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, 2005.

                                       or

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

For the transition period from ____________ to ____________

Commission file number 0-20028

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

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


     6504 BRIDGE POINT PARKWAY,
          AUSTIN, TEXAS                            78730
(Address of Principal Executive Offices)           (Zip Code)

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

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

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

                       Yes [X]       No  [  ]

Indicate by check mark whether the registrant is 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 [  ]  Accelerated filer [X]  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                      89,745,984
             (Class)                         (Outstanding at January 29, 2006)


<PAGE>


                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES


                                    FORM 10-Q

                     FOR THE QUARTER ENDED DECEMBER 31, 2005




                         INDEX

                                                                           Pages


Part I.    Financial Information

  Item 1.  Financial Statements (Unaudited):

           Condensed Consolidated Balance Sheets as of
           December 31, 2005 and March 31, 2005................................1

           Condensed Consolidated Statements of Operations and
           Comprehensive Loss for Each of the Three- and Nine-
           Month Periods Ended December 31, 2005 and December 31, 2004.........2

           Condensed Consolidated Statements of Cash Flows for
           the Nine- Month Periods Ended
           December 31, 2005 and December 31, 2004.............................3

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

  Item 2.  Management's Discussion and Analysis of Financial
           Condition and Results of Operations................................16

  Item 3.  Quantitative and Qualitative Disclosures about Market Risk.........39

  Item 4.  Controls and Procedures............................................39


Part II.   Other Information

  Item 1.  Legal Proceedings..................................................41

  Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds........41

  Item 3.  Defaults upon Senior Securities....................................41

  Item 4.  Submission of Matters to a Vote of Security Holders................41

  Item 5.  Other Information..................................................41

  Item 6.  Exhibits ..........................................................41

Signature  ...................................................................43


<PAGE>



                         PART I - FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS (UNAUDITED)

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

<TABLE>
<CAPTION>

                                                                         December 31, 2005            March 31, 2005
<S>                                                                             <C>                          <C>
                                                                        ----------------------       --------------------
ASSETS
Current assets:
   Cash and cash equivalents                                             $      1,832                 $      2,500
   Trade receivables, net of allowance of $99 and $115 as of
      December 31, 2005 and March 31, 2005                                      3,940                        1,464
   Inventory                                                                    5,172                        2,564
   Prepaid and other current assets                                             2,352                          920
                                                                       -----------------------       --------------------
      Total current assets                                                     13,296                        7,448
Property, plant and equipment, net                                              3,125                        2,383
Intellectual property, net                                                        314                          400
                                                                       -----------------------       --------------------
      Total assets                                                       $     16,735                 $     10,231
                                                                       =======================      =====================

LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities
   Accounts payable                                                      $      3,458                 $      3,251
   Accrued expenses                                                             4,393                        4,607
   Deferred revenue                                                               406                        1,241
     Note payable to stockholder                                                1,000                            -
                                                                       -----------------------       --------------------
      Total current liabilities                                                 9,257                        9,099
Long-term interest                                                             14,772                       12,536
Long-term debt, less unaccreted debt discount                                  17,822                            -
Long-term debt to stockholder, less unaccreted debt discount                   32,986                       34,656
                                                                       -----------------------       --------------------
   Total liabilities                                                           74,837                       56,291
                                                                       -----------------------       --------------------
Redeemable convertible preferred stock, $0.001 par value, 861 shares
authorized, issued and outstanding as of December 31, 2005, and
1,000 shares authorized, 861 issued and outstanding as of March 31,             8,610                        8,582
2005, liquidation value $8,610
                                                                       -----------------------       --------------------

Stockholders' equity (deficit):
Common stock, $0.001 par value, 200,000,000 shares authorized;
89,745,984 and 87,061,639 shares outstanding as of
December 31, 2005 and March 31, 2005                                               90                           87
Additional paid-in capital                                                    426,737                      415,745
Deferred compensation                                                            (120)                         (89)
Notes receivable from stockholder, net of allowance of $1.2 million
  as of December 31, 2005                                                      (3,890)                      (5,164)
Accumulated deficit                                                          (485,862)                    (461,328)
Accumulated other comprehensive loss                                           (3,667)                      (3,893)
                                                                       -----------------------       --------------------
    Total stockholders' deficit                                                (66,712)                    (54,642)
                                                                       -----------------------     ----------------------
    Total liabilities, preferred stock and stockholders' deficit         $     16,735               $       10,231
                                                                       =======================     ======================

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


</TABLE>
<PAGE>



                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
     CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                    (in thousands, except per share amounts)
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                       Three Months Ended              Nine Months Ended
                                                          December 31,                    December 31,
<S>                                                   <C>              <C>                <C>            <C>
                                                 -------------    --------------    -------------    ------------
                                                      2005             2004              2005            2004
                                                 -------------    --------------    -------------    ------------
Revenue:
     Licensing and royalty revenue                 $    254          $     94         $    571       $     279
     Battery and system sales                         4,565             2,453           13,171           8,019
                                                 -------------    --------------    -------------   -------------
         Total revenues                               4,819             2,547           13,742           8,298
Cost of Sales:                                        5,971             4,305           18,642          11,858
                                                 -------------    --------------    -------------   -------------
Gross profit (loss)                                  (1,152)           (1,758)          (4,900)         (3,560)
Operating expenses:
     Research and product development                 1,185             1,962            3,961           5,597
     Marketing                                          420               859            1,661           3,146
     General and administrative                       3,759             3,415           10,224           9,463
     Depreciation and amortization                      178               154              528             713
     (Gain) Loss on disposal of
        property, plant and equipment                    11            (4,172)            (611)         (4,643)
     Contract settlement charges, INI                     0               957                0             957
     Contract settlement charges, other                   0               541                0             541
     Asset impairment charge                            170                 -              170              87
                                                 -------------    --------------    -------------   -------------
         Total costs and expenses                     5,723             3,716           15,933          15,861
                                                 -------------    --------------    -------------   -------------
Operating loss                                       (6,875)           (5,474)         (20,833)        (19,421)
Interest and other income                               138               114              425             265
Interest and other expense                           (1,524)           (1,064)          (3,996)         (3,135)
                                                 -------------    --------------    -------------   -------------
Net loss                                             (8,261)           (6,424)         (24,404)        (22,291)
Dividends on preferred stock                             43                43              130             130
Preferred stock accretion                                 7               142               28             577
                                                 -------------    --------------    -------------   -------------
Net loss available to common stockholders            (8,311)        $  (6,609)        $(24,562)      $ (22,998)
                                                 =============    ==============    =============   =============
Other comprehensive loss:
     Net loss                                        (8,261)        $  (6,424)        $(24,404)      $ (22,291)
     Change in foreign currency translation
     adjustments                                         36                90              226             121
                                                 -------------    --------------    -------------    ------------
      Comprehensive loss                           $ (8,225)        $  (6,334)        $(24,178)      $ (22,170)
                                                 =============    ==============    =============    ============
Net loss per share available to common
stockholders                                       $  (0.09)        $   (0.08)        $  (0.28)      $   (0.29)
                                                 =============    ==============    =============    ============
Shares used in computing net loss per share
available to common stockholders, basic and
diluted.                                             89,715            82,431             89,223        79,575
                                                 =============    ==============    =============    ============


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

</TABLE>
<PAGE>



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

<TABLE>
<CAPTION>

                                                                               Nine Months Ended December 31,
                                                                        ------------------    ------------------
                                                                                2005                 2004
                                                                        ------------------    ------------------
<S>                                                                             <C>               <C>

Cash flows from operating activities:
Net loss                                                                 $    (24,404)         $    (22,291)
Adjustments to reconcile net loss to net cash used in
   operating activities:
     Depreciation and amortization                                                528                   713
     Asset impairment charge                                                      170                    87
     Contract settlement expenses                                                   -                   957
     Contract settlement payment to INI                                             -                (3,243)
     Gain on disposal of property, plant, equipment                              (611)               (4,065)
     Accretion of debt discount and other                                         770                   530
     Interest income on stockholder note receivable                              (210)                 (235)
     Reserve for stockholder note receivable                                    1,205
     Deferred compensation expense                                                (31)                 (154)
     Stock compensation expense                                                   203                     -
Changes in operating and other assets and liabilities:
     Trade receivables                                                         (2,476)                 (179)
     Inventory                                                                 (2,608)               (1,977)
     Prepaid and other current assets                                          (1,432)                 (337)
     Accounts payable                                                             207                 1,155
     Accrued expenses and long-term interest                                    2,022                 4,467
     Deferred revenue                                                            (835)                 (435)
                                                                        ------------------    ------------------
         Net cash (used in) provided by operating activities                  (27,502)              (25,007)
                                                                        ------------------    ------------------

Cash flows from investing activities:
     Effects of deconsolidation of joint venture                                    -                  (913)
     Purchases of property, plant & equipment                                  (1,355)                 (755)
     Proceeds from sale of property, plant & equipment                            611                 8,996
                                                                        ------------------    ------------------
         Net cash (used in) provided by investing activities                     (744)                7,328
                                                                        ------------------    ------------------

Cash flows from financing activities:
     Proceeds from note payable to stockholder                                  1,000
     Proceeds from long-term debt                                              19,639                    -
     Payment of long-term debt                                                      -                (6,741)
     Dividends paid                                                              (130)                 (130)
     Interest received on stockholder note receivable                             281                   301
     Cost of exchange of preferred stock                                                                (28)
     Proceeds from stock option exercises                                         656                   443
     Proceeds from issuance of common stock, net of issuance costs              5,906                26,005
                                                                        ------------------    ------------------
         Net cash provided by financing activities                             27,352                19,850
                                                                        ------------------    ------------------

Effect of foreign exchange rates on cash
     and cash equivalents                                                         226                   474
                                                                        ------------------    ------------------
Increase (decrease) in cash and cash equivalents                                 (668)                2,645
Cash and cash equivalents, beginning of period                                  2,500                 2,692
                                                                        ------------------    ------------------
Cash and cash equivalents, end of period                                 $      1,832          $      5,337
                                                                        ==================    ==================

Supplemental information:
     Issuance of common stock to INI for grant payable                   $          -          $       1,916
 The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
<PAGE>


                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2005
                                   (Unaudited)

1.   INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:

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

2.   BUSINESS AND BUSINESS STRATEGY:

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

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

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

On July 13, 2005, the Company  appointed Dr. James R. Akridge to succeed Stephan
Godevais  as its  Chief  Executive  Officer.  On  August 3,  2005,  the  Company
appointed Dr. Akridge to succeed Mr. Godevais as its president.  On September 9,
2005, the Company appointed Thomas F. Mezger as its new Chief Financial Officer.

<PAGE>

3.   LIQUIDITY AND CAPITAL RESOURCES:

At December 31, 2005, the Company's principal sources of liquidity were cash and
cash equivalents of $1.8 million and a $10.4 million  remaining on a $20 million
funding  commitment  made by Mr. Carl Berg,  chairman of the Company's  board of
directors  and its principal  stockholder  on June 13, 2005. Of the original $20
million  commitment,  $8.6  million was  applied to the  purchase by Berg & Berg
Enterprises  ("Berg & Berg"),  an affiliate of Mr. Berg, of the Company's Series
C-2 Convertible  Preferred  stock and Series C-1 Convertible  Preferred Stock in
July 2005 and December 2005. These  transactions are more fully discussed below.
Mr. Berg's funding  commitment was reduced by $1.0 and 2.0 million in connection
with  loans made by Berg & Berg on  December  27,  2005 and  January  19,  2005,
respectively.  The Company and Berg & Berg reached agreement on the terms of the
loans and the Company  issued new  promissory  notes on  February  3, 2006.  The
promissory  notes bear interest at the annual rate of 8% and mature on March 30,
2006. The outstanding principal amount of these notes may be converted by Berg &
Berg into shares of common  stock of the Company at any time before the maturity
date.  The loans  convert  at a  conversion  price  equal to 85% of the  average
closing bid price of the  Company's  common  stock  during the five trading days
prior to the  conversion  date,  provided that the  conversion  price can not be
lower  than  $1.90,  the  closing  bid price of the  Company's  common  stock on
February 2, 2006.  Following the issuance of these notes, Mr. Berg's  commitment
can be reduced by the amount of net proceeds  received from  subsequent  debt or
equity transactions (whether funded by Mr. Berg or a third party).

On July 13, 2005,  the Company  secured a $20.0  million loan from a third party
finance  company,  the full amount of which has been drawn down. Under the terms
of the loan  agreement,  which is  guaranteed  by Mr. Berg,  interest is payable
monthly and the entire  principal  balance is payable on July 13, 2010. The loan
bears  interest  per  annum at the  greater  of 6.75% or  LIBOR  plus  4.0%.  In
connection  with the loan the Company  purchased a rate cap agreement to protect
against  fluctuations  in LIBOR for the full  amount of the loan for a period of
three years.  The Company utilized $2.5 million of this loan to repay a June 30,
2005 draw from Mr. Berg under his funding commitment.

At December  31, 2005,  the Company had $4.3  million of Series C-1  Convertible
Preferred  Stock and $4.3  million of Series  C-2  Convertible  Preferred  Stock
outstanding,  all of which is  currently  held by Berg & Berg.  Pursuant  to the
terms of the two series of Convertible  Preferred  Stock, the preferred stock is
currently subject to redemption by the Company.  Berg & Berg has agreed that the
Company's  failure to redeem does not constitute a default under the certificate
of  designations  for either the Series C-1  Convertible  Preferred Stock or the
Series C-2 Convertible Preferred Stock and has waived the accrual of any default
interest  applicable in such  circumstances.  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 or the closing price
of the Company's  common stock on the conversion  date,  provided the conversion
price can be no lower than $1.98,  the closing bid price of the Company's common
stock on December 13, 2005 and (ii) 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 or the closing price of the Company's common stock on the conversion date,
provided the conversion  price can be no lower than $2.96, the closing bid price
of the Company's common stock on July 13, 2005.
<PAGE>

Currently,  the Company does not have sufficient  capital resources or sales and
gross profit to generate the cash flows required to meet the Company's operating
and capital  needs for the next 12 months.  Consequently,  one of the  Company's
primary  objectives has been to reduce  expenses and overhead,  which limits the
resources available for the development and  commercialization  of the Company's
technology.  The Company's limited  financial  resources could materially affect
the ability and the pace at which the  Company is able to  commercially  exploit
its Saphion(R) technology,  as well as other factors described under the Section
"Cautionary  Statements and Risk Factors."  Therefore,  the Company depends upon
its ability to periodically  arrange for additional  equity or debt financing to
meet its liquidity requirements.  Unless the Company's product sales are greater
than management  currently forecasts or there are other changes to the Company's
business plan, the Company will need to arrange for additional  financing within
the next three to six months in order to fund its operating  and capital  needs.
This  financing  could  take the form of debt or  equity.  Given  the  Company's
historical operating results and the amount of its existing debt, as well as the
other factors described under the section titled "Cautionary Statements and Risk
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  operations,  including  the  failure to achieve  expected
revenues, greater than expected expenses,  changes in OEM relationships,  market
conditions,  inability to  manufacture  products on a timely and cost  effective
basis,  the failure to timely realize our product  development  goals, and other
adverse developments. These events could have a negative impact on our available
liquidity sources during the next 12 months.

