Sevcon, Inc. (“Sevcon” or “the Company”) is a Delaware corporation organized on December 22, 1987 to carry on the electronic controls business previously performed by Tech/Ops, Inc. Through wholly-owned subsidiaries located in the United States, the United Kingdom, France, South Korea and Japan, the Company designs and sells, under the Sevcon name, microprocessor based controls for zero emission and hybrid electric vehicles. The controls are used to vary the speed and movement of vehicles, to integrate specialized functions and to prolong the shift life of vehicles’ power source. The Company’s customers are manufacturers of on-road, off-road and industrial vehicles including automobiles, buses, fork lift trucks, aerial lifts, mining vehicles, airport ground support vehicles, utility vehicles, sweepers and other battery powered vehicles. Through another subsidiary located in the United Kingdom, Sevcon, Inc. manufactures special metalized film capacitors that are used as components in the power electronics, signaling and audio equipment markets.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normally recurring accruals) necessary to present fairly the financial position of Sevcon, Inc. as of December 28, 2013March 29, 2014 and the results of operations and cash flows for the threesix months ended December 28, 2013.March 29, 2014. These unaudited interim financial statements should be read in conjunction with the 2013 annual consolidated financial statements and related notes included in the 2013 Sevcon,  Inc. Annual Report filed on Form 10-K (the “2013 10-K”). Unless otherwise indicated, each reference to a year means the Company’s fiscal year, which ends on September 30.

The results of operations for the threesix month period ended December 28, 2013March 29, 2014 are not necessarily indicative of the results to be expected for the full year.

There have been no changes since the end of 2013 to the significant accounting policies followed by Sevcon, Inc.

Under the Company’s 1996 Equity Incentive Plan (the “Plan”) there were 62,000183,400 shares reserved and available for grant at December 28, 2013.March 29, 2014.   There were 122,800106,000 shares reserved and available for grant at December 29, 2012.March 30, 2013.  There were no options granted or exercised in the quartersperiods ended December 28, 2013March 29, 2014 and December 29, 2012.March 30, 2013.

Recipients of grants must execute a standard form of non-competition agreement. The plan provides for the grant of Restricted Stock, Restricted Stock Units, Options, and Stock Appreciation Rights (“SARs”). SARs may be awarded either separately, or in relation to options granted, and for the grant of bonus shares. Options granted are exercisable at a price not less than fair market value on the date of grant.

A summary of option activity for all plans for the threesix months ended December 28, 2013March 29, 2014 is as follows:

The aggregate intrinsic value, if any, included in the table above represents the difference between the exercise price of the options and the market price of the Company’s common stock for the options that had exercise prices that were lower than the $5.27$11.36 and $4.85 closing market price of the Company’s common stock at December 28, 2013March 29, 2014 and September 30, 2013, respectively.

In December 2013, the Company granted 80,000 shares of restricted stock to seven employees, which will vest in five equal annual installmentsinstalments so long as the employee is then employed by the Company, or as determined by the Compensation Committee. The estimated fair value of the stock measured on the date of grant was $354,000, based on the fair market value of the stock on the date of issue. ThisThe unvested compensation is being charged to income on a straight line basis over five years. The charge to income for this employee restricted stock in the first six months of 2014 was $35,000 and the subsequent charge will be approximately $18,000 on a quarterly basis.

In February 2014, the Company granted 28,600 shares of restricted stock to eleven non-employee directors, which will vest on the day before the 2015 annual meeting providing that the grantee remains a director of the Company, or as otherwise determined by the Compensation Committee. The aggregate fair value of the stock measured on the date of grant was $213,000, based on the closing sale price of the stock on the date of grant. Compensation expense is being charged to income on a straight line basis over the twelve month period during which the forfeiture conditions lapse. The charge to income for these restricted stock grants in the first six months of fiscal 2014 was $18,000 and the subsequent charge will be approximately $53,000 on a quarterly basis.

