MAXWELL TECHNOLOGIES INC - 10-K Annual Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

	x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the fiscal year ended December 31, 2003

OR

	o	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 1-15477
MAXWELL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

Delaware		95-2390133
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9244 Balboa Avenue San Diego, California		92123
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (858) 503-3300

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.10 per share

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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

YES x NO o

As of June 30, 2003, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of Common Stock held by non-affiliates of the registrant based on the closing price of the Common Stock on the Nasdaq National Market was $42,341,760.

The number of shares of the registrant’s Common Stock outstanding as of March 1, 2004 was 14,394,668 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the 2004 Annual Meeting of Stockholders to be held on May 6, 2004 are incorporated by reference into Part III of this Annual Report on Form 10-K.

MAXWELL TECHNOLOGIES, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K
For the fiscal year ended December 31, 2003

			Page

PART I

Item	1.	Business	2
Item	2.	Properties	23
Item	3.	Legal Proceedings	23
Item	4.	Submission of Matters to a Vote of Security Holders	23

PART II

Item	5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	24
Item	6.	Selected Financial Data	25
Item	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item	7A.	Quantitative and Qualitative Disclosures About Market Risk	39
Item	8.	Financial Statements and Supplementary Data	40
Item	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	40
Item	9A.	Controls and Procedures	40

PART III

Item	10.	Directors and Executive Officers of the Registrant	42
Item	11.	Executive Compensation	42
Item	12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	42
Item	13.	Certain Relationships and Related Transactions	42
Item	14.	Principal Accountant Fees and Services	42

PART IV

Item	15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	43

FORWARD-LOOKING STATEMENTS

When used in this Annual Report on Form 10-K (this “Annual Report”), the words “believe,” “expect,” “anticipate” and similar expressions, together with other discussion of future trends or results, are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements are subject to certain risks and uncertainties, including those discussed below that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date of this Annual Report. All of these forward-looking statements are based on estimates and assumptions made by our management which, although believed to be reasonable, are inherently uncertain and difficult to predict; therefore, undue reliance should not be placed upon such statements. Actual results may differ materially and adversely from such statements due to known and unknown factors. The following important factors, among others, could cause our results of operations to be materially and adversely affected in future periods:

	•	further decline in the domestic and global economy that may delay the development and introduction by our customers of products that incorporate our components and systems;

	•	success in the introduction and marketing of new products into existing and new markets;

	•	ability to manufacture existing and new products in volumes demanded by our customers and at competitive prices with adequate gross margins;

	•	market success of the products into which our products are integrated;

	•	ability in growing markets to increase our market share relative to our competitors;

	•	success in meeting cost-reduction goals in the restructuring and reorganizing of our businesses;

	•	ability to successfully integrate our businesses with operations of acquired businesses; and

	•	ability to finance the growth of businesses with internal resources or through outside financing at reasonable rates.

Many of these factors are beyond our control. There can be no assurance that we will not incur new or additional unforeseen costs in connection with the ongoing conduct of our business. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Additional information regarding these factors and other risks is included in Part I, Item 1. “Business - Risk Factors” and Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as elsewhere within this Annual Report.

PART I

Unless the context otherwise requires, all references in this Annual Report to “Maxwell,” the “Company,” “we,” “us,” and “our” refer to Maxwell Technologies, Inc. and its subsidiaries; all references to “Electronic Components Group” refer to our former subsidiary, Maxwell Electronic Components Group, Inc., which has been merged into Maxwell; all references to “I-Bus/Phoenix” refer to our former subsidiary, I-Bus/Phoenix, Inc., and its subsidiaries; and all references to “PurePulse” refer to our non-operating subsidiary, PurePulse Technologies, Inc.

Item 1.

Business

Overview

Maxwell Technologies, Inc. is a Delaware corporation originally incorporated in 1965 under the name “Maxwell Laboratories, Inc.” In 1996, we changed our name to Maxwell Technologies, Inc. Presently headquartered in San Diego, California, we are a developer and manufacturer of innovative, cost-effective energy storage and power delivery solutions.