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

Impairment of Long-Lived Assets:

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

Stock-based Compensation:

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

<PAGE>

<TABLE>
<CAPTION>

                                                       Three Months Ended              Nine Months Ended
                                                          December 31,                    December 31,
<S>                                                   <C>              <C>                <C>            <C>
                                                 -------------    --------------    -------------    ------------
                                                      2005             2004              2005            2004
                                                 -------------    --------------    -------------    ------------
Net loss available to common stockholders         $  (8,311)       $                 $ (24,562)      $ (22,998)
  - as reported                                                        (6,609)
Add: stock-based compensation expense,
  net of related taxes                                 (639)           (1,024)          (1,917)         (3,071)
                                                 -------------    --------------    -------------    ------------
Net loss available to common stockholders            (8,950)           (7,633)         (26,479)        (26,069)
  - pro forma
Net loss available to common stockholders per
  share - as reported                                 (0.09)            (0.08)           (0.28)          (0.29)
Net loss available to common stockholders,
  basic and diluted, pro forma                        (0.10)            (0.09)           (0.30)          (0.33)

</TABLE>

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

<TABLE>
<CAPTION>
                                                      2006             2005
                                                -------------    --------------
<S>                                                   <C>              <C>
               Risk-free interest rate                 4.35%           3.62%
               Expected life                         5.00 years      5.00 years
               Volatility                              92.55%         103.14%
               Dividend yield                             -               -
</TABLE>

Recent Accounting Pronouncements:

In January 2003, the Financial  Accounting  Standards Board ("FASB") issued FASB
Interpretation  No. 46 ("FIN 46"),  Consolidation of Variable Interest Entities,
an  interpretation  of ARB NO. 51,  which  addresses  consolidation  by business
enterprises of variable interest entities ("VIEs") either:  (1) that do not have
sufficient  equity  investment  at risk to  permit  the  entity to  finance  its
activities without additional  subordinated  financial support,  or (2) in which
the equity investors lack an essential characteristic of a controlling financial
interest.   In  December  2003,   FASB  completed   deliberations   of  proposed
modifications  to  FIN  46  (Revised  Interpretations)   resulting  in  multiple
effective  dates  based on the nature as well as the  creation  date of the VIE.
VIEs  created  after  January  31,  2003,  but prior to January 1, 2004,  may be
accounted  for  either  based  on the  original  interpretation  or the  Revised
Interpretations.  However, the Revised  Interpretations must be applied no later
than the first  quarter of fiscal year 2004.  VIEs created after January 1, 2004
must be accounted for under the Revised  Interpretations.  The adoption of these
deferred  provisions in 2004 had no effect on the Company's  financial position,
results of operations or cash flows.
<PAGE>

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

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

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

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

Net Loss per Share:

Net loss per share is  computed  by dividing  the net loss  available  to common
stockholders by the weighted average shares of common stock  outstanding  during
the period.  The dilutive  effect of the options and warrants to purchase common
stock are excluded  from the  computation  of diluted net loss per share,  since
their effect is  antidilutive.  The antidilutive  instruments  excluded from the
diluted net loss per share  computation  for the three- and  nine-month  periods
ended December 31, 2005 and 2004 were as follows:
<PAGE>

<TABLE>
<CAPTION>
                                                       Three Months Ended              Nine Months Ended
                                                          December 31,                    December 31,
<S>                                                   <C>              <C>                <C>            <C>
                                                 -------------    --------------    -------------    ------------
                                                      2005             2004              2005            2004
                                                 -------------    --------------    -------------    ------------
Shares reserved for conversion of Series C
preferred stock                                   3,629,470         2,152,500         3,629,470        2,152,500
Common stock options                             11,774,226         9,698,000        11,774,226        9,698,000
Warrants to purchase common stock                 2,955,643         1,896,000         2,955,643        1,896,000
                                                 -------------    --------------    -------------    ------------
Total                                            18,359,339        13,746,500        18,359,339       13,746,500
                                                ==============    ==============   ==============    ============
</TABLE>



5.   INVENTORY:

Inventory consisted of the following (in thousands) at:
<TABLE>
<CAPTION>
                                                  December 31, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                     <C>

                    Raw materials                  $       1,518             $       464
                    Work in process                        2,273                     880
                    Finished goods                         1,381                   1,220
                                                --------------------     ------------------
                                                   $       5,172             $     2,564
                                                ======================    ==================
</TABLE>


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, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                     <C>

            Leasehold improvements                           659                     456
            Machinery and equipment                        6,339                   7,678
            Office and computer equipment                  1,834                   1,237
            Construction in progress                          46                      65
                                                --------------------     ------------------
              Total cost                                   8,878                   9,436
            Less:  accumulated depreciation               (5,530)                 (5,191)
            Less:  impairment                               (223)                 (1,862)
                                                --------------------     ------------------
              Total cost, net of depreciation     $        3,125             $     2,383
                                                ====================     ==================
</TABLE>
<PAGE>


An  impairment  charge of $170,425 was recorded  during the third  quarter ended
December  31,  2005,  pursuant  to  FASB  Statement  No.  144,  "Accounting  for
Impairment  or Disposal of  Long-Lived  Assets."  The charge  relates to certain
portions of the Company's information systems that are no longer in use.


7. INTELLECTUAL PROPERTY:

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

<TABLE>
<CAPTION>

                                                  December 31, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                     <C>
         Intellectual property before impairment  $       13,602                  13,602
         Less:  accumulated amortization                  (4,794)                 (4,708)
         Less:  Impairment                                (8,494)                 (8,494)
                                                ---------------------     ------------------
         Intellectual property, net               $          314             $       400
                                                =====================     ==================
</TABLE>

Amortization  expense for the three- and  nine-month  periods ended December 31,
2005, was approximately $29,000 and $87,000, respectively.  Amortization expense
for the three- and nine-month  periods ended December 31, 2004 was approximately
$29,000 and $87,000, respectively. Amortization expense on intellectual property
at December 31, 2005,  will be  approximately  $29,000 for the  remaining  three
months of fiscal 2006 and will be  approximately  $114,000 in fiscal  years 2007
through 2008, and approximately $58,000 for fiscal 2009.

8. DEBT:
<TABLE>
<CAPTION>

          (in thousands)                          December 31, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                     <C>
         2005 Loan balance                        $       20,000             $         -
         2001 Loan balance                                20,000                  20,000
         1998 Loan balance                                14,950                  14,950
         Note Payable to Stockholder                       1,000                       -
         Unaccreted debt discount                         (4,142)                   (294)
                                                ---------------------     ------------------
         Balance                                  $       51,808             $    34,656
                                                ---------------------     ------------------
</TABLE>
<PAGE>


In October 2001,  the Company  entered into a loan  agreement  (the "2001 Loan")
with  Berg & Berg.  Under  the  terms of the  agreement,  Berg & Berg  agreed to
advance  the  Company  funds  of up to  $20.0  million  between  the date of the
agreement  and December 31, 2003.  Interest on the 2001 Loan accrues at 8.0% per
annum, payable from time to time. On July 13, 2005, Berg & Berg agreed to extend
the maturity  date for the loan from  September 30, 2006, to September 30, 2008,
and the Company  granted to Berg & Berg a 90-day  option,  effective  October 1,
2006,  to require  that  interest  will accrue on the loan as compound  interest
rather than as simple interest. On November 8, 2002, the Company and Berg & Berg
amended an  affirmative  covenant in the  agreement  to  acknowledge  The Nasdaq
SmallCap Market as an acceptable  market for the listing of the Company's common
stock.  As of December 31,  2005,  accrued  interest on the loan  totaled  $6.31
million,  which is included in long-term interest.  In conjunction with the 2001
Loan,  Berg & Berg  received  a  warrant  to  purchase  1,402,743  shares of the
Company's  common  stock at the price of  $3.208  per  share.  The  warrant  was
exercisable  beginning  on the  date it was  issued  and on July  13,  2005  the
expiration  date  of the  warrants  was  extended  to  September  30,  2008,  in
consideration  for  extending  the  maturity  date of the loans.  The fair value
assigned to these warrants,  totaling  approximately  $2.332  million,  has been
reflected as  additional  consideration  for the debt  financing,  recorded as a
discount on the debt and accreted as interest expense over the life of the loan.
The warrants  were valued  using the  Black-Scholes  valuation  method using the
assumptions of a life of 38 months,  96.45% volatility,  and a risk free rate of
3.88%.  Through  December 31, 2005, a total of  approximately  $368,000 has been
accreted  and  included as  interest  expense.  The amounts  charged to interest
expense  on the  outstanding  balance  of the loan  for each of the  three-month
periods ended December 31, 2005 and 2004 was $409,000. Interest expense for each
of the  nine-month  periods ended  December 31, 2005 and 2004 was $1.22 million.
Interest payments on the loan are currently being deferred,  and are recorded as
long-term interest.

In July 1998,  the Company  entered  into an amended loan  agreement  (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, 2005, the Company had an outstanding
balance of $14.95 million under the 1998 Loan agreement. The loan bears interest
at one percent over the lender's borrowing rate  (approximately 9.0% at December
31, 2005).  On July 13, 2005, the parties  agreed to extend the loan's  maturity
date from September 30, 2006 to September 30, 2008,  and the Company  granted to
Berg & Berg a 90-day option, effective October 1, 2006, to require that interest
will accrue on the loan as compound  interest.  On November 8, 2002, the Company
and Berg & Berg amended an affirmative  covenant in the agreement to acknowledge
The  Nasdaq  SmallCap  Market as an  acceptable  market  for the  listing of the
Company's  common stock. As of December 31, 2005,  accrued  interest on the loan
totaled $8.464 million, which is included in long term interest. In fiscal 1999,
the Company issued to Berg & Berg warrants to purchase  594,031 shares of common
stock in  conjunction  with the 1998 Loan  agreement,  as amended.  The warrants
expired on June 16, 2004. The amount charged to interest expense for each of the
three-month  periods  ended  December 31, 2005 and 2004 was  $339,000.  Interest
expense for each of the nine-month  periods ended December 31, 2005 and 2004 was
$1.014 million.  Interest payments on the loan are currently being deferred, and
are recorded as long-term interest.
<PAGE>


On June 13, 2005, the Company  obtained a $20.0 million funding  commitment from
Mr.  Berg.  On June 30,  2005,  the  Company  drew down $2.5  million  from this
commitment  in the form of a loan,  which was  repaid in full by the  Company on
July 13, 2005,  including  interest at an annual rate of 5.0%. The amount of Mr.
Berg's funding commitment was reduced to $10.4 million in connection with Berg &
Berg's purchase of the Series C-2 Convertible Preferred Stock in July 2005, Berg
& Berg's  purchase  of the Series C-1  Convertible  Preferred  Stock in December
2005, and a $1.0 million loan from Berg & Berg in December 2005. This commitment
was further reduced by a $2.0 million loan from Berg & Berg in January 2006. The
terms of the  December  2005 and  January  2006 loans were not agreed upon until
February 3, 2006,  when the Company issued two promissory  notes  evidencing the
loans. The promissory notes bear interest at the annual rate of 8% and mature on
March 30, 2006. The outstanding principal amount of these notes may be converted
by Berg & Berg into shares of common stock of the Company at any time before the
maturity  date.  The loans  convert at a  conversion  price  equal to 85% of the
average closing bid price of the Company's  common stock during the five trading
days prior to the conversation date,  provided that the conversion price can not
be lower than  $1.90,  the closing bid price of the  Company's  common  stock on
February 2, 2006.

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%  (8.375% as of  December  31,
2005).  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 reflected as additional  consideration for the debt financing,
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  over the life of the loan.  Through  December 31,
2005,  a total of  approximately  $225,000  has been  accreted  and  included as
interest  expense.  The amounts  charged to interest  expense on the outstanding
balance of the loan for each of the three- and nine-month periods ended December
31, 2005 was $416,000 and $754,000.  Interest payments on the loan are currently
being paid on a monthly basis.

9. 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  Aladdin  Power  Systems,
K-Charge(TM) Power Systems and its U-Charge(TM) Power Systems. In addition,  the
Company has  established  a reserve for its 30-day right of return  policy under
which a direct customer may return a purchased  N-Charge(TM)  Power System.  The
total warranty liability as of December 31, 2005 is $1.369 million.
<PAGE>

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

<TABLE>
<CAPTION>

                                                  December 31, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                       <C>
            Beginning balance                     $   1,067                          490
              Less:  claims                            (671)                        (695)
              Less:  returns                             (2)                         (33)
              Plus:  accruals                           975                        1,305
                                                ---------------------     ------------------
            Ending balance                        $   1,369                  $     1,067
                                                =====================     ==================
</TABLE>


Litigation:

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

10. REDEEMABLE CONVERTIBLE PREFERRED STOCK:

On June 2,  2003,  the  Company  issued  1,000  shares of  Series C  Convertible
Preferred Stock and warrants to purchase the Company's  common stock for $10,000
per share,  raising net proceeds of $9.416  million.  On January 22,  2004,  the
holder of the Series C Convertible  Preferred  Stock  converted 139 of its 1,000
shares with the principal amount of $1.39 million,  including accrued and unpaid
dividends,  into 327,453 shares of the Company's  common stock at the conversion
price of $4.25 per share.  On November  30,  2004,  the Company  entered into an
amendment and exchange  agreement to exchange all of the  outstanding 861 shares
of the Company's Series C Convertible Preferred Stock, representing $8.6 million
of  principal.  The Series C Convertible  Preferred  Stock was exchanged for 431
shares of Series C-1 Convertible  Preferred  Stock,  with a stated value of $4.3
million, and 430 shares of Series C-2 Convertible Preferred Stock, with a stated
value of $4.3 million.  When issued, the Series C-1 Convertible  Preferred Stock
and the Series C-2  Convertible  Preferred  Stock were  convertible  into common
stock at $4.00 per share.  Each  series  carries a 2.0%  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.

