Intevac, Inc., 10-K, 12/31/02
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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K

     
(Mark One)
   
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the fiscal year ended December 31, 2002
 
or
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from           to

Commission file number 0-26946

INTEVAC, INC.

(Exact name of registrant as specified in its charter)
     
California
  94-3125814
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
3560 Bassett Street
Santa Clara, California 95054
(Address of principal executive office, including Zip Code)

Registrant’s telephone number, including area code:

(408) 986-9888

Securities registered pursuant to Section 12(b) of the Act: None

     
Title of each class Name of each Exchange on which registered


none
  none

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

Common Stock (no par value)

     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

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes o         No þ

     The aggregate market value of voting stock held by non-affiliates of the Registrant, as of June 29, 2002 was approximately $11,299,000 (based on the closing price for shares of the Registrant’s Common Stock as reported by the NASDAQ National Market System for the last trading day prior to that date). Shares of Common Stock held by each executive officer, director, and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

     On February 20, 2003 12,179,378 shares of the Registrant’s Common Stock, no par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant’s Proxy Statement for the 2003 Annual Meeting of Shareholders are incorporated by reference into Part III. Such proxy statement will be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.




TABLE OF CONTENTS

PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security-Holders
EXECUTIVE OFFICERS AND DIRECTORS
PART II
Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters
Item 6. Selected Consolidated Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Item 8. Financial Statements and Supplementary Data
CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF GRANT THORNTON LLP, INDEPENDENT AUDITORS
CONSOLIDATED BALANCE SHEETS (In thousands)
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except per share amounts)
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (In thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNATURES
EXHIBIT 4.3
EXHIBIT 21.1
EXHIBIT 23.1
EXHIBIT 99.1


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     This Annual Report on Form 10-K contains forward-looking statements, which involve risks and uncertainties. Words such as “believes,” “expects,” “plans,” “anticipates” and the like indicate forward-looking statements. These forward looking statements include comments related to projected customer requirements for new capacity and technology upgrades for our installed base of thin-film disk manufacturing equipment and the ability of our products to meet these requirements; the timing of delivery and/or acceptance of our backlog for revenue; the expected features, performance and competitive advantages of products we are developing including LIVAR®, low light level sensors and cameras, Threat Detection and Identification Systems and MDP-200 upgrade systems; and the cost of complying with government regulations. Intevac’s actual results may differ materially from the results discussed in the forward-looking statements for a variety of reasons, including those set forth under “Certain Factors Which May Affect Future Operating Results.”

PART I

Item 1.     Business

Overview

      Intevac, Inc.’s businesses are organized into three divisions:

  Equipment Products Division (“EPD”) — EPD designs, manufactures and sells complex capital equipment used to manufacture products such as thin-film disks for hard disk drives and flat panel displays.
 
  Photonics Technology Division (“PTD”) — PTD is developing extreme low light level sensors, cameras and systems for sale to military and government markets.
 
  Commercial Imaging Division (“CID”) — CID is developing commercial cameras and systems based on PTD technology.

      Systems sold by the Equipment Products Division (previously referred to as the Memory and Flat Panel Display Divisions) are used to deposit highly engineered thin-films of material on a substrate. Products manufactured with these systems include disks for computer hard disk drives and flat panel displays for use in consumer electronics products. These systems generally utilize proprietary manufacturing techniques and processes and operate under high levels of vacuum. The systems 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. EPD recorded sales of $27.1 million in 2002, a decrease from $42.7 million in 2001 as a result of lower sales of flat panel display manufacturing equipment. EPD’s rapid thermal processing product line, which accounted for $7.1 million of EPD’s 2002 sales, was sold to Photon Dynamics of San Jose, California in November 2002 for $20 million, which includes $2 million held in escrow. Release of the escrow is contingent upon the occurrence of certain conditions.

      The Photonics Technology Division is developing electro-optical sensors, cameras and systems that permit highly sensitive detection of photons in the visible and infrared portions of the spectrum. Products include LIVAR® systems for detection and positive target identification at long range and extreme low light level sensors and cameras for use in military applications. PTD sales to date consist primarily of contract research and development and prototype products funded by the US government. PTD sales decreased to $6.6 million in 2002 from $8.8 million in 2001 due to a lower level of research and development contract funding in 2002.

      The Commercial Imaging Division (formerly the Intensified Imaging Division) was formed in July 2002 with the charter of developing products based on PTD technology for sale to commercial markets. To date CID’s activities have consisted of market and product development, and accounted for $1.7 million, or 9%, of Intevac’s 2002 operating expenses. CID also assumed responsibility from PTD for activities related to the development of photodiodes for use in high-speed fiber optic systems. Further development of these photodiodes, which accounted for $0.5 million of CID’s 2002 operating expenses, was suspended at the end of 2002 due to weak market conditions in the telecommunications industry.

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      We were incorporated in October 1990 in California. Our principal executive offices are located at 3560 Bassett Street, Santa Clara, California 95054, and our phone number is (408) 986-9888. Our Internet home page is located at www.intevac.com; however the information in, or that can be accessed through, our home page is not part of this report. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on or through our Internet home page as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

Equipment Products Division

     Description of Business

      The thin-film disk deposition equipment portion of the Equipment Products Division was acquired from Varian Associates of Palo Alto, California in 1991. EPD developed a system, the MDP-250, for the deposition of magnetic films and protective overcoats onto thin-film disks used in computer hard disk drives (“HDD’s”). The MDP-250 gained wide acceptance and by the late 1990’s was being used in the manufacture of approximately half of the disks used in HDD’s worldwide. Sales of new MDP-250 systems peaked in 1997 and fell to zero by the middle of 1998 as the result of excess disk production capacity. Sales of MDP-250 systems for use in manufacturing remained depressed until the second half of 2002 when we received orders for 2 MDP-250 systems, which we delivered and recorded as revenue in 2002. Since the middle of 1998, our disk manufacturing equipment revenues have resulted primarily from the sale of R&D systems and technology upgrades, parts and service for the installed base of MDP-250 systems. We believe that there are approximately ninety MDP-250’s currently in use in production and R&D applications. We have sold both new and used MDP-250 systems in varying configurations at prices ranging from $1 million to greater than $3 million.

      The disk manufacturing industry has now consolidated into a small number of large manufacturers. We believe the majority of our active customers now utilize most of their capacity and that there is significant potential for these customers to both resume adding capacity and to upgrade the technical capability of their installed base to permit production of high density disks for perpendicular recording rather than the current longitudinal technology. However, we are not able to accurately predict when our customers will begin placing significant equipment orders again, or if they will place those orders with us, and this subjects Intevac to extreme uncertainty in projecting our 2003 revenue.

      During 2002 EPD also offered two types of products for sale for use in the manufacture of flat panel displays (“FPD’s”):

  D-STAR® systems, which are used to apply thin-films onto substrates.
 
  Rapid thermal processing systems, which are used to change the properties of a previously applied thin-film by thermally processing it at temperatures that would otherwise distort or destroy the underlying glass substrate.

      During 2002 EPD recognized $0.1 million in revenue from the sale of D-STAR® parts. As of December 31, 2002 EPD had installed upgrades on five D-STAR® systems installed in 2001 and installed one new D-STAR® system at customer factories in Japan, which had not yet been accepted by the customer or recognized as a sale by EPD. These systems accounted for $9.9 million of the inventory and $11.1 million of the backlog of orders we reported at December 31, 2002. EPD recognized $7.1 million of revenue in 2002 from the sale of rapid thermal processing systems, prior to the sale of the rapid thermal processing product line to Photon Dynamics in November 2002.

     Deposition Equipment for Disk Manufacturing

      Intevac has delivered approximately 112 MDP-250 disk manufacturing systems to customers including Fuji Electric, Fujitsu Limited, Hitachi, Komag, Maxtor, Mitsubishi, Nippon Sheet Glass, Seagate Technology, Sony and Trace Storage Technology. Intevac’s systems are used by disk manufacturers to apply thin layers of undercoats, magnetic alloys and protective overcoats to disks used in computer hard disk drives. We

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believe that Intevac systems are used to manufacture approximately half the worldwide supply of these disks. The mechanical design of the MDP-250 family has characteristics similar to the cluster tools widely used in semiconductor manufacturing in that each of the twelve process stations is separately vacuum pumped and vacuum isolated. The MDP-250 does not require a carrier or pallet to transport disks through the system. Rather, disks are automatically loaded into the system from cassettes, processed, and then automatically returned to the cassette. Intevac offers a number of process station options, including multiple options for the deposition of thin-films and carbon overcoats, heating stations, cooling stations and cleaning stations. Furthermore, these twelve process stations can be easily reconfigured to accommodate process changes.

      The rapid increase in areal density in computer memory storage is requiring the thin-films deposited by our MDP-250 series of equipment to become more complex. This complexity and new technologies such as perpendicular recording, are leading to the need for both new process capabilities and a need for more than twelve process stations. To answer the need for more process stations, Intevac introduced the MDP-200 series of equipment, a modular add-on system that allows manufacturers to seamlessly integrate additional process stations onto their MDP-250 system. The MDP-200 provides the capability to process disks through process stations serially or in parallel, giving manufacturers flexibility to integrate process steps with different process times. Intevac has also developed a suite of system upgrades (MDP-250B+ upgrades) that allow manufacturers to upgrade the vacuum level, speed and control systems of their installed base of MDP-250 systems.

      We have started development on a second generation stand-alone MDP-200, which is being developed to be compatible with existing media technology and next generation perpendicular media technology.

     Deposition Equipment for Flat Panel Display Manufacturing

      The manufacture of several types of flat panel displays, such as active matrix liquid crystal displays, require the deposition of thin-film layers of different materials onto a glass substrate. Intevac’s D-STAR® sputtering systems are designed to uniformly coat thin-films on substrates up to approximately one-meter square. Deposition materials include metals such as aluminum and chromium (used as conductors), silicon (for transistor applications), indium tin oxide (used as a transparent conductor) and complex oxides of materials such as magnesium and tantalum. Process modules are positioned around a central handling module designed to provide high throughput. Up to four back-to-back modules, each containing two vacuum isolated chambers, can be attached directly to the central handler unit. Additional back-to-back modules may also be attached in series to provide further process flexibility and capacity. Typically one or two modules are devoted to load/unload and the remaining positions are configured as dedicated process stations. Substrates are loaded into the system by a robot and then held on edge in a vertical orientation as they are processed. Vertical substrate handling allows for a relatively small system footprint, optimizes particulate control and reduces flexing of the substrate.

     Rapid Thermal Processing Equipment for Flat Panel Display Manufacturing

      Intevac sold its rapid thermal processing (“RTP”) product line to Photon Dynamics in November 2002. These RTP systems are used to rapidly modify the characteristics of thin-films deposited on glass substrates used in the manufacture of flat panel displays. The RTP systems employ rapid transient heating, which provides lower cost of ownership and higher throughput as compared to furnace and laser processing techniques. The RTP systems are typically used for thin-film activation after ion implant in the manufacture of low temperature polysilicon displays. Intevac’s RTP system customers included Sanyo, Sharp, Sony, Toppoly, ERSO and a joint venture of Sony and Toyota.

     Electron Beam Processing Equipment

      In December 1999, Intevac implemented a plan to terminate its electron beam product line. The plan included the delivery of the three electron beam systems on order, closure of the Hayward facility where the systems were manufactured and a $1.6 million charge related to the plan. In March 2000, we sold the electron beam business to Quemex Technology, Ltd. and Quemex assumed responsibility for Intevac’s Hayward

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facility. Intevac retained rights to the three systems on order, which were subsequently sold during 2000 and 2001.

     Distribution

      Domestic equipment sales are made by EPD’s direct sales force. International sales are made either by EPD’s direct sales force, or by distributors and representatives that provide services such as sales, installation, warranty and customer support. Intevac also has a subsidiary in Singapore to support EPD’s customers in Southeast Asia. Through the second quarter of 2000, we marketed our flat panel manufacturing equipment to the Far East through its Japanese joint venture, IMAT. During the third quarter of 2000 Intevac and its joint venture partner, Matsubo, transferred IMAT’s activities and employees to Matsubo, which became a distributor of EPD’s flat panel products, and shut down the operations of IMAT.

      The selling process for EPD’s products is a multi-level and long-term process involving individuals from marketing, engineering, operations, customer service and senior management. The process involves making samples for the prospective customer and responding to individual needs for moderate levels of machine customization. Installing and integrating new equipment requires a substantial investment by a customer. Sales of EPD’s systems depend, in significant part, upon the decision of a prospective customer to replace obsolete equipment or to increase manufacturing capacity by upgrading or expanding existing manufacturing facilities or constructing new manufacturing facilities, all of which typically involve a significant capital commitment. Therefore, customers often require a significant number of product presentations and demonstrations before making a purchasing decision. Accordingly, EPD’s systems typically have a lengthy sales cycle, during which EPD may expend substantial funds and management time and effort with no assurance that a sale will result.

     Competition

      The principal competitive factors affecting the markets for EPD’s products include price, product performance and functionality, integration and manageability of products, customer support and service, reputation and reliability. EPD’s products experience intense competition worldwide from competitors including Anelva 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 EPD’s competitors will not develop enhancements to, or future generations of, competitive products that offer superior price or performance features or that new competitors will not enter EPD’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.

     Backlog

      EPD’s backlog was $15.0 million and $26.5 million at December 31, 2002 and December 31, 2001, respectively. Sales of RTP systems in 2002 and the sale of the rapid thermal processing product line accounted for $7.4 million of the decrease. The balance of the decrease resulted from a lower backlog of disk manufacturing equipment. The majority of this backlog is scheduled for delivery and/or acceptance during the first half of 2003. $11.1 million of the backlog at December 31, 2002 relates to a D-STAR® system and a number of D-STAR® upgrades that are installed at the customer’s site and undergoing final installation and acceptance testing. The balance of the backlog consists of parts and upgrades for disk manufacturing equipment. Intevac includes in its backlog only those customer orders for which it has accepted signed purchase orders with assigned delivery dates. The equipment requirements of Intevac’s customers cannot be

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determined with accuracy, and therefore our backlog at any certain date may not be indicative of future demand for Intevac’s products.

     Customer Support

      EPD provides process and applications support, customer training, installation, start-up assistance and emergency service support to its customers. Process and applications support is provided by EPD’s equipment process engineers, who also visit customers at their plants to assist in process development projects. Intevac conducts training classes for process engineers, machine operators and machine service personnel. Additional training is also given during the machine installation.

      EPD generally provides a one-year warranty on its equipment. During this warranty period any necessary non-consumable parts are supplied and installed. Intevac employees provide field service support primarily in the United States, Singapore and Malaysia. In other countries, field service support is provided by Intevac’s distributors and sales representatives, supplemented by Intevac factory support. Intevac and its distributors stock consumables and spare parts to support the installed base of systems. These parts are generally available on a 24-hour per day basis.

     Manufacturing

      All of Intevac’s EPD manufacturing is conducted at its facility in Santa Clara, California. EPD’s manufacturing operations include electromechanical assembly, mechanical and vacuum assembly, fabrication of the sputter sources and system assembly, alignment and testing. Intevac makes extensive use of the infrastructure serving the semiconductor equipment business. EPD purchases vacuum pumps, valves, instrumentation and fittings, power supplies, printed wiring board assemblies, computers and control circuitry and custom mechanical parts made by forging, machining and welding. Until its closure in September 2002, EPD’s fabrication center manufactured a portion of the fabricated parts used in EPD products and also fabricated parts for commercial customers. We plan during 2003 to replace the fabrication center with a smaller model shop that will support Intevac’s engineering departments and make some of the parts used in Intevac products.

     Working Capital

      The production of large complex systems requires EPD to make significant investments in inventory both to fulfil customer orders and to maintain adequate supplies of spare parts to service previously shipped systems. EPD typically requires its customers to pay for systems in three installments, with a portion of the system price billed upon receipt of an order, a portion of the system price billed upon shipment, and the balance of the system price and any sales tax due upon completing installation and acceptance of the system at the customer’s factory. All customer product payments are recorded as customer advances pending revenue recognition. EPD also maintains an inventory of spare parts at our Singapore subsidiary to support our customers in Singapore and Malaysia. EPD’s inventories at December 31, 2002 and December 31, 2001, respectively, were $15.1 million and $21.0 million. EPD’s accounts receivable at December 31, 2002 and December 31, 2001, respectively, were $3.3 million and $6.4 million. EPD’s customer advances at December 31, 2002 and December 31, 2001, respectively, were $12.3 million and $13.5 million.

Photonics Technology Division

     Description of Business

      The Photonics Technology Division’s products have been developed by a team that initially began working together in the 1980’s in the Varian central research labs and night vision business unit. When Intevac was formed in 1991, it acquired Varian’s night vision business, and the related Varian central research lab activities and technology. The central research lab group became part of the R&D department for Intevac’s night vision business and continued to develop Intevac’s photocathode technology. In 1995, Intevac sold its night vision business to Litton Industries. However, the technical team remained at Intevac and formed PTD. Since 1995 PTD has been further developing its technology, with the majority of its activities being funded by

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R&D contracts from the United States Government and its contractors. During this period PTD has also worked collaboratively with other research organizations, including Stanford University, Lawrence Livermore National Laboratory and The Charles Stark Draper Laboratory. PTD is developing electro-optical sensors, cameras and systems that permit highly sensitive detection of photons in the visible and infrared portions of the spectrum. Products include LIVAR® systems for positive target identification at long range and extreme low light level sensors and cameras for use in military applications.

     LIVAR® Sensor Technology

      PTD develops and manufactures compact electro-optical sensors that permit highly sensitive detection of photons in the visible and infrared portions of the spectrum. One of these sensors is an Electron Bombarded Charge Coupled Device (“EBCCD”) which was originally developed under a cost-sharing Technology Development Agreement with the Defense Advanced Research Projects Agency (“DARPA”) from 1996 to 1998. The sensor consists of a photocathode integrated with a charge-coupled device (“CCD”) imager. When photons strike the photocathode, electrons are emitted and electrically accelerated. The electrons then illuminate the CCD imager, which in turn outputs a high resolution, low noise video signal. These devices are extraordinarily sensitive to infrared light with wavelengths just beyond the visible spectrum and are used in PTD’s LIVAR® target identification system.

     EBAPS® Sensor Technology

      A second type of sensor incorporates the same basic technology described above; however, the module contains a Complementary Metal-Oxide-Semiconductor (“CMOS”) imager instead of a CCD chip. This Electron Bombarded Active Pixel Sensor (“EBAPS®”) imager development was initially funded under a cost sharing project awarded to Intevac by the National Institute of Standards and Technology. This EBAPS® imager has comparable sensitivity to generation three night vision technology, but in a more compact package that offers video rate digital output, rather than the direct view “green glow” image provided by traditional night vision tubes. PTD’s objective is to reduce the cost of the EBAPS® sensor to significantly less than the cost of a traditional generation three night vision device. At this cost we believe that large available markets for military head mounted displays, homeland defense, law enforcement and commercial security applications can be addressed. Late in 2002 PTD was awarded an $860,000 contract from Science Application International Corporation (“SAIC”) to develop a prototype miniature camera based on its EBAPS® technology for head mounted display applications for the US Army.

     LIVAR® System Technology

      Intevac integrated its EBCCD sensor with a laser illuminator to create its Laser Illuminated Viewing and Ranging system (“LIVAR®”). The LIVAR® system is similar to RADAR, but with a number of improvements. The illuminator is an eye safe laser, rather than a microwave source, and the reflected signal is displayed as a digital video image, rather than as a blip. This enables real time, high-resolution imagery for target identification at much longer ranges than was previously possible.

      The potential benefit of the LIVAR® system is clear for military conflicts like those in Kosovo and Afghanistan. In such conflicts, casualties to US servicemen are politically unacceptable, and it is preferable for aircraft to operate at high altitudes where they are relatively safe from ground launched missile attacks. It is also unacceptable to inflict collateral damage to the other sides’ civilians or to other untargeted assets. However, these goals are mutually exclusive unless capability exists for positively identifying potential targets from long ranges.

      Currently the military uses several means for target location and identification including forward-looking infrared systems and RADAR. While these systems can detect targets at relatively long ranges, the resolution is poor, and positive identification is difficult, or impossible. The LIVAR® system complements existing FLIR and RADAR technology and enables long-range target identification in addition to target detection.

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     LIVAR® Products

      The first military program planning the widespread deployment of LIVAR® was approved late in 2001. PTD is under contract for the development phase of the program, and limited production is expected to commence in late 2003.

      Early in 2002 PTD delivered a manportable LIVAR® demonstrator unit to the US Army. Later in 2002 PTD announced the LIVAR 2200 product line which was derived from the original Army prototype system. The LIVAR 2200 is a man-portable, tripod mounted system.

      PTD is also under contract from DRS Sensor Systems, Inc. to integrate LIVAR® into the Army’s Cost Effective Targeting System (“CETS”). CETS is an autonomous gimbal-mounted sensor suite for unmanned ground vehicles.

      PTD cameras utilizing LIVAR® technology have been designed into the Airborne Laser (“ABL”) system being developed by a team consisting of the US Air Force, Boeing, Lockheed Martin and TRW. The ABL is an airborne system designed to shoot down missiles at ranges of up to 200 kilometers with high power lasers. Each ABL system includes three Intevac LIVAR® cameras, which are used to provide targeting data to the laser. The first ABL-equipped prototype flew in 2002, and field deployment of the ABL system is currently scheduled for 2008.

     Customers

      PTD’s contracts are generally issued by a government agency or by companies working under government contract. PTD’s customers include Advanced Scientific Concepts, DRS Sensors Systems, Lockheed Martin, Northrop Grumman, Raytheon, SAIC and the US Army Communications-Electronics Command (“CECOM”). PTD’s customers generally develop systems, which incorporate PTD’s products, over very long periods of time, generally a number of years, after which they begin production, provided the system development is successfull and production is funded by the contracting agency. PTD’s primary objective is to secure production subcontracts once its customers’ products have reached the production stage. Long term growth in PTD revenues and profits is dependent on PTD developing a production business in which the majority of revenue is derived from the sale of products, rather than from contract research and development.

     Distribution

      PTD markets directly to its customers and its selling process involves the solicitation of contracts and subcontracts from government agencies and from government contractors and subcontractors. A majority of contracts are bid at cost plus a fee, other contracts are bid at a fixed price, and some contracts are bid on a cost-sharing basis. The sales process involves government procurement regulations and sales are dependent on the continuing availability of government funding for our research programs. Future production orders for Intevac’s military products are dependent on future government funding of weapons systems that utilize Intevac products such as LIVAR®.

