reasonably estimated. The adoption of
this standard did not have a material effect on the Company's financial
position, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR
CORRECTIONS--A REPLACEMENT OF APB OPINION NO. 20 AND FASB STATEMENT NO. 3. SFAS
No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. This statement requires retrospective
application to prior periods' financial statements of changes in accounting
principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. This



                                       6
<PAGE>


statement redefines restatements as the revising of previously issued financial
statements to reflect the correction of an error. SFAS No. 154 requires that
retrospective application of a change in accounting principle be limited to the
direct effects of the change. This statement also requires that a change in
depreciation, amortization, or depletion method for long-lived, non-financial
assets be accounted for as a change in accounting estimate affected by a change
in accounting principle. SFAS No. 154 is effective for accounting changes and
corrections of errors beginning April 1, 2006. The adoption of this standard did
not have a material effect on the Company's 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-and nine-month periods
ended December 31, 2006 and 2005 were as follows:

<TABLE>
<CAPTION>
                                                                 Three Months Ended            Nine Months Ended
                                                                    December 31,                  December 31,
                                                                  2006         2005            2006         2005
                                                              ------------- ------------    ------------ ------------
<S>                                                              <C>          <C>             <C>          <C>
         Shares reserved for conversion of Series C
         preferred stock                                         3,628,634    3,629,470       3,628,634    3,629,470
         Common stock options                                    9,199,365   11,774,226       9,199,365   11,774,226
         Warrants to purchase common stock                       2.955,643    2,955,643       2,955,643    2,955,643
                                                              ------------- ------------    ------------ ------------
         Total                                                  15,783,642   18,359,339      15,783,642   18,359,339
                                                              ============= ============    ============ ============

5.   INVENTORY:

Inventory consisted of the following (in thousands) at:

                                                  December 31, 2006          March 31, 2006
                                                ----------------------    ---------------------

                    Raw materials                       $       1,665              $       891
                    Work in process                             5,810                    1,422
                    Finished goods                                924                      425
                                                ----------------------    ---------------------
                                                        $       8,399             $      2,738
                                                ======================    =====================
</TABLE>

Included in inventory at December 31, 2006 and March 31, 2006 were valuation
allowances of $5.0 million and $5.3 million, respectively to reduce their
carrying values to lower of cost or market.

6.   PROPERTY, PLANT AND EQUIPMENT, NET:

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

<TABLE>
<CAPTION>

                                                                  December 31, 2006            March 31, 2006
                                                               -------------------------    ----------------------
<S>                                                                     <C>                         <C>
            Leasehold improvements                                      $        1,079              $        738
            Machinery and equipment                                              3,846                     7,854
            Office and computer equipment                                        2,556                     2,032
            Construction in progress                                                56                        84
                                                               -------------------------    ----------------------
              Total cost                                                         7,537                     10,708
            Less:  accumulated depreciation                                     (4,006)                   (5,624)
            Less:  impairment                                                      (82)                   (2,032)
                                                               -------------------------    ----------------------
              Total cost, net of depreciation                           $        3,449             $       3,052
                                                               =========================    ======================




                                       7
<PAGE>

7.   INTELLECTUAL PROPERTY:

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

                                                           December 31, 2006          March 31, 2006
                                                         ----------------------    ---------------------
         Intellectual property before impairment                $      13,602             $     13,602
         Less:  accumulated amortization                               (4,908)                  (4,820)
         Less:  Impairment                                             (8,494)                  (8,494)
                                                         ----------------------    ---------------------
         Intellectual property, net                              $        200              $       288
                                                         ======================    =====================

</TABLE>

Amortization expense for the three- and nine-month periods ended December 31,
2006 and 2005 was approximately $29,000 and $88,000, respectively.

8.   CONVERTIBLE NOTES PAYABLE TO STOCKHOLDER:

On July 10, 2006, the Company issued convertible promissory notes in favor of
Berg & Berg Enterprises, LLC ("Berg & Berg"), an affiliate of Carl Berg, the
Company's chairman of the board and managing member of Berg & Berg, in the
principal amounts of $2.0 million. On July 20, 2006 the Company issued
convertible promissory notes in favor of Berg & Berg in the principal amount of
$1.0 million. These convertible promissory notes accrued interest at the annual
rate of 8.0% and were convertible at any time prior to maturity, into shares of
common stock of the Company at a conversion price equal to the closing bid price
of the Company's common stock on the trading day immediately prior to the
conversion date, provided that the conversion price cannot be lower than $1.73
and $1.33, respectively, the closing bid price of the Company's common stock on
July 9 and 19, 2006. The notes and accrued interest were converted into a total
of 1,885,302 common shares of the Company at $1.73 and $1.38, respectively. The
issuance of these shares of common stock was exempt from registration pursuant
to Section 3(a)(9) of the Securities Act of 1933, as amended. Under Rule 144 of
the Securities Act, these shares are restricted from trading by West Coast
Venture Capital, an affiliate of Mr. Berg, for one year from the date of
issuance, unless registered, and then may be traded only in compliance with the
volume restrictions and other applicable restrictions.

On June 21, 2006, the Company issued convertible promissory notes in favor of
Berg & Berg in the principal amounts of $2.0 million. These convertible
promissory notes accrued interest at the annual rate of 8.0% and were
convertible at any time prior to maturity, into shares of common stock of the
Company at a conversion price equal to the closing bid price of the Company's
common stock on the trading day immediately prior to the conversion date,
provided that the conversion price cannot be lower than $1.70, the closing bid
price of the Company's common stock on June 20, 2006. The notes and accrued
interest were converted into a total of 1,188,332 common shares of the Company
on July 25, 2006. The issuance of these shares of common stock was exempt from
registration pursuant to Section 3(a)(9) of the Securities Act of 1933, as
amended. Under Rule 144 of the Securities Act, these shares are restricted from
trading by West Coast Venture Capital for one year from the date of issuance,
unless registered, and then may be traded only in compliance with the volume
restrictions and other applicable restrictions.

In February and March 2006, the Company issued convertible promissory notes in
favor of Berg & Berg in an aggregate principal amount of $6.0 million (the
"Notes"). The Notes accrued interest at the annual rate of 8.0% and matured on
March 30 and June 30, 2006. The principal amount of the Notes, together with
accrued interest, was converted into 2,965,870 shares of common stock of the
Company, in accordance with their terms on April 3, 2006. The issuance of these
shares of common stock was exempt from registration pursuant to Section 3(a)(9)
of the Securities Act of 1933, as amended. Under Rule 144 of the Securities Act,
these shares are restricted from trading by West Coast Venture Capital for one
year from the date of issuance, unless registered, and then may be traded only
in compliance with the volume restrictions and other applicable restrictions.


                                       8
<PAGE>

<TABLE>
<CAPTION>
9.   LONG TERM DEBT:

         (in thousands)                            December 31, 2006               March 31, 2006
                                                ------------------------    -----------------------------
<S>                                                             <C>                       <C>
         2005 Loan balance                              $       20,000               $    20,000
         Unaccreted debt discount                               (1,636)                   (2,058)
                                                ------------------------    -----------------------------
         Balance                                        $       18,364               $    17,942
                                                ------------------------    -----------------------------

         2001 Loan to stockholder balance                       20,000                    20,000
         1998 Loan to stockholder balance                       14,950                    14,950
         Unaccreted debt discount                               (1,228)                   (1,780)
                                                ------------------------    -----------------------------
         Balance                                        $       33,722               $    33,170
                                                ------------------------    -----------------------------
</TABLE>


In June 2005, the Company obtained a $20.0 million funding commitment from Mr.
Carl Berg, the Company's chairman of the board and principal stockholder. The
amount of Mr. Berg's funding commitment was reduced in connection with the
purchase of the Series C-2 Convertible Preferred Stock in July 2005 by Berg &
Berg Enterprises LLC ("Berg & Berg"), the purchase of the Series C-1 Convertible
Preferred Stock in December 2005 by Berg & Berg, and the convertible notes
payable to stockholder discussed in Footnote 8. At December 31, 2006 this
funding commitment has been fully utilized by the Company.

