General

We develop, manufacture and sell high-energy power systems utilizing our proprietary phosphate-based lithium-ion technology for diverse applications, with special emphasis on portable appliances and future generations of hybrid and electric vehicles. Our mission is to promote the wide adoption of high-performance, safe, long cycle life, environmentally friendly, low-cost energy storage systems and address the significant market opportunity we believe is available to us by drawing on the numerous benefits of our latest energy storage technology, deep intellectual property portfolio, and the extensive experience of our management team.

Total revenue in fiscal 2009 was $26.2 million, an increase of 26% compared to the prior fiscal year. We believe revenue will continue to grow in fiscal year 2010 from new customer sales from the increasing demand in the U.S. and EMEA (Europe, Middle East and Africa) markets for alternative energy solution systems. We expanded the capacity of China manufacturing and support operations in our two wholly-owned subsidiaries.

Going Concern

As a result of our limited cash resources and history of operating losses there is substantial doubt about our ability to continue as a going concern. We presently have no further commitments for financing by our Chairman Carl Berg and/or his affiliates 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 2010.

2009 Highlights

Key product introductions and milestones based on our Epoch™ and Lithium Iron Magnesium Phosphate technology during the current year include:

† In March 2009, we introduced a new revision of U-Charge®, our third generation of Lithium Iron Magnesium Phosphate Energy Storage Systems, which are expected to be commercially available in the second quarter of fiscal 2010. U-Charge® features our safe, long-life lithium phosphate technology which utilizes a phosphate-based cathode material. We believe that the improved features and functionality of the latest U-Charge® lithium iron magnesium phosphate energy storage systems are well suited for EV, PHEV and similar applications. U-Charge® lithium phosphate energy storage systems address the safety and limited life weaknesses of other lithium technologies while offering a solution that is competitive in cost and performance. This revision of U-Charge® builds upon these features and adds improvements in state of charge, balancing and field repairability.

† We have continued the development of our Epoch™ technology. The attributes embodied in Epoch™ include communications, control, reliability, modularity and measurement feature enhancements. We believe that Epoch™ technology offers design and performance capabilities that will facilitate adoption in automotive, industrial, UPS, telecommunications, aerospace and military markets not traditionally served by other lithium-ion solutions. This technology will allow us to offer customer focused solutions based upon proven technology.

Our research and development efforts are focused on the design of new products utilizing our lithium iron magnesium phosphate chemistry, the continuous improvement of the manufacturing process of our second generation lithium phosphate technology, the development of different cell constructions to optimize power and size for new applications, as well as developing future materials based on the lithium iron magnesium phosphate technology platform.

Our business headquarters is in Austin, Texas. Our materials research and development center is in Las Vegas, Nevada. Our European sales and OEM manufacturing support center is in Mallusk, Northern Ireland. Our manufacturing and product development center is in Suzhou, China.

Result of Operations

Fiscal Years Ended March 31, 2009 (Fiscal 2009), March 31, 2008 (Fiscal 2008) and March 31, 2007 (Fiscal 2007)

The following table summarizes the results of our operations for the past three fiscal years (in thousands except for share data):

                              Year Ended
                                       Change                             Change
                                     Increase/                          Increase/
                    3/31/2009        (Decrease)        3/31/2008        (Decrease)        3/31/2007
Revenues:
Battery and
system sales        $   24,814   $  4,623        23 %  $   20,191   $  4,220        26 %  $   15,971
Licensing and
royalty revenue          1,343        757       129 %         586       (117 )     (17 )%        703
Total revenues          26,157      5,380        26 %      20,777      4,103        25 %      16,674
Cost of products
sold                    25,682      6,726        35 %      18,956      2,590        16 %      16,366
Gross margin               475     (1,346 )     (74 )%      1,821      1,513       491 %         308
Operating and
other expenses          16,327        325         2 %      16,002       (438 )      (3 )%     16,440
Loss /(gain) on
disposal of
assets                     137        121       756 %          16        (46 )     (74 )%         62
Impairments,
restructuring,
contract
settlement
charges                    731        577       375 %         154        130       542 %          24
Total operating
expenses                17,195      1,023         6 %      16,172       (354 )      (2 )%     16,526
Operating loss         (16,720 )   (2,369 )      17 %     (14,351 )    1,867       (12 )%    (16,218 )
Other(expense)
income, net             (4,506 )      583       (11 )%     (5,089 )      944       (16 )%     (6,033 )
Net loss               (21,226 )   (1,786 )       9 %     (19,440 )    2,811       (13 )%    (22,251 )
Dividends and
accretion on
preferred stock            172         (1 )       1 %         173          1         1 %         172
Net loss
available to
common
stockholders        $  (21,398 ) $ (1,785 )       9 %  $  (19,613 ) $  2,810       (13 )% $  (22,423 )
Net loss per
share available
to common
stockholders-
basic and diluted   $    (0.18 ) $   (0.0 )     (23 )% $    (0.18 ) $   0.04       (20 )% $    (0.22 )
Shares used in
computing net
loss per share
available to
common
stockholders,
basic and diluted      119,370      7,777         7 %     111,593     11,879        12 %      99,714

