SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number 0-26946

Intevac, Inc.

3560 Bassett Street

Registrant’s telephone number, including area code:

     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 þ          No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

     On November 5, 2001 12,003,622September 28, 2002 12,111,642 shares of the Registrant’s Common Stock, no par value, were outstanding.

INTEVAC, INC.

INDEX

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PART I.     FINANCIAL INFORMATION

INTEVAC, INC.

See accompanying notes.

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INTEVAC, INC.

See accompanying notes.

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INTEVAC, INC.

See accompanying notes.

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INTEVAC, INC.

     Intevac, Inc.’s (“Intevac” or the “Company”) primary business isbusinesses are the design, manufacture and sale of complex capital equipment that is used to manufacture products such as flat panel displays and thin-film disks for computer disk drivesand the design, manufacture and sale of commercial products based on technology developed by the Photonics Technology Division (the “Equipment Business”“Products Group”). The Company also develops and the development of highly sensitive electro-optical devices and systems for the US military and its allies (the “Photonics Business”Technology Division”).

     TheSystems sold by the Products Group’s (formerly the Equipment Business manufactures thin-film depositionDivision) Memory and rapid thermal processing equipment that isFlat Panel Display Divisions are typically used into deposit highly engineered thin-films of material on a substrate, or to modify the manufacturecharacteristics and properties of flat panelthin-films already deposited on a substrate. These systems generally utilize proprietary manufacturing techniques and processes, operate under high levels of vacuum, are designed for high-volume continuous operation and use precision robotics, computerized controls and complex software programs to fully automate and control the production process. Products manufactured with these systems include cell phone color displays, automotive displays, computer monitors and thin-film deposition and lubrication equipment that is used in the manufacture of thin-film disks for computer hard disk drives. Spare partsThe Products Group’s Intensified Imaging Division was formed during the second quarter of 2002 to design, manufacture and after-sale service are also sold to purchasers ofsell commercial products based on extreme low-light-level camera technology developed by the Company’s equipment, and sales of components are made to other manufacturers of vacuum equipment.Photonics Technology Division.

     The Photonics Business has developed technologyTechnology Division is developing electro-optical devices and systems that permitspermit highly sensitive detection of photons in the visible and short wave infrared portions of the spectrum. This technology when combined with advanced silicon integrated circuits makes it possible to produce highly sensitive video cameras. This development work is aimed at creating new products for both military and industrial applications. Products include Intensified Digital Video Sensors, cameras incorporating those sensors and Laser Illuminated Viewing and Ranging (“LIVAR®”) systems for positive target identification.identification at long range and low-cost extreme low-light-level cameras for use in security and military applications.

     The financial information at September 29, 200128, 2002 and for the three- and nine-month periods ended September 29, 200128, 2002 and September 30, 200029, 2001 is unaudited, but includes all adjustments (consisting only of normal recurring accruals) that the Company considers necessary for a fair presentation of the financial information set forth herein, in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information and footnotes required by U.S. GAAP for annual financial statements. For further information, refer to the Consolidated Financial Statements and footnotes thereto included or incorporated by reference in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.2001.

     The preparation of financial statements in conformity with U.S. GAAP 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 reported amounts of revenue and expenses during the reporting period. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statement. Certain prior year balances have been reclassified to conform with the current year presentation.statements.

     The Company evaluates the collectibility of trade receivables on an ongoing basis and provides reserves against potential losses when appropriate.

     The results for the three- and nine-month periods ended September 29, 200128, 2002 are not considered indicative of the results to be expected for any future period or for the entire year.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     TheInventories of systems and components are stated at the lower of inventorystandard cost or market. Inventories consist of the following:

     A significant portionFinished goods inventory consists solely of the finished goods is represented by inventorycompleted systems at both Intevac’s factory and customer sites that are undergoing installation and acceptance testing.

Inventory reserves included in the above numbers were $9.1 million and $13.0 million at September 28, 2002 and December 31, 2001, respectively. Each quarter, we analyze our inventory (raw materials, WIP and finished goods) against the forecast demand for the next 12 months. Parts with no forecast requirements in that period are considered excess and inventory provisions are established to write those parts down to zero net book value. During this process, some inventory is identified as having no future use or value to us and is disposed of against the reserves. During the nine months ended September 28, 2002, $5.3 million of inventory was disposed of and charged to the reserve. Most of the discarded inventory related to two MDP 250K Disk Sputtering systems which had been written down to estimated salvage value in 2000.

     The following table sets forth the computation of basic and diluted earnings (loss) per share:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(1)

Diluted EPS for the three- and nine-month periods ended September 29, 200128, 2002 and September 30, 200029, 2001 excludes “as converted” treatment of the Convertible Notes as their inclusion would be anti-dilutive. The number of “as converted” shares excluded for both the three-three-month periods ended September 28, 2002 and September 29, 2001 was 4,282,247 and 1,999,758, respectively, and the number of “as converted” shares excluded for the nine-month periods ended September 28, 2002 and September 29, 2001 was 2,640,992 and September 30, 2000 was 1,999,758.1,999,758, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(2)

Diluted EPS for the three- and nine-month periods ended September 29, 200128, 2002 and September 30, 200029, 2001 excludes the effect of shares issuable pursuant to employee stock options as their inclusion would be anti-dilutive. The number of employee stock option shares excluded for the three-month periods ended September 28, 2002 and September 29, 2001 was 128,391 and September 30, 2000 was 50,274, and 189,107, respectively, and the number of employee stock option shares excluded for the nine-month periods ended September 28, 2002 and September 29, 2001 was 130,222 and September 30, 2000 was 141,095, and 151,629, respectively.