Maxwell’s High Reliability business segment is comprised of three product lines:

	•	Ultracapacitors: Our primary product, ultracapacitors, includes our BOOSTCAP® ultracapacitor cells and multi-cell modules and POWERCACHE® backup power systems, which provide highly reliable power solutions for applications in consumer and industrial electronics, transportation and telecommunications.

	•	High-Voltage Capacitors: Our CONDIS® high-voltage grading and coupling capacitors are used in electric utility infrastructure and other applications involving transport, distribution and measurement of high-voltage electrical energy.

	•	Radiation-Mitigated Microelectronic Products: Our radiation-mitigated microelectronic products include power modules, memory modules and single-board computers for applications in the space and satellite industries.

We aim to design and manufacture our products to perform reliably for the life of the products and systems into which they are integrated. We seek to achieve high reliability through the application of proprietary technologies and rigorously controlled design, development, manufacturing and test processes. This high reliability strategy emphasizes the development and marketing of products that enable us to achieve higher profit margins than commodity electronic components and systems.

During the year ended December 31, 2003, we continued our efforts to focus our business and to exit non-strategic businesses. These efforts culminated in our exit from the low-margin power magnetics business and commensurate consolidation of the remaining value-added business into our ultracapacitor product line, and the sale of our Winding Equipment business segment. As the result of these actions, as well as other divestitures throughout 2002 and 2003, we have consolidated our operations into our High Reliability business segment. (See Part I, Item 1. “Business-Strategic Consolidation of Operations,” Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Acquisitions, Restructuring, Divestitures, Discontinued Operations and Other Events,” and Notes 2 and 3 to our Notes to Consolidated Financial Statements, for information regarding our business combinations, divestitures and phased-out operations.)

Products and Applications

Our products apply our expertise and proprietary power and microelectronics technology at both the component and system level for specialized, high-value applications for which customers require high reliability. We are recognized as a leading supplier of high reliability power and microelectronic components and systems for a wide variety of high-value applications.

Ultracapacitors

An ultracapacitor, also known as a supercapacitor, stores energy electrostatically by polarizing an electrolytic solution. Although it is an electrochemical device, there are no chemical reactions involved in its energy storage mechanism. The mechanism is highly reversible, allowing the ultracapacitor to be rapidly charged and discharged hundreds of thousands of times for various peak power applications.

Unlike conventional batteries, ultracapacitors can be recharged in as little as fractions of a second from any electrical energy source, and they operate reliably through hundreds of thousands to millions of discharge/recharge cycles with minimal degradation of performance. Traditional capacitors have very little energy storage capacity and discharge power too rapidly to be suitable for many power delivery applications. Ultracapacitors have much greater energy storage capacity than traditional capacitors and can discharge power over time periods ranging from fractions of a second to several minutes. Used in tandem with batteries, ultracapacitors can deliver bursts of energy to meet power demand peaks, enhance system performance and, thus, significantly extend battery life. In applications where alternative sources of recharge energy are available, ultracapacitors can replace batteries entirely.

Our ultracapacitors can be linked together in modules to satisfy higher energy storage and power delivery requirements, and can be charged from any primary energy source, such as a battery, generator, fuel cell or electrical outlet. Virtually any device that has peak power demands greater than its average power requirement is a candidate for our ultracapacitors as part of its energy storage and power delivery system.

Our ultracapacitor products have significant advantages over alternative choices, including:

	•	delivery of up to 100 times more instantaneous power;

	•	significantly lower weight per unit of electrical energy stored;

	•	the ability to discharge deeper and recharge much faster and more efficiently;

	•	the ability to operate reliably in extreme temperatures (–40 degrees C to +75 degrees C);

	•	minimal maintenance requirements;

	•	operational reliability for the life of the device or system; and

	•	minimal environmental issues associated with disposal.

Any device or system that requires storage of electrical energy and repeated discharges of variable amounts of power represents a potential application for ultracapacitors. With no moving parts and no chemical reactions, ultracapacitors provide a simple, solid state, highly reliable solution to buffer short-term mismatches between power available and power required.

