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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the three month period ended September 30, 2005



OR



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



For the transition period from
 to



Commission file number 1-15477



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MAXWELL TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 95-2390133                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification No.)
|                                                              | 
|9244 Balboa Avenue San Diego, California                      |  | 92123                              
|(Address of principal executive offices)                      |  | (Zip Code)                         



(858) 503-3300

(Registrants telephone number, including area code)



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange
Act).    YES  x    NO ̈



Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act.):     YES  x    NO ̈



The number of shares of the registrants Common
Stock outstanding as of October 27, 2005 was 16,540,119 shares.



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TABLE OF CONTENTS



MAXWELL
TECHNOLOGIES, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q



For the three month period ended September 30, 2005



|                                                                                                                             |  |                     
|---------------------------------------------------------------------------------------------------------------------------- |  | --------------------
|                                                                                                                             |  | Page                
|PART I  Financial Information                                                                                               |  |                     
|                                                                                                                             | 
|Item 1  Financial Statements:                                                                                               |  | 1                   
|                                                                                                                             | 
|Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 (unaudited)                             |  | 2                   
|                                                                                                                             | 
|Condensed Consolidated Statements of Operations  Three and Nine Month Periods Ended September 30, 2005 and 2004 (unaudited) |  | 3                   
|                                                                                                                             | 
|Condensed Consolidated Statements of Cash FlowsNine Month Periods Ended September 30, 2005 and 2004 (unaudited)             |  | 4                   
|                                                                                                                             | 
|Notes to Condensed Consolidated Financial Statements                                                                         |  | 5                   
|                                                                                                                             | 
|Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 12                  
|                                                                                                                             | 
|Risk Factors                                                                                                                 |  | 22                  
|                                                                                                                             | 
|Item 3  Quantitative and Qualitative Disclosures About Market Risk                                                          |  | 30                  
|                                                                                                                             | 
|Item 4  Controls and Procedures                                                                                             |  | 30                  
|                                                                                                                             | 
|PART II  Other Information                                                                                                  |  |                     
|                                                                                                                             | 
|Item 1  Legal Proceedings                                                                                                   |  | 32                  
|                                                                                                                             | 
|Item 2  Unregistered Sales of Equity Securities and Use of Proceeds                                                         |  | 32                  
|                                                                                                                             | 
|Item 3  Defaults Upon Senior Securities                                                                                     |  | 32                  
|                                                                                                                             | 
|Item 4  Submission of Matters to a Vote of Security Holders                                                                 |  | 32                  
|                                                                                                                             | 
|Item 5  Other Information                                                                                                   |  | 32                  
|                                                                                                                             | 
|Item 6  Exhibits                                                                                                            |  | 33                  
|                                                                                                                             | 
|Signatures                                                                                                                   |  | 34                  
|                                                                                                                             | 
|Certifications                                                                                                               |  | Exhibits31.1,31.2 32



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##### Table of Contents

PART I - Financial Information



|Item 1. | Financial Statements
|------- | --------------------



The accompanying unaudited financial statements, consisting of the condensed consolidated balance sheet as of September 30, 2005, the condensed
consolidated statements of operations for the three and nine month periods ended September 30, 2005 and 2004, and the condensed consolidated statements of cash flows for the nine month periods ended September 30, 2005 and 2004, have been
prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these
unaudited condensed consolidated financial statements do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes included thereto in the Annual Report on Form 10-K of Maxwell
Technologies, Inc. and its subsidiaries (the Company). For further information, refer to the consolidated financial statements and the footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2004.



The unaudited consolidated balance
sheet as of December 31, 2004 included herein has been derived from the audited consolidated financial statements as of December 31, 2004, but does not include all of the information and footnotes included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2004.



The preparation of financial
statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. In the opinion of the Company, these unaudited statements contain all adjustments (consisting of normal
recurring adjustments) necessary to present fairly the Companys consolidated financial position as of September 30, 2005, and the consolidated results of its operations and cash flows for all periods presented.



Actual results could differ from those estimates and operating results for
the three and nine month periods ended September 30, 2005 and are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2005.



1



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##### Table of Contents

MAXWELL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)



|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                             |  | September 30,2005 |         |   | December 31,2004 |  
|Assets                                                                                                                                                                       |  |                   |         |   |                  |   |         |  
|Current assets:                                                                                                                                                              |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                    |  | $                 | 11,330  |   |                  | $ | 10,740  |  
|Investments in marketable securities                                                                                                                                         |  |                   | 474     |   |                  |   | 2,055   |  
|Trade and other accounts receivable, net                                                                                                                                     |  |                   | 7,040   |   |                  |   | 6,911   |  
|Inventories, net                                                                                                                                                             |  |                   | 9,279   |   |                  |   | 8,105   |  
|Prepaid expenses and other current assets                                                                                                                                    |  |                   | 835     |   |                  |   | 921     |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total current assets                                                                                                                                                         |  |                   | 28,958  |   |                  |   | 28,732  |  
|Property and equipment, net                                                                                                                                                  |  |                   | 10,074  |   |                  |   | 10,892  |  
|Other intangible assets, net                                                                                                                                                 |  |                   | 1,606   |   |                  |   | 1,891   |  
|Goodwill                                                                                                                                                                     |  |                   | 18,828  |   |                  |   | 21,101  |  
|Prepaid pension asset                                                                                                                                                        |  |                   | 5,259   |   |                  |   | 5,060   |  
|Other non-current assets                                                                                                                                                     |  |                   |        |   |                  |   | 50      |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|                                                                                                                                                                             |  | $                 | 64,725  |   |                  | $ | 67,726  |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Accounts payable and accrued liabilities                                                                                                                                     |  | $                 | 6,147   |   |                  | $ | 7,291   |  
|Accrued warranty                                                                                                                                                             |  |                   | 769     |   |                  |   | 701     |  
|Accrued employee compensation                                                                                                                                                |  |                   | 2,221   |   |                  |   | 1,591   |  
|Short-term borrowings and current portion of long-term debt                                                                                                                  |  |                   | 1,725   |   |                  |   | 1,970   |  
|Deferred tax liability                                                                                                                                                       |  |                   | 249     |   |                  |   | 357     |  
|Net liabilities of discontinued operations                                                                                                                                   |  |                   | 702     |   |                  |   | 1,045   |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                    |  |                   | 11,813  |   |                  |   | 12,955  |  
|Deferred tax liability                                                                                                                                                       |  |                   | 1,189   |   |                  |   | 1,167   |  
|Long-term debt, excluding current portion                                                                                                                                    |  |                   | 534     |   |                  |   | 813     |  
|Commitments and contingencies                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                                        |  |                   |         |   |                  |   |         |  
|Common stock, $0.10 par value per share, 40,000 shares authorized; 16,540 and 15,695 shares issued and outstanding at September 30, 2005
and December 31, 2004, respectively |  |                   | 1,654   |   |                  |   | 1,569   |  
|Additional paid-in capital                                                                                                                                                   |  |                   | 135,583 |   |                  |   | 126,317 |  
|Unearned compensation                                                                                                                                                        |  |                   | (2,530  | ) |                  |   |        |  
|Accumulated deficit                                                                                                                                                          |  |                   | (86,480 | ) |                  |   | (81,306 | )
|Accumulated other comprehensive income                                                                                                                                       |  |                   | 2,962   |   |                  |   | 6,211   |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                                   |  |                   | 51,189  |   |                  |   | 52,791  |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|                                                                                                                                                                             |  | $                 | 64,725  |   |                  | $ | 67,726  |  
|                                                                                                                                                                             |  |                   |         |   |                  |   |         |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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MAXWELL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)



|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                              |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                              |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004   |  
|Revenues                                                      |  | $                               | 12,024 |   |                                | $ | 6,716  |      |  | $ | 32,828 |   |  | $ | 23,725 |  
|Cost of sales                                                 |  |                                 | 8,556  |   |                                |   | 5,198  |      |  |   | 23,384 |   |  |   | 17,388 |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                                  |  |                                 | 3,468  |   |                                |   | 1,518  |      |  |   | 9,444  |   |  |   | 6,337  |  
|Operating expenses:                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Selling, general and administrative                           |  |                                 | 3,117  |   |                                |   | 2,484  |      |  |   | 9,643  |   |  |   | 7,045  |  
|Research and development                                      |  |                                 | 1,760  |   |                                |   | 1,491  |      |  |   | 5,269  |   |  |   | 4,101  |  
|Amortization of other intangibles                             |  |                                 | 19     |   |                                |   | 19     |      |  |   | 57     |   |  |   | 57     |  
|Loss on disposal of property and equipment                    |  |                                 | 42     |   |                                |   | 123    |      |  |   | 42     |   |  |   | 42     |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                      |  |                                 | 4,938  |   |                                |   | 4,117  |      |  |   | 15,011 |   |  |   | 11,245 |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from operations                                          |  |                                 | (1,470 | ) |                                |   | (2,599 | )    |  |   | (5,567 | ) |  |   | (4,908 | )
|Interest income (expense), net                                |  |                                 | 45     |   |                                |   | (11    | )    |  |   | 132    |   |  |   | 51     |  
|Other income, net                                             |  |                                 |       |   |                                |   | 93     |      |  |   | 308    |   |  |   | 37     |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations before income taxes           |  |                                 | (1,425 | ) |                                |   | (2,517 | )    |  |   | (5,127 | ) |  |   | (4,820 | )
|Income tax benefit                                            |  |                                 | (197   | ) |                                |   | (137   | )    |  |   | (8     | ) |  |   | (73    | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                               |  |                                 | (1,228 | ) |                                |   | (2,380 | )    |  |   | (5,119 | ) |  |   | (4,747 | )
|Income (loss) from discontinued operations, net of tax        |  |                                 | (107   | ) |                                |   | (34    | )    |  |   | (55    | ) |  |   | 753    |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                      |  | $                               | (1,335 | ) |                                | $ | (2,414 | )    |  | $ | (5,174 | ) |  | $ | (3,994 | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share:                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                               |  | $                               | (0.07  | ) |                                | $ | (0.17  | )    |  | $ | (0.32  | ) |  | $ | (0.33  | )
|Income (loss) from discontinued operations, net of tax        |  |                                 | (0.01  | ) |                                |   |       |      |  |   | (0.01  | ) |  |   | 0.05   |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share                                            |  | $                               | (0.08  | ) |                                | $ | (0.17  | )    |  | $ | (0.33  | ) |  | $ | (0.28  | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing basic and diluted net loss per share |  |                                 | 16,242 |   |                                |   | 14,461 |      |  |   | 15,915 |   |  |   | 14,431 |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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MAXWELL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)



|                                                                                                   |  |                                |        |   |      |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                                   |  | Nine Months EndedSeptember 30, |       
|                                                                                                   |  | 2005                           |        |   | 2004 |  
|Operating activities:                                                                              |  |                                |        |   |      |   |        |  
|Loss from continuing operations                                                                    |  | $                              | (5,119 | ) |      | $ | (4,747 | )
|Adjustments to reconcile loss from continuing operations to net cash used in operating activities: |  |                                |        |   |      |   |        |  
|Depreciation and amortization                                                                      |  |                                | 2,854  |   |      |   | 2,503  |  
|Stock based compensation                                                                           |  |                                | 81     |   |      |   |       |  
|Loss on sale of property and equipment                                                             |  |                                | 42     |   |      |   | 42     |  
|Provision for losses on accounts receivable                                                        |  |                                | 51     |   |      |   | 223    |  
|Changes in operating assets and liabilities:                                                       |  |                                |        |   |      |   |        |  
|Trade and other accounts receivable                                                                |  |                                | (680   | ) |      |   | (56    | )
|Inventories                                                                                        |  |                                | (1,616 | ) |      |   | (1,561 | )
|Prepaid expenses and other assets                                                                  |  |                                | (209   | ) |      |   | 350    |  
|Deferred income taxes                                                                              |  |                                | (71    | ) |      |   | (74    | )
|Accounts payable and accrued liabilities                                                           |  |                                | (645   | ) |      |   | (2,808 | )
|Accrued employee compensation                                                                      |  |                                | 711    |   |      |   | (220   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash used in operating activities                                                              |  |                                | (4,601 | ) |      |   | (6,348 | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Investing activities:                                                                              |  |                                |        |   |      |   |        |  
|Purchases of property and equipment                                                                |  |                                | (2,561 | ) |      |   | (2,143 | )
|Proceeds from sale of property and equipment                                                       |  |                                |       |   |      |   | 17     |  
|Redemptions of marketable securities                                                               |  |                                | 5,437  |   |      |   | 1,551  |  
|Purchases of marketable securities                                                                 |  |                                | (3,806 | ) |      |   | (881   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash used in investing activities                                                              |  |                                | (930   | ) |      |   | (1,456 | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Financing activities:                                                                              |  |                                |        |   |      |   |        |  
|Principal payments on long-term debt and short-term borrowings                                     |  |                                | (3,459 | ) |      |   | (1,241 | )
|Proceeds from long-term and short-term borrowings                                                  |  |                                | 3,274  |   |      |   | 1,921  |  
|Proceeds from issuance of Company stock                                                            |  |                                | 6,738  |   |      |   | 907    |  
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash provided by financing activities                                                          |  |                                | 6,553  |   |      |   | 1,587  |  
|                                                                                                   |  |                                |        |   |      |   |        |  
|Increase (decrease) in cash and cash equivalents from continuing operations                        |  |                                | 1,022  |   |      |   | (6,217 | )
|Net cash (used in) provided by discontinued operations                                             |  |                                | (399   | ) |      |   | 309    |  
|Effect of exchange rate changes on cash and cash equivalents                                       |  |                                | (33    | ) |      |   | (186   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Increase (decrease) in cash and cash equivalents                                                   |  |                                | 590    |   |      |   | (6,094 | )
|Cash and cash equivalents, beginning of period                                                     |  |                                | 10,740 |   |      |   | 9,784  |  
|                                                                                                   |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                           |  | $                              | 11,330 |   |      | $ | 3,690  |  
|                                                                                                   |  |                                |        |   |      |   |        |  



See accompanying notes
to unaudited condensed consolidated financial statements.