     Intevac, Inc. has two reportable segments: Equipmentthe Products Group and Photonics.the Photonics Technology Division. The Company’s Equipment businessProducts Group sells complex capital equipment primarily used in the manufacturing of thin-film disks and flat panel displays and thin-film disks.commercial products based on technology developed by the Photonics Technology Division. The Company’s Photonics businessTechnology Division is developing military products utilizing electron sources that permit highly sensitive detection of photons in the visible and short-wave infrared spectrum.

     Included in corporate activities are general corporate expenses amortization expenses related to certain intangible assets and the reversal of a portion of a restructuring reserve established in September 1999, less an allocation of corporate expenses to operating units equal to 1% of net revenues.

     During the third quarter of 1999, the Company adopted an expense reduction plan that included closing one of the buildings at its Santa Clara facility and a reduction in force of 7 employees of the Company’s staff

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of contract and regular personnel. The reductions took place at the Company’s facilities in Santa Clara, California. The Company incurred a charge of $2,225,000 related to the expense reduction plan.

     During the first quarter of 2000, the Company vacated the building and negotiated a lease termination for that space with its landlord, which released the Company from the obligation to pay any rent after April 30, 2000. As a result, the Company reversed $615,000 of the restructuring reserve during the first quarter of 2000.

     During the fourth quarter of 1999, the Company adopted a plan to discontinue operations at its RPC Technologies, Inc. electron beam processing equipment subsidiary and to close the RPC facility in Hayward, California. Twenty-six employees of the Company’s staff of contract and regular personnel were terminated as a result. The Company incurred a charge of $1,639,000 related to this plan.

     In the first quarter of 2000, Intevac sold certain assets of its RPC Technologies, Inc. subsidiary to Quemex Technology. Proceeds from the sale included a cash payment, assumption of the Hayward facility lease and the assumption of certain other liabilities. Excluded from the sale were two previously leased systems and three completed systems remaining in inventory. The Company was able to reverse the portions of the restructuring reserve established to provide for future rents due on the facility and for the closure of the facility. However, since Intevac retained ownership of the two leased systems, the Company established an equivalent reserve to provide for any residual obligations at the end of the leases. Of the three systems in inventory, two were included in 2000 revenues and one is included in 2001 revenues. One of the two leased systems was sold to the lessee in the three months ending September 29, 2001.

The following table displays the activity in the building closure restructuring reserve, established in the third quarter of 1999, and in the RPC operation discontinuance restructuring reserve, established in the fourth quarter of 1999, through December 31, 2000.

     The Company accrued a tax benefit of $6.4 million for the nine-month period ended September 28, 2002. This resulted from federal tax law changes made in early 2002 that allow losses incurred in 2001 and 2002 to be carried back 5 years. The Company paid federal income taxes of approximately $5.2 million for 1996, $0.9 million for 1997 and $0.5 million for 1998. The Company received the $6.4 million refund early in the third quarter of 2002. The Company’s federal tax returns, and any refunds resulting from them, are subject to audit for 3 years from the date filed.

     For the three- and nine-month periods ended September 29, 2001, and September 30, 2000, the Company did not accrue a tax benefit due to the inability at that time to realize additional refunds from loss carry-backs. Based on management’s review, the Company increased its deferred tax asset valuation reserve by $1.3 million during

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

management’s review, the Company increased its deferred tax asset valuation reserve by $1.3 million during the three-month period ended September 29, 2001. As of September 29, 2001 the

The Company’s $14.5 million deferred tax asset is fully offset by a $14.5 million valuation allowance, resulting in a net deferred tax assets totaled $3.7 million. If in the futureasset of zero at September 28, 2002.

     On July 12, 2002 the Company cannot project with reasonable certainty that it will earn taxable income sufficient to realize all or partcompleted the exchange of $36,270,000 in aggregate principal amount of its 6 1/2% convertible notes due 2004 for $29,543,000 of its new 6 1/2% convertible subordinated notes due 2009 and $7,585,000 in cash, including $858,000 for accrued interest. The new 6 1/2% convertible subordinated notes due 2009 are convertible, at the holders’ option, into Intevac common shares at a conversion price of $7.00 per share. $1,275,000 in aggregate principal amount of the value6 1/2% convertible subordinated notes due 2004 remain outstanding after the closing of these net deferred tax assets,the exchange offer.

In accounting for the exchange of the convertible notes, the Company wrote off $368,000 of debt issuance costs related to the Convertible Notes due 2004, reflecting the portion of such costs attributable to the convertible notes exchanged. The remaining debt issuance costs will be amortized to interest expense over the valueremaining life of the net deferred tax assets not likelyConvertible Notes due 2004. In connection with the exchange offer, the Company incurred $756,000 of offering costs. Of this amount, $140,000 represented the cash portion of the exchange offer and was expensed during the 3 months ended September 28, 2002. The $616,000 balance of the exchange offering costs will be amortized to be realized.interest expense over the term of the new notes. There was no gain or loss associated with this transaction as $36,270,000 of Convertible Notes due 2004 were exchanged for $36,270,000 of cash and new securities.

     During the nine-month period ending September 29, 2001,2002, Intevac sold stock to its employees under the Company’s Stock Option and Employee Stock Purchase Plans. A total of 160,053108,020 shares were issued for which the Company received $418,000.$273,000.