Ultracapacitors’ high electrical energy storage capacity, their ability to deliver rapid bursts of high power and their ability to recharge rapidly from any energy source over hundreds of thousands to millions of cycles, make them a preferred solution for a wide variety of applications ranging from handheld consumer electronic devices, to all-electric automotive subsystems and hybrid-electric vehicle drive trains.

New power-hungry electronic products, such as digital cameras and wireless communication devices, the increasing use of electric power in vehicles and the growing demand for highly reliable, maintenance free, back-up power systems are creating significant markets for new energy storage and power delivery solutions. In many applications, power demand varies widely from moment to moment, with peak power demand typically much greater than the average power requirement. For example, automobiles require much more power to accelerate from a stop than to maintain a constant speed, and digital cameras require more power to display images on a screen than to store images in memory. (See Part I, Item 1. “Business-Risk Factors,” for information regarding the risks associated with widespread acceptance of large cell ultracapacitors and transportation applications, and information regarding the commercial viability of large cell ultracapacitors.)

Engineers historically have addressed power requirements by over-designing the engine, battery or other primary energy source to satisfy all of the system’s power demands, including demand peaks that occur infrequently and may last only a few seconds. Sizing the primary power source to meet such infrequent peak power requirements, rather than average power requirements, is costly and inefficient. Systems can be designed to be smaller, lighter and less costly by coupling conventional power sources with specialized energy storage components or modules that can deliver brief bursts of high power on demand for periods of time ranging from fractions of a second to several minutes.

The following diagram depicts the separation of a primary energy storage source from a peak power delivery component. Highly reliable components that enable this separation permit new designs to optimize the efficiency and cost effectiveness of the entire electrical power system.

Peak Power Application Model

CHART

Although conventional batteries historically are the most widely used component for both primary energy sourcing and peak power delivery, ultracapacitors, advanced batteries and flywheels increasingly are being used to separate and optimize these functions. Based, in part, on our products’ rapidly declining cost, high performance and “life-of-the-application” durability, we believe that our ultracapacitors are positioned to become a preferred component for many energy storage and peak power delivery applications.

We offer our BOOSTCAP® ultracapacitors in several form factors, ranging from postage stamp size 5-Farad small cells to cylindrical 2,600-Farad large cells approximately two inches in diameter and six inches long. We also offer our POWERCACHE® modules, which are rack-mounted energy storage modules containing multiple BOOSTCAP® large cell ultracapacitors.

We are supplying our BOOSTCAP® ultracapacitors in volumes and at price points that are opening numerous market opportunities for us. Our smaller sized ultracapacitors have been designed into digital cameras and other consumer electronic devices, industrial electronics such as actuators, remote transmitting devices, high-intensity scanners, computer memory boards and transportation applications such as subway car alarm systems and electric actuators that replace mechanical latches in aircraft and automobile doors. Many products into which our small cell ultracapacitors have been designed now are in commercial production. Our large cell ultracapacitors have been designed into industrial applications such as uninterruptible power supply systems and transportation applications such as hybrid buses, trucks and autos, electric rail systems and capacitive starting systems for diesel trucks and locomotives. We received our first commercial production order to supply ultracapacitors for hybrid gasoline-electric transit buses in February 2004, and other large cell design-ins are progressing through the field test and evaluation phase. (See Part I, Item 1. “Business-Risk Factors,” for information regarding the risks associated with widespread acceptance of large cell ultracapacitors and transportation applications, and information regarding the commercial viability of large cell ultracapacitors.)

The charts below describe a number of current applications for our BOOSTCAP® ultracapacitors that are now in commercial production or are in the field testing or prototyping and evaluation phase.

