UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2006.

                                       or

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

For the transition period from ____________ to ____________

Commission file number 0-20028

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

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


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

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

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

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

                             Yes   [X]      No   [  ]

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

Large accelerated filer [  ]  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                     94,453,775
         (Class)                          (Outstanding at August 2, 2006)


<PAGE>


                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES


                                    FORM 10-Q

                       FOR THE QUARTER ENDED JUNE 30, 2006




                                      INDEX

                                                                           Pages


Part I.    Financial Information

  Item 1.  Financial Statements (Unaudited):

  Condensed Consolidated Balance Sheets as of
  June 30, 2006 and March 31, 2006.............................................1

  Condensed Consolidated Statements of Operations and
  Comprehensive Loss for the Three-Month Periods
  Ended June 30, 2006 and June 30, 2005........................................2

  Condensed Consolidated Statements of Cash Flows for
  the Three-Month Periods Ended
  June 30, 2006 and June 30, 2005..............................................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.........37

  Item 4.  Controls and Procedures............................................37


Part II.   Other Information

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

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

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

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

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

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

Signature  ---................................................................41



<PAGE>


                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS (UNAUDITED)

<TABLE>
<CAPTION>
                    VALENCE TECHNOLOGY, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      (in thousands, except share amounts)
                                   (Unaudited)



                                                                         June 30, 2006       March 31, 2006
                                                                      -----------------    -----------------
<S>                                                                      <C>                   <C>
Assets
Current assets:
   Cash and cash equivalents                                            $         702         $        612
   Trade receivables, net of allowance of $90 and $99, respectively             2,684                2,376
   Inventory                                                                    6,115                2,738
   Prepaid and other current assets                                             2,123                2,566
                                                                      ----------------     ----------------
Total current assets                                                           11,624                8,292
Property, plant and equipment, net                                              3,144                3,052
Intellectual property, net                                                        259                  288
                                                                      ----------------     ----------------
Total assets                                                            $      15,027         $     11,632
                                                                      ================     ================
Liabilities and Stockholders' Deficit
Current liabilities:
   Convertible notes payable to stockholder                             $       2,004         $      6,000
   Accounts payable                                                             3,391                1,599
   Accrued expenses                                                             4,464                4,479
   Deferred revenue                                                               915                  464
                                                                      ----------------     ----------------
Total current liabilities                                                      10,774               12,542
Long-term interest payable to stockholder                                      16,247               15,580
Long-term debt, net of debt discount                                           18,062               17,942
Long-term debt to stockholder, net of debt discount                            33,354               33,170
                                                                      ----------------     ----------------
   Total liabilities                                                           78,437               79,234
                                                                      ----------------     ----------------
Commitments and contingencies
Redeemable convertible preferred stock, $0.001 par value,
   1,000 shares authorized, 861 issued and outstanding as of
   June 30, 2006 and March 31, 2006, liquidation value $8,610                   8,610               8,610
Stockholders' equity (deficit):
   Common stock, $0.001 par value, 200,000,000 shares authorized;
   94,442,525 and 89,883,539 shares outstanding as of June 30,
      2006 and March 31, 2006                                                      94                   90
   Additional paid-in capital                                                 436,669              426,745
   Notes receivable from stockholder                                          (5,234)              (5,164)
   Accumulated deficit                                                      (499,881)            (494,224)
   Accumulated other comprehensive loss                                       (3,668)              (3,659)
                                                                      ----------------      ---------------
Total stockholders' deficit                                                  (72,020)              (76,212)
                                                                      ----------------      ---------------
Total liabilities, preferred stock and stockholders' deficit            $      15,027         $     11,632
                                                                      ================      ===============

</TABLE>

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



<PAGE>
<TABLE>
<CAPTION>


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

                                                                Three Months Ended June 30,
                                                             --------------------------------
<S>                                                              <C>                  <C>

                                                                 2006                2005
                                                             --------------     --------------
Revenue:
     Battery and system sales                                   $    2,989        $     3,261
     Licensing and royalty revenue                                     179                144
                                                             --------------     --------------
Total revenues                                                       3,168              3,405

Cost of sales                                                        3,146              5,327
                                                             --------------     --------------
Gross margin profit (loss)                                              22            (1,922)
Operating expenses:
     Research and product development                                1,094              1,692
     Marketing                                                         429                723
     General and administrative                                      2,176              3,370
     Share based compensation                                          264                  -
     Depreciation and amortization                                     181                168
     Loss (gain) on disposal of assets                                  15              (615)
     Contract settlement charges                                        23                  -
                                                             --------------    ---------------
Total operating expenses                                             4,182              5,338
                                                             --------------    ---------------

Operating loss                                                     (4,160)            (7,260)
Interest and other income                                              108                92
Interest expense                                                   (1,562)              (975)
                                                             --------------    ---------------
Net loss                                                           (5,614)            (8,143)
Dividends on preferred stock                                            43                 43
Preferred stock accretion                                                -                 10
                                                             --------------    ---------------
Net loss available to common stockholders, basic and
     diluted                                                    $  (5,657)        $   (8,196)
                                                             ==============    ===============
Other comprehensive loss:
     Net loss                                                   $  (5,614)        $   (8,143)
     Change in foreign currency translation adjustments                (9)                 57
                                                             --------------    ---------------
Comprehensive loss                                              $  (5,623)        $   (8,086)
                                                             ==============    ===============

Net loss per share available to common stockholders             $   (0.06)        $    (0.09)
                                                             ==============    ===============

Shares used in computing net loss per share available to
common stockholders, basic and diluted.                             93,807             88,389
                                                             ==============    ===============

</TABLE>


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



<PAGE>

<TABLE>
<CAPTION>

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

                                                                                   Three Months Ended June 30,
                                                                             ------------------ --- ------------------
                                                                                   2006                   2005
                                                                             ------------------     ------------------
<S>                                                                                 <C>                     <C>

Cash flows from operating activities:
Net loss                                                                         $   (5,614)            $   (8,143)
Adjustments to reconcile net loss to net cash used in operating
     activities:
     Depreciation and amortization                                                       249                    168
     Loss (gain) on disposal of assets                                                    15                  (615)
     Accretion of debt discount and other                                                304                    229
     Interest income on stockholder note receivable                                     (70)                   (70)
     Compensation related to the issuance of stock options                               264                     13
Changes in operating and other assets and liabilities:
     Trade receivables                                                                 (308)                  (515)
     Inventory                                                                       (3,377)                (1,625)
     Prepaid and other current assets                                                    443                  (435)
     Accounts payable                                                                  1,792                  2,774
     Accrued expenses and long-term interest                                             693                   (39)
     Deferred revenue                                                                    451                  (112)
                                                                             ------------------     ------------------
Net cash used in operating activities                                                (5,158)                (8,370)
                                                                             ------------------     ------------------

Cash flows from investing activities:
     Purchases of property, plant & equipment                                          (327)                  (606)
     Proceeds from sale of property, plant & equipment                                    -                     622
                                                                             ------------------     ------------------
Net cash (used in) provided by investing activities                                    (327)                     16
                                                                             ------------------     ------------------

Cash flows from financing activities:
     Proceeds from notes payable to stockholder                                        2,000                  2,500
     Dividends paid                                                                        -                   (43)
     Interest received on stockholder note receivable                                      -                    281
     Proceeds from stock option exercises                                                122                    191
     Proceeds from issuance of common stock, net of issuance costs                     3,469                  5,991
                                                                             ------------------     ------------------
Net cash provided by financing activities                                              5,591                  8,920
                                                                             ------------------     ------------------

Effect of foreign exchange rates on cash
     and cash equivalents                                                               (16)                     26
                                                                             ------------------     ------------------
Increase in cash and cash equivalents                                                     90                    592
Cash and cash equivalents, beginning of period                                           612                  2,500
                                                                             ------------------     ------------------
Cash and cash equivalents, end of period                                         $       702            $     3,092
                                                                             ==================     ==================

Supplemental Information:
     Conversion of notes payable to stockholder into common stock                $     6,073            $         -
     Interest Paid                                                                       456                      -


 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
                                  June 30, 2006
                                   (Unaudited)



1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:

These interim  condensed  consolidated  financial  statements  are unaudited but
reflect,  in  the  opinion  of  management,  all  normal  recurring  adjustments
necessary to present fairly the financial position of Valence  Technology,  Inc.
and its  subsidiaries  (the  "Company")  as of June 30, 2006,  its  consolidated
results of operations  for each of the  three-month  periods ended June 30, 2006
and June 30, 2005, and the consolidated  cash flows for the three-month  periods
ended June 30, 2006 and June 30, 2005.  Because all the disclosures  required by
generally  accepted  accounting  principles  are  not  included,  these  interim
condensed  consolidated  financial statements should be read in conjunction with
the audited  financial  statements  and notes  thereto in the  Company's  Annual
Report on Form 10-K as of and for the year ended March 31, 2006. The results for
the three-month  periods ended June 30, 2006 are not  necessarily  indicative of
the results to be expected for the entire fiscal year ending March 31, 2007. The
year-end  condensed  consolidated  balance  sheet data as of March 31,  2006 was
derived from audited financial statements,  but does not include all disclosures
required by generally accepted accounting principles.

2. BUSINESS AND BUSINESS STRATEGY:

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

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

The Company's  business plan and strategy  focuses on the  generation of revenue
from product sales,  while  minimizing  costs through a manufacturing  plan that
utilizes  partnerships with contract  manufacturers  and internal  manufacturing
efforts  through its wholly  owned  subsidiaries  in China.  These  subsidiaries
initiated  operations in late fiscal 2005. The market for Saphion(R)  technology
will be developed by offering existing and new solutions that  differentiate the
Company's  products and its  customers'  products in both the  large-format  and
small-format  markets  through the Company's own product  launches,  such as the
N-Charge(TM)  Power System,  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.


<PAGE>

3. GOING CONCERN AND LIQUIDITY AND CAPITAL RESOURCES:

Going Concern:

The accompanying  condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern,  which  contemplates
the  realization of assets and  satisfaction of liabilities in the normal course
of  business.  The Company  has  incurred  operating  losses each year since its
inception in 1989 and had an  accumulated  deficit of $499.9  million as of June
30,  2006.  For the  three-month  period  ended June 30,  2006 the  Company  has
incurred a net loss available to common  stockholders  of $5.7 million.  For the
years ended March 31, 2006 and 2005,  the Company  sustained net losses of $32.9
and $32.2 million, respectively.  These factors, among others, indicate that the
Company may be unable to continue as a going concern for a reasonable  period of
time.  The Company's  ability to continue as a going concern is contingent  upon
its  ability to meet its  liquidity  requirements.  If the  Company is unable to
arrange for debt or equity  financing on favorable terms or at all the Company's
ability to continue as a going concern is uncertain.  These financial statements
do not give effect to any  adjustments  to the amounts  and  classifications  of
assets and liabilities  which might be necessary should the Company be unable to
continue as a going concern.