On July 13, 2005, the Company secured a $20.0 million loan (the "2005 Loan")
from a third party finance company, the full amount of which has been drawn
down. The loan is guaranteed by Mr. Berg. The loan matures in a lump sum on July
13, 2010. Interest is due monthly based on a floating interest rate. The
interest rate is calculated as the greater of 6.75% or the sum of LIBOR Rate,
rounded to the nearest 1/16th of 1.0%, plus 4.0% (9.38% as of December 31,
2006). The loan may not be prepaid in whole or in part on or prior to July 12,
2007. The loan may be prepaid during the period beginning on July 13, 2007
through July 12, 2009, with a 1.0% prepayment premium, and on July 13, 2009 and
thereafter with no prepayment premium. 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 a period of three years.

The Company used $2.5 million of the proceeds from the loan to repay a June 30,
2005 draw from Mr. Berg's funding commitment. In connection with the loan both
the third party finance company and Mr. Berg received warrants to purchase
600,000 shares of the Company's common stock at a price of $2.74 per share. The
warrants are exercisable beginning on the date they were issued and will expire
on July 13, 2008. The fair value assigned to these warrants, totaling
approximately $2.037 million, has been recorded as a discount on the debt and
will be 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 36 months, 96.45% volatility, and a risk free rate of 3.88%. Also in
connection with the loan, the Company incurred a loan commitment fee and
attorney's fees which, in addition to the interest rate cap agreement, have been
recorded as a discount on the debt and will be accreted as interest expense.
Through December 31, 2006, a total of approximately $742,000 has been accreted
and included as interest expense. Interest payments on the loan are currently
being paid on a monthly basis.

In October 2001, the Company entered into a loan agreement ("2001 Loan") with
Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the
Company funds of up to $20 million between the date of the agreement and
September 30, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable
from time 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. 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.


                                       9
<PAGE>


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 warrants were exercisable beginning on the date they were issued and expire
on 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 method using the assumptions of a life of 47 months, 100%
volatility, and a risk-free rate of 5.5%. Through December 31, 2006, a total of
$1.541 million has been accreted and included as interest expense. The amounts
charged to interest expense on the outstanding balance of the loan for the
three-month periods ended December 31, 2006 and 2005 were $409,000,
respectively. Interest payments on the loan are currently being deferred, and
are recorded as long-term interest. The accrued interest amounts for the 2001
Loan were $7.93 million and $6.708 million as of December 31, 2006 and March 31,
2006, respectively.

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 December 31, 2006, the Company had an outstanding balance of
$14.95 million under the 1998 Loan agreement. The loan bears interest at one
percent over lender's borrowing rate (9.0% at December 31, 2006). 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. 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. The accrued interest amounts for the 1998 Loan
were $9.813 million and $8.51 million as of December 31, 2006 and March 31,
2006, respectively.

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 were valued using the Black-Scholes valuation method and had an
average weighted fair value of approximately $3.63 per warrant at the time of
issuance, using the assumptions of a life of 36 months, 96.45% volatility, and a
risk free rate of 3.88%. The fair value of these warrants, totaling
approximately $2.159 million, has been reflected as additional consideration for
the debt financing, recorded as a discount on the debt and accreted as interest
expense to be amortized over the life of the line of credit. As of December 31,
2006, a total of $2.159 million has been accreted. Interest payments on the loan
are currently being deferred, and are recorded as long-term interest.

All of our assets are pledged as collateral under the 2001 Loan and the 1998
Loan to stockholder.

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 battery pack for Segway, Inc.
and its U-Charge(R) 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 total warranty liability as of
December 31, 2006 is $1.292 million included in accrued expenses on the
Company's balance sheet.

LITIGATION:

On February 14, 2006, Hydro-Quebec filed an action against Valence Technology,
Inc. in the United States District Court for the Western District of Texas
(Hydro-Quebec v. Valence Technology, Civil Action No. A06CA111). In its amended
complaint filed April 13, 2006, Hydro-Quebec alleges that Saphion(R) Technology,
the technology utilized in all of the Company's commercial products, infringes
U.S. Patent No.'s 5,910,382 and 6,514,640 exclusively licensed to Hydro-Quebec.
Hydro-Quebec's amended


                                       10
<PAGE>


complaint seeks injunctive relief and monetary damages. The action is in the
initial pleading state and the Company has filed a response denying the
allegations. The Court has issued a stay of proceedings pending the
outcome of reexaminations of the two patents by the US Patent and Trademark
Office.  The Company's management believes the action by Hydro-Quebec is
without merit and intends to vigorously defend the lawsuit, as well as pursue
all of its available legal remedies.

The Company is subject to, from time to time, various claims and litigation in
the normal course of business. In the opinion of management, all pending legal
matters are either covered by insurance or, if 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 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. When issued, the Series C-1 Convertible Preferred Stock and Series
C-2 Convertible Preferred Stock were convertible into common stock at $4.00 per
share. Each series carries a 2% annual dividend rate, payable quarterly in cash
or shares of common stock, and were redeemable on December 15, 2005. The Company
has the right to convert the preferred stock if the average of the dollar-volume
weighted average price of the Company's common stock for a ten-day trading
period is at or above $6.38 per share. If the preferred shares are not redeemed
in accordance with their terms, the holder of the preferred stock shall have the
option to require the Company to convert all or part of the redeemed shares at a
price of 95% of the lowest closing bid price of the Company's common stock
during the three days ending on and including the conversion date. The preferred
shares are currently outstanding and subject to redemption or conversion at the
holder's discretion.

Pursuant to assignment agreements entered into between the Company and Berg &
Berg on July 14, 2005 and December 14, 2005, Berg & Berg purchased all of the
outstanding Series C-1 Convertible Preferred Stock and Series C-2 Convertible
Preferred Stock from its original holder. Pursuant to the terms of the
assignment agreement, Berg & Berg agreed that the failure of the Company to
redeem the preferred stock on December 15, 2005 did not constitute a default
under the certificate of designations and has waived the accrual of any default
interest applicable in such circumstance. In exchange, the Company has agreed
(i) that the Series C-1 Convertible Preferred Stock may be converted, at any
time, into the Company's common stock at the lower of $4.00 per share or the
closing bid price of the Company's common stock on December 13, 2005 ($1.98) and
(ii) that the Series C-2 Convertible Preferred Stock may be converted, at any
time, into the Company's common stock at the lower of $4.00 per share or the
closing bid price of the Company's common stock on July 13, 2005 ($2.96).

In connection with the issue of the original issuance of the Series C
Convertible Preferred Stock, in June 2003, the Company issued to the Series C
Convertible Preferred Stock original 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
at $933,000. Accretion to the remaining redemption value of $8.61 million was
recorded over the eighteen-month period of the Series C Convertible Preferred
Stock ending December 2, 2004.

