SECURITIES AND EXCHANGE COMMISSION

FormFORM 10-Q

Commission file number 0-26946

Intevac, Inc.INTEVAC, INC.

3560 Bassett Street

Registrant’s telephone number, including area code: (408) 986-9888

     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 þx     No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

     On November 5, 2001 12,003,622March 30, 2002, 12,060,003 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 drives (the “Equipment Business”(“Equipment”). The Company also develops and the development of highly sensitive electro-optical devices (the “Photonics Business”and systems (“Photonics”).

     Systems sold by the Equipment Division are typically used to deposit highly engineered thin-films of material on a substrate, or to modify the characteristics and properties of thin-films already deposited on a substrate. Systems manufactured by the Equipment Division generally utilize proprietary manufacturing techniques and processes and operate under high levels of vacuum. The Equipment Business manufactures thin-film depositionsystems are designed for high-volume continuous operation and rapid thermal processing equipment that is used inuse precision robotics, computerized controls and complex software programs to fully automate and control the manufacture of flat panelproduction 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 parts and after-sale service areThe Equipment Division has also solddesigned ultra high vacuum automated equipment for Photonics to purchasersbe used for the future manufacture of the Company’s equipment, and sales of components are made to other manufacturers of vacuum equipment.low-cost low-light-level cameras.

     The Photonics Business has developed technologyDivision 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, low-cost low-light-level cameras for use in security and military applications and photodiodes for use in high-speed fiber optic systems.

     The financial information at September 29, 2001March 30, 2002 and for the three- and nine-monththree-month periods ended September 29,March 30, 2002 and March 31, 2001 and September 30, 2000 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 periodsthree-month period ended September 29, 2001March 30, 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)

The components of inventory consist of the following:

A significant portion of the finished goods is represented by inventory at customer sites undergoing installation and acceptance testing.

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

(1)	Diluted EPS for the three- and nine-month periods ended September 29, 2001 and September 30, 2000 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- and nine-month periods ended September 29, 2001 and September 30, 2000 was 1,999,758.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2.     Inventories

The components of inventory consist of the following:

     Finished goods inventory consists of completed units at customer sites undergoing installation and acceptance testing.

3.     Net Income (Loss) Per Share

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

(1)	Diluted EPS for the three-month periods ended March 30, 2002 and March 31, 2001 exclude “as converted” treatment of the convertible notes as their inclusion would be anti-dilutive. The number of “as converted” shares excluded for the three-month periods ended March 30, 2002 and March 31, 2001 was 1,820,364 and 1,999,758, respectively.
(2)	Diluted EPS for the three- and nine-monththree-month periods ended September 29,March 30, 2002 and March 31, 2001 and September 30, 2000 excludesexclude 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 29,March 30, 2002 and March 31, 2001 was 59,882 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 29, 2001 and September 30, 2000 was 141,095 and 151,629,173,590, respectively.

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     Intevac, Inc. has two reportable operating segments: Equipment and Photonics. The Company’s Equipment businessDivision sells complex capital equipment used in the manufacturing of flat panel displays and thin-film disks. The Company’s Photonics businessDivision is developing productsdevices and systems utilizing electron sources that permit highly sensitive detection of photons in the visible and the 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.

     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 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)

5.     Income Taxes

     The Company accrued a $2.2 million tax benefit for the three-month period ended September 29, 2001. AsMarch 30, 2002. This resulted from recent federal tax law changes that allow losses incurred in 2001 and 2002 to be carried back 5 years. The Company paid federal income taxes of September 29,approximately $5.1 million for 1996 and $0.9 million for 1997. The Company believes that at least $2.2 million of taxes paid are recoverable based on the loss incurred in 2001 and that additional taxes may also be recoverable, but the amount will not be determined and recorded until the Company files its 2001 federal income tax return either in the second or third quarter of 2002. For the three months ended March 31, 2001, the Company did not accrue a tax benefit due to the inability at that time to realize additional refunds from loss carry-backs. The Company’s $16.5 million deferred tax asset is fully offset by a $16.5 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.

     During the nine-monththree-month period ending September 29, 2001,March 30, 2002, Intevac sold stock to its employees under the Company’s Stock Option and Employee Stock Purchase Plans.Plan. A total of 160,05356,381 shares were issued for which the Company received $418,000.$144,000.