Liquidity and Capital Resources:

At June 30, 2006,  the Company's  principal  sources of liquidity  were cash and
cash equivalents of $702,000.  The Company expects our sources of liquidity will
not be sufficient for the remaining fiscal year. The Company anticipates product
sales during fiscal 2007 from the N-Charge(TM) Power System and the Segway pack,
which are  subject to  seasonal  fluctuations  and from the sale of  U-Charge(R)
Power Systems will be  insufficient to cover the Company's  operating  expenses.
Management  depends  upon our ability to  periodically  arrange  for  additional
equity or debt financing to meet our liquidity requirements.  Unless our product
sales are greater than management currently forecasts or there are other changes
to our business  plan, we will need to arrange for additional  financing  within
the next three to six months to fund operating and capital needs. This financing
could take the form of debt or equity.  Given our historical  operating  results
and the amount of our existing debt, as well as the other factors, we may not be
able to arrange for debt or equity  financing  from third  parties on  favorable
terms or at all.

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

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Revenue Recognition:

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


<PAGE>

Impairment of Long-Lived Assets:

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

Stock-based Compensation:

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

Recent Accounting Pronouncements:

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43,  Chapter 4. The  standard  requires  that  abnormal  amounts of idle
capacity and spoilage  costs should be excluded  from the cost of inventory  and
expensed when incurred.  The provision is effective for inventory costs incurred
beginning  April 1, 2006.  The adoption of this standard did not have a material
effect on the Company's financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets,
an amendment of APB No. 29,  Accounting for Nonmonetary  Transactions.  SFAS No.
153 requires  exchanges of productive  assets to be accounted for at fair value,
rather than at carryover  basis,  unless (1) neither the asset  received nor the
asset surrendered has a fair value that is determinable within reasonable limits
or (2) the transactions lack commercial substance. SFAS No. 153 is effective for
nonmonetary  asset  exchanges  beginning  April 1, 2006.  The  adoption  of this
standard did not have a material  effect on the  Company's  financial  position,
results of operations or cash flows.

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

In May  2005,  the FASB  issued  SFAS No.  154,  Accounting  Changes  and  Error
Corrections--A  Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS
No. 154 changes the  requirements  for the  accounting  for and  reporting  of a
change  in  accounting   principle.   This  statement   requires   retrospective
application  to prior  periods'  financial  statements  of changes in accounting
principle,  unless it is impracticable  to determine either the  period-specific
effects  or the  cumulative  effect  of the  change.  This  statement  redefines
restatements  as the  revising of  previously  issued  financial  statements  to
reflect the  correction of an error.  SFAS No. 154 requires  that  retrospective
application of a change in accounting principle be limited to the direct effects
of the change.  This  statement  also  requires  that a change in  depreciation,
amortization,  or  depletion  method  for  long-lived,  non-financial  assets be
accounted  for as a change  in  accounting  estimate  affected  by a  change  in
accounting  principle.  SFAS No. 154 is  effective  for  accounting  changes and
corrections of errors beginning April 1, 2006. The adoption of this standard did
not have a  material  effect on the  Company's  financial  position,  results of
operations or cash flows.

Net Loss per Share Available to Common Stockholders:

Net loss per share is  computed  by dividing  the net loss  available  to common
stockholders by the weighted average shares of common stock  outstanding  during
the period.  The dilutive  effect of the options and warrants to purchase common
stock are excluded  from the  computation  of diluted net loss per share,  since
their effect is  antidilutive.  The antidilutive  instruments  excluded from the
diluted net loss per share  computation for the  three-month  periods ended June
30, 2006 and 2005 were as follows:

<TABLE>
<CAPTION>

                                                          Three Months Ended
                                                               June 30,
                                                          2006         2005
                                                       ------------ ------------
          <S>                                             <C>           <C>
   Shares reserved for conversion of Series C
     preferred stock                                     3,629,470    2,152,500
   Common stock options                                  8,255,880   11,051,798
   Warrants to purchase common stock                     2,955,643    1,889,315
                                                       ------------ ------------
     Total                                              14,840,993   15,093,613
                                                       ============ ============
</TABLE>

5. INVENTORY:

   Inventory consisted of the following (in thousands) at:
<TABLE>
<CAPTION>

                                 June 30, 2006            March 31, 2006
                               ----------------          ----------------
          <S>                        <C>                       <C>

   Raw materials                 $       2,166              $     891
   Work in process                       2,840                  1,422
   Finished goods                        1,109                    425
                               ----------------          ----------------
                                 $       6,115              $   2,738
                               ================          ================
</TABLE>

Included  in  inventory  at June 30,  2006 and  March 31,  2006  were  valuation
allowances of $5.3 million to reduce their  carrying  values to lower of cost or
market.

<PAGE>

6. PROPERTY, PLANT AND EQUIPMENT:

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

<TABLE>
<CAPTION>

                                       June 30, 2006       March 31, 2006
                                      ----------------   -----------------
          <S>                              <C>                  <C>

  Leasehold improvements                    652                  738
  Machinery and equipment                 5,999                7,854
  Office and computer equipment           1,960                2,032
  Construction in progress                  237                   84
                                      ----------------   -----------------
    Total cost                            8,848               10,708
  Less:  accumulated depreciation        (5,613)              (5,624)
  Less:  impairment                         (91)              (2,032)
                                      ----------------   -----------------
    Total cost, net of depreciation     $  3,144           $    3,052
                                      ================   =================

</TABLE>

7. INTELLECTUAL PROPERTY:

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


                                           June 30, 2006         March 31, 2006
                                          ----------------     -----------------
    <S>                                         <C>                   <C>

  Intellectual property before impairment   $    13,602        $     13,602
  Less:  accumulated amortization                (4,849)             (4,820)
  Less:  impairment                              (8,494)             (8,494)
                                         -----------------     -----------------
  Intellectual property, net                 $      259         $       288
                                         ==================    =================

</TABLE>

Amortization  expense for the three-month  periods ended June 30, 2006 and 2005,
was approximately $29,000.

8. CONVERTIBLE NOTES PAYABLE TO STOCKHOLDER:

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

In February and March 2006, the Company issued  convertible  promissory notes in
favor of Berg & Berg in an  aggregate  principal  amount  of $6.0  million  (the
"Notes").  The Notes accrued  interest at the annual rate of 8.0% and matured on
March 30 and June 30, 2006.  The  principal  amount of the Notes,  together with
accrued  interest,  was converted into  2,965,870  shares of common stock of the
Company, in accordance with their terms on April 3, 2006.

<PAGE>

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

   (in thousands)                         June 30, 2006         March 31, 2006
                                       -------------------     -----------------
    <S>                                         <C>                   <C>
   2005 Loan balance                        $   20,000           $   20,000
   Unaccreted debt discount                    (1,938)              (2,058)
                                       -------------------     -----------------
   Balance                                  $   18,062           $   17,942
                                       -------------------     -----------------


   2001 Loan to stockholder balance             20,000               20,000
   1998 Loan to stockholder balance             14,950               14,950
   Unaccreted debt discount                    (1,596)               (1,780)
                                       -------------------    ------------------
   Balance                                  $   33,354           $   33,170
                                       -------------------    ------------------

</TABLE>

In June 2005, the Company  obtained a $20.0 million funding  commitment from Mr.
Carl Berg, the Company's  chairman of the board and principal  stockholder.  The
amount of Mr.  Berg's  funding  commitment  was reduced in  connection  with the
purchase of the Series C-2  Convertible  Preferred  Stock in July 2005 by Berg &
Berg Enterprises LLC ("Berg & Berg"), the purchase of the Series C-1 Convertible
Preferred  Stock in  December  2005 by Berg & Berg,  and the  convertible  notes
payable to  stockholder  discussed  in Footnote 8. At June 30, 2006 this funding
commitment has beenfully utilized by the Company.

On July 13,  2005,  the Company  secured a $20.0  million loan (the "2005 Loan")
from a third  party  finance  company,  the full  amount of which has been drawn
down. The loan is guaranteed by Mr. Berg. The loan matures in a lump sum on July
13,  2010.  Interest  is due  monthly  based on a floating  interest  rate.  The
interest  rate is  calculated  as the greater of 6.75% or the sum of LIBOR Rate,
rounded to the nearest  1/16th of 1.0%,  plus 4.0% (9.19% as of June 30,  2006).
The loan may not be  prepaid  in whole or in part on or prior to July 12,  2007.
The loan may be prepaid  during the period  beginning  on July 13, 2007  through
July  12,  2009,  with a 1.0%  prepayment  premium,  and on July  13,  2009  and
thereafter with no prepayment  premium. In connection with the loan, the Company
purchased a rate cap agreement to protect against  fluctuations in LIBOR for the
full amount of the loan for a period of three years.

The Company used $2.5 million of the proceeds  from the loan to repay a June 30,
2005 draw from Mr. Berg's funding  commitment.  In connection with the loan both
the third  party  finance  company and Mr.  Berg  received  warrants to purchase
600,000 shares of the Company's  common stock at a price of $2.74 per share. The
warrants are exercisable  beginning on the date they were issued and will expire
on  July  13,  2008.  The  fair  value  assigned  to  these  warrants,  totaling
approximately  $2.037  million,  has been recorded as a discount on the debt and
will be accreted as interest  expense  over the life of the loan.  The  warrants
were valued using the Black-Scholes  valuation method using the assumptions of a
life of 36 months,  96.45%  volatility,  and a risk free rate of 3.88%.  Also in
connection  with the  loan,  the  Company  incurred  a loan  commitment  fee and
attorney's fees which, in addition to the interest rate cap agreement, have been
recorded as a discount on the debt and will be accreted as interest expense over
the life of the loan.  Through June 30, 2006, a total of approximately  $465,033
has been  accreted and included as interest  expense.  Interest  payments on the
loan are currently being paid on a monthly basis.

In October 2001, the Company  entered into a loan  agreement  ("2001 Loan") with
Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the
Company  funds  of up to $20  million  between  the  date of the  agreement  and
September 30, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable
from time to time.  On July 13, 2005,  Berg & Berg agreed to extend the maturity
date for the loan  principal and interest  from  September 30, 2006 to September
30,  2008.  On  November  8,  2002,  the  Company  and  Berg & Berg  amended  an
affirmative  covenant in the agreement to acknowledge the Nasdaq SmallCap Market
as an acceptable market for the listing of the Company's Common Stock.