12.  STOCK-BASED COMPENSATION

The Company has a stock option plan (the "1990 Plan") under which options
granted may be incentive stock options or supplemental stock options. Options
are to be granted at a price not less than fair market value (incentive options)
or 85% of fair market value (supplemental options) on the date of grant. The



                                       11
<PAGE>


options vest as determined by the Board of Directors and are generally
exercisable over a five-year period. Unvested options are canceled and returned
to the 1990 Plan upon an employee's termination. Generally, vested options, not
exercised within three months of termination, are also canceled and returned to
the Plan. The 1990 Plan terminated on July 17, 2000, and as such, options may
not be granted after that date. Options granted prior to July 17, 2000 expire no
later than ten years from the date of grant.

In February 1996, the Board of Directors adopted a stock plan for outside
Directors (the "1996 Non-Employee Director's Stock Option Plan"). The plan
provides that new directors will receive an initial stock option of 100,000
shares of common stock upon their election to the Board. The exercise price for
this initial option will be the fair market value on the day it is granted. This
initial option will vest one-fifth on the first and second anniversaries of the
grant of the option, and quarterly over the next three years. A director who had
not received an option upon becoming a director will receive an initial stock
option of 100,000 shares on the date of the adoption of the plan. During the
first and second quarter of fiscal 2007, no shares were granted under this plan.
At December 31, 2006, the Company had 21,260 shares available for grant under
the 1996 Non-Employee Director's Stock Option Plan.

In October 1997, the Board of Directors adopted the 1997 Non-Officer Stock
Option Plan (the "1997 Plan"). The Company may grant options to non-officer
employees and consultants under the 1997 Plan. Options are to be granted at a
price not less than fair market value (incentive options) on the date of grant.
The options vest as determined by the Board of Directors, generally quarterly
over a three- or four-year period. The options expire no later than ten years
from the date of grant. Unvested options are canceled and returned to the 1997
Plan upon an employee's termination. Vested options, not exercised within three
months of termination, also are canceled and returned to the 1997 Plan. During
the first and second quarter of fiscal 2007, no shares were granted under this
plan. At December 31, 2006, the Company had 833,940 shares available for grant
under the 1997 Plan.

In January 2000, the Board of Directors adopted the 2000 Stock Option Plan (the
"2000 Plan"). The Company may grant incentive stock options to employees and
non-statutory stock options to non-employee members of the Board of Directors
and consultants under the 2000 Plan. Options are to be granted at a price not
less than fair market value on the date of grant. In the case of an incentive
stock option granted to an employee who owns stock possessing more than 10% of
the total combined voting power of all classes of stock of the Company or any
affiliate, the option is to be granted at a price not less than 110% of the fair
market value on the date of grant. The options are exercisable as determined by
the Board of Directors, generally over a four-year period. The options expire no
later than ten years from the date of grant. Unvested options are canceled and
returned to the 2000 Plan upon an employee's termination. Vested options, not
exercised within three months of termination, also are canceled and returned to
the 2000 Plan. During the first, second, and third quarter of fiscal 2007,
681,000 shares were granted under this plan. At December 31, 2006, the Company
had 2,368,822 shares available for grant under the 2000 Plan.

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

Aggregate option activity is as follows (shares in thousands):


                                  Outstanding Options
                            ----------------------------------------------------
                                     Number of              Weighted Average
                                       Shares                Exercise Price
                            -----------------------    -------------------------
 Balance at March 31, 2006              9,045                  $ 4.97
                            -----------------------    -------------------------
   Granted                                681                  $ 1.81
   Exercised                             (151)                 $ 1.49
   Canceled                            (3,600)                 $ 4.82
                            -----------------------    -------------------------
Balance at December 31, 2006            5,975                  $ 4.52
                            =======================    =========================




                                       12
<PAGE>

         The following table summarizes information about fixed stock options
         outstanding at December 31, 2006 (shares in thousands):

<TABLE>
<CAPTION>

                                                      Options Outstanding                        Options Exercisable
                                ---------------------------------------------------------------------------------------------

                                                 Weighted
                                                 Average                                                  Weighted
                                                Remaining                                                 Average
               Range of            Number     Contractual Life    Weighted Average        Number          Exercise
            Exercise Prices     Outstanding       (years)          Exercise Price       Exercisable         Price
------------------------------------------------------------------------------------------------------------------------------
<S>      <C>                    <C>              <C>              <C>                <C>                 <C>
         $0.63 - $1.99            1,410            7.82               1.65                373               1.49

         $1.99 - $4.62            2,753            7.58               3.05                732               3.37

         $4.62 - $10.06           1,538            2.35               6.49              1,480               6.54

         $10.06 - $15.75             60            3.65              11.73                 60              11.73

         $15.75 - $23.56            113            3.14              20.41                113              20.41

         $23.56 - $34.62            101            2.92              32.93                101              32.93
------------------------------------------------------------------------------------------------------------------------------
         $0.63 - $34.62           5,975            6.09               4.52              2,859               6.66
</TABLE>


         Compensation expense for stock plans has been determined based on the
         fair value at the grant date for options granted in the current fiscal
         year. For the three- and nine-months ended December 31, 2006, $426,000
         and $1.132 million of stock based compensation expense has been
         included in operating expenses in the condensed consolidated statements
         of operations and comprehensive loss. For fiscal year 2006,
         compensation expense was not recorded consistent with the provisions of
         SFAS 123, as amended by SFAS 148. Had compensation expense been
         recorded the pro forma net loss would have been reported as follows (in
         thousands):

<TABLE>
<CAPTION>

                                                                      THREE MONTHS ENDED     NINE MONTHS ENDED
                                                                         DECEMBER 31,           DECEMBER 31,
                                                                             2005                    2005
                                                                        -------------------- ---------------------
<S>                                                                          <C>                  <C>
            Net loss available to stockholders - as reported                 $ (7,106)            $  (23,357)

            Add: stock-based compensation expense, net of related
                taxes                                                            (639)                (1,917)
                                                                        -------------------- ---------------------
            Net loss available to stockholders - pro forma                   $ (7,745)            $  (25,274)

                                                                        ==================== =====================
            Net loss available to stockholders per share, basic and          $  (0.08)            $    (0.26)
            diluted - as reported
            Net loss available to stockholders per share, basic and          $  (0.09)            $    (0.28)
            diluted - pro forma


         As of December 31, 2006 the Company had a total of $3.021 million in
         compensation costs related to stock-based compensation to recognize
         over a remaining service period of 5 years for non-vested options. 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 fiscal years 2007 and 2006:

                                                                                            DECEMBER 31,
                                                                                         2006            2005
                                                                                    --------------- ----------------

                Risk-free interest rate                                                 4.65%           4.35%
                Expected life                                                         5.0 years       5.0 years
                Volatility                                                             83.19%           92.55%
                Dividend yield                                                          None             None

</TABLE>


                                       13
<PAGE>


13.  RELATED PARTY TRANSACTIONS:

On December 27, 2006, West Coast Venture Capital purchased 613,497 shares of the
Company's common stock for $1.0 million. The purchase price of $1.63 per share
equaled the closing bid price of the Company's common stock as of December 26,
2006.

On December 15, 2006, West Coast Venture Capital purchased 549,541 shares of the
Company's common stock for $1.0 million. The purchase price of $1.82 per share
equaled the closing bid price of the Company's common stock as of December 15,
2006.