Revenues and Gross Margin

Battery and system sales: Battery and systems sales totaled $ 24.8 million for the year ended March 31, 2009, as compared to $20.2 million for the year ended March 31, 2008, and $16.0 million for the year ended March 31, 2007. The increase in revenue in fiscal year 2009, compared to fiscal year 2008 was primarily due to higher large-format battery sales of the U-Charge® product to new and existing customers. The increase in revenues in fiscal 2008, compared to fiscal 2007, was primarily due to additional sales of the large-format batteries, to new and existing customers, which include U-Charge® and custom batteries designed for Segway. We had approximately $355,000 and $756,000 in deferred revenue on our balance sheet at March 31, 2009 and March 31, 2008, respectively, primarily related to sales shipping in the end of the fourth quarter. Segway sales accounted for 46%, 55% and 60% of our total product sales in 2009, 2008 and 2007, respectively. We expect sales of the large-format battery system to increase during fiscal 2010, due to the growing demand of alternative energy storage systems and the fulfillment of current sales agreements. The large-format battery system sales represent 45%, 30%, and 16% of our total revenue for fiscal 2009, 2008 and 2007, respectively. The growth in large-format battery systems sales are due to the increase in demand in alternative energy solutions driven largely by the rising costs of fossil fuels and a market focus on environmentally friendly energy solutions.

Licensing And Royalty Revenue : Licensing and royalty revenues relate to revenue from licensing agreements for our battery construction technology. Fiscal year 2009 licensing and royalty revenue was $1.3 million, compared to $586,000 in fiscal year 2008, and $703,000 in fiscal year 2007. Licensing and royalty revenue increased during fiscal year 2009 from a new agreement with VARTA Microbattery GmbH. During fiscal year 2009, we continued to receive revenue from the agreement with Amperex Technology Limited. We expect to continue to pursue a licensing strategy as our lithium phosphate technology receives greater market acceptance.

Gross Margin/(Deficit) : Gross margin as a percentage of revenue was 2% for the fiscal year ended March 31, 2009 as compared to 9% for the fiscal year ended March 31, 2008 and a gross margin of 2% for the fiscal year ended March 31, 2007. During fiscal year 2009, the gross margin decreased due to charges to cost of products sold related to the discontinued material costs of EpochTM and N-Charge®, totaling $2.6 million, or 10% of revenue, as compared to fiscal year 2008. In fiscal year 2008, the improvement in our manufacturing efficiency contributed to the increase in our gross margin. In addition, during fiscal year 2008, a vendor agreed to provide a credit of approximately $414,000 for defective inventory that had been received and written off by the Company in fiscal year 2007. As a result, included in fiscal year 2008 is $414,000 reduction of cost of goods which contributes to our improved gross margin. We expect cost of sales, as a percentage of sales, to decrease as production volumes increase and as the lower-cost strategy improves the manufacturing efficiency.