     On October 21, 2002 the Company made a payment of $82,000 to Lawrence Livermore National Laboratory to settle an expired royalty agreement. Of the total payment, $73,000 related to product on which revenue has already been recognized as of September 28, 2002, which was recorded in cost of net revenues resulting in a decrease to earnings per share of $0.01 for the three months ending September 28, 2002. The remainder of the payment was recorded as a prepaid expense. The financial statements included in this Form 10-Q are updated from the statements that Intevac issued in a press release on October 22, 2002.

On November 1, 2002 the Company completed the sale of its rapid thermal processing equipment business to Photon Dynamics, Inc. of San Jose, CA. Photon Dynamics paid $20.0 million cash and assumed certain liabilities. $2.0 million of the cash payment will be held in escrow for one year and is subject to a number of conditions. Photon Dynamics hired 23 of Intevac’s employees as a result of the transaction and will relocate them to Photon Dynamics’ San Jose facility.

     Certain prior year amounts in the Condensed Consolidated Financial Statements have been reclassified to conform to 2002 presentation.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Quarterly Report on Form 10-Q contains forward-looking statements, which involve risks and uncertainties. Words such as “believes”, “expects”, “anticipates” and the like indicate forward-looking statements. The Company’s actual results may differ materially from those discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, the risk factors set forth elsewhere in this Quarterly Report on Form 10-Q under “Certain Factors Which May Affect Future Operating Results” and in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K filed in March 2001,2002, Form 10-Q’s and Form 8-K’s.

Critical Accounting Policies and Estimates

     Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, inventories, income taxes, warranty obligations, long-lived assets, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis. The Audit Committee and our auditors review significant estimates and judgements prior to the public release of our financial results.

     Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K. We believe the following critical accounting policies affect the more significant judgments and estimates made in the preparation of our consolidated financial statements.

Revenue Recognition —We recognize revenue using the guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements.” Our revenue recognition policy requires that there is persuasive evidence of a sales contract, that the price is fixed, that product title has transferred, that product payment is not contingent on any factors and is reasonably assured, and that we have completed all the material tasks and deliverables required by the contract.

     Revenues for systems are recognized upon customer acceptance. For large deposition and rapid thermal processing systems shipped through a distributor, revenue is typically recognized after the distributor has accepted the system at our factory and the system has been shipped. For large deposition and RTP systems sold direct to end customers, revenue is recognized after installation and acceptance of the system at the customer site.

     There is a written acceptance and test procedure (“ATP”) for each system, which is specified in the customer purchase order. The ATP includes a detailed set of criteria that are required as a condition of customer acceptance. The ATP is typically conducted over one or more days during which the system is subjected to a number of tests to validate that the system is performing in a repeatable fashion, reliably and to specification. If material issues or problems are discovered during the ATP process, then they are corrected prior to customer acceptance.

     In the case of a direct end user sale, there are typically two ATP’s performed. The first ATP is performed at Intevac’s factory with the customer in attendance and must be approved by the customer prior to shipment of the system. The second ATP is performed after the system has been installed at the customer’s factory, again with the customer in attendance. Once the second ATP is approved by the customer, and the customer

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     In the case of a shipment through a distributor, an ATP is performed at Intevac’s factory with the distributor in attendance. Upon completion of the ATP, and after the distributor has accepted the system in writing and agreed to make any remaining payments due on the system, then the system is recognized as a sale and revenue for the entire system is recorded. The distributor then completes customer factory installation and ATP at its cost. When we believe that there may be higher than normal end-user installation and acceptance issues for systems shipped through a distributor, such as when a major new version of a product is delivered for the first time, then the acceptance and revenue recognition process follows the model described above for a direct end user sale. The primary difference in this case is that revenue recognition is dependent on the Company obtaining acceptance of the product by both its customer (the distributor) and its distributor’s customer (the end user).

     During the period that a system is undergoing customer acceptance (either distributor or end user), the value of the system remains in inventory and any payments received, or amounts invoiced, related to the system are included in customer advances. When revenue is recognized on the system, the inventory is charged to cost of net revenues, the customer advance is liquidated and the customer is billed for the unpaid balance of the system revenue.

     As of September 28, 2002 the Company reported $12.7 million of finished goods (see Note 2) which consisted of five capacity upgrades to FPD deposition systems undergoing final acceptance testing at the end user’s facility, a FPD silicon deposition system undergoing final acceptance testing at the end user’s facility, a rapid thermal processing system undergoing final acceptance testing at our customer’s factory, and a disk manufacturing system that was purchased in place by Company’s customer during the third quarter of 2002. The disk manufacturing system has not yet been delivered as the customer is still preparing their facility to accept the system. Taken as a whole, the above systems represent $16.0 million of the Company’s $30.3 million order backlog, and $14.5 million of the Company’s $19.3 million of customer advances (see Condensed Consolidated Balance Sheets).

     Revenues for technology upgrades, spare parts, consumables and prototype products built by the Photonics Technology Division are generally recognized upon shipment. Service and maintenance contract revenue, which to date has been insignificant, is recognized ratably over applicable contract periods or as the service is performed.