On August 17, 2006, West Coast Venture Capital purchased 534,759 shares of the
Company's common stock for $1.0 million. The purchase price of $1.87 per share
equaled the closing bid price of the Company's common stock as of August 16,
2006.

On August 3, 2006, West Coast Venture Capital purchased 1,298,702 shares of the
Company's common stock for $2.0 million. The purchase price of $1.54 per share
equaled the closing bid price of the Company's common stock as of August 3,
2006.

On May 11, 2006, West Coast Venture Capital purchased 646,552 shares of the
Company's common stock for $1.5 million. This represented a funding on the $20.0
million funding commitment previously made by Berg & Berg. The purchase price of
$2.32 per share equaled the closing bid price of the Company's common stock as
of May 10, 2006.

On April 3, 2006, West Coast Venture Capital purchased 401,606 shares of the
Company's common stock for $1.0 million. This represented a funding on the $20.0
million funding commitment previously made by Berg & Berg. The purchase price of
$2.49 per share equaled the closing bid price of the Company's common stock as
of March 31, 2006.

In June 2005, Mr. Carl Berg, our chairman of the board and principal
stockholder, agreed to provide a funding commitment of $20.0 million. On June
30, 2005, the Company drew down $2.5 million of this commitment. This draw took
the form of a loan at a 5.0% annual interest rate and was repaid with proceeds
from a July 2005 loan from a third party finance company. This funding
commitment was reduced by $4.3 million upon the purchase of the Series C-2
Convertible Preferred Stock on July 14, 2005 by Berg & Berg. On December 14,
2005, Mr. Berg's funding commitment was further reduced by $4.3 million in
connection with the purchase of the Company's Series C-1 Convertible Preferred
Stock by Berg & Berg. In February and March 2006, the Company issued convertible
promissory notes in favor of Berg & Berg in an aggregate principal amount of
$6.0 million (the "Notes"). The Notes accrued interest at the annual rate of
8.0% and matured on March 30 and June 30, 2006. The principal amount of the
Notes, together with accrued interest, was converted into 2,965,870 shares of
common stock of the Company, in accordance with their terms on April 3, 2006.

In June 2004, Mr. Berg agreed to provide a $20 million backup equity funding
commitment. This funding commitment was 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, 2006, the Company had drawn down
all of this commitment. This commitment can be reduced by the amount of net
proceeds received from the sale of the building or equipment from the Company's
Mallusk, Northern Ireland facility or the amount of net proceeds in a debt or
equity transaction, and may be increased if necessary under certain
circumstances. As of the date of this report, Mr. Berg has not requested that
his commitment be reduced.

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
September 30, 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. On November 8, 2002, the



                                       14
<PAGE>


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.

In July 1998, the Company entered into an amended loan agreement (the "1998
Loan") with Berg & Berg that allows the Company to borrow, prepay and re-borrow
up to $10.0 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 $15.0 million. As of December 31, 2006, 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 December
31, 2006). On July 13, 2005, the parties agreed to extend the loan's maturity
date from September 30, 2006 to September 30, 2008.

On January 1, 1998, the Company granted options to Mr. 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, an option to purchase 660,494
shares was granted 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 December 31, 2006, principal and interest amounts of $3.50
million and $1.59 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. On April 20, 2005, the
Company's Board of Directors approved a resolution to extend the maturity dates
of each of the Dawson Notes from September 5, 2005 to September 5, 2007.

As of December 31, 2006 and March 31, 2006, amounts of $5.16 million were
outstanding under Dawson Note One and Dawson Note Two. Under each of the Dawson
Notes, interest from the Issuance Date accrues on unpaid principal at the rate
of 5.69% per annum, or at the maximum rate permissible by law, whichever is
less. In accordance with the Dawson Notes, interest is due annually, has been
paid through March 4, 2005, and is in arrears at December 31, 2006.

14.  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 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 December 31, 2006 and March
31, 2006 is as follows (in thousands):

<TABLE>
<CAPTION>

                                                  December 31, 2006          March 31, 2006
                                                ----------------------    ---------------------
<S>                                                     <C>                       <C>
                    United States                       $         601             $        648
                    International                               3,048                    2,692
                                                ----------------------    ---------------------
                    Total                               $       3,649             $      3,340
                                                ======================    =====================

</TABLE>


                                       15
<PAGE>


Revenues by geographic area for the three- and nine-month periods ended December
31, 2006 and 2005 are as follows (in thousands):

<TABLE>
<CAPTION>

                                   Three Months Ended December 31,           Nine Months Ended December 31,
                                --------------------------------------    -------------------------------------
                                        2006                 2005                 2006                2005
                                ------------------    ----------------    -----------------    ----------------
<S>                                   <C>                  <C>                  <C>                 <C>
         United States                $     1,843          $    4,273           $    9,835          $   12,610
         International                        475                 546                2,027               1,132
                                ------------------    ----------------    -----------------    ----------------
         Total                        $     2,318          $    4,819           $   11,862          $   13,742
                                ==================    ================    =================    ================
</TABLE>


15.  SUBSEQUENT EVENTS:

From January 1, 2007 through February 2, 2007, the Company placed 823,000 shares
through a Controlled Equity Common Stock offering for a total net proceeds
amount of $1.274 million.

On January 18, 2007, West Coast Venture Capital purchased 662,252 shares of the
Company's common stock for $1.0 million. The purchase price of $1.51 per share
equaled the closing bid price of the Company's common stock as of January 17,
2007.

On February 2, 2007 West Coast Venture Capital purchased 657,894 shares of the
Company's common stock for $1.0 million. The purchase price of $1.52 per share
equaled the closing bid price of the Company's common stock as of February 1,
2007.

                                       16
<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 THE COMPANY, 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
OTHERS, DISCUSSED IN THE SECTIONS - "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "CAUTIONARY STATEMENTS 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 THIS 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-
AND NINE-MONTH PERIOD ENDED DECEMBER 31, 2006 ARE NOT NECESSARILY INDICATIVE OF
THE RESULTS TO BE EXPECTED FOR THE ENTIRE FISCAL YEAR ENDING MARCH 31, 2007.

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 owned
subsidiaries in China. These subsidiaries 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 commercial feasibility of our technology;

     o    Launched new Saphion(R) technology-based products, including our
          N-Charge(TM) Power System family and introduced our U-Charge(R) Power
          System family of products, intended to be a direct replacement for
          existing lead acid battery applications in the market today and to
          compete for emerging motive applications;

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



                                       17
<PAGE>


     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;

     o    Established key manufacturing partnerships in Asia to facilitate
          low-cost, quality production;

     o    Announced a joint technology development program with Segway Inc. to
          develop long-range battery packs using our Saphion(R) technology for
          Segway's human transporter product. Production of the Segway battery
          packs began in March 2005 and they are currently available through
          Segway's distribution channel;

      o   Consolidated three China facilities into one site to serve as our
          powder production, research and development, and assembly facility;

      o   Closed the Oxford, UK research facility; and;

      o   Developed 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 (NiMeH) and nickel-cadmium (NiCd) battery technologies.

At $2.3 million, our revenue for the third quarter of fiscal 2007 was within our
previously announced revenue guidance. Third quarter revenue for fiscal 2007
decreased $2.5 million, or 51.9%, from the third quarter of fiscal 2006. Gross
margin loss was (20.0%) for the third quarter of fiscal 2007, compared with
gross margin loss of (23.9%) for the third quarter of fiscal 2006. During the
third quarter of fiscal 2007, we continued our efforts to drive down costs while
increasing production at our subsidiaries in China, which became operational in
late fiscal 2005.