Operating Expenses



The following table summarizes our operating expenses during each of the past
three fiscal years (in thousands):



                                                              Year Ended
                                             Change                               Change
                          3/31/2009       $           %        3/31/2008       $           %        3/31/2007
Operating expenses
Research and product
development              $     4,241   $    564         15 %  $     3,677   $    (32 )       (1 )% $     3,709
Marketing                      2,922        475         19 %        2,447         86          4 %        2,361
General and
administrative                 8,746       (516 )       (6 )%       9,262       (390 )       (4 )%       9,652
Depreciation and
amortization                     418       (198 )      (32 )%         616        (50 )       (8 )%         666
Loss /(gain) on
disposal of assets               137        121        756 %           16        (46 )      (74 )%          62
Asset impairment
charge                           731        577        375 %          154        102        196 %           52
Contract settlement
charge, other                      -          -          - %            -        (24 )     (100 )%          24
Total operating
expenses                 $    17,195   $  1,023          6 %  $    16,172       (354 )       (2 )% $    16,526
Percent total revenue             66 %                                 78 %                                 99 %

We continued to focus on our operating expense management throughout fiscal 2009. Operating expenses as a percentage of revenue decreased to 66% in fiscal year 2009, versus 78% in fiscal year 2008, and 99% in fiscal year 2007. The reduction is the result of increased revenues and disciplined expense management.

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 totaled $ 4.2 million in fiscal year 2009, $3.7 million in fiscal year 2008, and $3.7 million in fiscal year 2007. During fiscal year 2009, research and development costs increased by approximately $0.6 million, or 15%, as compared to fiscal year 2008, primarily due to increases in wage and salary expenses, and increased product development expenses. Research and development expenses decreased from fiscal year 2007 to 2008 due to the reduction of consulting and material costs in our Nevada facility. During fiscal year 2009, $0.1 million of share based compensation was allocated to research and development expenses as compared to $0.3 million in fiscal year 2008, and $0.2 million in fiscal 2007. We expect research and development expenses to remain relatively steady as we create and develop new products.

Marketing: Marketing expenses consist primarily of costs related to sales and marketing personnel, and public relations and promotional materials. Marketing expenses of $3.0 million in fiscal year 2009 were $0.5 million, or 19% higher than fiscal year 2008. The increase in cost during fiscal year 2009, as compared to fiscal year 2008, was primarily related to wage and salary expenses related to additional employees, and travel and trade show expenses. During fiscal 2009, $0.3 million of share based compensation was allocated to marketing expenses as compared to $0.3 million in fiscal 2008, and $0.2 million in fiscal 2007. We expect marketing expenses to increase slightly as we focus on building a stronger market presence and continue to reach new customers.

General and Administrative:General and administrative expenses consist primarily of wage and salary expenses, share based compensation expense, and other related costs for finance, human resources, facilities, information technology, legal, audit, insurance, and corporate-related expenses. General and administrative expenses of $8.7 million in fiscal year 2009 represented a $0.5 million, or 6% decrease, over fiscal year 2008. General and administrative expenses include share based compensation of $0.3 million in fiscal year 2009, $1.7 million in fiscal year 2008, and $1.1 million in fiscal year 2007. The decrease was due to reduction in share based compensation expense related to expense reductions recorded in the period related to terminated employees. These reductions were partially offset by increases in spending for additional

legal, regulatory and facility expenses during fiscal year 2009. Fiscal year 2008 general and administrative expenses of $9.3 million represented a decrease of $0.4 million, or 4%, over fiscal year 2007 expenses. We expect general and administrative expenses to increase in line with our associated needs as the company grows.

Other Costs Related to Our Manufacturing Transition

Impairment Charge: There were impairment charges of approximately $731,000, $154,000 and $52,000 recorded during fiscal years 2009, 2008 and 2007 respectively. The fiscal 2009 impairment charge relates to fixed assets that were purchased for the expansion of our production facilities in China. These production assets were deemed to be impaired since the additional capacity provided by these assets will not be necessary to meet expected demand until later than previously expected. The 2008 and 2007 impairment charges also relate to a write-down of machinery and equipment.

Gain/Loss on Sale of Assets: Loss on sales of assets amounted to approximately $137,000, $16,000, and $62,000 in fiscal years 2009, 2008, and 2007, respectively, and resulted primarily from consolidating our China operations into two plants in Suzhou, China. 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, Interest Expense

Depreciation and Amortization: Depreciation and amortization expense totaled approximately $418,000, $616,000 and $666,000 for fiscal years ended March 31, 2009, 2008 and 2007, respectively.