4



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##### Table of Contents

MAXWELL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note 1  Description of Business



Maxwell Technologies, Inc. is a Delaware corporation that develops, manufactures, and markets innovative, cost-effective energy storage and power delivery
solutions. Our BOOSTCAP®ultracapacitor cells and multi-cell modules and
POWERCACHE®backup power systems provide safe and reliable power solutions for
applications in consumer electronics and industrial electronics, alternate energy generation, transportation and telecommunications. Our CONDIS®high-voltage grading and coupling capacitors help to ensure the safety and reliability of electric utility infrastructure and other
applications involving transport, distribution and measurement of high-voltage electrical energy. Our radiation-mitigated microelectronic products include power modules, memory modules and single board computers that incorporate powerful commercial
silicon for superior performance and high reliability in aerospace and space applications.



References to Maxwell, the Company, we, us, and our refer to Maxwell Technologies, Inc. and its subsidiaries; references to Maxwell SA refer to
our Swiss subsidiary, Maxwell Technologies, SA, 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 subsidiary, I-Bus/Phoenix, Inc., and its subsidiaries, and references to PurePulse refer to our non-operating subsidiary, PurePulse Technologies, Inc.



Note 2  Summary of Significant Accounting Policies



Basis of Presentation



The condensed consolidated financial statements include the accounts of Maxwell Technologies, Inc. and its subsidiaries. All
significant intercompany transactions and account balances are eliminated in consolidation.



In the opinion of management of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly
the financial position, results of operations, and cash flows of Maxwell Technologies, Inc. for all periods presented. The results reported in these condensed consolidated financial statements should not be regarded as necessarily indicative of
results that may be expected for any subsequent period or for the entire year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the
Companys latest Annual Report on Form 10-K. The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (U.S. - GAAP), in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X, and accordingly do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes thereto included in the Companys
Annual Report on Form 10-K.



The Companys defense
contracting business, which was sold in March 2001, and its PurePulse business, which was discontinued in September 2002, each of which was previously reported as a separate segment, have been classified as discontinued operations in the
accompanying condensed consolidated financial statements (Note 5). Our Winding Equipment segment, which was sold in December 2003, and which was recorded as continuing operations through the first three month period of fiscal year 2004, subsequently
was reclassified as discontinued operations. As a result of the reclassification of the Winding Equipment business, the Company now operates as a single reportable segment.



The preparation of financial statements in conformity with U.S. - GAAP requires management to make estimates and assumptions
that affect reported amounts and related disclosures. Estimates have been prepared on the basis of the most current information available. These estimates relate to the collectability of accounts receivable, the usage and recoverability of
inventories and long-lived assets, the impact of loss contracts, potential warranty costs, remaining obligations for vacant leased facilities, and the valuation of deferred tax assets. We have net deferred tax assets before our valuation allowance,
which are still available for us to use in the future to offset taxable income. The markets for many of the Companys products are extremely competitive and are characterized by rapid technological change, new product development, product
obsolescence and evolving industry standards. In addition, significant price erosion may occur over the life of certain products as the number of competitors continues to increase and price competition becomes intense. As a result of these issues
and other factors, including those discussed in the section entitled Risk Factors below, actual results could differ from the estimates used by management.



5



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##### Table of Contents

Certain prior period amounts have been reclassified to conform to the current period presentation. The
Companys fiscal quarters end on the last day of the calendar month on March 31, June 30, September 30, and December 31.



Revenue Recognition



We derive substantially all of our revenue from the sale of manufactured products. Such revenue is typically recognized, according to the guidelines of
Staff Accounting Bulletin Numbers 101 and 104, when title passes to the customer at either shipment from our facilities or receipt by our customer at their facility, depending on shipping terms. This method has been consistently applied from period
to period. License revenue is recognized, when the performance requirements have been met, the fee is fixed or determinable, and collection of fees is probable. In general, we do not offer discounts and there is no right of return. We do not provide
installation services or incur-post-sale obligations other than product warranty, which is accrued for at the time of sale. We also derive revenue on a percentage of completion basis for a product development contract. Those revenues, including
estimated profits, are recognized as costs are incurred and include provisions for any anticipated losses.



Computation of Net Loss per Share



Basic loss per share is computed as net loss divided by the weighted average number of common shares outstanding for the period. Diluted loss per share is calculated on the basis of the weighted average number of
common shares outstanding plus the dilutive effect of outstanding stock options and restricted stock awards of the Company, assuming their exercise using the treasury stock method.



The following table sets forth the computation of basic and diluted loss per
share (in thousands, except per share data):



|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                      |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                      |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004   |  
|Numerator                                                             |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic:                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                                       |  | $                               | (1,228 | ) |                                | $ | (2,380 | )    |  | $ | (5,119 | ) |  | $ | (4,747 | )
|Income (loss) from discontinued operations, net of tax                |  |                                 | (107   | ) |                                |   | (34    | )    |  |   | (55    | ) |  |   | 753    |  
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                              |  | $                               | (1,335 | ) |                                | $ | (2,414 | )    |  | $ | (5,174 | ) |  | $ | (3,994 | )
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Denominator                                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic:                                                                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Weighted average shares outstanding                                   |  |                                 | 16,242 |   |                                |   | 14,461 |      |  |   | 15,915 |   |  |   | 14,431 |  
|Diluted:                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Effect of dilutive securities:                                        |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Common stock options and restricted stock awards                      |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total weighted average common and potential common shares outstanding |  |                                 | 16,242 |   |                                |   | 14,461 |      |  |   | 15,915 |   |  |   | 14,431 |  
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share:                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from continuing operations                                       |  | $                               | (0.07  | ) |                                | $ | (0.17  | )    |  | $ | (0.32  | ) |  | $ | (0.33  | )
|Income from discontinued operations, net of tax                       |  |                                 | (0.01  | ) |                                |   |       |      |  |   | (0.01  | ) |  |   | 0.05   |  
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share                                  |  | $                               | (0.08  | ) |                                | $ | (0.17  | )    |  | $ | (0.33  | ) |  | $ | (0.28  | )
|                                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  



For the three and nine
month periods ended September 30, 2005 and 2004, incremental equivalent shares under common stock options and restricted stock awards of 1,146,860 and 885,054 for 2005, and 565,373 and 855,178 for 2004, respectively, were not included in the
computation of diluted net loss per share as their impact would have been anti-dilutive.



Stock Option Plans



The
Company has adopted the disclosure only provisions of Statement No. 123 of the Financial Accounting Standards Board (FASB), Accounting for Stock-Based Compensation (Statement No. 123) as amended by Statement
of Financial Accounting Standard (SFAS) No. 148, Accounting for Stock Based Compensation  Transitions and Disclosure. In accordance with the provisions of Statement No. 123, the Company applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plans, and accordingly, no compensation expense has been recognized for stock options granted in the periods ended September 30, 2005 and 2004.
However, $81,000 of compensation



6



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##### Table of Contents

expense was recognized for restricted stock awards during the three month period ended September 30, 2005. If the Company had elected to recognize
compensation cost based on the fair value method prescribed by Statement No. 123, the Companys net loss and net loss per share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share amounts):



|                                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                            |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                                                                                                            |  | 2005                             |        |   | 2004                            |   |        | 2005 |  |   | 2004   |  
|Net loss as reported                                                                                                                        |  | $                                | (1,335 | ) |                                 | $ | (2,414 | )    |  | $ | (5,174 | ) |  | $ | (3,994 | )
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                  | (296   | ) |                                 |   | (768   | )    |  |   | (933   | ) |  |   | (2,437 | )
|                                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss                                                                                                                          |  | $                                | (1,631 | ) |                                 | $ | (3,182 | )    |  | $ | (6,117 | ) |  | $ | (6,431 | )
|                                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share:                                                                                                                         |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted-as reported                                                                                                               |  | $                                | (0.08  | ) |                                 | $ | (0.17  | )    |  | $ | (0.33  | ) |  | $ | (0.28  | )
|                                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted-pro forma                                                                                                                 |  | $                                | (0.10  | ) |                                 | $ | (0.22  | )    |  | $ | (0.38  | ) |  | $ | (0.45  | )
|                                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  



At the Annual Meeting
of Stockholders on May 5, 2005, the Board of Directors approved the 2005 Omnibus Equity Incentive Stock Plan (The Plan). The Plan has reserved 750,000 shares for issuance of stock options, restricted stock, stock appreciation
rights, performance awards, and other stock awards.



The pro
forma adjustments shown above are not indicative of future period pro forma adjustments when the calculation will reflect all applicable stock options. The fair value of Company options at the date of grant was estimated using the Black-Scholes
option-pricing model with assumptions as follows:



|                   |  |                           |   |  |                 |  |                    |   |  |                               
|------------------ |  | ------------------------- | - |  | --------------- |  | ------------------ | - |  | ------------------------------
|                   |  | Risk- Free Interest Rates |   |  | Dividend Yields |  | Volatility Factors |   |  | Weighted-Average Expected Life
|Three Months Ended |  |                           |   |  |                 |  |                    |   |  |                               
|September 30, 2005 |  | 4.3                       | % |  |                |  | 57                 | % |  | 4 years                       
|September 30, 2004 |  | 3.6                       | % |  |                |  | 56                 | % |  | 5 years                       
|Nine Months Ended  |  |                           |   |  |                 |  |                    |   |  |                               
|September 30, 2005 |  | 4.2                       | % |  |                |  | 57                 | % |  | 4 years                       
|September 30, 2004 |  | 3.4                       | % |  |                |  | 56                 | % |  | 5 years                       



Effective Date of SFAS
No. 123R



On April 15, 2005, the Securities and
Exchange Commission (SEC) issued a final rule on the effective dates for application of SFAS No. 123R, Share-Based Payment. SFAS No. 123R is effective beginning with the first interim or annual reporting period of the
Companys first fiscal year beginning on or after June 15, 2005. Presently, the Company has elected to adopt this statement effective January 1, 2006.



The impact of adoption of SFAS 123R cannot be predicted at this time because that will depend on the method of adoption
elected, the fair value and number of share-based payments granted in the future. However, had the Company adopted SFAS 123R in prior periods, the magnitude of the impact of that standard would have approximated the impact of SFAS 123 assuming the
application of the Black-Scholes model as described in the disclosure of pro forma net loss and pro forma loss per share in the notes to our consolidated financial statements. SFAS 123R also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods
after adoption.



