News Column

MAXWELL TECHNOLOGIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 20, 2014

The following discussion of our financial condition and results of operations for the years ended December 31, 2013, 2012 and 2011 should be read in conjunction with our consolidated financial statements and the related notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. In addition, the discussion contains forward-looking statements that are subject to risks and uncertainties, including estimates based on our judgment. These estimates include, but are not limited to, assessing the collectability of accounts receivable, applied and unapplied production costs, production capacities, the usage and recoverability of inventories and long-lived assets, deferred income taxes, the incurrence of warranty obligations, stock compensation expense, impairment of goodwill and other intangible assets, strategies, future revenues and other operating results, cash balances and access to liquidity, the cost to complete certain projects, the probability that the performance criteria of restricted stock awards will be met and accruals for estimated losses from legal matters. For further discussion regarding forward looking statements, see the section of this Annual Report on Form 10-K entitled Special Note Regarding Forward-Looking Statements. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in the following sections: • Executive Overview • 2013 Highlights • Results of Operations



• Liquidity and Capital Resources

• Contractual Obligations

• Critical Accounting Estimates

• Impact of Inflation

• Pending Accounting Pronouncements

• Off Balance Sheet Arrangements

Executive Overview Maxwell is a global leader in developing, manufacturing and marketing advanced energy storage and power delivery products for transportation, industrial, information technology and other applications, and microelectronic products for space and satellite applications. Our strategy is to establish a compelling value proposition for our products by designing and manufacturing them to perform reliably with minimal maintenance over long operational lifetimes. We have three product lines: ultracapacitors with applications in multiple industries, including transportation, automotive, information technology, renewable energy and consumer and industrial electronics; high-voltage capacitors applied mainly in electrical utility infrastructure; and radiation-hardened microelectronic products for space and satellite applications. Our primary objective is to grow revenue and profit margins by creating and satisfying demand for ultracapacitor-based energy storage and power delivery solutions. We are focusing on establishing and expanding market opportunities for ultracapacitors and being the preferred supplier for ultracapacitor products worldwide. We believe that the transportation industry represents the largest market opportunity for ultracapacitors, primarily for applications related to engine starting, electrical system augmentation, and braking energy recuperation and hybrid electric drive systems for transit buses, trucks and autos, and electric rail vehicles. Backup power and power quality applications, including instantly available power for uninterruptible power supply systems, and stabilizing the output of renewable energy generation systems may also represent significant market opportunities. We also seek to expand market opportunities for our high-voltage capacitor and radiation-hardened microelectronic products. The market for high-voltage capacitors consists mainly of expansion, upgrading and maintenance of existing electrical utility infrastructure and new infrastructure installations in developing countries. Such installations are capital-intensive and frequently are subject to regulation, availability of government funding and general economic conditions. Although the market for microelectronics products for space and satellite applications is relatively small, the specialized nature of these products and the requirement for failure-free reliability allows us to generate profit margins significantly higher than those for commodity electronic components. 30



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In 2013, revenues were $193.5 million, representing an overall increase of 22% compared with 2012. This growth is primarily attributable to higher revenue for our ultracapacitor products, for which revenue increased by 42% to $136.3 million in 2013 compared with $96.0 million in 2012. This increase in revenues for our ultracapacitor products is primarily attributable to revenue growth in the two primary markets in which we currently sell our products, the hybrid transit vehicle and wind energy markets. In addition, the increase in ultracapacitor revenues is partially due to the net impact of deferring revenue on certain sales arrangements which resulted in $11.3 million in additional revenue in 2013. For 2012, there was net decrease to ultracapacitor revenues of $6.1 million related to the net impact of revenue deferrals. Revenues for our high voltage capacitor products were $43.3 million in 2013 compared with $45.6 million in 2012, while revenues for our microelectronics products were $13.9 million in 2013 compared with $17.7 million in 2012. The decline in revenue for our microelectronics products is related to a general decline in government funded programs. Overall gross profit margin for fiscal year 2013 decreased to 39% compared with 41% in 2012, primarily due to sales mix, where a higher portion of our sales was attributable to our ultracapacitor products, which earn lower margins than our other product lines. Operating expenses were 35% of revenue for 2013 and 35% of revenue for 2012. As of December 31, 2013, we had cash and cash equivalents of $30.6 million. Management believes that this available cash balance, combined with cash we expect to generate from operations, will be sufficient to fund our operations, obligations as they become due, and capital investments for at least the next twelve months. Going forward, we will continue to focus on growing our business and strengthening our market leadership and brand recognition through further penetration of existing markets, entry into new markets and development of new products. Our primary focus will be to grow our ultracapacitor product sales through continued market penetration in primary applications, including automotive, transportation, renewable energy and backup power. In order to achieve our growth objectives, we will need to overcome risks and challenges facing our business. A significant challenge we face is our ability to manage dependence on a small number of vertical markets, including some that are driven by government regulation or are highly dependent on government subsidy programs. For example, a large portion of our current ultracapacitor business is concentrated in the Chinese hybrid transit vehicle and wind energy markets, which are heavily dependent on government regulation and subsidy. These markets may experience slower rates of growth when there are changes or delays in government policies and subsidy programs that support our sales into these markets. In 2013, the Chinese government subsidy program for diesel electric hybrid buses concluded and an announcement of a renewal or replacement of the subsidy program has not occurred. However, our Chinese bus customers have indicated that they have received significant orders for battery-powered plug-in hybrid buses, which are subject to a current Chinese government subsidy program, and incorporate ultracapacitor content similar to that for diesel-electric hybrid buses. We are focused on supporting this plug-in hybrid demand, which contributed to sales of our ultracapacitor products in 2013. Although we believe the long-term prospects for the automotive, wind and bus markets remain positive, we are pursuing growth opportunities for our products in other vertical markets, including applications for back-up power, power quality and heavy vehicle engine starting, in order to further diversify our market presence and augment our long-term growth prospects. Other significant risks and challenges we face include the ability to maintain profitability; the ability to develop our management team, product development infrastructure and manufacturing capacity to facilitate growth; competing technologies that may capture market share and interfere with our planned growth; and hiring, developing and retaining key personnel critical to the execution of our strategy. We will be attentive to these risks and will focus on trying to grow our revenues and profits, and on developing new products and promoting the value proposition of our products versus competing technologies. 2013 Highlights During 2013, we continued to focus on researching new technologies, developing strategic alliances, introducing new products, increasing production capacity, reducing product costs, funding capital improvements, and improving production processes. Some of these efforts are described below: • In March, at the Mid-America Trucking Show at the Kentucky Expo Center, we