     We perform best efforts research and development work under various government-sponsored research contracts. Typically, for each contract, we commit to perform certain research and development efforts up to an agreed upon amount. In connection with these contracts, we receive funding on an incremental basis up to a ceiling. Some of these contracts are cost sharing in nature, where Intevac is reimbursed for a portion of the total costs expended. Revenue on these contracts is recognized in accordance with contract terms, typically as costs are incurred. In addition, we have, from time to time, negotiated with a third party to fund a portion of our costs in return for a joint interest to our rights at the end of the contract. In the event that a particular contract over-runs its agreed upon amount, we may be liable for the additional costs.

     These contracts are accounted for under ARB No. 43, Chapter 11, Section A, which addresses Cost-Plus-Fixed-Fee Contracts. The contracts are all cost-type, with financial terms that are a mixture of fixed fee, incentive fee, no fee and cost-sharing. The deliverables under each contract range from reports to prototype hardware. In none of the contracts is there an obligation for either party to continue the program once the funds have been expended. The efforts can be terminated at any time for convenience, in which case we would be reimbursed for our actual incurred costs, plus fee if applicable, for the completed effort. We own the entire right, title and interest to each invention discovered under the contract, unless we specifically give up that right. The US Government has a paid-up license to use any invention/intellectual property for government purposes only.

     Our shipping terms are customarily FOB shipping point. For systems sold directly to the end user, our obligations remaining after shipment include installation, end user factory acceptance and warranty. For

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Inventories —We make provisions for potentially excess and obsolete inventory based on backlog and forecasted demand. However, order backlog is subject to revisions, cancellations, and rescheduling. Actual demand will inevitably differ from forecasted demand due to a number of factors. For example, the thin-film disk industry has suffered from over-capacity and poor financial results, which has led to industry consolidation. Consolidation can lead to the availability of used equipment that competes at very low prices with our products. Financial stress and consolidation in the Company’s customer base can also lead to the cancellation of orders for products after we have incurred substantial costs related to those orders. Such problems have resulted, and may continue to result, in excess and obsolete inventory, and the provision of related reserves.

Warranty —The Company’s standard warranty is twelve months from customer acceptance. During this warranty period any necessary non-consumable parts are supplied and installed. A provision for the estimated warranty cost is recorded at the time revenue is recognized.

Results of Operations

     Net revenues.Net revenues consist primarily of sales of equipment used to manufacture flat panel displays, andequipment used to manufacture thin-film disks, for computer hard disk drives, related equipment and system components electron beam processing equipment (“Equipment”) and contract research and development related to the development of highly sensitive electro-optical devices under government sponsored R&D contracts and sales of derivative products (“Photonics”). Net revenues from system sales are recognized upon customer acceptance. Net revenues from sales of related equipment and system components are recognized upon product shipment. Contract research and development revenue is recognized in accordance with contract terms, typically as costs are incurred.systems. Net revenues decreased by 24%20% to $6.7 million for the three-month period ended September 28, 2002 from $8.4 million for the three-month period ended September 29, 20012001. Net revenues from $11.0the Products Group declined to $4.8 million for the three-month period ended September 30, 2000. Net revenues28, 2002 from Equipment declined to $6.5 million for the three-month period ended September 29, 2001. The decrease in Products Group sales was due primarily to lower sales of disk manufacturing equipment during the third quarter of 2002, and, to a lesser extent, the sale of an electron beam processing system during the third quarter of 2001, partially offset by an increase in sales of flat panel manufacturing equipment in the 2002 quarter. Net revenues for the three-month periods ended September 28, 2002 and September 29, 2001 include $2.5 million and $1.8 million, respectively, of sales of Rapid Thermal Processing equipment, a product line which the Company sold in November 2002. During the third quarter of 2002, Intevac drastically reduced the size of its fabrication center and stopped accepting orders for outside business. The fabrication center contributed sales of $0.3 million in both the three-month periods ended September 28, 2002 and September 29, 2001. Net revenues from $8.9the Photonics Technology Division increased to $2.0 million for the three-month period ended September 30, 2000. The decrease in Equipment sales was primarily the result of a decrease in domestic sales of disk manufacturing equipment, which was partially offset by an increase in international sales of flat panel manufacturing equipment and electron beam processing manufacturing equipment. Net revenues28, 2002 from Photonics decreased to $1.9 million for the three-month period ended September 29, 2001 from $2.12001.

     International sales decreased by 25% to $4.1 million for the three-month period ended September 30, 2000.

     International sales increased by 122% to28, 2002 from $5.5 million for the three-month period ended September 29, 2001 from $2.5 million for the three-month period ended September 30, 2000.2001. The increasedecrease in international sales was primarily due to an increasea decrease in net revenues from flat panel displaydisk manufacturing and electron beam processing manufacturing equipment. International sales constituted 61% of net revenues for the three-month period ended September 28, 2002 and 66% of net revenues for the three-month period ended September 29, 2001 and 23% of net revenues for the three-month period ended September 30, 2000.2001.

     Backlog.The Company’s backlog of orders for its products was $30.3 million at September 28, 2002 and $42.1 million at September 29, 2001. The reduction was primarily due to a lower backlog of flat panel deposition systems, five of which were included in fourth quarter 2001 and $37.1 million at September 30, 2000.revenues. The Company includes in backlog the value of purchase orders for its products that have scheduled delivery dates.

     Gross margin.Cost of net revenues consists primarily of purchased materials, fabrication, assembly, test and installation labor and overhead, customer-specific engineering costs, warranty costs, royalties, provisions for inventory reserves, scrap and costs attributable to contract research and development. Gross margin increasedwas 20% for both the three-month periods ended September 28, 2002 and September 29, 2001.