Our business headquarters is located in Austin, Texas, our research and
development center is in Las Vegas, Nevada, our European sales is in Mallusk,
Northern Ireland, our Asia sales office in Shanghai, China and our manufacturing
and product development center is in Suzhou, 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 and impairment of long-lived assets. 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:

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


                                       18
<PAGE>


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.


RESULTS OF OPERATIONS

The following table summarizes the results of our operations for the
three-months (also referred to as the third quarter) and nine-months ended
December 31, 2006 and December 31, 2005:

<TABLE>
<CAPTION>

                                      Three Months Ended                            Nine Months Ended
                            ----------------------------------------    ------------------------------------------
                            December 31, 2006     December 31, 2005     December 31, 2006      December 31, 2005
                            ----------------------------------------    ------------------------------------------
<S>                         <C>                   <C>                    <C>                    <C>
(dollars in thousands)         % of Revenue          % of Revenue           % of Revenue          % of Revenue
Battery and systems sales    $ 2,085      90%      $ 4,565      95%      $ 11,261      95%      $ 13,171      96%
Licensing and royalty            233      10%          254       5%            601      5%           571       4%
                            ----------------------------------------    ------------------------------------------
Total revenues                 2,318     100%        4,819     100%         11,862    100%        13,742     100%
Gross profit (loss)             (464)    -20%       (1,152)    -24%            638      5%        (4,900)    -36%
Operating expenses             3,994     172%        4,518      94%         12,397    105%        14,728     107%
Operating loss                (4,458)   -192%       (5,670)   -118%       (11,759)    -99%       (19,628)   -143%
                            ----------------------------------------    ------------------------------------------
Net loss                      (5,919)   -255%       (7,056)   -146%       (16,258)   -137%     $ (23,199)   -169%
                            ========================================    ==========================================
</TABLE>

REVENUES AND GROSS MARGIN

BATTERY AND SYSTEM SALES: Battery and system sales decreased by $2.48 million,
or (54.3%), to $2.085 million in the third quarter of fiscal 2007 from $4.565
million in the third quarter of fiscal 2006. Battery and system sales decreased
by $1.91 million, or (14.5%), in the first nine-months of fiscal 2007 from
$13.171 million in the first nine-months of fiscal 2006. The decrease in battery
and system sales was primarily the result of a revised shipping schedule of
batteries to Segway and a temporary shortage of key components. Overall, we saw
a 68% decrease in large-format sales in the third quarter of fiscal 2007
compared to the second quarter of fiscal 2007. These systems comprised 62% of
our total revenue for the three months ended December 31, 2006. Due to the shift
in our revenue base from small-format to large-format products and the high cost
of doing business in the retail channel during the third quarter of fiscal 2006,
we ceased sales of N-Charge products through our retail channels. We continue to
sell the N-Charge product through our reseller channels with a continued
emphasis in the healthcare and education sectors. Revenues from the sales of our
small-format products accounted for 21% and 24% of our total revenue for the
three months ended December 31, 2006 and 2005. Product shipments to resellers
that are subject to right of return and monies received for future obligations
are recorded on the balance sheet as deferred revenue. We had $224,000 in
deferred revenue on our balance sheet at December 31, 2006.

LICENSING AND ROYALTY REVENUE: Licensing and royalty revenues relate to revenue
from licensing agreements for our battery construction technology. Fiscal third
quarter 2007 licensing and royalty revenue was $233,000 compared with $254,000
for the same quarter in fiscal 2006. 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.



                                       19
<PAGE>

GROSS MARGIN (LOSS): Gross margin as a percentage of revenue was (20.0)% for the
third quarter of fiscal 2007 as compared to (23.9%) in the third quarter of
fiscal 2006. Gross margin was 5.4% in the first nine-months of fiscal 2007 and
was (35.6%) in the first nine-months of fiscal 2006. Gross margins in fiscal
2006 were impacted by the ramp-up cost of the Segway Inc. product as well as the
manufacturing transition to China. We have successfully transitioned our battery
manufacturing and product assembly operations to contract manufacturers in Asia
and as well as our manufacturing and product development operations to our
subsidiaries in Suzhou, China. As is the case in the first quarter of 2007, we
expect cost of sales to continue to decrease as a percentage of sales as
production volumes increase, manufacturing yields improve and as we fully
capitalize on our lower-cost manufacturing strategy.

OPERATING EXPENSES

The following table summarizes operating expenses for the three months and nine
months ended December 31, 2006 and December 31, 2005:

<TABLE>
<CAPTION>

                                  Three Months Ended December 31,                    Nine Months Ended December 31,
                           ----------------------------------------------    ------------------------------------------------
(dollars in thousands)                             Increase/     %                                     Increase/     %
                            2006        2005       (Decrease)    Change        2006         2005       (Decrease)    Change
                           --------    --------    ----------    --------    ---------    ----------   ----------    --------
<S>                         <C>      <C>             <C>          <C>        <C>         <C>          <C>             <C>
Research and product
development                    911     $1,185          (274)       -23%        2,800       3,961        (1,161)        -29%
Marketing                      663        420           243         58%        1,639       1,661           (22)         -1%
General and
administrative               1,885      2,554          (669)       -26%        6,285       9,019        (2,734)        -30%
Share based
Compensation                   426          -           426        100%        1,132           -         1,132         100%
Depreciation and
amortization                   193        178            15          8%          599         528            71          13%
(Gain)/Loss on
disposal of assets             (84)        11           (95)      -864%          (82)       (611)         (693)       -113%
Asset impairment
charge                           -        170          (170)      -100%            -         170          (170)       -100%
Contract settlement              -          -             -          -            24           -            24         100%
Total operating
expenses                     3,994     $4,518          (524)       -12%       12,397     $14,728         2,331         -16%
Percentage of revenues        172%        94%                                   105%        107%

</TABLE>


During the third quarter of fiscal 2007, operating expenses were 172.3% of
revenue and 93.8% of revenue during the same quarter last year. In the first
nine-months of fiscal 2007, operating expenses were 104.5% of revenue and were
107.2% of revenue in the first nine-months of fiscal 2006. The year-to-date
decrease is primarily the result of personnel and expense reduction actions
taken during the last three quarters. We reduced operating expenses by $2.331
million or 15.8% for the first nine-months of fiscal 2007, as compared with the
first nine-months of fiscal 2006.

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
$274,000, or 23.1%, to $911,000 for the third quarter of fiscal 2007 from $1.185
million for the third quarter of fiscal 2006. Research and product development
expenses decreased by $1.161 million, or 29.3%, in the first nine-months of
fiscal 2007 to $2.8 million from $3.961 million in the first nine-months of
fiscal 2006. The decrease in research and development expenses is the result of
cessation of product development work in our Northern Ireland and Oxford England
facilities, as well as reduced temporary staff and consulting expenses and
materials usage in our Henderson, Nevada facility.



                                       20
<PAGE>


MARKETING. Marketing expenses consist primarily of costs related to sales and
marketing personnel, public relations and promotional materials. Marketing
expenses of $663,000 in the third quarter of fiscal 2007 were $243,000 higher
than the comparable period of fiscal 2006. This increase in marketing expenses
is the result of increased marketing efforts in the current quarter. First
nine-months of fiscal 2007 marketing expenses of $1.639 million were $22,000
lower than the comparable period in fiscal 2006. The decrease in marketing
expenses was the result of reduced spending for consulting related to European
market development, and reduced lead generation and media advertising
expenditures applicable to the retail channel. 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 $1.885 million and $2.554 million for the third fiscal quarters of 2007
and 2006, respectively. General and administrative expenses decreased by $2.734
million, or 30.3%, to $6.285 million in the first nine-months of fiscal 2007
from $9.019 million in the first nine-months of fiscal 2006. The decrease was
largely due to the continued shift of resources to our Asian operations and
improved efficiencies in our US support operations.