     Competition

      Competitors exist for our products and a number of these competitors have greater resources than Intevac. For example, ITT Industries and Northrop Grumman, who are large and well-established defense contractors, are the primary U.S. manufacturers of generation three night vision devices and their derivative products. Our extreme low light level cameras are intended to displace some generation three night vision based products and we expect that ITT Industries and Northrop Grumman will continue to enhance the performance of their products and aggressively promote continued sales of their products. There are also a number of international companies that manufacture night vision devices and products with a varying range of performance and price that may compete with our products. Furthermore, Raytheon, Lockheed Martin, FLIR Systems and Wescam manufacture cooled infrared systems. Our LIVAR® target identification products will compete with these cooled infrared systems and target detection and identification systems offered by these and other manufacturers. In order to effectively compete with these manufacturers, Intevac will need to

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develop products on a cost-effective and timely basis that will offer attractive features and pricing relative to the products offered by our competitors.

      Additionally, we expect that the sales of most of our products will be made through subcontracts to primary contractors. The degree of gross profit that can be generated under a subcontract is a function of the relative proportion of the primary contractor’s end product that we manufacture under our subcontract. This relative proportion is negotiated on a contract by contract basis. For example, in a LIVAR® system, if we only provide the LIVAR® sensor and related electronics, then our revenue and gross profit will be less than if we provide the sensor and related electronics, the laser illuminator, the lens, the display and the integration of these and any other necessary components.

     Backlog

      PTD’s backlog was $3.2 million and $4.1 million at December 31, 2002 and December 31, 2001, respectively. PTD’s backlog consists primarily of research contracts. Many of PTD’s research contracts are multiyear programs, which are released in multiple phases. PTD only includes in backlog the portion of each program that has been funded, and whose funding has been released to PTD by the contracting agency. The majority of PTD’s backlog at December 31, 2002 is scheduled for completion during the first half of 2003.

     Manufacturing

      PTD’s research and manufacturing operations are located in approximately 26,000 square feet of space at Intevac’s Santa Clara headquarters. Laboratories and clean room facilities account for approximately 15,000 square feet of this space. PTD’s manufacturing operations include the manufacture of advanced photocathodes and sensors, lasers, cameras and integrated camera systems. PTD makes extensive use of advanced manufacturing techniques and equipment, and its operations include vacuum, electromechanical and optical system assembly. PTD makes use of the infrastructure serving the semiconductor, camera and optics manufacturing industries. In manufacturing its sensors, PTD purchases wafers, components, processing supplies and chemicals. In manufacturing its camera systems, PTD purchases printed circuit boards, electromechanical components and assemblies, mechanical components and enclosures, optical components and computers.

     Working Capital

      PTD generally invoices its R&D customers either as costs are incurred, or as program milestones are achieved, depending upon contract terms. As a government contractor, PTD invoices customers using estimated annual rates approved by the Defense Contracts Audit Agency (“DCAA”). A majority of PTD’s contracts are Cost Plus Fixed Fee (“CPFF”) contracts. 15% of the “Fee” on any CPFF contract is withheld pending completion of the program and DCAA’s annual audit of Intevac’s actual rates. The withheld portion of the Fee is included in accounts receivable and totaled $157,000 as of December 31, 2002 and $125,000 as of December 31, 2001. PTD’s accounts receivable at December 31, 2002 and December 31, 2001, respectively, were $1.7 million and $1.7 million. PTD’s inventory consists of component parts used in the manufacture of its sensors, material, labor and overhead charged to research and development contracts that has not yet been billed to the customer and LIVAR® parts and assemblies. PTD’s inventories at December 31, 2002 and December 31, 2001, respectively, were $0.8 million and $0.7 million.

Commercial Imaging Division

     Description of Business

      The Commercial Imaging Division (formerly the Intensified Imaging Division) was formed in July 2002 with the charter of developing commercial products based on PTD technology. CID’s initial product offerings will include low light level video cameras and Threat Detection and Identification Systems (“TDIS”).

      To date CID’s activities have consisted of market and product development and accounted for $1.7 million, or 9%, of Intevac’s 2002 operating expenses. CID also assumed responsibility from PTD for

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activities related to the development of photodiodes for use in high-speed fiber optic systems. Future development of these photodiodes, which accounted for $0.5 million of CID’s 2002 operating expenses, was suspended at the end of 2002 due to weak market conditions in the telecommunications industry. Existing photodiode products remain available for sale to customers.

     Products

      CID expects to begin the manufacture and sale of commercial products in the second half of 2003. During 2002 CID began development efforts on core camera modules that will serve as the basis for CID products. Starting with low light level compact video cameras targeting closed circuit television (“CCTV”) systems, CID plans to offer generation III capability at a significantly lower price. In addition, networked cameras will be introduced to leverage communication infrastructure, providing customers with remote monitoring.

      Building on PTD’s LIVAR® technology, CID plans to announce its Threat Detection and Identification Systems product line later in 2003. CID’s TDIS systems plan to harness the long-range capabilities of active eye safe imaging developed by PTD, coupled with the latest digital processing and communication developments. The TDIS systems plan to offer scaleable solutions to government and private industry customers that require surveillance for large outdoor areas and perimeters, such as borders, ports, airports and water districts. These systems are expected to offer cost benefits over today’s conventional CCTV solutions. CID is developing systems for medium-range applications (up to one kilometer) to very long-range applications (up to 3 kilometers) which are expected to allow customers to identify threats with high-resolution imagery while minimizing false alarms.

     Distribution

      CID plans to distribute its products through direct sales, value-added resellers and by teaming with complementary large companies that have established distribution networks in place. CID’s near term focus targets direct sales to government agencies responsible for securing the nation’s infrastructure and transportation systems. To date, CID has directly approached several agencies that report to the Department of Homeland Security with proposals to act as the primary contractor for medium to large area surveillance systems.

     Competition

      Well established competitors exist for CID’s products and a number of these competitors have greater resources than Intevac. CID’s products will sell in competition with products derived from military night vision tube technology and produced by companies such as ITT Industries, with uncooled forward looking infrared cameras and other target detection and identification systems produced by companies such as FLIR Systems and Wescam, with products based on electron multiplied charge coupled devices manufactured by companies such as E2V and Texas Instruments, and with color CCTV cameras offered by numerous manufacturers that are less expensive, but offer significantly less low light capability. In order to effectively compete with these manufacturers, CID will need to develop products on a cost-effective and timely basis that will offer attractive features and pricing relative to the products offered by our competitors.

     Backlog

      CID had no backlog as of December 31, 2002.

     Manufacturing

      The EPD and PTD manufacturing organizations will initially manufacture CID’s products.

     Working Capital

      CID had no inventory, accounts receivable or customer advances at December 31, 2002.

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Research and Development

      Intevac’s products serve markets characterized by rapid technological change and evolving industry standards. Intevac routinely invests substantial amounts in research and development and expects to continue an active development program. Our research and development expenses were $10.8 million, $14.5 million and $10.6 million, respectively, in 2002, 2001, and 2000. Research and development expenses represented 32%, 28% and 29%, respectively, of net revenues in 2002, 2001 and 2000. Research and development spending declined during 2002 as the result of the completion during 2001 of the design activities related to development of the D-STAR®, RTP and MDP-200 platforms, partially offset by an increase in CID and PTD research and development.

      Research and development expenses do not include costs of $5.2 million, $8.0 million and $6.0 million in 2002, 2001 and 2000, respectively, related to PTD contract research and development which are included in cost of goods sold. Research and development expenses also do not include costs of $0.3 million, $0.5 million and $0.7 million incurred by EPD in 2002, 2001 and 2000, respectively, and reimbursed under the terms of research and development cost sharing agreements related to development of disk and flat panel manufacturing equipment.

Customer Concentration

      Historically, a significant portion of our revenue in any particular period has been attributable to sales to a limited number of customers. In 2002, Seagate, Toppoly, and the US Army Communications-Electronics Command each accounted for more than 10% of Intevac’s consolidated revenues, and in aggregate accounted for 74% of net revenue. In 2001, equipment sales through Matsubo, our Japanese distributor, accounted for 49% of net revenues. In 2000, MMC Technology, Seagate, Westt and Matsubo each accounted for more than 10% of Intevac’s consolidated revenues and in aggregate accounted for 56% of net revenues. Intevac’s largest customers change from period to period, and it is expected that sales of its products to relatively few customers will continue to account for a high percentage of its net revenues in the foreseeable future.

      Foreign sales accounted for 52% of revenues in 2002, 73% of revenues in 2001, and 27% of revenues in 2000. The majority of Intevac’s foreign sales are to companies in the Far East and we anticipate that sales to customers in the Far East will continue to be a significant portion of our EPD revenues.

Patents and Licensing

      Intevac currently holds 28 patents issued in the United States and 26 patents issued in foreign countries, and has patent applications pending in the United States and foreign countries. Of the 28 U.S. patents, 15 relate to disk and flat panel equipment and 13 relate to photonics. Of the foreign patents, 13 relate to disk equipment and flat panel equipment and 13 relate to photonics. In addition, Intevac has the right to utilize certain patents under licensing arrangements with Litton Industries, Stanford University, Lawrence Livermore Laboratories and Alum Rock Technology.

Employees

      At December 31, 2002, Intevac had 136 employees, including 4 contract employees. 71 of these employees were in research and development, 33 in manufacturing, and 32 in administration, customer support and marketing. Of the 136 employees, 69 were in EPD, 38 were in PTD, 13 were in CID and 16 were in Corporate.

Compliance with Environmental Regulations

      We are subject to a variety of governmental regulations relating to the use, storage, discharge, handling, emission, generation, manufacture, treatment and disposal of toxic or otherwise hazardous substances, chemicals, materials or waste. We treat the cost of complying with government regulations and operating a safe workplace as a normal cost of business and allocate the cost of these activities to all functions, except where the cost of those activities can be isolated and charged to a specific function. We believe the

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environmental standards and regulations promulgated by government agencies in Santa Clara, California are rigorous and set a high standard of compliance for Intevac. We believe our costs of compliance with these regulations and standards are comparable to other companies operating similar facilities in Santa Clara, California.

Certain Factors Which May Affect Future Operating Results

 
Revenue generated by our businesses during 2003 may not provide sufficient gross profit to cover operating and interest expenses.

      A significant increase in the sales of disk manufacturing equipment and/or deposition equipment for the manufacture of flat panel displays and/or photonics-based revenues will be necessary for Intevac to be able to generate sufficient gross profit to offset expected operating and net interest expenses during 2003. The majority of our revenues and gross profit have historically been derived from sales of disk manufacturing equipment and deposition and rapid thermal processing equipment for the manufacture of flat panel displays. Our sales of disk manufacturing equipment have been severely depressed since the middle of 1998. While we believe that the disk manufacturing industry will need to make substantial investments to upgrade its productive capacity, the timing of this investment is uncertain and there can be no assurance that it will happen, or that we will be selected to provide these upgrades. We sold our rapid thermal processing product line to Photon Dynamics in November 2002, a product line which accounted for $7.1 million of our net revenues during 2002. Additionally, other than for products that are already shipped and undergoing installation and acceptance testing, we have no current backlog of orders for deposition products for the manufacture of flat panel displays. PTD has yet to earn an annual profit. Failure to generate sufficient net revenues and gross profit in 2003 to offset operating and interest expenses would have an adverse effect on our business, net worth and cash.

 
We sell our equipment products to a small number of large customers. Competition is intense and loss of one of those customers would significantly reduce potential future revenues.

      We experience intense competition in EPD. For example, our disk and flat panel products experience competition worldwide from competitors including Anelva Corporation, Ulvac Japan, Ltd. and Unaxis Holdings, Ltd., each of which has sold substantial numbers of systems worldwide. Anelva, Ulvac and Unaxis all have substantially greater financial, technical, marketing, manufacturing and other resources than we do. There can be no assurance that our 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 our markets and develop such enhanced products. Accordingly, competition for our customers is intense, and suppliers of equipment may offer substantial pricing concessions and incentives to attract our customers or retain existing customers. The loss of any one of our large customers would significantly reduce potential future revenues.

 
We may not have the financial resources to repurchase our convertible notes if one of the events giving holders the right to require us to repurchase their notes occurs.

      Certain events give holders of our convertible notes, including both our convertible notes due 2004 (“2004 Notes”) and convertible notes due 2009 (“2009 Notes”), the right to require us to repurchase their notes. These events include the termination of trading of our common stock or a transaction that results in a change in control (which includes a person acquiring beneficial ownership of greater than 50% of our shares, a merger or consolidation, the sale of all or substantially all of our assets, or a change in the majority of our directors). In the case of the 2009 Notes only, a distribution to our common stock holders of all the capital stock of a subsidiary that at the time constitutes our Photonics business will also give the holders of the 2009 Notes the right to require us to repurchase their 2009 Notes. If one of these designated events were to occur, we may not have enough funds to pay the repurchase price for all notes for which repurchase is requested. Moreover, any future credit agreements or other debt agreements may prohibit such a repurchase, or may provide that such a repurchase constitutes an event of default under that debt agreement. If we are put in a position where one of these designated events has occurred but we are prohibited from repurchasing the notes, we could seek the consent of our lenders to repurchase the notes in question, or could attempt to

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refinance the debt agreements. If we do not obtain the lenders consent, we could not repurchase the notes, which would constitute an event of default under the particular indenture governing those notes, which might in turn also constitute an event of default under the terms of our other debt.
 
The majority of our future revenue is dependent on new products. If these new products are not successful, then our results of operations will be severely impacted.

      We have invested heavily, and continue to invest, in the development of new products. PTD’s LIVAR® target identification and low light level camera technologies are designed to offer significantly improved capability to military customers. EPD’s D-STAR® deposition tool for flat panel display manufacturing is intended to displace products offered by competing manufacturers. EPD continues to invest heavily to develop products for the thin-film disk manufacturing industry. CID is developing commercial products based on the technology developed by PTD. These businesses will require substantial further investment in sales and marketing, in product development and in additional production facilities. There can be no assurance that we will succeed in these activities and generate significant sales of products. Failure of any of these products to perform as intended, to penetrate their markets and develop into profitable product lines would have an adverse effect on our business.

 
Demand for capital equipment is cyclical, which subjects our business to long periods of depressed revenues interspersed with periods of unusually high revenues.

      EPD sells equipment to capital intensive industries, which sell commodity products such as 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 ours tends to be amplified. When supply of these commodity products exceeds demand, the demand for new capital equipment such as ours tends to be depressed. The cyclical nature of the capital equipment industry means that in some years sales of new systems by us will be unusually high, and that in other years sales of new systems by us will be severely depressed. Sales of systems for thin-film disk production have been severely depressed since the middle of 1998, and continue to be depressed. Failure to anticipate or respond quickly to the industry business cycle could have an adverse effect on our business.

 
      Our significant amount of debt could have a negative effect on us and on our security holders.

      We have $1.0 million of convertible notes due in 2004 and $29.6 million of convertible notes due in 2009 outstanding. The aggregate $30.6 million of convertible notes commits us to substantial principal and interest obligations. Our significant amount of debt could harm Intevac and holders of our common stock and convertible notes in many ways, including:

  •  reducing the funds available to finance our business operations and for other corporate purposes because a portion of our cash flow from operations must be dedicated to the payment of principal and interest on our debt;
 
  •  impairing our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes;
 
  •  placing us at a competitive disadvantage because we are substantially more leveraged than certain of our competitors;
 
  •  hindering our ability to adjust rapidly to changing market conditions; and
 
  •  making us more vulnerable financially in the event of a further downturn in general economic conditions or in our business.

      Our ability to meet our debt service obligations will depend on our future operating performance and cash flow. Our operating performance and cash flow, in part, are subject to business, financial and economic factors beyond our control.

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      We may undertake significant additional financing transactions in order to maintain sufficient cash to conduct our operations.

      We may need to obtain additional financing to fund our future operations, and we may seek to raise additional funds through a variety of alternative sources, including the sale of additional securities or from other financing arrangements or asset sales. Our board of directors has from time to time considered a number of possible transactions. Such transactions might include:

  •  selling off a portion of our assets to raise additional capital;
 
  •  undertaking a rights offering to obtain financing from our existing shareholders;
 
  •  attempting to raise additional equity through public or private offerings;
 
  •  attempting to raise additional debt financing; or
 
  •  obtaining a line of credit.

      We may undertake one or more of these transactions. We do not know whether we will be able to complete any of these transactions on a timely basis, on terms satisfactory to us, or at all. For example, we may not have access to new capital in the public or private markets until our results of operations improve, if at all. In addition, some of these transactions may result in significant dilution to our existing security holders or impairment of their rights. Nonetheless, if we are unable to complete one or more of these transactions, our ability to maintain our ongoing operations, and to pay principal and interest in cash on our outstanding notes when due, may be jeopardized.

 
      Our business is subject to rapid technical change, which requires us to continually develop new products in order to sustain and grow our revenue.

      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 our business. From time to time, we have experienced delays in the introduction of, and technical difficulties with, some of our systems and enhancements. Our future success in developing and selling equipment will depend upon a variety of factors, including our ability to accurately predict future customer requirements, technological advances, cost of ownership, our introduction of new products on schedule, cost-effective manufacturing and product performance in the field. Our 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 our business.

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

      EPD 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 systems that we manufacture must be customized to meet individual customer site or operating requirements. We have limited 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 our products. Any of these factors could adversely affect our business.

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      The sales of our disk and flat panel products are dependent on substantial capital investment by our customers, far in excess of the cost of our products.

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

 
      Our business depends on the integrity of our intellectual property rights.

      There can be no assurance that:

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

      Failure to adequately protect our intellectual property rights could have an adverse effect upon our business.

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

 
      Our operating results fluctuate significantly.

      Over the last eight quarters our operating loss as a percentage of net revenues has fluctuated between approximately 59% and 1% of net revenues. Over the same period our sales per quarter have fluctuated between $23.6 million and $6.7 million. We anticipate that our sales and operating margins will continue to fluctuate. As a result, period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance.

 
      Operating costs in northern California are high.

      Our 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. Our operating results depend in significant part upon our 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 our business.

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      Business interruptions could adversely affect our business.

      Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control.

 
      A significant portion of our sales are made to international customers.

      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. We earn a significant portion of our revenue from international sales, and there can be no assurance that any of these factors will not have an adverse effect on our business.

      We generally quote and sell our products in US dollars. However, for some Japanese customers, we have quoted and sold our products in Japanese Yen. From time to time, we have entered into foreign currency contracts in an effort to reduce the overall risk of currency fluctuations to our 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 our business.

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

 
      We expect the market price of our common stock and convertible notes to be volatile.

      The market price of our common stock has experienced both significant increases in valuation and significant decreases in valuation, over short periods of time. We believe that factors such as announcements of developments related to our business, fluctuations in our 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 us or our 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 our relationships with customers and suppliers could cause the price of our 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, have experienced extreme price fluctuations that have often been unrelated to the operating performance of affected companies. Any of these factors could adversely affect the market price of our common stock and convertible notes. Our common stock is not heavily traded in the market, with daily volume averaging approximately 8,000 shares in 2002. As a result, any attempt by a shareholder to either acquire or dispose of a significant position in our stock could cause significant fluctuations in the price of the shares.

 
      We routinely evaluate acquisition candidates and other diversification strategies.

      We have completed multiple acquisitions as part of our efforts to expand and diversify our business. For example, our business was initially acquired from Varian Associates in 1991. We acquired our gravity lubrication and rapid thermal processing product lines in two acquisitions. We also acquired the RPC electron beam processing business in late 1997, and subsequently closed this business. We sold the rapid thermal processing product line in November 2002. We intend to continue to evaluate new acquisition candidates, divestiture and diversification strategies. Any acquisition involves 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 and other functions. Any future

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acquisitions may also result in potentially dilutive issuance of equity securities, acquisition or divestiture related write-offs and the assumption of debt and contingent liabilities. Any of the above factors could adversely affect our business.
 
      We use hazardous materials.

      We are subject to a variety of governmental regulations relating to the use, storage, discharge, handling, emission, generation, manufacture, treatment and disposal of toxic or otherwise 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 us or our officers, directors or employees, suspension of production, alteration of our manufacturing process or cessation of operations. Such regulations could require us to acquire expensive remediation or abatement equipment or to incur substantial expenses to comply with environmental regulations. Any failure by us to properly manage the use, disposal or storage of, or adequately restrict the release of, hazardous or toxic substances could subject us to significant liabilities.

 
      Our directors and executive officers control a majority of our outstanding common stock.

      Based on the shares outstanding on December 31, 2002, our current directors and their affiliates and our executive officers, in the aggregate, beneficially own a majority of the outstanding shares of common stock. These shareholders, acting together, are able to effectively control all matters requiring approval by our shareholders, including the election of a majority of the directors and approval of significant corporate transactions. Two of our directors also hold in aggregate 7% of the outstanding convertible notes.

Item 2.     Properties

      Intevac leases a 119,583 square foot facility in Santa Clara, California. The two-story facility includes offices, manufacturing, engineering labs and clean rooms. All of Intevac’s operations, with the exception of our Singapore customer support office, are housed at the Santa Clara facility. As of December 31, 2002 approximately 20,600 square feet of the facility previously occupied by our fabrication center was not being utilized. Additionally, a portion of the facility dedicated to the Equipment Products Division manufacturing operations was significantly underutilized. The costs related to these underutilized spaces are included in selling, general and administrative expense, and totaled $198,000 and $0, respectively, in 2002 and 2001. If the utilization rate of the facility continues at the same level as at the end of 2002, then approximately $1.1 million of excess facility cost will be included in 2003 selling, general and administrative expense. The lease for the Santa Clara facility expires in March 2007. Intevac has an option to extend the lease for an additional five-year period, with a monthly base rent to be negotiated by Intevac and the lessor. If Intevac and the lessor are unable to reach agreement with respect to such monthly base rent, an appraisal process set forth in the lease will determine the monthly base rent for the extension. Intevac also leases a facility of approximately 2,400 square feet in Singapore to house the Singapore customer support organization. This lease expires in December 2003. Intevac believes that its current facilities are suitable and adequate for its current and foreseeable operations. Intevac operates with one full manufacturing shift and one partial manufacturing shift. Intevac believes that it has sufficient productive capacity to meet its current needs.

Item 3.     Legal Proceedings

      On June 12, 1996 two Australian Army Black Hawk Helicopters collided in midair during nighttime maneuvers. Eighteen Australian servicemen perished and twelve were injured. Intevac was named as a defendant in a lawsuit related to this crash. The lawsuit was filed in Stamford, Connecticut Superior Court on June 10, 1999 by Mark Durkin, the administrator of the estates of the deceased crewmembers, the injured crewmembers and the spouses of the deceased and/or injured crewmembers. Included in the suit’s allegations were assertions that the crash was caused by defective night vision goggles. The suit named three US manufacturers of military night vision goggles, of which Intevac was one. The suit also named the manufacturer of the pilot’s helmets, two manufacturers of night vision system test equipment and the manufacturer of the helicopters. The suit claimed damages for 13 personnel killed in the crash, 5 personnel injured in the crash and spouses of those killed or injured. It is known that the Australian Army established a

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Board of Inquiry to investigate the accident and that one of the conclusions of the Board of Inquiry was that the accident was not caused by defective night vision goggles.