<PAGE>

In  conjunction  with the 2001 Loan,  Berg & Berg received a warrant to purchase
1,402,743 shares of the Company's common stock at the price of $3.208 per share.
The warrants were exercisable beginning on the date they were issued and expired
on  August  30,  2005.  The fair  value  assigned  to these  warrants,  totaling
approximately $2.768 million has been reflected as additional  consideration for
the debt financing,  recorded as a discount on the debt and accreted as interest
expense  over  the  life  of the  loan.  The  warrants  were  valued  using  the
Black-Scholes  method  using  the  assumptions  of a  life  of 47  months,  100%
volatility,  and a risk-free  rate of 5.5%.  Through  June 30,  2006, a total of
$2.473 million has been accreted and included as interest  expense.  The amounts
charged  to  interest  expense  on the  outstanding  balance of the loan for the
three-month  periods  ended  June  30,  2006 and 2005  were  $404,000.  Interest
payments on the loan are currently being deferred, and are recorded as long-term
interest. The accrued interest amounts for the 2001 Loan were $7.113 million and
$6.708 million as of June 30, 2006 and March 31, 2006, respectively.

In July 1998, the Company  entered into an amended loan agreement  ("1998 Loan")
with Berg & Berg that allows the Company to borrow,  prepay and  re-borrow up to
$10 million  principal under a promissory note on a revolving basis. In November
2000,  the 1998 Loan agreement was amended to increase the maximum amount to $15
million.  As of June 30, 2006, the Company had an outstanding  balance of $14.95
million under the 1998 Loan  agreement.  The loan bears  interest at one percent
over lender's borrowing rate  (approximately 9.0% at June 30, 2006). On July 13,
2005,  Berg & Berg agreed to extend the maturity date for the loan principal and
interest from September 30, 2006 to September 30, 2008. On November 8, 2002, the
Company and Berg & Berg  amended an  affirmative  covenant in the  agreement  to
acknowledge the Nasdaq  SmallCap Market as an acceptable  market for the listing
of the Company's  Common Stock.  The accrued  interest amounts for the 1998 Loan
were $9.134  million and $8.51  million as of June 30, 2005 and March 31,  2005,
respectively.

In fiscal 1999, the Company issued warrants to purchase 594,031 shares of common
stock to Berg & Berg in conjunction  with the 1998 Loan  agreement,  as amended.
The warrants  were valued using the  Black-Scholes  valuation  method and had an
average  weighted fair value of  approximately  $3.63 per warrant at the time of
issuance, using the assumptions of a life of 36 months, 96.45% volatility, and a
risk  free  rate  of  3.88%.   The  fair  value  of  these  warrants,   totaling
approximately $2.159 million, has been reflected as additional consideration for
the debt financing,  recorded as a discount on the debt and accreted as interest
expense  to be  amortized  over the life of the line of  credit.  As of June 30,
2006,  a total of $2.159  million  has been  accreted.  The  amounts  charged to
interest  expense for the three-month  periods ended June 30, 2006 and 2005 were
$335,000.  Interest  payments on the loan are currently being deferred,  and are
recorded as long-term interest.

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


10. COMMITMENTS AND CONTINGENCIES:

Warranties:

The Company has  established a warranty  reserve in connection  with the sale of
N-Charge(TM)  Power Systems covering a 12-month warranty period during which the
Company would provide a replacement  unit to any customer  returning a purchased
product because of a product performance issue. The Company has also established
a warranty reserve in relation to the sale of its 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
June 30, 2006 is $1.348 million.

Litigation:

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

<PAGE>

The action is in the initial pleading state and the Company has filed a response
denying  the  allegations.  The  Company's  management  believes  the  action by
Hydro-Quebec is without merit and intends to vigorously  defend the lawsuit,  as
well as pursue all of its available legal remedies.

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

11. REDEEMABLE CONVERTIBLE PREFERRED STOCK:

On June 2,  2003,  the  Company  issued  1,000  shares of  Series C  Convertible
Preferred Stock and warrants to purchase the Company's  common stock for $10,000
per share,  raising net proceeds of $9.416  million.  On January 22,  2004,  the
holder of the Series C Convertible  Preferred  Stock  converted 139 of its 1,000
shares with the principal amount of $1.39 million,  including accrued and unpaid
dividends,  into 327,453 shares of the Company's  common stock at the conversion
price of $4.25 per share.  On November  30,  2004,  the Company  entered into an
amendment and exchange  agreement to exchange all  outstanding 861 shares of the
Company's  Series C Convertible  Preferred Stock,  representing  $8.6 million of
principal. The Series C Convertible Preferred Stock was exchanged for 431 shares
of Series C-1 Convertible  Preferred Stock, with a stated value of $4.3 million,
and 430 shares of Series C-2 Convertible Preferred Stock, with a stated value of
$4.3 million. When issued, the Series C-1 Convertible Preferred Stock and Series
C-2 Convertible  Preferred Stock were convertible into common stock at $4.00 per
share. Each series carries a 2% annual dividend rate,  payable quarterly in cash
or shares of common stock, and were redeemable on December 15, 2005. The Company
has the right to convert the preferred stock if the average of the dollar-volume
weighted  average  price of the  Company's  common  stock for a ten-day  trading
period is at or above $6.38 per share. If the preferred  shares are not redeemed
in accordance with their terms, the holder of the preferred stock shall have the
option to require the Company to convert all or part of the redeemed shares at a
price of 95% of the  lowest  closing  bid price of the  Company's  common  stock
during the three days ending on and including the conversion date. The preferred
shares are currently  outstanding and subject to redemption or conversion at the
holder's discretion.

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

In  connection  with  the  issue  of  the  original  issuance  of the  Series  C
Convertible  Preferred  Stock,  in June 2003, the Company issued to the Series C
Convertible Preferred Stock original holder a warrant to purchase 352,900 shares
of the Company's common stock. The warrant is exercisable at a purchase price of
$5.00 per share and  expires  in June 2008.  The  warrant  was valued  using the
Black-Scholes  valuation  model.  The warrant was recorded to additional paid in
capital at its relative fair value to the Series C Convertible  Preferred  Stock
at $933,000.  Accretion to the remaining  redemption  value of $8.61 million was
recorded over the  eighteen-month  period of the Series C Convertible  Preferred
Stock ending December 2, 2004.

12. Stock-Based Compensation

The  Company  has a stock  option plan (the "1990  Plan")  under  which  options
granted may be incentive  stock options or supplemental  stock options.  Options
are to be granted at a price not less than fair market value (incentive options)
or 85% of fair market  value  (supplemental  options) on the date of grant.  The
options  vest  as  determined  by the  Board  of  Directors  and  are  generally
exercisable over a five-year period.  Unvested options are canceled and returned
to the 1990 Plan upon an employee's termination.  Generally, vested options, not
exercised within three months of termination,  are also canceled and returned to
the 1990 Plan.  The 1990 Plan  terminated on July 17, 2000,  and as such options
may not be granted  after  that date.  Options  granted  prior to July 17,  2000
expire no later than ten years from the date of grant.

In  February  1996,  the Board of  Directors  adopted a stock  plan for  outside
Directors  (the "1996  Non-Employee  Director's  Stock Option  Plan").  The plan
provides  that new  directors  will  receive an initial  stock option of 100,000
shares of common stock upon their election to the Board.  The exercise price for
this initial option will be the fair market value on the day it is granted. This
initial option will vest one-fifth on the first and second  anniversaries of the
grant of the option, and quarterly over the next three years. A director who had
not received an option upon  becoming a director  will receive an initial  stock
option of 100,000  shares on the date of the  adoption  of the plan.  During the
first quarter of fiscal 2007 no shares were granted under this plan. At June 30,
2006,  the  Company  had  21,260  shares  available  for  grant  under  the 1996
Non-Employee Director's Stock Option Plan.

In October  1997,  the Board of  Directors  adopted the 1997  Non-Officer  Stock
Option Plan (the "1997  Plan").  The Company  may grant  options to  non-officer
employees and  consultants  under the 1997 Plan.  Options are to be granted at a
price not less than fair market value (incentive  options) on the date of grant.
The options vest as determined by the Board of  Directors,  generally  quarterly
over a three- or four-year  period.  The options  expire no later than ten years
from the date of grant.  Unvested  options are canceled and returned to the 1997
Plan upon an employee's termination.  Vested options, not exercised within three
months of termination,  also are canceled and returned to the 1997 Plan.  During
the first quarter of fiscal 2007 no shares were granted under this plan. At June
30,  2006,  the Company had 750,781  shares  available  for grant under the 1997
Plan.

In January 2000, the Board of Directors  adopted the 2000 Stock Option Plan (the
"2000  Plan").  The Company may grant  incentive  stock options to employees and
non-statutory  stock options to  non-employee  members of the Board of Directors
and  consultants  under the 2000 Plan.  Options are to be granted at a price not
less than fair market  value on the date of grant.  In the case of an  incentive
stock option granted to an employee who owns stock  possessing  more than 10% of
the total  combined  voting  power of all classes of stock of the Company or any
affiliate, the option is to be granted at a price not less than 110% of the fair
market value on the date of grant.  The options are exercisable as determined by
the Board of Directors, generally over a four-year period. The options expire no
later than ten years from the date of grant.  Unvested  options are canceled and
returned to the 2000 Plan upon an employee's  termination.  Vested options,  not
exercised within three months of termination,  also are canceled and returned to
the 2000 Plan. During fiscal year 2005, a total of 1,778,000 shares were granted
under this plan.  During the first  quarter of fiscal 2007  269,000  shares were
granted  under this plan.  At June 30, 2006,  the Company had  1,662,641  shares
available for grant under the 2000 Plan.  When options are exercised the Company
issues new shares to the grantee.