7



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##### Table of Contents

Note 3  Balance Sheet Details



Inventories



Inventories are accounted for at the lower of cost or market on the first-in, first-out basis and consisted of the following (in thousands):



|                                 |  |                   |        |   |                   |   |        |  
|-------------------------------- |  | ----------------- | ------ | - | ----------------- | - | ------ | -
|                                 |  | September 30,2005 |        |   | December 31, 2004 |  
|Inventories:                     |  |                   |        |   |                   |   |        |  
|Raw material and purchased parts |  | $                 | 6,674  |   |                   | $ | 5,454  |  
|Work-in-process                  |  |                   | 2,156  |   |                   |   | 1,574  |  
|Finished goods                   |  |                   | 3,977  |   |                   |   | 5,104  |  
|Inventory reserve                |  |                   | (3,528 | ) |                   |   | (4,027 | )
|                                 |  |                   |        |   |                   |   |        |  
|                                 |  | $                 | 9,279  |   |                   | $ | 8,105  |  
|                                 |  |                   |        |   |                   |   |        |  



Other Intangible Assets



Other Intangible Assets consisted of the following (in
thousands):



|                          |  |                      |       |                          |   |      |                             |  |                    |     |  |   |      
|------------------------- |  | -------------------- | ----- | ------------------------ | - | ---- | --------------------------- |  | ------------------ | --- |  | - | -----
|                          |  | Gross Carrying Value |       | Accumulated Amortization |   |      | Foreign Currency Adjustment |  | Net Carrying Value
|As of September 30, 2005: |  |                      |       |                          |   |      |                             |  |                    |     |  |   |      
|Developed core technology |  | $                    | 1,100 |                          | $ | (402 | )                           |  | $                  | 147 |  | $ | 845  
|Patents                   |  |                      | 988   |                          |   | (227 | )                           |  |                    |    |  |   | 761  
|                          |  |                      |       |                          |   |      |                             |  |                    |     |  |   |      
|                          |  | $                    | 2,088 |                          | $ | (629 | )                           |  | $                  | 147 |  | $ | 1,606
|                          |  |                      |       |                          |   |      |                             |  |                    |     |  |   |      



Goodwill



The change in the carrying amount of goodwill from December 31, 2004 to
September 30, 2005 is as follows (in thousands):



|                                         |  |   |        |  
|---------------------------------------- |  | - | ------ | -
|Balance at December 31, 2004             |  | $ | 21,101 |  
|Foreign currency translation adjustments |  |   | (2,273 | )
|                                         |  |   |        |  
|Balance at September 30, 2005            |  | $ | 18,828 |  
|                                         |  |   |        |  



Warranty Reserve



We generally provide a warranty to our customers for one to two years in the
normal course of business. We accrue for the estimated warranty costs at the time of recognizing revenue. The estimated warranty liability is calculated based on historical warranty costs and the historical time frame such costs are incurred plus
any known warranty exposure.



The following table sets forth an
analysis of the warranty reserve activity for the nine month period ended September 30, 2005 and year ended December 31, 2004 (in thousands):



|                                        |  |                    |      |   |                   |   |       |  
|--------------------------------------- |  | ------------------ | ---- | - | ----------------- | - | ----- | -
|                                        |  | September 30, 2005 |      |   | December 31, 2004 |  
|Accrued Warranty:                       |  |                    |      |   |                   |   |       |  
|Beginning balance                       |  | $                  | 701  |   |                   | $ | 1,262 |  
|New product warranties                  |  |                    | 259  |   |                   |   | 489   |  
|Settlement of warranties                |  |                    | (134 | ) |                   |   | (746  | )
|Other changes/adjustments to warranties |  |                    | (57  | ) |                   |   | (304  | )
|                                        |  |                    |      |   |                   |   |       |  
|Ending balance                          |  | $                  | 769  |   |                   | $ | 701   |  
|                                        |  |                    |      |   |                   |   |       |  



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##### Table of Contents

Note 4  Comprehensive Loss



The components of other comprehensive loss are as follows (in thousands):



|                                         |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                         |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                         |  | 2005                             |        |   | 2004                            |   |        | 2005 |  |   | 2004   |  
|Net loss                                 |  | $                                | (1,335 | ) |                                 | $ | (2,414 | )    |  | $ | (5,174 | ) |  | $ | (3,994 | )
|Foreign currency translation adjustments |  |                                  | (184   | ) |                                 |   | 107    |      |  |   | (3,250 | ) |  |   | (438   | )
|Unrealized gain (loss) on securities     |  |                                  | 5      |   |                                 |   | 6      |      |  |   | 1      |   |  |   | (1     | )
|                                         |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Comprehensive Loss                       |  | $                                | (1,514 | ) |                                 | $ | (2,301 | )    |  | $ | (8,423 | ) |  | $ | (4,433 | )
|                                         |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  



Note 5  Discontinued
Operations



As part of a sale of the Companys
defense contracting business in 2001, the Company retained certain leases and lease obligations that will expire in 2006. As of September 30, 2005, net remaining lease obligations are $286,000, all of which has been reserved as it appears more
likely than not the facility will remain vacant even though the owner continues to market the property. Additional liabilities of $123,000, which are included in the $286,000 reserve, were recognized for the three month period ended
September 30, 2005.



In September 2002, the Company
suspended the operations of its PurePulse Technologies, Inc. subsidiary. PurePulse had been designing and developing systems that generate extremely intense, broad-spectrum, pulsed light to purify water and inactivate viruses and other pathogens
that contaminate vaccines and products sourced from human or animal tissues. The Company continues to preserve its intellectual property and certain other technology assets for a possible future sale of such assets.



In December 2003, the Companys Maxwell Technologies, SA subsidiary sold
all fixed assets, substantially all inventory except work in process inventory, and all warranty and employee agreement obligations of its Metar Winding Equipment business segment located in Matran, Switzerland to Metar SA, a new company whose
principal stockholder is a former CEO of Montena SA. From January to June of 2004, the new Metar company completed certain work in progress related to customer orders received by Maxwell Technologies, SA before the date of sale. The Company
concluded its continuing involvement in the Metar Winding Equipment business in the second quarter of 2004 with shipment of the final Metar product order owned by the Company. In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, the results of operations related to the Winding Equipment business, which was recorded as continuing operations through the first quarter of 2004, have been reflected as discontinued operations.



Operating results of the discontinued operations are shown separately, net of
tax, in the accompanying consolidated statements of operations. The businesses included in discontinued operations had $40,000 of royalty income in the three month period ended September 30, 2005 and no sales in the three month period ended
September 30, 2004. Royalty income and product sales for the nine month periods ended September 30, 2005 and 2004 were $40,000 and $1.0 million, respectively. These amounts are included in discontinued operations in the accompanying
consolidated statements of operations.



Note 6  Related Parties



We transact business with one company considered to be a
related party. Our Swiss subsidiary, Maxwell SA, leases its facility from Montena SA, which owns approximately 16% of the Companys stock. Mr. Jose Cortes is the CEO of Montena SA and is a member of the Maxwell Technologies, Inc. board of
directors. The amount of lease payments paid to Montena SA during the three month periods ended September 30, 2005 and 2004 were $197,000 and $194,000, respectively, and during the nine month periods ended September 30, 2005 and 2004 were
$604,000 and $586,000, respectively.



Note 7  Legal Proceedings



We have been named as a defendant in a suit filed on
March 4, 2004 in the Superior Court of the State of California for the County of San Luis Obispo. This suit, Edmonds vs. I-Bus/Phoenix, Inc., was filed by the plaintiff on his behalf and alleges damages concerning the repurchase of
I-Bus/Phoenix, Inc. shares. While the Companys legal counsel cannot express an opinion on this matter, management believes that any liability of the Company that may arise out of or with respect to this matter will not materially
adversely affect the Companys consolidated financial position, results of operations or cash flows.



9



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##### Table of Contents

Note 8  Short-Term and Long-Term Borrowings



In March 2005, we renewed our $3.0 million U.S. credit line on substantially the same terms as the prior credit line. This
line is secured by accounts receivable and assets of the Company and bears interest at the banks prime rate plus 1.75%, but subject to a minimum interest rate of 5.75%. The agreement requires us to maintain a minimum tangible net worth of
$23.2 million plus 50% of any consideration from future equity and debt transactions plus 50% of net income in each fiscal quarter after the date of the agreement. As of September 30, 2005, none of the U.S. credit line was drawn.



Maxwell SA, our Swiss subsidiary, has a 2.0 million Swiss Francs
(approximately $1.5 million as of September 30, 2005) credit agreement with a Swiss bank. Borrowings under the credit agreement bear interest at 2.52%. Borrowings under the credit agreement are unsecured. As of September 30, 2005, the full
amount of the credit line was drawn.



Maxwell SA, our Swiss
subsidiary, has a 1.0 million Swiss Francs (approximately $774,000 as of September 30, 2005) overdraft credit agreement with a Swiss bank. Borrowings under the credit agreement bear interest at 5.0%. Borrowings under the credit agreement
are unsecured. As of September 30, 2005, none of the overdraft credit line was drawn.



Maxwell SA has a term loan with a maximum draw of 1.15 million Swiss Francs (approximately $890,000 as of September 30, 2005) for financing the acquisition of specific capital equipment. An installment
payment of 230,000 Swiss Francs (approximately $184,000) was made on this term loan on June 1, 2005. Borrowings under the term loan are secured by the equipment being purchased. This credit agreement bears interest at the Swiss inter-bank
borrowing rate plus 2.0%. The term loan can be borrowed in quarterly advances up to the maximum draw and repaid over one to five years. As of September 30, 2005, the balance on this term loan was 920,000 Swiss Francs (approximately $712,000).
The interest rate on the funds borrowed at September 30, 2005 was 4.0%.



Maxwell SA requires advances from customers for certain product lines and issues bank guarantees that give the customer the right of return on their advance if the product is not delivered by a specific date. As of
September 30, 2005, there were no issued guarantees related to these product arrangements.



Note 9  Defined Benefit Plan



We have a retirement plan for our Swiss subsidiary that is classified as a defined benefit pension plan. The pension benefit is based on compensation, length of service and credited investment earnings. The plan
guarantees both a minimum rate of return as well as minimum annuity purchase rates. The Companys funding policy with respect to the pension plan is to contribute the amount required by Swiss law, using the required percentage applied to the
employees compensation. There is no offset provision based on the obligation level of the fund. In addition, the employee is required to contribute an identical amount to the pension plan. This plan has a measurement date of December 31.
Components of the net periodic benefit cost were as follows (in thousands):



|                               |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  
|------------------------------ |  | ------------------------------- | ---- | - | ------------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                               |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                               |  | 2005                            |      |   | 2004                           |   |      | 2005 |  |   | 2004 |  
|Service cost                   |  | $                               | 78   |   |                                | $ | 89   |      |  | $ | 186  |   |  | $ | 267  |  
|Interest cost                  |  |                                 | 132  |   |                                |   | 124  |      |  |   | 316  |   |  |   | 372  |  
|Expected return on plan assets |  |                                 | (327 | ) |                                |   | (236 | )    |  |   | (699 | ) |  |   | (708 | )
|Net loss/gain amortization     |  |                                 | (1   | ) |                                |   |     |      |  |   | (2   | ) |  |   |     |  
|                               |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  
|Net periodic benefit           |  | $                               | (118 | ) |                                | $ | (23  | )    |  | $ | (199 | ) |  | $ | (69  | )
|                               |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  



Employer contributions
paid during the three and nine month periods ended September 30, 2005, were $69,000 and $212,000, respectively. Employer contributions paid during the three and nine month periods ended September 30, 2004 were $304,000 and $450,000,
respectively. Additional employer contributions of approximately $77,000 are expected to be paid during the remainder of fiscal 2005.



Note 10  Contingencies



The Company is the subject of a government audit of a business sold in 2001. A contract, not assumed by the acquirers of the Companys former defense
contract business, entered into in 1990 and completed in the late 1990s is currently being



10



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##### Table of Contents

audited by the U.S. Defense Departments auditing services. The Company has submitted documentation supporting approximately $550,000 of costs
associated with local and state taxes, which were charged to the contract. The Company believes such costs were properly charged.



The Defense Departments auditing services is auditing a contract entered into in 1995 and completed in 1999 by a company purchased by our
Microelectronics Group. The Company has requested a release of liability from the prime contractor. There is no assurance such a release will be obtained or the Company will not incur some liability.



The Company enters into indemnification agreements in the ordinary course of
business in which the indemnified party is held harmless and is reimbursed for losses incurred from claims by third parties. In connection with divestitures of certain assets or businesses, the Company often provides indemnities to the buyer with
respect to certain matters including, for example, environmental liabilities and unidentified liabilities related to periods prior to the disposition. Due to the uncertain nature of the indemnities, the maximum liability cannot be quantified.
Liabilities for obligations are recorded where appropriate and when they are probable and can be reasonably estimated. Historically, the Company has not made significant payments for these obligations.