5-Farad to 100-Farad Ultracapacitors

Market			Application		Stage of Commercialization


Consumer Electronics
	•	Digital cameras	•	Battery enhancement and peak power supply	•	Commercial production

Industrial Electronics
	•	Scanners	•	Energy storage, back-up power and	•	Commercial production
	•	Utility meters		peak power supply
	•	Actuators
	•	IV pumps
	•	Memory boards

Energy Generation
	•	Windmill power generators	•	System control and optimization as well as energy storage and peak power supply	•	Commercial production

Fuel Cell Augmentation
	•	Stationary fuel cell systems	•	Startup and peak load buffering to optimize system size and cost	•	Field testing and evaluation
	•	Fuel cell drive trains	•	Initial starting and braking energy recapture and reuse in vehicles	•	Field testing and evaluation

Transportation
	•	Helicopter airbags	•	Energy storage, back up power and	•	Commercial preproduction and
	•	Emergency lighting		peak power supply		production, except automobile and
	•	Airplane door actuators				airplane door actuators which are in
	•	Pilot transponders				the prototyping and evaluation phase
	•	Automobile door actuators

Our smaller capacity 5- to 10-Farad ultracapacitors have entered commercial production, meaning that some of our customers purchased production quantities of ultracapacitors from us in 2003 and have begun commercial production of the products into which our ultracapacitors are integrated. (See Part I, Item 1. “Business-Risk Factors,” for information regarding the risks associated with widespread acceptance of large cell ultracapacitors and transportation applications, and information regarding the commercial viability of large cell ultracapacitors.)

300-Farad to 2,600-Farad Ultracapacitors

Market			Application		Stage of Commercialization

Industrial & Telecommunications
	•	Uninterruptible power supply systems	•	Short-term bridge power for uninterruptible power supply systems that incorporate fuel cells or generators as the long-term back up power source for telecommunication base stations	•	Field testing and evaluation of Maxwell proprietary POWERCACHE® rack mount systems underway

			•	Energy storage and peak power supply for automated industrial equipment	•	Prototyping and evaluation of integrated systems

Transportation
	•	Rail systems	•	Recapture of braking energy and initial acceleration for electric trains	•	Field testing and evaluation of in-station as well as on-board modules developed by third party system integrators

			•	Capacitive starting systems for diesel locomotives	•	Prototyping and evaluation of capacitive starting subsystems developed by third party integrators

	•	Bus and truck systems	•	Recapture of braking energy and initial acceleration for internal combustion/hybrid-electric and fuel cell drive trains	•	Initial production for gasoline-electric bus drive trains and field testing and evaluation of truck diesel-electric hybrid drive trains developed by third party integrators

			•	Capacitive starting systems for diesel engines	•	Prototyping and evaluation of capacitive starting subsystems developed by third party integrators

			•	All-electric short-haul buses, fork lifts, vans and other high stop/start vehicles	•	Prototyping and evaluation of vehicles developed by third party integrators

	•	Automobile systems (12 and 42 volts)	•	Recapture of braking energy	•	Prototyping and evaluation of modules developed by Maxwell and by third party integrators, and of electrical subsystems developed by third party integrators
			•	Initial acceleration for internal combustion/electric and fuel cell drive trains

			•	Distributed power for all-electric power steering and braking and other subsystems

Our large cell ultracapacitors have been designed into large integrated systems that are being evaluated by potential customers. We expect increased sampling and prototyping activity in 2004, with certain applications moving into commercial production by the end of the year. In preparation for this commercial production, we are currently installing our first highly-automated, large cell assembly line, which we expect to be completed by year end 2004.

Applications such as bus, truck and auto drive trains, electric rail systems and uninterruptible power supplies require integrated modules consisting of up to hundreds of ultracapacitor cells. To facilitate adoption of ultracapacitors for these larger systems, we are complementing our internal capabilities with those of third parties who possess the systems integration and power and thermal management capabilities to provide fully-integrated systems and modules. (See Part I, Item 1. “Business-Risk Factors,” for the risks associated with widespread acceptance of large cell ultracapacitors and transportation applications, and information regarding the commercial viability of large cell ultracapacitors.)

We have also developed integration technologies to accelerate the adoption by our customers of multi-cell ultracapacitor modules and systems. These include proprietary electrical balancing, thermal management systems and interconnect technologies.

High-Voltage Capacitors

Electric utility grids have switches, circuit breakers, step-down transformers and measurement instruments responsible for the transport, distribution and measurement of high-voltage electricity. High-voltage capacitors are used to protect these systems from high-voltage arcing. In addition to performance, these applications require extremely high reliability and durability, with failure rates less than a few percent measured in decades.