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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”,“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 — Intevac recognizes revenue using the guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements.” Intevac’s revenue recognition policy requires that there be 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 the Company has completed all the material tasks and deliverables required by the contract.

     Revenues for systems are recognized upon customer acceptance. For large deposition and RTP systems shipped through a distributor, revenue is typically recognized after the distributor has accepted the system at Intevac’s 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. When the Company believes that there may be higher than normal end-user installation and acceptance issues for systems shipped through a distributor, such as when the first unit of a newly designed system is delivered, then the Company defers revenue recognition until the distributor’s customer has also accepted the system. Revenues for technology upgrades, spare parts, consumable and prototype products built by the Photonics 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.

     The Company performs best efforts research and development work under various research contracts. Revenue on these contracts is recognized in accordance with contract terms, typically as costs are incurred. Typically, for each contract, the Company commits to perform certain research and development efforts up to an agreed upon amount. In connection with these contracts, the Company receives 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. In addition, the Company has, from time to time, negotiated with a third party to fund a portion of the Company’s costs in return for a joint interest to the Company’s rights at the end

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Inventories — Intevac makes 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 the Company’s products. Financial stress and consolidation in the Company’s customer base can also lead to the cancellation of orders for products after the Company has 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%33% to $8.4$6.7 million for the three-month periodthree months ended September 29, 2001March 30, 2002 from $11.0$10.0 million for the three-month periodthree months ended September 30, 2000.March 31, 2001. Net revenues from Equipment declineddecreased to $6.5$4.9 million for the three-month periodthree months ended September 29, 2001March 30, 2002 from $8.9$7.9 million for the three-month periodthree months ended September 30, 2000.March 31, 2001. The decrease in Equipment salesrevenue was primarily the result of a decrease in domestic sales of disk manufacturing equipment, which was partially offset by an increase in international salesdecreased shipments of flat panel manufacturing equipment and electron beam processingof disk equipment spare parts. Equipment revenues included the sale of a MDP 200 modular add-on system that was integrated with a previously delivered MDP 250 disk manufacturing equipment.system. Net revenues from Photonics decreased to $1.9$1.7 million for the three-month periodthree months ended September 29, 2001March 30, 2002 from $2.1 million for the three months ended March 31, 2001. The decrease in Photonics net revenues was the result of lower research and development contract revenues in the three-month period ended SeptemberMarch 30, 2000.2002, partially offset by revenue from the sale of two Model 120 LIVAR Cameras.

     International sales increaseddecreased by 122%65% to $5.5$2.4 million for the three-month periodthree months ended September 29, 2001March 30, 2002 from $2.5$6.9 million for the three-month periodthree months ended September 30, 2000.March 31, 2001. The increasedecrease in international sales was primarily due to an increasea reduction in net revenues from disk manufacturing equipment and from flat panel display and electron beam processing manufacturing equipment. International sales constituted 66%37% of net revenues for the three-month periodthree months ended September 29, 2001March 30, 2002 and 23%69% of net revenues for the three-month periodthree months ended September 30, 2000.March 31, 2001.

     Backlog.The Company’s backlog of orders for its products was $42.1$27.3 million at September 29, 2001March 30, 2002 and $37.1$46.0 million at September 30, 2000.March 31, 2001. The reduction was primarily due to a lower backlog of flat panel deposition systems, five of which were taken to revenue in the fourth quarter of 2001. 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 increaseddecreased to 20%14.4% for the three months ended March 30, 2002 from 34.0% for the three months ended March 31, 2001.

     Equipment gross margins decreased to 15.5% for the three-month period ended September 29, 2001March 30, 2002 from 5%45.0% for the three-month period ended September 30, 2000 as the resultMarch 31, 2001. Equipment margins decreased primarily due to a reduction in shipments of an increase in Equipment gross marginstechnology upgrades and high initial costs to 32% from 9%, partially offset by a decrease incomplete Intevac’s first MDP 200 system. Photonics gross margins increased to (22%11.3% during the three months ended March 30, 2002 from (8.1%) from (4%).