Note 11  Stock Activity



During the three and nine month periods ended September 30, 2005,
249,142 and 356,600 shares, respectively, were issued pursuant to the Companys stock purchase plan, restricted stock awards, and exercises of stock options.



In July 2005, the Company sold 488,888 shares of its common stock at $11.25 per share pursuant to a Prospectus Supplement
filed with the Securities and Exchange Commission (SEC), which represented the remaining amount available for sale on the Form S-3 registration statement filed in September 2004. The Company received proceeds of approximately $5.4
million (net of offering expenses) that the Company intends to use for working capital, purchase of equipment and general corporate purposes.



The Companys 2005 Omnibus Equity Incentive Plan (the Incentive Plan) provides for the grant of stock based awards, including incentive
stock options, non-qualified stock options, stock appreciation rights, performance awards, restricted stock, and restricted stock unit awards. A total of 750,000 shares have been reserved for issuance under the Incentive Plan, and as of
September 30, 2005, 185,000 shares had been issued for restricted stock awards to members of the board of directors and executive management. The restricted stock is subject to certain performance goals and a minimum one-year vesting period.
All unvested restricted stock is forfeited upon voluntary termination or termination for cause. The Company has made estimates regarding whether achievement of performance goals is probable or not and when it expects those goals to be achieved.
Stock compensation expense is recognized ratably from the date of the award through the estimated date of achievement using variable plan accounting. Based on the fair market value of its common stock at the end of the reporting period, the Company
recorded unearned compensation totaling $2.5 million as a component of stockholders equity, in connection with the restricted stock awards. The Company recognized compensation expense of $81,000 in the three and nine month periods ended
September 30, 2005 related to the restricted stock awards.



11



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##### Table of Contents

|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------



Unless the context otherwise requires, all references in this Quarterly Report on Form 10-Q (this Quarterly
Report) to Maxwell, the Company, we, us, and our refer to Maxwell Technologies, Inc. and its subsidiaries; all references to Maxwell SA refer to our Swiss Subsidiary,
Maxwell Technologies, SA, 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 subsidiary, I-Bus/Phoenix, Inc., and its subsidiaries; and all references to PurePulse refer to our non-operating subsidiary, PurePulse Technologies, Inc.



FORWARD-LOOKING STATEMENTS



When used in this Quarterly 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 Quarterly 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:



| |  |  | decline in the domestic and global economies that may delay the development and introduction by our customers of products that incorporate our components and systems;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increasing number of competitors and resulting price competition;
| | - |  | -----------------------------------------------------------------



| |  |  | 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, which may be restricted due to supply of materials or components, and at competitive prices
with adequate gross margins;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | market success of the products into which our products are integrated;
| | - |  | ----------------------------------------------------------------------



| |  |  | ability in growing markets to maintain or increase our market share relative to our competitors;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | ability to produce our products at quality levels demanded by our customers;
| | - |  | ----------------------------------------------------------------------------



| |  |  | ability to invent and protect proprietary technology that creates a compelling value proposition for our customers and differentiates our products from those of our competitors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ability to successfully integrate our businesses with operations of businesses we may acquire;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | ability to finance the growth of our business with internal resources or through outside financing;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | impact of currency exchange rates; and
| | - |  | --------------------------------------



| |  |  | availability of qualified staff.
| | - |  | --------------------------------



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.



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##### Table of Contents

Executive Summary



Our Managements Discussion and Analysis of Financial Condition and Results of Operations first presents an overview of our business and strategic
plan followed by a summary of the highlights from the three month period ended September 30, 2005, with a discussion of the different aspects of our business. On pages 14 to 17, we discuss our results of operations for the three and nine month
periods ended September 30, 2005 compared with the three and nine month periods ended September 30, 2004. On pages 17 and 18, we provide an analysis of changes in our balance sheet and cash flows, and discuss our capital requirements and
financing activities in the section entitled Liquidity and Capital Resources. On pages 19 to 21, we discuss our critical accounting policies, the impact of inflation on our business and new accounting pronouncements impacting the
Company. Finally, beginning on page 22, we discuss certain risks related to our business, financial condition and results of operations.



It should be noted the following discussion and the historical information included therein contain forward-looking statements that are subject to risks
and uncertainties, including estimates based on our judgment in assessing the collectability of accounts receivable, the usage and recoverability of inventories and long-lived assets, the estimation of loss contracts, the incurrence of losses on
warranty costs and vacant leased facilities and the valuation of deferred tax assets. In addition, our estimation of liquidity for fiscal year 2005 may be significantly different than our actual results. Negative changes in revenues will affect our
estimation in cost of sales, research and development, selling, general and administrative and other aspects of our business, including cash flows.



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 operates as one business segment called High Reliability, which has
two manufacturing locations (San Diego, California and Rossens, Switzerland) and 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, alternative energy creation and storage, 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 RADPAK® 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, 2004, we completed the discontinuance
of our Winding Equipment product line segment, which was sold in December 2003, with the shipment of the final product order we were obligated to fulfill. Therefore, the financial statements for the three and nine month periods ended
September 30, 2004 include the reclassification of the Winding Equipment product line segment to discontinued operations as required under FASB Statement No. 144.



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##### Table of Contents

Highlights of the Three Month Period Ended September 30, 2005



We realized sequential revenue growth of 9% over our prior quarter, which
was driven by double-digit growth in Ultracapacitor and High Voltage product lines. We reported a net loss for the three month period ended September 30, 2005 of approximately $1.3 million, or $.08 per diluted share, versus a net loss of $2.4
million, or $0.17 per diluted share, for the three month period ended September 30, 2004.



During the three and nine month periods ended September 30, 2005, we continued to focus on developing strategic alliances, introducing new products, reducing product costs, and increasing revenue. Some of these
efforts are described below:



| |  |  | In February 2005, Northrop Grumman Space Technology (NGST) selected Maxwells SCS750 single board computer for spacecraft control and payload data management for the National
Polar-orbiting Operational Environmental Satellite System (NPOESS). We began hardware deliveries during the three month period ended September 30, 2005.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2005, we received approval from the United States Advanced Battery Consortium (USABC) to commence development of a compact, low-cost, high-performance, 48-volt
ultracapacitor-based electrical energy storage module for applications in passenger vehicles.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2005, Diehl (Luftfahrt Elektronik GmbH), a leading producer of aerospace systems and controls, selected Maxwells BOOSTCAP® ultracapacitors to power emergency actuation systems for doors and evacuation slides in
passenger aircraft, including the new Airbus 380 jumbo jet.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2005, Maxwell raised approximately $5.4 million through the sale of common stock pursuant to a previously filed shelf registration statement.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2005, Maxwell announced that Orbital Sciences Corp. has selected Maxwells SCS750 single board computer (SBC) to manage payload data for NASAs Glory earth science
mission. Glory is a three year mission that will investigate the composition of greenhouse gasses and the effect of solar radiation on the earths environment.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In August 2005, Maxwell announced that its Microelectronics unit has been certified to the stringent AS9100 quality assurance standard for suppliers to the aerospace industry. This
certification was granted after an extensive audit of Maxwells Microelectronics unit verified that it meets aerospace industry-specific quality assurance standards for design, development, production, installation and servicing.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In September 2005, Maxwell announced that it has unveiled a compact, fully integrated, 48-volt multi-cell BOOSTCAP® ultracapacitor module to ease integration for heavy-duty transportation and industrial
applications.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In October 2005, Maxwell announced that its BCAP0350 D cell ultracapacitor cells and multi-cell packs and modules have successfully completed Underwriters
Laboratories (UL) recognition process, qualifying them to bear the UL Recognized Component Mark.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



Three Month Period Ended September 30, 2005 Compared with Same Period for September 30, 2004



Revenues



Revenues for the three month period ended September 30, 2005 were approximately $12.0 million compared with $6.7 million for the three month period
ended September 30, 2004. This represents an increase of $5.3 million, or 79%. The increase in revenue is primarily attributable to increases in sales of ultracapacitors (approximately $2.4 million) and high voltage capacitors and
microelectronics products (approximately $2.9 million). Increased ultracapacitor revenue was driven by demand from the windmill and public transportation markets. High voltage demand was driven by customers and markets in China. Microelectronics
revenue increases were primarily attributable to the NPOESS contract awarded in the first quarter of 2005.



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##### Table of Contents

Gross Profit



For the three month periods ended September 30, 2005 and 2004, gross profit was approximately $3.5 million and $1.5 million, which represented 29%
and 23% of revenue, respectively. Gross profit was favorably impacted by increased revenue for all three product lines as fixed manufacturing costs were spread over more units, increased focus on core product lines and improved manufacturing
efficiencies.



Operating Expenses



Total Operating Expenses



Total operating expenses were approximately $4.9 million for the three month
period ended September 30, 2005, compared with approximately $4.1 million for the same period in 2004. Operating expenses, as a percentage of revenue, for the three month periods ended September 30, 2005 and 2004 were 41% and 61%,
respectively. The increase in operating expenses is explained in the selling, general and administrative and research and development sections below.



Selling, General & Administrative (SG&A) Expense



Selling, general and administrative (SG&A) expense as a percentage of revenues decreased to 26% for the three month period ended September 30,
2005 from 37% for the three month period ended September 30, 2004 as a result of increased revenues. SG&A increased $633,000 for the three month period ended September 30, 2005 compared with the three month period ended
September 30, 2004. The increase was primarily related to audit and SOX fees, additional accounting staff in both locations, and the reinstatement in 2005 of a 30% voluntary reduction in 2004 executive pay. Additionally, the Company recognized
compensation expense of $81,000 in the three month period ended September 30, 2005 related to restricted stock awards.



Research & Development (R&D) Expense



As a percentage of revenue, R&D expense was 15% for the three month period ended September 30, 2005 compared with 22% for the same period in
2004, as a result of the increase in revenues. The increase of $269,000 in the R&D expense in 2005 as compared to 2004 relates primarily to increased costs associated with additional staff and expenses to support our unreimbursable efforts
associated with the USABC project.



Loss from Continuing Operations before
Income Taxes



The loss from continuing operations before
income taxes decreased to approximately $1.4 million, or 12% of revenues for the three month period ended September 30, 2005 compared with $2.5 million, or 37% of revenues for the same period in 2004. The reduced loss was primarily related to
the increases in revenue and gross profit margin, as discussed above.



Provision for Income Taxes



We recorded an
income tax benefit of $197,000 for the three month period ended September 30, 2005 compared with an income tax benefit of $137,000 for the same period in 2004. The income tax benefit recorded in the three month period ended September 30,
2005 related to the extension of a temporary (five year) reduction in the federal tax rate at our Swiss subsidiary.



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 on distribution to the United States because it is not anticipated such earnings will be remitted to the United States. If remitted, the additional United States taxes paid would not be material.



Nine Month Period Ended September 30, 2005 Compared to Same Period for
September 30, 2004



Revenues



Revenues for the nine month period ended September 30, 2005 were $32.8
million compared with $23.7 million for the same period in 2004. This represents an increase of $9.1 million, or 38%. The increase in revenue is attributable to increases in sales of ultracapacitors of approximately $4.5 million, high voltage
capacitors and microelectronics products of approximately $5.6 million partially offset by a reduction in Power Systems Products of $1.0 million. The revenue for the



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##### Table of Contents

nine month period ended September 30, 2004 included the final $1.0 million in license fees from YEC in exchange for the right to manufacture our
BOOSTCAP® ultracapacitors in China.



Included in the nine month period ended September 30, 2005 was
approximately $2.9 million of revenue from two contracts recently awarded to us. One is a development program from USABC, for an advanced ultracapacitor automotive module and the other is a fixed fee contract for the development and delivery of
space computer hardware where revenue is being recognized under the percentage of completion method of accounting.



Gross Profit



For the nine month period ended September 30, 2005 gross profit was approximately $9.4 million, or 29% of revenue, compared with $6.3 million, or 27%
of revenue, for the nine month period ended September 30, 2004. The improvement in gross profit is partially offset by reserves of approximately $618,000 and $940,000 in the nine month period ended September 30, 2005 and 2004,
respectively, for ultracapacitor orders received that were priced below our current product cost. Additionally, we recorded a reserve of approximately $450,000 in the third quarter of 2004 against our excess small-cell BOOSTCAP® inventories. The improvement in gross profit margin is
primarily attributable to increases in sales and ultracapacitor manufacturing efficiencies for the nine month period ended September 30, 2005.