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 expenses were
$193,000 and $178,000 for the third quarters of fiscal 2006 and 2005,
respectively. Depreciation and amortization expenses were $599,000 and $528,000
in the first nine-months of fiscal 2007 and 2006 respectively. The nominal
increase in depreciation expense relates to recent additions to property, plant,
and equipment in the U.S and in China during the past four fiscal quarters.

INTEREST EXPENSE. Interest expense relates to our short-term and long-term debt
to stockholders and the long term debt from the third party loan obtained on
July 13, 2005. Interest expense was $1.809 million and $1.524 million for the
third quarter of fiscal 2007 and 2006, respectively, and was $5.195 million and
$3.996 million for the first nine-months of fiscal 2007 and fiscal 2006,
respectively. The increase in interest expense is related to only having a
partial year of long-term debt outstanding in 2005.

SHARE BASED COMPENSATION. Share based compensation of $1.132 million for the
first nine-months of 2007 represents compensation costs recognized for all
share-based payments granted on or after April 1, 2006 and awards granted to
employees prior to April 1, 2006 that remain unvested on that date.


LIQUIDITY AND CAPITAL RESOURCES

LIQUIDITY

At December 31, 2006, the Company's principal sources of liquidity were cash and
cash equivalents of $1.88 million. The Company expects our sources of liquidity
will not be sufficient for the remaining fiscal year. The Company anticipates
product sales during fiscal 2007 from the N-Charge(TM) Power System and the
battery pack for Segway, Inc., which are subject to seasonal fluctuations and
the sale of the U-Charge(R) Power System will be insufficient to cover the
Company's operating expenses. Management depends upon our ability to
periodically arrange for additional equity or debt financing to meet our
liquidity requirements. Unless our product sales are greater than management
currently forecasts or there are other changes to our business plan, we will
need to arrange for additional financing within the next three to six months to
fund operating and capital needs. This financing could take the form of debt or
equity. Given our historical operating results and the amount of our existing
debt, as well as the other factors, we may not be able to arrange for debt or
equity financing from third parties on favorable terms or at all.


                                       21
<PAGE>


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

As a result of our limited cash resources and history of operating losses, our
previous auditors have expressed in their report on our consolidated financial
statements included in our audited March 31, 2006 consolidated financial
statements that there is substantial doubt about our ability to continue as a
going concern. We presently have no further commitments for financing by Mr.
Berg or any other source. If we are unable to obtain financing from Mr. Berg or
others on terms acceptable to us, or at all, we may be forced to cease all
operations and liquidate our assets. 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 fiscal 2007.

The following table summarizes our statement of cash flows for the nine months
ended December 31, 2006 and 2005:

<TABLE>
<CAPTION>
                                                                         Nine Months Ended December 31,
                                                                       ------------------------------------
                                                                                       --
(dollars in thousands)                                                      2006                2005
                                                                       ---------------    -----------------
<S>                                                                       <C>                  <C>
Net cash flows provided by (used in)
Operating activities                                                      $  (15,467)          $  (27,502)
Investing activities                                                          (1,415)                (744)
Financing activities                                                          18,077               27,352
Effect of foreign exchange rates                                                  73                  226
                                                                       ---------------    -----------------
Net increase/(decrease) in cash and cash equivalents                       $   1,268           $     (688)
                                                                       ===============    =================
</TABLE>

Our use of cash from operations the first nine-months of fiscal 2007 and fiscal
2006 was $15.467 million and $27.502 million, respectively. The cash used for
operating activities during the first nine months of our fiscal 2007 operating
activities was primarily for operating losses and working capital. Cash used for
operating losses in the first nine months of fiscal 2007 decreased from the same
period of fiscal 2006 by $12.035 million. Working capital in the first nine
months of fiscal 2007 was more than working capital in the first nine months of
fiscal 2006 by $3.393 million. The increase in working capital was primarily due
to increases in inventory.

In the first nine months of fiscal 2007, we had a net decrease in net cash from
investing activities of $1.415 million. Cash used in investing activities during
the first nine months of fiscal 2006 relates to purchases of equipment
domestically and in China.

We obtained cash from financing activities of $18.077 million and $27.352
million during the first nine months of fiscal 2007 and 2006, respectively. The
financing activities in the first nine months of fiscal 2007 included $5.0
million convertible short term notes payable to Berg & Berg, a $7.5 million
issuance of common stock to West Coast Venture Capital, an affiliate of Mr.
Berg, and $245,000 in stock option exercises. In addition, the Company received
net proceeds of $5.332 million from the sale of stock under a controlled equity
offering agreement with Cantor Fitzgerald.

As a result of the above, we had a net increase in cash and cash equivalents of
$1.268 million during the first nine months of fiscal 2007.

CAPITAL COMMITMENTS AND DEBT

At December 31, 2006, we had commitments for capital expenditures for the next
12 months of approximately $761,000 relating to manufacturing equipment. We may
require additional capital expenditures in order to meet


                                       22
<PAGE>


greater demand levels for our products than are currently anticipated and/or to
support our transition of operations to China.

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

(Dollars in thousands)                                     December 31, 2006
                                                          ---------------------
1998 long-term debt to Berg & Berg                               $      14,950
2001 long-term debt to Berg & Berg                                      20,000
2005 long-term debt to third-party                                      20,000
Interest on long-term debt                                              17,743
Current portion  of interest on long-term debt                             126
                                                          ---------------------
Total long-term debt                                             $      72,819
                                                          =====================

Repayment obligations of short-term and long-term debt principal as of December
31, 2006 are:

<TABLE>
<CAPTION>
                                                                   Fiscal year
                             ----------------------------------------------------------------------------------------
<S>                           <C>        <C>          <C>          <C>          <C>        <C>            <C>
(Dollars in thousands)        2007       2008         2009         2010         2011       Thereafter        Total
                             -------    --------    ---------    ---------    ---------    ------------    ----------
Principal repayment            -           -        $34,950         -         $20,000           -           $54,950

</TABLE>

If not converted to common stock, the redemption obligation for the Series C-1
Convertible Preferred Stock and Series C-2 Convertible Preferred Stock is $8.6
million. The Series C-1 Convertible Preferred Stock may be converted, at any
time, into shares of our common stock at the lower of $4.00 or the closing price
of our common stock on the conversion date, provided the conversion price can be
no lower than $1.98, the closing price of the common stock on December 13, 2005.
The Series C-2 Convertible Preferred Stock may be converted, at any time, into
shares of our common stock at the lower of $4.00 or the closing price of our
common stock on the conversion date, provided the conversion price can be no
lower than $2.96, the closing bid price of our common stock on July 13, 2005.
The preferred shares are currently outstanding and subject to redemption or
conversion at the holder's discretion.

If cash flow from operations is not adequate to meet debt obligations,
additional debt or equity financing will be required. There can be no assurance
that we could obtain the additional financing.