     Equipment gross margins were depressed induring 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, Equipmentthree months ended March 31, 2001. Photonics gross margins in the thirdfirst quarter of 2000 2002

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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 Division. Company funded research and development expense increaseddecreased to $3.8$3.1 million for the three-month periodthree months ended September 29, 2001March 30, 2002 from $2.7$3.5 million for the three-month periodthree months ended September 30, 2000,March 31, 2001, representing 46%46.9% and 25%34.9%, respectively, of net revenue. This increasedecrease was primarily the result of higherreduced spending for development of flat panel manufacturing equipment.equipment, partially offset by increased spending for photonics.

     Research and development expenses do not include costs of $1.6$1.3 million and $2.0$2.1 million, respectively, for the three-month periods ended September 29,March 30, 2002 and March 31, 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 forexpenses also do not include costs of $0.1 million in each of the three-month periodperiods ended SeptemberMarch 30, 2000 does not include $0.1 million of costs2002 and March 31, 2001, 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 are made by the Company’s direct sales force, whereas international sales 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 $1.6was $1.7 million for the three-month period ended September 29, 2001 from $1.4 million forboth the three-month periodperiods ended SeptemberMarch 30, 2000,2002 and March 31, 2001, representing 20%25.6% and 13%16.7%, respectively, of net revenue. The primary reason for the increase was an increase in the selling, general and administrative salaries related to 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.

     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.convertible notes. Interest expense was $0.7 million and $0.8 million, respectively, in both of the three-month periods ended September 29, 2001March 30, 2002 and September 30, 2000. Interest expense declined due to the retirement of the $1.9 million of short-term debt during the first quarter ofMarch 31, 2001.

     Interest income and other, net.Interest income and other, net consists primarily of interest incometotaled $0.2 million and dividends on($1.3) million for the Company’s investments, foreign currency hedging gainsthree months ended March 30, 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.March 31, 2001, respectively. Interest income and other, net declinedin 2002 consisted of $0.2 million of interest and dividend income on investments. Interest income and other, net in 2001 consisted of $0.7 million of interest and dividend income on investments offset by the establishment of a reserve related to $0.5the Company’s $2.0 million investment in commercial paper issued by Pacific Gas and Electric Company, which had filed for reorganization under Chapter 11 of the three-month period ended September 29, 2001 from $0.8 million for the three-month period ended September 30, 2000. The decline was primarily the result of reduced interest income caused by lower cash balances and lower interest rates duringUS Bankruptcy Code in early 2001.

     Provision for (benefit from) income taxes.The Company accrued a $2.2 million tax benefit for the three-month period ended March 30, 2002. This resulted from recent federal tax law changes that allow losses incurred in 2001 and 2002 to be carried back 5 years. The Company paid federal income taxes of approximately $5.1 million for 1996 and $0.9 million for 1997. The Company believes that at least $2.2 million of taxes paid are recoverable based on the loss incurred in 2001 and that additional taxes may also be recoverable, but the amount will not be determined and recorded until the Company files its 2001 federal income tax return either in the second or third quarter of 2002. For the three-month periodsthree months ended September 29,March 31, 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

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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, 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 nine-month period ended September 29, 2001. As of September 29, 2001 the Company’s 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 part 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.

Liquidity and Capital Resources

     The Company’s operating activities used cash of $11.2$3.7 million forduring the nine-month periodthree months ended September 29, 2001.March 30, 2002. The cash used was due primarily to the net loss incurred and increases in receivables and inventory, which were partially offset by increased customer advances and depreciation and amortization. In the three

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     The Company’s investing activities used cash of $0.2 million for the three months ended March 30, 2002 as a result of the purchase of fixed assets. In the three months ended March 31, 2001, the Company’s investing activities provided cash of $29.4$26.2 million for the nine-month period ended September 29, 2001 as a result of the net sale of investments. During the three months ended March 31, 2001, the Company converted the majority of its short-term investments which was partially offset by the purchase of fixed assets.into cash or cash equivalents.

     The Company’s financing activities provided cash of $0.4$0.1 million and $0.2 million for the nine-month periodthree-month periods ended September 29,March 30, 2002 and March 31, 2001, respectively, as the result of the sale of the Company’s common stock to its employees through the Company’s employee benefit plans.