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

<TABLE>
<CAPTION>

                                                        Outstanding options
                                           -----------------------------------------------
                                                                       Weighted Average
                                             Number of Shares           Exercise Price
                                           ----------------------    ---------------------
         <S>                                        <C>                        <C>

    Balance at March 31, 2006                         9,045              $      4.97
        Granted                                         269              $      1.83
        Exercised                                      (75)              $      1.44
        Canceled                                      (984)              $      3.25
                                           ----------------------    ---------------------
    Balance at June 30, 2006                          8,255              $      4.91
                                           ======================    =====================
</TABLE>

The following table summarizes information about fixed stock options outstanding
at June 30, 2006 (shares in thousands):

<TABLE>
<CAPTION>

                                         Outstanding options                                Options Exercisable
                        -------------------------------------------------------    --------------------------------------
                                              Weighted
                                              Average
                                             Remaining            Weighted                                  Weighted
 Range of Exercise         Number           Contractual           Average               Number               Average
       Prices            Outstanding        Life (years)       Exercise Price         Exercisable        Exercise Price
---------------------   --------------    -----------------   -----------------    ------------------    ----------------
         <S>                <C>                 <C>                 <C>                   <C>                   <C>

   $0.63 - $1.99            1,190               7.11                $1.61                  181                $1.44
   $1.99 - $4.62            3,316               7.22                $2.96                1,095                $2.89
   $4.62 - $10.06           3,476               3.35                $6.47                3,411                $6.50
  $10.06 - $15.75              60               3.65               $11.73                   60               $11.73
  $15.75 - $23.56             113               3.14               $20.41                  113               $20.41
  $23.56 - $34.62             100               2.92               $32.93                  100               $32.93
---------------------   --------------    -----------------   -----------------    ------------------    ----------------
   $0.63 - $34.62           8,255               5.44                $4.91                4,960                $6.43

</TABLE>


The aggregate  intrinsic value of options outstanding and options exercisable at
June 30, 2006 was $199,957 and $51,653,  respectively.  Compensation expense for
stock  plans has been  determined  based on the fair value at the grant date for
options granted in the current fiscal year. For the first quarter of fiscal year
2007,  $264,000  of  stock  based  compensation  expense  has been  included  in
operating  expenses in the  three-month  period  ended June 30,  2006  condensed
consolidated  statements of operations and  comprehensive  loss. For fiscal year
2006,  compensation  expense was not recorded  consistent with the provisions of
SFAS 123, as amended by SFAS 148. Had compensation expense been recorded the pro
forma net loss would have been reported as follows (in thousands):

<TABLE>
<CAPTION>

                                                            Three Months Ended June 30,
                                                                2006            2005
                                                           --------------------------------
              <S>                                                 <C>            <C>

     Net loss available to stockholders - as reported           $(5,657)         $(8,196)
     Add: stock-based compensation expense, net of
         related taxes                                                 -            (580)
                                                           --------------------------------
     Net loss available to stockholders - pro forma             $(5,657)         $(8,776)
                                                           ================================
     Net loss available to stockholders per share,             $ (0.06)          $ (0.09)
     basic and diluted - as reported
     Net loss available to stockholders per share,
     basic and diluted - pro forma                             $ (0.06)          $ (0.10)

</TABLE>

As of June 30,  2006 the Company  had a total of $2.29  million in  compensation
costs related to stock-based  compensation to recognize over a remaining service
period of 5 years for non-vested options (with a weighted average service period
of 2.25 years).  Expected volatility is based on the Company's  historical stock
price  volatility.  The risk free  interest  rate is based on the U.S.  Treasury
yield  curve  in  effect  on  the  date  of the  grant.  The  Company  estimates
forfeitures  based on  historical  data.  The fair value of each option grant is
estimated at the date of grant using the  Black-Scholes  pricing  model with the
following weighted average assumptions for grants in fiscal years 2007 and 2006:

<TABLE>
<CAPTION>

                                              Three Months Ended June 30,
                                                   2006            2005
                                              --------------------------------
               <S>                                 <C>              <C>

         Risk-free interest rate                  4.79%           3.72%
         Expected life                          5.0 years       5.0 years
         Volatility                              84.86%          93.31%
         Dividend yield                           None            None


</TABLE>


13. RELATED PARTY TRANSACTIONS:

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

In July 2006, the Company issued  convertible  promissory notes in the aggregate
principal  amount of $2.0 million and $1.0 million to Berg & Berg, which are due
with interest in August 2006 and October 2006,  respectively.  These convertible
promissory  notes  accrued  interest  at  the  annual  rate  of  8.0%  and  were
convertible  at any time prior to  maturity,  into shares of common stock of the
Company at a  conversion  price equal to the closing bid price of the  Company's
common  stock on the  trading  day  immediately  prior to the  conversion  date,
provided  that the  conversion  price cannot be lower than $1.73 and $1.33,  the
closing  bid price of the  Company's  common  stock on July 7, 2006 and July 20,
2006,  respectively.  On July 25, 2006 these notes were converted into 1,885,302
common shares of the Company at $1.73 and $1.38, respectively.

In June 2006, the Company issued  convertible  promissory notes in the aggregate
principal  amount of $2.0 million to Berg & Berg, which are due with interest in
September  2006.  These  convertible  promissory  notes accrued  interest at the
annual rate of 8.0% and were  convertible  at any time prior to  maturity,  into
shares of common stock of the Company at a conversion price equal to the closing
bid price of the Company's common stock on the trading day immediately  prior to
the conversion  date,  provided that the  conversion  price cannot be lower than
$1.70, the closing bid price of the Company's common stock on June 20, 2006. The
notes and accrued  interest  were  converted  into a total of  1,188,332  common
shares of the Company on July 25, 2006.

<PAGE>

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

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

On March 28, 2006 the Company  entered  into a tri-party  agreement  with Berg &
Berg  and  another   corporation   to  jointly   develop  and  improve   certain
manufacturing  processes. In consideration for this agreement,  the Company will
issue  $250,000  in  common  stock  to the  other  corporation  and may  provide
equipment  and other  resources in  consideration  for research and  development
costs and intellectual  property rights although the Company is not obligated to
do so.

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

In June 2004, Mr. Berg agreed to provide an additional $20 million backup equity
funding  commitment.  This additional  funding  commitment was in the form of an
equity  line of credit and  allowed  the Company to request Mr. Berg to purchase
shares of common stock from time to time at the average closing bid price of the
stock for the five days prior to the purchase  date.  As of June 30,  2006,  the
Company has drawn down all of this commitment. This commitment can be reduced by
the amount of net proceeds  received  from the sale of the building or equipment
from the  Company's  Mallusk,  Northern  Ireland  facility  or the amount of net
proceeds in a debt or equity  transaction,  and may be  increased  if  necessary
under  certain  circumstances.  As of the date of this report,  Mr. Berg has not
requested that his commitment be reduced.

In October 2001, the Company  entered into a loan  agreement  ("2001 Loan") with
Berg & Berg. Under the terms of the agreement, Berg & Berg agreed to advance the
Company  funds  of up to $20  million  between  the  date of the  agreement  and
September 30, 2003. Interest on the 2001 Loan accrues at 8.0% per annum, payable
from time to time.  On July 13, 2005,  Berg & Berg agreed to extend the maturity
date for the loan  principal and interest  from  September 30, 2006 to September
30,  2008.  On  November  8,  2002,  the  Company  and  Berg & Berg  amended  an
affirmative  covenant in the agreement to acknowledge the Nasdaq SmallCap Market
as an acceptable market for the listing of the Company's Common Stock.

In July 1998,  the Company  entered  into an amended loan  agreement  (the "1998
Loan") with Berg & Berg that allows the Company to borrow,  prepay and re-borrow
up to $10.0 million  principal under a promissory note on a revolving  basis. In
November  2000,  the 1998 Loan  agreement  was amended to  increase  the maximum
amount to $15.0 million. As of December 31, 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.

<PAGE>

On January 1, 1998, the Company  granted  options to Mr.  Dawson,  the Company's
then Chairman of the Board, Chief Executive Officer and President,  an incentive
stock  option to  purchase  39,506  shares,  which was  granted  pursuant to the
Company's  1990 Plan (the "1990  Plan").  Also,  an option to  purchase  660,494
shares was granted pursuant to the Company's 1990 Plan and an option to purchase
300,000 shares was granted outside of any equity plan of the Company, neither of
which were incentive stock options (the  "Nonstatutory  Options").  The exercise
price of all three  options is $5.0625 per share,  the fair market  value on the
date of the grant. The Compensation  Committee of the Company approved the early
exercise of the  Nonstatutory  Options on March 5, 1998.  The options  permitted
exercise by cash,  shares,  full recourse notes or non-recourse notes secured by
independent collateral. The Nonstatutory Options were exercised on March 5, 1998
with  non-recourse  promissory notes in the amounts of $3,343,750  ("Dawson Note
One") and  $1,518,750  ("Dawson Note Two")  (collectively,  the "Dawson  Notes")
secured by the shares acquired upon exercise plus 842,650 shares previously held
by Mr.  Dawson.  As of March 31, 2006,  principal and interest  amounts of $3.50
million and $1.59 million were outstanding under Dawson Note One and Dawson Note
Two,  respectively,  and  under  each of the  Dawson  Notes,  interest  from the
issuance date accrues on unpaid  principal at the rate of 5.77% per annum, or at
the maximum rate  permissible by law,  whichever is less. On April 20, 2005, the
Company's Board of Directors  approved a resolution to extend the maturity dates
of each of the Dawson Notes from September 5, 2005 to September 5, 2007.

As of June 30,  2006 and March 31,  2006,  amounts  of $5.23  million  and $5.16
million were  outstanding  under Dawson Note One and Dawson Note Two. Under each
of the Dawson Notes, interest from the Issuance Date accrues on unpaid principal
at the rate of 5.69% per  annum,  or at the  maximum  rate  permissible  by law,
whichever  is  less.  In  accordance  with the  Dawson  Notes,  interest  is due
annually,  has been paid  through  March 4, 2005,  and is in arrears at June 30,
2006.

14. SEGMENT AND GEOGRAPHIC INFORMATION:

The Company's chief operating decision maker is its Chief Executive Officer, who
reviews  operating  results to make decisions  about resource  allocation and to
assess  performance.  The Company's chief operating decision maker views results
of operations of a single  operating  segment,  the development and marketing of
the Company's Saphion(R)  technology.  The Company's Chief Executive Officer has
organized the Company functionally to develop, market and manufacture Saphion(R)
products.