     Products Group gross margins decreased to 20% for the three-month period ended September 29, 200128, 2002 from 5%32% for the three-month period ended September 30, 2000 as29, 2001. The reduction in gross margin was due

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     Photonics Technology Division gross margins increased to 32%23% in the three months ended September 28, 2002 from 9%, partially offset by a decrease in Photonics gross margins to (22%) from (4%).

     Equipment gross margins were depressed in the third quarter of 2000 as the result of the establishment of a $2.0 million inventory reserve related to the expected cost of updating and reconfiguring slow moving disk sputtering systems in inventory. Excluding the effect of this reserve, Equipment gross margins in the third quarter of 2000 were 32%.

three months ended September 29, 2001. Photonics gross margins were negativelyfavorably impacted asby an increase in the resultshipment of an increased proportionprototype products and by a reduction in the portion of Photonics revenue generated from cost-sharing research and development contracts. The Company expects that Photonics gross margins in the Photonics Technology Division will fluctuate from quarter to quarter based on the relative mix of sales derived from prototype products, from fully funded research and development contracts and from cost-shared research and development contracts.

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     Research and development.Research and development expense consists primarily of prototype materials, salaries and related costs of employees engaged in ongoing research, design and development activities for flat panel manufacturing equipment, disk manufacturing equipment and research by the Photonics Technology Division. Company funded research and development expense increaseddecreased to $2.3 million for the three-month period ended September 28, 2002 from $3.8 million for the three-month period ended September 29, 2001, from $2.7 million for the three-month period ended September 30, 2000, representing 46%34% and 25%46%, respectively, of net revenue. This increaseThe decrease was primarily the result of higherlower spending for the development of flat panel and disk manufacturing equipment.equipment, partially offset by research and development spending in the Company’s commercial Intensified Imaging Division that was formed in the second quarter of 2002. The 2001 spending was driven by development of the MDP 200 system and a flat panel deposition system.

     Research and development expenses do not include costs of $1.6$1.4 million and $2.0$1.6 million, respectively, for the three-month periods ended September 29, 200128, 2002 and September 30, 200029, 2001 related to contract research and development performed by the Company’s Photonics business.Technology Division. These expenses are included in cost of net revenues.

     Research and development expense for the three-monththree-months period ended September 30, 200028, 2002 also does not include costs of $0.1 million of costs reimbursed under the terms of avarious research and development cost sharing agreement with a Japanese company. Since 1993 the Company has received $9.5 million under this cost sharing agreement. Research and development expense for the three-month period ended September 29, 2001 does not include $32,000 of costs reimbursed under the terms of a research and development cost sharing agreement with the National Institute of Standards and Technology related to development of super lattice sources for thin-film disk manufacturing.agreements.

     Selling, general and administrative.Selling, general and administrative expense consists primarily of selling, marketing, customer support, production of customer samples, financial, travel, management, legal and professional services and bad debt expense. Domestic sales and international sales of thin-film disk manufacturing products in Singapore, Malaysia and Taiwan are made by the Company’s direct sales force, whereas other international sales of thin-film disk manufacturing and other products are made by distributors and representatives that provide services such as sales, installation, warranty and customer support. The Company also has a subsidiary in Singapore to support customers in Southeast Asia. Through the second quarter of 2000, the Company marketed its flat panel manufacturing equipment to the Far East through its Japanese joint venture, IMAT. During the third quarter of 2000 the Company and its joint venture partner, Matsubo, transferred IMAT’s activities and employees to Matsubo, which became a distributor of the Company’s flat panel products, and shut down the operations of IMAT.

     Selling, general and administrative expense increased to $2.0 million for the three-month period ended September 28, 2002 from $1.6 million for the three-month period ended September 29, 2001, from $1.4 million for the three-month period ended September 30, 2000, representing 20%29% and 13%20%, respectively, of net revenue. The primary reasonincrease was primarily the result of a representative commission due for the increase wassale of a flat panel manufacturing system and an increase in the selling, general and administrative salaries related topersonnel in the Equipment business.

Restructuring expense.Restructuring expense was ($23,000) during the three-month period ended September 30, 2000. During the third quarter of 2000, the Company completed a September 1999 restructuring plan and reversed the unused $23,000 balance of the related reserve.Products Group.

     Interest expense.Interest expense consists primarily of interest on the Company’s Convertible Notes, and, to a lesser extent, interest on approximately $1.9 million of short-term debt related to the purchase of Cathode Technology in 1996.Notes. Interest expense was $0.7$1.1 million and $0.8$0.7 million, respectively, in the three-month periods ended September 29, 200128, 2002 and September 30, 2000.29, 2001. Interest expense declinedincreased in 2002 due to the retirementwrite-off of $0.4 million of the $1.9debt issuance costs related to the Company’s convertible notes due in 2004 and the write-off of $0.1 million of short-term debt during the first quarter of 2001.offering costs related to the convertible note exchange.

     Interest income and other, net.Interest income and other, net consists primarily of interest incometotaled $0.2 million and dividends on$0.5 million for the Company’s investments, foreign currency hedging gainsthree months ended September 28, 2002 and losses, early payment discounts on the purchase of inventories, goods and services and, in 2000, the Company’s 49% share of the loss incurred by IMAT.September 29, 2001, respectively. Interest income and other, net declined to $0.5 million for the three-month period ended September 29,in 2002 consisted primarily of interest and dividend income on investments. Interest income and other, net in 2001 from $0.8 million for the three-month period ended September 30, 2000. The decline wasconsisted primarily the result of reduced interest and dividend income caused by lower cash balanceson investments and lower interest rates during 2001.foreign currency hedging gains.