demonstrated our ultracapacitor-based Engine Start Module ("ESM"), which

delivers the quick-burst power large diesel engines need to crank in

extreme weather, for class 4 to 8 trucks down to minus 40 degrees

Fahrenheit. The ESM, which is being evaluated by more than 20 truck

fleets, delivers power for hundreds of thousands reliable starts, and in

most cases, will outlast the vehicle itself. • In April, we announced that we are supplying ultracapacitors for an



energy-saving braking energy recuperation system that American Maglev

Technology is installing on light rail vehicles operated by the Portland,

Oregon area's Tri-County Metropolitan Transportation District. 31



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• In May, we announced Shanghai ISSON Power Quality Co., Ltd. installed 126

of our 125V Heavy Transportation Modules in a power system that operates

26 ship-to-shore cranes for loading and unloading container ships at the Yangshan Deep-Water Port. This installation, one of the largest ultracapacitor installations in the world and the biggest in Asia, stabilizes voltage and smooths the fluctuation of the power output, for the electric cranes, allowing for uninterrupted operations.



• In June, we announced a collaboration with Soitec on a California Energy

Commission-funded, two-phase program to demonstrate the cost and

efficiency benefits of combining an ultracapacitor-based energy storage

system with Soitec's Concentrix™ CPV technology.

• In September, we announced that we were selected to supply ultracapacitors

to Caterpillar Inc. for a high efficiency energy management system that

supports Caterpillar's fuel-saving hydra-electric technology in the

industry's largest ever hydraulic mining shovel. The 1,400 ton shovel's

energy management system incorporates 98 of Maxwell's 125V ultracapacitor

modules.

• Also in September, we announced a collaboration with Celadon, Inc., to

provide ultracapacitors for remote controls. The ultracapacitors are

expected to lower overall waste and create a worry free experience for end

users, who will no longer need to deal with remote control battery replacement and disposal. • In November, we announced that we are supplying ultracapacitors to Crosspoint Kinetics LLC, a subsidiary of Cummins Crosspoint LLC



("Cummins"), one of the world's largest distributors for Cummins engines,

parts and service, to store energy and deliver power in a

second-generation parallel electric hybrid drive system for small

para-transit bus, shuttle bus and package delivery vehicle applications.

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Results of Operations



The following table presents certain statement of operations data expressed as a percentage of revenue for the periods indicated:

Years Ended December 31, 2013 2012 2011 Total revenue 100 % 100 % 100 % Cost of revenue 61 % 59 % 61 % Gross profit 39 % 41 % 39 % Operating expenses: Selling, general and administrative 23 % 21 % 24 % Research and development 12 % 14 % 15 % Total operating expenses 35 % 35 % 39 % Operating income 4 % 6 % - % Other income, net - % - % 1 % Income from operations before income taxes 4 % 6 % 1 % Income tax provision 1 % 1 % 2 % Net income (loss) 3 % 5 % (1 )% Year Ended December 31, 2013 Compared with Year Ended December 31, 2012 Net income reported for 2013 was $6.3 million, or $0.22 per diluted share, compared with net income of $7.2 million, or $0.25 per diluted share, in 2012. Revenue grew 22% in 2013 compared with 2012, while gross profit declined as a percentage of revenue from 41% in 2012 to 39% in 2013. Total operating expenses were generally consistent in 2013 compared with 2012. Revenue and Gross Profit The following table presents revenue, cost of revenue and gross profit for the years ended December 31, 2013 and 2012 (in thousands, except percentage): Year Ended December 31, Year Ended December 31, 2013 2012 % of % of % Amount Revenue Amount Revenue Increase Change Revenue $ 193,534 100 % $ 159,258 100 % $ 34,276 22 % Cost of revenue 118,241 61 % 94,206 59 % 24,035 26 % Gross profit $ 75,293 39 % $ 65,052 41 % $ 10,241 16 % Revenue in 2013 increased 22% to $193.5 million, compared with $159.3 million in 2012. Ultracapacitor product revenue increased by 42% to $136.3 million in 2013, compared with $96.0 million in the prior year. This increase in revenues for our ultracapacitor products was primarily influenced by sales growth in the two primary markets in which we currently sell our products, the hybrid transit vehicle and wind energy markets. In addition, the increase in ultracapacitor revenues is partially due to the net impact of deferring revenue on certain sales arrangements which resulted in $11.3 million in additional revenue in 2013. For 2012, there was net decrease to ultracapacitor revenues of $6.1 million related to the net impact of revenue deferrals. Future sales levels for our ultracapacitor products in the hybrid transit bus market are currently uncertain, primarily due to uncertainty as to whether the Chinese government subsidy program for diesel hybrid transit vehicles will be renewed or replaced. Sales of high voltage capacitor products totaled $43.3 million for 2013, down 5% from the $45.6 million recorded in 2012, while revenue from our microelectronic products, which tend to vary widely, totaled $13.9 million for 2013, down 22% from the $17.7 million recorded in 2012. A substantial amount of our revenue is generated through our Swiss subsidiary which has a functional currency of the Swiss Franc. As such, reported revenue can be materially impacted by the changes in exchange rates between the Swiss Franc and the U.S. Dollar, our reporting currency. Due to the weakening of the U.S. Dollar against the Swiss Franc during 2013 compared with 2012, revenue was positively impacted by $391,000. 33