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 December 31, 2006, 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
                                           --------------------------------------------------------------------------
                                                             LESS THAN                                    MORE THAN
CONTRACTUAL OBLIGATIONS                       TOTAL          ONE YEAR       1-2 YEARS     3-5 YEARS        5 YEARS
----------------------------------------   -------------    ------------    ----------    -----------    ------------
<S>                                           <C>               <C>            <C>          <C>              <C>
Short and long-term debt obligations          $  72,819         $   126        $    -       $ 72,693         $     -
Operating lease obligations                       1,142             273           403            466               -
Purchase obligations                             22,479          22,479             -              -               -
Redemption of Convertible Preferred
Stock                                             8,610           8,610             -              -               -
                                           -------------    ------------    ----------    -----------    ------------

Total                                         $ 105,050       $  31,488        $  403       $ 73,159         $     -
                                           =============    ============    ==========    ===========    ============

</TABLE>



                                       23
<PAGE>


CHANGE IN CERTIFYING ACCOUNTANT

On January 22, 2007, the Company was informed that its principal independent
registered public accounting firm, Helin, Donovan, Trubee & Wilkinson, LLP
(HDT&W) had consummated a merger with Pohl, McNabola, Berg & Co., LLP located in
San Francisco, California. The name of the post merger firm is PMB Helin
Donovan, LLP and the post-merger firm will succeed HDT&W as our principal
independent registered public accounting firm.


                                       24
<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


THERE IS DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN

We have experienced significant operating losses in the current and prior years.
At December 31, 2006 our principal sources of liquidity were cash and cash
equivalents of $1.88 million. Although Mr. Berg may continue to fund the
Company's operations he is under no obligation to do so. We intend to improve
our liquidity by the continued monitoring and reduction of manufacturing,
facility and administrative costs. However, notwithstanding these efforts, we do
not expect that our cash on hand and cash generated by operations will be
sufficient to fund our operating and capital needs beyond the next three months.
As a result of our limited cash resources and history of operating losses, our
previous auditors have expressed in their report on our consolidated financial
statements included in our audited March 31, 2006 consolidated financial
statements that there is substantial doubt about our ability to continue as a
going concern. We presently have no further commitments for financing by Mr.
Berg or any other source. If we are unable to obtain financing from Mr. Berg or
others on terms acceptable to us, or at all, we may be forced to cease all
operations and liquidate our assets.

WE HAVE ENCOUNTERED PROBLEMS IN OUR PRODUCTION PROCESSES THAT HAVE LIMITED OUR
ABILITY AT TIMES TO PRODUCE SUFFICIENT BATTERIES TO MEET THE DEMANDS OF OUR
CUSTOMERS. IF THESE ISSUES RECUR AND WE ARE UNABLE TO TIMELY RESOLVE THESE
PROBLEMS, OUR INABILITY TO PRODUCE BATTERIES WILL HAVE A MATERIAL ADVERSE IMPACT
ON OUR ABILITY TO GROW REVENUES AND MAINTAIN OUR CUSTOMER BASE.

During the third and fourth quarter of fiscal 2006 we experienced problems in
our production processes that limited our ability to produce a sufficient number
of batteries to meet the demands of our customers. These production issues have
had a negative impact on gross margins as manufacturing yields have suffered.
Any inability to timely produce batteries may have a material adverse impact on
our ability to grow revenues and maintain our customer base.

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

Currently, we do not have sufficient capital resources, 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 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. 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;




                                       25
<PAGE>

     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 or 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 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 $510.6 million as of December 31, 2006. 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 2007. 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 $16.4 million for the
nine-month period ended December 31, 2006, a net loss available to common
stockholders of $32.9 million for the fiscal year ended March 31, 2006 and a net
loss available to common stockholders of $32.2 million for the fiscal year ended
March 31, 2005. 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 and may be required to
liquidate our assets.

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 have and will continue to have a significant amount of indebtedness and other
obligations. As of December 31, 2006, we had approximately $69.9 million of
total consolidated indebtedness. Included in this amount are $33.7 million of
loans outstanding to an affiliate, $17.7 million of accumulated interest
associated with those loans and $18.5 million of principal and interest
outstanding with a third party finance company. Our substantial indebtedness and
other obligations could negatively impact our operations in the future. For
example, it could:

     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;


                                       26
<PAGE>


     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 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. Berg or related entities. If we fail to meet our obligations pursuant to
these loan agreements, these lenders 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 nine-month period ended December 31,
2006, Segway Inc., D&H Distributing Co., Inc., and PC Connection, Inc.
contributed 52%, 11%, and 9%, of our revenues, 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 we, or our customers, 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.

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 our
customers' changing needs and to develop products that receive widespread
customer acceptance could significantly harm our results of operations.


                                       27
<PAGE>


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 our 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
foreign owned enterprises in China. We currently manufacture our batteries and
assemble our products in China. 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. We have experienced
production process issues, which have limited our ability to produce a
sufficient number of batteries to meet current demand. If we fail to correct
these issues in a manner that allows us to meet customer demand, or if any of
our manufacturing partners are unable to manufacture products in commercial
quantities on a timely and cost-effective basis, we could lose our 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 product 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;


                                       28
<PAGE>


     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

     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 THREE 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'S 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.
We may not be able to find or retain suitable employees in China and we may have
to train personnel to perform necessary functions for our manufacturing, senior
management and development operations. This may divert management's attention,
lead to disruptions in operations and delay implementation of our business
strategy, all of which could negatively impact our profitability.

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 product 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 or phosphate, which may reduce or
          eliminate our ability to sell or license in certain markets;


                                       29
<PAGE>

     o    foreign governments may impose 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;

     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 have had 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 DEVELOPMENT AND PRODUCT
IMPLEMENTATION 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 be certain 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 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



                                       30
<PAGE>


economy as a whole, and many of our customers are in industries that also
are viewed as under-performing in 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.

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 are issued 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 be issued. Furthermore,
if these patent applications issue, some foreign countries provide significantly
less effective patent enforcement than in 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
ADVANTAGES OF OUR RESEARCH AND MANUFACTURING SYSTEMS.

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
others 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.


                                       31
<PAGE>


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 are currently
engaged in one intellectual property proceeding alleging the Company's
SAPHION(R) I cathode material infringes two patents owned by the University of
Texas, while the Company believes it has strong defenses to such allegations, an
adverse decision could force us to do one or more of the following:

     o    stop selling, incorporating, or using our products that use the
          SAPHION(R) I cathode material challenged intellectual property;

     o    pay damages for the use of SAPHION(R) I cathode material;

     o    obtain a license to sell or use the SAPHION(R) I cathode material,
          which license may not be available on reasonable terms, or at all; or

     o    redesign those products or manufacturing processes that use the
          SAPHION(R) I cathode material, which may not be economically or
          technologically feasible.

We may become involved in more litigation and proceedings in the future. In the
future we may be subject to claims or an inquiry regarding our alleged
unauthorized use of a third party's intellectual property. An adverse outcome in
such future litigation could result in similar risks as noted above with respect
to the third party's intellectual property. 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.

                  RISKS ASSOCIATED WITH DOING BUSINESS IN CHINA

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

We manufacture and export our products from China. Our products sold in the
United States are currently not subject to U.S. import duties. On September 19,
2000, the United States Senate voted to permanently normalize trade with China,
which provides a favorable category of United States 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 ("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 affect 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 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.


                                       32
<PAGE>



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 such 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.

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 in 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, substantially increase taxes on foreign businesses or 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 effects 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 ("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


                                       33
<PAGE>



     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 structure 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 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 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 disaster 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 among
enterprises 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 there is no assurance 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, such a
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


                                       34
<PAGE>


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 AUTHORITY.