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     Provision for (benefit from) income taxes.For the three-month periods ended September 29, 2001 and September 30, 2000, the Company did not accrue a tax benefit due to the inability to realize additional refunds from loss carry-backs. Based on management’s review, the Company increased its deferred tax asset valuation

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Net revenues.Net revenues increased by 7% to $27.9 million for the nine-month period ended September 29, 2001 from $26.1 million for the nine-month period ended September 30, 2000. Net revenues from Equipment sales declined slightly to $20.7 million for the nine-month period ended September 29, 2001 from $20.9 million for the nine-month period ended September 30, 2000. Net revenues from Photonics increased to $7.2 million for the nine-month period ended September 29, 2001 from $5.2 million for the nine-month period ended September 30, 2000. The increase in Photonics sales was primarily the result of increased contract research and development sales partially offset by reduced product sales.

     International sales increased by 147% to $15.9 million for the nine-month period ended September 29, 2001 from $6.4 million for the nine-month period ended September 30, 2000. The increase in international sales was primarily due to an increase in sales of disk manufacturing equipment, and to a lesser extent an increase in the sales of rapid thermal processing systems for flat panel display manufacturing. International sales constituted 57% of net revenues for the nine-month period ended September 29, 2001 and 25% of net revenues for the nine-month period ended September 30, 2000.

Gross margin.Gross margin was 18% for the nine-month period ended September 29, 2001 as compared to 12% for the nine-month period ended September 30, 2000. Gross margin in the Equipment business increased to 26% for the nine-month period ended September 29, 2001 as compared to 19% for the nine-month period ended September 30, 2000. Equipment gross margins in the nine-month periods ended September 29, 2001 and September 30, 2000, respectively, were negatively impacted by the establishment of $2.4 million and $3.1 million of inventory reserves related to systems inventory. Excluding the effect of these reserves, Equipment gross margins were 37% and 34%, respectively, in the nine-month periods ended September 29, 2001 and September 30, 2000.

     Photonics gross margins increased slightly to (5%) for the nine-month period ended September 29, 2001 from (10%) for the nine-month period ended September��30, 2000. Photonics gross margins in both years have been negatively impacted by a significant portion of revenue being derived from cost-sharing research and development contracts. The Company expects that Photonics gross margins will fluctuate based on the relative mix of sales derived from prototype products, from fully funded research and development contracts and from cost-shared research and development contracts.

Research and development.Company funded research and development expense increased by 42% to $11.0 million for the nine-month period ended September 29, 2001 from $7.7 million for the nine-month period ended September 30, 2000, representing 39% and 29%, respectively, of net revenue. This increase was primarily the result of increased expense for the development of flat panel display manufacturing equipment and photonics products, partially offset by reduced spending for development of disk manufacturing equipment.

     Research and development expenses do not include costs of $7.1 million and $4.3 million, respectively, for the nine-month periods ended September 29, 2001 and September 30, 2000 related to contract research and development performed by the Company’s Photonics business. These expenses are included in cost of net revenues.

     Research and development expense for the nine-month period ended September 30, 2000 does not include $0.6 million of costs reimbursed under the terms of a research and development cost sharing agreement with a Japanese company. Research and development expense for the nine-month period ended September 29, 2001 does not include $0.4 million of costs reimbursed under the terms of a research and development cost sharing agreement with the National Institute of Standards and Technology related to development of super lattice sources for thin-film disk manufacturing.

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Selling, general and administrative.Selling, general and administrative expense increased by 72% to $5.1 million for the nine-month period ended September 29, 2001 from $3.0 million for the nine-month period ended September 30, 2000, representing 18% and 11%, respectively, of net revenue. The primary reasons for the increase were a $1.5 million credit to bad debt expense during the nine-month period ended September 30, 2000 and increased selling, general and administrative salaries in the Equipment business during the nine-month period ended September 29, 2001.

Restructuring expense (gain).Restructuring gain was ($0.6) million in the nine-month period ended September 30, 2000. During the nine months ended September 30, 2000 the Company vacated approximately 47,000 square feet of its Santa Clara Headquarters and negotiated an early lease termination for the space. As a result, the Company reversed approximately $0.6 million of previously accrued restructuring expense relating to future rents on the vacated space.

Interest expense.Interest expense declined to $2.2 million in the nine-month period ended September 29, 2001 from $2.3 million in the nine-month period ended September 30, 2000, due to the retirement of $1.9 million of short-term debt during the first quarter of 2001.

Interest income and other, net.Interest income and other, net decreased to $1.0 million for the nine-month period ended September 29, 2001 from $2.3 million for the nine-month period ended September 30, 2000. The decrease was primarily the result of a $0.8 million loss on the disposition of Pacific Gas and Electric commercial paper and lower interest income due to reduced interest rates and cash balances.

Provision for (benefit from) income taxes.For the nine-month periods ended September 29, 2001 and September 30, 2000,28, 2002, the Company did not accrue a tax benefit due to the inability to realize additional refunds from loss carry-backs. Based on management’s review, the Company increased its deferred tax asset valuation reserve by $1.3 million during the three-month period ended September 29, 2001. The Company’s $14.5 million deferred tax asset is fully offset by a $14.5 million valuation allowance, resulting in a net deferred tax asset of zero at September 29, 2002.