Operating Expenses



Total Operating Expenses



Total operating expenses were approximately $15.0 million for the nine month period ended September 30, 2005, compared with approximately $11.2 million for the same period in 2004. Operating expenses for the nine month period ended
September 30, 2005 were approximately 46% of revenue compared with 47% of revenue for the same period in 2004. The increase in operating expenses is explained in the selling, general and administrative and research and development sections
below.



Selling, General & Administrative (SG&A) Expense



Selling, general and administrative (SG&A) expenses
as a percentage of revenues were 29% for the nine month period ended September 30, 2005 compared with 30% for the same period in 2004. SG&A increased $2.6 million for the nine month period ended September 30, 2005 compared with the
nine month period ended September 30, 2004. This increase was primarily related to audit and SOX fees, additional accounting staff in both locations, and the reinstatement in 2005 of a 30% voluntary reduction in 2004 executive pay.
Additionally, the Company recognized compensation expense of $81,000 in the nine month period ended September 30, 2005 related to restricted stock awards.



Research & Development (R&D) Expense



Research and development (R&D) expenses as a percentage of revenue were 16% for the nine month period ended September 30, 2005 compared with 17%
for the same period in 2004. The $1.2 million increase in R&D expenses was related primarily to engineering development costs, software license and process costs, and increased staff to support the unreimbursable efforts associated with the
USABC project.



Loss from Continuing Operations before Income Taxes



The loss from continuing operations before income taxes
increased to $5.1 million, or 16% of revenue for the nine month period ended September 30, 2005, compared with $4.8 million, or 20% of revenue for the same period in 2004. The increase was primarily related to the increase in operating expenses
as discussed above.



Provision for Income Taxes



We recorded an income tax benefit of $8,000 for the nine month period ended
September 30, 2005 compared with an income tax benefit of $73,000 for the same period ended September 30, 2004. The income tax benefit for the nine month period ended September 30, 2005 primarily related to the extension of a
temporary (five year) reduction in the federal tax rate at our Swiss subsidiary, which required us to adjust our deferred tax liabilities. The reduction in deferred tax liabilities (approximately $204,000) was offset with tax liabilities generated
from profitable Swiss operations (approximately $196,000). The Companys tax rates have been adjusted to reflect the extension of the temporary reduction in the Swiss federal tax rate, which was renewed in September 2005. The provision for
income taxes based on our Swiss subsidiarys income cannot be offset by the Companys consolidated loss from continuing operations.



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##### Table of Contents

Unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements
without giving effect to the United States Federal taxes that may be payable on distribution to the United States because it is not anticipated such earnings will be remitted to the United States. If remitted, the additional United States Federal
taxes paid would not be material.



Discontinued Operations



In December 2003, Maxwell SA (our Swiss subsidiary formerly known as
Montena Components Ltd.) sold all of the fixed assets, substantially all inventory, and all warranty and employee agreement obligations of its Winding Equipment business, located in Matran, Switzerland, to Metar SA, a new company formed by the
former CEO of Montena Components Ltd and a Metar SA employee. The business was sold for $324,000, and we recognized a loss on disposal, net of tax, of $529,000. The new Metar company completed, during January through June 2004, certain work in
progress related to customer orders received by Maxwell SA before the date of sale. We concluded our continuing involvement in the Winding Equipment business in the second quarter of 2004 with the shipment of the final Metar product order we were
obligated to fulfill. The results of operations related to the Winding Equipment business which was reported as continuing operations through the nine month period ended September 30, 2004 (sales of $1.0 million and cost of sales of $205,000)
have been reclassified as discontinued operations.



The
businesses included in discontinued operations had $40,000 of royalty income in the three month period ended September 30, 2005 and no sales in the three month period ended September 30, 2004. Royalty income and product sales for the nine
month periods ended September 30, 2005 and 2004 were $40,000 and $1.0 million, respectively. These amounts are included in discontinued operations in the accompanying consolidated statements of operations.



In March 2001, we sold our Government Systems business for $20.7 million and
recorded a gain of $1.1 million, net of a $2.7 million provision mainly related to ongoing lease obligations. As of September 30, 2005 the remaining lease obligation, which expires in April 2006, was $286,000 which was fully reserved. An
additional $123,000 reserve, included in the $286,000 reserve balance, was recognized during the three month period ended September 30, 2005. As of December 31, 2004 the remaining lease obligation was $650,000 with a reserve of $608,000.



Liquidity and Capital Resources



Changes in Cash Flow



During the nine month period ended September 30, 2005, we used $4.6 million of cash in operating activities, compared
with $6.3 million during the same period in 2004. The reduction in the cash used in operating activities for the nine month period ended September 30, 2005 compared with the same period of the prior year is a result of an increase in
liabilities due to deferred revenue for a product development contract and higher revenue volume, offset in part by an increase in the loss from continuing operations of approximately $372,000.



Accounts payable and other accrued liabilities were approximately $6.1
million at September 30, 2005 compared with approximately $7.3 million at December 31, 2004. The decrease is due to lower accrued liabilities for audit and SOX related expenses as well as lower reserves for loss contracts received in 2004
and shipped in 2005.



Investments in marketable securities
decreased to approximately $474,000 at September 30, 2005 from approximately $2.1 million at December 31, 2004 as a result of net redemptions of approximately $1.6 million.



The Company purchased approximately $2.6 million and $2.1 million of property and equipment during the nine month periods
ended September 30, 2005 and 2004, respectively.



In July
2005, the Company sold 488,888 shares of its common stock at $11.25 per share pursuant to a Prospectus Supplement filed with the Securities and Exchange Commission (SEC), which represented the remaining amount available for sale on the
Form S-3 registration statement filed in September 2004. The Company received proceeds of approximately $5.4 million (net of offering expenses) that the Company intends to use for working capital, purchase of equipment and general corporate
purposes.



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##### Table of Contents

Liquidity



In March 2005, we renewed our $3.0 million line of credit from a U.S. bank that is available for working capital needs; the line has not been used to
date. We also have a line of credit for 2.0 million Swiss Francs (approximately $1.5 million at September 30, 2005) from a Swiss bank for working capital in Switzerland, which was renewed in August 2005. The line was fully used as of
September 30, 2005. We also have a 920,000 Swiss Francs (approximately $712,000 as of September 30, 2005) term loan from a Swiss bank for capital equipment purchases as of September 30, 2005. We have an agreement with another Swiss
bank, which allows us to maintain negative bank account balances up to 1.0 million Swiss Francs (approximately $774,000 as of September 30, 2005). We did not maintain any negative bank account balances as of September 30, 2005.



We raised approximately $10.1 million, net of offering
expenses, in November 2004 from the sale of shares of common stock that were registered pursuant to the shelf registration statement on Form S-3 filed in September 2004. We raised an additional $5.4 million, net of offering expenses, in July 2005
from the sale of shares of common stock, which represented the remaining amount available for sale on the Form S-3 registration statement.



We believe the liquidity provided by the existing cash and cash equivalents and investments in marketable securities, borrowings available under our lines
of credit and cash recently raised by the sales of shares of common stock on Form S-3, will provide sufficient capital to fund our capital equipment and working capital requirements and potential operating losses for the next 12 months. However, we
may raise additional capital through the issuance of equity, debt or other sources for equipment purchases or general corporate uses in the event business needs or circumstances and market conditions warrant it.



Short-term and Long-term Borrowings



Short-term Borrowings



Maxwell SA, our Swiss subsidiary, has a 2.0 million Swiss Francs
(approximately $1.5 million as of September 30, 2005) credit agreement with a Swiss bank, which was renewed in August 2005. Borrowings under the credit agreement bear interest at 2.52%. Borrowings under the credit agreement are unsecured. As of
September 30, 2005, the full amount of the credit line was drawn.



We have an agreement with another Swiss bank, which allows us to maintain negative bank account balances up to 1.0 million Swiss Francs (approximately $774,000 as of September 30, 2005). We did not maintain any negative bank
account balances as of September 30, 2005.



Maxwell SA
requires advances from customers for certain product lines and issues bank guarantees that give the customer the right of return on their advance if the product is not delivered by a specific date. As of September 30, 2005, we had issued no
guarantees related to these product arrangements.



In March
2005, we renewed our $3.0 million U.S. credit line on substantially the same terms as the prior credit line. This line is secured by accounts receivable and assets of the Company and bears interest at the banks prime rate plus 1.75%, but
subject to a minimum interest rate of 5.75%. The agreement requires us to maintain a minimum tangible net worth of $23.2 million plus 50% of any consideration from future equity and debt transactions plus 50% of net income in each fiscal quarter
after the date of the agreement. As of September 30, 2005, none of the U.S. credit line was drawn.



Long-term Borrowings



Maxwell SA has a term loan with a maximum draw of 1.15 million Swiss Francs (approximately $890,000, as of September 30, 2005) for financing the
acquisition of specific capital equipment. An installment payment of 230,000 Swiss Francs (approximately $184,000 as of September 30, 2005) was made on this term loan on June 1, 2005. Borrowings under the term loan are secured by the
equipment being purchased. This credit agreement bears interest at the Swiss inter-bank borrowing rate plus 2.0%. The term loan has been drawn to the maximum amount and is being repaid in annual installments over five years. As of September 30,
2005 the balance on this term loan is 920,000 Swiss Francs (approximately $712,000). The interest rate on the funds borrowed at September 30, 2005 was 4.0%.



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##### Table of Contents

Contractual Obligations



The following table identifies significant contractual obligations outstanding as of September 30, 2005 (in thousands):



|                                |  |                       |        |                  |   |           |  |           |       |                   |   |   |  |   |  
|------------------------------- |  | --------------------- | ------ | ---------------- | - | --------- |  | --------- | ----- | ----------------- | - | - |  | - | -
|                                |  | Payment due by period
|                                |  | Total                 |        | Less than 1 Year |   | 1-3 Years |  | 3-5 Years |       | More than 5 Years
|Operating lease obligations (1) |  | $                     | 4,284  |                  | $ | 1,534     |  | $         | 2,750 |                   | $ |  |  | $ | 
|Purchase commitments (2)        |  |                       | 9,263  |                  |   | 9,125     |  |           | 138   |                   |   |  |  |   | 
|Debt obligations (3)            |  |                       | 2,259  |                  |   | 1,725     |  |           | 534   |                   |   |  |  |   | 
|                                |  |                       |        |                  |   |           |  |           |       |                   |   |   |  |   |  
|Total                           |  | $                     | 15,806 |                  | $ | 12,384    |  | $         | 3,422 |                   | $ |  |  | $ | 
|                                |  |                       |        |                  |   |           |  |           |       |                   |   |   |  |   |  

---

|(1) | Operating lease obligations represent building leases for U.S. and Switzerland locations as well as vehicle leases for management personnel at our Switzerland facility.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Purchase commitments primarily represent the value of non-cancelable purchase orders and an estimate of purchase orders that if cancelled would result in a significant penalty to
the Company.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Debt obligations represent long-term and short-term borrowings and current portion of long-term debt.
|--- | -----------------------------------------------------------------------------------------------------



Off-Balance Sheet Arrangements



As of September 30, 2005, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.



Critical Accounting Policies



This discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America, which we refer to as U.S.-GAAP. We have used certain assumptions and
judgments in the preparation of these financial statements, which assumptions and estimates may potentially affect the reported amounts of assets and liabilities and the disclosure of contingencies as well as reported amounts of revenues and
expenses. The following may involve a higher degree of judgment and complexity and, as such, management assumptions and conclusions in these areas may significantly impact the results of operations of the Company.



Revenue Recognition



We derive substantially all of our revenue from the sale of manufactured products. Such revenue is typically recognized,
according to the guidelines of Staff Accounting Bulletin Numbers 101 and 104, when title passes to the customer at either shipment from our facilities or receipt by our customer at their facility, depending on shipping terms. This method has been
consistently applied from period to period. License fee revenue is recognized when the performance requirements have been met, the fee is fixed or determinable, and collection of fees is probable. In general, we do not offer discounts and there is
no right of return. We do not provide installation services or incur-post-sale obligations other than product warranty, which is accrued for at the time of recognizing the revenue. We also derive revenue on a percentage of completion basis for a
product development contract. Those revenues, including estimated profits, are recognized as costs are incurred and include provisions for any anticipated losses.