Pursuant to  assignment  agreements  entered into between the Company and Berg &
Berg  in  July  2005  and  December,  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 Valence to redeem
the  preferred  stock on December 15, 2005 shall not  constitute a default under
<PAGE>

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 or the closing price
of the  Company's  common  stock on  December  13,  2005 and (ii) 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 or the closing price of the Company's  common
stock on the  conversation  date,  provided the conversion price can be no lower
than  $2.96,  the closing bid price of the  Company's  common  stock on July 13,
2005.

In connection with the issue of the original  issuance of the Company's Series C
Convertible  Preferred  Stock in June 2003,  the Company  issued to the original
purchaser 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.

11. RELATED PARTY TRANSACTIONS:

On June 13, 2005, Mr. Berg agreed to provide an additional $20.0 million funding
commitment. This funding commitment can take the form of debt or equity. On June
30, 2005, the Company drew down $2.5 million of this commitment.  This draw took
the form of a bridge  loan at a 5.0%  annual  interest  rate and was repaid with
proceeds from the 2005 Loan. 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  original $20.0 million 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.
Additionally,  on December 27, 2005 and January 19,  2006,  the  commitment  was
reduced  by $1.0  million  and $2.0  million,  respectively,  when  the  Company
borrowed  the amounts  from Berg & Berg,  which  borrowings  were  evidenced  by
promissory  notes issues on February 3, 2006. The promissory notes bear interest
at the annual rate of 8% and mature on March 30, 2006. The outstanding principal
amount of these  notes  may be  converted  by Berg & Berg into  shares of common
stock of the company at any time before the maturity  date. The loans convert at
a  conversion  price  equal  to 85% of the  average  closing  bid  price  of the
Company's  common stock  during the five  trading  days prior to the  conversion
date,  provided  that the  conversion  price can not be lower  than  $1.90,  the
closing bid price of the Company's  common stock on February 2, 2006. Mr. Berg's
funding commitment will be reduced by the amount of net proceeds received from a
debt or equity transaction. Berg & Berg is an affiliate of Carl Berg, a director
and principal stockholder of the Company.

In June 2004,  Mr. Berg agreed to provide an  additional  $20.0  million  backup
equity funding  commitment.  This additional funding commitment came in the form
of an equity  line of credit and  allowed  the  Company to request  Mr.  Berg to
purchase  shares of common  stock from time to time at the  average  closing bid
price of the stock for the five days prior to the purchase  date. As of June 30,
2005, the Company has drawn down the full amount of this commitment.
<PAGE>

At December  31, 2005,  the Company had $4.3  million of Series C-1  Convertible
Preferred  Stock and $4.3  million of Series  C-2  Convertible  Preferred  Stock
outstanding,  all of  which  is  currently  held  by Berg &  Berg.  Pursuant  to
assignment agreements entered into between the Company and Berg & Berg, (i) Berg
& Berg  acquired  the  Series  C-2  Convertible  Preferred  Stock and Series C-1
Convertible  Preferred  Stock for an  aggregate of $8.6  million  (plus  accrued
dividends),  (ii) Berg & Berg agreed that the  Company's  failure to redeem does
not constitute a default under the  certificate of  designations  for either the
Series C-1 Convertible  Preferred Stock or the Series C-2 Convertible  Preferred
Stock  and  waived  the  accrual  of any  default  interest  applicable  in such
circumstances  and (iii) the Company has agreed that the Series C-1 Stock may be
converted at any time into the  Company's  common stock at the lower of $4.00 or
the closing price of the Company's common stock on the conversion date, provided
the  conversion  price can be no lower than $1.98,  the closing bid price of the
Company's  common stock on December  13,  2005,  and the Series C-2 Stock may be
converted at any time into the  Company's  common stock at the lower of $4.00 or
the closing price of the Company's common stock on the conversion date, provided
the  conversion  price can be no lower than $2.96,  the closing bid price of the
Company's common stock on July 13, 2005.

In October 2001,  the Company  entered into a loan  agreement  (the "2001 Loan")
with  Berg & Berg.  Under  the  terms of the  agreement,  Berg & Berg  agreed to
advance  the  Company  funds  of up to  $20.0  million  between  the date of the
agreement  and December 31, 2003.  Interest on the 2001 Loan accrues at 8.0% per
annum, payable from time to time. On July 13, 2005, Berg & Berg agreed to extend
the maturity  date for the loan from  September 30, 2006, to September 30, 2008,
and the Company  granted to Berg & Berg a 90-day  option,  effective  October 1,
2006,  to require  that  interest  will accrue on the loan as compound  interest
rather than as simple interest.

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, 2005, the Company had an outstanding
balance of $14.95 million under the 1998 Loan agreement. The loan bears interest
at one percent over the lender's borrowing rate  (approximately 9.0% at December
31, 2005).  On July 13, 2005, the parties  agreed to extend the loan's  maturity
date from September 30, 2006 to September 30, 2008,  and the Company  granted to
Berg & Berg a 90-day option, effective October 1, 2006, to require that interest
will accrue on the loan as compound interest.

On January 1, 1998,  the  Company  granted Mr. Lev Dawson,  the  Company's  then
Chairman of the Board, Chief Executive Officer and President, an incentive stock
option to purchase  39,506 shares,  which was granted  pursuant to the Company's
1990 Plan (the "1990  Plan").  The Company also granted Mr.  Dawson an option to
purchase  660,494  shares  pursuant to the Company's 1990 Plan, and an option to
purchase  300,000 shares was granted  outside of any equity plan of the Company,
neither of which were incentive stock options (the "Nonstatutory  Options"). The
exercise price of all three options is $5.0625 per share,  the fair market value
on the date of the grant. The Compensation Committee of the Company approved the
early  exercise  of the  Nonstatutory  Options  on March 5,  1998.  The  options
permitted  exercise by cash, shares,  full-recourse  notes or non-recourse notes
secured by independent  collateral.  The Nonstatutory  Options were exercised on
March 5, 1998 with non-recourse  promissory notes in the amounts of $3.3 million
("Dawson  Note One") and $1.5 million  ("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, 2005,  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.
<PAGE>

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

For the  quarter  ended  December  31,  2005,  the  Company has taken a bad debt
reserve  against  "Dawson  Note  One" and  "Dawson  Note  Two"  equal to $1.205
million,  which was included in general and  administrative  expenses within the
accompanying  statement of  operations.  The reserve is equal to the  difference
between  the  combined  face  value of the notes of $4.8  million  and the third
quarter of fiscal 2006 average market value of $1.99 per share for the Company's
stock for the 1.842 million shares that serve as collateral for the notes.

12. 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, 2005 and March
31, 2005 is as follows (in thousands):

<TABLE>
<CAPTION>

                                                  December 31, 2005         March 31, 2005
                                                ---------------------     ------------------
                          <S>                            <C>                       <C>
                    United States                 $     742                  $       987
                    International                     2,697                        1,796
                                                ---------------------     ------------------
                    Total                         $   3,439                  $     2,783
                                                =====================     ==================
</TABLE>

Revenues by geographic area for the three- and nine-month periods ended December
31, 2005 and 2004 are as follows (in thousands):

<TABLE>
<CAPTION>

                                        Three Months Ended              Nine Months Ended
                                           December 31,                    December 31,
<S>                                    <C>              <C>                <C>            <C>
                                  -------------    ---------------    -------------    ------------
                                       2005             2004              2005            2004
                                  -------------    ---------------    -------------    ------------
            United States          $   4,273        $    2,272         $  12,610        $  7,510
            International                546               275             1,132             788
                                  -------------    ---------------    -------------    ------------
            Total                      4,819        $    2,547         $  13,742        $  8,298
                                  =============    ===============    =============    ============
</TABLE>
<PAGE>

13. SUBSEQUENT EVENTS:

On January 19, 2006, Berg & Berg loaned to the Company $2.0 million  pursuant to
Mr. Berg's $20.0 million  funding  commitment  made on July 13, 2005,  which was
evidenced  by a promissory  note issued by the Company on February 3, 2006.  The
promissory note bears interest at the annual rate of 8% and matures on March 30,
2006. The outstanding  principal  amount of this note may be converted by Berg &
Berg into shares of common  stock of the Company at any time before the maturity
date.  The loan  converts  at a  conversion  price  equal to 85% of the  average
closing bid price of the  Company's  common  stock  during the five trading days
prior to the  conversion  date,  provided that the  conversion  price can not be
lower  than  $1.90,  the  closing  bid price of the  Company's  common  stock on
February 2, 2006.  As of January 29, 2006,  the  remaining  amount of Mr. Berg's
funding commitment is $8.4 million.

On February 3, 2006,  the Company  appointed  Dr.  Chuntai Guo, its current Vice
President of Business Development for Asia, as its new President of Asia-Pacific
operations.

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 periods ended December 31, 2005 are not  necessarily  indicative
of the results to be expected for the entire fiscal year ending March 31, 2006.

Overview

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

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

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

     o    Proven the feasibility of our technology;

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

     o    Demonstrated capability for high volume production;

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

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

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

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

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

     o    Completed  design  of a  U-Charge(TM)  Power  System  and  fuel  gauge
          designed  specifically for the electric  wheelchair  market.  This new
          product was launched on January 23, 2006.
<PAGE>

At $4.8  million,  our revenue for the third  quarter of fiscal 2006 was in line
with our previously announced revenue guidance. Third quarter revenue for fiscal
2006  increased $2.3 million,  or 89.2%,  from the third quarter of fiscal 2005.
Gross  margin loss was (23.9%) for the third  quarter of fiscal  2006,  compared
with (69.0%) for the third  quarter of fiscal 2005.  During the third quarter of
fiscal 2006, we continued our efforts to transition our  manufacturing and other
operations to our WFOE's in China, which became operational in late fiscal 2005.
To  support  our  manufacturing  and  product  development  efforts in China and
provide the financial  resources  necessary to expand our customer base, on June
13, 2005, we secured a funding  commitment  from Carl Berg,  our chairman of the
board and  principal  stockholder.  At December 31, 2005,  we had $10.4  million
remaining available on this funding commitment.  Additionally, on July 13, 2005,
we entered  into a $20.0  million  loan  agreement  with a third  party  finance
company, the full amount of which has been drawn down.

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

Basis of Presentation, Critical Accounting Policies and Estimates

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

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

<PAGE>


review this  estimate on a quarterly  basis.  From time to time we provide sales
incentives in the form of rebates or other price adjustments; these are recorded
as reductions to revenue as incurred.  Licensing  fees are recognized as revenue
upon completion of an executed  agreement and delivery of licensed  information,
if there are no significant  remaining vendor  obligations and collection of the
related receivable is reasonably  assured.  Royalty revenues are recognized upon
licensee revenue reporting and when collectibility is reasonably assured.

Impairment of Long-Lived Assets

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

Results of Operations

The  following  table  summarizes  the results of our  operations  for the three
months (also  referred to as the third  quarter) and nine months ended  December
31, 2005 and December 31, 2004:

<TABLE>
<CAPTION>
                                          Three Months Ended                           Nine Months Ended
                                ---------------------------------------    ------------------------------------------
                                December 31, 2005     December 31,2004     December 31, 2005      December 31, 2004
                                ---------------------------------------    ------------------------------------------
<S>                                 <C>     <C>        <C>      <C>            <C>      <C>          <C>         <C>
 dollars in thousands)              % of  Revenue       % of  Revenue         % of  Revenue         % of  Revenue
Licensing and royalty revenue    $   254       5%     $  94        4%       $   571        4%    $     279       3%
Battery and systems sales          4,565      95%     2,453       96%        13,171       96%        8,019      97%
                                ---------  -------  ---------  --------   -----------  -------  ----------   ------
Total revenues                     4,819     100%     2,547      100%        13,742      100%        8,298     100%
Gross profit (loss)               (1,152)    -24%    (1,758)     -69%        (4,900)     -36%       (3,560)    -43%
Operating expenses                 5,723     119%     3,716      146%        15,933      116%       15,861     191%
Operating loss                    (6,875)   -143%    (5,474)    -215%       (20,833)    -152%      (19,421)   -234%
                                ---------  -------  ---------  --------   -----------  -------  ----------   -------
Net loss                        $ (8,261)   -171%    (6,424)    -252%     $ (24,404)    -178%    $ (22,291)   -269%
                                =========  =======  =========  ========   ===========  =======  ===========  =======
</TABLE>

<PAGE>

Revenues and Gross Margin

Battery and System Sales:  Battery and system sales increased by $2.112 million,
or 86.1%,  to $4.565  million in the third  quarter of fiscal  2006 from  $2.453
million in the third quarter of fiscal 2005.  Battery and system sales increased
by $5.153  million,  or 64.3%, in the nine month period ended December 31, 2005,
from $8.019  million in the nine month  period  ended  December  31,  2004.  The
increase in battery and system  sales was  primarily  the result of sales of the
Segway Inc. battery pack and other U-Charge  products.  These systems  comprised
59.3% and  55.4% of our  total  revenue  for the  three  and nine  months  ended
December  31,  2005.  During  the  third  quarter  of  fiscal  2006 the  Company
experienced issues with our powder production processes that limited our ability
to produce a sufficient  number of batteries to meet customer demand and limited
our revenues for the third quarter of fiscal 2006.  Subsequent to the end of the
third quarter of fiscal 2006 we  implemented  a number of process  enhancements,
which we believe have  resolved  our powder  production  issues.  We believe our
current powder  production  capacity will enable us to meet projected  demand in
future  periods.  However,  because our process  enhancements  were  implemented
during the fourth  quarter of fiscal  2006,  our past  production  problems  may
restrict our ability to satisfy  customer  requirements in the fourth quarter of
fiscal 2006 and consequently restrict our revenues during the period. 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 we 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 24.0% and 36.4% of our total
revenue for the three and nine months ended December 31, 2005. Product shipments
to  resellers  that are  subject  to right of return  and  monies  received  for
exclusivity of future  obligations are recorded on the balance sheet as deferred
revenue.  We had $406,000 in deferred  revenue on our balance  sheet at December
31, 2005.