Net revenues.Net revenues decreased 22% to $21.8 million for the nine months ended September 28, 2002 from $27.9 million for the nine months ended September 29, 2001. Net revenues from the Products Group decreased to $16.3 million for the nine months ended September 28, 2002 from $20.7 million for nine months ended September 29, 2001. The decrease in net revenues from the Products Group was due primarily to lower revenues in 2002 from technology upgrades and spare parts and the sale of two electron beam manufacturing systems during the nine months ended September 29, 2001, partially offset by an increase in the sales of disk and flat panel manufacturing systems in 2002. Net revenues for the nine-month periods ended September 28, 2002 and September 29, 2001 include $5.0 million and $3.3 million, respectively, of sales of Rapid Thermal Processing equipment, a product line which the Company sold in November 2002. Intevac’s fabrication center contributed sales of $0.6 million and $1.5 million in the nine month periods ended September 28, 2002 and September 29, 2001, respectively. Net revenues from the Photonics Technology Division decreased to $5.5 million for the nine months ended September 28, 2002 from $7.2 million for the nine months ended September 29, 2001. The decrease in Photonics net revenues was primarily the result of decreased contract R&D activities during 2002.

     International sales decreased 22% to $12.4 million for the nine months ended September 28, 2002 from $15.9 million for the nine months ended September 29, 2001. The decrease in international sales during the nine months ended September 28, 2002 was primarily due to a decrease in revenue from disk manufacturing and electron beam processing equipment. International sales constituted 57% of net revenues for both of the nine-month periods ended September 28, 2002 and September 29, 2001.

Gross margin.Gross margin was 20% for the nine months ended September 28, 2002 as compared to 18% for the nine months ended September 29, 2001. Gross margin in the Products Group declined to 22% in the nine months ended September 28, 2002 from 26% in the nine months ended September 29, 2001. Products Group gross margin in the nine months ended September 28, 2002 was negatively impacted by the high initial costs to complete Intevac’s first MDP 200 system and by under-utilization of the factory. Products Group gross margin in the nine months ended September 29, 2001 was negatively impacted by the provision of a $2.4 million inventory reserve related to a custom multi-chip module system manufactured for a customer that ceased operations and by the sale of an electron beam processing system at a low gross margin.

     Photonics Technology Division gross margin increased to 14% for the nine months ended September 28, 2002 from (5%) for the nine months ended September 29, 2001 due primarily to a reduction in the portion of Photonics revenue generated from cost-sharing research and development contracts. The Company expects that gross margins in the Photonics Technology Division will fluctuate from quarter to quarter based on the relative mix of revenues derived from sales of prototype products, from fully funded research and development contracts and from cost shared research and development contracts.

Research and development.Company funded research and development expense decreased 23% to $8.4 million for the nine months ended September 28, 2002 from $11.0 million for the nine months ended September 29, 2001, representing 39% of net revenue in each period. The decrease was primarily the result of lower spending for the development of flat panel and disk manufacturing equipment, partially offset by accelerated depreciation of $0.5 million on a disk manufacturing system that was disposed of during the second quarter of 2002 and by research and development spending in the Company’s Intensified Imaging Division that was formed in the second quarter of 2002.

     Research and development expenses do not include costs of $4.2 million and $7.1 million, respectively, for the nine-month periods ended September 28, 2002 and September 29, 2001 related to contract research

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     Research and development expenses also do not include costs of $0.3 million and $0.4 million, respectively, in the nine-month periods ended September 28, 2002 and September 29, 2001, reimbursed under the terms of various research and development cost sharing agreements.

Selling, general and administrative.Selling, general and administrative expense was $5.5 million and $5.1 million for the nine-month periods ended September 28, 2002 and September 29, 2001, representing 25% and 18%, respectively, of net revenue. The increase was primarily due to commissions paid on the sale of flat panel manufacturing systems.

Interest expense.Interest expense increased to $2.4 million for the nine months ended September 28, 2002 from $2.2 million in the nine months ended September 29, 2001. The increase in interest expense was due to the write-off of $0.5 million of debt issuance and offering costs related to the successful exchange of the Company’s convertible notes due 2004.

Interest income and other, net.Interest income and other, net totaled $0.6 million and $1.0 million for the nine months ended September 28, 2002 and September 29, 2001, respectively. Interest income and other, net in 2002 consisted primarily of interest and dividend income on investments. Interest and other income, net in 2001 consisted of a $0.8 million loss on the disposition of Pacific Gas & Electric commercial paper, which was offset primarily by interest and dividend income on other investments.

Provision for (benefit from) income taxes.The Company accrued a tax benefit of $6.4 million for the nine-month period ended September 28, 2002. This resulted from federal tax law changes early in 2002 that increased the length of time over which losses incurred in 2001 and 2002 could be carried back from 2 years to 5 years. The Company paid federal income taxes of approximately $5.2 million for 1996, $0.9 million for 1997 and $0.5 million for 1998. For the nine months ended September 29, 2001, the Company did not accrue a tax benefit due to the inability at that time to realize additional refunds from loss carry-backs. Based on management’s review, the Company increased its deferred tax asset valuation reserve by $1.3 million during the nine-month period ended September 29, 2001. As of September 29, 2001 theThe Company’s $14.5 million deferred tax asset is fully offset by a $14.5 million valuation allowance, resulting in a net deferred tax assets totaled $3.7 million. If in the future the Company cannot project with reasonable certainty that it will earn taxable income sufficient to realize all or partasset of the value of these net deferred tax assets, the Company will expense the value of the net deferred tax assets not likely to be realized.zero at September 29, 2002.