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The following table presents revenue mix by product line for the years ended December 31, 2013 and 2012:

Year Ended December 31, 2013 2012 Ultracapacitors 71 % 60 % High-voltage capacitors 22 % 29 % Microelectronics products 7 % 11 % Total 100 % 100 % Gross profit in 2013 increased $10.2 million, or 16%, to $75.3 million compared with 2012. As a percentage of revenue, gross profit decreased to 39% in 2013 compared with 41% in 2012. The decrease in gross profit as a percent of revenue was primarily due to sales mix, where a higher proportion of our overall sales volume was attributable to our ultracapacitor products, which earn lower margins than our other product lines. Of the increase in gross profit in absolute dollars, $11.7 million related to an increase in sales which was partially offset by a $1.6 million increase to our reserve for excess and obsolete inventory and a $464,000 reserve for product rework costs. Selling, General & Administrative Expense The following table presents selling, general and administrative expense for the years ended December 31, 2013 and 2012 (in thousands, except percentage): Year Ended December 31, Year Ended December 31, 2013 2012 % of % of % Amount Revenue Amount Revenue Increase Change Selling, general and administrative $ 44,195 23 % $ 33,656 21 % $ 10,539 31 % Selling, general and administrative expenses were 23% of revenue in 2013, compared with 21% in 2012, while total expense increased by $10.5 million, or 31%. The increase in absolute dollars was primarily driven by an increase in legal expenses of $3.0 million, an increase in audit and tax fees of $1.7 million and an increase of $790,000 in consulting expenses, mainly related to the audit committee's investigation, our internal review and the restatement of previously issued financial statements. Further, there was an increase of $3.2 million in payroll expenses related to increased headcount, including the retention of our new chief operating officer. In addition, there was an increase in bonus expense of $1.7 million, as the performance targets under our 2013 bonus program were substantially achieved, whereas there was no bonus expense recorded in 2012 as the performance targets under our 2012 bonus program were not achieved. Research and Development Expense The following table presents research and development expense for the years ended December 31, 2013 and 2012 (in thousands, except percentage): Year Ended December 31, Year Ended December 31, 2013 2012 % of % of % Amount Revenue Amount Revenue Increase Change Research and development $ 22,542 12 % $ 21,700 14 % $ 842 4 % Research and development expense was $22.5 million in 2013 compared with $21.7 million in 2012, an increase of approximately $842,000 or 4%. As a percentage of revenues, research and development expense was 12% in 2013 compared with 14% in 2012. The increase in absolute dollars was primarily driven by an increase in facility costs of $843,000 due to continued expansion of our research and development facilities. Provision for Income Taxes We recorded an income tax provision of $2.2 million for the year ended December 31, 2013 compared with $2.3 million for the year ended December 31, 2012. This provision is primarily related to our Swiss operations. Unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements without giving effect to the United States taxes that may be payable as it is not anticipated such earnings will be remitted to the United States. The Company has established a valuation allowance against its U.S. federal and state deferred tax assets, as well as the deferred tax assets of certain foreign subsidiaries, due to the uncertainty surrounding the realization of such assets as evidenced by the cumulative losses from operations through December 31, 2013. Management periodically evaluates the recoverability of the deferred tax assets and at 34



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such time as it is determined that it is more likely than not that deferred assets are realizable, the valuation allowance will be reduced accordingly. Year Ended December 31, 2012 Compared with Year Ended December 31, 2011 Net income reported for 2012 was $7.2 million, or $0.25 per diluted share, compared with a net loss of $1.4 million, or $0.05 per share, in 2011. Revenue grew by 8% in 2012 compared with 2011, while both cost of revenue and operating expenses declined as a percentage of revenue. During 2011, we recorded a reduction in revenue for the settlement of a legal matter with a customer of $2.6 million, and a gain on embedded derivatives of $1.1 million. During 2012, we continued to achieve improved operating results due to revenue growth combined with continued improvements in gross profit and operating efficiency. Revenue and Gross Profit The following table presents revenue, cost of revenue and gross profit for the years ended December 31, 2012 and 2011 (in thousands, except percentage): Year Ended December 31, Year Ended December 31, 2012 2011 % of % of % Amount Revenue Amount Revenue Increase Change Revenue $ 159,258 100 % $ 147,176 100 % $ 12,082 8 % Cost of revenue 94,206 59 % 90,106 61 % 4,100 5 % Gross profit $ 65,052 41 % $ 57,070 39 % $ 7,982 14 % Revenue in 2012 increased 8% to $159.3 million, compared with $147.2 million in 2011. Ultracapacitor product revenue increased by 10% to $96.0 million in 2012, compared with $86.8 million in the prior year. The increase in ultracapacitor revenue was influenced primarily by sales growth in the hybrid transit bus market, offset by lower sales for wind energy and certain backup power applications. In addition, this increase in ultracapacitor revenues is partially offset by the net impact of deferring revenue on certain sales arrangements which resulted in a net decrease to revenue of $6.1 million in 2012. For 2011, there was net decrease to ultracapacitor revenues of $8.3 million related to the net impact of revenue deferrals. Sales of high voltage capacitor products totaled $45.6 million for 2012, up 8% from the $42.3 million recorded in 2011. The increase in high voltage capacitor revenue was primarily due to an increase in sales volume, as well as changes in our pricing policy resulting in the denomination of most sales in the Swiss Franc instead of the Euro. Revenue from our microelectronic products was relatively flat year-over-year. A substantial amount of our revenue is generated through our Swiss subsidiary which has a functional currency of the Swiss Franc. As such, reported revenue can be materially impacted by the changes in exchange rates between the Swiss Franc and the U.S. Dollar, our reporting currency. Due to the strengthening of the U.S. Dollar against the Swiss Franc during 2012 compared with 2011, revenue was negatively impacted by $2.7 million. The following table presents revenue mix by product line for the years ended December 31, 2012 and 2011: Year Ended December 31, 2012 2011 Ultracapacitors 60 % 59 % High-voltage capacitors 29 % 29 % Microelectronics products 11 % 12 % Total 100 % 100 % Gross profit in 2012 increased $8.0 million, or 14%, to $65.1 million compared with 2011. As a percentage of revenue, gross profit increased to 41% in 2012 compared with 39% in 2011. Of the increase in gross profit in absolute dollars, $5.3 million related to an increase in the volume of sales, and $1.4 million was due to net reductions in product costs for our high voltage product line. In addition, there was an increase in gross profit in absolute dollars due to the classification as contra-revenue of a legal settlement expense related to a customer dispute recorded in 2011 of $2.6 million. Offsetting these increases was a decrease in gross profit in absolute dollars of $1.3 million related to the impact of changes in foreign currency exchange rates, primarily changes between the Swiss Franc and the U.S. Dollar. Selling, General & Administrative Expense 35