A summary of restricted stock activity for the threesix months ended December 28, 2013March 29, 2014 is as follows:

Stock-based compensation expense was $59,000$68,000 and $71,000$127,000 for the three and six month periods ended December 28, 2013March 29, 2014 and December$97,000 and $168,000 for the three and six month periods ended March 30, 2013. At March 29, 2012, respectively. At December 28, 2013,2014, there was $667,000$812,000 of unrecognized compensation expense related to restricted stock granted under the Plan. The Company expects to recognize that cost over a weighted average period of 4.03.1 years.

The Company has two reportable segments: electronic controls and capacitors. The electronic controls segment produces microprocessor based control systems for zero emission and hybrid electric vehicles. The capacitors segment produces metalized film capacitors for sale to electronic equipment manufacturers. Each segment has its own management team and sales force and the capacitors segment has its own manufacturing facility.

The significant accounting policies of the segments are the same as those described above and in Note 1 to the Notes to Consolidated Financial Statements in the 2013 10-K. Inter-segment revenues are accounted for at current market prices. The Company evaluates the performance of each segment principally based on operating income. The Company does not allocate income taxes, interest income and expense or foreign currency translation gains and losses to segments. Information concerning operations of these businesses is as follows:

In the electronic controls segment, revenues derive from the following products and services:

The cost of research and development programs is charged against income as incurred and was as follows:

In recent years the Company has received several awards of research and development grants by the Technology Strategy Board, a public body established by the U.K. government to stimulate technology-enabled innovation.

In 2011, the Company was awarded a research and development grant by the Technology Strategy Board to lead a collaborative project with Cummins Generator Technologies and Newcastle University in the U.K. to develop an innovative electric drive system for electric vehicles using advanced switched reluctance motor technology. The Company recorded grant income from this Technology Strategy Board project of $17,000$16,000 and $33,000 in the first quarter ofthree and six month periods ended March 29, 2014, respectively, associated with research and development expense of $50,000.$47,000 and $97,000, respectively, in the same periods. The Company recorded grant income of $6,000$38,000 and $44,000 in the three and six month periods ended March 30, 2013, respectively, associated with research and development expense of $19,000 in respect of this Technology Strategy Board grant$111,000 and $130,000, respectively, in the same period in 2013.periods.

In 2013, the Company was awarded a research and development grant by the Technology Strategy Board as one of a consortium of organizations in the U.K to research and design ultra-efficient systems for electric and hybrid vehicles. The Company recorded grant income from this Technology Strategy Board project of $1,000$2,000 and $3,000 in the first quarter ofthree and six month periods ended March 29, 2014, respectively, associated with research and development expense of $3,000.$7,000 and $10,000, respectively, in the same periods. The Company did not record any grant income or incur any research and development expense in respect of this grant in the first quartersix months of 2013.

In July 2013, the Company was awarded a grant of approximately $480,000 by the Low Emission Transport Collaborative Projects Fund, a U.K. government body. The grant is to develop next-generation controls for high-voltage, low-power applications. This grant will defray part of the research and development expense associated with this project over the period from July 2013 to March 2015. The Company recorded grant income from this project of $139,000 and $236,000 in the first quarter ofthree and six month periods ended March 29, 2014, of $97,000respectively, associated with research and development expense of $422,000.$547,000 and $969,000, respectively, in the same periods.  The Company did not record any grant income or incur any research and development expense in respect of this grant in the first quartersix months of 2013.

The grant income in the first quartersix months of 2014 and 2013 was recorded as a reduction of research and development expense.

Sevcon has defined contribution plans covering the majority of its U.S. and U.K. employees in the controls business. There is also a small defined contribution plan covering senior managers in the capacitor business. The Company has frozen U.K. and U.S. defined benefit plans for which no future benefits are being earned by employees.  The following table sets forth the components of the net pension cost for the three and six month periods ended December 28,March 29, 2014 and March 30, 2013, and December 29, 2012, respectively:

Sevcon, Inc. contributed $50,000$100,000 to its frozen U.S. defined benefit plan in the threesix months ended December 28, 2013;March 29, 2014; it presently anticipates contributing $150,000a further $100,000 to fund its U.S. plan in the remainder of fiscal 2014. In addition, employer contributions to the U.K. defined benefit plan were $121,000$204,000 in the first threesix months and are estimated to total $368,000$494,000 in 2014.