Liquidity and Capital Resources

     The Company’s operating activities usedprovided cash of $11.2$4.5 million for the nine-month periodnine months ended September 29, 2001.28, 2002. The cash usedprovided was due primarily to increases in inventorycustomer advances and to non-cash charges for depreciation and amortization, which were partially offset by the net loss incurred by the Company, which was partially offsetCompany. In the nine months ended September 29, 2001, the Company’s operating activities used cash of $11.2 million due primarily to inventory increases and the net loss incurred by an increase in customer advances, bythe Company. Lower billings during the three months ended September 28, 2002 led to a decreasereduction in accounts receivable at that date as compared to the balance at December 31, 2001. Inventories increased slightly overall from December 31, 2001 to September 28, 2002, however the mix of inventory was quite different. At September, 28, 2002 more than half of the Company’s inventory was represented by systems undergoing installation and by depreciation and amortization.acceptance testing at customer sites. Work-in-progress inventory was sharply lower as fewer new systems were in production at September 28, 2002 than were in production at December 31, 2001.

     The Company’s investing activities used cash of $1.1 million for the nine months ended September 28, 2002 as a result of the purchase of fixed assets. In the nine months ended September 29, 2001, the Company’s investing activities provided cash of $29.4 million for the nine-month period ended September 29, 2001 as a result of the net sale of investments, which was partially offset by the purchase of fixed assets. During the nine months ended September 29, 2001, the Company converted all of its short-term investments into cash or cash equivalents.

     The Company’s financing activities used cash of $7.2 million for the nine months ended September 28, 2002 as a result of the exchange of most of the Company’s convertible notes due 2004 for new convertible notes due 2009 and cash. Sale of the Company’s common stock to its employees through the Company’s

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Certain Factors Which May Affect Future Operating Results

     Our products are complex, constantly evolving, Revenue generated by our businesses during 2003 may not provide sufficient gross profit to cover operating

     Intevac’s Equipment Division products have a large numberA significant increase in the sales of components and are highly complex. Intevac may experience delays and technical andthin-film disk manufacturing difficulties in future introductions equipment and/or volume productiondeposition equipment for the manufacture of new systems flat panel displays and/or enhancements. In addition, some ofphotonics based revenues will be necessary for the systems built by Intevac may be customizedCompany to meet individual customer requirements. Intevac has limited manufacturing capacity and engineering resources and may be unable to complete development, manufacture and shipment of its products,

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     Our ability to remain competitive requires substantial investments in research and development. The failure to develop, manufacture and market new systems, or to enhance existing systems, would have an adverse effect on Intevac’sour business. In the past, Intevac has experienced delays fromFrom time to time, we have experienced delays in the introduction of, and technical difficulties with, some of itsour systems and enhancements. Intevac’sOur future success in developing and selling equipment dependswill depend upon a variety of factors, including accurate prediction ofour ability to accurately predict future customer requirements, technologytechnological advances, cost of ownership, our introduction of new products on schedule, cost-effective manufacturing and product performance in the field. Intevac’sOur new product decisions and development commitments must anticipate continuously evolving industry requirements significantly in advance of sales. Any failure to accurately predict customer requirements and to develop new generations of products to meet those requirements would have an adverse effect on Intevac’sour business.

     To date the activitiesOur Products Group systems have a large number of components and are highly complex. We may experience delays and technical and manufacturing difficulties in future introductions or volume production of new systems or enhancements. In addition, some of the Photonics Divisionsystems that we manufacture must be customized to meet individual customer site or operating requirements. We have concentrated onlimited manufacturing capacity and engineering resources and may be unable to complete the development, manufacture and shipment of these products, or to meet the required technical specifications for these products in a timely manner. Such delays could lead to rescheduling of orders in backlog, or in extreme situations, to cancellation of orders. In addition, we may incur substantial unanticipated costs early in a product’s life cycle, such as increased engineering, manufacturing, installation and support costs that we may be unable to pass on to the customer. In some instances, we depend upon a sole supplier or a limited number of suppliers for complex components or sub-assemblies utilized in its technology and prototype products that demonstrate this technology. Revenues have been derived primarily from research and development contracts funded by the United States Government and its contractors.products. Any of these factors could adversely affect our business.

     The Company continues to develop standard photonics products for sale to military and commercial customers. The Photonics Division will require substantial further investment in sales and marketing, in product development and in additional production facilities to support the planned transition to volume sales of photonics products to militaryour disk and commercial customers. There can be no assurance that the Company will succeed in these activities and generate significant increases in sales of products based on its photonics technology.

The majority of our Equipment revenues have historically come from the sale of equipment used to manufacture thin-film disks, and to a lesser extent, from the sale of equipment used to manufacture flat panel displays.products are dependent on substantial capital investment by our
customers.

     The purchase of Intevac’sour systems, along withand the purchase of other related equipment and facilities, requires extremely large capital expenditures by our customers. These costs are far in excess of the cost of the Intevac systems.our systems alone. The magnitude of such capital expenditures requires that our customers have access to large amounts of capital and that they are willing to invest that capital over long periods of time to be able to purchase our

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