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The following table presents selling, general and administrative expense for the years ended December 31, 2012 and 2011 (in thousands, except percentage):

Year Ended December 31, Year Ended December 31, 2012 2011 % of % of % Amount Revenue Amount Revenue Decrease Change Selling, general and administrative $ 33,656 21 % $ 35,218 24 % $ (1,562 ) (4 )% Selling, general and administrative expenses were 21% of revenue in 2012, compared with 24% in 2011, while total expense decreased by $1.6 million, or 4%. The decrease in absolute dollars was primarily attributable to a $1.9 million decrease in legal expenses related to the resolution of certain legal matters. In addition, there was a $1.2 million decrease in bonus expense, as no bonus expense was recorded for 2012 as the financial targets for our bonus program were not achieved, and $384,000 decrease in labor expense due to lower headcount. Offsetting these decreases, advertising costs and consulting fees increased by $1.5 million, primarily related to the roll out of a new ultracapacitor product, the Engine Start Module, increased participation in trade shows and other advertising media, and fees for marketing consultants. Further, there was an increase in net foreign exchange gains of $490,000. Research and Development Expense The following table presents research and development expense for the years ended December 31, 2012 and 2011 (in thousands, except percentage): Year Ended December 31, Year Ended December 31, 2012 2011 % of % of % Amount Revenue Amount Revenue Decrease Change Research and development $ 21,700 14 % $ 22,356 15 % $ (656 ) (3 )% Research and development expense was $21.7 million in 2012 compared with $22.4 million in 2011, a decrease of approximately $656,000 or 3%. As a percentage of revenues, research and development expense was 14% in 2012 compared with 15% in 2011. The decrease in absolute dollars was primarily driven by a $584,000 decrease in salary and contract labor costs, primarily related to higher development expenses and contract labor costs incurred in 2011 for the design of the Engine Start Module. In addition, bonus expense decreased by $474,000, as no bonus expense was recorded for 2012 as the financial targets for our bonus program were not achieved. Offsetting these decreases, was a $357,000 increase in information technology expense, and a $242,000 increase in depreciation and amortization expense, associated with recent investments in our research and development facilities and infrastructure. Gain on embedded derivatives During the year ended December 31, 2011, we recorded a gain on embedded derivatives of $1.1 million. The gain recorded on the embedded derivatives represented the change in the fair market value on revaluation of the debenture conversion rights on the dates of conversion compared with the beginning of the year. In February 2011, the remaining principal balance of the convertible debentures was converted to shares of our common stock. As such, there was no impact to the consolidated statement of operations in 2012 related to the fair value measurement of these derivative instruments. Provision for Income Taxes We recorded an income tax provision of $2.3 million for the year ended December 31, 2012 compared with $1.9 million for the year ended December 31, 2011. This provision is primarily related to our Swiss operations. Unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements without giving effect to the United States taxes that may be payable as it is not anticipated such earnings will be remitted to the United States. The Company has established a valuation allowance against its U.S. federal and state deferred tax assets, as well as the deferred tax asset of a foreign subsidiary, due to the uncertainty surrounding the realization of such assets as evidenced by the cumulative losses from operations through December 31, 2012. Management periodically evaluates the recoverability of the deferred tax assets and at such time as it is determined that it is more likely than not that deferred assets are realizable, the valuation allowance will be reduced accordingly. 36



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Liquidity and Capital Resources Changes in Cash Flow The following table summarizes our cash flows from operating, investing and financing activities for each of the past three fiscal years (in thousands): Years Ended December 31, 2013 2012 2011 Total cash provided by (used in): Operating activities $ 19,891$ (1,146 )$ (5,101 ) Investing activities (16,850 ) (15,200 ) (14,466 ) Financing activities (1,356 ) 15,569 10,432 Effect of exchange rate changes on cash and cash equivalents 223 227 (1,405 ) Increase (decrease) in cash and cash equivalents $ 1,908 $ (550



) $ (10,540 )