Production Costs



In anticipation of an increase in production capacity, expected efficiencies from economies of scale, and a new production line expected to reduce future
costs, we have accepted ultracapacitor orders that were priced below our production costs. These orders have shipped at various times throughout the nine months ended September 30, 2005. We have reduced our production costs in the third quarter
of 2005 to the point where our production costs are lower than the current selling price. We will be installing a new ultracapacitor production line in our facility located in Rossens, Switzerland. The new production line will create production
efficiencies, thereby reducing production costs even further. Production efficiencies will be gained as each process of the line is implemented and as production volume increases. Actual production costs during the remainder of 2005 may differ from
our estimates of these efficiencies and/or production volumes and could result in an adverse impact on our results of operations and the recording of additional losses.



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Accounts Receivable



We establish and maintain customer credit limits based on references, financial information, credit-worthiness and payment history. Accounts receivable
consist primarily of amounts due to us from our normal business activities. We maintain an allowance for doubtful accounts to reflect anticipated bad debts based on past collection history and any specific risks identified in the portfolio. We
determine our bad debt reserve based on an analysis we make to measure our reserve requirements and we establish specific reserves when we recognize the inability of our customer to pay its obligation. If we become aware of increasing negative
changes in the financial condition of our customers, or if economic conditions change adversely, we may have to increase the allowance. A significant increase in such allowances could adversely impact our financial condition and results of
operations.



Remaining Lease Obligation from Discontinued Operations



We have provided an estimate of the liability of
Government Systems business associated with a remaining lease obligation, which has been recorded in discontinued operations. In making this estimate, we considered factors such as the commercial real estate market, including our estimate as to how
and when we will be able to sub-lease, terminate or buy out the remaining lease obligation. We expect that our estimated liability will be sufficient to conclude this lease obligation.



Excess and Obsolete Inventory



We value inventories at the lower of cost or market on the first-in, first-out basis. In assessing the ultimate realization of inventories, we make
judgments as to future demand requirements and compare that with current and committed inventory levels. The markets for the Companys products are extremely competitive and are characterized by rapid technological change, new product
development, product obsolescence and evolving industry standards. In addition, price competition is intense and significant price erosion generally occurs over the life of a product. We have recorded significant charges for reserves in recent
periods to reflect changes in market conditions. We believe that future events are subject to change and revisions in estimates may have a significant adverse impact on our balance sheet and statement of operations.



Warranty



We generally provide a warranty to our customers for one to two years in the normal course of business. We accrue for the
estimated warranty at the time of recognizing revenue based on historical warranty costs and the historical time frame such costs are paid plus any known warranty exposure. We have limited historical experience with some of our products in
evaluating the potential liability that could be created by claims under our warranty. If the claims made under such warranty exceed expected levels against which we have reserved, our results of operations and financial condition could be
materially adversely affected. Further, warranty periods in other parts of the world are subject to local laws, which may impact our future reserves.



Long-Lived Assets and Other Intangible Assets



Long-lived assets such as property and equipment and other intangible assets are reviewed for impairment whenever events and changes in business
circumstances indicate that the carrying value of the long-lived asset may not be recoverable in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. The most significant assumptions in the analysis
of impairment involve estimates of future undiscounted cash flows. We use cash flow assumptions consistent with our business plans and consider other relevant information. If we determine the carrying value of the long-lived asset may not be
recoverable, a permanent impairment charge is recorded for the amount by which the carrying value of the long-lived assets exceeds its fair market value. If there are changes in business circumstances or in the key assumptions used in estimating
undiscounted cash flows, we may be required to recognize an impairment charge to reduce the carrying value of our long-lived assets.



Goodwill



We account for goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. This standard requires that goodwill no longer
be amortized but be subject to an annual impairment test and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. The first step consists of estimating the fair value of each reporting unit
and comparing those estimated fair values with the carrying values of the reporting unit, which includes the allocated goodwill. If the fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by
determining an implied fair value of goodwill. The implied fair value of goodwill is the residual fair value derived by deducting the fair value of a reporting units assets and liabilities from its estimated fair value,



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which was calculated in step one. The impairment charge represents the excess of the carrying amount of the reporting units goodwill over the implied
fair value of their goodwill.



In assessing the implied fair
value of goodwill, we have made assumptions regarding estimates of future cash flows and other operating factors. The most significant assumptions in the analysis of impairment involve estimates of revenue and expense forecasts of the reporting
unit. If there are changes in business circumstances in the key assumptions used in estimating the fair value of the reporting unit, we may be required to recognize an impairment charge to reduce the carrying value of our goodwill. We cannot state
with certainty that we may not incur charges for impairment of goodwill in the future if the fair value of the Company were to decrease due to market conditions or other unanticipated circumstances. Any additional impairment charges may adversely
affect our results of operations.



Valuation Allowance for Deferred Tax
Assets



A valuation allowance is provided for deferred tax
assets if it is more likely than not that these items will either expire before we are able to realize their benefit, or that future deductibility is uncertain. In general, companies that have had a recent history of operating losses are faced with
a difficult burden of proof as to their ability to generate sufficient future income in order to realize the benefit of the deferred tax assets. We determined it was appropriate to record a valuation allowance as of September 30, 2005 and
December 31, 2004 against our deferred tax assets because at this time it is more likely than not that we will not be able to use these benefits based on the recent history of losses. The deferred tax assets are still available for us to use in
the future to offset taxes on taxable income, which would result in the recognition of a tax benefit and a reduction to our effective tax rate.



Impact of Inflation



We believe inflation has not had a material impact on our results of operations for the three month periods ended September 30, 2005 and 2004.
However, there can be no assurance that future inflation would not have an adverse impact on our operating results and financial condition.



New Accounting Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS
123R, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, or SFAS 123. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements
based on their fair values and does not allow the previously permitted pro forma disclosure as an alternative to financial statement recognition. SFAS 123R supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, or APB 25, and related interpretations and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R is scheduled to be effective beginning in the first quarter of fiscal 2006. SFAS 123R allows for either prospective
recognition of compensation expense or retroactive recognition, which may date back to the original issuance of SFAS 123 or only to interim periods in the year of adoption. The Company is currently evaluating these transition methods.



The impact of adoption of SFAS 123R cannot be predicted at this time because
that will depend on the method of adoption elected, the fair value and number of share-based payments granted in the future. However, had the Company adopted SFAS 123R in prior periods, the magnitude of the impact of that standard would have
approximated the impact of SFAS 123 assuming the application of the Black-Scholes model as described in the disclosure of pro forma net loss and pro forma loss per share in the notes to our consolidated financial statements. SFAS 123R also requires
the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption.



In May of 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections.This new standard replaces APB Opinion No. 20, Accounting Changes, and SFAS Statement No. 3, Reporting Accounting
Changes in Interim Financial Statements. Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior periods financial statements presented under the new accounting
principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived non-financial
asset be accounted for as a change in estimate (i.e. prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a restatement. This
new standard is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. In accordance with the effective date of SFAS No.154, the Company plans to adopt this new standard at the
beginning of the Companys fiscal year in 2006.



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Risk Factors



An investment in
our common stock involves a high degree of risk. Our business, financial condition and results of operations could be seriously harmed if potentially adverse developments, some of which are described below, materialize and cannot be resolved
successfully. In any such case, the market price of our common stock could decline and you may lose all or part of your investment in our common stock.



The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties, including those not presently known to
us or that we currently deem immaterial, may also result in decreased revenues, increased expenses or other adverse impacts that could result in a decline in the price of our common stock. You should also refer to the other information set forth in
this Quarterly Report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, including our financial statements and the related notes.



We have a history of losses and we may not achieve or maintain profitability in the future, which may decrease the market value of our
common stock.



We have incurred net losses in our last six
fiscal years. We cannot assure you that we will become profitable in the foreseeable future, if ever. Even if we do achieve profitability, we may experience significant fluctuations in our revenues and we may incur net losses from period to period
as a result of a number of factors, including but not limited to the following:



| |  |  | the amounts invested in developing, manufacturing and marketing our products in any period as compared with the volume of sales of those products in the same period;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increasing number of competitors and resulting price competition;
| | - |  | -----------------------------------------------------------------



| |  |  | fluctuations in demand for our products by our OEM customers;
| | - |  | -------------------------------------------------------------



| |  |  | the prices at which we sell our products and services as compared with the prices of our competitors and our product costs;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing of our product introductions may lag behind those of our competitors;
| | - |  | --------------------------------------------------------------------------------



| |  |  | inability to manufacture our products at a cost level that supports adequate gross margins; and
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | any negative impacts resulting from acquisitions we have made or may make.
| | - |  | --------------------------------------------------------------------------



In addition, we incur significant costs developing and marketing products based on new technologies and, in order to increase our market share, we have
and may sell our products at profit margins below those we ultimately expect to achieve and/or we may significantly reduce the prices of our products and services in a particular quarter or quarters. Presently, we have made a strategic decision to
accept certain orders to sell products to a limited number of customers at prices below our manufacturing costs. The impact of the foregoing may cause our operating results to be below the expectations of public market analysts and investors, which
may result in a decrease in the market value of our common stock.



A
significant portion of our revenues are dependent on a small number of customers.



We expect that a small number of customers will continue to represent a large portion of our revenues for the foreseeable future. As a result, if our relationship with any of our customers were disrupted, we would
lose a significant portion of our anticipated net revenues. Factors that could influence our relationships with our customers include:



| |  |  | our ability to maintain our products at prices that are competitive with those of other competitive suppliers;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | our ability to maintain features and quality standards for our products sufficient to meet the expectations of our customers; and
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| |  |  | our ability to produce, ship and deliver a sufficient quantity of our products in a timely manner to meet the needs of our customers.
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Our large cell ultracapacitors designed for transportation and industrial applications may not gain widespread
commercial acceptance, which will adversely impact our revenues and growth opportunities, and our overall business prospects.



We have designed our large cell ultracapacitor products primarily for use in transportation and industrial applications. Currently, most of the major
automotive companies are pursuing initiatives to develop alternative power sources for cars and trucks for hybrid drive train power and to augment the current 12-volt electrical system. We believe our ultracapacitors provide an innovative
alternative power solution for both of these applications, and we are currently in discussions with several major automotive companies and their suppliers with regard to designing our ultracapacitors into their future products. However, the historic
per unit cost of ultracapacitors has prevented ultracapacitors from gaining widespread commercial acceptance. In addition, there are other competing technologies such as advanced batteries, compressed gas and hydrolytic fluids and competing
ultracapacitors. We believe that the long-term success of our ultracapacitors will be determined by our ability to reduce the cost of production, outperform the competing technologies and to have our ultracapacitors widely designed into the next
generation of the power drive trains in hybrid powered cars and trucks and the first generation of up rated 12 and 42-volt electrical systems. If our ultracapacitors fail to achieve widespread commercial acceptance in this next generation of
automotive products, our revenues and growth opportunities will be adversely impacted in future periods and our overall business prospects will be significantly impaired.



We may be unable to produce our large cell ultracapacitors in commercial quantities or reduce the cost of production enough to be
commercially viable for widespread application, which will adversely impact our revenues and growth opportunities, and our overall business prospects.



If we are not able to produce large quantities of our large cell ultracapacitors in the near future at a significantly lower per unit cost, our large cell
ultracapacitors may not be a commercially viable alternative to traditional or other alternative energy storage and power delivery devices. Although we have been selling a BOOSTCAP®large cell ultracapacitor designed for transportation and industrial applications, we have only produced this ultracapacitor in
limited quantities and at a relatively high cost as compared with traditional energy storage and power delivery devices. We are currently investing significant resources in improving the cell design for higher performance at lower cost and in
automating and scaling up our manufacturing capacity to permit us to produce ultracapacitors in commercial quantities sufficient to meet the needs of our potential customers. Furthermore, we believe, based on discussions with potential customers in
the automotive and transportation industry, that our ultracapacitors will not provide a commercially viable solution for our customers needs unless we are able to reduce the per unit cost dramatically below our current per unit cost. If we are
not successful in the near future in reducing our cost of production and establishing the capability to produce large quantities of ultracapacitors at a reduced cost, we may not be able to generate commercial acceptance of, and sufficient revenue
from, this product to recover our significant investment in the development and manufacturing scale-up of this product and our overall business prospects will be significantly impaired.