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

<TABLE>
<CAPTION>

                                                    June 30, 2006         March 31, 2006
                                                --------------------    -------------------

<S>                                                     <C>                       <C>
                    United States                  $     866                 $    648
                    International                      2,537                    2,692
                                                --------------------    -------------------
                    Total                          $   3,403                 $  3,340
                                                ====================    ===================

</TABLE>


Revenues by geographic area are as follows (in thousands):
<TABLE>
<CAPTION>

                                          Three Months Ended June 30,
                                      -----------------------------------
                                            2006                2005

            <S>                              <C>                 <C>
                                      -----------------    --------------
         United States                    $    2,779          $    3,207
         International                           389                 198
                                      -----------------    --------------
         Total                            $    3,168          $    3,405
                                      =================    ==============
</TABLE>

<PAGE>

15. SUBSEQUENT EVENTS:

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

In July 2006, the Company issued  convertible  promissory notes in the aggregate
principal  amount of $2.0 million and $1.0 million to Berg & Berg, which are due
with interest in August 2006 and October 2006,  respectively.  These convertible
promissory  notes  accrued  interest  at  the  annual  rate  of  8.0%  and  were
convertible  at any time prior to  maturity,  into shares of common stock of the
Company at a  conversion  price equal to the closing bid price of the  Company's
common  stock on the  trading  day  immediately  prior to the  conversion  date,
provided  that the  conversion  price cannot be lower than $1.73 and $1.33,  the
closing  bid price of the  Company's  common  stock on July 7, 2006 and July 20,
2006,  respectively.  On July 25, 2006 these notes were converted into 1,885,302
common shares of the Company at $1.73 and $1.38, respectively.

On June 21, 2006, the Company issued  convertible  promissory  notes in favor of
Berg & Berg  Enterprises,  LLC ("Berg & Berg"),  an affiliate of Carl Berg,  the
Company's  chairman  of the board  and  managing  member of Berg & Berg,  in the
principal amounts of $2.0 million.  These  convertible  promissory notes accrued
interest  at the annual rate of 8.0% and were  convertible  at any time prior to
maturity,  into  shares of common  stock of the  Company.  The notes and accrued
interest  were  converted  at $1.70 per share into a total of  1,188,332  common
shares of the Company on July 25, 2006.

<PAGE>


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

This Report contains  statements that  constitute  "forward-looking  statements"
within the meaning of Section 21E of the  Securities  Exchange  Act of 1934,  as
amended,  and Section 27A of the Securities  Act of 1933, as amended.  The words
"expect," "estimate," "anticipate," "predict," "believe" and similar expressions
and  variations  thereof are  intended to identify  forward-looking  statements.
These  statements  appear  in a number  of  places  in the  Report  and  include
statements  regarding  the  intent,  belief or current  expectations  of Valence
Technology, Inc., to which we refer in this Report as the Company, we or us, our
directors or officers with respect to, among other things,  (a) trends affecting
our financial  condition or results of operations,  (b) our product  development
strategies,  (c) trends  affecting our  manufacturing  capabilities;  (d) trends
affecting the commercial acceptability of our products, and (e) our business and
growth   strategies.   You  are   cautioned   not  to  put  undue   reliance  on
forward-looking  statements.  Forward-looking  statements  are not guarantees of
future performance and involve risks and  uncertainties,  and actual results may
differ  materially from those projected in this Report,  for the reasons,  among
others,  discussed in the sections -  "Management's  Discussion  and Analysis of
Financial  Condition and Results of Operations" and  "Cautionary  Statements and
Risk Factors." The following  discussion  should be read in conjunction with our
financial  statements  and  related  notes,  which are a part of this  Report or
incorporated  by reference to our reports filed with the Securities and Exchange
Commission,  to which we refer in this Report as the Commission. We undertake no
obligation to publicly revise these forward-looking statements to reflect events
or  circumstances  that  arise  after  the  date  hereof.  The  results  for the
three-month  period ended June 30, 2006 are not  necessarily  indicative  of the
results to be expected for the entire fiscal year ending March 31, 2007.

Overview

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

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

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

o    Proven the feasibility of our technology;

o    Launched  new   Saphion(R)   technology-based   products,   including   our
     N-Charge(TM)  Power System family and  introduced  our  U-Charge(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    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;


<PAGE>


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

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

o    Established  three  China  facilities  to serve as our  powder  production,
     research and development, and assembly facilities; and

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.

At $3.2  million,  our revenue for the first  quarter of fiscal 2007 was in line
with our previously announced revenue guidance. First quarter revenue for fiscal
2007  decreased  $200,000,  or 7.0%,  from the first quarter of fiscal 2006.
Gross margin profit was 1.0% for the first quarter of fiscal 2007, compared with
gross margin loss of (56.4%) for the first  quarter of fiscal  2006.  During the
first quarter of fiscal 2007, we continued our efforts to increase production at
our subsidiaries in China, which became operational in late fiscal 2005.

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

Basis of Presentation, Critical Accounting Policies and Estimates

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

Revenue Recognition

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

<PAGE>


Impairment of Long-Lived Assets

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

Results of Operations

The  following  table  summarizes  the results of our  operations  for the three
months (also  referred to as the first quarter) ended June 30, 2006 and June 30,
2005:
<TABLE>
<CAPTION>

                                                 Three Months Ended
                                    ---------------------------------------------
                                       June 30, 2006            June 30, 2005
                                    ---------------------    --------------------
<S>                                      <C>       <C>              <C>      <C>

(dollars in thousands)                  % of Revenue            % of Revenue
Battery and systems sales            $    2,989     94%       $    3,261     96%
Licensing and royalty                       179      6%              144      4%
revenue
                                    ------------- -------    ------------ -------
Total revenues                            3,168    100%            3,405    100%
Gross margin profit (loss)                   22      1%          (1,922)    -56%
Operating expenses                        4,182    132%            5,338    157%
Operating loss                           (4,160)  -131%          (7,260)   -213%
                                    ------------- -------    ------------ -------
Net loss                               $ (5,614)  -177%        $ (8,143)   -239%
                                    ============= =======    ============ =======
</TABLE>

Revenues and Gross Margin

Battery and System  Sales:  Battery and system sales  decreased by $300,000,  or
8.3%, to $2.99 million in the first quarter of fiscal 2007 from $3.26 million in
the first quarter of fiscal 2006. We  implemented  design  modifications  in our
finished goods and  recertified  our small format  batteries for a major product
compliance  organization  that further  effected sales  fulfillment in the first
quarter.  As a result,  inventory increased from $2.74 million at March 31, 2006
to $6.12  million at June 30,  2006.  Due to the shift in our revenue  base from
small-format to large-format products and the high cost of doing business in the
retail  channel  during the third  quarter of fiscal  2006,  we ceased  sales of
N-Charge products through our retail channels.  We continue to sell the N-Charge
product  through  our  reseller  channels  with  a  continued  emphasis  in  the
healthcare and education  sectors.  Revenues from the sales of our  small-format
products  accounted  for 21% and 55% of our total  revenue for the three  months
ended June 30, 2006 and 2005. Product shipments to resellers that are subject to
right of return and monies  received for future  obligations are recorded on the
balance sheet as deferred  revenue.  We had $915,000 in deferred  revenue on our
balance sheet at June 30, 2006.

Licensing and Royalty Revenue:  Licensing and royalty revenues relate to revenue
from licensing agreements for our battery construction technology.  Fiscal first
quarter 2007 licensing and royalty  revenue was $179,000  compared with $144,000
for the  same  quarter  in  fiscal  2006.  Licensing  and  royalty  revenue  was
exclusively from our license  agreement with Amperex  Technology  Limited (ATL),
which makes on-going royalty payments as sales are made using our technology. We
expect to continue to pursue a licensing  strategy as our Saphion(R)  technology
receives greater market acceptance.


<PAGE>

Gross Margin  Profit  (Loss):  Gross  margin  profit  (loss) as a percentage  of
revenue  was 1% for the first  quarter of fiscal  2007 as compared to (56.4%) in
the first quarter of fiscal 2006.  Gross margins in fiscal 2006 were impacted by
the  ramp-up  cost of the  Segway  Inc.  product  as  well as the  manufacturing
transition to China. We have successfully transitioned our battery manufacturing
and product assembly operations to contract manufacturers in Asia and as well as
our  manufacturing  and product  development  operations to our  subsidiaries in
Suzhou,  China.  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.  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. As is the case in the first quarter of 2007, we expect
cost of sales to continue to decrease  as a  percentage  of sales as  production
volumes increase, manufacturing yields improve and as we fully capitalize on our
lower-cost manufacturing strategy.

Operating Expenses

The following  table  summarizes  operating  expenses for the three months ended
June 30, 2006 and June 30, 2005:
<TABLE>
<CAPTION>

                                               Three Months Ended June 30,
                                    ---------------------------------------------------
(dollars in thousands)                                            Increase/     %
                                        2006          2005        (Decrease)    Change
                                    -------------   ----------    ----------    -------
<S>                                      <C>           <C>             <C>         <C>

Research and product development        $1,094        1,692       $   (598)       -35%
Marketing                                  429          723           (294)       -41%
General and administrative               2,176        3,370         (1,194)       -35%
Depreciation and amortization              181          168              13         8%
Share based compensation                   264            -             264       100%
(Gain)/Loss on disposal of assets           15        (615)             630       102%
Contract settlement charges                 23            -              23       100%
Total operating expenses                $4,182       $5,338        $ (1,156)      -22%
Percentage of revenues                    132%         157%

</TABLE>


During the first quarter of fiscal 2007,  Total operating  expenses were 132% of
revenue  compared  to 157% of revenue  during the same  quarter  last year.  The
decrease is primarily  the result of  personnel  and expense  reduction  actions
taken during the last three  quarters.  We reduced  operating  expenses by $1.16
million or 22% for the first three months of fiscal 2007,  as compared  with the
first three months of fiscal 2006.

Research  and Product  Development.  Research and product  development  expenses
consist  primarily of personnel,  equipment and materials to support our efforts
to  develop  battery  chemistry  and  products,   as  well  as  to  improve  our
manufacturing processes.  Research and product development expenses decreased by
$598,000,  or 35%, to $1.09  million  for the first  quarter of fiscal 2007 from
$1.69 million for the first quarter of fiscal 2006. 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 $429,000 in the first quarter of fiscal 2007 were $294,000  lower or
41% than in the  comparable  period of fiscal  2006.  The  decrease in marketing
expenses  in the  three-month  period  ended June 30,  2006 over the  comparable
period in 2005 was the  result of reduced  spending  for  consulting  related to
European market  development,  and reduced lead generation and media advertising
expenditures  applicable to the retail channel.  We expect marketing expenses to
grow as we  expand  and  develop  our  channels,  launch  additional  Saphion(R)
products, and continue our branding efforts.

General  and  Administrative.   General  and  administrative   expenses  consist
primarily of salaries and other  related  costs for  finance,  human  resources,
facilities,  accounting,  information  technology,  legal, and corporate-related
expenses,  including our China initiatives.  General and administrative expenses
totaled $2.18  million and $3.37  million for the first fiscal  quarters of 2007
and 2006,  respectively.  The decrease was largely due to the continued shift of
resources to our Asian  operations and improved  efficiencies  in our US support
operations.