Net cash provided by operating activities was $19.9 million in 2013, compared with net cash used in operating activities of $1.1 million in 2012 and $5.1 million in 2011. Operating cash flows for 2013 related primarily to net income of $6.3 million, which included non-cash charges of $14.8 million. In addition, there was a decrease in deferred revenue of $5.4 million, an increase in accrued employee compensation of $4.0 million, an increase in inventory of $4.6 million and a decrease in accounts receivable of $3.7 million. The decrease in deferred revenue was primarily due to the recognition of revenue for sales for which we had received cash prior to the satisfaction of the criteria for revenue recognition. The increase in accrued employee compensation was primarily due to an increase in accrued bonus, as the performance targets under our bonus program were substantially achieved for 2013, but were not achieved for 2012. The increase in inventory relates to the build-up of inventory to meet anticipated demand in the first half of 2014. The decrease in accounts receivable was primarily due to improved collections, as well as a change in shipment linearity, where shipments occurred more evenly at the end of 2013, as opposed to having been more weighted to the last month of the year in 2012. The increase in operating cash flows for 2013 compared with 2012 relates primarily to a decrease in accounts receivable in 2013 compared with accounts receivable growth in 2012. Further, in 2012, operating cash flows were affected by settlement payments to the SEC and DOJ totaling $5.4 million, whereas no similar payments were made during 2013. Finally, 2013 operating cash flows related to net income of $6.3 million, which included non-cash charges of $14.8 million, compared with 2012 where operating cash flows included net income of $7.1 million, which included non-cash charges of $9.5 million. Net cash used in investing activities was $16.9 million for the year ended December 31, 2013, compared with $15.2 million in 2012 and $14.5 million in 2011. Capital expenditures in 2013 were primarily focused on investments in increased production capacity, including equipment for our new manufacturing facility in Peoria, Arizona, our corporate research and development facility in San Diego, California and our manufacturing facility in Rossens, Switzerland. Cash used in investing activities in 2012 and 2011 was primarily related to investments in increased production capacity, including equipment for our new manufacturing facility in Peoria, Arizona, our corporate research and development facility in San Diego, California and investments in our information technology infrastructure. Net cash used in financing activities was $1.4 million for the year ended December 31, 2013, compared with net cash provided by financing activities of $15.6 million in 2012 and $10.4 million in 2011. During the year ended December 31, 2013, net cash used in financing activities primarily resulted from net payments on long term and short term borrowings of $1.7 million, offset by cash proceeds from our stock-based compensation plans of $412,000. During the year ended December 31, 2012, cash proceeds resulted primarily from the issuance of common stock under a secondary security offering of $10.3 million, net proceeds on long term and short term borrowings of $3.8 million and associated with our stock-based compensation plans of $1.8 million. During the year ended December 31, 2011, cash provided by investing activities resulted primarily from the release of $8.0 million in restricted cash upon the settlement of the remaining principal balance of our convertible debentures and cash proceeds of $2.8 million associated with our stock compensation plans. Liquidity As of December 31, 2013, we had approximately $30.6 million in cash and cash equivalents, and working capital of $63.3 million. Management believes that cash we expect to generate from operations, combined with available cash balances, will be sufficient to fund our operations, obligations as they become due, and capital equipment expenditures for at least the next twelve months. In addition, we may choose to issue additional debt to supplement our existing cash balances and cash from operating activities. 37



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We have an accrual of 295,000 Euro ($406,000 as of December 31, 2013) for settlement of a customer dispute, which is available to the customer as a discount on future purchases of our products through December 31, 2014. Any balance of this original, non-cash settlement value of 1.3 million Euro not used as product discount by December 31, 2014 will be payable in cash at that time. Capital expenditures are expected to be approximately $12.5 million in 2014. Approximately 60% of our planned capital spending is focused on ultracapacitor production capacity expansion and investments to improve manufacturing processes. Additionally, 11% of our planned capital spending is focused on product development, 11% will support our information technology infrastructure, and the remaining planned capital spending is primarily related to improvements in our facilities. As of December 31, 2013, the amount of cash and short-term investments held by foreign subsidiaries was $22.5 million. If these funds are needed for our operations in the U.S. in the future, we may be required to accrue and pay taxes to repatriate these funds at a rate of approximately 5%. We intend to permanently reinvest earnings of our foreign subsidiaries. Credit Facility In December 2011, we entered into a credit agreement whereby we obtained a secured credit facility in the form of a revolving line of credit up to a maximum of $15.0 million (the "Revolving Line of Credit") and an equipment term loan (the "Equipment Term Loan") (together, the "Credit Facility"). The availability of the Revolving Line of Credit expired on February 5, 2014, and we have not borrowed any amounts to date under the Revolving Line of Credit. In general, amounts borrowed under the Credit Facility are secured by a lien on all of our assets other than our intellectual property. In addition, under the credit agreement, we are required to pledge 65% of our equity interests in our Swiss subsidiary. We have also agreed not to encumber any of our intellectual property. The agreement contains certain restrictive covenants that limit our ability to, among other things; (i) incur additional indebtedness or guarantees; (ii) create liens or other encumbrances on our property; (iii) enter into a merger or similar transaction; (iv) invest in another entity; (v) declare or pay dividends; and (vi) invest in fixed assets in excess of a defined dollar amount. Repayment of amounts owed pursuant to the Credit Facility may be accelerated in the event that we are in violation of the representations, warranties and covenants made in the credit agreement, including certain financial covenants. The financial covenants that we must meet during the term of the credit agreement include quarterly minimum liquidity ratios, minimum quick ratios and EBITDA targets and an annual net income target. Borrowings under the Credit Facility bear interest, payable monthly, at either (i) the bank's prime rate or (ii) LIBOR plus 2.25%, at our option subject to certain limitations. Further, we incur an unused commitment fee, payable quarterly, equal to 0.25% per annum of the average daily unused amount of the Revolving Line of Credit. As of December 31, 2013, we were not in compliance with the financial covenant pertaining to the quarterly EBITDA target for the quarter ended December 31, 2013. As a result of this noncompliance, the bank's obligation to extend any further credit ceased and terminated and the outstanding debt balance is immediately callable by the bank. As of December 31, 2012, we were not in compliance with the credit agreement due to the restatement of previously issued financial statement which resulted in the violation of various covenants. As a result of these events of noncompliance, borrowings outstanding under the Credit Facility have been classified as a current obligation in the accompanying consolidated balance sheets as of December 31, 2012 and 2013. The Equipment Term Loan was available to finance 80% of eligible equipment purchases made between April 1, 2011 and April 30, 2012. During this period, we borrowed $5.0 million under the Equipment Term Loan. As of December 31, 2013, $2.2 million was outstanding under this loan and the applicable interest rate was LIBOR plus 2.25% (2.5% as of December 31, 2012). If the bank does not exercise its right to accelerate repayment, under the original terms of the Credit Facility, principal and interest under the Equipment Term Loan are payable in 36 equal monthly installments such that the Equipment Term Loan is fully repaid by the maturity date of April 30, 2015, but may be prepaid in whole or in part at any time. Short-term borrowings Maxwell's Swiss subsidiary, Maxwell SA, has a 3.0 million Swiss Franc-denominated (approximately $3.4 million as of December 31, 2013) short-term loan agreement with a Swiss bank, which renews semi-annually and bears interest at 1.60%. Borrowings under the short-term loan agreement are unsecured and as of December 31, 2013 and 2012, the full amount of the loan was drawn. Maxwell SA has a 2.0 million Swiss Franc-denominated (approximately $2.2 million as of December 31, 2013) credit agreement with this same Swiss bank, which renews annually and bears interest at 1.7%. Borrowings under the credit agreement are unsecured and as of December 31, 2013 and 2012, the full amount available under the credit line was drawn. Maxwell SA also has a 1.0 million Swiss Franc-denominated (approximately $1.1 million as of December 31, 2013) credit agreement with another Swiss bank, and the available balance of the line can be withdrawn or reduced by the bank at any 38