It may also be difficult for us to solve management, technological, engineering and other problems, which may arise in
connection with our manufacturing processes. These problems may include production volumes and yields, quality assurance, adequate and timely supply of high quality materials and components and shortages of qualified management and other personnel.
In addition, we may elect to have some of our products manufactured by third parties. If we outsource the manufacture of our products, we will face risks with respect to quality assurance, cost and the absence of close engineering support.



We may not be able to develop and market our products successfully, and
thus may not be able to achieve or maintain profitability in the future.



Historically, we relied in part upon government contracts relating to our defense contracting business to fund our research and development, and we have derived a significant portion of our revenues from the
government sector. In March 2001, we sold our defense contracting business and we now generate the majority of our revenue from developing, manufacturing and marketing commercial products, many of which have been developed since 2000. If we are
unable to continue to develop or to market our products successfully, we may not achieve or maintain profitability in the future.



In recent years, we have introduced many of our products into commercial markets and, upon such introductions, we also must demonstrate our capabilities
as a reliable supplier of these products. Some of our products are alternatives to established products or provide capabilities that do not presently exist in the marketplace. Our products are sold in highly competitive and rapidly changing markets.
The success of our products is significantly affected by their cost, technology standards, performance and reliability and end-user preferences. In addition, the success of our products depends on a number of factors, including our ability to:



| |  |  | hire and maintain an engineering and marketing staff sufficiently skilled to identify and design new products;
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| |  |  | identify and develop attractive markets for our new products and technologies and accurately anticipate demand;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | develop appropriate commercial sales and distribution channels;
| | - |  | ---------------------------------------------------------------



| |  |  | develop and manufacture new products that we can sell at competitive prices, with adequate margins;
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| |  |  | deliver products that meet our customers requirements for quality and reliability;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | increase our manufacturing capacity and improve manufacturing efficiency to meet our customer demands while maintaining quality;
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| |  |  | successfully respond to technological changes by improving our existing products and technologies;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | demonstrate that our products have technological and/or economic advantages over the products of our competitors;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | successfully respond to competitors that are more experienced, have significantly greater resources and have a larger base of customers; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | secure the raw materials required at the prices necessary to manufacture and deliver competitive products.
| | - |  | ----------------------------------------------------------------------------------------------------------



We may not be able to obtain sufficient capital to meet potential customer demand or
corporate needs, which could require us to change our business strategy and result in decreased profitability and a loss of customers.



We believe that in the future we will need a substantial amount of additional capital for a number of purposes, including the following:



| |  |  | to meet potential volume production requirements for several of our product lines, in particular our ultracapacitors, which require high-speed automated production lines to achieve
targeted customer volume and price requirements;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | to expand our manufacturing capabilities and develop viable out-source partners and other production alternatives;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | to fund our continuing expansion into commercial markets and compete effectively in those markets;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | to develop new technology and cost effective solutions in our business; and
| | - |  | ---------------------------------------------------------------------------



| |  |  | to acquire new or complementary businesses, product lines and technologies.
| | - |  | ---------------------------------------------------------------------------



In July 2005, we raised approximately $5.4 million (net of offering expenses) through the sale of our common stock pursuant to a shelf registration
statement on Form S-3; however there can be no assurance that any necessary additional financing will be available to us on acceptable terms or at all. If adequate funds are not available when needed, we may be required to change or delay our
planned growth, which could result in decreased revenues, profits and a loss of customers. The issuance of additional shares will result in dilution of our current stockholders. Further, if additional financing is accomplished by the issuance of
debt, the service cost, or interest, will reduce net income or increase net losses and may also require the issuance of warrants to purchase shares of common stock.



If we are unable to secure qualified and adequate sources for our materials, components and sub-assemblies, we may not be able to make
our products at competitive costs and we may have difficulty meeting customer demand, which could damage our relationships with our customers.



Our ability to manufacture products depends in part on our ability to secure qualified and adequate sources of materials, components and sub-assemblies at
prices that enable us to make our products at competitive costs. Some of our suppliers are currently the sole source of one or more items that we need to manufacture our products. Although we seek to reduce our dependence on sole and limited source
suppliers, the partial or complete loss of these sources could have at least a temporary adverse effect on our business and results of operations, and damage customer relationships. Upon occasion, we



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have experienced difficulty in obtaining timely delivery of supplies from outside suppliers, which has adversely affected our delivery time to our customers.
There can be no assurance that such supply problems will not recur.



Our
product lines may be subject to increased or intense competition, and this may adversely affect our ability to maintain our gross margins. If our competitors develop and commercialize products faster than we do, or commercialize products that are
superior to our products, our commercial opportunities will be reduced or eliminated.



The extent to which any of our products achieve market acceptance will depend on competitive factors, many of which are beyond our control. Competition in our markets is intense and has been accentuated by the rapid
pace of technological development. Our competitors include large fully-integrated electronics companies. We may not be able to develop, fund or invest in one or more of our product lines to the same degree as our competitors do, or we may not be
able to do so in a timely manner or at all. Many of these entities have substantially greater research and development capabilities and financial, manufacturing, technological, marketing and sales resources than we do, as well as more experience in
research and development, product testing, manufacturing, marketing and sales. These organizations also compete with us to:



| |  |  | attract parties for collaborations or joint ventures;
| | - |  | -----------------------------------------------------



| |  |  | license the proprietary technology that is competitive with our technology; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | attract and hire scientific and engineering talent.
| | - |  | ---------------------------------------------------



Our competitors may succeed in developing and commercializing products earlier than we do. Our competitors may also develop products or technologies that
are superior to those we are developing, and render our product candidates or technology obsolete or non-competitive. If we cannot successfully compete with new or existing products, our sales and revenue would suffer and we may not ever become
profitable.



If our OEM customers fail to purchase our components or to sell
sufficient quantities of their products incorporating our components, or if our OEM customers sales timing and volume fluctuates, it could prevent us from achieving our sales and market share goals.



Sales to a relatively small number of OEM customers, as opposed to direct
retail sales to customers, make up a large portion of our revenues. For example, one customer, ABB Ltd., accounted for approximately 24% of revenues in the third quarter of 2005. Our ability to make sales to OEM customers depends on our ability to
compete effectively, primarily on price, delivery and quality. The timing and volume of these sales depend upon the sales levels and shipping schedules for the products of our OEM customers. Thus, even if we develop a successful component, our sales
will not increase unless the product into which our component is incorporated is successful. If our OEM customers fail to sell a sufficient quantity of products incorporating our components, or if the OEM customers sales timing and volume
fluctuate, it could prevent us from achieving our sales targets and negatively impact our market share. Our OEM customers typically require a long development and engineering process before incorporating our products and services into their systems
and products. This period of time is in addition to the time we spend on basic research and product development. As a result, we are vulnerable to changes in technology or end user preferences.



Our opportunity to sell our products to our OEM customers typically occurs at
infrequent intervals, depending on when the OEM customer designs a new product or enhances an existing one. If we are not aware of an OEMs product development schedule, or if we cannot provide components or technologies when they develop their
products, we may miss a sales opportunity that may not reappear for some time.



We might be faced with product liability or warranty claims, either directly or indirectly through our customers, and we have limited historical experience with some of our products as to our potential liability.



We offer our customers a warranty for our products. Any defects that may
occur in our products could, in turn, lead to defects in our customers products that incorporate our products. The occurrence of defects in our products could give rise to warranty claims against us or to liability for damages. Such defects
could also lead to liability for consequential damages. Defects in our products could, moreover, impair the markets acceptance of our products. Any of these events could have a material adverse effect on our business and financial condition.
We have limited historical experience with some of our products in evaluating the potential liability that could be created by claims under our warranty. If the claims made under such warranty exceed expected levels against which we have reserved,
our results of operations and financial condition could



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be materially adversely affected. Additionally, warranty periods in some international locations are mandated by law. Changes in such laws will affect our
warranty reserves.



Unfavorable economic conditions in the U.S. and abroad
may adversely affect our OEM customers and prevent us from achieving sales growth.



Many of our new products are components designed to be integrated into new products and systems to be introduced to the marketplace by our OEM customers. Unfavorable economic conditions in 2003 and 2004, for example,
slowed capital spending on U.S. electric utility infrastructure and delayed the introduction of certain new products by our OEM customers. A repeat of such unfavorable economic conditions may adversely affect our ability to market and sell our new
products in the future.



A prolonged economic downturn could materially harm
our business.



Any negative trends in the general economy,
including trends resulting from actual or threatened military action by the United States and threats of terrorist attacks in the United States and abroad, could cause a decrease in capital spending in many of the markets we serve. In particular, a
downward cycle affecting the technology, automotive and industrial, and military and aerospace markets would likely result in a reduction in demand for our products. In addition, if our customers own markets and financial performance decline,
we may not be able to collect outstanding amounts due to us. Any of these circumstances could harm our consolidated financial position, results of operations and cash flows.



If we are unable to protect our intellectual property adequately, such as in the Peoples Republic of China (PRC), we could lose our
competitive advantage in the industry segments in which we do business.



Our success depends on establishing and protecting our intellectual property rights. If we are unable to protect our intellectual property adequately, we could lose our competitive advantage in the industry segments
in which we do business. Although we try to protect our intellectual property rights through patents, trademarks, copyrights, trade secrets and other measures, these steps may not prevent infringement, misappropriation or other misuse by third
parties. We have taken steps to protect our intellectual property rights under the laws of certain foreign countries, but our efforts may not be effective to the extent that foreign laws are not as protective as the laws of the U.S. For example, we
have licensed the rights to manufacture and market our patented ultracapacitor technology in the PRC to a company located in the PRC. Patent and other intellectual property rights receive substantially less protections in the PRC than is available
in the United States. In addition, we face the possibility that third parties might reverse engineer our products to discover how they work and introduce competing products, or that third parties might independently develop products and
intellectual property similar to ours.



We have increased our
emphasis on protecting our technologies and products through patents. Our success depends on maintaining our patents, adding to them where appropriate, and developing products and applications without infringing the patent and proprietary rights of
others. The following risks, among others, are involved in protecting our patents:



| |  |  | our patents may be circumvented or challenged and held unenforceable or invalid;
| | - |  | --------------------------------------------------------------------------------



| |  |  | our pending or future patent applications, if any, may not be issued in a timely manner and may not provide the protections we seek; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | others may claim rights in the patented and other proprietary technology that we own or license.
| | - |  | ------------------------------------------------------------------------------------------------



If our patents are invalidated or if it is determined that we, or the licensor of the patent, do not hold sole rights to the
patent, we could lose our competitive advantage in the industry segments in which we do business.



Competing research and patent activity in our product areas is substantial. Conflicting patent and other proprietary rights claims may result in disputes
or litigation. Although we do not believe that our products or proprietary rights infringe on third party rights, infringement claims could be asserted against us in the future. Also, we may not be able to stop a third party product from infringing
on our proprietary rights without litigation. If we are subject to such claims, or if we are forced to bring such claims, we could face time-consuming, costly litigation that may result in product shipment delays and possible damage payments or
injunctions that could prevent us from making, using or selling infringing products. In addition, such litigation could increase our operating expenses and adversely impact our operating results. We may also be required to enter into royalty or
licensing agreements on unfavorable terms as part of a judgment or settlement which could have a negative impact on the amount of revenue derived from our products or proprietary rights.



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Our ability to enter into successful alliances or other strategic arrangements may affect our success.



Our growth and success will be dependent to a substantial extent on our
reputation. Since we anticipate licensing our technology to others, our reputation may be affected by the performance of the companies to which we license our technology. Our licenses may grant exclusivity with respect to certain uses or geographic
areas. For example, we granted an exclusive license to YEC to manufacture and sell our BOOSTCAP®products in China and to sell to other mutually agreed customers elsewhere in Asia. As a result, we will be wholly dependent on the success of the licensee for success with respect to any exclusive use or geographical area. As with
YEC, we anticipate that future alliances may be with foreign partners or entities. As a result, such future alliances may be subject to the political climate and economies of the foreign countries where such partners reside and operate. We cannot
assure you that our alliance partners or other partners will provide us with the support we anticipate, that any of the alliances or other relationships will be successful in developing our technology for use with their intended products, or that
any of the alliances or other relationships will be successful in manufacturing and marketing their technologies for such products once developed. Any of our international operations will also be subject to certain external business risks such as
exchange rate fluctuations, political instability and a significant weakening of a local economy in which a foreign entity with which we have an affiliation operates or is located. Certain provisions of the alliance agreements that are for our
benefit may be subject to restrictions in foreign laws that limit our ability to enforce those contractual provisions. Failure of these alliances to be successful could have a material adverse effect on our business and prospects.