Maxwell, through its acquisition in 2002 of Montena Components Ltd., or Montena, and its CONDIS® line of high-voltage capacitor products, is the world’s largest producer of such products, with more than 20 years of experience in the industry. Engineers who have specific expertise in high-voltage systems develop and test our capacitors in our high-voltage laboratory in Rossens, Switzerland. Our high-voltage capacitors are produced through a proprietary, automated winding and assembly process to ensure consistent quality and reliability. We intend to upgrade our high-voltage capacitor production facility in 2004 to double its output capacity and significantly shorten order delivery intervals.

Currently, we sell our high-voltage capacitors to large systems integrators, such as ABB Ltd., Alstrom Corporation and Siemens AG, who install and service electrical utilities around the world.

Radiation-Mitigated Microelectronic Products

Manufacturers of commercial and military satellites and other spacecraft require on-board microelectronic devices and systems that meet specific functional requirements and can withstand exposure to solar radiation that is encountered in space. In the past, microelectronic components and systems for these special applications have used only radiation-hardened silicon. However, the process of designing and producing radiation-hardened silicon is lengthy and expensive and there are fewer specialty fabricators, so supply of radiation-hardened silicon is limited. As a result, demand for components made with the latest commercial silicon, protected by shielding and other radiation mitigation techniques, is growing. Commercial silicon provides higher functionality and costs significantly less than radiation-hardened silicon. The ability to provide radiation-mitigated commercial silicon requires expertise in power electronics, circuit design, silicon selection, radiation shielding and extensive expertise in quality assurance testing.

We design, manufacture and market radiation-mitigated microelectronic products, including power modules, memory modules and single-board computers, for the space and satellite markets. Using highly adaptable, proprietary, packaging and shielding and other radiation mitigation techniques, we custom design products that allow original equipment manufacturers, or OEMs, to use powerful, low cost, commercial silicon protected with the level of radiation shielding required for reliable performance in the environment in which they are to be deployed.

Business Strategy

Our primary objective is to make ultracapacitors an “accepted energy option” and for Maxwell to become a leading ultracapacitor company. To accomplish this, we focus on:

•	Becoming a standard energy option

	•	By facilitating the integration of ultracapacitors into power hungry applications through: training engineers in the methodology of integration of ultracapacitors; using educational techniques including seminars, apprenticeships and white papers; participating in standards committees; and integrating ultracapacitor mathematical models into broadly accepted simulation software, among other efforts.

	•	By demonstrating the broad application universe of ultracapacitors, including through government sponsored projects, competitions and demonstrations.

	•	By partnering with key customers in strategic application fields.

•	Becoming a leading ultracapacitor company

	•	By focusing on cost enabled markets.

	•	By designing products for the “life-of-the-application.”

	•	By being a highly reliable supplier through global sourcing.

	•	By maintaining the highest level of technology and performance while focusing on product cost.

	•	By developing and deploying enabling systems, cell balancing systems, smart modules, charging systems and safety compliance systems.

	•	By maintaining broad and deep protections of key intellectual property.

In addition, we seek to expand revenue and market opportunities for our high-voltage capacitors and radiation-mitigated microelectronic products. While these are niche business areas with highly specialized applications, they also represent high-margin products for which we are a leading technology provider. Going forward, we plan to maintain and expand this competitive position by leveraging our technological expertise to develop new products that not only meet the demands of our current markets, but also address additional applications as well. For example, we recently introduced a new single-board computer for the space and satellite market. This product, which leverages our expertise in reliability and radiation-mitigated microelectronics, provides access to a new market opportunity by addressing an application that we did not already serve.