     TheIntevac has incurred operating losses each year since 1998 and the Company believescannot predict with certainty when it will return to profitability. We anticipate generating positive cash flow during the 2002 fiscal year, but that itsis dependent on continued growth in the business and our continued ability to obtain advances from our customers. Additionally, as of March 30, 2002 we had $37.5 million of outstanding Convertible Notes, which mature in March 2004. We do not currently have the funds available sources of fundsto repay the debt and anticipated cash flows from operationsthere can be no assurance that the Company will be adequateable to finance current operationsrestructure the debt or secure additional equity and/or debt financing to redeem the Convertible Notes on terms favorable to the Company and anticipated capital expenditures through at least fiscal 2001.its shareholders, if the Convertible Notes are not converted by their holders into Intevac common stock prior to their maturity.

Certain Factors Which May Affect Future Operating Results

     $37.5 Million of convertible notes are outstanding and will mature in 2004.

     In connection with the sale of $57.5 million of its 6 1/2% Convertible Subordinated Notes Due 2004 (the “Convertible Notes”) in February 1997, Intevac incurred a substantial increase in the ratio of long-term debt to total capitalization (shareholders’ equity plus long-term debt). At each noteholder’s option, the Convertible Notes may be exchanged, prior to maturity, into Intevac common shares at a price of $20.625 per share, which is substantially above current market price. During 2001 and 1999 Intevac spent a total of $11.9 million to repurchase $20.0 million of the Convertible Notes. The $37.5 million of the Convertible Notes that remain outstanding as of March 30, 2002 commit Intevac to substantial principal and interest obligations that are significantly in excess of the Company’s $14.5 million cash balance at March 30, 2002. Intevac may, from time to time, repurchase and retire additional Convertible Notes prior to their maturity date.

The degree to which Intevac is leveraged could have an adverse effect on Intevac’s ability to obtain additional financing for working capital, acquisitions or other purposes, and could make it more vulnerable to industry downturns and competitive pressures. Intevac’s ability to meet its debt service obligations will be dependent on Intevac’s future performance, which will be subject to financial, business and other factors affecting the operations of Intevac, many of which are beyond its control. In the event that the Company’s noteholders do not choose to exchange their Convertible Notes for Intevac common stock prior to the Convertible Notes’ 2004 maturity date, the Company will be required to repay the Convertible Notes at maturity. If this is the case, then there can be no assurance that the Company will have generated sufficient cash from operations to repay the Convertible Notes without raising additional capital through the sale of additional debt or equity. Additionally, there can be no assurance that the Company will be able to secure additional equity and/or debt financing on terms favorable to the Company and its shareholders, or at all.

     Intevac has invested heavily in the development of products that address new markets. The Equipment Division has developed a flexible deposition tool and a rapid thermal processing tool to address growing segments of the flat panel display equipment market that are intended to displace products offered by competing manufacturers. The Photonics Division’s LIVAR target identification system and low-cost low-light level camera products are designed to offer significantly improved capability relative to any products currently offered in the marketplace. Additionally, the Photonics Division is entering a new market for the

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Intevac sells capital equipment to capital intensive industries, which manufacture and sell commodity products such as flat panel displays and disk drives. These industries operate with high fixed costs. When demand for these commodity products exceeds capacity, then demand for new capital equipment such as Intevac’s tends to be amplified. When supply of these commodity products exceeds capacity, then demand for new capital equipment such as Intevac’s tends to be depressed. The cyclical nature of the capital equipment industry means that in some years sales of new systems by the Company will be unusually high, and that in other years sales of new systems by the Company will be severely depressed. Failure to anticipate or respond quickly to the industry business cycle could have an adverse effect on Intevac’s business.

     Intevac’s 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, will have an adverse effect on Intevac’s business. From time to time in the past, Intevac has experienced delays in the introduction of, and technical difficulties with, some of its systems and enhancements. Intevac’s future success in developing and selling equipment will depend upon a variety of factors, including accurate prediction of future customer requirements, technology advances, cost of ownership, introduction of new products on schedule, cost-effective manufacturing and product performance in the field. Intevac’s 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’s business.

                  Our products are complex, constantly evolving and are often designed and manufactured to individual customer requirements whichthat require additional engineering.

     Intevac’s Equipment Division products have a large number of components and are highly complex. Intevac may experience delays and technical and manufacturing difficulties in future introductions or volume production of new systems or enhancements. In addition, some of the systems built by Intevac maymust be customized to meet individual customer site or operating requirements. Intevac has limited manufacturing capacity and engineering resources and may be unable to complete the development, manufacture and shipment of its products,

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Intevac’s 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’s business. In the past, Intevac has experienced delays from time to time in the introduction of, and technical difficulties with, some of its systems and enhancements. Intevac’s success in developing and selling equipment depends upon a variety of factors, including accurate prediction of future customer requirements, technology advances, cost of ownership, introduction of new products on schedule, cost-effective manufacturing and product performance in the field. Intevac’s 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’s business.