Interest Expense: Interest expense relates to our long-term debt with a stockholder and third party. Interest expense was $5.2 million, $6.4 million, and $6.4 million for the fiscal years 2009, 2008, and 2007, respectively. Interest expense fluctuations are a result of changes in the underlying interest rate on one of the loans, which is indexed to the Libor rate.

Liquidity and Capital Resources

At March 31, 2009, our principal source of liquidity was cash and cash equivalents of $4.0 million. We do not expect our cash and cash equivalents will be sufficient to fund our operating and capital needs for the next three to six months following March 31, 2009 nor do we anticipate product sales during fiscal 2010 will be sufficient to cover our operating expenses. Historically, we have relied upon management's 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 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 on favorable terms or at all.

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 the Company's product development goals, and other adverse developments. These events could have a negative impact on our available liquidity sources during the remaining fiscal year.

The following table summarizes our statement of cash flows for the fiscal years ended March 31, 2009, 2008 and 2007 (in thousands):

                                                       Year Ended March 31,
                                                   2009        2008        2007
     Net cash flows provided by (used in)
     Operating activities                        $ (15,423 ) $ (14,660 ) $ (20,307 )
     Investing activities                           (3,555 )    (1,628 )    (2,204 )
     Financing activities                           20,359      17,709      23,185
     Effect of foreign exchange rates                   12          27        (118 )
     Net increase in cash and cash equivalents   $   1,393   $   1,448   $     556

Our use of cash from operations during fiscal 2009, fiscal 2008 and fiscal 2007 was $15.4 million, $14.7 million and $20.3 million, respectively. The cash used for operating activities during all periods was primarily for operating losses and working capital. Cash used for operating activities in fiscal 2009 was higher than in fiscal 2008 mainly due to the increase in spending related to salaries and wages, offset by decreases in spending related to some of the operating expenses as described above in the section titled "Operating Expenses." Cash used for operating activities in fiscal 2008 was lower than in fiscal 2007 primarily from the impact of decreases in some of the operating expenses as described above in the section titled "Operating Expenses."

In fiscal 2009, 2008, and 2007, we spent net cash from investing activities of $3.6 million, $1.6 million, and $2.2 million, respectively, primarily on property, plant, and equipment for our China facilities.

We obtained net cash from financing activities of $20.4 million and $17.7 million during fiscal 2009 and 2008, respectively. The 2009 financing includes $10.2 million in sales of common stock to private investors, $9.2 million from the conversion of notes payable to common stock and the exercise of warrants held by Berg & Berg, and $0.9 million from the exercise of stock options by employees.. The 2008 financing includes $8.2 million in sales of common stock to private investors and $9.0 million in sales of common stock to Carl Berg and his affiliates. Cash from the 2007 financing activities includes $8.4 million in sales of common stock to private investors, $9.5 million in sales of common stock to a related party, and $5.0 million from the conversion of notes payable to common stock held by Berg & Berg. As a result of the above, we had a net increase in cash and cash equivalents of $1.4 million during fiscal 2009, a net increase of $1.4 million during fiscal 2008, and a net increase of $556,000 during fiscal 2007.

On January 14, 2008, we filed a Form S-3 Registration Statement with the SEC utilizing a "shelf" registration process. On January 22, 2008, the Form S-3 Registration was declared effective by the SEC. Pursuant to this "shelf" registration statement, the Company may sell debt or equity securities described in the accompanying prospectus in one or more offerings up to a total public offering price of $50,000,000. We believe that this shelf registration statement provides us additional flexibility with regards to potential financings that we may undertake when market conditions permit or our financial condition may require.

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

In accordance with terms of the At Market Issuance Sales Agreement, we may issue and sell up to 5,000,000 shares of common stock in a series of transactions over time as we may direct through the Sales Agent. Sales of shares may be made in privately negotiated transactions and/or any other method permitted by law, including sales deemed to be an "at the market" offering as defined in Rule 415 under the Securities Act of 1933, which includes sales made directly on the NASDAQ Capital Market, the existing trading market for the Company's common stock, or sales made to or through a market maker other than on an exchange. The Sales Agent will make all sales on a best efforts basis using commercially reasonable efforts consistent with its normal trading and sales practices, on mutually agreed terms between the Sales Agent and the Company. Unless the Company and the Sales Agent agree to a lesser amount with respect to certain persons or classes of persons, the compensation to the Sales Agent for sales of common stock sold pursuant to the Agreement will be 6.0% of the gross proceeds of the sales price per share.