Manufacturing

We have consolidated the manufacturing of our ultracapacitors, high-voltage capacitors and radiation-mitigated microelectronic products into two production facilities located in San Diego, California, and Rossens, Switzerland. Over the past four years, we have made substantial capital investments to build and outfit state-of-the-art production facilities, which include both mechanization and full scale automation. We have also added an advanced information technology infrastructure, and have implemented new manufacturing and business processes and systems to increase our manufacturing capacity and improve efficiency, planning and product quality. Our production facilities have been designed with flexible overhead power grids and modular manufacturing cells and equipment that allow factory operations to be reconfigured rapidly at minimal expense. We believe that our manufacturing facilities and resources give us sufficient capacity to meet near-term demand for all of our product lines and to expand capacity as required without significant additional capital expenditure. (See Part I, Item 1. “Business – Risk Factors,” for information regarding the risks associated with expansion of our manufacturing capacity.)

Acceptance of our ultracapacitor products and high-voltage capacitor products depends in part on compliance and certification with a number of U.S. and foreign standards for electronic components and systems. Among the entities that promulgate such standards are Underwriters Laboratories, Canadian Standards Association and Committee European. We incorporate compliance with such standards into our quality assurance protocols in building and testing these products.

Ultracapacitors

In 2001, we installed an automated assembly line for our 5-Farad and 10-Farad small cell ultracapacitors at our San Diego production facility. This line can produce approximately 40,000 to 50,000 small cells per 24-hour production day. Current production is approximately 20,000 to 25,000 small cells per day based on a 12-hour production day.

We produce our large cell ultracapacitors on a pilot production line in our Rossens, Switzerland, production facility. We are in the process of installing our first high-volume, semi-automated manufacturing lines for our 300-Farad to 2,700-Farad ultracapacitors in our Swiss facility. We are also in the process of redesigning our larger form factor products to facilitate this automation and to incorporate lower cost materials. In addition to significantly reducing material cost, the new designs reduced both the number of parts in a finished cell and the number of manufacturing process steps to a fraction of those required for previous designs.

In February 2003, we formed an ultracapacitor manufacturing and marketing alliance with Yeong-Long Technologies Co., Ltd., or YEC. YEC is a $200 million per annum manufacturer of electrolytic capacitors headquartered in Taichung, Taiwan, with manufacturing and sales operations in mainland China. We entered into this alliance in order to commercialize our proprietary BOOSTCAP® ultracapacitors in China, and to help position us as a global supplier of ultracapacitors with production facilities in North America and Europe, and access to facilities in Asia. This alliance allows YEC to produce and sell our ultracapacitor products on a non-exclusive basis in the Chinese market, under a royalty-bearing agreement. It also provides for YEC to develop products in new form factors, and it permits us to utilize YEC’s manufacturing capacity for our distribution outside of China.

High-Voltage Capacitors

We produce our high-voltage grading and coupling capacitors at our Rossens, Switzerland, production facility. We are the only high-voltage capacitor producer that manufactures its products with automated winding and stacking, and assembly processes. This enables us to produce consistent, high quality and highly reliable products, and gives us sufficient capacity to satisfy global customer demand. We are upgrading the assembly portion of the process to a “cell-based,” “just-in-time” design this year, in order to double our current production capacity without additional direct labor or capital, and shorten “order-to-delivery” times. We estimate that by mid-2004, using state-of-the-art manufacturing techniques, the new production facility will be capable of reducing lead times by 50% and doubling production output. We believe this upgrade will allow us to expand our market penetration into capacitive voltage divider products, which we estimate would double the size of the market we currently serve.

Radiation-Mitigated Microelectronics Products

We produce our radiation-mitigated microelectronics products at our San Diego production facility. We have reengineered our production processes for radiation-mitigated microelectronics, resulting in dramatic reductions in cycle time and a significant increase in yield. Customer audits confirm our belief that we have “top-tier” manufacturing capabilities for highly reliable, radiation-mitigated power modules, memory modules and single-board computers, and that we have ample capacity to meet the demands of our customers in the space and satellite markets.

Our radiation-mitigated microelectronics production operations include die characterization, packaging, electrical, environmental and life testing. During 2002 and 2003, manufacturing cycle times were reduced and operator productivity increased, such that the current facility is capable of doubling production volumes without the need for additional direct labor or capital.