     To date the activities of the Photonics Division have concentrated on the development of 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. The Company continues to develop standard photonicsPhotonics 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 photonicsPhotonics products to military 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 photonicsPhotonics technology.

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     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. The purchase of Intevac’s systems, along with 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.systems alone. The magnitude of such capital expenditures requires that our customers have access to large amounts of capital and that they arebe willing to invest that capital over long periods of time to be able to purchase our equipment. Some of our customers particularly those that purchase our disk manufacturing products, may not be willing, or able, to make the magnitude of capital investment required to purchase our products.required.

     Intevac derives a significant proportion of its revenues from sales of equipment to manufacturers of computer disk drives and disk drive components. The disk drive industry has experienced a long period of over-supply, the reduction of the number of disks used per disk drive and intensely competitive pricing. Since 1997, many of the manufacturers of hard disk drives and their component suppliers have reported substantial losses. Some of these manufacturers have gone out of business. Others have been acquired by their customers or by their competitors. Accordingly, the potential market for Intevac’s disk equipment products has been reduced. As a result of these factors, Intevac has experienced significant reductions in its quarterly revenues, and has incurred quarterly losses, since the third quarter of 1998. Additionally, the financial strength of the industry has deteriorated which subjects Intevac to increased credit risk on its accounts receivable. Intevac is

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Intevac’s Equipment Division sells capital equipment to capital intensive industries, which sell commodity products such as disks, disk drives and flat panel displays. These industries operate with high fixed costs. When demand for these commodity products exceeds capacity, demand for new capital equipment such as Intevac’s tends to be amplified. When supply of these commodity products exceeds capacity, demand for new capital equipment such as Intevac’s tends to be depressed. The cyclical nature of the capital equipment industry means that in some years, such as 1997, sales of new systems by the Company will be unusually high, and that in other years, such as 2001, sales of new systems by the Company will be severely depressed. Failure to anticipate, or respond quickly to the industry business cycle could have an adverse effect on Intevac’s business.

     Over the past few years the amount of data that can be stored on a single thin-film computer disk has been increasing at approximately 100% per year. Although the number of disk drives produced has continued to increase each year, the growth in areal density has resulted in a reduction in the number of disks required per disk drive. TrendFocus, a market research firm specializing in the disk drive industry, projects that the number of thin-film disks used worldwide will declinedeclined in 2001 from 2000 levels .and are expected to remain at the same level in 2002. Without a significant technological change or an increase in the number of disks required, Intevac’s disk equipment sales are largely limited to upgrades of existing capacity,systems, rather than capacity expansion.expansion or system replacement.

     Intevac experiences intense competition in the Equipment Division. For example, Intevac’s equipment products experience competition worldwide from competitors including Anelva Corporation, Applied Films Corporation, Ulvac Japan, Ltd. and Unaxis Holdings, Ltd., each of which have sold substantial numbers of systems worldwide. Anelva, Ulvac and Unaxis all have substantially greater financial, technical, marketing, manufacturing and other resources than Intevac. There can be no assurance that Intevac’s competitors will not develop enhancements to, or future generations of, competitive products that will offer superior price or performance features or that new competitors will not enter Intevac’s markets and develop such enhanced products.

     Given the lengthy sales cycle and the significant investment required to integrate equipment into the manufacturing process, Intevac believes that once a manufacturer has selected a particular supplier’s equipment for a specific application, that manufacturer generally relies upon that supplier’s equipment and frequently will continue to purchase any additional equipment for that application from the same supplier. Accordingly, competition for customers in the equipment industry is intense, and suppliers of equipment may offer substantial pricing concessions and incentives to attract new customers or retain existing customers.