<PAGE>

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

Depreciation  and  Amortization.  Depreciation  and  amortization  expenses were
$181,000  and  $168,000  for  the  first  quarters  of  fiscal  2007  and  2006,
respectively.  The nominal  increase in  depreciation  expense relates to recent
additions to property,  plant,  and equipment in the U.S and in China during the
past three fiscal quarters.

Share based  compensation.  Share based  compensation  of $264,000 for the first
quarter of 2007 represent  compensation  costs  recognized  for all  share-based
payments granted on or after April 1, 2006 and awards granted to employees prior
to April 1, 2006 that remain unvested on that date.

Liquidity and Capital Resources

Liquidity

At June 30, 2006,  the Company's  principal  sources of liquidity  were cash and
cash equivalents of $702,000.  The Company expects our sources of liquidity will
not be sufficient for the remaining fiscal year. The Company anticipates product
sales during fiscal 2007 from the N-Charge(TM) Power System and the Segway pack,
which are subject to seasonal fluctuations and the sale of the U-Charge(R) Power
System  will  be  insufficient  to  cover  the  Company's   operating  expenses.
Management  depends  upon our ability to  periodically  arrange  for  additional
equity or debt financing to meet our liquidity requirements.  Unless our product
sales are greater than management currently forecasts or there are other changes
to our business  plan, we will need to arrange for additional  financing  within
the next three to six months to fund operating and capital needs. This financing
could take the form of debt or equity.  Given our historical  operating  results
and the amount of our existing debt, as well as the other factors, we may not be
able to arrange for debt or equity  financing  from third  parties on  favorable
terms or at all.

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

As a result of our limited cash resources and history of operating  losses,  our
auditors have expressed in their report on our consolidated financial statements
included in our audited March 31, 2006  consolidated  financial  statements that
there is substantial doubt about our ability to continue as a going concern.  We
presently  have no further  commitments  for  financing by Mr. Berg or any other
source.  If we are unable to obtain  financing  from Mr. Berg or others on terms
acceptable  to us,  or at all,  we may be forced  to cease  all  operations  and
liquidate our assets.  Our cash  requirements may vary materially from those now
planned because of changes in our  operations,  including the failure to achieve
expected revenues, greater than expected expenses, changes in OEM relationships,
market conditions,  the failure to timely realize our product development goals,
and other adverse developments. These events could have a negative impact on our
available liquidity sources during fiscal 2007.

The following table  summarizes our statement of cash flows for the three months
ended June 30, 2006 and 2005:

<TABLE>
<CAPTION>

                                                    Three Months Ended June 30,
                                               --------------------------------------
(dollars in thousands)                               2006                 2005
                                               ------------------    ----------------
<S>                                                   <C>                   <C>

Net cash flows provided by (used in)
Operating activities                              $  (5,158)           $   (8,370)
Investing activities                                   (327)                   16
Financing activities                                   5,591                8,920
Effect of foreign exchange rates                        (16)                   26
                                               ------------------    ----------------
Net increase in cash and cash equivalents         $       90           $      592
                                               ==================    ================

</TABLE>

<PAGE>

Our use of cash from operations the first three months of fiscal 2007 and fiscal
2006 was  $5.16  million  and  $8.37  million,  respectively.  The cash used for
operating  activities during the first three months of our fiscal 2007 operating
activities was primarily for operating losses and working capital. Cash used for
operating  losses in the first three  months of fiscal 2007  decreased  from the
same period of fiscal 2006 by $3.21 million.  Working capital in the first three
months of fiscal 2007 was greater than working capital in the first three months
of fiscal 2006 by $3.68 million.  The increase in working  capital was primarily
due to an increase in  manufacturing  of  inventory  from  increased  production
volumes.

In the first three  months of fiscal  2007,  we had a net  decrease in cash from
investing  activities of $327,000.  Cash used in investing activities during the
first three months of fiscal 2006 relates to purchases of equipment domestically
and in China.

We obtained  cash from  financing  activities of $5.59 million and $8.92 million
during  the  first  three  months of fiscal  2007 and  2006,  respectively.  The
financing  activities  in the first three months of fiscal 2007  included a $2.0
million  convertible  short  term note  payable to Berg & Berg,  a $2.5  million
issuance of common  stock to West Coast  Venture  Capital,  an  affiliate of Mr.
Berg, and $122,000 in stock option exercises.  In addition, the Company received
net  proceeds  of  $969,000  from the sale of stock  under a  controlled  equity
offering agreement with Cantor Fitzgerald.

As a result of the above, we had a net increase in cash and cash  equivalents of
$90,000 during the first three months of fiscal 2007.

Capital Commitments and Debt

At June 30, 2006, we had  commitments for capital  expenditures  for the next 12
months of approximately  $100,000  relating to manufacturing  equipment.  We may
require additional  capital  expenditures in order to meet greater demand levels
for our products than are currently anticipated and/or to support our transition
of operations to China.

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

<TABLE>
<CAPTION>

(Dollars in thousands)                                       June 30, 2006
                                                          ---------------------
<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
Short term convertible notes payable                                2,004
Interest on long-term debt                                         16,247
Current portion  of interest on long-term debt                        116
                                                          ---------------------
Total                                                       $      73,317

                                                          =====================

</TABLE>

Repayment  obligations of short-term and long-term debt principal as of June 30,
2006 are:
<TABLE>
<CAPTION>

                                                                  Fiscal year
                            -----------------------------------------------------------------------------------------
(Dollars in thousands)        2007       2008         2009         2010         2011       Thereafter        Total
                            ---------   --------    ---------    ---------    ---------    ------------    ----------
<S>                            <C>        <C>          <C>          <C>          <C>           <C>             <C>
Principal repayment          $2,000                 $34,950          -         $20,000          -            $56,950

</TABLE>

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

<PAGE>

The Series C-2 Convertible  Preferred Stock may be converted,  at any time, into
shares of our  common  stock at the lower of $4.00 or the  closing  price of our
common stock on the conversion  date,  provided the  conversion  price can be no
lower than $2.96,  the closing bid price of our common  stock on July 13,  2005.
The  preferred  shares are  currently  outstanding  and subject to redemption or
conversion at the holder's discretion.

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


Inflation

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

Tabular Disclosure of Contractual Obligations

The following  table sets forth,  as of June 30, 2006 our  scheduled  principal,
interest  and other  contractual  annual  cash  obligations  due for each of the
periods indicated below (in thousands):

<TABLE>
<CAPTION>

                                                                     Payment Due by Period
                                           --------------------------------------------------------------------------
                                                             Less than                                    More than
Contractual Obligations                       Total          One Year       1-2 Years     3-5 Years        5 Years
----------------------------------------   -------------    ------------    ----------    -----------    ------------
<S>                                            <C>              <C>            <C>            <C>             <C>

Long-term debt obligations                  $  71,313        $     116       $      -       $ 71,197       $      -
Notes payable                                   2,004            2,004
Operating lease obligations                     1,348              547            606            195              -
Purchase obligations                            6,695            6,695              -              -              -
Redemption of Convertible Preferred
  Stock                                         8,610            8,610              -              -              -
                                           -------------    ------------    ----------    -----------    ------------
Total                                       $  89,970        $  17,972       $    606       $ 71,392       $      -
                                           =============    ============    ==========    ===========    ============

</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


There is doubt about our ability to continue as a going concern

We have experienced significant operating losses in the current and prior years.
At June  30,  2006  our  principal  sources  of  liquidity  were  cash  and cash
equivalents  of $702,000.  Although Mr. Berg may continue to fund the  Company's
operations  he is under  no  obligation  to do so.  We  intend  to  improve  our
liquidity by the continued  monitoring and reduction of manufacturing,  facility
and administrative  costs.  However,  notwithstanding  these efforts,  we do not
expect that our cash on hand and cash generated by operations will be sufficient
to fund our  operating  and capital  needs  beyond the next three  months.  As a
result of our limited  cash  resources  and  history of  operating  losses,  our
auditors have expressed in their report on our consolidated financial statements
included in our audited March 31, 2006  consolidated  financial  statements that
there is substantial doubt about our ability to continue as a going concern.  We
presently  have no further  commitments  for  financing by Mr. Berg or any other
source.  If we are unable to obtain  financing  from Mr. Berg or others on terms
acceptable  to us,  or at all,  we may be forced  to cease  all  operations  and
liquidate our assets.

We have encountered  problems in our production  processes that have limited our
ability  at times to produce  sufficient  batteries  to meet the  demands of our
customers.  If these  issues  recur and we are  unable to timely  resolve  these
problems, our inability to produce batteries will have a material adverse impact
on our ability to grow revenues and maintain our customer base.

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

Our limited financial resources could materially affect our business, our
ability to commercially exploit our technology and our ability to respond to
unanticipated development, and could place us at a disadvantage to our
competitors.

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

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

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


<PAGE>

   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 or catastrophic  external
      events;

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

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

We have a history of losses and an accumulated  deficit and may never achieve or
sustain significant revenues or profitability.

We have incurred  operating losses each year since our inception in 1989 and had
an accumulated  deficit of $499.9 million as of June 30, 2006. We have sustained
recurring losses related primarily to the research and development and marketing
of our products  combined with the lack of sufficient sales to provide for these
needs.  We  anticipate  that we will  continue  to incur  operating  losses  and
negative  cash  flows  during  fiscal  2007.  We may never  achieve  or  sustain
sufficient revenues or profitability in the future.

If we continue  to  experience  significant  losses we may be unable to maintain
sufficient liquidity to provide for our operating needs.

We reported a net loss available to common  stockholders of $5.7 million for the
three-month  period  ended  June  30,  2006,  a net  loss  available  to  common
stockholders of $32.9 million for the fiscal year ended March 31, 2006 and a net
loss available to common stockholders of $32.2 million for the fiscal year ended
March 31, 2005.  If we cannot  achieve a  competitive  cost  structure,  achieve
profitability  and access the capital  markets on acceptable  terms,  we will be
unable to fund our obligations and sustain our operations and may be required to
liquidate our assets.

Our  working   capital   requirements   may  increase   beyond  those  currently
anticipated.

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

Our  indebtedness  and other  obligations are  substantial and could  materially
affect our  business  and our  ability to incur  additional  debt to fund future
needs.