      On July 27, 2000 the Connecticut Superior Court disallowed the defendants’ motion to dismiss the lawsuit. On October 30, 2001 the Connecticut Supreme Court reversed the Superior Court’s decision and remanded the case to the trial court with the direction to grant the defendants’ motion to dismiss the suit subject to conditions already agreed to by the defendants. These conditions agreed to by the defendants include (1) consenting to jurisdiction in Australia; (2) accepting service of process in connection with an action in Australia; (3) making their personnel and records available for litigation in Australia; (4) waiving any applicable statutes of limitation in Australia up to six months from April 26, 2002, the date of dismissal of this action or for such other reasonable time as may be required as a condition of dismissing this action; (5) satisfying any judgement that may be entered against them in Australia; and (6) consenting to the reopening of the action in Connecticut in the event the above conditions are not met as to any proper defendant in the action.

      On October 21, 2002 a lawsuit was filed in Queensland, Australia by Gerard Bampton, a member of the Australian Special Air Services Regiment who was injured in the 1996 crash. Included in the suit’s allegations are assertions that the crash was caused by defective night vision goggles. The suit names three US manufacturers of military night vision goggles, of which Intevac was one. The suit also names the manufacturer of the helicopters. Investigations made at the time of the original Durkin lawsuit lead us to believe that we have meritorious defenses against the new lawsuit. However, there can be no assurance that the resolution of the suit will not have a material adverse effect on our business, operating results and financial condition.

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

      No matters were submitted to a vote of security-holders during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.

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EXECUTIVE OFFICERS AND DIRECTORS

      Certain information about Intevac’s directors and executive officers is listed below:

             
Name Age Position



Executive Officers and Directors:
           
Norman H. Pond
    64     Chairman of the Board
Kevin Fairbairn
    49     President, Chief Executive Officer and Director
Verle Aebi
    48     President of Photonics Technology Division
Charles B. Eddy III
    52     Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary
David Dury(1)
    54     Director
Robert D. Hempstead(1)(2)
    59     Director
David N. Lambeth(2)
    55     Director
Robert Lemos(1)
    62     Director
H. Joseph Smead
    77     Director
Other Key Officers:
           
Kimberly Burk
    37     Human Resources Director
Daniel Gentry
    56     Vice President and General Manager of Equipment Products Division
Stephen Gustafson
    31     Director, Product Operations, Photonics Technology Division
Timothy Justyn
    40     Vice President, Operations, Equipment Products Division
Christopher Lane
    36     Vice President and General Manager of Commercial Imaging Division


(1)  Member of Audit Committee
 
(2)  Member of Compensation Committee

      Mr. Pond is a founder of Intevac and has served as Chairman of the Board since February 1991. Mr. Pond served as President and Chief Executive Officer from February 1991 until July 2000 and again from September 2001 through January 2002. Mr. Pond holds a BS in physics from the University of Missouri at Rolla and a MS in physics from the University of California at Los Angeles.

      Mr. Fairbairn joined Intevac as President and Chief Executive Officer in January 2002 and was appointed a Director of the Company in February 2002. Before joining Intevac, Mr. Fairbairn was employed by Applied Materials from July 1985 to January 2002, most recently as Vice-President and General Manager of the Conductor Etch Organization with responsibility for the Silicon and Metal Etch Divisions. From 1996 to 1999, Mr. Fairbairn was General Manager of Applied’s Plasma Enhanced Chemical Vapor Deposition Business Unit and from 1993 to 1996, he was General Manager of Applied’s Plasma Silane CVD Product Business Unit. Mr. Fairbairn holds a MA in Engineering Sciences from Cambridge University.

      Mr. Aebi has served as President of the Photonics Division since July 2000. Mr. Aebi served as General Manager of the Photonics Division since May 1995 and was elected as a Vice President of the Company in September 1995. From 1988 through 1994, Mr. Aebi was the Engineering Manager of the Company’s night vision business, where he was responsible for new product development in the areas of advanced photocathodes and image intensifiers. Mr. Aebi holds a BS in physics and an MS in electrical engineering from Stanford University.

      Mr. Eddy has served as Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary of Intevac since April 1991. Mr. Eddy holds a BS in engineering science from the University of Virginia and a MBA from Dartmouth College.

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      Mr. Dury has served as a Director of Intevac since July 2002. Mr. Dury is a co-founder of Mentor Capital Group, a venture capital firm. From 1996 to 2000, Mr. Dury served as Senior Vice-President and Chief Financial Officer of Aspect Development, a software development firm. Mr. Dury holds a BA in psychology from Duke University and an MBA from Cornell University.

      Dr. Hempstead has served as a Director of Intevac since March 1997 and served as Chief Operating Officer of Intevac from April 1996 through June 1999. Dr. Hempstead served as Chief Technology Officer at Veeco Instruments from December 1999 to December 2002. Dr. Hempstead is currently a self-employed consultant. Dr. Hempstead holds a BS and MS in electrical engineering from the Massachusetts Institute of Technology and a Ph.D. in physics from the University of Illinois.

      Dr. Lambeth has served as a Director of Intevac since May 1996. Dr. Lambeth has been Professor of both Electrical and Computer Engineering and Material Science Engineering at Carnegie Mellon University since 1989. Dr. Lambeth was Associate Director of the Data Storage Systems at Carnegie Mellon University from 1989 to 1999. Since 1988, Dr. Lambeth has been the owner of Lambeth Systems, an engineering consulting and research firm. Dr. Lambeth holds a BS in electrical engineering from the University of Missouri and a Ph.D. in physics from the Massachusetts Institute of Technology.

      Mr. Lemos has served as a Director of Intevac since August 2002. Mr. Lemos retired from Varian Associates, Inc. in 1999 after 23 years, including serving as Vice-President and Chief Financial Officer from 1988 to 1999. Mr. Lemos has a BS in Business from the University of San Francisco, a JD in law from Hastings College and a LLM in law from New York University.

      Dr. Smead has served as a Director of Intevac since February 1991. Dr. Smead joined Kaiser Aerospace and Electronics Corporation (“Kaiser”) in 1974 and served as Kaiser’s President from 1974 until October 1997. Dr. Smead served as President and Chairman of the Board of Directors of K Systems, Inc., Kaiser’s parent company, from 1977 until October 1997. Dr. Smead served as Chairman of the Board of Directors of Kaiser until December 1999. Dr. Smead resigned as a director of Kaiser and its subsidiaries in December 2000. Dr. Smead holds a BS in electrical engineering from the University of Colorado, a MS in electrical engineering from the University of Washington and a Ph.D. in electrical engineering from Purdue University.

      Ms. Burk has served as Human Resources Director of Intevac since May 2000. Prior to joining Intevac, Ms. Burk served as Human Resources Manager of Moen, Inc., from 1999 to 2000 and served as Human Resources Manager of Lawson Mardon from 1994 to 1999. Ms. Burk holds a BS in Sociology from Northern Illinois University.

      Mr. Gentry has served as the General Manager of the Equipment Products Division of Intevac since 2002. Mr Gentry joined Intevac in March 1991 and has served as Sales and Marketing Manager for the Company’s memory and flat panel equipment products. Mr. Gentry was elected a Vice-President of the Company in September 1995. Mr. Gentry holds a BS and MS in Electrical Engineering from the Massachusetts Institute of Technology and a MBA from Harvard University.

      Mr. Gustafson has served as Director of Product Operations of Intevac since May 2002. Before joining Intevac, from 1995 to May 2002, Mr. Gustafson was employed by Applied Materials as a Sr. Operations Manager in the Conductor Etch Organization. Mr. Gustafson holds a BA in Humanities from San Jose State University.

      Mr. Justyn has served as Vice President, Operations of Intevac since April 1997. Mr. Justyn joined Intevac in February 1991 and has served in various roles in our Equipment Products Division and our former night vision business. Mr. Justyn holds a BS in Chemical Engineering from the University of California, Santa Barbara.

      Mr. Lane has served as General Manager of the Commercial Imaging Division since he joined Intevac in July 2002 and was elected a Vice-President in February 2003. Before joining Intevac, from 1990 to July 2002, Mr. Lane was employed by Applied Materials, most recently as Director of Engineering, CVD and Etch in the Conductor Etch Organization. Mr. Lane holds a BS in Mechanical Engineering, a MS in Engineering Management and a MBA, all from California Polytechnic State University at San Luis Obispo.

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PART II

Item 5.     Market for Registrant’s Common Equity and Related Shareholder Matters

      Intevac’s Common Stock commenced trading on the NASDAQ National Market on November 21, 1995 and is traded under the symbol “IVAC.” As of December 31, 2002, there were approximately 2,000 holders of record of the Common Stock. The following table sets forth for the periods indicated the high and low closing sale prices for the Common Stock as reported on the NASDAQ National Market.

                   
High Low


Fiscal 2001
               
 
First Quarter
  $ 5.890     $ 3.500  
 
Second Quarter
  $ 5.950     $ 4.400  
 
Third Quarter
  $ 4.980     $ 1.950  
 
Fourth Quarter
  $ 4.240     $ 2.380  
Fiscal 2002
               
 
First Quarter
  $ 4.390     $ 2.380  
 
Second Quarter
  $ 5.110     $ 2.500  
 
Third Quarter
  $ 4.250     $ 2.060  
 
Fourth Quarter
  $ 4.000     $ 3.490  

Dividend Policy

      Intevac currently anticipates that it will retain its earnings, if any, for use in the operation of its business and does not expect to pay cash dividends on its capital stock in the foreseeable future.

Equity Compensation Plan Information

      The following table summarizes the number of outstanding options granted to employees and directors, as well as the number of securities remaining available for future issuance, under the Company’s equity compensation plans at December 31, 2002.

                         
(a) (c)
Number of securities (b) Number of securities
to be issued upon Weighted-average remaining available
exercise of exercise price of for future issuance
outstanding options, outstanding options, under equity
Plan Category warrants and rights warrants and rights compensation plans




(1)
Equity compensation plans approved by security holders(2)
    1,850,082     $ 5.02       401,715  
Equity compensation plans not approved by security holders
        $        
     
     
     
 
Total
    1,850,082     $ 5.02       401,715  
     
     
     
 


(1)  Excludes securities reflected in column (a).
 
(2)  Included in the column (c) amount are 185,946 shares available for future issuance under Intevac’s 1995 Employee Stock Purchase Plan.

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Item 6.     Selected Consolidated Financial Data

      The following selected financial data of Intevac is qualified by reference to, and should be read in conjunction with, the consolidated financial statements of Intevac, including the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, each appearing elsewhere in this report.

                                             
Year Ended December 31,

2002 2001 2000 1999 1998





(in thousands, except per share data)
Consolidated Statement of Operations Data:
                                       
Net revenues:
                                       
 
Systems and components
  $ 27,625     $ 43,599     $ 30,074     $ 35,895     $ 90,085  
 
Technology development
    6,159       7,885       5,975       7,067       5,890  
     
     
     
     
     
 
   
Total net revenues
    33,784       51,484       36,049       42,962       95,975  
Cost of net revenues:
                                       
 
Systems and components
    20,009       30,025       20,658       32,511       64,481  
 
Technology development
    5,150       7,988       6,022       5,907       4,709  
 
Goodwill write-off
                1,056              
 
Inventory provisions
    1,316       3,716       6,323       1,992       2,527  
     
     
     
     
     
 
   
Total cost of net revenues
    26,475       41,729       34,059       40,410       71,717  
Gross profit
    7,309       9,755       1,990       2,552       24,258  
Operating expenses:
                                       
 
Research and development
    10,846       14,478       10,576       14,136       12,743  
 
Selling, general and administrative
    7,752       6,745       4,415       7,226       10,879  
 
Restructuring and other
                (638 )     3,069       1,088  
     
     
     
     
     
 
   
Total operating expenses
    18,598       21,223       14,353       24,431       24,710  
     
     
     
     
     
 
Operating loss
    (11,289 )     (11,468 )     (12,363 )     (21,879 )     (452 )
Interest expense
    (2,981 )     (2,912 )     (3,033 )     (3,711 )     (4,187 )
Interest income and other income, net
    16,452       2,473       3,072       9,831       3,176  
     
     
     
     
     
 
Income (loss) from continuing operations before income taxes
    2,182       (11,907 )     (12,324 )     (15,759 )     (1,463 )
Provision for (benefit from) income taxes
    (6,592 )     5,029             (5,989 )     (882 )
     
     
     
     
     
 
Income (loss) from continuing operations
    8,774       (16,936 )     (12,324 )     (9,770 )     (581 )
Income from discontinued operations, net
                            1,005  
     
     
     
     
     
 
Net income (loss)
  $ 8,774     $ (16,936 )   $ (12,324 )   $ (9,770 )   $ 424  
     
     
     
     
     
 
Basic earnings per share:
                                       
 
Income (loss) from continuing operations
  $ 0.73     $ (1.42 )   $ (1.04 )   $ (0.83 )   $ (0.05 )
 
Net income (loss)
  $ 0.73     $ (1.42 )   $ (1.04 )   $ (0.83 )   $ 0.04  
 
Shares used in per share calculations
    12,077       11,955       11,803       11,777       12,052  
Diluted earnings per share:
                                       
 
Income (loss) from continuing operations
  $ 0.66     $ (1.42 )   $ (1.04 )   $ (0.83 )   $ (0.05 )
 
Net income (loss)
  $ 0.66     $ (1.42 )   $ (1.04 )   $ (0.83 )   $ 0.03  
 
Shares used in per share calculations
    15,262       11,955       11,803       11,777       12,354  
Consolidated Balance Sheet Data:
                                       
Cash, cash equivalents and short-term investments
  $ 28,457     $ 18,157     $ 38,403     $ 40,895     $ 60,916  
Working capital
    31,309       27,160       41,093       51,579       77,774  
Total assets
    60,298       60,165       83,936       94,382       122,976  
Long-term debt
    30,568       37,545       41,245       43,188       59,461  
Total shareholders’ equity
    10,545       1,408       17,804       29,623       40,436  

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Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

      The following discussion and analysis contains forward-looking statements which involve risks and uncertainties. Words such as “believes,” “expects,” “anticipates” and the like indicate forward-looking statements. These forward looking statements include comments related to our projected revenue, gross margin, operating expense, income tax expense, effective tax rate and cash balances; our projected customer requirements for new capacity and technology upgrades for our installed base of thin-film disk manufacturing equipment and when, and if, our customers will place orders for these products, our plans to construct a model shop and the projected use for the model shop, PTD’s ability to proliferate its technology into major military weapons programs; and the timing of delivery and/or acceptance of our backlog for revenue. Intevac’s actual results may differ materially from the results discussed in the forward-looking statements for a variety of reasons, including those set forth under “Certain Factors Which May Affect Future Operating Results” and should be read in conjunction with the Consolidated Financial Statements and related Notes contained elsewhere in this Annual Report on Form 10-K.

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 disclosure 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. The Audit Committee and our auditors review significant estimates and judgements at the end of each quarter 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 this 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 guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements.” Our policy allows revenue recognition when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. On January 1, 2003, Intevac changed its revenue recognition policy for system orders received after December 31, 2002.

          System Revenue Recognition for Orders Received Before 12/31/02

      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.

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      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 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 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.

      In the case of a shipment through a distributor, an ATP is performed at Intevac’s factory. 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 shipped and revenue for the entire system is recorded. The distributor then completes customer factory installation and the 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 Intevac obtaining acceptance of the product by both our customer (the distributor) and our 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 December 31, 2002 the Company reported $9.9 million of finished goods (see Inventories), which consisted of five capacity upgrades to Flat Panel Display (“FPD”) deposition systems undergoing final acceptance testing at the end user’s facility and a FPD silicon deposition system undergoing final acceptance testing at the end user’s facility. Taken as a whole, the above systems represent $10.9 million of the Company’s $18.2 million order backlog, and $9.8 million of the Company’s $12.3 million of customer advances (see Consolidated Balance Sheets).

          System Revenue Recognition for Orders Received After 12/31/02

      Certain of Intevac’s product sales with customer acceptance provisions are accounted for as multiple-element arrangements. If the Company has met previously defined customer acceptance experience levels with the specific type of equipment, then Intevac recognizes revenue for the fair market value of the equipment upon shipment and transfer of title and recognizes revenue for the fair market value of installation and acceptance services when those services are completed. For products that have not been demonstrated to meet product specifications prior to shipment, revenue is recognized at customer acceptance. In the event that Intevac’s customer chooses not to complete installation and acceptance, and Intevac’s obligations under the contract to complete installation, acceptance or any other tasks (with the exception of warranty obligations) have been fully discharged, then Intevac recognizes any remainder revenue to the extent that collectibility under the contract is reasonably assured. For contracts with end user customer acceptance provisions established prior to 2003, Intevac has deferred all revenue recognition until completion of installation and customer acceptance. The revenue recognition policy outlined above and implemented for system orders received after December 31, 2002 was made to better conform Intevac’s revenue recognition policies to industry accounting practice for companies selling similar equipment. The effect of adopting this policy in years prior to 2003 would have been no change in 2002 revenues, a decrease in 2001 revenues of $1.5 million and an increase of 2000 revenues of $1.5 million. The effect on net income of adopting this policy in years prior to 2003 would have been no effect in 2002 net income, a decrease in 2001 net income of $33,000 and an increase in 2000 net income of $33,000.

          Other Systems and non-System Revenue Recognition

      Revenues for systems without installation and acceptance provisions, technology upgrades, spare parts, consumables and prototype products built by PTD are generally recognized upon shipment. Service and

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maintenance contract revenue, which to date has been insignificant, is recognized ratably over applicable contract periods or as the service is performed.

      Our shipping terms are customarily FOB shipping point. For systems sold directly to the end user, our obligations remaining after shipment typically include installation, end user factory acceptance and warranty. For systems sold to distributors, typically the distributor assumes responsibility for installation and end user customer acceptance. In some cases, the distributor will assume some or all of the warranty liability. For products other than systems and system upgrades, warranty is the only obligation we have after shipment.

          Technology Development Revenue Recognition

      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 in our technology rights developed pursuant to the contract. In the event that total cost incurred under 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 providing reports to providing 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.

      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 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 our 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.

      Valuation of long-lived and intangible assets and goodwill — We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

  •  significant under-performance relative to expected historical or projected future operating results;
 
  •  significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
 
  •  significant negative industry or economic trends;
 
  •  significant decline in our stock price for a sustained period; and
 
  •  our market capitalization relative to net book value.

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      When we determine that the carrying value of long-lived assets, intangibles or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

Results of Operations

      Net revenues. Net revenues consist primarily of sales of equipment used to manufacture thin-film disks, equipment used to manufacture flat panel displays, related equipment and system components, and contract research and development related to the development of electro-optical devices and systems. Net revenues totaled $33.8 million, $51.5 million and $36.0 million in 2002, 2001 and 2000, respectively.

      Equipment Products Division (“EPD”) revenues totaled $27.1 million, $42.7 million and $28.8 million in 2002, 2001 and 2000, respectively. EPD revenues decreased in 2002 due to a decrease in sales of flat panel manufacturing systems and disk system upgrades and components, partially offset by an increase in sales of disk manufacturing systems. EPD revenues increased in 2001 from 2000 due to an increase in sales of flat panel manufacturing systems, partially offset by a decrease in sales of disk manufacturing systems, disk systems upgrades and components. EPD delivered, and recognized revenue on, five of its D-STAR® deposition systems during 2001. During 2002 EPD delivered upgrades to the five systems and one new D-STAR® system. Revenue recognition on the five upgrades and one new system was pending final customer acceptance at December 31, 2002. Net revenues for 2002 and 2001 include $7.1 million and $6.8 million, respectively, of sales of rapid thermal processing equipment, a product line the Company sold in November 2002. There were no sales of rapid thermal processing equipment in 2000. EPD’s fabrication center, which manufactured machined parts, contributed sales to outside customers of $0.6 million, $1.8 million and $5.0 million in 2002, 2001 and 2000, respectively. The fabrication center was closed in September 2002. EPD plans to replace the fabrication center with a smaller model shop during 2003. The model shop will manufacture engineering prototypes and parts for use in our products.

      The disk manufacturing industry has now consolidated into a small number of large manufacturers. We believe that the majority of our active customers now utilize most of their capacity and that there is significant potential for these customers to both resume adding capacity and to upgrade the technical capability of their installed base to permit production of high density disks for perpendicular recording rather than the current longitudinal technology. However, we are not able to accurately predict when our customers will begin placing significant equipment orders again, or if they will place those orders with us, and this subjects us to a high degree of uncertainty in projecting our 2003 revenue.

      Photonics Technology Division (“PTD”) revenues totaled $6.6 million, $8.8 million and $7.2 million in 2002, 2001 and 2000, respectively. PTD revenues decreased in 2002 as a result of a decrease in revenues from contract research and development. PTD revenues increased in 2001 over 2000 as the result of increased revenues from contract research and development. PTD revenues in 2003 are expected to be primarily derived from contract research and development, but with some increase in revenue from LIVAR® target identification systems. Substantial growth in future PTD revenues is dependent on PTD proliferating its technology into major military weapons programs and obtaining production subcontracts for these programs.

      The Commercial Imaging Division (“CID”) was formed in July 2002 with the charter of developing commercial products based on PTD technology. CID also assumed responsibility from PTD for activities related to the development of photodiodes for use in high-speed fiber optic systems. CID’s 2002 revenues totaled $43,000 related to the sale of sample photodiodes. Further development of these photodiodes was suspended at the end of 2002 due to weak market conditions in the telecommunications industry. CID expects to initiate the sale of commercial products based on PTD’s LIVAR® and low light level technology during 2003, but does not expect to realize significant revenues from these products in 2003.

      Intevac’s backlog of orders at December 31, 2002 was $18.2 million, as compared to a December 31, 2001 backlog of $30.6 million. The $18.2 million of backlog at December 31, 2002 consisted of $15.0 million of EPD backlog and $3.2 million of PTD backlog. The $30.6 million of backlog at December 31, 2001 consisted of $26.5 million of EPD backlog and $4.1 million of PTD backlog. The reduction in EPD backlog

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was primarily due to a reduction in the number of rapid thermal processing systems and disk manufacturing systems on order. Most of Intevac’s backlog at December 31, 2002 is scheduled for either customer acceptance or delivery during the first half of 2003. The Company needs to book substantial orders in 2003 in order for 2003 sales to meet or exceed 2002 sales.

      Significant portions of our revenues in any particular period have been attributable to sales to a limited number of customers. In 2002, Seagate, Toppoly and the US Army Communications-Electronics Command each accounted for more than 10% of Intevac’s consolidated net revenues and in aggregate accounted for 74% of consolidated net revenues. In 2001, equipment sales through Matsubo, our Japanese distributor, accounted for 49% of consolidated net revenues. In 2000, MMC Technology, Seagate, Westt and Matsubo each accounted for more than 10% of Intevac’s consolidated net revenues and in aggregate accounted for 56% of consolidated net revenues. Our largest customers tend to change from period to period.

      International sales totaled $17.5 million, $37.3 million and $9.6 million in 2002, 2001 and 2000, respectively, accounting for 52%, 73% and 27% of net revenues. The decrease in international sales in 2002 compared to 2001 was primarily due to a decrease in net revenues from flat panel manufacturing systems, and to a lesser extent, to a decrease in net revenues from disk system upgrades and components. The increase in international sales in 2001 over 2000 was primarily due to an increase in net revenues from flat panel manufacturing systems. Substantially all of Intevac’s international sales are to customers in the Far East.