     In connection with the sale of $57.5 million of its 6 1/2% Convertible Subordinated Notes Due 2004 (the “Convertible Notes”) in February 1997, Intevac incurred a substantial increase in the ratio of long-term debt to total capitalization (shareholders’ equity plus long-term debt). During 1999 Intevac spent $9.7 million to repurchase $16.3 million of the Convertible Notes. The $41.2 million of the Convertible Notes that remain outstanding as of September 29, 2001 commit Intevac to substantial principal and interest obligations. The degree to which Intevac is leveraged could have an adverse effect on Intevac’s ability to obtain additional financing for working capital, acquisitions or other purposes and could make it more vulnerable to industry downturns and competitive pressures. Intevac’s ability to meet its debt service obligations will be dependent on Intevac’s future performance, which will be subject to financial, business and other factors affecting the operations of Intevac, many of which are beyond its control.

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     There can be no assurance that:

	•	any of Intevac’s pending or future patent applications will be allowed or that any of the allowed applications will be issued as patents, or
	•	any patent owned by Intevac will not be invalidated, deemed unenforceable, circumvented or challenged, or
	•	the rights granted under our patents will provide competitive advantages to Intevac, or
	•	any of Intevac’s pending or future patent applications will be issued with claims of the scope sought by Intevac, if at all, or
	•	others will not develop similar products, duplicate Intevac’s products or design around the patents owned by Intevac, or
	•	foreign patent rights, intellectual property laws or Intevac’s agreements will adequately protect Intevac’s intellectual property rights.

     Failure to adequately protect Intevac’s intellectual property rights could have an adverse effect upon Intevac’s business.

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     From time to time Intevac has received claims that it is infringing third parties’ intellectual property rights. There can be no assurance that third parties will not in the future claim infringement by Intevac with respect to current or future patents, trademarks, or other proprietary rights relating to Intevac’s disk sputtering systems, flat panel manufacturing equipment or other products. Any present or future claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require Intevac to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to Intevac, or at all. Any of the foregoing could have an adverse effect upon Intevac’s business.

     Over the last elevennine quarters Intevac’s operating loss as a percentage of net revenues has fluctuated frombetween approximately (79%(59%) to (8%and (1%) of net revenues. Over the same period sales per quarter have fluctuated between $13.8$23.6 million and $5.9 million. Intevac anticipates that its sales and operating margins will continue to fluctuate. As a result, period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance.

Intevac’s operations are located in Santa Clara, California. The cost of living in northern California is extremely high, which increases both the cost of doing business and the cost and difficulty of recruiting new employees. Intevac’s operating results depend in significant part upon its ability to effectively manage costs and to retain and attract qualified management, engineering, marketing, manufacturing, customer support, sales and administrative personnel. The failure to control costs and to attract and retain qualified personnel could have an adverse effect on Intevac’s business.

Intevac’s operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. Additionally, the costs of electricity and natural gas have increased significantly. Any further cost increases will impact the Company’s ability to achieve profitability.

     Sales and operating activities outside of the United States are subject to inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies, tariffs, quotas, taxes and other market barriers, political and economic instability, restrictions on the export or import of technology, potentially limited intellectual property protection, difficulties in staffing and managing international operations and potentially adverse tax consequences. Intevac earns a significant portion of its revenue from international sales, and there can be no assurance that any of these factors will not have an adverse effect on Intevac’s business.

     Intevac generally quotes and sells its products in US dollars. However, in some cases, Intevac has quoted and sold its products in Japanese Yen. In those cases Intevac may enter into foreign currency contracts in an effort to reduce the overall risk of currency fluctuations to Intevac’s business. However, there can be no assurance that the offer and sale of products denominated in foreign currencies, and the related foreign currency hedging activities will not adversely affect Intevac’s results of operations.

     Intevac’s two principal competitors for disk sputtering equipment are based in foreign countries and have cost structures based on foreign currencies. Accordingly, currency fluctuations could cause Intevac’s products to be more, or less, competitive than its competitors’ products. Currency fluctuations will decrease, or increase, Intevac’s cost structure relative to those of its competitors, which could impact Intevac’s competitive position.

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     Intevac’s stock price has experienced both significant increases in valuation, and significant decreases in valuation, over short periods of time. Intevac believes that factors such as announcements of developments related to Intevac’s business, fluctuations in Intevac’s operating results, failure to meet securities analysts’ expectations, general conditions in the disk drive and thin-film media manufacturing industries and the worldwide economy, announcements of technological innovations, new systems or product enhancements by Intevac or its competitors, fluctuations in the level of cooperative development funding, acquisitions, changes in governmental regulations, developments in patents or other intellectual property rights and changes in Intevac’s relationships with customers and suppliers could cause the price of Intevac’s Common Stock to continue to fluctuate substantially. In addition, in recent years the stock market in general, and the market for small capitalization and high technology stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Any of these factors could adversely affect the market price of Intevac’s Common Stock.