We have and will continue to have a significant amount of indebtedness and other
obligations.  As of June 30, 2006, we had  approximately  $69.8 million of total
consolidated  indebtedness.  Included in this amount are $35.4  million of loans
outstanding to an affiliate,  $16.3 million of accumulated  interest  associated
with those loans and $18.1 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  of,  and  interest  on,  our
      indebtedness,  thereby  reducing  the  funds  available  to us  for  other
      purposes;

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

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

All of our  assets are  pledged as  collateral  under our loan  agreements.  Our
failure  to meet the  obligations  under  our loan  agreements  could  result in
foreclosure of our assets.

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

We depend on a small number of customers  for our  revenues,  and our results of
operations  and  financial  condition  could  be  harmed  if we were to lose the
business of any one of them.

To date,  our  existing  purchase  orders in  commercial  quantities  are from a
limited number of customers.  During the three-month period ended June 30, 2006,
Segway Inc., D&H  Distributing  Co., Inc., and PC Connection,  Inc.  contributed
68%, 5%, and 4%, of our revenues,  respectively. We anticipate that sales of our
products to a limited  number of key  customers  will  continue to account for a
significant portion of our total revenues.  We do not have long-term  agreements
with  any of our  customers  and do not  expect  to  enter  into  any  long-term
agreements in the near future.  As a result,  we face the substantial  risk that
one or  more  of the  following  events  could  occur:

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

   o  development by a customer of other sources of supply;

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

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

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

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

Our business will be adversely affected if our Saphion(R)  technology  batteries
are not commercially accepted.

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

If we are unable to  develop,  manufacture  and market  products  that gain wide
customer acceptance, our business will be adversely affected.

<PAGE>

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

If our products  fail to perform as expected,  we could lose existing and future
business,  and our ability to develop,  market and sell our  batteries  could be
harmed.

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

Our  failure  to  cost-effectively   manufacture  our  technologically   complex
batteries  in  commercial   quantities  which  satisfy  our  customers'  product
specifications  and their  expectations  for product  quality and delivery could
damage our  customer  relationships  and  result in  significant  lost  business
opportunities for us.

To be successful, we must cost-effectively  manufacture commercial quantities of
our technologically  complex batteries that meet our customer specifications for
quality and timely delivery. To facilitate commercialization of our products, we
will need to  further  reduce  our  manufacturing  costs,  which we intend to do
through the  effective  utilization  of  manufacturing  partners and  continuous
improvement  of our  manufacturing  and  development  operations  in our  wholly
foreign owned  enterprises in China. We currently  manufacture our batteries and
assemble  our products in China.  We are  dependent  on the  performance  of our
manufacturing  partners,  as  well  as  our  own  manufacturing   operations  to
manufacture  and deliver  our  products to our  customers.  We have  experienced
production  process  issues,  which  have  limited  our  ability  to  produce  a
sufficient  number of batteries to meet  current  demand.  If we fail to correct
these issues in a manner that allows us to meet  customer  demand,  or if any of
our  manufacturing  partners are unable to  manufacture  products in  commercial
quantities on a timely and cost-effective basis, we could lose our customers and
adversely impact our ability to attract future customers.

In  addition  to being used in our own  product  lines,  our  battery  cells are
intended to be  incorporated  into other  products.  If we do not form effective
arrangements with OEMs to commercialize these products,  our profitability could
be impaired.

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

Failure to implement an effective  licensing  business  strategy will  adversely
affect our revenue, cash flow and profitability.

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

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

<PAGE>

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

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

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

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

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

The fact  that we  depend  on a sole  source  supplier  or a  limited  number of
suppliers for key raw materials may delay our production of batteries.

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

We have 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.

Our ongoing  manufacturing  and development  operations in China are complex and
having  these  remote  operations  may divert  management's  attention,  lead to
disruptions in operations and delay implementation of our business strategy.

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

We  expect  to sell a  significant  portion  of our  products  to and  derive  a
significant portion of our licensing revenues from customers located outside the
United  States.  Foreign  government  regulations,   currency  fluctuations  and
increased costs associated with international  sales could make our products and
licenses  unaffordable  in  foreign  markets,  which  would  reduce  our  future
profitability.

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

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

<PAGE>

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

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

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

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

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

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

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

We may need to expand our employee base and  operations in order to  effectively
distribute  our  products  commercially,  which may  strain our  management  and
resources and could harm our business.

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

Competition  for personnel,  in particular for product  development  and product
implementation  personnel, is intense, and we may have difficulty attracting the
personnel necessary to effectively operate our business.

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

International  political events and the threat of ongoing  terrorist  activities
could  interrupt  manufacturing  of our  batteries  and our  products at our OEM
facilities  or our own  facilities  and  cause us to lose  sales  and  marketing
opportunities.

The  terrorist  attacks that took place in the United  States on  September  11,
2001,  along  with  the  U.S.  military  campaigns  against  terrorism  in Iraq,
Afghanistan,  and  elsewhere,  and  continued  violence  in the Middle East have
created many economic and political uncertainties,  some of which may materially
harm our business and revenues.  International  political  instability resulting
from these events could temporarily or permanently disrupt  manufacturing of our
batteries and products at our OEM  facilities or our own  facilities in Asia and
elsewhere, and have an immediate adverse impact on our business. Since September
11, 2001,  some economic  commentators  have  indicated that spending on capital

<PAGE>

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.

If we are sued on a product  liability claim, our insurance  policies may not be
sufficient.

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

Our patent  applications  may not result in issued  patents,  which would have a
material adverse effect on our ability to commercially exploit our products.

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

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

If we cannot protect or enforce our existing  intellectual property rights or if
our pending patent applications do not result in issued patents, we may lose the
advantages of our research and manufacturing systems.

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

<PAGE>


Intellectual   property   infringement   claims  brought  against  us  could  be
time-consuming  and expensive to defend, and if any of our products or processes
is found to be infringing, we may not be able to procure licenses to use patents
necessary to our business at reasonable terms, if at all.

In recent  years,  there has been  significant  litigation  in the United States
involving patents and other intellectual property rights. While we are currently
engaged  in  one  intellectual   property   proceeding  alleging  the  Company's
SAPHION(R) I cathode  material  infringes two patents owned by the University of
Texas, while the Company believes it has strong defenses to such allegations, an
adverse decision could force us to do one or more of the following:

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

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

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

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

We may become involved in more litigation and proceedings in the future.  In the
future  we  may be  subject  to  claims  or an  inquiry  regarding  our  alleged
unauthorized use of a third party's intellectual property. An adverse outcome in
such future litigation could result in similar risks as noted above with respect
to the third  party's  intellectual  property.  Whether  or not an  intellectual
property  litigation  claim is valid,  the cost of responding to it, in terms of
legal fees and expenses  and the  diversion of  management  resources,  could be
expensive and harm our business.

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.


                  Risks Associated with Doing Business in China

Since our products are manufactured in China and we have transferred  additional
operations to China, we face risks if China loses Normal Trade Relations  status
with the United States.

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

<PAGE>

status for China.  The loss of NTR status for China,  changes in current  tariff
structures or adoption in the United States of other trade  policies  adverse to
China could have an adverse affect on our business.

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

Because  the Chinese  legal  system in general,  and the  intellectual  property
regime  in  particular,  are  relatively  weak,  we may not be  able to  enforce
intellectual property rights in China and elsewhere.

We currently  manufacture  and export our products from China.  The legal regime
protecting  intellectual  property rights in China is weak.  Because the Chinese
legal system in general, and the intellectual property regime in particular, are
relatively weak, it is often difficult to enforce  intellectual  property rights
in China.

Enforcing  agreements  and laws in China is  difficult or may be  impossible  as
China does not have a comprehensive system of laws.

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

The  government  of China may change or even  reverse its  policies of promoting
private industry and foreign investment, in which case our assets and operations
may be at risk.

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

The  government  of China  continues  to exercise  substantial  control over the
Chinese economy which could have a negative impact on our business.

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

Changes in China's political and economic policies could harm our business.


<PAGE>

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

   o  economic structure,

   o  level of government involvement in the economy,

   o  level of development

   o  level of capital reinvestment,

   o  control of foreign exchange

   o  methods of allocating resources, and

   o  balance of payments position.

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

Business  practices  in China may entail  greater risk and  dependence  upon the
personal  relationships of senior management than is common in North America and
therefore some of our agreements  with other parties in China could be difficult
or impossible to enforce.

The  business  structure  of China  is,  in some  respects,  different  from the
business  culture in Western  countries  and may  present  some  difficulty  for
Western investors reviewing  contractual  relationships among companies in China
and  evaluating  the  merits  of an  investment.  Personal  relationships  among
business  principals  of  companies  and  business  entities  in China  are very
significant in the business culture. In some cases,  because so much reliance is
based upon personal  relationships,  written contracts among businesses in China
may be less detailed and specific than is commonly  accepted for similar written
agreements  in  Western  countries.   In  some  cases,   material  terms  of  an
understanding  are not  contained  in the  written  agreement  but exist as oral
agreements  only. In other cases,  the terms of  transactions  which may involve
material amounts of money are not documented at all. In addition, in contrast to
Western business  practices where a written agreement  specifically  defines the
terms,   rights  and  obligations  of  the  parties  in  a  legally-binding  and
enforceable  manner,  the parties to a written  agreement in China may view that
agreement more as a starting point for an ongoing  business  relationship  which
will evolve and require ongoing modification. As a result, written agreements in
China may appear to the Western reader to look more like outline agreements that
precede a formal written agreement.  While these documents may appear incomplete
or unenforceable to a Western reader,  the parties to the agreement in China may
feel that they have a more  complete  understanding  than is apparent to someone
who  is  only  reading  the  written   agreement  without  having  attended  the
negotiations.  As a  result,  contractual  arrangements  in  China  may be  more
difficult to review and understand.  Also,  despite legal  developments in China
over the past 20 years, adequate laws, comparable with Western standards, do not
exist in all areas and it is unclear how many of our business arrangements would
be interpreted or enforced by a court in China.

Our operations could be materially interrupted, and we may suffer a large amount
of loss, in the case of fire,  casualty or theft at one of our  manufacturing or
other facilities.

<PAGE>

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

The system of taxation in China is uncertain and subject to unpredictable change
that could affect our profitability.

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

It is uncertain whether we will be able to recover  value-added taxes imposed by
the Chinese taxing authority.

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

Any  recurrence of severe acute  respiratory  syndrome  ("SARS"),  avian flu, or
another  widespread  public health problem,  could adversely affect our business
and results of operations.

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

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

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

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

Our production and shipping  capabilities could be adversely affected by ongoing
tensions between the Chinese and Taiwanese governments.