      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 was 22%, 19% and 6% in 2002, 2001 and 2000, respectively.

      Gross margin in EPD was 25%, 23% and 12% in 2002, 2001 and 2000, respectively. EPD gross margin in 2002 improved slightly over 2001 due primarily to lower production costs and by a reduction in inventory provisions, partially offset by the under-absorption of manufacturing overhead due to low manufacturing volume. EPD gross margin improved from 2000 to 2001, but was tempered by high initial costs to manufacture Intevac’s redesigned flat panel manufacturing systems and establishment of $2.4 million of inventory reserves related to a cancelled order for a custom flat panel system. 2001 EPD gross margin excluding the effect of the inventory reserve would have been 29%. EPD gross margin in 2000 was negatively impacted by establishment of $5.1 million of reserves related to slow moving equipment inventory and an $0.8 million write-off of goodwill related to electronically swept source technology, which was acquired in 1996 and subsequently abandoned. 2000 Equipment gross margin excluding the effect of these two items would have been 32%. $11.1 million of EPD’s backlog at 12/31/02 relates to D-STAR® products that will not generate any significant gross margin. We are not able to accurately project the 2003 gross margin for the balance of the equipment business as it will vary depending on a number of factors, including, factory utilization and pricing achieved on future orders.

      Gross margin in PTD was 10%, (2%) and (8%) in 2002, 2001 and 2000, respectively. PTD gross margins improved in 2002 due to a higher portion of the revenue being derived from fully funded research and development contracts. PTD gross margins in 2001 and 2000 were negatively impacted by a significant portion of revenue being derived from cost-sharing research and development contracts versus fully funded research and development contracts. We expect that 2003 PTD gross margins will improve based on the majority of revenues being derived from fully funded research and development contracts and from prototype products.

      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 disk manufacturing equipment, flat panel manufacturing equipment, imaging products and Company funded research performed by PTD. Research and development expense totaled $10.8 million, $14.5 million and $10.6 million in 2002, 2001 and 2000, respectively, representing 32%, 28% and 29% of net revenue. The dollar decrease from 2001 to 2002 was the result of the completion during 2001 of the design activities related to development of the D-STAR®, RTP and MDP-200 platforms, partially offset by increased expenses related to the development of CID products and PTD technology and products. The dollar increase from 2000 to 2001 was primarily the result of increased expenses related to the development and redesign of flat panel

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manufacturing equipment and, to a lesser extent, the development of PTD technology and products. We expect that research and development expenses in 2003 will be slightly lower than in 2002 as a result of the sale of the rapid thermal processing product line, partially offset by projected increases in CID and in PTD.

      Research and development expenses do not include costs of $5.2 million, $8.0 million and $6.0 million in 2002, 2001 and 2000, respectively, related to PTD contract research and development, which are included in cost of net revenues. Research and development expenses also do not include costs of $0.3 million, $0.5 million and $0.7 million incurred by Intevac in 2002, 2001 and 2000, respectively, and reimbursed under the terms of research and development cost sharing agreements related to development of disk and flat panel manufacturing equipment.

      Selling, general and administrative. Selling, general and administrative expense consists primarily of selling, marketing, customer support, production of customer samples, financial, travel, management, liability insurance, legal and professional services and bad debt expense. Domestic sales and international sales of disk manufacturing products in Singapore, Malaysia and Taiwan are made by the Company’s direct sales force, whereas other international sales of 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, Intevac 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 totaled $7.8 million, $6.7 million and $4.4 million in 2002, 2001, and 2000, respectively, representing 23%, 13% and 12% of net revenue. The increase in 2002 over 2001 was primarily the result of representative commissions paid on the sale of flat panel manufacturing systems, an increase in selling, general and administrative personnel in PTD and an increase in corporate general and administrative expenses. The increase from 2000 to 2001 was primarily due to a $1.5 million credit to bad debt expense recognized in 2000. We expect that selling, general and administrative expenses will increase in 2003 over 2002 due to an increase in marketing resources, the charge for underutilized space and higher charges for directors and officers insurance.

      Restructuring and other. Restructuring and other was a gain of $0.6 million in 2000. 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. The Company incurred a charge of $2.2 million in 1999 related to the expense reduction plan. In the fourth quarter of 1999, $0.1 million of the restructuring reserve was reversed due to lower than expected costs on the closure of the facility. 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 $0.6 million of the restructuring reserve during the first quarter of 2000. During the third quarter of 2000, the Company completed all activities related to closing the vacated portion of the building and reversed the remaining $23,000 of the restructuring reserve.

      Interest expense. Interest expense consists primarily of interest on the convertible notes, amortization of debt issuance costs, and, to a lesser extent in 2000, interest on approximately $2.0 million of long-term debt related to the purchase of Cathode Technology in 1996. Interest expense totaled $3.0 million, $2.9 million and $3.0 million in 2002, 2001 and 2000, respectively. The increase in interest expense in 2002 over 2001 was due primarily to the write-off of $0.5 million of debt offering costs from the original convertible note offering in 1997 as a result of the exchange of these notes for new convertible notes in July 2002. The decline in interest expense in 2001 from 2000 was primarily the result of the repurchase by Intevac of $3.7 million of the convertible notes during 2001, and, to a lesser extent, the repayment of the Cathode Technology debt in January 2001. Interest expense on Intevac’s outstanding convertible notes is expected to be $2.1 million in 2003.

      Interest income and other, net. Interest income and other, net totaled $16.5 million, $2.5 million and $3.1 million in 2002, 2001 and 2000, respectively. Interest income and other, net in 2002 consisted of

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$0.3 million of interest income on investments, a $15.4 million gain on the sale of the rapid thermal processing product line, a $0.3 million gain on the sale of fixed assets, $0.4 million of dividends from 601 California Avenue LLC and $0.1 million of early payment discounts and other income. Interest income and other, net in 2001 consisted of $1.2 million of interest income on investments, a $1.4 million gain from the repurchase of Intevac’s convertible notes, $0.4 million of dividends from 601 California Avenue LLC, a $0.8 million loss on the disposition of Pacific Gas and Electric commercial paper and $0.3 million of early payment discounts and other income. Interest income and other, net in 2000 consisted of $2.3 million of interest income on investments, $0.4 million of dividends from in 601 California Avenue LLC, $0.2 million of gains on foreign currency forward contracts and $0.2 million of early payment discounts and other income.

      Provision for (benefit from) income taxes. In 2002, Intevac recorded an income tax benefit of $6.6 million. This resulted from the enactment of the Job Creation and Worker Assistance Act of 2002 which increased the length of time, from 2 years to 5 years, over which losses incurred in 2001 and 2002 could be carried back against taxes paid in prior years. We paid federal income taxes of approximately $5.2 million for 1996, $0.9 million for 1997 and $0.5 million for 1998. Our federal tax returns, and any refunds resulting from them, are subject to audit for 3 years from the date filed. Intevac’s net deferred tax asset totaled zero at December 31, 2002, net of a $12.1 million valuation allowance. We have substantial net operating loss carry-forwards which can be used to limit the taxes paid in the future and to reduce our effective tax rate to less than the statutory income tax rates in effect.

      In 2001, Intevac recorded $5.0 million of income tax expense to provide additional valuation allowance against deferred tax assets. Our net deferred tax assets totaled zero at December 31, 2001, net of a $19.2 million valuation allowance established due to the uncertainty of realizing certain tax credits, loss carry-forwards and other deferred tax assets.

      Intevac’s estimated effective tax rate for 2000 was 0%. We did not accrue a tax benefit during 2000 due to the inability to realize additional refunds from loss carry-backs.

Liquidity and Capital Resources

      Intevac’s operating activities provided cash of $0.9 million in 2002. The cash provided was primarily a result of the operating loss being more than offset by a refund of federal income taxes paid in prior years, depreciation and amortization. Operating activities in 2001 used cash of $11.8 million, primarily due to the net loss incurred, which was partially offset by depreciation, amortization and an increase in the valuation allowance against deferred tax assets. Operating activities in 2000 generated cash of $22,000, primarily as a result of the net loss incurred being offset by an increase in customer advances, a refund of federal income taxes paid in prior years, depreciation and amortization.

      Investing activities in 2002 provided cash of $16.8 million as a result of the sale of the rapid thermal processing product line and the sale of equipment, which was partially offset by the purchase of fixed assets. Investing activities in 2001 provided cash of $28.9 million as a result of the net sale of investments, which was partially offset by the purchase of fixed assets. Investing activities in 2000 provided cash of $0.8 million as a result of the net sale of investments, which was partially offset by the purchase of fixed assets.

      Intevac’s financing activities used cash of $7.4 million in 2002, primarily as a result of the exchange of most of our convertible notes due 2004 for new convertible notes due 2009 and cash. On July 12, 2002 we completed the exchange of $36.3 million in aggregate principal amount of our convertible notes due 2004 for $29.5 million of our new 6 1/2% Convertible Subordinated Notes due 2009 and $7.6 million in cash, including $0.9 million for accrued interest. Sales of Intevac’s common stock to its employees through our employee benefit plans provided cash of $0.3 million. Financing activities in 2001 used cash of $3.7 million, due to the repurchase of a portion of the convertible notes and the repayment of the Cathode Technology debt, partially offset by the sale of Intevac’s stock to employees under its employee benefit plans. Financing activities in 2000 provided cash of $0.5 million from the sale of Intevac’s stock to employees under its employee benefit plans.

      At December 31, 2002, Intevac had $28.5 million of cash and cash equivalents. Intevac intends to undertake approximately $3 million in capital expenditures during the next 12 months and believes the

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existing cash and cash equivalent balances will be sufficient to meet its cash requirements for the next twelve months.

      Intevac has incurred operating losses each year since 1998 and cannot predict with certainty when it will return to operating profitability. 2003 operating profitability and cash flow are contingent upon a number of factors, but in particular on the receipt by the Equipment Products Division of large multi-system disk manufacturing equipment orders deliverable for revenue in 2003. While the Company is forecasting the receipt of these orders in 2003, it is not able to accurately predict when, or if, its Equipment Products Division will actually receive these orders. Without the receipt of substantial equipment orders deliverable for revenue during 2003, the Company is likely to incur an operating loss and consume a significant portion of its cash during 2003.

Item 7A.     Quantitative and Qualitative Disclosure About Market Risk

      Interest rate risk. The table below presents principal amounts and related weighted-average interest rates by year of maturity for the Company’s debt obligations.

                                                                   
Fair
2003 2004 2005 2006 2007 Beyond Total Value








(dollars in thousands)
Long-term debt
                                                               
 
Fixed rate
        $ 1,025                       $ 29,543     $ 30,568     $ 23,449  
 
Average rate
    6.50 %     6.50 %     6.50 %     6.50 %     6.50 %     6.50 %                

      Foreign exchange risk. From time to time, the Company enters into foreign currency forward exchange contracts to hedge anticipated foreign currency transaction, translation and re-measurement exposures. The objective of these contracts is to minimize the impact of foreign currency exchange rate movements on the Company’s operating results. At December 31, 2002, the Company did not have any foreign currency forward exchange contracts.

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Item 8.     Financial Statements and Supplementary Data

INTEVAC, INC.

 

CONSOLIDATED FINANCIAL STATEMENTS

Contents

         
Page

Report of Grant Thornton LLP, Independent Auditors
    31  
Consolidated Balance Sheets
    32  
Consolidated Statements of Operations and Comprehensive Income
    33  
Consolidated Statement of Shareholders’ Equity
    34  
Consolidated Statements of Cash Flows
    35  
Notes to Consolidated Financial Statements
    36  

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REPORT OF GRANT THORNTON LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders

Intevac, Inc.

      We have audited the accompanying consolidated balance sheets of Intevac, Inc. as of December 31, 2002 and 2001 and the related consolidated statements of operations and comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the data in the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intevac, Inc. at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the data in the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

Grant Thornton LLP

San Jose, California

January 29, 2003

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INTEVAC, INC.

 

CONSOLIDATED BALANCE SHEETS

(In thousands)
                       
December 31,

2002 2001


ASSETS
Current assets:
               
 
Cash and cash equivalents
  $ 28,457     $ 18,157  
 
Trade and other accounts receivable, net of allowances of $269 and $225 at December 31, 2002 and 2001
    4,991       8,046  
 
Income taxes recoverable
    214        
 
Inventories, including $9,914 and $4,070 held at customer locations at December 31, 2002 and 2001
    15,871       21,691  
 
Prepaid expenses and other current assets
    961       478  
     
     
 
Total current assets
    50,494       48,372  
Property, plant and equipment, at cost:
               
 
Leasehold improvements
    5,751       5,873  
 
Machinery and equipment
    16,216       21,096  
     
     
 
      21,967       26,969  
 
Less accumulated depreciation and amortization
    15,174       18,105  
     
     
 
      6,793       8,864  
Investment in 601 California Avenue LLC
    2,431       2,431  
Debt issuance costs, net of amortization of $2,482 and $1,808 at December 31, 2002 and 2001
    577       495  
Other long term assets
    3       3  
     
     
 
     
Total assets
  $ 60,298     $ 60,165  
     
     
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
 
Book overdraft
  $ 459     $ 242  
 
Accounts payable
    1,280       2,386  
 
Accrued payroll and related liabilities
    1,379       1,573  
 
Other accrued liabilities
    3,723       3,547  
 
Customer advances
    12,344       13,464  
     
     
 
Total current liabilities
    19,185       21,212  
Convertible notes
    30,568       37,545  
Commitments
           
Shareholders’ equity:
               
 
Undesignated preferred stock, no par value, 10,000 shares authorized, no shares issued and outstanding
           
 
Common stock, no par value:
               
   
Authorized shares — 50,000
               
   
Issued and outstanding shares – 12,125 and 12,004 at December 31, 2002 and 2001, respectively
    19,389       19,093  
 
Accumulated other comprehensive income
    189       122  
 
Accumulated deficit
    (9,033 )     (17,807 )
     
     
 
     
Total shareholders’ equity
    10,545       1,408  
     
     
 
     
Total liabilities and shareholders’ equity
  $ 60,298     $ 60,165  
     
     
 

See accompanying notes.

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INTEVAC, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)
                             
Years Ended December 31,

2002 2001 2000



Net revenues:
                       
 
Systems and components
  $ 27,625     $ 43,599     $ 30,254  
 
Technology development
    6,159       7,885       5,795  
     
     
     
 
   
Total net revenues
    33,784       51,484       36,049  
Cost of net revenues:
                       
 
Systems and components
    20,009       30,025       20,658  
 
Technology development
    5,150       7,988       6,022  
 
Goodwill write-off
                1,056  
 
Inventory provisions
    1,316       3,716       6,323  
     
     
     
 
   
Total cost of net revenues
    26,475       41,729       34,059  
Gross profit
    7,309       9,755       1,990  
Operating expenses:
                       
 
Research and development
    10,846       14,478       10,576  
 
Selling, general and administrative
    7,752       6,745       4,415  
 
Restructuring and other
                (638 )
     
     
     
 
Total operating expenses
    18,598       21,223       14,353  
     
     
     
 
Operating loss
    (11,289 )     (11,468 )     (12,363 )
Interest expense
    (2,981 )     (2,912 )     (3,033 )
Interest income
    284       1,245       2,341  
Other income and expense, net
    16,168       1,228       731  
     
     
     
 
Income (loss) before income taxes
    2,182       (11,907 )     (12,324 )
Provision for (benefit from) income taxes
    (6,592 )     5,029        
     
     
     
 
Net income (loss)
  $ 8,774     $ (16,936 )   $ (12,324 )
     
     
     
 
Other comprehensive income:
                       
 
Foreign currency translation adjustments
    67       122        
     
     
     
 
Total adjustments
    67       122        
     
     
     
 
Total comprehensive income (loss)
  $ 8,841     $ (16,814 )   $ (12,324 )
     
     
     
 
Basic income (loss) per share:
                       
 
Net income (loss)
  $ 0.73     $ (1.42 )   $ (1.04 )
 
Shares used in per share amounts
    12,077       11,955       11,803  
Diluted income (loss) per share:
                       
 
Net income (loss)
  $ 0.66     $ (1.42 )   $ (1.04 )
 
Shares used in per share amounts
    15,262       11,955       11,803  

See accompanying notes.

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INTEVAC, INC.

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(In thousands)
                                             
Accumulated Retained
Common Stock Other Earnings Total

Comprehensive (Accum. Shareholders’
Shares Amount Income Deficit) Equity





Balance at January 1, 2000
    11,715     $ 18,170     $     $ 11,453     $ 29,623  
 
Shares issued in connection with:
                                       
   
Exercise of stock options
    20       58                   58  
   
Employee stock purchase plan
    109       418                   418  
 
Income tax benefits realized from activity in employee stock plans
          29                   29  
 
Net loss
                      (12,324 )     (12,324 )
     
     
     
     
     
 
Balance at December 31, 2000
    11,844     $ 18,675     $     $ (871 )   $ 17,804  
 
Shares issued in connection with:
                                       
   
Exercise of stock options
    41       13                   13  
   
Employee stock purchase plan
    119       405                   405  
 
Foreign currency translation adjustment
                122             122  
 
Net loss
                      (16,936 )     (16,936 )
     
     
     
     
     
 
Balance at December 31, 2001
    12,004     $ 19,093     $ 122     $ (17,807 )   $ 1,408  
 
Shares issued in connection with:
                                       
   
Exercise of stock options
    13       19                   19  
   
Employee stock purchase plan
    108       273                   273  
 
Compensation expense in the form of common stock
          4                   4  
 
Foreign currency translation adjustment
                67             67  
 
Net income
                      8,774       8,774  
     
     
     
     
     
 
Balance at December 31, 2002
    12,125     $ 19,389     $ 189     $ (9,033 )   $ 10,545  
     
     
     
     
     
 

See accompanying notes.

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INTEVAC, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
                             
Years Ending December 31,

2002 2001 2000



Operating activities
                       
Net income (loss)
  $ 8,774     $ (16,936 )   $ (12,324 )
Adjustments to reconcile net income (loss) to net cash and cash equivalents provided by (used in) operating activities:
                       
 
Depreciation
    2,577       3,916       3,721  
 
Deferred income taxes
          4,988       2,734  
 
Amortization of intangibles
          7       1,042  
 
Amortization of debt offering costs
    672       244       244  
 
Goodwill write-off
                1,056  
 
Inventory provisions
    1,316       3,716       6,323  
 
Gain on sale of Rapid Thermal Processing product line
    (15,428 )            
 
Gain on sale of equipment
    (324 )            
 
Gain on purchase of convertible notes
    (23 )     (1,408 )      
 
Compensation expense in the form of common stock
    4              
 
Loss on IMAT investment
                125  
 
Restructuring and other charges — non-cash portion
                856  
 
Loss on disposal of investment
          803        
 
Loss on disposal of equipment
    13       8       2  
 
Changes in assets and liabilities:
                       
   
Accounts receivable
    2,264       1,547       1,614  
   
Inventory
    3,359       (7,252 )     (6,666 )
   
Prepaid expenses and other assets
    (492 )     366       (332 )
   
Accounts payable
    (1,107 )     443       929  
   
Accrued payroll and other accrued liabilities
    335       639       (5,768 )
   
Customer advances
    (1,120 )     (2,853 )     6,466  
     
     
     
 
Total adjustments
    (7,954 )     5,164       12,346  
     
     
     
 
Net cash and cash equivalents provided by (used in) operating activities
    820       (11,772 )     22  
Investing activities
                       
Purchase of investments
          (5,463 )     (116,271 )
Proceeds from sales and maturities of investments
          38,447       120,084  
Net proceeds from sale of Rapid Thermal Processing product line
    17,780              
Proceeds from sale of equipment
    535              
Purchase of equipment
    (1,480 )     (4,050 )     (2,990 )
     
     
     
 
Net cash and cash equivalents provided by investing activities
    16,835       28,934       823  
Financing activities
                       
Proceeds from issuance of common stock
    292       418       476  
Repurchase of Intevac convertible notes
    (225 )     (2,257 )      
Exchange of Intevac convertible notes due 2004
    (7,483 )            
Repayment of notes payable
          (1,904 )      
     
     
     
 
Net cash and cash equivalents provided by (used in) financing activities
    (7,416 )     (3,743 )     476  
Effect of exchange rate changes on cash
    61       122        
     
     
     
 
Net increase in cash and cash equivalents
    10,300       13,541       1,321  
Cash and cash equivalents at beginning of period
    18,157       4,616       3,295  
     
     
     
 
Cash and cash equivalents at end of period
  $ 28,457     $ 18,157     $ 4,616  
     
     
     
 
Cash paid (received) for:
                       
 
Interest
  $ 2,456     $ 2,715     $ 2,789  
 
Income taxes
    2       2       2  
 
Income tax refund
    (6,369 )           (5,803 )
Other non-cash changes:
                       
 
Inventories transferred to (from) property, plant and equipment
  $ (514 )   $ (2,322 )   $ 304  
 
Exchange of $36.3M of convertible notes due 2004 for $29.5M of convertible notes 2009 (exchange completed July 2002)
                 
 
Income tax benefit realized from activity in employee stock plans
                29  

See accompanying notes.

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INTEVAC, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Business and Nature of Operations

      Intevac, Inc.’s businesses are the design, manufacture and sale of complex capital equipment used to manufacture products such as thin-film disks and flat panel displays (the “Equipment Products Division”), the development of highly sensitive electro-optical devices and systems for the US military and its allies (the “Photonics Technology Division”) and the design, manufacture and sale of commercial products based on technology developed by the Photonics Technology Division (the “Commercial Imaging Division”).

      Systems sold by the Equipment Products Division are used to deposit highly engineered thin-films of material 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 disks for computer hard disk drives and flat panel displays for use in consumer electronics products.

      The Photonics Technology Division is developing electro-optical sensors, cameras and systems that permit highly sensitive detection of photons in the visible and infrared portions of the spectrum. This development work is aimed at creating new products for both military and industrial applications. Products include Laser Illuminated Viewing and Ranging (“LIVAR®”) systems for positive target identification at long range and low-cost extreme low light level cameras for use in military applications.

      The Commercial Imaging Division was formed in July 2002 with the charter of developing products based on PTD technology for sale to commercial markets.

2. Summary of Significant Accounting Policies

 
Basis of Presentation

      The consolidated financial statements include the accounts of Intevac and its wholly owned subsidiaries. All inter-company transactions and balances have been eliminated.

 
Revenue Recognition

      We recognize revenue using guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements.” Our policy allows revenue recognition when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. On January 1, 2003, Intevac changed its revenue recognition policy for system orders received after 2002.

 
System Revenue Recognition for Orders Received Before 12/31/02

      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 rapid thermal processing 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      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 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 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.