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Intevac believes that thin-film disks will continue to be the dominant medium for data storage for the foreseeable future. However, it is possible that competing technologies may at some time reduce the demand for thin-film disks, which would adversely affect Intevac’s disk equipment business.

Intevac’s operating results depend in significant part upon its ability to retain and attract qualified management, engineering, marketing, manufacturing, customer support, sales and administrative personnel. Competition in northern California for such personnel is intense. The cost of living in northern California is also extremely high, which further increases the cost and difficulty of recruiting new employees. There can be no assurance that Intevac will be successful in attracting new employees and retaining its staff. The failure to attract and retain such personnel could have an adverse effect on Intevac’s business.

Intevac’s operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. For example, the Company’s facility in California has been subject, in the last year, to electrical blackouts as a consequence of a shortage of available electrical power. These types of disruptions, or other unanticipated disruptions, could adversely impact the Company’s profitability.

     Sales and operating activities outside of the United States are subject to certain inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies, tariffs, quotas, taxes and other market barriers, political and economic instability, restrictions on the export or import of technology, potentially limited intellectual property protection, difficulties in staffing and managing international operations and potentially adverse tax consequences. Intevac earns a significant portion of its revenue from international sales, and there can be no assurance that any of these factors will not have an adverse effect on Intevac’s business.

     Intevac generally quotes and sells its products in US dollars. However, for some Japanese customers, Intevac quotes and sells its products in Japanese Yen. Intevac, from time to time, enters into foreign currency contracts in an effort to reduce the overall risk of currency fluctuations to Intevac’s business. However, there can be no assurance that the offer and sale of products in foreign denominated currencies, and the related foreign currency hedging activities will not adversely affect Intevac’s business.

Intevac’s two principal competitors for disk sputtering equipment are based in foreign countries and have cost structures based on foreign currencies. Accordingly, currency fluctuations could cause Intevac’s products to be more, or less, competitive than its competitors’ products. Currency fluctuations will decrease, or increase, Intevac’s cost structure relative to those of its competitors, which could impact Intevac’s gross margins.

     Intevac has completed multiple acquisitions as part of its efforts to growexpand and diversify its business. For example, Intevac’s business was initially acquired from Varian Associates in 1991. Additionally, Intevac acquired its current gravity lubrication, CSS test equipment and rapid thermal processing product lines in three acquisitions. Intevac also acquired its RPC electron beam processing business in late 1997, and subsequently closed this business. Intevac intends to continue to evaluate new acquisition candidates and diversification strategies. Any acquisition will involve numerous risks, including difficulties in the assimilation of the acquired company’s employees, operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company’s key employees. Additionally, unanticipated expenses, difficulties and consequences may be incurred relating to the integration of technologies, research and development, and administrative functions. Any future acquisitions may result in potentially dilutive issuances

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     Intevac is subject to a variety of governmental regulations relating to the use, storage, discharge, handling, emission, generation, manufacture, treatment and disposal of toxic or otherotherwise hazardous substances, chemicals, materials or waste. Any failure to comply with current or future regulations could result in substantial civil penalties or criminal fines being imposed on Intevac or its officers, directors or employees, suspension of production, alteration of its manufacturing process or cessation of operations. Such regulations could require Intevac to acquire expensive remediation or abatement equipment or to incur substantial expenses to comply with environmental regulations. Any failure by Intevac to properly manage the use, disposal or storage of, or adequately restrict the release of, hazardous or toxic substances could subject Intevac to significant liabilities.

     A majority of the Common Stock outstanding is controlled by the directors and executive officers of Intevac.

     Based on the shares outstanding on September 29, 2001,March 30, 2002, the presentcurrent directors and their affiliates and executive officers, in the aggregate, beneficially own a majority of the outstanding shares of Common Stock. As a result, theseThese shareholders, acting together, are able to effectively control all matters requiring approval by the shareholders of Intevac, including the election of a majority of the directors and approval of significant corporate transactions.