We face risks associated with the marketing, distribution and sale of our products
internationally and, if we are unable to manage these risks effectively, it could impair our ability to increase sales.



We derive a significant portion of our revenues from sales to customers located outside the U.S. We expect our international sales to continue to
represent a significant and increasing portion of our future revenues. As a result, our business will continue to be subject to certain risks, such as foreign government regulations, export controls, changes in tax laws, tax treaties, tariffs,
freight rates and timely and accurate financial reporting from our international subsidiary. Additionally, as a result of our international operations and related revenue generated outside of the U.S., the dollar amount of our current and future
revenues, expenses and debt may be materially affected by fluctuations in foreign currency exchange rates.



Similarly, assets or liabilities of our consolidated subsidiary that are not denominated in its functional currency are subject to effects of currency
fluctuations, which may affect our reported earnings. If we are unable to manage these risks effectively, it could impair our ability to increase international sales.



We have substantial operations in Switzerland. Having substantial international operations increases the difficulty of
managing our financial reporting and internal controls and procedures. In addition, to the extent we are unable to respond to political, economic and other conditions in these countries effectively, our business, results of operations and financial
condition could be materially adversely affected. Moreover, changes in the mix of income from our foreign subsidiaries, expiration of tax holidays and changes in tax laws and regulations could increase our tax rates.



Two ongoing contract department audits by the Defense Department could result in charges
to our earnings and have a negative effect on our cash position and we may be subject to additional future audits.



A contract, not assumed by the acquirers of our former defense contract business, entered into in 1990 and completed in the late 1990s is currently being
audited by the Defense Departments auditing services. We have submitted documentation supporting approximately $550,000 of costs charged to the contract. We believe that such costs were properly charged.



There can be no assurance that the Defense Departments auditing
services will accept the documentation submitted and that the matters will be resolved in our favor.



The Defense Departments auditing service is also auditing a contract entered into in 1995 and completed in 1999 by a company purchased by our
Microelectronics group. We have requested a release of liability from the prime contractor. There is no assurance that such a release will be obtained and that we will not incur some liability.



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If we are unable to retain key personnel, we could lose our technological and competitive advantage in some product
areas and business segments.



Since many of our products
employ emerging technologies, our success depends upon the continued service of our key technical and senior management personnel. Some of our engineers are the key developers of our products and technologies and are recognized as leaders in their
area of expertise. The loss of such engineers could threaten our technological and competitive advantage in some product areas and product lines.



Our performance also depends on our ability to identify, hire, train, retain and motivate qualified personnel, especially key executives, operations staff
and highly skilled engineers. The industries in which we compete are characterized by a high level of employee mobility and aggressive recruiting of skilled personnel in a highly competitive employment market. Our employees may terminate their
employment with us at any time.



Our ability to increase market share and
sales depends on our ability to hire, train and retain qualified marketing and sales personnel.



Because many of our products are new, we have limited experience marketing and selling them. To sell our products, our marketing and sales personnel must
demonstrate the advantages of our products over the products offered by our competitors, and we must be able to demonstrate the value of new technology in order to sell new products to existing and new customers. The highly technical nature of the
products we offer requires that we attract and retain qualified marketing and sales personnel, and we may have difficulty doing that in a highly competitive employment market. Also, as part of our sales and marketing strategy, we enter into
arrangements with distributors and sales representatives and depend upon their efforts to sell our products. Our arrangements with outside distributors and sales representatives may not be successful.



Our business and operations would suffer in the event of system failures.



Despite the implementation of security measures, redundancy and backup
our internal information technology networking systems are vulnerable to damages from computer viruses, unauthorized access, energy blackouts, natural disasters, terrorism, war and telecommunication failures. Additionally, from time to time, we
install new or upgraded business management systems. To the extent such systems fail or are not properly implemented, we may experience material disruption to our business including our ability to report operating results on a timely basis.



Changes in financial accounting standards related to stock option expenses
are expected to have a significant adverse effect on our reported results.



The Financial Accounting Standards Board (FASB) recently issued a revised standard that requires that we record compensation expense in our statement of operations for employee stock options using the fair value
method. The adoption of the new standard is expected to have a significant adverse effect on our reported earnings, although it will not affect our cash flows, and may adversely impact our ability in the future to provide accurate guidance on future
financial results due to the variability of the factors used to establish the value of stock options.



Future changes in financial accounting standards or practices may cause adverse unexpected revenue or expense fluctuations and affect our reported results of operations.



A change in accounting standards or practices can have a significant effect
on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future.
Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct business.



Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.



Changing laws, regulations and standards relating to corporate governance
and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are creating significant additional expenses and uncertainty for public companies. We are committed to maintaining high standards
of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, significantly increased general and administrative expenses
and diversion of management time to such compliance activities. Our recent efforts to comply with section 404 of the Sarbanes-Oxley Act of 2002 and the



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related regulations have required a significant effort of the company and its available resources, and resulted in significant cost to us. These efforts are
increased because of our substantial international operations.



Anti-takeover provisions in our certificate of incorporation and bylaws could prevent certain transactions and could make a takeover more difficult.



Some provisions in our certificate of incorporation and bylaws could make it more difficult for a third party to acquire
control of Maxwell, even if such change in control would be beneficial to our stockholders. We have a staggered board of directors, which means that our directors are divided into three classes. The directors in each class are elected to serve three
year terms. Since the three year terms of each class overlap the terms of the other classes of directors, the entire board of directors cannot be replaced in any one year. Furthermore, our certificate of incorporation contains a fair price
provision which may require a potential acquirer to obtain the consent of our board to any business combination involving Maxwell.



We have adopted a program under which our stockholders have rights to purchase our stock directly from us at a below-market price if a company or person
attempts to buy us without negotiating with the board. This program is intended to encourage a buyer to negotiate with us, but may have the effect of discouraging offers from possible buyers.



The provisions of our certificate of incorporation and bylaws could delay,
deter or prevent a merger, tender offer, or other business combination or change in control involving us that some, or a majority, of our stockholders might consider to be in their best interests. This includes offers or attempted takeovers that
could result in our stockholders receiving a premium over the market price for their shares of our common stock.



Our common stock experiences limited trading volume and our stock price has been volatile.



Our common stock is traded on the NASDAQ National Market. The trading volume of our common stock each day is relatively low.
This means that sales or purchases of relatively small blocks of stock can have a significant impact on the price at which our stock is traded. We believe that factors such as quarterly fluctuations in financial results, announcements of new
technologies impacting our products, announcements by competitors or changes in securities analysts recommendations could cause the price of our stock to fluctuate substantially. These fluctuations, as well as general economic conditions such
as recessions or higher interest rates, may adversely affect the market price of our common stock.



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|Item 3. | 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



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 loans. Changes in these currency exchange rates impact the U.S. dollar amount of revenue, expenses and debt. The amount of net exchange rate change on transactions was immaterial in the current
and prior periods. We do not hedge our currency exposures.



Interest Rate
Risk



At September 30, 2005, we had approximately
$2.3 million or 2.9 million Swiss Franc denominated term debt, of which approximately $534,000 is classified as long-term debt. The carrying value of these borrowings approximates fair value due to the short maturity dates of these instruments.
We do not anticipate significant interest rate swings in the near future; however, any exchange loss or gain may significantly affect our balance sheet or statement of operations. A 10% increase in the interest rate on our debt would not have a
material effect on our related interest expense.



We invest
excess cash in debt instruments of the U.S. Government and its agencies, high-quality corporate issuers and money market accounts. The primary objective of our investment activities is to preserve principal while maximizing yields without
significantly increasing risk. Current policies do not allow the use of interest rate derivative instruments to manage exposure to interest rate changes. As of September 30, 2005, third parties managed approximately $3.3 million of the
investment portfolio under guidelines approved by the Companys Board of Directors. The balance of our cash is invested in money market accounts with banks. A 10% increase in the interest rate on our marketable securities would not have a
material effect on our related interest income.



|Item 4. | Controls and Procedures
|------- | -----------------------



Evaluation of Disclosure Controls and Procedures



The Companys management, including Richard D. Balanson, our Chief Executive Officer, and Tim T. Hart, our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of
the end of the period covered by this Quarterly Report (the Evaluation Date). Based on this evaluation, they believe that:



| |  |  | We have made progress on our material weakness which existed at December 31, 2004 relating to adequate review of our financial closing procedures surrounding accrued expenses
by increasing our internal accounting staff at our San Diego location from four to six persons, and at our Rossens, Switzerland location from two to three persons. All but one of these employees were hired during the second quarter and therefore are
still learning the Companys systems and procedures. Management continues to monitor the effectiveness of the staffing, and believes it is adequate at this time.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have implemented a Monitoring Plan to test the effectiveness of our controls for the year 2005. Based on this plan we started testing on a quarterly basis during 2005 the
Companys business processes and controls identified at December 31, 2004. Testing to date indicates that our controls are functioning properly.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Because we have not completed the training and integration of our internal accounting staff which we believe will resolve the material weakness noted above, the Companys
disclosure controls and procedures were not effective as of September 30, 2005.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Changes in Internal Controls over Financial Reporting



As discussed above, we have implemented improvements to our internal controls over financial reporting by increasing our internal accounting staff in both of our locations (San Diego, California and Rossens,
Switzerland) and by implementing a monitoring plan. There has not been any other change in our internal control over financial reporting that occurred during



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the three month period ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.



Limitations on the Effectiveness of Controls



The Companys management, including the Chief
Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud. The Companys disclosure controls and procedures have been
designed to provide reasonable assurance that the controls and procedures will meet their objectives. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems
objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can
be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any
system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and
not be detected.



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PART II  OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



From time to time we are involved in litigation arising out of our operations. We maintain liability insurance, including product liability coverage, in
amounts we believe to be adequate. The Companys subsidiary I-Bus/Phoenix, Inc. has been named as a defendant in a suit filed on March 4, 2004 in the Superior Court of the State of California for the County of San Luis Obispo. This suit,
Edmonds vs. I-Bus/Phoenix, Inc., was filed by the plaintiff on his behalf and alleges damages concerning the repurchase of I-Bus/Phoenix, Inc. shares. While the Companys legal counsel cannot express an opinion on this matter, management
believes that any liability of the Company that may arise out of or with respect to this matter will have no significant adverse effect on the consolidated financial position, results of operations or cash flows of the Company.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------



None.



|Item 3. | Defaults upon Senior Securities
|------- | -------------------------------



None.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------



None.



|Item 5. | Other Information
|------- | -----------------



None.



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|Item 6. | Exhibits
|------- | --------



|      |  |                                                                                                                                                                                                             
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 
|10.39 |  | Separation agreement dated August 18, 2005 between Registrant and former Chief Financial Officer (incorporated by reference to Registrants Form 8-K dated August 19,
2005).                                
|      | 
|10.40 |  | Employment agreement dated August 19, 2005 between Registrant and current Chief Financial Officer (incorporated by reference to Registrants Form 8-K dated August 19,
2005).                               
|      | 
|31.1  |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (Section 302 Certification) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *                                     
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (Section 302 Certification) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *                                     
|      | 
|32    |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification), as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. *

---

|* | Filed herewith.
|- | ---------------



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SIGNATURES



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



|                       |  |  |  |                            |  |                 |  |                                                                                                                                 
|---------------------- |  |  |  | -------------------------- |  | --------------- |  | --------------------------------------------------------------------------------------------------------------------------------
|Date: November 4, 2005 |  |  |  | MAXWELL TECHNOLOGIES, INC.
|                       |  |  |  |                           
|                       |  |  |  |                            |  | By:             |  | /s/ Richard D. Balanson                                                                                                         
|                       |  |  |  |                            |  |                 |  | Richard D. Balanson                                                                                                             
|                       |  |  |  |                            |  |                 |  | President and Chief Executive Officer                                                                                           
|                       |  |  | 
|Date: November 4, 2005 |  |  |  | By:                        |  | /s/ Tim T. Hart
|                       |  |  |  |                            |  |                 |  | Tim T. Hart                                                                                                                     
|                       |  |  |  |                            |  |                 |  | Vice President, Finance, Treasurer, Corporate Secretary and Chief Financial Officer (Principal Financial and Accounting Officer)



34