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time. As of December 31, 2013 and 2012, no amounts were drawn under the credit line. Interest rates applicable to any draws on the line will be determined at the time of draw. Other long-term borrowings The Company has various financing agreements for vehicles. These agreements are for up to a three-year repayment period with interest rates ranging from 1.9% to 5.1%. At December 31, 2013 and 2012, $179,000 and $159,000, respectively, was outstanding under these agreements. Dividends Over the remaining term of the Equipment Term Loan, which is scheduled to be repaid by April 2015, we are not permitted to declare or pay dividends. Contractual Obligations Payment due by period (in thousands) Less More than 1-3 3-5 than Total 1 Year Years Years 5 Years Operating lease obligations (1) $ 23,124$ 4,314$ 7,287$ 5,479$ 6,044 Purchase commitments (2) 7,512 7,512 - - - Debt obligations (3) 8,175 8,068 107 - - Pension benefit payments (4) 32,577 1,608 3,848 3,462 23,659 Foreign tax obligation (5) 2,129 2,129 - - - Legal settlements (6) 406 406 - - - Total $ 73,923$ 24,037$ 11,242$ 8,941$ 29,703 _____________



(1) Operating lease obligations primarily represent building leases.

(2) Purchase commitments primarily represent the value of non-cancelable purchase orders and an estimate of purchase orders that if canceled would result in a significant penalty. (3) Debt obligations represent long-term and short-term borrowings and interest payable of $161,000. (4) Pension benefit payments represent the expected amounts to be paid for pension benefits. (5) The foreign tax obligation represents payroll and other taxes and surcharges related to our operations in Asia.



(6) Amount represents payments due in connection with legal settlements.