The table below presents information about the Company’s pension plan assets measured and recorded at fair value as of December 28, 2013March 29, 2014 and indicates the fair value hierarchy of the inputs utilized by the Company to determine the fair values.

Inventories, net of reserve, were comprised of:

The Company's financial instruments consist mainly of cash and cash equivalents, short-term investments, accounts receivable and accounts payable. The carrying amount of these financial instruments as of December 28, 2013March 29, 2014 approximates fair value due to the short-term nature of these instruments. The fair value of the Company’s long term debt at December 28, 2013March 29, 2014 approximated $1,763,000$1,753,000 (the carrying value on the consolidated balance sheet at December 28, 2013)March 29, 2014) based on recent financial market pricing. The long term debt representedrepresents a level 2 liability in accordance with the fair value hierarchy described in Note 8.

Set out below is an analysis of other accrued expenses at December 28, 2013March 29, 2014 and September 30, 2013, which shows separately any items in excess of 5% of total current liabilities:

At December 28, 2013March 29, 2014, the Company had $63,000$53,000 outstanding under a U.K. bank loan entered into in April 2010, with a fixed interest rate of 6.8%. The loan, which was entered into by the U.K. metalized film capacitor subsidiary to purchase an item of capital equipment, is denominated in British Pounds. The loan agreement provides for equal monthly installments of $4,000 comprising interest and principal for a five year period commencing in May 2010. Of the total amount outstanding at December 28, 2013, $47,000March 29, 2014, $49,000 is shown in the current liabilities section of the accompanying consolidated balance sheet under current debt, representing the principal element of the loan installments ending on DecemberMarch 31, 2013.2015. Included in other long term liabilities at December 28, 2013,March 29, 2014, is $16,000$4,000 which represents the principal element of the loan installments payable in the fiscal year 2015. The fair market value of the debt at December 28, 2013March 29, 2014 was $63,000.$53,000.

The Company’s wholly owned subsidiary, Sevcon USA, Inc., has a $3,500,000 secured revolving credit facility with RBS Citizens, National Association for working capital and general corporate purposes. The loan and security agreement will expire on June 14, 2017 when all outstanding principal and unpaid interest will be due and payable in full.  The facility may be paid before maturity in whole or in part at the option of Sevcon USA, Inc., without penalty or premium.  Interest on the loan is payable monthly, and in the firstsecond quarter of 2014, was calculated at a margin of 3.25%3.125% over LIBOR.  Under the facility, Sevcon USA, Inc. must maintain, on a quarterly basis, a debt to tangible net worth ratio of no more than 2.40:1 and a debt service coverage ratio of no less than 1.25:1 for each rolling twelve-month period.  Upon entering into the revolving credit facility, Sevcon USA, Inc. drew down $1,700,000, which was the total amount outstanding at December 28, 2013.March 29, 2014.  This $1,700,000 is shown in the accompanying consolidated balance sheet under long-term debt. The carrying value of the debt approximated to fair value based on current interest rates.

In July 2013, the Company’s U.K. bank renewed the overdraft facilities of the Company’s U.K. controls and capacitor subsidiaries. The Company’s U.K. controlsfacilities total $1,495,000 and capacitor subsidiaries each have multi-currency overdraft facilities which together total $1,470,000 and which are secured by real estate owned by those companies. In common with bank overdrafts in Europe, the renewal of the facilities is for a twelve month period although in line with normal practice in Europe, they can be withdrawn on demand by the bank. The facilities were unused at December 28, 2013.March 29, 2014.

In preparing these interim consolidated financial statements, the Company has evaluated, for potential recognition or disclosure, events or transactions subsequent to the end of the most recent quarterly period, the issuance date of these financial statements.

Statements in this discussion and analysis about the Company’s anticipated financial results and growth, as well as those about the development of its products and markets, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Important factors that could cause these statements not to be realized include the risks discussed under “Risk Factors” below and others discussed in this report.

As of December 28, 2013,March 29, 2014, there have been no material changes to the critical accounting estimates described in the Company’s 20122013 10-K. However, if the business and economic realities vary from those assumed in these judgments and estimates, actual operating results may differ materially from the amounts derived from these judgments and estimates. In addition, if the continuing worldwide economic troubles continue to have a negative effect on our business, estimates used in future periods may vary materially from those included in the Company’s previous disclosures.