Licensing and Royalty Revenue:  Licensing and royalty revenues relate to revenue
from licensing agreements for our battery construction technology.  Fiscal third
quarter 2006  licensing and royalty  revenue was $254,000  compared with $94,000
for the same quarter in fiscal 2005. Licensing and royalty revenue was primarily
from our license agreement with Amperex  Technology  Limited (ATL),  which makes
on-going royalty payments as sales are made using our technology.  For the first
nine months of fiscal 2006,  licensing  and royalty  revenue from the  agreement
with ATL was $570,000.  We expect to continue to pursue a licensing  strategy as
our Saphion(R) technology receives greater market acceptance.

Gross Margin (Loss):  Gross margin (loss) as a percentage of revenue was (23.9%)
for the third quarter of fiscal 2006 as compared to (69.0%) in the third quarter
of fiscal  2005.  Gross  margin  (loss) was (35.7%) for the first nine months of
fiscal 2006  compared to (42.9%)  for the first nine months of fiscal  2005.  We
maintained  a  negative  gross  margin on our sales in all  periods  because  of
insufficient  production  and sales  volumes to  facilitate  the coverage of our
indirect  and fixed  manufacturing  and  operating  costs.  Gross  margins  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
WFOE's in Suzhou,  China. During the third quarter of fiscal 2006 the Company we
<PAGE>

experienced issues with our powder production processes that limited our ability
to produce a sufficient number of batteries to meet customer demand.  Subsequent
to the end of the  third  quarter  of  fiscal  2006 we  implemented  a number of
process  enhancements  which we now believe have resolved our powder  production
issues. We believe our current powder production capacity will enable us to meet
projected demand in future periods.  However, these production issues have had a
negative  impact on gross  margins  for the  third  quarter  of  fiscal  2006 as
manufacturing  yields have suffered,  and can possibly have a negative effect on
gross margins  during the fourth quarter of fiscal 2006, as well. 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, 2005 and December 31, 2004:

<TABLE>
<CAPTION>


                                  Three Months Ended December 31,                    Nine Months Ended December 31,
                           ----------------------------------------------    ------------------------------------------------
(dollars in thousands)                             Increase/        %                                  Increase/        %
                            2005        2004       (Decrease)    Change        2005         2004       (Decrease)    Change
                           --------    --------    ----------    --------    ---------    ----------   ----------   --------
<S>                          <C>         <C>          <C>           <C>         <C>         <C>          <C>           <C>
Research and product
development                $1,185      $1,962        $ (777)        -40%      $3,961         5,597     $ (1,636)       -29%
Marketing                     420         859          (439)        -51%       1,661         3,146       (1,485)       -47%
General and
administrative              3,759       3,415           344          10%      10,224         9,463          761          8%
Depreciation and
amortization                  178         154            24          16%         528           713         (185)       -26%
(Gain)/Loss on
disposal of assets             11      (4,172)       (4,183)       -100%        (611)       (4,643)       4,032         87%
Contract settlement
charges, INI                    0         957          (957)       -100%           0           957         (957)      -100%
Contract settlement
charges, other                  0         541          (541)       -100%           0           541         (541)      -100%
Asset impairment
charge                        170           -           170         100%         170            87           83         95%
Total operating
expenses                   $5,723      $3,716        $2,007          54%     $15,933       $15,861         $ 72          0%
Percentage of revenues       119%         146%                                   116%          191%
</TABLE>


During the third  quarter of fiscal  2006,  operating  expenses  were  118.7% of
revenue  compared to 145.9% of revenue during the same quarter last year. In the
first nine  months of fiscal  2006,  operating  expenses  were 115.9% of revenue
compared  to 191.1% of  revenue  in the first nine  months of fiscal  2005.  The
decrease is primarily the result of increased  revenue,  which  increased  89.2%
from the third  quarter  of fiscal  2005,  and our focus on  expense  reductions
during the quarter.  Notwithstanding  the bad debt reserve  allowance  charge of
$1.205  million  relating to the Lev Dawson notes (see  "Related  Parties")  and
reflected in general and administrative  expenses and a $4.172 million gain from
the sale of property,  plant, and equipment in the third quarter of fiscal 2005,
we reduced operating expenses by $5.3 million or 26.6% for the first nine months
of fiscal 2006, as compared with the first nine months of fiscal 2005. Excluding
the bad debt  reserve  allowance  charge of $1.205  million  relating to the Lev
Dawson notes (see "Related Parties"),  as well as a $4.172 million gain from the
sale of  property,  plan and  equipment  that  occurred in the third  quarter of
fiscal 2005,  operating  expenses  decreased  by $3.37  million or 42.7 % in the
third quarter of 2006 from the third quarter of fiscal 2005.
<PAGE>

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
$777,000, or 39.6.%, to $1.185 million for the third quarter of fiscal 2006 from
$1.962  million  for the third  quarter of fiscal  2005.  Research  and  product
development  expenses  decreased by $1.636 million,  or 29.2%, in the first nine
months of fiscal 2006 to $3.961  million  from $5.597  million in the first nine
months of fiscal 2005. The decrease in research and development  expenses is the
result  of  cessation  of  product  development  work  in our  Northern  Ireland
facility,  as well as  reduced  temporary  staff  and  consulting  expenses  and
materials usage in our Henderson, Nevada facility.

Marketing.  Marketing  expenses consist  primarily of costs related to sales and
marketing  personnel,  public  relations and  promotional  materials.  Marketing
expenses of $420,000 in the third quarter of fiscal 2006 were $439,000  lower or
51.6% than in the comparable period of fiscal 2005. For the first nine months of
fiscal 2006,  marketing  expenses of $1.661 million were $1.484 million lower or
47.2% than the  comparable  period in fiscal  2005.  The  decrease in  marketing
expenses in the  nine-month  period ended  December 31, 2005 over the comparable
period in fiscal 2005 was the result of reduced  spending  for lead  generation,
consulting related to European market development, and reduced media advertising
expenditures.

General  and  Administrative.   General  and  administrative   expenses  consist
primarily of salaries and other  related  costs for  finance,  human  resources,
facilities,  accounting,  information  technology,  legal, and corporate-related
expenses,  including our China initiatives.  General and administrative expenses
totaled $3.759 million and $3.415 million for the third fiscal  quarters of 2006
and  2005,  respectively.  General  and  administrative  expenses  increased  by
$761,000,  or 8.0%,  to $10.224  million in the first nine months of fiscal 2006
from  $9.463million  in the first nine  months of fiscal  2005.  Included in the
fiscal 2006 third quarter's  general and  administrative  expenses is a bad debt
reserve allowance charge of $1.205 million relating to the Lev Dawson notes (see
"Related Parties). Included in general and administrative expenses for the third
quarter  of fiscal  2005 was a $4.172  million  gain from the sale of  property,
plant  and  equipment.  Excluding  these  two  adjustments,  operating  expenses
decreased  by $5.3  million,  or 26.6% for the first nine  months of fiscal 2006
compared to the same period in fiscal 2005.  The decrease was largely due to the
continued shift of resources to our Asia 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
$611,000 in the first nine months of fiscal  2006.  The  majority of the gain is
related to the sale of our Northern  Ireland  facility  property  and  equipment
completed in April 2005. Additionally, we determined that some equipment was not
required in our manufacturing and development  operations in Suzhou,  China, and
was sold for fair value.

Depreciation and Amortization

Depreciation  and  Amortization.  Depreciation  and  amortization  expenses were
$178,000  and  $154,000  for  the  third  quarters  of  fiscal  2006  and  2005,
respectively.  Depreciation and amortization expenses were $528,000 and $713,000
in the nine month periods ended  December 31, 2005 and 2004,  respectively.  The
decrease  in  depreciation  resulted  from the sale of  assets  in our  Northern
Ireland  facility  in the  third  quarter  of  fiscal  2005,  the  impact of the
impairment charges to intellectual  property and property,  plant, and equipment
and the impact of the sale of our Henderson, Nevada facility.
<PAGE>

Impairment.  An  impairment  charge of $170,425  was  recorded  during the third
quarter ended December 31, 2005, pursuant to FASB Statement No. 144, "Accounting
for  Impairment  or Disposal of  Long-Lived  Assets." The charge  relates to the
certain portions of the Company's information systems that are no longer in use.

Interest Expense

Interest  Expense.  Interest expense  primarily relates to our long-term debt to
stockholders as well as the long term debt from the third party loan obtained on
July 13, 2005.  Interest  expense was $1.524  million and $1.064 million for the
third quarter of fiscal 2006 and 2005, respectively,  and was $3.996 million and
$3.135  million for the nine month  periods  ended  December  31, 2005 and 2004,
respectively.

Liquidity and Capital Resources

Liquidity

At December 31, 2005, the Company's principal sources of liquidity were cash and
cash equivalents of $1.8 million and a $10.4 million  remaining on a $20 million
funding  commitment  made by Mr. Carl Berg,  chairman of the Company's  board of
directors and its principal stockholder, on June 13, 2005. Of the original $20.0
million funding  commitment,  $8.6 million was applied to the purchase by Berg &
Berg Enterprises LLC ("Berg & Berg"), an affiliate of Mr. Berg, of the Company's
Series C-2 Convertible  Preferred  Stock and C-1 Convertible  Preferred Stock in
July 2005 and December 2005. These  transactions are more fully discussed below.
On December  27, 2005 and January 19,  2006,  Berg & Berg issued two  promissory
notes in the amount of $1.0  million  and $2.0  million to the  Company  and Mr.
Berg's funding  commitment was reduced by equal  amounts.  The promissory  notes
bear  interest  at the  annual  rate of 8% and  mature  on March 30,  2006.  The
outstanding principal amount of these notes may be converted by Berg & Berg into
shares of common stock of the Company at any time before the maturity  date. The
loans  convert at a  conversion  price equal to 85% of the  average  closing bid
price of the  Company's  common  stock during the five trading days prior to the
conversion date, provided that the conversion price can not be lower than $1.90,
the  closing  bid  price of the  Company's  on  February  2,  2006.  Mr.  Berg's
commitment  can be  reduced  by the  amount of net  proceeds  received  from any
subsequent debt or equity transaction (whether funded by Berg or a third party).

On July 13, 2005,  the Company  secured a $20.0  million loan from a third party
finance  company,  the full amount of which has been drawn down. Under the terms
of the loan agreement, which is guaranteed by Mr. Berg, interest will be payable
monthly and the entire  principal  balance is payable on July 13, 2010. The loan
bears  interest  per  annum at the  greater  of 6.75% or  LIBOR  plus  4.0%.  In
connection  with the loan the Company  purchased a rate cap agreement to protect
against  fluctuations  in LIBOR for the full  amount of the loan for a period of
three years.  The Company utilized $2.5 million of this loan to repay a June 30,
2005 draw from Mr. Berg under his funding commitment.

At December  31, 2005,  the Company had $4.3  million of Series C-1  Convertible
Preferred  Stock and $4.3  million of Series  C-2  Convertible  Preferred  Stock
outstanding,  all of which is  currently  held by Berg & Berg.  Pursuant  to the
terms of the two series of Convertible  Preferred  Stock, the preferred stock is
currently subject to redemption by the Company.  Berg & Berg has agreed that the
Company's  failure to redeem does not constitute a default under the certificate
of  designations  for either the Series C-1  Convertible  Preferred Stock or the
Series C-2 Convertible Preferred Stock and has waived the accrual of any default
interest  applicable in such  circumstances.  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 or the closing price
of the Company's  common stock on the conversion  date,  provided the conversion
price can be no lower than $1.98,  the closing bid price of the Company's common
stock on December 13, 2005 and (ii) 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 or the closing price of the Company's common stock on the conversion date,
provided the conversion  price can be no lower than $2.96, the closing bid price
of the Company's stock on July 13, 2005.
<PAGE>

On July 13,  2005 we secured a $20.0  million  loan from a third  party  finance
company,  the full amount of which has been drawn  down.  Under the terms of the
loan  agreement,  which is  guaranteed  by Mr.  Berg,  interest  will be payable
monthly and the entire  principal  balance will be payable on July 13, 2010. The
loan  will  bear  interest  at the  greater  of  6.75% or LIBOR  plus  4.0%.  In
connection  with the loan we purchased a rate cap  agreement to protect  against
fluctuations  in LIBOR  for the full  amount  of the loan for a period  of three
years. We utilized $2.5 million of this loan to repay a June 30, 2005, draw from
Mr. Berg under his funding commitment.
<PAGE>

Currently,  we do not have  capital  resources,  or  sufficient  sales and gross
profit to generate  the cash flows  required to meet our  operating  and capital
needs for the next 12 months.  As a consequence,  one of our primary  objectives
has been to reduce  expenses and overhead  which limits the resources  available
for  the  development  and  commercialization  of our  technology.  Our  limited
financial resources could materially affect the ability and the pace at which we
are able to  commercially  exploit our Saphion(R)  technology,  as well as other
factors  described under the Section  "Cautionary  Statements and Risk Factors."
Therefore,  we depend upon our ability to  periodically  arrange for  additional
equity or debt financing to meet its 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 our  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
described under the section titled "Cautionary  Statements and Risk Factors," we
may not be able to arrange for debt or equity  financing  from third  parties on
favorable terms or at all.