      In the case of a shipment through a distributor, an ATP is performed at Intevac’s factory. 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 shipped and revenue for the entire system is recorded. The distributor then completes customer factory installation and the 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 December 31, 2002 the Company reported $9.9 million of finished goods which consisted of five capacity upgrades to Flat Panel Display (“FPD”) deposition systems undergoing final acceptance testing at the end user’s facility and a FPD silicon deposition system undergoing final acceptance testing at the end user’s facility. Taken as a whole, the above systems represent $10.9 million of the Company’s $18.2 million order backlog, and $9.8 million of the Company’s $12.3 million of customer advances.

 
System Revenue Recognition for Orders Received After 12/31/02

      Certain of Intevac’s product sales with customer acceptance provisions are accounted for as multiple-element arrangements. If the Company has met previously defined customer acceptance experience levels with the specific type of equipment, then Intevac recognizes revenue for the fair market value of the equipment upon shipment and transfer of title and recognizes revenue for the fair market value of installation and acceptance services when those services are completed. For products that have not been demonstrated to meet product specifications prior to shipment, revenue is recognized at customer acceptance. In the event that Intevac’s customer chooses not to complete installation and acceptance, and Intevac’s obligations under the contract to complete installation, acceptance or any other tasks (with the exception of warranty obligations) have been fully discharged, then Intevac recognizes any remainder revenue to the extent that collectibility under the contract is reasonably assured. For contracts with end user customer acceptance provisions established prior to 2003, Intevac has deferred all revenue recognition until completion of installation and customer acceptance. The revenue recognition policy outlined above and implemented for system orders received after December 31, 2002 was made to better conform Intevac’s revenue recognition policies to industry accounting practice for companies selling similar equipment. The effect of adopting this policy in years prior to 2003 would have been no change in 2002 revenues, a decrease in 2001 revenues of $1.5 million and an increase of 2000 revenues of $1.5 million. The effect on net income of adopting this policy in years prior to 2003 would have been no effect in 2002 net income, a decrease in 2001 net income of $33,000 and an increase in 2000 net income of $33,000.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Other Systems and non-System Revenue Recognition

      Revenues for systems without installation and acceptance provisions, technology upgrades, spare parts, consumables and prototype products built by PTD 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.

      Our shipping terms are customarily FOB shipping point. For systems sold directly to the end user, our obligations remaining after shipment typically include installation, end user factory acceptance and warranty. For systems sold to distributors, typically the distributor assumes responsibility for installation and end user customer acceptance. In some cases, the distributor will assume some or all of the warranty liability. For products other than systems and system upgrades, warranty is typically the only obligation we have after shipment.

          Technology Development Revenue Recognition

      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 overruns 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.

          Trade Receivables and Doubtful Accounts

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

          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 when revenue is recognized.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table displays the activity in the warranty provision account for 2002 and 2001:

                 
2002 2001


(in thousands)
Beginning balance
  $ 906     $ 745  
Expenditures incurred under warranties
    (794 )     (623 )
Accruals for product warranties issued during the reporting period
    410       769  
Adjustments to previously existing warranty accruals
    323       15  
     
     
 
Ending balance
  $ 845     $ 906  
     
     
 

     International Distribution Costs

      The Company makes payments to agents and representatives under agreements related to international sales in return for obtaining orders and providing installation and warranty services. These payments to agents and representatives are included in selling, general and administrative expenses. These amounts totaled approximately $300,000, $141,000 and $0 for the years ended December 31, 2002, 2001 and 2000, respectively.

     Customer Advances

      Customer advances generally represent nonrefundable deposits invoiced by the Company in connection with receiving customer purchase orders and other events preceding acceptance of systems. Customer advances related to products that have not been shipped to customers, and included in accounts receivable were $0 and $857,000 at December 31, 2002 and 2001, respectively.

     Cash, Cash Equivalents and Short-term Investments

      The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

      Short-term investments consist principally of highly rated debt instruments with maturities generally between one and twelve months and are carried at fair value. These investments are typically short-term in nature and therefore bear minimal interest rate risk.

      Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. All debt securities are classified as available- for-sale under Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” Securities classified as available-for-sale are reported at fair market value with the related unrealized gains and losses included in retained earnings. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in other income and expenses. The cost of securities sold is based on the specific identification method.

      Cash and cash equivalents represent cash accounts and money market funds.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Valuation of Long-lived and Intangible Assets and Goodwill

      We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

  •  significant underperformance relative to expected historical or projected future operating results;
 
  •  significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
 
  •  significant negative industry or economic trends;
 
  •  significant decline in our stock price for a sustained period; and
 
  •  our market capitalization relative to net book value.

      When we determine that the carrying value of long-lived assets, intangibles or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. In 2000, Intevac determined that the intangible assets related to the purchase of Cathode Technology Corporation and Lotus Technologies, Inc. had become impaired. This determination was based on a review of the future revenue expected from products based on these technologies. At December 31, 2000 the remaining goodwill related to those purchases, amounting to $1,056,000, was written off. Of this write-off, $818,000 is included in the Equipment Products business segment and $238,000 is included in Corporate activities.

     Foreign Exchange Contracts

      Intevac may enter into foreign currency forward exchange contracts to hedge certain of its foreign currency transaction, translation and re-measurement exposures. Our accounting policies for some of these instruments are based on our designation of such instruments as hedging transactions. Instruments not designated as a hedge transaction will be “marked to market” at the end of each accounting period. The criteria we use for designating an instrument as a hedge include effectiveness in exposure reduction and one-to-one matching of the derivative financial instrument to the underlying transaction being hedged. Gains and losses on foreign currency forward exchange contracts that are designated and effective as hedges of existing transactions are recognized in income in the same period as losses and gains on the underlying transactions are recognized and generally offset.

      During fiscal 2000 Intevac entered into yen denominated foreign currency forward exchange contracts to hedge anticipated yen denominated sales. We did not designate these foreign currency forward contracts as hedge transactions; therefore, the contracts were “marked to market.” In fiscal 2000 we realized gains of $111,000 related to foreign currency forward exchange contracts. As of December 31, 2002, Intevac had no foreign currency forward exchange contracts outstanding.

     Financial Instruments

      The carrying amount of the short-term financial instruments (cash and cash equivalents, short-term investments, accounts receivable and certain other liabilities) approximates fair value due to the short-term maturity of those instruments. Based on the quoted market prices for the same or similar issues or on the current rates offered for debt of the same remaining maturities, the fair value of the $30.6 million of outstanding convertible notes as of December 31, 2002 is $23.4 million.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Inventories

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

                 
December 31,

2002 2001


(in thousands)
Raw materials
  $ 3,329     $ 5,659  
Work-in-progress
    2,628       11,962  
Finished goods
    9,914       4,070  
     
     
 
    $ 15,871     $ 21,691  
     
     
 

      Finished goods inventory consists solely of completed systems at customer sites that are undergoing installation and acceptance testing.

      Inventory reserves included in the above numbers were $9.6 million and $12.7 million at December 31, 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 twelve months ended December 31, 2002, $1.3 million was added to inventory reserves based on the quarterly analysis and $4.2 million of inventory was disposed of and charged to the reserve. Most of the disposed inventory related to two MDP 250K Disk Sputtering systems that had been written down to estimated salvage value in 2000. Inventory reserves were further reduced by $0.2 million due to the sale of the rapid thermal processing product line.

      During the twelve months ended December 31, 2001, $3.7 million was added to inventory reserves based on the quarterly analysis and $0.7 million of inventory was disposed of and charged to the reserve. The major increase in inventory reserves was the establishment of a $2.4 million reserve related to a cancelled order for a custom flat panel system. The system was written down to the value that was recoverable if the system could be reconfigured for a different customer. Inventory reserves increased by an additional $0.9 million when a customer cancelled an order for a disk manufacturing system and forfeited its customer advance. The forfeited advance was applied to the inventory made excess by the cancelled order.

     Property, Plant and Equipment

      Equipment and leasehold improvements are carried at cost less allowances for accumulated depreciation and amortization. Gains and losses on dispositions are reflected in the consolidated statements of operations.

      Depreciation for machinery and equipment is computed using the straight-line method over the estimated useful lives of the assets, which are generally three to seven years. Amortization of leasehold improvements is computed using the shorter of the remaining terms of the leases or the estimated economic useful lives of the improvements.

     Intangible Assets

      Intevac amortizes intangible assets on a straight-line basis over the estimated useful lives, which range from two to seven years.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Comprehensive Income

      SFAS No. 130, “Reporting Comprehensive Income” requires unrealized gains or losses on our available-for-sale securities and the foreign currency translation adjustments, which prior to the adoption were reported separately in shareholders’ equity, to be included in other comprehensive income. As of December 31, 2002, the $189,000 balance of accumulated other comprehensive income is comprised entirely of accumulated foreign currency translation adjustments.

     Employee Stock Plans

      At December 31, 2002, Intevac had two stock-based employee compensation plans, which are described more fully in Note 11. We account for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Intevac does not have any plans to adopt the fair value requirements of SFAS 123 for reporting purposes.

      Pro forma information regarding net income and earnings per share is required by SFAS 123, which also requires that the information be determined as if we had accounted for our employee stock options granted subsequent to December 31, 1994 under the fair value method of this Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes multiple option pricing model with the following weighted average assumptions for 2002, 2001 and 2000, respectively: risk-free interest rates of 1.64%, 3.03% and 5.17%; dividend yields of 0.0%, 0.0% and 0.0%; volatility factors of the expected market price of Intevac’s common stock of 0.933, 0.946 and 0.936; and a weighted-average expected life of the option of 0.25, 0.25 and 0.25 years beyond each respective vesting period.

      The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option models require the input of highly subjective assumptions including the expected stock price volatility. Because Intevac’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

      Under the 1995 Employee Stock Purchase Plan, as amended in 1999, (the “ESPP”), Intevac is authorized to issue up to 1,000,000 shares of common stock to participating employees. Under the terms of the ESPP, employees can choose to have up to 10% of their annual base earnings withheld to purchase Intevac’s common stock. The purchase price of the stock is 85% of the lower of the subscription date fair market value or the purchase date fair market value. Under the ESPP, we sold 108,020, 118,904 and 108,784 shares to employees in 2002, 2001 and 2000, respectively. As of December 31, 2002, 185,946 shares remained reserved for issuance under the ESPP. We do not recognize compensation cost related to employee purchase rights under the plan. To comply with the pro forma reporting requirements of SFAS 123, compensation cost is estimated for the fair value of the employees’ purchase rights using the Black-Scholes model with the following assumptions for those rights granted in 2002, 2001 and 2000, respectively: risk-free interest rates of 1.12%, 1.93% and 5.36%; dividend yield of 0.0%, 0.0% and 0.0%; expected volatility of 0.933, 0.946 and 0.936; and an expected life of 1.50, 2.00 and 2.00 years (the offering period ends July 31, 2003 for the subscription period that began in February 2002). The weighted average fair value of those purchase rights granted in 2002, 2001 and 2000 1999 were $1.71, $2.47 and $2.78, respectively per share.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table illustrates the effect on net income and earnings per share if Intevac had applied the fair value-recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation.

                           
2002 2001 2000



(in thousands, except per share data)
Net income (loss), as reported
  $ 8,774     $ (16,936 )   $ (12,324 )
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
    (157 )     (895 )     (819 )
     
     
     
 
Pro forma net income (loss)
  $ 8,617     $ (17,831 )   $ (13,143 )
     
     
     
 
Earnings per share
                       
 
Basic — as reported
  $ 0.73     $ (1.42 )   $ (1.04 )
 
Basic — pro forma
  $ 0.71     $ (1.49 )   $ (1.11 )
 
Diluted — as reported
  $ 0.66     $ (1.42 )   $ (1.04 )
 
Diluted — pro forma
  $ 0.65     $ (1.49 )   $ (1.11 )

     Financial Presentation

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

     Net income (loss) per share

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

                             
2002 2001 2000



(in thousands)
Numerator:
                       
 
Numerator for basic loss per share — income (loss) available to common stockholders
  $ 8,774     $ (16,936 )   $ (12,324 )
 
Effect of dilutive securities:
                       
   
6 1/2% convertible notes(1)
    1,338              
     
     
     
 
 
Numerator for diluted earnings per share — income (loss) available to common stockholders after assumed conversions
  $ 10,112     $ (16,936 )   $ (12,324 )
     
     
     
 
Denominator:
                       
 
Denominator for basic earnings per share — weighted-average shares
    12,077       11,955       11,803  
 
Effect of dilutive securities:
                       
   
Employee stock options(2)
    137              
   
6 1/2% convertible notes(1)
    3,048              
     
     
     
 
 
Dilutive potential common shares
    3,185              
     
     
     
 
 
Denominator for diluted earnings per share — adjusted weighted-average shares and assumed conversions
    15,262       11,955       11,803  
     
     
     
 

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(1)  Diluted EPS for the twelve-month periods ended December 31, 2001 and 2000 excludes “as converted” treatment of the convertible notes, as their inclusion would be anti-dilutive. The number of “as converted” shares excluded from the twelve-month periods ended December 31, 2001 and 2000 was 1,954,910 and 1,999,758, respectively.
 
(2)  Potentially dilutive securities, consisting of shares issuable upon exercise of employee stock options, are excluded from the calculation of diluted EPS as their effect would be anti-dilutive. The weighted average number of employee stock options excluded from the twelve-month periods ended December 31, 2002, 2001 and 2000 was 1,328,278, 1,637,268, and 1,474,961, respectively.

     Use of Estimates

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.

     New Accounting Pronouncements

      In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations.” SFAS 143 requires that asset retirement obligations that are identifiable upon acquisition and construction, and during the operating life of a long-lived asset be recorded as a liability using the present value of the estimated cash flows. A corresponding amount would be capitalized as part of the asset’s carrying amount and amortized to expense over the asset’s useful life. Intevac will adopt the provisions of SFAS 143 effective January 1, 2003. We do not expect the adoption of this statement to have a material impact on our financial statements.

      In July 2002, FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” which supercedes EITF No. 94-3, “Liability Recognition for Certain Employment Termination Benefits and Other Costs to Exit an Activity.” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No. 94-3 had recognized the liability at the commitment date to an exit plan. Adoption of this standard is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the impact of the adoption of this statement to have a material impact on our financial statements.

      In November 2002, the Emerging Issues Task Force (“EITF”) issued EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 prescribes a method to account for contracts that have multiple elements or deliverables. It provides guidance on how to allocate the value of a contract to its different deliverables, as well as guidance on when to recognize revenue allocated to each deliverable over its performance period. The provisions of EITF 00-21 will apply to revenue arrangements entered into in the fiscal periods beginning after June 15, 2003. We do not expect the adoption of EITF No. 00-21 to have a material impact on our financial statements.

3. Concentrations

     Credit Risk and Significant Customers

      Financial instruments that potentially subject Intevac to significant concentrations of credit risk consist of cash equivalents, short-term investments, accounts receivable and foreign exchange forward contracts. We generally invests our excess cash in money market funds and in commercial paper, which have contracted maturities generally within one year. By policy, our investments in commercial paper, certificates of deposit,

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Eurodollar time deposits, or banker’s acceptances are rated A1/ P1 or better. In 2001, Intevac recorded a loss of $803,000 on its investment in commercial paper issued by Pacific Gas & Electric.

      Our largest customers tend to change from period to period. Historically, a significant portion of Intevac’s revenues in any particular period have been attributable to sales to a limited number of customers. In 2002, three customers accounted for 42%, 21%, and 11%, respectively, of our consolidated revenues and in aggregate accounted for 74% of net revenues. In 2001, one customer accounted for 49% of our consolidated net revenues. In 2000, four customers accounted for 17%, 16%, 12% and 11%, respectively, of our consolidated revenues and in aggregate accounted for 56% of net revenues. Intevac performs credit evaluations of its customers’ financial conditions and requires deposits on system orders but does not generally require collateral or other security to support customer receivables.

     Products

      Disk manufacturing and flat panel manufacturing equipment together contributed a significant portion of our revenues in 2002 and 2001, while disk manufacturing equipment alone contributed a significant portion of our revenues in 2000. We expect that our ability to maintain or expand our current levels of revenues and to return to operating profitability in the future will depend upon our success in enhancing our existing systems and developing and manufacturing competitive disk manufacturing equipment and our success in developing both military and commercial products based on our LIVAR® and low light technology.

4. Sale of Rapid Thermal Processing Product Line

      In the fourth quarter of 2002, Intevac sold its Rapid Thermal Processing product line to Photon Dynamics, Inc. (“PDI”) for $20 million cash and the assumption of certain liabilities. $2 million of the cash payment will be held in escrow for one year, and is not included in total assets on the consolidated balance sheet as of December 31, 2002, due to the contingencies related to the release of these funds from escrow. Release of the escrow at the end of this period is subject to a number of conditions. In connection with this sale, we recorded a gain of $15.4 million, which is included in other income and expense, net on the Consolidated Statement of Operations. The following table recaps the gain from the sale and the effect on Intevac’s balance sheet (in thousands):

           
Cash received from PDI (excluding the $2 million in escrow)
  $ 18,000  
Less: Accounts receivable transferred to PDI
    (594 )
Inventory transferred to PDI
    (1,911 )
Warranty and retrofit liability transferred to PDI
    163  
Other assets and liabilities transferred to PDI
    (10 )
Expenses associated with the transaction
    (220 )
     
 
 
Net gain on sale
  $ 15,428  
     
 

5. Equity Investments

 
601 California Avenue LLC

      In 1995, Intevac entered into a Limited Liability Company Operating Agreement (the “Operating Agreement”), which expires December 31, 2015, with 601 California Avenue LLC (the “LLC”), a California limited liability company formed and owned by Intevac and certain shareholders of Intevac at that time. Under the Operating Agreement we transferred our leasehold interest in the site of our discontinued night vision business (the “Site”) in exchange for a preferred share in the LLC with a face value of $3,900,000. We are accounting for the investment under the cost method and have recorded our investment in the LLC at

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

$2,431,000, which represents our historical carrying value of the leasehold interest in the Site. The preferred share in the LLC pays a 10% annual cumulative preferred dividend.

      During 1996, the LLC formed a joint venture with Stanford University (the “Stanford JV”). The Stanford JV developed the property and fully leased it to a high quality tenant on a long-term lease. The LLC is a highly profitable enterprise whose primary asset is its interest in the Stanford JV. The Company received dividends of $390,000 from the LLC in each of the last three years. As of December 31, 2002 all outstanding cumulative dividends on the preferred share had been paid. These dividends are included in other income and expense.

     IMAT Inc.

      On June 27, 1997, Intevac entered into an agreement with Matsubo to form a joint venture responsible for the sales and service of Intevac’s flat panel display equipment in Japan and other Asian countries. We invested $436,000 for 49% of the voting stock of the joint venture. The joint venture was accounted for by the equity method. Gains and losses related to our share of the joint venture were reflected in other income and expense, net on the consolidated statements of operations. Intevac’s equity in the net income or (loss) of IMAT, Inc. was ($125,000) in 2000. During the third quarter of 2000, Intevac and its joint venture partner, Matsubo, transferred IMAT’s activities and employees to Matsubo and terminated the operations of IMAT.

6. Commitments

      We lease certain facilities under non-cancelable operating leases that expire at various times up to March 2007. The facility leases require Intevac to pay for all normal maintenance costs. The lease for the primary facility in Santa Clara includes an option to extend the lease for an additional five-year period.

      Future minimum rental payments under these leases at December 31, 2002 are as follows (in thousands):

         
2003
  $ 2,971  
2004
    3,070  
2005
    3,192  
2006
    3,318  
2007
    838  
     
 
Total
  $ 13,389  
     
 

      Gross rental expense was approximately $2,873,000, $2,993,000 and $1,596,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Offsetting rental expense for the year ending December 31, 2000 was sublease income of $62,000.

7. Employee Benefit Plan

      In 1991, Intevac established a defined contribution retirement plan with 401(k) plan features. The plan covers all United States employees eighteen years and older. Employees may make contributions by a percentage reduction in their salaries, not to exceed the statutorily prescribed annual limit. We made cash contributions of $276,000, $301,000 and $123,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Employees may choose among twelve investment options for their contributions and their share of Intevac’s contributions, and they are able to move funds between investment options at any time. Intevac’s common stock is not one of the investment options. Administrative expenses relating to the plan are insignificant.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8. Notes Payable

      In 1996, Intevac issued notes related to the purchase of Cathode Technology Corporation. The notes bore interest at 5.58% compounded monthly and payable quarterly. The balance on the notes was paid in full in January 2001.

9. Convertible Notes

      During the first quarter of 1997, Intevac completed an offering of $57.5 million of its 6 1/2% Convertible Subordinated Notes (the “2004 Notes”), which mature March 1, 2004. Interest is payable each March 1st and September 1st. The notes are convertible into shares of Intevac’s common stock at $20.625 per share. Expenses associated with the offering of approximately $2.3 million were deferred. Such expenses are being amortized to interest expense over the term of the notes.

      On July 12, 2002 we completed the exchange of $36.3 million in aggregate principal amount of our 2004 Notes for $29.5 million of our new 6 1/2% Convertible Subordinated Notes due 2009 (the “2009 Notes”) and $7.6 million in cash, including $0.9 million for accrued interest. The 2009 Notes are convertible, at the holders’ option, into Intevac common shares at a conversion price of $7.00 per share. $1.3 million in aggregate principal amount of the 2004 Notes remained outstanding after the closing of the exchange offer.

      In accounting for the exchange of the convertible notes, we wrote off $0.4 million of debt issuance costs related to the 2004 Notes, 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 remaining life of the 2004 Notes. In connection with the exchange offer, Intevac incurred $0.8 million of offering costs. Of this amount, $0.2 million represented the cash portion of the exchange offer and was expensed during the 3 months ended September 28, 2002. The $0.6 million balance of the exchange offering costs will be amortized to interest expense over the term of the 2009 Notes. There was no gain or loss associated with this transaction as $36.3 million of 2004 Notes were exchanged for $36.3 million of cash and new securities.

      During 2002, in addition to the note exchange described above, Intevac repurchased $0.3 million, face value, of its 2004 Notes. The repurchase resulted in a gain of $23,000. During 2001, Intevac repurchased $3.7 million, face value, of its 2004 Notes. The repurchase resulted in a gain of $1.4 million. In accordance with adoption of SFAS 145, the gain on the note repurchase is included in Other income and expense, net on the consolidated statements of operations.

10. Segment Reporting

 
Segment Description

      Intevac, Inc. has three reportable operating segments: Equipment Products, Photonics Technology and Commercial Imaging. Our Equipment Products Division sells complex capital equipment used in the manufacturing of thin-film disks and flat panel displays. Our Photonics Technology Division is developing sensors and cameras that permit highly sensitive detection of photons in the visible and infrared portions of the spectrum. Our Commercial Imaging Division is developing commercial products based on technology developed by PTD.

      Included in corporate activities are general corporate expenses, the equity in net loss of IMAT, Inc. (see Note 5), amortization expenses related to certain intangible assets and the reversal in 2000 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. Assets of corporate activities include unallocated cash and short-term investments, deferred income tax assets (which were written off in 2001) and certain intangibles and other assets.