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

<PAGE>


                       Risks Associated with Our Industry

If competing  technologies  that  outperform  our batteries  were  developed and
successfully  introduced,  then  our  products  might  not be  able  to  compete
effectively in our targeted market segments.

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

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

Our principal competitors have greater financial and marketing resources than we
do and they may  therefore  develop  batteries  similar or  superior  to ours or
otherwise compete more successfully than we do.

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

Laws  regulating the manufacture or  transportation  of batteries may be enacted
which  could  result  in a  delay  in the  production  of our  batteries  or the
imposition of additional costs that could harm our ability to be profitable.

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

<PAGE>

be adopted by the United States.  While we fall under the equivalency levels for
the United States and comply with all safety packaging  requirements  worldwide,
future DOT or IATA  regulations  or  enforcement  policies  could impose  costly
transportation requirements.  In addition,  compliance with any new DOT and IATA
approval process could require significant time and resources from our technical
staff and, if redesign  were  necessary,  could  delay the  introduction  of new
products.

                  General Risks Associated with Stock Ownership

Corporate  insiders or their  affiliates  will be able to  exercise  significant
control over matters  requiring  stockholder  approval  that might not be in the
best interests of our stockholders as a whole.

As of August 2, 2006,  our officers,  directors and their  affiliates as a group
beneficially  owned  approximately  49.1% of our outstanding  common stock. Carl
Berg, our chairman of the board,  beneficially owns  approximately  46.3% of our
outstanding  common  stock.  As a  result,  these  stockholders  will be able to
exercise  significant control over all matters requiring  stockholder  approval,
including  the election of directors and the approval of  significant  corporate
transactions,  which could delay or prevent  someone  from  acquiring or merging
with us. The  interest  of our  officers  and  directors,  when  acting in their
capacity as stockholders, may lead them to: o vote for the election of directors
who agree with the incumbent officers' or directors' preferred corporate policy;
or  o  oppose  or  support   significant   corporate   transactions  when  these
transactions further their interest as incumbent officers or directors,  even if
these interests  diverge from their  interests as  stockholders  per se and thus
from the interests of other stockholders.

Some provisions of our charter documents may make takeover  attempts  difficult,
which could  depress  the price of our stock and limit the price that  potential
acquirers may be willing to pay for our common stock.

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

At any given time we might not meet the continued  listing  requirements  of The
Nasdaq SmallCap Market.

Given the volatility of our stock and trends in the stock market in general,  at
any  given  time we might not meet the  continued  listing  requirements  of The
Nasdaq SmallCap Market.  Among other  requirements,  Nasdaq requires the minimum
bid price of a company's  registered  shares to be $1.00. On August 2, 2006, the
closing price of our common stock was $1.51.  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,

<PAGE>


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

   o  our relationships with current or future collaborative partners, and

   o  other factors and events beyond our control.

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

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

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 94,442,525 shares of common stock as of
June 30, 2006. In addition,  at June 30, 2006, we had  11,211,523  shares of our
common stock reserved for issuance  under  warrants and stock options plans.  In
connection with the potential conversion of the Series C-1 Convertible Preferred
Stock and Series C-2 Convertible Preferred Stock, issued on December 1, 2004, we
may need to issue up to 2,176,767 and  1,452,703  shares,  respectively,  of our
common stock (based on a conversion price of $1.98 and $2.96, respectively).

We  do  not  intend  to  pay  dividends  on  our  common  stock,  and  therefore
stockholders will be able to recover their investment in our common stock, if at
all, only by selling the shares of our stock that they hold.

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

Our business is subject to changing regulations relating to corporate governance
and  public  disclosure  that  has  increased  both  our  costs  and the risk of
noncompliance.

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

In particular,  our efforts to comply with Section 404 of the Sarbanes-Oxley Act
of 2002 and the related  regulations  regarding  our required  assessment of our
internal controls over financial reporting and our independent registered public
accounting  firm's  audit of that  assessment  has  required,  and  continues to
require, the commitment of significant financial and managerial resources. There
is no assurance  that these efforts will be completed on a timely and successful
basis.  Because  these laws,  regulations  and  standards are subject to varying
interpretations,  their  application  in  practice  may evolve  over time as new
guidance becomes available.  This evolution may result in continuing uncertainty
regarding  compliance  matters  and  additional  costs  necessitated  by ongoing
revisions to our disclosure and governance practices.


<PAGE>

In the event that our Chief  Executive  Officer,  Chief  Financial  Officer,  or
independent  registered  public  accounting  firm  determine  that our  internal
controls over financial reporting are not effective as defined under Section 404
of the  Sarbanes-Oxley  Act of 2002,  there may be a material  adverse impact in
investor perceptions and a decline in the market price of our stock.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We considered the provisions of Financial Reporting Release No. 48, "Disclosures
of Accounting  Policies for  Derivative  Financial  Instruments  and  Derivative
Commodity   Instruments,   and  Disclosures  of  Quantitative   and  Qualitative
Information about Market Risk Inherent in Derivative Commodity  Instruments." On
July 13, 2005, in connection  with a $20.0 million loan  agreement  with a third
party finance  company with an adjustable  interest rate equal to the greater of
6.75% or the sum of the LIBOR  rate plus 4.0%  (9.19% as of June 30,  2006),  we
entered into a rate cap agreement which caps the LIBOR rate at 5.5% (On July 12,
2006, the most recent  adjustment  date, the LIBOR rate was 5.345%) 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 June 30, 2006)
and the second loan to the  stockholder  has a fixed  interest rate of 8.0%. The
loan to the third party finance company has a monthly floating  interest rate as
described  above.  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 and short-term
debt:

<TABLE>
<CAPTION>

                             2007          2008          2009          2010         2011        Thereafter     Total
                          ----------    ----------    ----------    ----------    ----------    ----------   -----------
<S>                           <C>           <C>           <C>           <C>          <C>           <C>           <C>
                                                       (dollars in thousands)
Liabilities:
Fixed rate debt           $  2,000          -          20,000            -               -           -       $   22,000
Variable rate debt        $      -          -          14,950            -               -           -       $   14,950
Variable rate debt        $      -          -               -            -          20,000           -       $   20,000

</TABLE>

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

ITEM 4. CONTROLS AND PROCEDURES

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

<PAGE>


Material weakness in internal control over financial reporting

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

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

Changes in internal controls

There was no change in our internal controls during the fiscal first quarter
2007 that has materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.


<PAGE>


                          PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

We are subject  to,  from time to time,  various  claims and  litigation  in the
normal course of business.  In our opinion, all pending legal matters are either
covered by insurance or, if not insured, will not have a material adverse impact
on our consolidated financial statements.

ITEM 1A. RISK FACTORS

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

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

None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5.  OTHER INFORMATION

None.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

EXHIBIT NO.

10.1 (1)  Letter  Agreement,  dated  April 3,  2006 by and  between  Valence
          Technology, Inc. and West Coast Venture Capital, Inc.

10.2 (2)  Controlled Equity Offering Sales Agreement, dated April 13, 2006 by
          and between Valence Technology, Inc. and Cantor Fitzgerald & Co.

10.3 (3)  Letter Agreement, dated May 11, 2006 by and between Valence
          Technology, Inc. and West Coast Venture Capital, Inc.

10.4 (4)  Promissory Note dated June 21, 2006 issued by the Company to Berg &
          Berg Enterprises, LLC

10.5 (5)  Promissory Note dated July 10, 2006  issued by the Company to Berg &
          Berg Enterprises, LLC

10.6 (6)  Promissory Note dated July 20, 2006  issued by the Company to Berg &
          Berg Enterprises, LLC

10.7 (7)  Letter Agreement, dated August 3, 2006 by and between Valence
          Technology, Inc. and West Coast Venture Capital, Inc.

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.

Footnotes

(1)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  March 29,  2006,  filed  with the
          Securities and Exchange Commission on April 4, 2006.

(2)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  April 13,  2006,  filed  with the
          Securities and Exchange Commission on April 13, 2006.

(3)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report  on Form  8-K,  dated  May 11,  2006,  filed  with the
          Securities and Exchange Commission on May 17, 2006.

(4)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  June 21,  2006,  filed  with the
          Securities and Exchange Commission on June 26, 2006.

(5)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  July 10,  2006,  filed  with the
          Securities and Exchange Commission on July 12, 2006.

(6)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  July 20,  2006,  filed  with the
          Securities and Exchange Commission on July 21, 2006.

(7)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  August 3,  2006,  filed  with the
          Securities and Exchange Commission on August 8, 2006.




<PAGE>


                                    SIGNATURE

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

VALENCE TECHNOLOGY, INC.

Date: August 7, 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 (1)  Letter Agreement, dated April 3, 2006 by and between Valence
          Technology, Inc. and West Coast Venture Capital, Inc.
10.2 (2)  Controlled Equity Offering Sales Agreement, dated April 13, 2006 by
          and between Valence Technology, Inc. and Cantor Fitzgerald & Co.
10.3 (3)  Letter Agreement, dated May 11, 2006 by and between Valence
          Technology, Inc. and West Coast Venture Capital, Inc.
10.4 (4)  Promissory Note dated June 21, 2006 issued by the Company to Berg &
          Berg Enterprises, LLC
10.5 (5)  Promissory Note dated July 10, 2006  issued by the Company to Berg &
          Berg Enterprises, LLC
10.6 (6)  Promissory Note dated July 20, 2006  issued by the Company to Berg &
          Berg Enterprises, LLC
10.7 (7)  Letter Agreement, dated August 3, 2006 by and between Valence
          Technology, Inc. and West Coast Venture Capital, Inc.
31.1      Certification of James R. Akridge, Principal Executive Officer,
          pursuant to Rule 13a-14and 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.



Footnotes

(1)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  March 29,  2006,  filed  with the
          Securities and Exchange Commission on April 4, 2006.

(2)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  April 13,  2006,  filed  with the
          Securities and Exchange Commission on April 13, 2006.

(3)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report  on Form  8-K,  dated  May 11,  2006,  filed  with the
          Securities and Exchange Commission on May 17, 2006.

(4)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  June 21,  2006,  filed  with the
          Securities and Exchange Commission on June 26, 2006.

(5)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  July 10,  2006,  filed  with the
          Securities and Exchange Commission on July 12, 2006.

(6)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form  8-K,  dated  July 20,  2006,  filed  with the
          Securities and Exchange Commission on July 21, 2006.

(7)       Incorporated by reference to the exhibit so described in the Company's
          Current  Report on Form 8-K,  dated  August 3,  2006,  filed  with the
          Securities and Exchange Commission on August 8, 2006.