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

The following table summarizes our statement of cash flows for the nine months
ended December 31, 2005 and 2004:

<TABLE>
<CAPTION>

                                              Nine Months Ended December 31,
<S>                                                 <C>              <C>
                                             --------------    --------------
                                                  2005               2004
                                             --------------    --------------
Net cash flows provided by (used in)
Operating activities                          $   (27,502)      $   (25,007)
Investing activities                                 (744)            7,328
Financing activities                               27,352            19,850
Effect of foreign exchange rates                      226               474
                                             --------------    --------------
Net increase/(decrease) in cash and
  cash equivalents                            $      (668)      $     2,645
                                             ==============    ==============
</TABLE>

Our use of cash from  operations the first nine months of fiscal 2006 and fiscal
2005 was  $27.5  million  and  $25.0  million,  respectively.  The cash used for
operating  activities  during the first nine months of our fiscal 2006 operating
activities was primarily for operating losses and working capital. Cash used for
operating losses in the first nine months of fiscal 2006 increased from the same
period of fiscal  2005 by $2.5  million.  Cash used for  working  capital in the
first nine months of fiscal 2006 was greater than cash used for working  capital
in the first nine months of fiscal 2005 by $7.5  million.  The  increase in cash
used for working  capital was  primarily  due to an  increase  in  purchases  of
inventory from increased production.
<PAGE>

In the first nine months of fiscal 2006,  we had a net decrease in net cash from
investing  activities of $744,000.  Cash used in investing activities during the
first nine months of fiscal 2006 relates to purchases of equipment for our China
manufacturing facilities and enterprise software,  offset by sales proceeds from
the sale of property and equipment from our Northern Ireland facility.

We obtained  cash from  financing  activities of $27.4 million and $19.9 million
during  the  first  nine  months  of fiscal  2006 and  2005,  respectively.  The
financing  activities  in the first nine months of fiscal 2006  included a $20.0
million loan agreement with a third party finance  company and equity  issuances
totaling $6.0 million to Berg & Berg under our equity line agreement.

As a result of the above, we had a net decrease in cash and cash  equivalents of
$668,000  during the first nine months of fiscal 2006 and a net increase of $2.6
million for the first nine months of fiscal 2005.

Capital Commitments and Debt

At December 31, 2005, we had commitments for capital  expenditures  for the next
12 months of approximately $50,000 relating to the continuing  implementation of
enterprise  software  and  $1.0  million  for  production  equipment  in our new
manufacturing  facility in China.  We anticipate  that we will incur  additional
capital expenses as we expand our China  operations.  We may require  additional
capital  expenditures  in order to meet greater  demand  levels for our products
than currently are anticipated.

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

<TABLE>
<CAPTION>


(Dollars in thousands)                                       December 31, 2005
                                                          ---------------------
<S>                                                                  <C>

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
Bridge Loan                                                          1,000
Interest on long-term debt                                          14,772
Current portion of long-term debt                                      107
                                                          ---------------------
Total                                                        $      70,829
                                                          =====================
</TABLE>


Repayment  obligations of short-term and long-term debt principal as of December
31, 2005 are:

<TABLE>
<CAPTION>

                                                              Fiscal year
                           -------------------------------------------------------------------------------------
(Dollars in thousands)      2006        2007       2008         2009        2010       Thereafter       Total
                           --------    -------    --------    ---------    --------    ------------    ---------
<S>                          <C>          <C>       <C>           <C>        <C>            <C>            <C>
Principal repayment         1,000-        -          -         34,950         -          20,000         55,950
</TABLE>

<PAGE>

If not converted to common stock the redemption  obligations  for the Series C-1
Convertible  Preferred Stock and Series C-2 Convertible Preferred Stock are $4.3
million and $4.3 million, respectively.

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,  2005,  our  scheduled
principal,  interest and other contractual  annual cash obligations due for each
of the periods indicated below (in thousands):

<TABLE>
<CAPTION>

                                                                     Payment Due by Period
                                           ------------------------------------------------------------------------
                                                            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         $   70,829     $   1,107      $     -       $  69,722       $      -
Operating lease obligations                      1,592            554           915             123             -
Purchase obligations                             7,611          7,611             -               -             -
Redemption of Convertible Preferred
Stock                                            8,610          8,610             -               -             -
                                             -----------   ------------   -----------   ------------    ------------
Total                                        $   88,642    $   17,882      $   915       $ 69,845        $      -
                                             ===========   ============   ===========   ============    ============
</TABLE>

<PAGE>


                     CAUTIONARY STATEMENTS AND RISK FACTORS

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

                          RISKS RELATED TO OUR BUSINESS

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

At December 31, 2005, the Company's principal sources of liquidity were cash and
cash  equivalents  of $1.8  million and a $10.4  million  remaining on a funding
commitment  made by Mr. Carl Berg,  chairman of the Company's board of directors
and its principal stockholder on June 13, 2005. Since December 31, 2005, we have
drawn down $2.0 million on this funding  commitment  leaving $8.4  million.  Mr.
Berg's funding commitment will be reduced by the amount of net proceeds received
from any subsequent debt or equity transaction  (whether funded by Mr. Berg or a
third party).

Currently, we do not have sufficient capital resources or sales and gross profit
to generate the cash flows  required to meet our operating and capital needs for
the next 12 months. As a consequence,  one of our primary objectives has been to
reduce  expenses  and  overhead  which limits the  resources  available  for the
development  and  commercialization  of our  technology.  Our limited  financial
resources could materially  affect the ability and the pace at which we are able
to commercially exploit our Saphion(R) technology. We depend 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, the Company
will need to  arrange  for  additional  financing  within  the next three to six
months to fund its 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.

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

WE HAVE ENCOUNTERED  PROBLEMS IN OUR PRODUCTION  PROCESSES THAT HAVE LIMITED OUR
ABILITY TO PRODUCE SUFFICIENT BATTERIES TO MEET THE DEMANDS OF OUR CUSTOMERS. IF
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.
<PAGE>

During  the  third  quarter  if  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.  We  implemented  a number of
process  enhancements  during the  fourth  quarter  of fiscal  2006,  and we now
believe our current powder production  capacity will enable us to meet projected
demand in future periods.  These production issues have had a negative impact on
gross margins for the third quarter of fiscal 2006 as manufacturing  yields have
suffered,  and can possibly have a negative  effect on gross margins  during the
fourth  quarter of fiscal 2006.  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  DEVELOPMENTS,  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  for  the  development  and
commercialization  of our  technology.  Our limited  financial  resources  could
materially affect our ability, and the pace at which we are able to commercially
exploit our Saphion(R) technology. For example, it could:

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

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

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

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

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

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

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

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

We have incurred  operating losses each year since our inception in 1989 and had
an  accumulated  deficit of $485.8  million as of  December  31,  2005.  We have
sustained recurring losses related primarily to the research and development and
marketing of our products  combined with the lack of sufficient sales to provide
for these needs. We anticipate  that we will continue to incur operating  losses
and negative  cash flows during  fiscal  2006.  We may never  achieve or sustain
sufficient revenues or profitability in the future.

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

We reported a net loss available to common  stockholders of $24.6 million in the
nine month  period  ended  December  31,  2005,  a net loss  available to common
stockholders of $32.2 million for the fiscal year ended March 31, 2005 and a net
loss available to common stockholders of $56.1 million for the fiscal year ended
March 31, 2004.  If we cannot  achieve a  competitive  cost  structure,  achieve
profitability  and access the capital  markets on acceptable  terms,  we will be
unable to fund our obligations and sustain our operations.

OUR  WORKING   CAPITAL   REQUIREMENTS   MAY  INCREASE   BEYOND  THOSE  CURRENTLY
ANTICIPATED.

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

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

We now have and will continue to have a significant amount of indebtedness and
other obligations. As of December 31, 2005, we had approximately $70.8 million
of total consolidated indebtedness and other obligations. Included in this
amount are $36.0 million of loans outstanding to an affiliate, $14.7 million of
accumulated interest associated with those loans, and $20.1 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   and  interest  on  our
          indebtedness,  thereby  reducing  the funds  available to us for other
          purposes;

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

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

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, Mr. Berg may declare all amounts borrowed from them to be
due and  payable  together  with  accrued and unpaid  interest.  If this were to
occur,  we would not have the  financial  resources  to repay our debt and these
lenders could proceed against our assets.

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

To date,  our  existing  purchase  orders in  commercial  quantities  are from a
limited  number of  customers.  During the nine month period ended  December 31,
2005,  one customer,  Segway Inc.,  contributed  approximately  51.1% of revenue
while D&H Distributors  contributed  approximately 15.1% of revenue.  During the
third  quarter of fiscal  2006,  Segway Inc.  and D&H  Distributors  contributed
approximately 57.9% and 11.9% of revenue, respectively. We anticipate that sales
of our products to a limited  number of key  customers  will continue to account
for a  significant  portion  of our  total  revenues.  We do not have  long-term
agreements  with  any of our  customers  and do not  expect  to  enter  into any
long-term  agreements in the near future.  As a result,  we face the substantial
risk that one or more of the following events could occur:

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

     o    development by a customer of other sources of supply;

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

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

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

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

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

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

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

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

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

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

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

To be successful, we must cost-effectively  manufacture commercial quantities of
our  technologically  complex  batteries that meet customer  specifications  for
quality and timely delivery. To facilitate commercialization of our products, we
will need to  further  reduce  our  manufacturing  costs,  which we intend to do
through the  effective  utilization  of  manufacturing  partners and  continuous
improvement of our manufacturing and development  operations in our wholly-owned
subsidiaries in China.  We currently  manufacture our batteries and assemble our
products  in China  and  Taiwan.  We 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  are  currently
experiencing 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  customers and
adversely impact our ability to attract future customers.

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

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

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

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

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

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

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

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

     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 FOUR 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.
<PAGE>

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

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

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

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

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

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

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

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

     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.
<PAGE>

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

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

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

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

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

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

The  terrorist  attacks that took place in the United  States on  September  11,
2001,  along  with  the  U.S.  military  campaigns  against  terrorism  in Iraq,
Afghanistan,  and  elsewhere,  and  continued  violence  in the Middle East have
created many economic and political uncertainties,  some of which may materially
harm our business and revenues.  International  political  instability resulting
from these events could temporarily or permanently  disrupt our manufacturing of
our batteries and products at our OEM  facilities or our own  facilities in Asia
and  elsewhere,  and have an immediate  adverse  impact on our  business.  Since
September 11, 2001, some economic  commentators  have indicated that spending on
capital  equipment  of the type  that use our  batteries  has been  weaker  than
spending in the economy as a whole,  and many of our customers are in industries
that also are viewed as  under-performing  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.
<PAGE>

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

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

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

Our  ability to compete  successfully  will depend on whether we can protect our
existing  proprietary  technology  and  manufacturing  processes.  We  rely on a
combination of patent and trade secret protection, non-disclosure agreements and
cross-licensing agreements.  These measures may not be adequate to safeguard the
proprietary  technology underlying our batteries.  Employees,  consultants,  and
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.
<PAGE>

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

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

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

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

     o    pay significant damages to third parties;

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

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

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

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

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

                  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  WITH
THE UNITED STATES.

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

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

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

We currently  manufacture  and export our products from China.  The legal regime
protecting  intellectual  property 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.

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

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

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 the disparities of
per capita  wealth among  citizens of China and between  regions  within  China,
could also lead to further readjustment of the government's reform measures.  It
is not possible to predict whether the Chinese government will continue to be as
supportive  of private  business  in China,  nor is it  possible  to predict how
future reforms will affect our business.

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

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

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

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

     o    economic structure;

     o    level of government involvement in the economy;

     o    level of development;

     o    level of capital reinvestment;

     o    control of foreign exchange,

     o    currency valuation,

     o    methods of allocating resources; and

     o    balance of payments position.

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

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

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

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

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

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

Many tax rules are not  published in China and those that are  published  can be
ambiguous  and  contradictory,  leaving a  considerable  amount of discretion to
local  tax  authorities.  China  currently  offers  tax and  other  preferential
incentives to encourage foreign investment. However, the country's tax regime is
undergoing  review and we cannot  assure you that such tax and other  incentives
will continue to be made available.  Currently, China levies a 10.0% withholding
tax on dividends received from Chinese-foreign  joint ventures. If we enter into
a joint venture with a Chinese  company as part of our strategy to reduce costs,
the joint  venture may be  considered  a  Chinese-foreign  joint  venture if the
majority of its equity interests are owned by a foreign shareholder. A temporary
exemption  from this  withholding  tax has been  granted to  foreign  investors.
However, there is no indication when this exemption will end.

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

China's  turnover tax system  consists of value-added  tax,  consumption tax and
business tax. Export sales are exempted under Value-Added Tax (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
VAT system were announced  affecting the  recoverability  of input VAT beginning
January  1,  2004.  Our VAT  expense  will  depend on the  reaction  of both our
suppliers and customers. Continued efforts by the Chinese government to increase
tax revenues could result in the revisions to tax laws or their  interpretation,
which could increase our VAT and various tax liabilities.

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

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

     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
or adopt a  reunification  plan.  If an  invasion  by China  were to occur,  the
ability of our manufacturing and assembly partners could be adversely  affected,
potentially limiting our production capabilities. An invasion could also lead to
sanctions or military  action by the United  States and/or  European  countries,
which could further adversely affect our business.

                       RISKS ASSOCIATED WITH OUR INDUSTRY

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

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

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

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

Competition  in the  rechargeable  battery  industry  is intense.  The  industry
consists  of major  domestic  and  international  companies,  most of which have
financial,  technical,  marketing, sales, manufacturing,  distribution and other
resources  substantially greater than ours. There is a risk that other companies
may develop  batteries  similar or superior to ours. In addition,  many of these
companies  have name  recognition,  established  positions  in the  market,  and
long-standing  relationships with OEMs and other customers.  We believe that our
primary  competitors are existing suppliers of cylindrical  lithium-ion,  nickel
cadmium,  nickel  metal-hydride and in some cases,  non-SLI lead-acid batteries.
These suppliers  include Sanyo,  Matsushita  Industrial  Co., Ltd.  (Panasonic),
Sony,  Toshiba,  SAFT  E-One  Moli  Energy  as  well as the  numerous  lead-acid
manufacturers  throughout the world.  Most of these companies are very large and
have substantial  resources and market presence.  We expect that we will compete
<PAGE>

against  manufacturers  of other types of batteries in our targeted  application
segments.  There is also a risk that we may not be able to compete  successfully
against  manufacturers  of  other  types  of  batteries  in any of our  targeted
applications.