China's turnover tax system consists of value-added tax ("VAT"), consumption tax
and business tax. Export sales are exempted under VAT rules and an exporter who
incurs 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 value-added
tax 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 revisions to tax laws or their interpretation,
which could increase our VAT and various tax liabilities.

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

A renewed outbreak of SARS, avian 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.

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
and 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 even 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 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.



                                       35
<PAGE>


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 exploitations 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 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 or 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
domestically and internationally. Under 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), and U-Charge(R) Power System
currently fall within the level such that they are not exempt and require a
Class 9 designation for transportation. The revised United 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 and 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 February 2, 2007, our officers, directors and their affiliates as a group
beneficially owned approximately 48.0% of our outstanding common stock. Carl
Berg, our chairman of the board, beneficially owns approximately 46.0% 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:


                                       36
<PAGE>

     o    vote for the 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 interest 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 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 February 2, 2007, the
closing price of our common stock was $1.57. 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,

     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.



                                       37
<PAGE>


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 102,939,645 shares of common stock as of
December 31, 2006. In addition, at December 31, 2006, we had 12,155,008 shares
of our common stock reserved for issuance under warrants and stock options
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 may need to issue up to 2,174,242 and 1,454,392 shares,
respectively, of our common stock (based on a conversion price of $1.98 and
$2.96, respectively).

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 independent registered public
accounting firm's audit of that assessment has required, and continues to
require, the commitment of significant financial and managerial resources. There
is no assurance 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, Chief Financial Officer, or
independent registered public accounting firm determine that our internal
controls over financial reporting are not effective as defined under Section 404
of the Sarbanes-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." On
July 13, 2005, in connection with a $20.0 million loan agreement with a third
party finance company with an adjustable interest rate equal to the greater of
6.75% or the sum of the LIBOR rate plus 4.0% (9.375% at December 31, 2006), we
entered into a rate cap agreement which caps the LIBOR rate at 5.5% (On January
8, 2007, the most recent adjustment date, the LIBOR rate was 5.32%) In addition,
we are exposed to financial market risks, including changes in foreign currency
exchange rates and interest rates.



                                       38
<PAGE>


We also have long-term debt in the form of two loans to a stockholder, which
mature in September 2008, and one loan to a third party finance company which
matures in July 2010. The first loan to the stockholder has an adjustable rate
of interest at 1.0% above the lender's borrowing rate (9.0% at September 30,
2006) and the second loan to the stockholder has a fixed interest rate of 8.0%.
The loan to the third party finance company has a monthly floating interest rate
as described above. The table below presents principal amounts by fiscal year
for our long-term and short-term debt:

<TABLE>
<CAPTION>

                              2007   2008    2009           2010       2011    THEREAFTER        TOTAL
                                                  (dollars in thousands)

<S>                     <C>      <C>    <C>    <C>            <C>    <C>                <C>    <C>
Liabilities:
Fixed rate debt           $       -       -   20,000           -          -             -  $   20,000
Variable rate debt        $       -       -   14,950           -          -             -  $   14,950
Variable rate debt        $       -       -        -           -     20,000             -  $   20,000
</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

The term "disclosure controls and procedures" refers to the controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by the company in the reports that it files under the Securities
Exchange Act of 1934 ("Exchange Act") is recorded, processed, summarized and
reported, within required time periods. Disclosure controls and procedures,
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports the Company files or submits
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer as appropriate
to allow timely decisions regarding required disclosure. Our management, with
the participation of our Chief Executive Officer and Chief Financial Officer
carried out an evaluation of the effectiveness of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-15(b).

MATERIAL WEAKNESS IN INTERNAL CONTROL OVER FINANCIAL REPORTING

A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.

Management conducted an evaluation of the effectiveness of internal control over
financial reporting based on the framework in Internal Control. Management
determined there were an insufficient number of personnel with appropriate
technical accounting and SEC reporting expertise to perform a timely financial
close process, adhere to certain control disciplines, and to evaluate and
properly record certain non-routine and complex transactions. Management
determined that this control deficiency constitutes a material weakness.

CHANGES IN INTERNAL CONTROLS

There was no change in our internal controls during the fiscal first and second
quarters of 2007 that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.


                                       39
<PAGE>



                          PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

On February 14, 2006, Hydro-Quebec filed an action against us in the United
States District Court for the Western District of Texas (Hydro-Quebec v. Valence
Technology, Civil Action No. A06CA111). In its amended complaint filed April 13,
2006, Hydro-Quebec alleges that Saphion(R) Technology, the technology utilized
in all of our commercial products, infringes U.S. Patent No. 5,910,382 and
6,514,640 exclusively licensed to Hydro-Quebec. Hydro-Quebec's complaint seeks
injunctive relief and monetary damages. The action is in the initial pleading
state and we have filed a response denying the allegations in the amended
complaint. Our management believes the action by Hydro-Quebec is without merit
and intends to vigorously defend the lawsuit, as well as pursue all of its
available legal remedies. The court has issued a stay of proceedings pending the
outcome of reexaminations of the two patents by the US Patent and Trademark
Office.

We are subject to, from time to time, various claims and litigation in the
normal course of business. 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 consolidated financial statements

ITEM 1A. RISK FACTORS

Information regarding risk factors appears in Item 2 "Management's Discussion
and Analysis of Financial Condition and Results of Operations," and various risk
factors faced by us are also discussed elsewhere in Item 2 of this report. In
addition, risk factors are included in Item 1A of our Annual Report on Form 10-K
for our fiscal year ending March 31, 2006, filed with the Commission on June 29,
2006. There are no material changes from the risk factors previously disclosed
on our Annual Report on Form 10-K for the fiscal year ending March 31, 2006.
..

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

None.

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>
10.10 (1)              Letter from Helin, Donovan, Trubee & Wilkinson, LLP dated February 6, 2007.

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 Thomas F. Mezger, 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 Executive Officer, pursuant to 18 U.S.C.
                       Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



                                       40

32.2                   Certification of Thomas F. Mezger, Principal Financial Officer, pursuant to 18 U.S.C.
                       Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

FOOTNOTES
 (1)                       Incorporated by reference to the exhibit so described
                           in the Company's Current Report on Form 8-K, dated
                           February 6, 2007, filed with the Securities and
                           Exchange Commission on February 6, 2007.

</TABLE>


                                       41
<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.


Dated:  February 6, 2007         By:     /s/ James R. Akridge
                                         ---------------------------------------
                                         James R. Akridge
                                         Chief Executive Officer (Principal
                                         Executive Officer)


                                 By:     /s/ Thomas F. Mezger
                                         ---------------------------------------
                                         Thomas F. Mezger
                                         Chief Financial Officer and Assistant
                                         Secretary (Principal Financial Officer)





                                       42
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EXHIBIT INDEX

EXHIBIT NO.

<S>                     <C>
10.10 (1)              Letter from Helin, Donovan, Trubee & Wilkinson, LLP dated February 6, 2007.

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 Thomas F. Mezger, 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 Executive Officer, pursuant to 18 U.S.C.
                       Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2                   Certification of Thomas F. Mezger, Principal Financial Officer, pursuant to 18 U.S.C.
                       Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


FOOTNOTES
 (1)                       Incorporated by reference to the exhibit so described
                           in the Company's Current Report on Form 8-K, dated
                           February 6, 2007, filed with the Securities and
                           Exchange Commission on February 6, 2007.

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