Critical Accounting Estimates We consider an accounting estimate to be critical if: 1) the accounting estimate requires us to make assumptions about matters that were uncertain at the time the accounting estimate was made and 2) changes in the estimate are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Also see Note 1, Summary of Significant Accounting Policies, in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, which discusses the significant accounting policies. We believe the following are either (i) critical accounting policies that require us to make significant estimates or assumptions in the preparation of our consolidated financial statements or (ii) other key accounting policies that may require us to make difficult or subjective judgments. Revenue Recognition Nature of Estimates Required. Sales revenue is primarily derived from the sale of products directly to customers. Product revenue is recognized when all of the criteria for revenue recognition are met. Customer agreements and other terms of the sale are evaluated to determine when the criteria for revenue recognition have been met, and therefore when revenue should be recognized. Revenue recognition is deferred until all the criteria for revenue recognition have been met. Assumptions and Approach Used. Product revenue is recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists (upon contract signing or receipt of an authorized purchase order from a customer); (2) title passes to the customer at either shipment from our facilities or receipt at the customer facility, depending on shipping terms; (3) price is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collectability is 39 -------------------------------------------------------------------------------- reasonably assured. Customer contracts, or purchase orders and order confirmations, are generally used to determine the existence of an arrangement. Shipping documents are used to verify product delivery. We assess whether a price is fixed or determinable based upon the payment terms associated with the transaction. We assess the collectability of accounts receivable based primarily upon creditworthiness of the customer as determined by credit checks and analysis, as well as the customer's payment history. If we determine that a particular sale does not meet all of the above criteria for revenue recognition, revenue is deferred until all of the criteria are determined to have been achieved. For example, if we determine that collectability is not reasonably assured at the time of sale, we defer revenue recognition, typically until the period in which cash is received from the customer. Beginning in the fourth quarter of 2011, for three distributors of our products, we offered extended payment terms which allowed these distributors to pay us after they received payment from their customer, with respect to certain sales transactions. Also beginning in the fourth quarter of 2011, for one other distributor of our products, we offered return rights and profit margin protection with respect to certain sales transactions. Therefore, for these four distributors, we determined that the revenue recognition criteria were not met at the time of delivery, as there was no fixed or determinable price, nor was collection reasonably assured, at least with respect to certain sales transactions. As a result, for the three distributors provided with extended payment terms, which did not provide for a fixed or determinable price, we determined to defer the recognition of revenue on all sales beginning in the fourth quarter of 2011 to the period in which cash is received. For the one distributor provided with return rights and profit margin protection, for which we could not estimate exposure, we determined to defer the recognition of revenue on all sales beginning in the fourth quarter of 2011 until the distributor confirmed to us that it is not entitled to any further returns or credits. During the third quarter of 2013, this distributor confirmed to us that it was not entitled to any further returns or credits, therefore, previously deferred revenue related to this distributor was recognized in the quarter ended September 30, 2013. Although we had deferred revenue for a significant amount of sales to these four distributors as of December 31, 2011and 2012, the amount of deferred revenue related to these distributors as of December 31, 2013 is insignificant. In addition to the deferred revenue arrangements discussed in the preceding paragraph, revenue is not recognized for sales that do not meet the revenue recognition criteria at the time of sale. Revenue is recognized once all of the criteria for revenue recognition are determined to have been met. For example, if we do not believe that collection of the sales price is reasonably assured at the time of sale, we defer revenue recognition until cash is received. As of December 31, 2013 and December 31, 2012, cumulative sales totaling $4.5 million and $15.8 million, respectively, had not yet been recognized as revenue. We have recorded the cost basis of inventory shipped to customers prior to the achievement of the revenue recognition criteria of approximately $2.5 million and $9.2 million at December 31, 2013 and 2012, respectively, in "inventory" in the consolidated balance sheets. If we receive cash payment from the customer prior to the achievement of the revenue recognition criteria, the amount received from the customer is recorded as deferred revenue in the consolidated balance sheets. Total deferred revenue in our consolidated balance sheets as of December 31, 2013 and 2012 of $1.0 million and $6.4 million, respectively, relates to cash received from customers on sales for which the revenue recognition criteria were not achieved, customer advances, as well as other less significant customer arrangements requiring the deferral of revenue. Excess and Obsolete Inventory Nature of Estimates Required. Estimates are principally based on assumptions regarding the ability to sell the items in our inventory. Due to the uncertainty and potential volatility inherent in these estimates, changes in our assumptions could materially affect our results of operations. Assumptions and Approach Used. Our estimate for excess and obsolete inventory is evaluated on a quarterly basis and is based on rolling historical inventory usage and assumptions regarding future product demand. As actual levels of inventory change or specific products become slow moving or obsolete, our estimated reserve may materially change. Pension Nature of Estimates Required. We use several significant assumptions within the actuarial models utilized in measuring the pension benefit obligation and to estimate the fair values of real estate assets held by the pension plan. Assumptions and Approach Used. The discount rate and expected return on assets are estimates impacting plan expense and asset and liability measurement. We evaluate these critical assumptions at least annually. In addition, we appraise the fair value of real estate assets annually. We periodically evaluate other assumptions involving demographic factors, such as retirement age, mortality and turnover, and update them to reflect our experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. The projected benefit 40 -------------------------------------------------------------------------------- obligation as of December 31, 2013 was $32.6 million and the fair value of plan assets was $43.1 million. The Company does not have any rights to the assets of the plan. Stock-Based Compensation Nature of Estimates Required. Our stock-based compensation awards include stock options, restricted stock, restricted stock units, and shares issued under our employee stock purchase plan. We record compensation expense for our stock-based compensation awards in accordance with the criteria set forth in the Stock Compensation Subtopic of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC"). Under the guidance, the fair value of each employee stock option is estimated on the date of grant using an option pricing model that meets certain requirements. Although we do not grant stock option awards as part of our ordinary compensation program, we use the Black-Scholes option pricing model to estimate the fair value of any stock option grants. However, the fair values generated by this model may not be indicative of the actual fair values of our stock options. The determination of the fair value of stock options utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected term, a risk-free interest rate and expected dividends. The fair value of restricted stock and restricted stock units is based on the closing market price of our common stock on the date of grant. In addition, for restricted stock awards with performance-based vesting criteria, we estimate the probability of achievement of the performance criteria and recognize compensation expense related to those awards expected to vest. Compensation expense equal to the fair value of each award is recognized ratably over the requisite service period. For restricted stock awards with vesting contingent on Company performance conditions, the impact of changes in the expected outcomes of the related performance condition are recognized as a cumulative adjustment in the consolidated statement of operations in the period in which the expectation changes. Share-based compensation expense recognized in the consolidated statement of operations is based on awards ultimately expected to vest. The FASB ASC requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods with a cumulative adjustment if actual forfeitures differ from those estimates. Assumptions and Approach Used. In determining the value of stock option grants, we estimate an expected dividend yield of zero because we have never paid cash dividends and have no present intention to pay cash