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

At the  present  time,  international,  federal,  state,  and local  laws do not
directly  regulate the storage,  use, and disposal of the component parts of our
batteries.  However,  laws and regulations  may be enacted in the future,  which
could impose environmental,  health and safety controls on the storage, use, and
disposal  of certain  chemicals  and metals used in the  manufacture  of lithium
polymer  batteries.  Satisfying  any future laws or  regulations  could  require
significant  time and resources from our technical  staff and possible  redesign
which may result in substantial expenditures and delays in the production of our
product,   all  of  which  could  harm  our   business  and  reduce  our  future
profitability.  The  transportation  of lithium  and  lithium-ion  batteries  is
regulated both  internationally  and  domestically.  Under the recently  revised
United Nations recommendations and as adopted by the International Air Transport
Association   (IATA),   our   N-Charge(TM)   Power  System  (Model  VNC-65)  and
N-Charge(TM)  Power  System  II  are  exempt  from a  Class  9  designation  for
transportation,  while  our  N-Charge(TM)  Power  System  (Model  VNC-130),  our
K-Charge(TM)  Power System,  and U-Charge(TM) Power System currently fall within
the level such that they are not exempt and  require a Class 9  designation  for
transportation.  The revised  United  Nations  recommendations  are not U.S. law
until such time as they are incorporated  into the Department of  Transportation
(DOT) Hazardous Material Regulations.  However, DOT has proposed new regulations
harmonizing with the U.N. guidelines.  At present it is not known if or when the
proposed  regulations would be adopted by the United States. While we fall under
the  equivalency  levels  for the  United  States  and  comply  with all  safety
packaging requirements worldwide,  future DOT or IATA regulations or enforcement
policies  could  impose  costly   transportation   requirements.   In  addition,
compliance with any new DOT or IATA approval  process could require  significant
time and  resources  from our technical  staff and, if redesign were  necessary,
could delay the introduction of new products.

                  GENERAL RISKS ASSOCIATED WITH STOCK OWNERSHIP

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

As of January 30, 2006, our officers,  directors and their affiliates as a group
beneficially  owned  approximately  45.3% of our outstanding  common stock. Carl
Berg, our chairman of the board,  beneficially owns  approximately  42.4% 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:
<PAGE>

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

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

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

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

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

Given the volatility of our stock and trends in the stock market in general,  at
any  given  time we might not meet the  continued  listing  requirements  of The
Nasdaq SmallCap Market.  Among other  requirements,  Nasdaq requires the minimum
bid price of a company's registered shares to be $1.00. On January 30, 2006, the
closing price of our common stock was $1.70.  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.
<PAGE>

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

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

The market  price of our common stock could drop as a result of sales of a large
number of shares in the market or in response to the perception that these sales
could occur.  In addition,  these sales might make it more  difficult  for us to
sell equity or equity-related  securities in the future at a time and price that
we deem appropriate.  We had outstanding 89,745,984 shares of common stock as of
December 31, 2005. In addition,  at December 31, 2005, we had 14,729,869  shares
of our common stock reserved for issuance under warrants and stock option plans.
In  connection  with the  potential  conversion  of the Series  C-1  Convertible
Preferred Stock and Series C-2 Convertible Preferred Stock issued on December 1,
2004, we may need to issue up to 2,176,767and 1,452,703 shares, respectively, of
our common stock  (based on a  conversion  price not lower than $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 registered independent public
accounting  firm's  audit of that  assessment  has  required,  and  continues to
require,  the  commitment of  significant  financial and  managerial  resources.
Although we believe that the ongoing review of our internal controls will enable
us to  provide  an  assessment  of our  internal  controls  and  our  registered
independent  public accounting firm to provide its audit opinion as of March 31,
2006,  as required by Section 404 of the  Sarbanes-Oxley  Act of 2002, we cannot
assure you that  these  efforts  will be  completed  on a timely and  successful
basis.
<PAGE>

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
registered  independent  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% (7.75% at September  30,  2005,  we
entered into a rate cap agreement  which caps the LIBOR rate at 5.5% (On January
6, 2006, the most recent adjustment date, the LIBOR rate was 4.42%) In addition,
we are exposed to financial market risks,  including changes in foreign currency
exchange rates and interest rates.

We also have  long-term  debt in the form of two loans 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 December  31,
2005) 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. Each 0.25% increase in interest on the adjustable rate loan would increase
our annual interest expense by approximately  $74,000.  The table below presents
principal amounts by fiscal year for our long-term debt:

<TABLE>
<CAPTION>


                           2006    2007    2008    2009    2010    Thereafter    Total
                           ----    ----    ----    ----    ----    ----------  ----------
<S>                         <C>    <C>      <C>     <C>     <C>       <C>           <C>
                                         (dollars in thousands)
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.
<PAGE>

ITEM 4. CONTROLS AND PROCEDURES

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

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

As required by Section 404 of the Sarbanes-Oxley Act of 2002, the Sarbanes-Oxley
Act, our management  certified to the  effectiveness of our internal controls in
connection  with the  preparation  of our financial  statements for fiscal 2005,
which  certification  was attested to by our independent  public  accountants as
part of their audit. During fiscal 2006, we have made significant changes to our
operations,  particularly  in China.  We have not  completed  our  review of our
internal controls as part of our Section 404 certification for 2006. This review
could identify  significant  deficiencies or material weaknesses in our internal
controls, which we would be required to remediate in order to satisfy our annual
obligations under Section 404 of the Sarbanes-Oxley Act.

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

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


<PAGE>

                          PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

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

ITEM 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 7 of our Annual  Report on Form
10-K/A for our fiscal year ending March 31, 2005,  filed with the  Commission on
June 23, 2005.  Material changes from the risk factors  previously  disclosed on
our Annual  Report on Form 10-K/A for the fiscal year ending  March 31, 2005 are
identified  below.

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

At December 31, 2005, the Company's principal sources of liquidity were cash and
cash  equivalents  of $1.8  million and a $10.4  million  remaining on a funding
commitment  made by Mr. Carl Berg,  chairman of the Company's board of directors
and its principal stockholder on June 13, 2005. Since December 31, 2005, we have
drawn down $2.0 million on this funding  commitment  leaving $8.4  million.  Mr.
Berg's funding commitment will be reduced by the amount of net proceeds received
from any subsequent debt or equity transaction  (whether funded by Mr. Berg or a
third party).

Currently, we do not have sufficient capital resources or sales and gross profit
to generate the cash flows  required to meet our operating and capital needs for
the next 12 months. As a consequence,  one of our primary objectives has been to
reduce  expenses  and  overhead  which limits the  resources  available  for the
development  and  commercialization  of our  technology.  Our limited  financial
resources could materially  affect the ability and the pace at which we are able
to commercially exploit our Saphion(R) technology. We depend 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, the Company
will need to  arrange  for  additional  financing  within  the next three to six
months to fund its 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.

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

WE HAVE ENCOUNTERED  PROBLEMS IN OUR PRODUCTION  PROCESSES THAT HAVE LIMITED OUR
ABILITY TO PRODUCE SUFFICIENT BATTERIES TO MEET THE DEMANDS OF OUR CUSTOMERS. IF
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  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.  We  implemented  a number of
process  enhancements  during the  fourth  quarter  of fiscal  2006,  and we now
believe our current powder production  capacity will enable us to meet projected
demand in future periods.  These production issues have had a negative impact on
gross margins for the third quarter of fiscal 2006 as manufacturing  yields have
suffered,  and can possibly have a negative  effect on gross margins  during the
fourth  quarter of fiscal 2006.  Any inability to timely  produce  batteries may
have a material  adverse impact on our ability to grow revenues and maintain our
Customer base.

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

None.
<PAGE>

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5.  OTHER INFORMATION

On February 3, 2006,  the Company  executed two  promissory  notes,  in the face
amounts of $1 million and $2  million,  respectively  (the  "Notes") in favor of
Berg & Berg  Enterprises,  LLC  ("Berg  &  Berg").  The  Notes  were  issued  in
connection with bridge loans by Berg & Berg on December 27, 2005 and January 19,
2006, respectively, the terms of which were not agreed upon by the parties until
February 3, 2006, the date of the Notes. Interest accrues quarterly on the Notes
at a compound  rate of 8.0% or, if less,  the maximum rate allowed by applicable
law. The Notes mature on March 30, 2006.  At any time prior to maturity,  Berg &
Berg can convert the  outstanding  principal  amount of the Notes into shares of
common  stock of the Company at a  conversion  price equal to 85% of the average
closing bid price of the  Company's  common  stock  during the five trading days
prior to the  conversion  date,  provided that the  conversion  price can not be
lower than $1.90,  the closing bid price of the  Company's  stock on February 2,
2006.  The  summary of the terms of the  promissory  notes is  qualified  in its
entirety by the text of the  promissory  notes,  a copy of which are attached to
this Form 10-Q as Exhibits 10.1 and 10.2.

On February 3, 2006,  the Company  appointed  Dr.  Chuntai Guo, its current Vice
President of Business Development for Asia, as its new President of Asia-Pacific
Operations,  responsible  for the  day-to-day  operation  and  management of the
Company's Asia-Pacific operations,  business and affairs. Dr. Guo, 50, has spent
the last five  years as  general  manager  and chief  technology  officer at TCL
Hyperpower  Battery Inc. There are no family  relationships  between Dr. Guo and
any  director or  executive  officer of Valence.  Dr.  Guo's  receives an annual
salary of $200,000 US. In connection  with his  employment,  Dr. Guo was granted
options to  purchase  150,000  shares of Valence  common  stock with an exercise
price of $1.99 per share.  The options vest 25% on the first  anniversary of his
employment  with Valence with the remaining 75% to vest quarterly over the three
years thereafter.  The summary of the terms of Dr. Guo's employment agreement is
qualified  in its  entirety  by the  text of the  agreement,  a copy of which is
attached to this Form 10-Q as Exhibit 10.3.


<PAGE>

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

EXHIBIT NO.

10.1     Promissory   Note,   dated  February  3,  2006,   executed  by  Valence
         Technology, Inc. in favor of Berg & Berg Enterprises, LLC

10.2     Promissory   Note,   dated  February  3,  2006,   executed  by  Valence
         Technology, Inc. in favor of Berg & Berg Enterprises, LLC

10.3     Employment  Agreement between Valence Technology (Suzhou) Co., Ltd. and
         Mr. Guo Chuntai.

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

32.2     Certification  of  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.

<PAGE>


                                    SIGNATURE

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

VALENCE TECHNOLOGY, INC.

Date: February 8, 2006              By: /s/ James R. Akridge
                                        ------------------------------
                                        James R. Akridge
                                        President and Chief Executive Officer
                                        (Principal Executive Officer)



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

<PAGE>


EXHIBIT INDEX

EXHIBIT NO.


10.1     Promissory   Note,   dated  February  3,  2006,   executed  by  Valence
         Technology, Inc. in favor of Berg & Berg Enterprises, LLC

10.2     Promissory   Note,   dated  February  3,  2006,   executed  by  Valence
         Technology, Inc. in favor of Berg & Berg Enterprises, LLC

10.3     Employment  Agreement between Valence Technology (Suzhou) Co., Ltd. and
         Mr. Guo Chuntai.

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

32.2     Certification  of  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.


<PAGE>

EXHIBIT 10.1


                                 PROMISSORY NOTE


                                                        6504 Bridgepoint Parkway
$1,000,000.00                                                      Austin, Texas


Dated:  February 3, 2005

Valence  Technology,  Inc.,  a  Delaware  corporation  ("Borrower"),  for  value
received,  hereby promises to pay to the order of Berg & Berg  Enterprises,  LLC
("Lender"),  in lawful  money of the United  States of  America,  the  aggregate
principal amount of One Million Dollars ($1,000,000.00).

1.  Principal and Interest  Payments;  Prepayments.  The  outstanding  principal
balance and accrued  interest  owing under this Note shall be due and payable in
full on March 30,  2006,  or such  earlier  date as may be  provided in the Loan
Agreement  (defined in paragraph 4, below).  Interest shall be due on the unpaid
principal  balance  of this Note from time to time at the rates set forth in the
Loan Agreement.  This Note may, without premium or penalty,  be prepaid in whole
or in part, prior to the stated maturity date as provided in the Loan Agreement.
Any partial prepayment shall be applied first to unpaid accrued interest and the
balance, if any, shall be applied to principal. No amounts prepaid hereunder may
be reborrowed.

2. Conversion  Rights.  On any trading day (Conversion  Date) during the term of
this Promissory  Note but no earlier than two days after the Borrower  announces
its third quarter FY2006 earnings,  Lender may convert the outstanding principal
balance and accrued  interest  owing under this Note into shares of common stock
of the Borrower by so  notifying  Borrower.  The number of shares that  Borrower
shall  issue to Lender in exchange  for the  outstanding  principal  balance and
accrued  interest  owing under this Note,  shall be  determined  by dividing the
outstanding  principal  balance  and accrued  interest  owing under this Note by
eighty-five  percent (85%) of the average  closing bid price of the common stock
on the  principal  market during the five trading days ending on the trading day
immediately  prior to the Conversion  Date (the  "Conversion  Price"),  provided
however,  that the Conversion  price can be no lower than $1.90, the closing bid
price of Borrower's common stock on February 2, 2006. If the number of shares to
be issued would create a fractional share of common stock, such fractional share
shall be disregarded  and the number of shares of common stock issuable shall be
rounded to the nearest  whole number of shares.  Within two Business  Days after
the  Conversion  Date,  the Company shall cause its Transfer  Agent to prepare a
certificate  in the  name  of  Lender  representing  the  number  of  shares  as
determined in accordance with this paragraph. If Lender converts the outstanding
principal balance and accrued interest owing under this Note to shares of common
stock this Promissory Note shall be satisfied and of no further effect.