The following table compares the results by segment for the three months ended December 28, 2013March 29, 2014 with the same period in the prior year. The table shows the effect of currency and volume changes in percentage terms:

In the controls business segment, sales were higher than the firstsecond quarter last year in all three of our three main geographic markets. Excluding foreign currency effects, revenuessales in the Far East increased 38%82% driven by stronger product demand for aerial work platform applications in China and Japan. Sales in Europe increased 5% from the firstsecond quarter last year, in Europe,also reflecting stronger aerial work platform business, as well as highercontinued modest growth in product demand for four-wheel on-road electric vehicleEV applications. Sales were higherincreased 7% from the second quarter last year in North America driven largely by 31% driven by increased product demandan increase in bothsales of 160% to two-wheel, on-road OEM’s which more than offset a combined reduction in sales of 32% in the traditional areas of aerial work platform, airport ground support and fork lift truck markets whilethe mining sector.

In the capacitor business, volumes shipped were 17%31% higher compared to the firstsecond quarter last year, largely reflecting continuing higher demand from railway signaling customers.

Gross profit of $3,832,000$3,602,000 was 42.3%39.3% of sales in the firstsecond quarter, compared to $2,240,000$3,007,000 or 33.7%37.5% of sales in the same quarter last year. The increase in the gross profit percentage compared to the prior year was largely due to an improved sales mix in both the controls business as well as fixed overhead costs being a lower percentageand the capacitor business and the impact of sales as sales volumes increased year-on-year.the cost savings implemented in the controls division in the second quarter last year.

Selling, research and administrative expenseexpenses in the firstsecond quarter increased by $541,000 from the second quarter of fiscal 2013, this increase largely reflects continued investment in engineering and research and development resources, including the hiring of additional engineering staff. Engineering and research and development expense as a percentage of total sales was 12% in the second quarter of fiscal 2014, compared with 13% in the same period last year In addition, the Company recorded grant income of $157,000 in the second quarter of 2014 compared to $38,000 in the same period last year; this grant income was $3,122,000,recorded as a reduction of research and development expense in each year.

The Company recorded income before income taxes of $139,000 in the second quarter of 2014 compared to a loss before income taxes of $576,000 in the same period last year. There was an income tax benefit of $23,000 compared with a benefit of $638,000, in the same period last year. The tax benefit recorded in the second quarter of 2014 reflects the significant variance in income tax rates in the jurisdictions in which the Company operates and the relative profit or 9%loss made in each business.

Sales in the six months ended March 29, 2014 were $18,219,000, an increase of 3,562,000 or 24%, compared to the same period last year when sales were $14,657,000. Foreign currency fluctuations increased reported sales in the first half year by $430,000, or 3%, mainly due to a weaker U.S. Dollar compared to both the British Pound and the Euro than in the prior year period.

In the controls business segment, volumes shipped were higher in all geographic regions in which the Company operates; Europe, North America and the Far East were 17%, 16% and 71% higher, respectively, compared to the same period last year. ThisThe Company’s traditional markets were 25% higher than the same period last year driven by higher sales to customers in aerial work platform and fork lift truck, as well as higher demand for on-road applications and aftermarket products. Sales increases in these sectors more than offset an 18% decrease year-on-year partly reflectsin sales to mining customers. Sales in the four-wheel on-road sector were up substantially at 62% year-over-year, while sales in the two-wheel on-road sector were slightly lower than last year.

Gross profit of $7,434,000 was 40.8% of sales in the period compared to $5,247,000, or 35.8%, in the comparable period in 2013; this increase in gross profit percentage was due to improved sales mix in both the controls business and the capacitor business and the impact of the cost savings implemented in the controls business in the second quarter last year.