Suppliers

We generally purchase components and materials, such as electronic components, dielectric materials and enclosures of metal and plastic, from a number of suppliers. For certain products, such as our radiation-mitigated microelectronic products or our high-voltage capacitors, we rely on a limited number of suppliers or a single supplier. Although we believe there are alternative sources for some of the components and materials that we currently obtain from a single source, there can be no assurance that we will be able to identify and qualify alternative suppliers in a timely manner. Therefore, in critical

component areas, we “bank,” or store, critical high value materials, especially silicon die. We are working to reduce our dependence on sole and limited source suppliers through an extensive global sourcing effort. (See Part I, Item 1. “Business-Risk Factors,” for information regarding risks associated with securing sources for our materials.)

Marketing and Sales

We market and sell all of our components and systems products through both direct and indirect sales organizations in North America, Europe and Asia for integration by OEM customers into larger systems and other products. Because the introduction of emerging technologies requires customer acceptance of new and different technical approaches, and because many of our OEM customers have rigorous vendor qualification processes, the initial sale of our products can take months or even years.

Our principal marketing strategy is to cultivate long-term customer relationships by becoming a preferred supplier with an opportunity to compete for multiple supply agreements and follow-on contracts with our key OEM customers. As these design-in sales tend to be technical and engineering-intensive, we organize customer-specific teams composed of sales, engineering, research and development and other technical personnel to work closely with our customers across multiple disciplines to satisfy their requirements for form, fit, function, environment and mechanics. As time-to-market often is the primary consideration in our customers’ decisions to outsource components or systems and in their selection of a vendor, the initial sale and design-in process frequently evolves into ongoing account management to their outsource sub-contractors to ensure on-time delivery and responsive technical support and problem-solving.

Because of the nature of each of our three product lines, we conduct discrete marketing programs intended to position and promote our products. These include trade shows, seminars, advertising, public relations, distribution of product literature and Internet websites. We employ marketing communications specialists to develop and implement our marketing programs, design and develop marketing materials, negotiate advertising media purchases, write and place product news releases and manage our marketing websites.

We have an alliance with YEC to manufacture and market our proprietary BOOSTCAP® ultracapacitor products in China. Through this alliance, we seek to expand our ultracapacitor product line into China. (See Part I, Item 1. “Business-Manufacturing,” for information regarding our relationship with YEC.)

Competition

Each of our product lines has competitors, many of whom have longer operating histories, significantly greater financial, technical, marketing and other resources, greater name recognition and larger installed customer bases. In some of the target markets for our emerging technologies, we face competition both from products utilizing well-established, existing technologies and alternative novel technologies.

Ultracapacitors

Our ultracapacitor products have two types of competitors: other ultracapacitor suppliers and developers of alternative technologies. Although a number of companies are developing ultracapacitor technology, we have two principal competitors in ultracapacitor or supercapacitor products: Panasonic, a division of Matsushita Electric Industrial Co., Ltd., and EPCOS AG. The key competitive factors in the ultracapacitor market are price, performance (energy stored and power delivered per unit volume), durability and reliability, form factor, operational lifetime and breadth of product offerings. We believe that we compete favorably with respect to these competitive factors.

Ultracapacitors also compete with other technologies, including advanced batteries in power quality and peak power applications, and with flywheels and batteries in back-up energy storage applications. We believe that their high durability, long life, high performance and low cost give ultracapacitors a competitive advantage over these alternative choices. In addition, in many applications, a coupling of ultracapacitors with some of these alternative solutions provide an optimized solution for the customer.

High-Voltage Capacitors

Maxwell, through its acquisition in 2002 of Montena and its CONDIS® line of high-voltage capacitor products, is the world’s largest producer of such products. Our principal competitors in the high-voltage capacitor markets are in-house production groups of certain of our customers and other independent manufacturers, such as the Coil Product Division of Trench Limited in Canada and Europe and Hochspannungsgeräte Porz GmbH in Germany. We believe that we compete favorably with respect to being a consistent supplier of highly reliable high-voltage capacitors, and with respect to our expertise in high-voltage systems. Over the last ten years, our largest customer, ABB Ltd., has gone from predominantly in-house production of grading and coupling capacitors to outsourcing 100% of their needs to us.