3. Place and Manner of Payment.  All amounts payable  hereunder shall be payable
in immediately available funds to Lender at 10050 Bandley Drive,  Cupertino,  CA
95014,  unless  another place of payment is specified in writing by Lender.  All
payments shall be made in immediately available funds.
<PAGE>

4.  Other  Agreements.  This Note  evidences  indebtedness  incurred  under that
certain Loan  Agreement  dated  October 5, 2001 between  Borrower and Lender (as
amended from time to time, the "Loan  Agreement"),  and is secured by a security
interest granted pursuant to that certain  Security  Agreement  between Borrower
and Lender (as amended from time to time, the "Security  Agreement".)  Reference
is made to the Loan  Agreement and the Security  Agreement for a description  of
the terms and conditions upon which the Note was issued, the rights, limitations
of rights,  obligations  and duties of Borrower and the holder of the Note,  and
certain  definitions of terms, all of which are incorporated herein by reference
(and all capitalized terms used herein without definition shall have the meaning
set forth in the Loan Agreement.)


5. Default. In the case an Event of Default shall occur, the aggregate unpaid
principal balance plus accrued interest on this Note shall become or may be
declared to be due and payable in the manner and with the effect provided in the
Loan Agreement.

6. Waiver; Expenses. Borrower waives presentment and demand for payment, notice
of dishonor, protest and notice of protest of this Note and all other demands or
notices, and shall pay all Lender Expenses relating to this Note or the
enforcement by Lender of its rights hereunder.

7.  Governing Law. This Note shall be governed by, and construed and enforced in
accordance with, the laws of the State of California, excluding conflict of laws
principles that would cause the application of laws of any other jurisdiction.

8.  Successors  and  Assigns.  The  provisions  of this Note shall  inure to the
benefit of and be binding on any  successor  to Borrower and shall extend to any
holder hereof.

                                      * * *


     IN WITNESS WHEREOF,  the undersigned has duly executed this Promissory Note
as of the first date above written.



                                        VALENCE TECHNOLOGY, INC.,
                                        a Delaware Corporation



                                        By:  /s Thomas F. Mezger
                                             --------------------
                                        Its: Chief Financial Officer

<PAGE>


EXHIBIT 10.2


                                 PROMISSORY NOTE


                                                        6504 Bridgepoint Parkway
$2,000,000.00                                                      Austin, Texas


Dated:  February 3, 2006

Valence  Technology,  Inc.,  a  Delaware  corporation  ("Borrower"),  for  value
received,  hereby promises to pay to the order of Berg & Berg  Enterprises,  LLC
("Lender"),  in lawful  money of the United  States of  America,  the  aggregate
principal amount of Two Million Dollars ($2,000,000.00).

1.  Principal and Interest  Payments;  Prepayments.  The  outstanding  principal
balance and accrued  interest  owing under this Note shall be due and payable in
full on March 30,  2006,  or such  earlier  date as may be  provided in the Loan
Agreement  (defined in paragraph 4, below).  Interest shall be due on the unpaid
principal  balance  of this Note from time to time at the rates set forth in the
Loan Agreement.  This Note may, without premium or penalty,  be prepaid in whole
or in part, prior to the stated maturity date as provided in the Loan Agreement.
Any partial prepayment shall be applied first to unpaid accrued interest and the
balance, if any, shall be applied to principal. No amounts prepaid hereunder may
be reborrowed.

2. Conversion  Rights.  On any trading day (Conversion  Date) during the term of
this Promissory  Note but no earlier than two days after the Borrower  announces
its third quarter FY2006 earnings,  Lender may convert the outstanding principal
balance and accrued  interest  owing under this Note into shares of common stock
of the Borrower by so  notifying  Borrower.  The number of shares that  Borrower
shall  issue to Lender in exchange  for the  outstanding  principal  balance and
accrued  interest  owing under this Note,  shall be  determined  by dividing the
outstanding  principal  balance  and accrued  interest  owing under this Note by
eighty-five  percent (85%) of the average  closing bid price of the common stock
on the  principal  market during the five trading days ending on the trading day
immediately  prior to the Conversion  Date (the  "Conversion  Price"),  provided
however,  that the Conversion  price can be no lower than $1.90, the closing bid
price of Borrower's common stock on February 2, 2006. If the number of shares to
be issued would create a fractional share of common stock, such fractional share
shall be disregarded  and the number of shares of common stock issuable shall be
rounded to the nearest  whole number of shares.  Within two Business  Days after
the  Conversion  Date,  the Company shall cause its Transfer  Agent to prepare a
certificate  in the  name  of  Lender  representing  the  number  of  shares  as
determined in accordance with this paragraph. If Lender converts the outstanding
principal balance and accrued interest owing under this Note to shares of common
stock this Promissory Note shall be satisfied and of no further effect.
<PAGE>

3. Place and Manner of Payment.  All amounts payable  hereunder shall be payable
in immediately available funds to Lender at 10050 Bandley Drive,  Cupertino,  CA
95014,  unless  another place of payment is specified in writing by Lender.  All
payments shall be made in immediately available funds.

4.  Other  Agreements.  This Note  evidences  indebtedness  incurred  under that
certain Loan  Agreement  dated  October 5, 2001 between  Borrower and Lender (as
amended from time to time, the "Loan  Agreement"),  and is secured by a security
interest granted pursuant to that certain  Security  Agreement  between Borrower
and Lender (as amended from time to time, the "Security  Agreement".)  Reference
is made to the Loan  Agreement and the Security  Agreement for a description  of
the terms and conditions upon which the Note was issued, the rights, limitations
of rights,  obligations  and duties of Borrower and the holder of the Note,  and
certain  definitions of terms, all of which are incorporated herein by reference
(and all capitalized terms used herein without definition shall have the meaning
set forth in the Loan Agreement.)

5. Default.  In the case an Event of Default shall occur,  the aggregate  unpaid
principal  balance  plus  accrued  interest on this Note shall  become or may be
declared to be due and payable in the manner and with the effect provided in the
Loan Agreement.

6. Waiver; Expenses.  Borrower waives presentment and demand for payment, notice
of dishonor, protest and notice of protest of this Note and all other demands or
notices,  and  shall  pay all  Lender  Expenses  relating  to  this  Note or the
enforcement by Lender of its rights hereunder.

7.  Governing Law. This Note shall be governed by, and construed and enforced in
accordance with, the laws of the State of California, excluding conflict of laws
principles that would cause the application of laws of any other jurisdiction.

8.  Successors  and  Assigns.  The  provisions  of this Note shall  inure to the
benefit of and be binding on any  successor  to Borrower and shall extend to any
holder hereof.

                                     * * *


     IN WITNESS WHEREOF,  the undersigned has duly executed this Promissory Note
as of the first date above written.



                                        VALENCE TECHNOLOGY, INC.,
                                        a Delaware Corporation



                                        By:  /s Thomas F. Mezger
                                             ---------------------
                                        Its: Chief Financial Officer




<PAGE>


EXHIBIT 10.3

                              EMPLOYMENT AGREEMENT

This  agreement  constitutes  the employee's  principal  statement of employment
terms and sets out  particulars  of the terms and  conditions of the  employment
between  Valence  Technology  (Suzhou)  Co.,  Ltd.  (hereinafter  referred to as
"company")  and Mr. Guo Chuntai  (hereinafter  referred  to as "you"),  includes
particulars which are required to provide under Chinese employment legislation.

1.    Commencement of Employment

1.1.  The employment with the company begins on December 1st, 2005. No period of
      previous  employment  with  any  former  employer  counts  as  part of the
      continuous period of employment with the Company.

2.    Position and Location

2.1.  The  employee is employed as Vice  President of Business  Development  for
      Asia and report to the  President and Chief  Executive  Officer of Valence
      Technology,  Inc. The employment will be based at the Company's offices at
      Suzhou,  China.  The Company reserves the right to appoint the employee to
      other positions (whether within the Company or any Associated Company), to
      require the employee to undertake  additional  or other duties  (which are
      within the employee's  skill and  competence)  and to base the employee at
      other  locations  whether  temporarily  or permanently as the needs of the
      business require.

2.2.  The employee  will be required to travel on the business of the Company to
      such places as may be reasonably  necessary for the proper  performance of
      your duties, both in the PRC and overseas.

3.    Duties

      During the employment the employee shall:

3.1.  Comply with all reasonable requests, instructions and regulations relating
      to the  Company  or to any of its  Associated  Company as well as with all
      restrictions  on your powers and authority which the Company shall specify
      from time to time;

3.2.  During the working  hours devote the whole of the time and  attention  and
      ability to the duties;

3.3.  Working and  faithfully  serve the Company to the best of your ability and
      use your reasonable endeavors to promote the interests of the Company;

3.4.  Not without the written  consent of the Company  directly or indirectly be
      engaged, concerned or interested in any other business whatsoever provided
      that you shall not be  prohibited  from holding by way of  investment  any
      securities  listed or dealt on the Stock  Exchange and comprising not more
      than 1% of the securities of the class in question; and
<PAGE>

3.5.  Not  engage in any other form of paid  activity  during the course of your
      employment,  should such activity constitute either a conflict of interest
      in terms of the  Company's  primary  dealings  or business  affairs,  or a
      conflict in scheduling  which would result in your inability or diminished
      capacity howsoever arising to manage the responsibilities  associated with
      your employment with the Company,  whether during or outside working hours
      without first obtaining written consent may result in summary dismissal.

3.6.  The Company has  established  sound  systems for  occupational  safety and
      health,  you should  strictly  follow the relevant  rules and standards on
      occupational safety and health,  prevent accidents in the process of work,
      and reduce occupational hazards.

4.    Compensation

4.1.  Your basic  monthly  salary is RMB  134,849.92  and is payable  monthly in
      arrears less the  individual  income tax and any  statutory  and voluntary
      deductions.  Your salary  will  normally be paid at 25th of each month and
      will normally be reviewed  annually,  with no commitment by the Company to
      increase your salary at that time.

4.2.  You  shall be liable  to PRC  individual  income  taxes  arising  from the
      employment remuneration,  and the Company shall withhold the corresponding
      tax liability from the payment of your employment remuneration.

4.3.  If at any time money is owed and  payable by you to the  Company,  whether
      under this agreement or otherwise, including any excess holiday, unsettled
      income tax due on your  remuneration  under this  agreement,  it is agreed
      that the  Company  may deduct the sum or sums from time to time owed to it
      from payment due to you from the Company, howsoever arising.

4.4.  You will be eligible  for  150,000  stock  options of Valence  Technology,
      Inc., vested over a four years' period according to the company policy.

5.    Hours of Work

      Your normal hours of work are from 8:30 am to 5:30 pm each day of the week
      from Monday to Friday (inclusive). And you shall not work for more than 40
      hours a week on  average.  Given the nature of your  duties  you will,  be
      expected to work  overtime as the needs of the  business  dictate  with no
      extra salaries in  consideration  of being included in your usually salary
      and increased duration of your holidays the Company provide you.

6.    Holidays and Holiday Pay

6.1.  In addition to the statutory public holidays in China,, marriage leave and
      mourning leave, the employee is entitled to take 20 working days of annual
      leave each year.

6.2.  All  holiday  dates must have the prior  agreement  of the Company or such
      person as it shall nominate.  You shall not be permitted to take more than
      ten working days  holiday at any one time without the express  approval of
      the President and Chief Executive Officer of Valence Technology, Inc.
<PAGE>

6.3.  If you join or leave the Company during the course of a holiday year, your
      holiday  entitlement  will be  calculated  pro rata based on the number of
      fully  completed  calendar  months of  service  for the period of the year
      during which you have been employed.

6.4.  No more than 10 days holiday  entitlement  can be carried forward into the
      next holiday year but must be taken by March 31st in the following holiday
      year. There is no entitlement to payment in lieu of holidays not taken.

6.5.  On termination of employment,  other than  termination  pursuant to clause
      12, you will be paid for any untaken accrued  holiday  entitlement for the
      current  holiday  year at a rate of the annual  salary for each day owing.
      The Company  reserves the right to make a deduction from your final salary
      for holiday taken in excess of your accrued holiday entitlement.

7.    Expenses

      With the prior  approval  of the  Company  and within  such  limits as the
      Company may from time to time lay down,  all reasonable  expenses  wholly,
      exclusively  and  necessarily  incurred by you in carrying out your duties
      will be reimbursed to you, on production of  appropriate  receipts  and/or
      vouchers.

8.    Sickness, Injury and Incapacity

8.1.  If the employee is ill and unable to come to work you should  contact your
      manager, or such person as the Company may nominate, by 10 am on the first
      day of  absence,  with an  estimate  of how long you will be away.  If you
      cannot call yourself you should arrange for someone else to do it for you,
      the  employee  is obliged to provide the  related  evidence  issued by the
      hospital immediately after you come to work.

8.2.  Failure to notify the Company or failure to provide the aforesaid evidence
      will amount to unauthorized  absence and may lead to instant  dismissal or
      to your pay being withheld for the duration of such unauthorized absence.

8.3.  The  Company  reserves  the  right to  terminate  your  employment  if the
      employee  is unable to  perform  your  duties  efficiently  for  prolonged
      periods through sickness, injury or incapability.

8.4.  When the employee is absent from work for more than three working days the
      employee is required  to provide the Company  with a medical  certificate.
      When the  employee  is absent  from work  between  four and seven days the
      Company will require you to produce a self-certificate as evidence of your
      sickness, injury or incapacity.

8.5.  At the  request of the  Company,  you may be required to produce a medical
      certificate and/or to undergo a medical  examination by the Company doctor
      or a  doctor  nominated  by the  Company  at any time  during a period  of
      absence due to illness or incapacity. If you refuse the requirement of the
      company, company has the right to terminate the agreement immediately.
<PAGE>

8.6.  In the event that you or a medical  practitioner  provides  information to
      the Company  concerning your health,  you expressly consent to the Company
      retaining  such  information  on  your  personnel  file  for so long as is
      reasonably necessary for the purposes of ensuring that it complies in full
      with its obligations under heath and safety legislation and of effectively
      managing  the aspects of its  business in which the  employee is involved.
      You undertake to sign any additional consents that may be required for the
      Company to process such information for such purposes.