Selling, research and administrative expenses in the period were $6,528,000, an increase of 2013$238,000 from the same period in 2013; the increase in operating expense year-on-year reflects increased investment in engineering and research and development and sales and marketing in response to the reduction inincreased sales levels and customer demand compared to the prior year. Engineering and research and development expense as a percentage of total sales was 11% in the first quarterhalf of 2014, compared with 14% in the same period last year.  TheIn addition, the Company also recorded grant income of $115,000$272,000 in the first quarterhalf of 2014 compared to $6,000$44,000 in the first quartersame period in the prior year; this grant income was recorded as a reduction of research and development expense in each year. period.

The decrease in selling, research and administrative expense also reflects lower consulting and legal expensesCompany recorded operating income in the first quarterhalf of fiscal 2014 thanof $906,000 compared with an operating loss in the first quarter last year when we recorded the cost of the final round of consultation in closing our U.K. defined benefit pension plan.

In the first quarterhalf of 2014 interest expense was $16,000, a decrease of $8,000 compared to the prior year due to the Company’s U.K. bank overdraft facility being little used during the first quarter of 2014. There was a foreign currency loss of $85,000 in the first quarter of 2014 compared to a loss of $201,000 in the same period last year.

The Company recorded net income after income tax for the quarterfirst half of $488,0002014 of $650,000 or income of $.14$0.19 per diluted share compared to a net loss after taxfor the first half of $1,302,000,2013 of $1,240,000 or a loss$0.37 per diluted share of $.39, in the same quarter last year.

Cash balances at the end of the firstsecond quarter of 2014 were $2,159,000,$1,450,000 compared to $2,062,000 on September 30, 2013, an increasea reduction in cash of $97,000$612,000 in the first threesix months of 2014.

In the first six months of 2014, operating activities used $341,000 of cash. Excluding the impact of currency fluctuations, receivables increased by $508,000, inventories increased by $136,000 and prepaid expenses increased by $530,000, all of which reduced cash during the period. Accounts payable increased by $99,000 which increased cash in the period. Accrued expenses and accrued taxes decreased by $167,000 and $83,000, respectively, which reduced cash in the period. The number of days sales in receivables increased in the first six months of 2014 by one day from 65 days at September 30, 2013 to 66 days at March 29, 2014. Capital expenditures in the first six months were $249,000. Exchange rate changes increased reported cash by $64,000 in the first six months of $555,000.2014.

The Company had a U.K. bank loan of $63,000,$53,000, of which $47,000$49,000 was short-term and $16,000$4,000 long-term debt at December 28, 2013.March 29, 2014. It has overdraft facilities in the United Kingdom amounting to $1,470,000$1,495,000, which were unused as of December 28, 2013March 29, 2014 and September 30, 2013. The overdraft facility of the U.K. capacitor subsidiary is secured by a legal charge over the facilityproperty owned and occupied by that company. The overdraft facility of the U.K. controls subsidiary is secured by a legal charge over a facilityproperty owned by that company. Both facilities were renewed in the third quarter of 2013 for a further period of twelve months but, in line with normal practice in Europe, can be withdrawn on demand by the bank. Management believes that, if these facilities were withdrawn, adequate alternative credit resources would be available. However, this would depend on the Company’s situation and the economic environment at the time. Accordingly, management does not rely on their availability in projecting the adequacy of the Company’s capital resources.

The Company’s wholly owned subsidiary, Sevcon USA, Inc., has a $3,500,000 secured revolving credit facility with RBS Citizens, National Association for working capital and general corporate purposes. The obligations under the revolving credit facility are guaranteed by the Company and are secured by all of the assets of Sevcon USA, Inc. and a pledge of all of the capital stock of Sevcon USA, Inc.  The facility imposes customary limitations on Sevcon USA, Inc.’s ability to, among other things, pay dividends, make distributions, and incur additional indebtedness.  Under the facility, Sevcon USA, Inc. must maintain, on a quarterly basis, a debt to tangible net worth ratio of no more than 2.40:1 and a debt service coverage ratio of no less than 1.25:1 for each rolling twelve-month period.  Upon entering into the revolving credit facility, Sevcon USA, Inc. drew down $1,700,000, which was the total amount outstanding at December 28, 2013.March 29, 2014. The revolving credit facility will expire on June 14, 2017 when all outstanding principal and unpaid interest will be due and payable in full.