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Segment Profit or Loss and Segment Assets

      We evaluate performance and allocates resources based on a number of factors including, profit or loss from operations and future revenue potential. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.

     Business Segment Net Revenues

                           
2002 2001 2000



(in thousands)
Equipment Products
  $ 27,100     $ 42,723     $ 28,797  
Photonics Technology
    6,641       8,761       7,252  
Commercial Imaging
    43              
     
     
     
 
 
Total
  $ 33,784     $ 51,484     $ 36,049  
     
     
     
 

     Business Segment Profit & Loss

                         
2002 2001 2000



(in thousands)
Equipment Products(1)(2)
  $ (5,139 )   $ (7,234 )   $ (8,048 )
Photonics Technology(3)
    (2,173 )     (2,595 )     (2,164 )
Commercial Imaging
    (1,656 )            
Corporate activities(4)
    (2,321 )     (1,639 )     (2,151 )
     
     
     
 
Operating loss
    (11,289 )     (11,468 )     (12,363 )
Interest expense
    (2,981 )     (2,912 )     (3,033 )
Interest income
    284       1,245       2,341  
Other income and expense, net
    16,168       1,228       731  
     
     
     
 
Income (loss) before income taxes
  $ 2,182     $ (11,907 )   $ (12,324 )
     
     
     
 


(1)  Includes goodwill write-off of $818,000 in 2000.
 
(2)  Includes inventory provisions of $847,000, $3,830,000 and $6,007,000 in 2002, 2001 and 2000, respectively.
 
(3)  Includes inventory provisions of $469,000, ($114,000) and $316,000 in 2002, 2001 and 2000, respectively.
 
(4)  Includes goodwill write-off of $238,000 in 2000.

     Business Segment Assets

                   
2002 2001


(in thousands)
Equipment Products
  $ 20,162     $ 31,843  
Photonics Technology
    7,719       7,253  
Commercial Imaging
           
Corporate activities
    32,417       21,069  
     
     
 
 
Total assets
  $ 60,298     $ 60,165  
     
     
 

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Business Segment Property, Plant & Equipment

                   
Additions 2002 2001



(in thousands)
Equipment Products
  $ 89     $ 692  
Photonics Technology
    1,203       3,010  
Commercial Imaging
           
Corporate activities
    188       348  
     
     
 
 
Total additions
  $ 1,480     $ 4,050  
     
     
 
                           
Depreciation 2002 2001 2000




(in thousands)
Equipment Products
  $ 1,346     $ 2,559     $ 2,387  
Photonics Technology
    860       799       716  
Commercial Imaging
                 
Corporate activities
    371       558       618  
     
     
     
 
 
Total depreciation
  $ 2,577     $ 3,916     $ 3,721  
     
     
     
 

     Geographic Area Net Trade Revenues

                           
2002 2001 2000



(in thousands)
United States
  $ 16,332     $ 14,154     $ 26,466  
Far East
    17,150       36,363       9,414  
Europe
    301       827       49  
Rest of World
    1       140       120  
     
     
     
 
 
Total revenues
  $ 33,784     $ 51,484     $ 36,049  
     
     
     
 

11. Shareholders’ Equity

      Intevac’s Articles of Incorporation authorize 10,000,000 shares of Preferred Stock. The Board of Directors has the authority to issue the Preferred Stock in one or more series and to fix the price, rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the shareholders.

     Stock Option/ Stock Issuance Plans

      The Board of Directors approved the 1991 Stock Option/ Stock Issuance Plan (the “1991 Plan”) in 1991. The maximum number of shares that may be issued over the term of the 1991 Plan is 2,666,667 shares. The 1991 Plan is divided into two separate components: the Option Grant Program and the Stock Issuance Program. Under the Option Grant Program, Intevac may grant either incentive stock options or nonqualified options or implement stock appreciation rights provisions at the discretion of the Board of Directors. Exercisability, option price, and other terms are determined by the Board of Directors, but the option price shall not be less than 85% and 100% of the fair market value for nonqualified options and incentive stock options, respectively, as determined by the Board of Directors. Options granted under the 1991 Plan are immediately exercisable; however, unexercised options and shares purchased upon the exercise of the options

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

are subject to vesting over a five-year period. Intevac may repurchase shares that are not vested. No shares were subject to repurchase at December 31, 2002, 2001 and 2000.

      In 1995, the Board of Directors approved adoption of (i) the 1995 Stock Option/ Stock Issuance Plan (the “1995 Plan”) under which employees, non-employee directors and consultants may be granted stock options to purchase stock or issued shares of stock at not less than 85% of fair market value on the grant/issuance date; and (ii) the Employee Stock Purchase Plan. The 1995 Plan, as amended in 2000, serves as the successor equity incentive program to our 1991 Plan. Upon adoption of the 1995 Plan, all shares available for issuance under the 1991 Plan were transferred to the 1995 Plan. As of December 31, 2002, 2,065,851 shares of common stock are authorized for future issuance under the 1995 Plan. Options granted under the 1995 Plan are exercisable upon vesting and vest over periods of up to five years. Options currently expire no later than ten years from the date of grant.

      A summary of Intevac’s stock option activity and related information for the years ended December 31 follows:

                                                   
2002 2001 2000



Weighted-Average Weighted-Average Weighted-Average
Options Exercise Price Options Exercise Price Options Exercise Price






Outstanding — beginning of year
    1,802,022     $ 5.22       1,570,297     $ 5.39       1,496,370     $ 5.82  
 
Granted
    429,800       3.19       341,900       3.90       336,100       3.75  
 
Exercised
    (13,400 )     1.46       (41,149 )     0.30       (20,261 )     2.86  
 
Forfeited
    (368,340 )     4.00       (69,026 )     5.32       (241,912 )     5.99  
Outstanding — end of year
    1,850,082       5.02       1,802,022       5.22       1,570,297       5.39  
Exercisable at end of year
    1,188,382     $ 5.81       1,062,242     $ 5.89       878,157     $ 5.84  
Weighted-average per share fair value of options granted during the year
          $ 1.58             $ 1.93             $ 2.20  

Outstanding and Exercisable by Price Range as of December 31, 2002

                                         
Options Outstanding Options Exercisable


Number Number
Outstanding As of Weighted Average Weighted Exercisable As of Weighted
Range of December 31, Remaining Average December 31, Average
Exercise Prices 2002 Contractual Life Exercise Price 2002 Exercise Price






$1.275 – $ 2.630
    334,812       7.35 yrs     $ 2.49       84,812     $ 2.09  
$3.063 – $ 3.550
    203,040       8.64 yrs     $ 3.22       61,380     $ 3.25  
$3.570 – $ 3.980
    211,790       8.04 yrs     $ 3.81       107,110     $ 3.74  
$4.000 – $ 5.120
    190,500       8.71 yrs     $ 4.40       104,300     $ 4.44  
$5.375 – $ 5.690
    121,640       6.71 yrs     $ 5.41       83,360     $ 5.39  
$6.000 – $ 6.000
    353,161       2.61 yrs     $ 6.00       353,161     $ 6.00  
$6.063 – $ 6.625
    161,300       5.71 yrs     $ 6.46       140,680     $ 6.46  
$6.750 – $ 7.625
    180,779       3.87 yrs     $ 7.48       172,819     $ 7.50  
$7.688 – $21.250
    93,060       5.09 yrs     $ 10.60       80,760     $ 10.99  
     
                     
         
$1.275 – $21.250
    1,850,082       6.17 yrs     $ 5.02       1,188,382     $ 5.81  

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

12. Income Taxes

      The provision for (benefit from) income taxes on income from continuing operations consists of the following (in thousands):

                             
Years Ended December 31,

2002 2001 2000



Federal:
                       
 
Current
  $ (6,585 )   $     $  
 
Deferred
          3,771        
     
     
     
 
      (6,585 )     3,771        
State:
                       
 
Current
    2              
 
Deferred
          1,217        
     
     
     
 
      2       1,217        
Foreign:
                       
 
Current
    (9 )     41        
     
     
     
 
   
Total
  $ (6,592 )   $ 5,029     $  
     
     
     
 

      The tax benefits associated with exercises of nonqualified stock options and disqualifying dispositions of stock acquired through the incentive stock option and employee stock purchase plans reduced taxes currently payable for 2002, 2001 and 2000 as shown above by $0, $0 and $29,000, respectively. Such benefits are credited to additional paid-in capital when realized.

      Deferred income taxes reflect the net tax effects of temporary differences between losses reported and the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets computed in accordance with SFAS 109 are as follows (in thousands):

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                   
December 31,

2002 2001


Deferred tax assets:
               
 
Vacation accrual, rent accrual and warranty reserve
  $ 1,167     $ 1,260  
 
Depreciation
    1,370       1,237  
 
Inventory valuation
    3,534       5,505  
 
Research and other tax credit carry-forwards
    513       1,767  
 
Federal and State NOL carry-forward
    4,962       6,745  
 
Basis difference in subsidiary investment
          2,337  
 
Other
    587       428  
     
     
 
      12,133       19,279  
Valuation allowance for deferred tax assets
    (12,083 )     (19,227 )
     
     
 
Total deferred tax assets
  $ 50     $ 52  
     
     
 
Deferred tax liabilities:
               
 
Other
  $ 50     $ 52  
     
     
 
Total deferred tax liabilities
  $ 50     $ 52  
     
     
 
Net deferred tax assets
  $     $  
     
     
 

      The valuation allowance decreased by $7,144,000 during 2002 due primarily to the carry-back of 2001 net operating losses, which resulted in a tax refund of $6,585,000. This carry-back resulted from the enactment of the Job Creation and Worker Assistance Act of 2002, which increased the length of time over which losses incurred in 2001 could be carried back from 2 years to 5 years. The Federal and State net operating loss carry-forwards of $13,166,000 and $8,319,000 expire at various dates through 2021 and 2013, respectively, if not previously utilized.

      A reconciliation of the income tax provision on income from continuing operations at the federal statutory rate of 34% to the income tax provision at the effective tax rate is as follows (in thousands):

                           
Years Ended December 31,

2002 2001 2000



Income taxes (benefit) computed at the federal statutory rate
  $ 766     $ (4,125 )   $ (4,314 )
State taxes (net of federal benefit)
    109       (408 )     (640 )
Tax exempt income
                (14 )
Goodwill amortization
                713  
Research and other tax credit
    (142 )     (1,033 )      
Effect of tax rate changes and other permanent differences
    (181 )     44       650  
Valuation allowance
    (7,144 )     10,551       3,605  
     
     
     
 
 
Total
  $ (6,592 )   $ 5,029     $  
     
     
     
 

13. Research and Development Cost Sharing Agreements

      In 1992 Intevac entered into an agreement with a Japanese company to perform best efforts joint research and development work. The nature of the project was to develop a glass-coating machine to be used in the production of flat panel displays. We were funded for one-half of the actual costs of the project up to a ceiling of $9,450,000. At December 31, 1999, we had received the entire amount under the contract. Qualifying costs

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INTEVAC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of approximately $3,108,000 for the year ended December 31, 2000 were incurred on this project, resulting in offsets against research and development costs of approximately $583,000 in 2000. As of December 31, 2000, the entire advance had been applied to qualifying costs. Each party received certain manufacturing and marketing rights for separate regions of the world. The agreement also calls for 5% royalty payments by each party to the other party, based on production and sales.

14. Other Accrued Liabilities

                 
December 31,

2002 2001


(in thousands)
Accrued product warranties
  $ 845     $ 906  
Accrued interest expense
    662       813  
Accrued rent expense
    1,435       1,241  
Other
    781       587  
     
     
 
Total other accrued liabilities
  $ 3,723     $ 3,547  
     
     
 

15. Quarterly Consolidated Results of Operations (Unaudited)

                                 
Three Months Ended

March 30, June 29, Sept. 28, Dec. 31,
2002 2002 2002 2002




(in thousands, except per share data)
Net sales
  $ 6,670     $ 8,385     $ 6,737     $ 11,992  
Gross profit
    963       2,003       1,342       3,001  
Net income (loss)(1)(2)(3)
    (2,142 )     809       (3,835 )     13,942  
Basic earnings per share
  $ (0.18 )   $ 0.07     $ (0.32 )   $ 1.15  
Diluted earnings per share
    (0.18 )     0.07       (0.32 )     0.86  
                                 
Three Months Ended

March 31, June 30, Sept. 29, Dec. 31,
2001 2001 2001 2001




(in thousands, except per share data)
Net sales
  $ 10,005     $ 9,490     $ 8,414     $ 23,575  
Gross profit
    3,400       (181 )     1,682       4,854  
Net loss(4)
    (3,784 )     (4,540 )     (5,356 )     (3,256 )
Basic and diluted loss per share
  $ (0.32 )   $ (0.38 )   $ (0.45 )   $ (0.27 )


(1)  Net income (loss) for the three months ended March 30, 2002, June 29, 2002 and December 31, 2002 include tax benefits of $2.2 million, $4.2 million and $0.2 million, respectively, booked as a result of the enactment of the Job Creation and Worker Assistance Act of 2002.
 
(2)  Net income (loss) for the three months ended December 31, 2002 includes a gain of $15.4 million from the sale of the rapid thermal processing product line.
 
(3)  Net income (loss) for the three months ended December 31, 2002 includes a gain of $0.3 million from the sale of fabrication shop fixed assets.
 
(4)  Net loss for the three months ended December 31, 2001 includes a gain of $1.4 million from the repurchase of Intevac’s convertible notes.

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Item 9.      Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

      None.

PART III

 
Item 10.      Directors and Officers of the Registrant

      The information required by this item relating to the Company’s directors and nominees and disclosure relating to compliance with Section 16(a) of the Securities Exchange Act of 1934 is included under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for the 2003 Annual Meeting of Shareholders and is incorporated herein by reference. The information required by this item relating to the Company’s executive officers and key employees is included under the caption “Executive Officers and Directors” under Item 4 in Part I of this Annual Report on Form 10-K.

 
Item 11.      Executive Compensation

      The information required by this item is included under the caption “Executive Compensation and Related Information” in the Company’s Proxy Statement for the 2003 Annual Meeting of Shareholders and is incorporated herein by reference.

 
Item 12.      Security Ownership of Certain Beneficial Owners and Management

      The information required by this item is included under the caption “Ownership of Securities” in the Company’s Proxy Statement for the 2003 Annual Meeting of Shareholders and is incorporated herein by reference.

 
Item 13.      Certain Relationships and Related Transactions

      The information required by this item is included under the caption “Certain Transactions” in the Company’s Proxy Statement for the 2003 Annual Meeting of Shareholders and is incorporated herein by reference.

 
Item 14.      Controls and Procedures

      Evaluation of disclosure controls and procedures. Within 90 days prior to the filing date of this Annual Report on Form 10-K (the “Evaluation Date”), we evaluated, under the supervision of our chief executive officer and our chief financial officer, the effectiveness of our disclosure controls and procedures. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

      Changes in internal controls. Subsequent to the Evaluation Date, there were no significant changes in our internal controls or in other factors that could significantly affect such controls, including any corrective actions with regards to significant deficiencies and material weaknesses.

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PART IV

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

      (a) List of Documents filed as part of this Annual Report on Form 10-K.

  1. The following consolidated financial statements of Intevac, Inc. are filed in Part II, Item 8 of this Report on Form 10-K:

  Report of Grant Thornton LLP, Independent Auditors
 
  Consolidated Balance Sheets — December 31, 2002 and 2001
 
  Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2002, 2001 and 2000
 
  Consolidated Statement of Shareholders’ Equity for the years ended December 31, 2002, 2001 and 2000
 
  Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000
 
  Notes to Consolidated Financial Statements — Years Ended December 31, 2002, 2001 and 2000

      2.   Financial Statement Schedules.

  The following financial statement schedule of Intevac, Inc. is filed in Part IV, Item 14(a) of this Annual Report on Form 10-K:
 
  Schedule II — Valuation and Qualifying Accounts
 
  All other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements or notes thereto.

      3.   Exhibits

             
Exhibit
Number Description


  *****2.1         Asset Purchase Agreement between Intevac, Inc. and Photon Dynamics, Inc. dated as of October 22, 2002
  *3.1         Amended and Restated Articles of Incorporation of the Registrant
  *3.2         Bylaws of the Registrant
  ***4.2         Indenture, dated as of February 15, 1997, between the Company and State Street Bank and Trust Company of California, N.A. as Trustee, including the form of the Convertible Notes
  4.3         Indenture, dated as of July 12, 2002, between the Company and State Street Bank and Trust Company of California, N.A. as Trustee, including the form of the Convertible Notes
  *10.1         The Registrant’s 1991 Stock Option/ Stock Issuance Plan
  *10.2         The Registrant’s 1995 Stock Option/ Stock Issuance Plan, as amended
  *10.3         The Registrant’s Employee Stock Purchase Plan, as amended
  ****10.5         Lease, dated February 5, 2001 regarding the space located at 3560, 3570 and 3580 Bassett Street, Santa Clara, California
  *10.8         601 California Avenue LLC Limited Liability Operating Agreement, dated July 28, 1995
  *10.9         The Registrant’s 401(k) Profit Sharing Plan
  21.1         Subsidiaries of the Registrant
  23.1         Consent of Grant Thornton LLP, Independent Auditors
  24.1         Power of Attorney (see page 57)
  99.1         Certification Pursuant to 18 U.S.C. Section 1350

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  Previously filed as an exhibit to the Registration Statement on Form S-1 (No. 33-97806)

  **  Previously filed as an exhibit to the Registration Statement on Form S-1 (No. 333-05531)

  ***  Previously filed as an exhibit to the Registration Statement on Form S-3 (No. 333-24275)

****  Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000

*****  Incorporated by reference to the exhibit filed with the Company’s Report on Form 8-K filed November 14, 2002

      (b) Reports on Form 8-K

  On November 14, 2002, the registrant filed a report on Form 8-K regarding the sale of the assets of its Rapid Thermal Processing product line to Photon Dynamics, Inc.

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SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 11, 2003.

  INTEVAC, INC.

  By:  /s/ CHARLES B. EDDY III
 
  Charles B. Eddy III
  Vice President, Finance and Administration,
  Chief Financial Officer, Treasurer and Secretary
  (Principal Financial and Accounting Officer)

POWER OF ATTORNEY

      KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Kevin Fairbairn and Charles B. Eddy III, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

      Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

             
Signature Title Date



 
/s/ KEVIN FAIRBAIRN

Kevin Fairbairn
  President, Chief Executive Officer and Director (Principal Executive Officer)   March 11, 2003
 
/s/ NORMAN H. POND

Norman H. Pond
  Chairman of the Board   March 11, 2003
 
/s/ CHARLES B. EDDY III

Charles B. Eddy III
  Vice President, Finance and Administration, Chief Financial Officer Treasurer and Secretary (Principal Financial and Accounting Officer)   March 11, 2003
 
/s/ DAVID DURY

David Dury
  Director   March 11, 2003
 
/s/ ROBERT D. HEMPSTEAD

Robert D. Hempstead
  Director   March 11, 2003

57


Table of Contents

             
Signature Title Date



 
/s/ DAVID N. LAMBETH

David N. Lambeth
  Director   March 11, 2003
 
/s/ ROBERT LEMOS

Robert Lemos
  Director   March 11, 2003
 
/s/ H. JOSEPH SMEAD

H. Joseph Smead
  Director   March 11, 2003

58


Table of Contents

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

INTEVAC, INC.

                                             
Additions (Reductions)

Balance at Charged (Credited) Balance at
Beginning to Costs and Charged (Credited) End of
Description of Period Expenses to Other Accounts Deductions - Describe Period






Year ended December 31, 2000:
                                       
 
Deducted from asset accounts:
                                       
   
Allowance for doubtful accounts
  $ 1,713,076     $ (1,544,172 )   $ (2,892 )   $ 52,500 (1)   $ 113,512  
   
Inventory provisions
    4,105,930       6,323,014       (311,136 )     1,370,681 (2)     8,747,127  
Year ended December 31, 2001:
                                       
 
Deducted from asset accounts:
                                       
   
Allowance for doubtful accounts
  $ 113,512     $ 40,515     $ 70,833     $ (484 )(1)   $ 225,344  
   
Inventory provisions
    8,747,127       3,715,817       896,000       698,077 (2)     12,660,867  
Year ended December 31, 2002:
                                       
 
Deducted from asset accounts:
                                       
   
Allowance for doubtful accounts
  $ 225,344     $ 72,717     $     $ 28,741 (1)   $ 269,320  
   
Inventory provisions
    12,660,867       1,315,582       (229,367 )     4,189,035 (2)     9,558,047  


(1)  Write-offs of amounts deemed uncollectible.
 
(2)  Write-off of inventory having no future use or value to the Company

59


Table of Contents

I, Kevin Fairbairn certify that:

        1. I have reviewed this annual report on Form 10-K of Intevac, Inc.;
 
        2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
 
        3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
 
        4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

  a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
 
  b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
 
  c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

  a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

        6. The registrant’s other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

  /s/ KEVIN FAIRBAIRN
 
  Kevin Fairbairn
  President, Chief Executive Officer and Director

Date: March 11, 2003

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I, Charles B. Eddy certify that:

        1. I have reviewed this annual report on Form 10-K of Intevac, Inc.;
 
        2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
 
        3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
 
        4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

  a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
 
  b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
 
  c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

  a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

        6. The registrant’s other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

  /s/ CHARLES B. EDDY III
 
  Charles B. Eddy III
  Vice President, Finance and Administration,
  Chief Financial Officer, Treasurer and Secretary

Date: March 11, 2003

61


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EXHIBIT INDEX

             
Exhibit
Number Description


  *****2.1         Asset Purchase Agreement between Intevac, Inc. and Photon Dynamics, Inc. dated as of October 22, 2002
  *3.1         Amended and Restated Articles of Incorporation of the Registrant
  *3.2         Bylaws of the Registrant
  ***4.2         Indenture, dated as of February 15, 1997, between the Company and State Street Bank and Trust Company of California, N.A. as Trustee, including the form of the Convertible Notes
  4.3         Indenture, dated as of July 12, 2002, between the Company and State Street Bank and Trust Company of California, N.A. as Trustee, including the form of the Convertible Notes
  *10.1         The Registrant’s 1991 Stock Option/ Stock Issuance Plan
  *10.2         The Registrant’s 1995 Stock Option/ Stock Issuance Plan, as amended
  *10.3         The Registrant’s Employee Stock Purchase Plan, as amended
  ****10.5         Lease, dated February 5, 2001 regarding the space located at 3560, 3570 and 3580 Bassett Street, Santa Clara, California
  *10.8         601 California Avenue LLC Limited Liability Operating Agreement, dated July 28, 1995
  *10.9         The Registrant’s 401(k) Profit Sharing Plan
  21.1         Subsidiaries of the Registrant
  23.1         Consent of Grant Thornton LLP, Independent Auditors
  24.1         Power of Attorney (see page 57)
  99.1         Certification Pursuant to 18 U.S.C. Section 1350


  Previously filed as an exhibit to the Registration Statement on Form S-1 (No. 33-97806)

  **  Previously filed as an exhibit to the Registration Statement on Form S-1 (No. 333-05531)

  ***  Previously filed as an exhibit to the Registration Statement on Form S-3 (No. 333-24275)

****  Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000

*****  Incorporated by reference to the exhibit filed with the Company’s Report on Form 8-K filed November 14, 2002

62

<PAGE>
                                                                     Exhibit 4.3

================================================================================

                                  INTEVAC, INC.