8.7.  According  to the  Company  policy  related to sick leave the  employee is
      required to cooperate in the maintenance of necessary records.

9.    Insurance and Welfare

      Both parties shall pay the social insurance such as unemployment,  medical
      insurance, etc. as required by national, provincial and municipal relevant
      regulations, if applicable.

10.   Confidentiality, Proprietary information, and Non-competition

10.1. You need sign a separate  Confidentiality,  Proprietary  information,  and
      Non-competition agreement on your first day of employment.

11.   Notice

11.1. During  the  first  two  months  of  your  employment  (which  shall  be a
      probationary  period),  the  period of notice to be given by either you or
      the Company to terminate  your  employment  shall be one week's  notice in
      writing.  Thereafter,  the period of notice required to be given by either
      you or the  Company  shall be one  month's  notice in  writing  during the
      service.

11.2. The Company  reserves the right, in its discretion,  to make an adjustment
      of your post,  which can lead to the  increase  or decrease of your salary
      stipulated in this agreement. Your refusal of the new post shall be deemed
      as demanding the termination of this Employment Agreement.

11.3. During any period of notice given by you or the Company,  the Company may,
      in its absolute discretion, require you either to remain away from work on
      paid  leave or  provide  you with  alternative  work of a broadly  similar
      nature to the work you  normally  perform.  The company may require you to
      use any accrued holiday during your notice period.

12.   Termination of the agreement

12.1. The agreement can be terminated through unanimous negotiation between both
      Parties.
<PAGE>

12.2. If one of following  cases occurs to Employee,  company can  terminate the
      agreement immediately without prior notice or payment of severance:

      (a)  The  employee  is  proven  to  be  incompetent   for  the  employment
      requirements

      (b) The employee  seriously  breaches  labor  discipline or regulations as
      stipulated  by the company.  Such serious  breaches  include,  but are not
      limited to, breaches of  confidentiality,  exclusivity of employment,  the
      responsibility to maintain work  qualifications,  labor safety and hygiene
      rules,  this  agreement  and other  policies and  procedures of company in
      place from time to time.

      (c) Employee commits a serious  dereliction of duty, such as failure to be
      exclusively  employed  by company,  failure to adhere to labor  safety and
      hygiene  rules,  failure to  maintain  work  qualifications  or failure to
      adhere to other  relevant  provisions and other policies and procedures of
      company, or engages in graft, such as taking advantage of his/her position
      with company for dishonest,  illegal, or personal ends, resulting in major
      harm to company's interests.

      (d)  Employee's  criminal  liability  is  prosecuted  according  to law or
      employee is sent for re-education through labor.

      (e) Other  circumstances  agreed between  employee and company or provided
      for under PRC laws and regulations.

12.3. If one of following cases occurs, company can terminate the agreement, but
      company  must give a written  notice to employee 30 days before  hand,  or
      payment in lieu of notice:

      (a) Employee suffers a non-work-related  illness or injury, and at the end
      of his/her medical  treatment  period,  cannot engage in his/her  original
      work or in other suitable work arranged by company,  or cannot be assigned
      other suitable work in a manner compliant with relevant trade regulations.
      The Parties agree that company has  discretion to decide  whether  another
      existing and open position is suitable and that  employee  would undergo a
      probationary period of two months on that new position:

      (b) Employee is incompetent  for his/her job,  remains  incompetent  after
      usual  training  for  his/her  assigned  position or after  assignment  to
      another post (which new post need not carry similar  responsibilities  and
      salary) already existing within company.

      (c) The performance of this agreement becomes impossible due to relocation
      of the enterprise,  the absorption of an enterprise  through merger or the
      transfer  of company  assets,  restructuring  of  company  or other  major
      changes in the objective  circumstances upon which the Agreement was based
      at the time of its conclusion,  and consultations between the Parties fail
      to produce agreement on amendment of this agreement within seven days from
      the commencement of such consultations.

      (d) Company is in a period of statutory  readjustment when on the verge of
      bankruptcy,  or is experiencing  major difficulties in terms of production
      or operation,  or must relocate for reasons of  environmental  protection,
      and company truly needs to reduce personnel

      (e) Other conditions stipulated by PRC laws and regulations.
<PAGE>

13.   Collective Agreements

      There  are no  collective  agreements,  which  affect  the  terms  of your
      employment with the Company.

14.   Disciplinary and Grievance Procedure

14.1. You will  comply  with such  rules or  procedures  regarding  disciplinary
      matters  as may be  published  by the  Company  from  time to  time.  Such
      disciplinary  rules and  procedures do not form part of your  agreement of
      employment.

14.2. If you have any grievance of either personal or general  concern  relating
      to your employment  with the Company,  which has not been resolved to your
      satisfaction  in  informal  discussion,  you should in the first  instance
      refer the matter to the Human  Resources  Manager  of  Valence  Technology
      (Suzhou) Co.,  Ltd. If the outcome of this  decision is not  satisfactory,
      you should take up the  grievance  issue with the Vice  President of Human
      Resources for Valence Technology,  Inc. If the outcome of this decision is
      not  satisfactory,  you  should  take  up the  grievance  issue  with  the
      President  and Chief  Executive  Officer of Valence  Technology,  Inc. The
      decision  of  the  President  and  Chief  Executive   Officer  of  Valence
      Technology, Inc. will be final.

15.   Property

      On termination of your employment for whatever reason you shall deliver up
      to the Company all confidential  information,  correspondence,  documents,
      lists,  disks,  other  papers (or other  means off  storing  or  recording
      information)  and any copies thereof and any other  property  belonging to
      the Company or any Associated  Company which may be in your  possession or
      under your  control  and you shall not  without he written  consent of the
      Company take any copies thereof.

16.   Post Termination Restrictions

16.1. On termination of employment you shall not:

      (a) for a period of 24 months,  whether on your own behalf or on behalf of
      any other  person,  firm or  company,  directly or  indirectly  solicit or
      endeavor to solicit for the purposes of employment or offer  employment to
      or employ  any senior or key  employee  of the  Company or any  Associated
      Company prior tome termination of your employment;

      (b) for a period of 24 months,  whether on your own behalf or on behalf of
      any other  person,  firm or  company,  directly or  indirectly  solicit or
      canvass  business from or interfere with or accept orders from any person,
      firm or company whom,  within a period of months prior to the  termination
      of your employment, was a client or business partner of the Company or any
      Associated  Company  and with whom you had  dealings in the course of your
      employment.
<PAGE>

16.2. The length of any  restriction  under  clause  16.1 will be reduced by the
      length of any period of notice  during  which the  employee is required to
      remain away from work pursuant to clause 11.3.

17.   Data Protection

You   acknowledge and accept that  information  relating to you may be processed
      by the Company in order to fulfill the Company's  obligations to you under
      your employment  agreement  and/or for reasons relating to your employment
      with the Company  and you hereby  explicitly  consent to such  processing,
      which  may  include  the  processing  of  sensitive  personal  data.  Such
      processing will be principally for personnel,  administrative  and payroll
      purposes.

18.   Monitoring of Telecommunications

The   Company  has the right to  monitor  any and all  aspects  of its  computer
      systems that are made  available to you and to monitor,  intercept  and/or
      record any  communications  made by you,  including  any type of e-mail or
      Internet  communications  and you hereby expressly  consent to the Company
      doing so.

      The employee is required to comply with all aspects of any  policies  that
      may from time to time be  published by the Company  concerning  the use by
      its  employees of equipment of the type referred to in this clause that it
      may make available for their use.

19.   Previous Agreements

This  Agreement supersedes any previous agreement between you and the Company or
      any Associated Company in relation to your employment.

20.   Law

The   terms of this  Agreement  shall be governed by and construed in accordance
      with Chinese law and any dispute in connection with your employment  shall
      be submitted to the labor dispute  arbitration  committee for arbitration.
      Any party that is not satisfied with the  adjudication  of arbitration may
      file the lawsuit and be subject to the  jurisdiction of the People's Court
      of the PRC.

21.   Term of the agreement

      The  term of the  agreement  is two  years,  from  December  1st,  2005 to
      November 30th, 2007, and the agreement is subject to renewal when the said
      term expires, with the consent of both parties.

                                        Guo   Chuntai


                                        Signature: /s/ Guo Chuntai
                                                   -------------------


                                        Date: November 3, 2005

                                        Valence Technology (Suzhou) Co., Ltd.


                                        Signature and chop:

                                        Date: November 4, 2005



<PAGE>

EXHIBIT 31.1

                 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER OF
                            VALENCE TECHNOLOGY, INC.

I, James R. Akridge, certify that:

1. I have reviewed  this  quarterly  report on Form 10-Q of Valence  Technology,
Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4. The  registrant's  other  certifying  officer(s)  and I are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal  control over financial
reporting  (as defined in Exchange Act Rules  13a-15(f) and  15d-15(f))  for the
registrant and have:

     a)  Designed  such  disclosure  controls  and  procedures,  or caused  such
disclosure  controls and  procedures to be designed  under our  supervision,  to
ensure that  material  information  relating to the  registrant,  including  its
consolidated subsidiaries,  is made known to us by others within those entities,
particularly during the period in which this report is being prepared;

     b) Designed such internal control over financial reporting,  or caused such
internal control over financial  reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles;

     c) Evaluated the effectiveness of the registrant's  disclosure controls and
procedures and presented in this report our conclusions  about the effectiveness
of the disclosure  controls and procedures,  as of the end of the period covered
by this report based on such evaluation; and

     d) Disclosed in this report any change in the registrant's internal control
over  financial  reporting  that occurred  during the  registrant's  most recent
fiscal quarter (the registrant's  fourth fiscal quarter in the case of an annual
report) that has  materially  affected,  or is  reasonably  likely to materially
affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying  officer(s) and I have disclosed,  based on
our most recent evaluation of internal control over financial reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors (or persons performing the equivalent functions):

     a) All significant  deficiencies  and material  weaknesses in the design or
operation of internal  control over  financial  reporting  which are  reasonably
likely  to  adversely  affect  the  registrant's  ability  to  record,  process,
summarize and report financial information; and

     b) Any fraud,  whether or not material,  that involves  management or other
employees who have a significant role in the registrant's  internal control over
financial reporting.

Date:  February 8, 2006             /s/ James R. Akridge
                                    -----------------------------------
                                    James R. Akridge,
                                    Principal Executive Officer


<PAGE>


EXHIBIT 31.2

                 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER OF
                            VALENCE TECHNOLOGY, INC.

I, Thomas F. Mezger, certify that:

1. I have reviewed  this  quarterly  report on Form 10-Q of Valence  Technology,
Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4. The  registrant's  other  certifying  officer(s)  and I are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal  control over financial
reporting  (as defined in Exchange Act Rules  13a-15(f) and  15d-15(f))  for the
registrant and have:

     (a)  Designed  such  disclosure  controls  and  procedures,  or caused such
disclosure  controls and  procedures to be designed  under our  supervision,  to
ensure that  material  information  relating to the  registrant,  including  its
consolidated subsidiaries,  is made known to us by others within those entities,
particularly during the period in which this report is being prepared;

     (b) Designed such internal control over financial reporting, or caused such
internal control over financial  reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles;

     (c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions  about the effectiveness
of the disclosure  controls and procedures,  as of the end of the period covered
by this report based on such evaluation; and

     (d)  Disclosed  in this  report  any  change in the  registrant's  internal
control over financial  reporting  that occurred  during the  registrant's  most
recent fiscal quarter (the registrant's  fourth fiscal quarter in the case of an
annual  report)  that  has  materially  affected,  or is  reasonably  likely  to
materially affect, the registrant's  internal control over financial  reporting;
and

5. The registrant's other certifying  officer(s) and I have disclosed,  based on
our most recent evaluation of internal control over financial reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors (or persons performing the equivalent functions):

     (a) All significant  deficiencies and material  weaknesses in the design or
operation of internal  control over  financial  reporting  which are  reasonably
likely  to  adversely  affect  the  registrant's  ability  to  record,  process,
summarize and report financial information; and

     (b) Any fraud,  whether or not material,  that involves management or other
employees who have a significant role in the registrant's  internal control over
financial reporting.

Date: February 8, 2006                  /s/ Thomas F. Mezger
                                        -------------------------------
                                        Thomas F. Mezger,
                                        Principal Financial Officer


<PAGE>


EXHIBIT 32.1

                                CERTIFICATION OF
                         PRINCIPAL EXECUTIVE OFFICER OF
                            VALENCE TECHNOLOGY, INC.

This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 and accompanies the quarterly  report on Form 10-Q (the "Form 10-Q") for
the quarter ended December 31, 2005, of Valence Technology, Inc. (the "Issuer").

          I,   James R. Akridge,  the Principal Executive Officer of the Issuer,
               certify that to the best of my knowledge:

               (i)  the  Form  10-Q  fully  complies  with the  requirements  of
                    Section  13(a) or Section 15(d) of the  Securities  Exchange
                    Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and

               (ii) the information  contained in the Form 10-Q fairly presents,
                    in  all  material  respects,  the  financial  condition  and
                    results of operations of the Issuer.

Dated:  February 8, 2006                /s/ James R. Akridge
                                        -------------------------------
                                        James R. Akridge



<PAGE>


EXHIBIT 32.2

                                CERTIFICATION OF
                         PRINCIPAL FINANCIAL OFFICER OF
                            VALENCE TECHNOLOGY, INC.

This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 and accompanies the quarterly  report on Form 10-Q (the "Form 10-Q") for
the quarter ended December 31, 2005, of Valence Technology, Inc. (the "Issuer").

          I,   Thomas F. Mezger, the Principal  Financial Officer of the Issuer,
               certify that to the best of my knowledge:

               (i)  the  Form  10-Q  fully  complies  with the  requirements  of
                    Section  13(a) or Section 15(d) of the  Securities  Exchange
                    Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and

               (ii) the information  contained in the Form 10-Q fairly presents,
                    in  all  material  respects,  the  financial  condition  and
                    results of operations of the Issuer.


Dated:  February 8, 2006                /s/ Thomas F. Mezger
                                        -------------------------------
                                        Thomas F. Mezger