Through March 31, 2009, we had sold 4,288,400 shares with proceeds net of commissions of $14.1 million under the At Market Issuance Sales Agreement. As of the date of this Report, we have made no further decisions as to whether or when we may seek to make additional sales under the At Market Issuance Sales Agreement.

At March 31, 2009, the redemption obligation for our Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock, all of which is currently held by Berg & Berg, is $8.6 million, plus accrued dividends, which as of March 31, 2009 totaled approximately $603,000. The preferred shares are currently subject to redemption or conversion at the holder's discretion. We do not have sufficient resources to effect

this redemption; however, Berg & Berg has agreed that our failure to redeem the Series C-1 Convertible Preferred Stock and the Series C-2 Convertible Preferred Stock does not constitute a default under the certificate of designations for either the Series C-1 Convertible Preferred Stock or the Series C-2 Convertible Preferred Stock and has waived the accrual of any default interest applicable. Berg & Berg also has agreed to defer the payment of dividends on the Series C-1 Convertible Preferred Stock and Series C-2 Convertible Preferred Stock. According to our agreement with Berg & Berg, dividends will continue to accrue (without interest) on the Series C-1 Convertible Preferred Stock and the Series C-2 Convertible Preferred Stock according to the terms of the applicable certificates of designation; and such dividends are not payable until such time as the parties mutually agree, or upon redemption or conversion in accordance with the terms of the applicable certificates of designation. We have no present intention to pay dividends on this preferred stock, including the accrued dividends. The Series C-1 Convertible Preferred Stock may be converted, at any time, into shares of our common stock at the lower of $4.00 or the closing price of our common stock on the conversion date, provided the conversion price can be no lower than $1.98, the closing price of the common stock on December 13, 2005. The Series C-2 Convertible Preferred Stock may be converted, at any time, into shares of our common stock at the lower of $4.00 or the closing price of our common stock on the conversion date, provided the conversion price can be no lower than $2.96, the closing bid price of our common stock on July 13, 2005.

Related Party Transactions

On November 15, 2008, Berg & Berg purchased approximately 1.7 million shares of the Company's common stock. As payment of the purchase price of the common stock, Berg & Berg surrendered certain promissory notes issued on July 23, 2008 and amended September 30, 2008 ($542,000 in principal and approximately $14,000 in accrued interest), and June 26, 2008 ($2.5 million in principal and approximately $78,000 in accrued interest). The surrendered promissory notes were the second and first working capital loan installments, respectively, made pursuant to an agreement between the Company and Berg & Berg whereby Berg & Berg agreed to provide up to $10.0 million in interim working capital loans from time to time in order to supplement the Company's working capital and other financial needs. This agreement expired on November 15, 2008 and accordingly, all outstanding amounts were paid on November 15, 2008. No future draws can be taken against this loan.

On April 24, 2008, Berg & Berg, an affiliate of our Chairman, Carl Berg, exercised a warrant to purchase 600,000 shares of the Company's common stock. The purchase price was $ 2.74 per share as set forth in the warrant. On July 13, 2005, we entered into an agreement with SFT I, Inc., providing for a $20 million loan to Valence. In exchange for entry into the Loan Agreement and the guaranty of the loan, SFT I, Inc. and Berg & Berg were each issued three year warrants to purchase 600,000 shares of our common stock, at $2.74 per share, the closing price of our common stock on July 12, 2005.

On February 21, 2008, Berg & Berg purchased 280,112 shares of the Company's common stock for $1.0 million. The purchase price of $3.57 per share equaled the closing bid price of the Company's common stock as of February 27, 2008.

On February 22, 2008, Berg & Berg purchased 330,033 shares of the Company's common stock for $1.0 million. The purchase price of $3.03 per share equaled the closing bid price of the Company's common stock as of February 21, 2008.

. . .