                                       AND
                              ---------------------

           STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A.

                                   AS TRUSTEE

                6-1/2% CONVERTIBLE SUBORDINATED NOTES DUE 2009

                              ---------------------
                                    INDENTURE

                            DATED AS OF JULY 12, 2002





================================================================================

<PAGE>
                                TABLE OF CONTENTS
                                                                           PAGE

ARTICLE I Definitions and Incorporation by Reference.........................1

      SECTION 1.01   Definitions.............................................1

      SECTION 1.02   Other Definitions.......................................7

      SECTION 1.03   Incorporation by Reference of Trust Indenture Act.......8

      SECTION 1.04   Rules of Construction...................................8

ARTICLE II The Securities....................................................9

      SECTION 2.01   Form and Dating.........................................9

      SECTION 2.02   Execution and Authentication...........................10

      SECTION 2.03   Registrar, Paying Agent and Conversion Agent...........10

      SECTION 2.04   Paying Agent to Hold Money in Trust....................11

      SECTION 2.05   Securityholder.........................................11

      SECTION 2.06   Transfer and Exchange..................................11

      SECTION 2.07   Replacement Securities.................................12

      SECTION 2.08   Outstanding Securities.................................12

      SECTION 2.09   Treasury Securities....................................12

      SECTION 2.10   Temporary Securities: Exchange of Global Security

                     for Certificated Securities............................13

      SECTION 2.11   Cancellation...........................................13

      SECTION 2.12   Defaulted Interest.....................................14

ARTICLE III Redemption......................................................14

      SECTION 3.01   Notices to Trustee.....................................14

      SECTION 3.02   Selection of Securities to be Redeemed.................14

      SECTION 3.03   Notice of Redemption...................................14

      SECTION 3.04   Effect of Notice of Redemption.........................15

      SECTION 3.05   Deposit of Redemption
 Price............................15

      SECTION 3.06   Securities Redeemed in Part............................15

      SECTION 3.07   Optional Redemption....................................16

      SECTION 3.08   Designated Event Offer.................................16

      SECTION 3.09   Conversion Arrangement on Underwritten Call for

                     Redemption.............................................18

ARTICLE IV Covenants........................................................18

      SECTION 4.01   Payment of Securities..................................18

      SECTION 4.02   SEC Reports............................................19

      SECTION 4.03   Compliance Certificate.................................19

      SECTION 4.04   Stay, Extension and Usury Law..........................19

      SECTION 4.05   Corporate Existence....................................20

      SECTION 4.06   Maintenance of Properties..............................20

      SECTION 4.07   Payment of Taxes and Other Claims......................20


                                      i

<PAGE>
                                TABLE OF CONTENTS
                                   (Continued)


      SECTION 4.08   Designated Event.......................................20

      SECTION 4.09   Triggering Distribution................................21

      SECTION 4.10   Further Instruments and Acts...........................21

ARTICLE V Conversion........................................................21

      SECTION 5.01   Conversion Privilege...................................21

      SECTION 5.02   Conversion Procedure...................................22

      SECTION 5.03   Fractional Shares......................................22

      SECTION 5.04   Taxes on Conversion....................................22

      SECTION 5.05   Company to Provide Stock...............................23

      SECTION 5.06   Adjustment of Conversion Price.........................23

      SECTION 5.07   No Adjustment..........................................26

      SECTION 5.08   Other Adjustments......................................26

      SECTION 5.09   Adjustments for Tax Purposes...........................27

      SECTION 5.10   Adjustments by the Company.............................27

      SECTION 5.11   Notice of Adjustment...................................27

      SECTION 5.12   Notice of Certain Transactions.........................27

      SECTION 5.13   Effect of Reclassifications, Consolidations,

                     Mergers or Sales on Conversion Privilege...............27

      SECTION 5.14   Trustee's Disclaimer...................................28

      SECTION 5.15   Automatic Conversion...................................29


ARTICLE VI Subordination....................................................30

      SECTION 6.01   Agreement to Subordinate...............................30

      SECTION 6.02   No Payment on Securities if Senior Debt in Default.....30

      SECTION 6.03   Distribution on Acceleration of Securities;

                     Dissolution and Reorganization: Subrogation of

                     Securities.............................................31

      SECTION 6.04   Reliance by Holders of Senior Debt on

                     Subordination Provisions...............................34

      SECTION 6.05   No Waiver of Subordination Provisions..................34

      SECTION 6.06   Trustee's Relation to Senior Debt......................35

  SECTION 6.07   Other Provisions Subject Hereto..........................  35

      SECTION 6.08   Certain Conversions and Repurchases Deemed Payment.....35


ARTICLE VII Successors......................................................36

      SECTION 7.01   Merger, Consolidation or Sale of Assets................36

      SECTION 7.02   Successor Corporate Entity Substituted.................36


ARTICLE VIII Defaults and Remedies..........................................37

      SECTION 8.01   Events of Default......................................37

      SECTION 8.02   Acceleration...........................................38

      SECTION 8.03   Other Remedies.........................................38


                                       ii

<PAGE>
                                TABLE OF CONTENTS
                                   (Continued)


      SECTION 8.04   Waiver of Past Defaults................................39

      SECTION 8.05   Control by Majority....................................39

      SECTION 8.06   Limitation on Suits....................................39

      SECTION 8.07   Rights of Securityholders to Receive Payment...........39

      SECTION 8.08   Collection Suit by Trustee.............................40

      SECTION 8.09   Trustee May File Proofs of Claim.......................40

      SECTION 8.10   Priorities.............................................40

      SECTION 8.11   Undertaking for Costs..................................40


ARTICLE IX Trustee..........................................................40

      SECTION 9.01   Duties of Trustee......................................41

      SECTION 9.02   Rights of Trustee......................................41

      SECTION 9.03   Individual Rights of Trustee...........................42

      SECTION 9.04   Trustee's Disclaimer...................................42

      SECTION 9.05   Notice of Defaults.....................................42

      SECTION 9.06   Reports by Trustee to Securityholders..................42

      SECTION 9.07   Compensation and Indemnity.............................42

      SECTION 9.08   Replacement of Trustee.................................43

      SECTION 9.09   Successor Trustee by Merger, Etc.......................44

      SECTION 9.10   Eligibility; Disqualification..........................44

      SECTION 9.11   Preferential Collection of Claims Against Company......44

      SECTION 9.12   Sections Applicable to Registrar, Paying Agent and

                     Conversion Agent.......................................44


ARTICLE X Discharge of Indenture............................................45

      SECTION 10.01  Termination of Company's Obligation....................45

      SECTION 10.02  Repayment to Company...................................45


ARTICLE XI Amendments, Supplements and Waivers..............................45

      SECTION 11.01  Without Consent of Securityholders.....................45

      SECTION 11.02  With Consent of Securityholders........................46

      SECTION 11.03  Compliance with Trust Indenture Act....................47

      SECTION 11.04  Revocation and Effect of Consents......................47

      SECTION 11.05  Notation on or Exchange of Securities..................48

      SECTION 11.06  Trustee Protected......................................48


ARTICLE XII Miscellaneous...................................................48

      SECTION 12.01  Trust Indenture Act Controls...........................48

      SECTION 12.02  Notices................................................48

      SECTION 12.03  Communication by Securityholders with Other

                     Securityholders........................................49

      SECTION 12.04  Certificate and Opinion as to Conditions Precedent.....49


                                       iii

<PAGE>
                               TABLE OF CONTENTS
                                  (Continued)


      SECTION 12.05  Statements Required in Certificate or Opinion..........49

      SECTION 12.06  Rules by Trustee and Agents............................49

      SECTION 12.07  Legal Holidays.........................................49

      SECTION 12.08  No Recourse Against Others.............................50

      SECTION 12.09  Counterparts...........................................50

      SECTION 12.10  Variable Provisions....................................50

      SECTION 12.11  Governing Law..........................................51

      SECTION 12.12  No Adverse Interpretation of Other Agreements..........51

      SECTION 12.13  Successors.............................................51

      SECTION 12.14  Severability...........................................51

      SECTION 12.15  Table of Contents, Headings, Etc.......................51


ARTICLE XIII Repurchase Offer...............................................51

      SECTION 13.01  Repurchase Offer.......................................51

      SECTION 13.02  Repurchase Notice......................................52

      SECTION 13.03  Deposit of Repurchase Offer Amount.....................53

      SECTION 13.04  Compliance with Applicable Laws........................53


EXHIBIT A     FORM OF CONVERTIBLE SUBORDINATED NOTE........................A-1


                                       iv

<PAGE>
      INDENTURE dated as of July 12, 2002 between Intevac, Inc., a California
corporation (the "Company") and State Street Bank and Trust Company of
California, N.A., a national banking association under the laws of the United
States of America, as Trustee (the "Trustee").

      Each party agrees as follows for the benefit of the other party and for
the equal and ratable benefit of the Securityholders of the Company's 6-1/2%
Convertible Subordinated Notes due 2009 (the "Securities"):

                                   ARTICLE I

                   Definitions and Incorporation by Reference

SECTION 1.01 Definitions

      "Affiliate" of any specified person means any other person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified person. For the purposes of this definition,
"control" (including, with correlative meanings, the terms "controlling",
"controlled by" and "under common control with"), as used with respect to any
person, shall mean the possession, directly or indirectly, of the power to
direct or cause the direction of the management or policies of such person,
whether through the ownership of voting securities or by agreement or otherwise.

      "Agent" means any Registrar, Paying Agent, Conversion Agent or
co-registrar.

      "Board of Directors" means the Board of Directors of the Company or any
authorized committee of the Board.

      "Board Resolution" means a copy of a resolution of the Board of Directors
certified by the Secretary or an Assistant Secretary of the Company to be in
full force and effect on the date of such certification and delivery to the
Trustee.

      "Business Day" means any day that is not a Legal Holiday.

      "Capital Stock" means with respect to any entity any and all shares,
interests, participations, rights or other equivalents (however designated) of
equity interests in entity, including, without limitation, corporate stock and
partnership interests.

      "Change of Control" means any event where: (i) any "person" or "group" (as
such terms are used in Section 13(d) and 14(d) of the Exchange Act) is or
becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the
Exchange Act) of shares representing more than 50% of the combined voting power
of the then-outstanding securities entitled to vote generally in elections of
directors of the Company ("Voting Stock"), (ii) the Company consolidates with or
merges into any other corporation, or any other corporation merges into the
Company, and, in the case of any such transaction, the outstanding Common Stock
of the Company is reclassified into or exchanged

<PAGE>
for any other property or security, unless the shareholders of the Company
immediately before such transaction own, directly or indirectly immediately
following such transaction, at least a majority of the combined voting power of
the outstanding voting securities of the Corporate Entity resulting from such
transaction in substantially the same proportion as their ownership of the
Voting Stock immediately before such transaction, (iii) the Company conveys,
transfers or leases all or substantially all of its assets to any person, unless
such conveyance, transfer or lease is to a corporation and the shareholders of
the Company immediately before such conveyance, transfer or lease own, directly
or indirectly immediately following such transaction, at least a majority of the
combined voting power of the Corporate Entity to which such assets are so
conveyed, transferred or leased in the same proportion as their ownership of the
Voting Stock immediately before such transaction, or (iv) any time the
Continuing Directors do not constitute a majority of the Board of Directors of
the Company (or, if applicable, a successor corporation to the Company);
provided, that a Change of Control shall not be deemed to have occurred if at
least 90% of the consideration (excluding cash payments for fractional shares)
in the transaction or transactions constituting the Change of Control consists
of shares of common stock that are, or upon issuance will be, traded on a United
States national securities exchange or approved for trading on an established
automated over-the-counter trading market in the United States.

      "Common Stock" means the common stock of the Company as the same exists at
the date of the execution of this Indenture or as such stock may be constituted
from time to time.

      "Company" means the party named as such above until a successor replaces
it in accordance with Article VI and thereafter means the successor.

      "Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (i) was a member of such Board of
Directors on the date of this Indenture or (ii) was nominated for election or
elected to such Board of Directors with the approval of a majority of the
Continuing Directors who were members of such board at the time of such
nomination or election.

      "Corporate Entity" shall be any corporation, limited liability company or
other business entity.

      "Custodian" means State Street Bank and Trust Company of California, N.A.,
as custodian with respect to the Global Securities, or any successor entity
thereto.

      "Daily Market Price" means the price of a share of Common Stock on the
relevant date, determined (a) on the basis of the last reported sale price
regular way of the Common Stock as reported on the NNM, or if the Common Stock
is not then listed on the NNM, as reported on such national securities exchange
upon which the Common Stock is listed, or (b) if there is no such reported sale
on the day in question, on the basis of the average of the closing bid and asked
quotations regular way as so reported, or (c) if the Common Stock is not listed
on the NNM or on any national securities exchange, on the basis of the average
of the high bid and low asked quotations regular way on the day in question in
the over-the-counter market as reported by the

                                       -2-

<PAGE>
National Association of Securities Dealers Automated Quotation System, or if not
so quoted, as reported by National Quotation Bureau, Incorporated, or a similar
organization.

      "Default" means any event that is, or with the passage of time or the
giving of notice or both, would be an Event of Default. "Depositary" means The
Depository Trust Company, its nominees and their respective successors.

      "Designated Event" means the occurrence of a Change of Control or a
Termination of Trading.

      "Designated Senior Debt" means any Senior Debt which, at the date of
determination, has an aggregate principal amount outstanding of, or commitments
to lend up to, at least $10.0 million and is specifically designated by the
Company in the instrument evidencing or governing such Senior Debt as
"Designated Senior Debt" for purposes of this Indenture (provided, that such
instrument may place limitations and conditions on the right of such Senior Debt
to exercise the rights of Designated Senior Debt).

      "Exchange Act" means the Securities Exchange Act of 1934, as amended.

      "Excess Payment" means the excess of (A) the aggregate of the cash and
fair market value of other consideration paid by the Company or any of its
Subsidiaries with respect to the shares acquired in a tender offer or other
negotiated transaction over (B) the Daily Market Price on the Trading Day
immediately following the completion of such tender offer or other negotiated
transaction multiplied by the number of acquired shares.

      "GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession in the United States, which are in effect from time to time.

      "Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.

      "Indebtedness" means, with respect to any person, all obligations, whether
or not contingent, of such person (i)(a) for borrowed money (including, but not
limited to, any indebtedness secured by a security interest, mortgage or other
lien on the assets of such person which is (1) given to secure all or part of
the purchase price of property subject thereto, whether given to the vendor of
such property or to another, or (2) existing on property at the time of
acquisition thereof), (b) evidenced by a note, debenture, bond or other written
instrument, (c) under a lease required to be capitalized on the balance sheet of
the lessee under GAAP or under any lease or related document (including a

                                       -3-

<PAGE>
purchase agreement) which provides that such person is contractually obligated
to purchase or to cause a third party to purchase such leased property, (d) in
respect of letters of credit, loan, bank guarantees or bankers' acceptances, (e)
with respect to Indebtedness secured by a mortgage, pledge, lien, encumbrance,
charge or adverse claim affecting title or resulting in an encumbrance to which
the property or assets of such person are subject, whether or not the obligation
secured thereby shall have been assumed or guaranteed by or shall otherwise be
such person's legal liability, (f) in respect of the balance of the deferred and
unpaid purchase price of any property or assets, (g) under interest rate,
currency or credit swap agreements, cap, floor and collar agreements, spot and
forward-contracts and similar agreements and arrangements; (ii) with respect to
any obligation of others of the type described in the preceding clause (i) or
under clause (iii) below assumed by or guaranteed in any manner by such person
or in effect guaranteed by such person through an agreement to purchase
(including, without limitation, "take or pay" and similar arrangements),
contingent or otherwise (and the obligations of such person under any such
assumptions, guarantees or other such arrangements); and (iii) any and all
deferrals, renewals, extensions, refinancings and refundings of, or amendments,
modifications or supplements to, any of the foregoing.

      "Indenture" means this Indenture as amended from time to time.

      "Issuance Date" means the date on which the Securities are first
authenticated and issued.

      "Material Subsidiary" means any Subsidiary of the Company which at the
date of determination is a "significant subsidiary" as defined in Rule 1-02(w)
of Regulation S-X under the Securities Act and the Exchange Act (as such
Regulation is in effect on the date hereof).

      "NNM" means the Nasdaq Stock Market's National Market.

      "Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.

      "Offering Circular" means the Offering Circular relating to the Securities
dated June 21, 2002, as supplemented on July 3, 2002, and as the same may be
amended or further supplemented from time to time.

      "Officers' Certificate" means a certificate signed by two Officers, one of
whom must be the Chairman of the Board, the President, the Chief Financial
Officer, the Treasurer or a Vice-President of the Company. See Sections 12.04
and 12.05 hereof.

      "Opinion of Counsel" means a written opinion from legal counsel who is
acceptable to the Trustee. The counsel may be an employee of or counsel to the
Company or the Trustee. See Sections 12.04 and 12.05 hereof.

      "person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust, unincorporated organization or
government or any agency or political subdivision thereof.

                                       -4-

<PAGE>
      "Photonics Business" means the design, development, manufacture and
service of the Photonic Products by the Company or one of its Subsidiaries.

      "Photonics Products" means:

        (i) the Company's Electron Bombarded Charge Coupled Device ("EBCCD")
            that is a sensor that has a transparent glass window on one side
            through which photons are focused onto a photocathode grown on the
            vacuum side of the window, such that when these photons strike the
            photocathode through the window, electrons are emitted into the
            vacuum and these electrons are then electrically accelerated through
            the vacuum and strike a charge coupled device ("CCD") imager, which
            in turn outputs a high resolution, low noise video signal;

       (ii) the Company's Electron Bombarded Active Pixel Sensor ("EBAPS") that
            incorporates the same basic technology as described in clause (i)
            above but contains a Complementary Metal-Oxide-Semiconductor
            ("CMOS") imager instead of a CCD chip;

      (iii) the Company's Laser Illuminated Viewing and Ranging system ("LIVAR")
            that is an EBCCD sensor with a laser illuminator that operates in a
            manner similar to RADAR, but utilizing an eye safe laser, rather
            than a longer wavelength microwave source, and displaying the
            reflected signal as a digital video image, rather than as a blip;
            and

       (iv) any products derived from the devices specified in (i) through (iii)
            above.

      "principal" of a debt security means the principal of the security plus
the premium, if any, on the security.

      "Representative" means the trustee, agent or representative (if any) for
an issue of Senior Debt.

      "SEC" means the Securities and Exchange Commission.

      "Securities" means the Securities described in the preamble above that are
issued, authenticated and delivered under this Indenture.

      "Securities Act" means the Securities Act of 1933, as amended.

      "Securityholder" or "holder" means a person in whose name a Security is
registered.

      "Senior Debt" means the principal of, premium, if any, interest, on, and
fees, costs and expenses in connection with, and other amounts due on
Indebtedness of the Company, whether

                                       -5-

<PAGE>

outstanding on the date of the Indenture or thereafter created, incurred,
assumed or guaranteed by the Company, unless, in the instrument creating or
evidencing or pursuant to which Indebtedness is outstanding, it is expressly
provided that such Indebtedness is not senior in right of payment to the
Securities. Senior Debt includes, with respect to the obligations described
above, interest accruing, pursuant to the terms of such Senior Debt, on or after
the filing of any petition in bankruptcy or for reorganization relating to the
Company, whether or not post-filing interest is allowed in such proceeding, at
the rate specified in the instrument governing the relevant obligation.
Notwithstanding anything to the contrary in the foregoing, Senior Debt shall not
include: (a) Indebtedness of the Company to a Subsidiary of the Company; (b) the
Securities; (c) the Company's 6-1/2% Convertible Subordinated Notes due 2004;
(d) Indebtedness of or amount owned by the Company for compensation to
employees, or for goods, services or material purchased in the ordinary course
of business; or (e) any liability for federal, state, local or other taxes owed
or owing by the Company. For the purposes of this definition of Senior Debt
under this Indenture, it is the intent of the parties hereto that the Securities
issued under this Indenture be "Senior Debt" (as defined under that certain
Indenture, dated February 15, 1997, between the Company and State Street Bank
and Trust Company of California, N.A. (the "2004 Indenture")) for purposes of
the 6-1/2% Convertible Subordinated Notes due 2004 (the "Existing Notes") issued
under the 2004 Indenture, and in furtherance thereof, the parties hereto agree
that nothing contained in this Indenture or in the definition of Senior Debt
under this Indenture is meant to or shall be construed to expressly provide that
the Securities issued under this Indenture are not superior to the Existing
Notes.

      "Subsidiary" means any corporation, association or other business entity
of which more than 50% of the total voting power of shares of Capital Stock
entitled (without regard to the occurrence of any contingency) to vote in the
election of directors, managers or trustees thereof is at the time owned or
controlled, directly or indirectly, by any person or one or more of the other
Subsidiaries of that person or a combination thereof.

      "Termination of Trading" will be deemed to have occurred if the Common
Stock (or other common stock into which the Securities are then convertible) is
neither listed for trading on a United States national securities exchange nor
approved for trading on an established automated over-the-counter trading market
in the United States.

      "TIA" means the Trust Indenture Act of 1939, and rules and regulations
thereunder as so amended as in effect on the date of execution of this
Indenture; provided, however, in the event that Trust Indenture Act of 1939 is
amended after such date, "Trust Indenture Act" means, to the extent required by
any such amendment, the Trust Indenture Act of 1939 as so amended.

      "Trading Day" shall mean (A) if the applicable security is quoted on the
NNM, a day on which trades may be made thereon, (B) if the applicable security
is listed or admitted for trading on the New York Stock Exchange or another
national securities exchange, a day on which the New York Stock Exchange or such
other national securities exchange is open for business or (C) if the applicable
security is not so listed, admitted for trading or quoted, any day other than a
Saturday or Sunday or a day on which banking institutions in the State of New
York or the State of California are authorized or obligated by law or executive
order to close.


                                      -6-

<PAGE>
      "Triggering Distribution" means an event where the Company declares or
makes any dividend or other distribution to all of the holders of the Common
Stock of shares of Capital Stock of any Subsidiary that at the time constitutes
the Company's Photonics Business.

      "Trustee" means the party named as such above until a successor replaces
it in accordance with the applicable provisions of this Indenture and thereafter
means the successor.

      "Trust Officer" means any officer or assistant officer of the Trustee
assigned by the Trustee to administer this Indenture.

      SECTION 1.02 Other Definitions.