dividends. In addition, over the remaining term of the Equipment Term Loan, which is scheduled to be fully repaid by April 2015, we are not permitted to declare or pay dividends. Expected volatility is based on our historical stock prices using a mathematical formula to measure the standard deviation of the change in the natural logarithm of our underlying stock price over a period of time commensurate with the expected option life. The risk-free interest rate is derived from the zero coupon rate on U.S. Treasury instruments with a term commensurate with the option's expected life. The expected term calculation is based on the actual life of historical stock option grants. For restricted stock awards with vesting contingent on the achievement of Company performance conditions, the amount of compensation expense is estimated based on the expected achievement of the performance condition. This requires us to make estimates of the likelihood of the achievement of Company performance conditions, which is highly judgmental. We base our judgments as to the expected achievement of Company performance conditions based on the financial projections of the Company that are used by management for business purposes, which represent our best estimate of expected Company performance. If it is unlikely that a performance condition will be achieved, no compensation expense is recognized unless is later determined that achievement of the performance condition is likely. Further, the requisite service period is estimated based on the expected achievement date of the performance condition. We evaluate the assumptions used to value stock-based awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of stock-based awards, we may be required to accelerate, increase or decrease any remaining, unrecognized stock-based compensation expense. To the extent that we grant additional stock-based awards, compensation expense will increase in relation to the fair value of the additional grants. Compensation expense may be significantly impacted in the future to the extent our estimates differ from actual results. Income Taxes Nature of Estimates Required. We record an income tax valuation allowance when the realization of certain deferred tax assets, including net operating losses, is not likely. Not included in the net operating loss deferred tax asset is approximately $9.8 million of gross deferred tax asset attributable to stock option exercises, restricted stock grants, and disqualifying dispositions of both incentive stock options and stock issued under the Company's ESPP. According to a provision within ASC 718, Stock Compensation, concerning when tax benefits related to excess stock option deductions can be credited to paid-in capital, the related valuation allowance cannot be reversed, even if the facts and circumstances indicate it is more likely than 41 -------------------------------------------------------------------------------- not than the deferred tax asset can be realized. The valuation allowance will only be reversed as the related deferred tax asset is applied to reduce taxes payable. We do not record deferred income taxes on the undistributed earnings of our foreign subsidiaries based upon our intention to permanently reinvest undistributed earnings. We may be subject to income and withholding taxes if earnings of the foreign subsidiaries were distributed. Withholding taxes of approximately $2.7 million would be payable upon remittance of all previously unremitted earnings at December 31, 2013. Assumptions and Approach Used. Deferred income taxes arise from temporary differences between tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. Significant judgments and estimates are required in this evaluation. If we determine that we are able to realize a portion or all of these deferred tax assets in the future, we will record an adjustment to increase their recorded value and a corresponding adjustment to increase income or additional paid in capital, as appropriate, in that same period. Commitments and Contingencies Nature of Estimates Required. We are involved in litigation, regulatory and other proceedings and claims. We prosecute and defend these matters aggressively. However, there are many uncertainties associated with any litigation, and there can be no assurance that these actions or other third party claims against us will be resolved without costly litigation and/or substantial settlement charges. Assumptions and Approach Used. We disclose information concerning contingent liabilities with respect to these claims and proceedings for which an unfavorable outcome is more than remote. We recognize liabilities for these claims and proceedings as appropriate based upon the probability of loss and our ability to estimate losses and to fairly present, in conjunction with the disclosures of these matters in our consolidated financial statements, management's view of our exposure. We review outstanding claims and proceedings with external counsel as appropriate to assess probability and estimates of loss. We will recognize a liability related to claims and proceedings at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated. When the reasonable estimate is a range, the recognized liability will be the best estimate within the range. If no amount in the range is a better estimate than any other amount, the minimum amount of the range will be recognized. We re-evaluate these assessments each quarter or as new and significant information becomes available to determine whether a liability should be recognized or if any existing liability should be adjusted. The actual cost of ultimately resolving a claim or proceeding may be substantially different from the amount of the recognized liability. In addition, because it is not permissible to recognize a liability until the loss is both probable and estimable, in some cases there may be insufficient time to recognize a liability prior to the actual incurrence of the loss (upon verdict and judgment at trial, for example, or in the case of a quickly negotiated settlement). Impact of Inflation We believe that inflation has not had a material impact on our results of operations for any of our fiscal years in the three-year period ended December 31, 2013. However, there can be no assurance that future inflation would not have an adverse impact on our operating results and financial condition. Pending Accounting Pronouncements None. Off Balance Sheet Arrangements None. Item 7A. Quantitative and Qualitative Disclosures about Market Risk We face exposure to financial market risks, including adverse movements in foreign currency exchange rates and changes in interest rates. These exposures may change over time and could have a material adverse impact on our financial results. We have not entered into or invested in any instruments that are subject to market risk, except as follows: Foreign Currency Risk 42 -------------------------------------------------------------------------------- Our primary foreign currency exposure is related to our subsidiary in Switzerland. Maxwell SA has Euro and local currency (Swiss Franc) revenue, and operating expenses as well as local currency loans. Changes in these currency exchange rates impact the reported amount (U.S. dollar) of revenue, expenses and debt. As part of our risk management strategy, we use forward contracts to hedge certain foreign currency exposures. Our objective is to offset gains and losses resulting from these exposures with gains and losses on the forward contracts, thereby reducing volatility of earnings. We use the forward contracts to hedge certain monetary assets and liabilities, primarily receivables and payables, denominated in a foreign currency. The change in fair value of these instruments represents a natural hedge as their gains and losses partially offset the changes in the fair value of the underlying monetary assets and liabilities due to movements in currency exchange rates. As of December 31, 2013, the impact of a theoretical detrimental change in foreign currency exchange rates of 10% on the foreign currency forward contracts would result in a hypothetical loss of $3.4 million, however, considering the offsetting impact of such a theoretical change in exchange rates on the underlying assets and liabilities being hedged, the hypothetical loss is only $11,000, which would be recorded in income from continuing operations in the consolidated statement of operations. For local currency debt carried by our Swiss subsidiary, the impact of a hypothetical 10% detrimental change in foreign currency exchange rates would result in a hypothetical loss of $636,000, which would be recorded in accumulated other comprehensive income on the consolidated balance sheet. Interest Rate Risk At December 31, 2013, we had approximately $8.0 million in debt, $100,000 of which is classified as long-term debt. Changes in interest rates may affect the consolidated balance sheet and statement of operations. The impact on earnings or cash flow during the next fiscal year from a change of 100 basis points (or 1%) in the interest rate would have a $80,000 effect on interest expense. Fair Value Risk We have a net pension asset of $10.6 million at December 31, 2013, including plan assets of $43.1 million, which are recorded at fair value. The plan assets consist of 57% debt and equity securities, 40% real estate and 3% cash and cash equivalents. The fair value measurement of the real estate is subject to the real estate market forces in Switzerland. The fair value of debt and equity securities is determined based on quoted prices in active markets for identical assets and is subject to interest rate risk. We manage our risk by having a diversified portfolio. See Note 12 to the consolidated financial statements for further discussion on the pension assets. 43



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