Radiation-Mitigated Microelectronic Products

Our radiation-mitigated power modules, memory modules and single-board computers compete with the products of traditional radiation-hardened integrated circuit suppliers such as Honeywell Corporation, Lockheed Martin Corporation and BAE Systems. We also compete with commercial suppliers with product lines that have favorable radiation tolerance characteristics, such as National Semiconductor Corporation, Analog Devices Inc. and Temic Instruments B.V. (in Europe). Our proprietary radiation-mitigation technology enables us to provide flexible, low-cost, radiation protection solutions utilizing the most advanced commercial electronic circuits and processors. In that market, we compete with high reliability packaging houses such as Austin Semiconductor, Inc., White Microelectronics, Inc. and Teledyne Microelectronics, a unit of Teledyne Technologies, Inc., for monolithic and multichip modules.

Research and Development

We maintain active research and development programs to improve existing products and to develop new products. For the year ended December 31, 2003, our research and development expenditures totaled approximately $5.9 million, compared with $8.4 million and $11.5 million in the years ended December 31, 2002 and December 31, 2001, respectively. The decrease reflects the divestiture of several business lines and the elimination of associated research and development expense.

In general, we focus our research and product development activities on:

	•	designing and producing products that perform reliably for the life of the end product into which they are integrated;

	•	making our products less expensive to produce, to enable market growth through competitive pricing;

	•	designing our products to have state-of-the-art technical performance;

	•	designing new products that provide novel solutions to expand our market opportunities; and

	•	designing our products to have small size and weight.

Most of the current research, development and engineering activity for our products is focused on material sciences, including electrically conducting and dielectric materials, ceramics and radiation-tolerant silicon and ceramic composites, to improve performance, reliability, ease of manufacture and cost. Efforts also are focused on product design for high-volume manufacturing, manufacturing engineering and manufacturing processes.

	•	The principal focus of our ultracapacitor development activities is to increase power density and power delivery and to dramatically reduce the cost of using the technology. Our ultracapacitor designs focus on low-cost, high-capacity devices in standard sizes ranging from 5-Farad to 2,600-Farad cells. We seek to penetrate cost-sensitive applications at multi-million unit volumes.

	•	The principal focus of our high-voltage capacitor development efforts is to enhance reliability and reduce the weight and size of the capacitors while improving high-voltage performance characteristics. We also are directing our design efforts to develop high-voltage capacitors for additional applications.

	•	The principal focus of our microelectronics product development activities is on circuit design, shielding and other radiation-mitigation techniques that allow the use of powerful commercial silicon components in space and satellite applications where ultra high reliability is an absolute requirement. We are also focused on the


		creation of system solutions which overcome the basic failure rate of individual components through architectural approaches, including redundancy, mitigation and correction. This involves expertise in system architecture, including algorithm and micro-code development, circuit design and the physics of radiation effects on silicon electronic components.

Intellectual Property

We are continuing to place increased emphasis on inventing proprietary technologies that significantly increase the value and uniqueness of our product portfolio, and on obtaining patents to provide the broadest possible protection for those products and related technologies. Our ultimate success will depend in part on our ability to protect existing patents, pursue patent protection and develop new technologies not protected by the patents of third parties. As of December 31, 2003, we held 42 issued patents and had more than 15 pending patent applications in the U.S. Of that total, 26 issued patents related to our ultracapacitor and microelectronics technology and products. Of these 26 patents, one expires in August 2004, and the balance expire at various times ranging from 2014 to 2024. All of the remaining 16 patents relate to purification and sterilization technology developed by PurePulse, which suspended operations in 2002. Our pending patent applications and any future patent applications may not be allowed. We routinely seek to protect our new developments and technologies through obtaining patents in the U.S. and corresponding foreign patents in the principal countries of Europe and Asia. At present, with the minor exceptions of microcode architectures within our radiation-mitigated microelectronics product line, we do not rely on licenses from any third parties to produce or commercialize our products.

The existing patent portfolios and pending patent applications covering the technologies associated with our ultracapacitor and microelectronic products relate primarily to:

	•	Ultracapacitors