<TABLE>
<CAPTION>
                                                                      Defined in
                                                                    Term Section
<S>                                                                     <C>
"Agent Members"...................................................      2.01

"Automatic Conversion"............................................      15.15

"Automatic Conversion Notice".....................................      15.15

"Bankruptcy Custodian"............................................      8.01

"Bankruptcy Law"..................................................      8.01

"Designated Event Offer"..........................................      4.08

"Designated Event Payment"........................................      4.08

"Designated Event Payment Date"...................................      3.08

"Commencement Date"...............................................      3.08

"Conversion Agent"................................................      2.03

"Conversion Date".................................................      5.02

"Conversion Price"................................................      5.01

"Current Market Price"............................................      5.06(e)

"Event of Default"................................................      8.01

"Global Security".................................................      2.01

"Legal Holiday"...................................................      12.07

"Offer Amount"....................................................      3.08

"Officer".........................................................      12.10

"Paying Agent"....................................................      2.03

"Payment Blockage Notice".........................................      6.02

"Payment Blockage Period".........................................      6.02

"Payment Default".................................................      8.01
</TABLE>



                                      -7-

<PAGE>

<TABLE>
<CAPTION>
                                                                      Defined in
                                                                    Term Section
<S>                                                                     <C>
"Purchase Agreement"..............................................      2.01

"Purchase Date"...................................................      5.06

"Registrar".......................................................      2.03

"Repurchase Commencement Date"....................................      13.01

"Repurchase Offer"................................................      4.09

"Repurchase Offer Agreement"......................................      13.01

"Repurchase Payment"..............................................      4.09

"Repurchase Payment Date".........................................      4.09

"Restricted Securities"...........................................      2.01

"Tender Period"...................................................      3.08
</TABLE>


      SECTION 1.03 Incorporation by Reference of Trust Indenture Act. Whenever
this Indenture refers to a provision of the TIA, the provision is incorporated
by reference in and made a part of this Indenture.

      The following TIA terms used in this Indenture have the following
meanings:

      "indenture securities" means the Securities;

      "indenture security holder" means a Securityholder;

      "indenture to be qualified" means this Indenture;

      "indenture trustee" or "institutional trustee" means the Trustee; and

      "obligor" on the Securities means the Company or any other obligor on
the Securities.

      All other terms used in this Indenture that are defined by the TIA,
defined by TIA reference to another statute or defined by SEC rule under the TIA
have the meanings so assigned to them.

      SECTION 1.04 Rules of Construction. Unless the context otherwise requires:

            (a) a term has the meaning assigned to it;

            (b) an accounting term not otherwise defined has the meaning
assigned to it in accordance with GAAP consistently applied;

            (c) "or" is not exclusive;


                                      -8-

<PAGE>
            (d) words in the singular include the plural, and words in the
plural include the singular; and

            (e) provisions apply to successive events and transactions.

                                   ARTICLE II

                                 The Securities

      SECTION 2.01 Form and Dating. The Securities and the Trustee's certificate
of authentication shall be substantially in the form of Exhibit A which is
hereby incorporated in and expressly made a part of this Indenture.

      The Securities may have notations, legends or endorsements required by
law, stock exchange rule, agreements to which the Company is subject, if any, or
usage (provided that any such notation, legend or endorsement is in a form
acceptable to the Company). The Company shall furnish any such legend not
contained in Exhibit A to the Trustee in writing. The Securities shall be dated
the date of their authentication. The terms and provisions of the Securities set
forth in Exhibit A are part of the terms of this Indenture and to the extent
applicable, the Company and the Trustee, by their execution and delivery of this
Indenture, expressly agree to such terms and provisions and to be bound thereby.

            (a) Global Securities. The Securities shall be issued in the form of
one or more global Securities in definitive, fully registered form without
interest coupons with the global securities legend set forth in Exhibit A hereto
(a "Global Security"). The Global Securities shall be deposited on behalf of the
purchasers of the Securities represented thereby with the Trustee as Custodian
for the Depositary, and registered in the name of the Depositary or a nominee of
the Depositary, duly executed by the Company and authenticated by the Trustee as
hereinafter provided. The aggregate principal amount of the Global Security may
from time to time be increased or decreased by adjustments made on the records
of the Trustee and the Depositary or its nominee as hereinafter provided in this
Article II.

            (b) Book-Entry Provisions. This Section 2.01(b) shall apply only to
a Global Security deposited with or on behalf of the Depositary.

      The Company shall execute and the Trustee shall, in accordance with this
Section 2.01(b) and the written order of the Company, authenticate and deliver
initially one or more Global Securities that (i) shall be registered in the name
of Cede & Co. or other nominee of such Depositary and (ii) shall be delivered by
the Trustee to such Depositary or pursuant to such Depositary's instructions or
held by the Trustee as Custodian for the Depositary pursuant to a FAST Balance
Certificate Agreement between the Depositary and the Trustee.

      Members of, or participants in, the Depositary ("Agent Members") shall
have no rights under this Indenture with respect to any Global Security held on
their behalf by the Depositary or by the Trustee as the Custodian for the
Depositary or under such Global Security, and the Depositary or its


                                      -9-

<PAGE>
nominee, as the case may be, may be treated by the Company, the Trustee and any
agent of the Company or the Trustee as the absolute owner of such Global
Security for all purposes whatsoever. Notwithstanding the foregoing, nothing
herein shall prevent the Company, the Trustee or any agent of the Company or the
Trustee from giving effect to any written certification, proxy or other
authorization furnished by the Depositary or impair, as between the Depositary
and its Agent Members, the operation of customary practices of such Depositary
governing the exercise of the rights of a holder of a beneficial interest in any
Global Security.

      SECTION 2.02 Execution and Authentication. Two Officers shall sign the
Securities for the Company by manual or facsimile signature.

      If an Officer whose signature is on a Security no longer holds that office
at the time the Security is authenticated, the Security shall nevertheless be
valid.

      A Security shall not be valid until authenticated by the manual signature
of an authorized officer of the Trustee. The signature shall be conclusive
evidence that the Security has been authenticated under this Indenture.

      Upon a written order of the Company signed by two Officers, the Trustee
shall authenticate the Securities for original issue up to an aggregate
principal amount of $29,543,000. The aggregate principal amount of Securities
outstanding at any time shall not exceed such aggregate amount of $29,543,000
except as provided in Section 2.07.

      The Trustee may appoint an authenticating agent acceptable to the Company
to authenticate Securities. An authenticating agent may authenticate Securities
whenever the Trustee may do so. Each reference in this Indenture to
authentication by the Trustee includes authentication by such agent. An
authenticating agent has the same rights as an Agent to deal with the Company or
an Affiliate.

      SECTION 2.03 Registrar, Paying Agent and Conversion Agent. The Company
shall maintain in the Borough of Manhattan, City of New York, State of New York
(i) an office or agency where Securities may be presented for registration of
transfer or for exchange ("Registrar"), (ii) an office or agency where
Securities may be presented for payment ("Paying Agent") and (iii) an office or
agency where Securities may be presented for conversion ("Conversion Agent").
The Registrar shall keep a register of the Securities and of their transfer and
exchange. The Company may appoint the Registrar, the Paying Agent and the
Conversion Agent. The Company may appoint one or more co-registrars, one or more
additional paying agents and one or more additional conversion agents in such
other locations as it shall determine; provided that no such designation shall
in any manner relieve the Company of its obligation to maintain an office or
agency in the Borough of Manhattan, The City of New York, State of New York, for
such purposes. The term "Paying Agent" includes any additional paying agent and
the term "Conversion Agent" includes any additional conversion agent. The
Company may change any Paying Agent, Registrar, co-registrar or Conversion Agent
without prior notice to any Securityholder. The Company shall notify the Trustee
of the name and address of any Agent not a party to this Indenture. If the
Company fails to appoint or maintain another entity as Registrar, Paying Agent
or Conversion Agent, the Trustee shall act as such. The


                                      -10-

<PAGE>
Company or any of its Affiliates may act as Paying Agent, Registrar,
co-registrar or Conversion Agent. The Company initially appoints the Trustee as
Paying Agent, Registrar, Conversion Agent and Custodian and the Trustee hereby
accepts such appointments and each of the corporate trust office of the Trustee
in Los Angeles, California and the office or agency of the Trustee in the
Borough of Manhattan, The City of New York, State of New York (which shall
initially be State Street Bank and Trust Company, N.A., an Affiliate of the
Trustee located at 61 Broadway, Concourse Level, Corporate Trust Window, New
York, New York 10006), shall be considered as one such office or agency of the
Company for the aforesaid purposes.

      SECTION 2.04 Paying Agent to Hold Money in Trust. The Company shall
require each Paying Agent other than the Trustee to agree in writing that the
Paying Agent will hold in trust for the benefit of Securityholders or the
Trustee all money held by the Paying Agent for the payment of principal or
interest, and will notify the Trustee of any default by the Company in making
any such payment. While any such default continues, the Trustee may require a
Paying Agent to pay all money held by it to the Trustee. The Company at any time
may require a Paying Agent to pay all money held by it to the Trustee and to
account for any money disbursed by it. Upon payment over to the Trustee, the
Paying Agent (if other than the Company or an Affiliate of the Company) shall
have no further liability for the money. If the Company or an Affiliate of the
Company acts as Paying Agent, it shall segregate and hold in a separate trust
fund for the benefit of the Securityholders all money held by it as Paying
Agent.

      SECTION 2.05 Securityholder. The Trustee shall preserve in as current a
form as is reasonably practicable the most recent list available to it of the
names and addresses of Securityholders. If the Trustee is not the Registrar, the
Company shall furnish to the Trustee on or before each interest payment date and
at such other times as the Trustee may request in writing a list in such form
and as of such date as the Trustee may reasonably require of the names and
addresses of Securityholders.

      SECTION 2.06 Transfer and Exchange. When Securities are presented to the
Registrar or a co-registrar with a request to register a transfer or to exchange
them for an equal principal amount of Securities of other denominations, the
Registrar shall register the transfer or make the exchange if its requirements
for such transactions are met. To permit registrations of transfers and
exchanges, the Company shall issue and the Trustee shall authenticate Securities
at the Registrar's request. No service charge shall be made for any registration
of transfer or exchange (except as otherwise expressly permitted herein), but
the Company may require payment of a sum sufficient to cover any transfer tax or
similar governmental charge payable in connection therewith (other than any such
transfer tax or similar governmental charge payable upon exchanges pursuant to
Sections 2.10, 3.06, 3.08, 5.02 or 11.05 hereof).

      The Company shall not be required (i) to register the transfer of or
exchange Securities during a period beginning at the opening of business 15 days
before the day of any selection of Securities for redemption under Section 3.02
hereof and ending at the close of business on the day of selection, or (ii) to
exchange or register the transfer of any Security so selected for redemption in
whole or in part, except the unredeemed portion of any Security being redeemed
in part or (iii) to


                                      -11-

<PAGE>
register the transfer of or exchange Securities submitted for repurchase (and
not withdrawn) under Sections 4.08 or 4.09 hereof.

      The Trustee shall have no responsibility for any actions taken or not
taken by the Depositary.

      SECTION 2.07 Replacement Securities. If the holder of a Security claims
that the Security has been lost, destroyed or wrongfully taken or if such
Security is mutilated and is surrendered to the Trustee, the Company shall issue
and the Trustee shall authenticate a replacement Security if the Trustee's and
the Company's requirements are met. If required by the Trustee or the Company,
an indemnity bond must be sufficient in the judgment of both to protect the
Company, the Trustee, any Agent or any authenticating agent from any loss which
any of them may suffer if a Security is replaced. The Company may charge for its
expenses in replacing a Security.

      In case any such mutilated, destroyed, lost or stolen Security has become
or is about to become due and payable, or is about to be redeemed or purchased
by the Company pursuant to Article III hereof or converted into shares of Common
Stock pursuant to Article V hereof, the Company in its discretion may, instead
of issuing a new Security, pay, redeem, purchase or convert such Security, as
the case may be.

      Every replacement Security is an additional obligation of the Company.

      SECTION 2.08 Outstanding Securities. The Securities outstanding at any
time are all the Securities authenticated by the Trustee except for those
canceled by it, those delivered to it for cancellation, and those described in
this Section as not outstanding.

      If a Security is replaced, paid, redeemed, or purchased or converted
pursuant to Section 2.07 hereof, it ceases to be outstanding unless, in the case
of a replaced Security, the Trustee receives proof satisfactory to it that the
replaced Security is held by a bona fide purchaser.

      If Securities are considered paid under Section 4.01 hereof, they cease to
be outstanding and interest on them ceases to accrue.

      A Security does not cease to be outstanding because the Company or an
Affiliate of the Company holds the Security.

      SECTION 2.09 Treasury Securities. In determining whether the
Securityholders of the required principal amount of Securities have concurred in
any direction, waiver or consent, Securities owned by the Company or an
Affiliate of the Company shall be considered as though they are not outstanding,
except that for the purposes of determining whether the Trustee shall be
protected in relying on any such direction, waiver or consent, only Securities
which a Trust Officer knows are so owned shall be so disregarded.


                                      -12-

<PAGE>
      SECTION 2.10 Temporary Securities: Exchange of Global Security for
Certificated Securities.

            (a)   Until definitive Securities are ready for delivery, the
Company may prepare and the Trustee shall authenticate temporary Securities.
Temporary Securities shall be substantially in the form of definitive securities
but may have variations that the Company considers appropriate for temporary
Securities. Without unreasonable delay, the Company shall prepare and the
Trustee shall authenticate definitive Securities in exchange for temporary
Securities.

            (b)   Any Global Security or Securities deposited with the
Depositary or with the Trustee as Custodian for the Depositary pursuant to
Section 2.01 shall be transferred to the beneficial owners thereof in the form
of certificated securities only if such transfer complies with Section 2.06 and
(i) the Depositary notifies the Company that it is unwilling or unable to
continue as Depositary for such Global Security or if at any time such
Depositary ceases to be a "clearing agency" registered under the Exchange Act
and a successor Depositary is not appointed by the Company within 90 days of
such notice, or (ii) an Event of Default has occurred and is continuing.

            (c)   Any Global Security that is transferable to the beneficial
owners thereof in the form of certificated Securities pursuant to this Section
2.10 shall be surrendered by the Depositary to the Trustee to be so transferred,
in whole or from time to time in part, without charge, and the Trustee shall
authenticate and deliver, upon such transfer of each portion of such Global
Security, an equal aggregate principal amount at maturity of Securities of
authorized denominations in the form of certificated Securities. Any portion of
a Global Security transferred pursuant to this Section shall be executed,
authenticated and delivered only in denominations of $1,000 and any integral
multiple thereof and registered in such names as the Depositary shall direct.


            (d)   Prior to any transfer pursuant to Section 2.10(b), the
registered holder of a Global Security may grant proxies and otherwise authorize
any person, including Agent Members and persons that may hold interests through
Agent Members, to take any action which a holder is entitled to take under this
Indenture or the Securities.

            (e)   In the event of the occurrence of either of the events
specified in Section 2.10(b), the Company will promptly make available to the
Trustee a reasonable supply of certificated Securities in definitive form
without interest coupons.

      SECTION 2.11 Cancellation. The Company at any time may deliver Securities
to the Trustee for cancellation. The Registrar, Paying Agent and Conversion
Agent shall forward to the Trustee any Securities surrendered to them for
registration of transfer, redemption, purchase, conversion, exchange or payment.
The Trustee shall promptly cancel all Securities surrendered for registration of
transfer, redemption, purchase, conversion, exchange, payment, replacement or
cancellation and shall destroy all canceled Securities unless the Company
otherwise directs. The Company may not issue new Securities to replace
Securities that it has paid or that have been delivered to the Trustee for
cancellation or that any holder has converted.


                                      -13-

<PAGE>
      SECTION 2.12 Defaulted Interest. If the Company fails to make a payment of
interest, it shall pay such defaulted interest plus any interest payable on the
defaulted interest, in any lawful manner. It may pay such defaulted interest,
plus any such interest payable thereon, to the persons who are Securityholders
on a subsequent special record date. The Company shall fix any such record date
and payment date. At least 15 days before any such record date, the Company
shall mail to Securityholders a notice that states the record date, payment
date, and amount of such interest to be paid.

                                  ARTICLE III

                                   Redemption

      SECTION 3.01 Notices to Trustee. If the Company elects to redeem
Securities pursuant to Section 3.07 hereof, it shall notify the Trustee of the
redemption date and the principal amount of Securities to be redeemed. The
Company shall give each notice provided for in this Section 3.01 to the Trustee
at least 20 days before the redemption date (unless a shorter notice period
shall be satisfactory to the Trustee).

      SECTION 3.02 Selection of Securities to be Redeemed. If less than all the
Securities are to be redeemed, the Trustee shall select the Securities to be
redeemed by a method that complies with the requirements of the principal
national securities exchange, if any, on which the Securities are listed, or, if
the Securities are not so listed, on a pro rata basis. The Trustee shall make
the selection not more than 60 days and not less than 15 days before the
redemption date from Securities outstanding not previously called for
redemption. The Trustee may select for redemption portions of the principal of
Securities that have denominations larger than $1,000. Securities and portions
of them it selects shall be in amounts of $1,000 or integral multiples of
$1,000. Provisions of this Indenture that apply to Securities called for
redemption also apply to portions of Securities called for redemption. The
Trustee shall notify the Company promptly of the Securities or portions of
Securities to be called for redemption.

      If any Security selected for partial redemption is converted in part after
such selection, the converted portion of such Security shall be deemed (so far
as may be) to be the portion to be selected for redemption. The Securities (or
portions thereof) so selected shall be deemed duly selected for redemption for
all purposes hereof, notwithstanding that any such Security is converted in
whole or in part before the mailing of the notice of redemption. Upon any
redemption of less than all the Securities, the Company and the Trustee may
treat as outstanding any Securities surrendered for conversion during the period
15 days next preceding the mailing of a notice of redemption and need not treat
as outstanding any Security authenticated and delivered during such period in
exchange for the unconverted portion of any Security converted in part during
such period.

      SECTION 3.03 Notice of Redemption. At least 15 days but not more than 60
days before a redemption date, the Company shall mail a notice of redemption to
each holder whose Securities are to be redeemed at such holder's registered
address.

      The notice shall identify the Securities to be redeemed and shall state:


                                      -14-

<PAGE>
            (a)   the redemption date;

            (b)   the redemption price;

            (c)   if any Security is being redeemed in part, the portion of the
principal amount of such Security to be redeemed and that, after the redemption
date, upon cancellation of such Security, a new Security or Securities in
principal amount equal to the unredeemed portion will be issued in the name of
the holder thereof;

            (d)   the name and address of the Paying Agent;

            (e)   that Securities called for redemption must be surrendered to
the Paying Agent to collect the redemption price plus accrued interest;

            (f)   that, unless the Company defaults in making such redemption
payment or the Paying Agent is prohibited from making such payment pursuant to
the terms of this Indenture, by law or otherwise, interest on Securities called
for redemption ceases to accrue on and after the redemption date; and

            (g)   the paragraph of the Securities pursuant to which the
Securities called for redemption are being redeemed.

      Such notice shall also state the current Conversion Price and the date on
which the right to convert such Securities or portions thereof into Common Stock
of the Company will expire.

      At the Company's request, the Trustee shall give notice of redemption in
the Company's name and at its expense.

      SECTION 3.04 Effect of Notice of Redemption. Once notice of redemption is
mailed, Securities called for redemption become due and payable on the
redemption date at the price set forth in the Security.

      SECTION 3.05 Deposit of Redemption Price. On or before the redemption
date, the Company shall deposit with the Trustee or with the Paying Agent money
sufficient to pay the redemption price of and accrued interest, up to but not
including the redemption date on all Securities to be redeemed on that date
(subject to the right of holders of record on the relevant record date to
receive interest, due on an interest payment date) unless theretofore converted
into Common Stock pursuant to the provisions hereof. The Trustee or the Paying
Agent shall return to the Company any money not required for that purpose.

      SECTION 3.06 Securities Redeemed in Part. Upon surrender of a Security
that is redeemed in part, the Company shall issue and the Trustee shall
authenticate for the holder at the expense of the Company a new Security equal
in principal amount to the unredeemed portion of the Security surrendered.


                                      -15-

<PAGE>
      SECTION 3.07 Optional Redemption. The Company may redeem all or any
portion of the Securities, upon the terms and at the redemption price set forth
in each of the Securities. Any redemption pursuant to this Section 3.07 shall be
made pursuant to the provisions of Section 3.01 through 3.06 hereof.

      SECTION 3.08 Designated Event Offer.

            (a)   In the event that, pursuant to Section 4.08 hereof, the
Company shall commence a Designated Event Offer, the Company shall follow the
procedures in this Section 3.08.

            (b)   The Designated Event Offer shall remain open for a period
specified by the Company which shall be no less than 30 calendar days and no
more than 40 calendar days following its commencement on the date of the mailing
of notice in accordance with Section 4.08 hereof (the "Commencement Date"),
except to the extent that a longer period is required by applicable law (the
"Tender Period"). Upon the expiration of the Tender Period (the "Designated
Event Payment Date"), the Company shall purchase the principal amount of
Securities required to be purchased pursuant to Section 4.08 hereof (the "Offer
Amount").

            (c)   If the Designated Event Payment Date is on or after an
interest payment record date and on or before the related interest payment date,
any accrued interest, to the related interest payment date will be paid to the
person in whose name a Security is registered at the close of business on such
record date, and no additional interest, will be payable to Securityholders who
tender Securities pursuant to the Designated Event Offer.

            (d)   The Company shall provide the Trustee with written notice of
the Designated Event Offer at least 10 Business Days before the Commencement
Date.

            (e)   On or before the Commencement Date, the Company or the Trustee
(at the request and expense of the Company) shall send, by first class mail, a
notice to each of the Securityholders, which shall govern the terms of the
Designated Event Offer and shall state:

                  (i)   that the Designated Event Offer is being made pursuant
to this Section 3.08 and Section 4.08 hereof and that all Securities tendered
will be accepted for payment;

                  (ii)  the purchase price (as determined in accordance with
Section 4.08 hereof), the length of time the Designated Event Offer will remain
open and the Designated Event Payment Date;

                  (iii) that any Security or portion thereof not tendered or
accepted for payment will continue to accrue interest;

                  (iv)  that, unless the Company defaults in the payment of the
Designated Event Payment, any Security or portion thereof accepted for payment
pursuant to the Designated Event Offer shall cease to accrue interest, after the
Designated Event Payment Date;


                                      -16-

<PAGE>
                  (v)   that Securityholders electing to have a Security or
portion thereof purchased pursuant to any Designated Event Offer will be
required to surrender the Security, with the form entitled "Option of
Securityholder To Elect Purchase" on the reverse of the Security completed, to
the Paying Agent at the address specified in the notice prior to the close of
business on the third Business Day preceding the Designated Event Payment Date;

                  (vi)  that Securityholders will be entitled to withdraw their
election if the Paying Agent receives, not later than the close of business on
the second Business Day preceding the Designated Event Payment Date, or such
longer period as may be required by law, a letter or a telegram, telex,
facsimile transmission (receipt of which is confirmed and promptly followed by a
letter) setting forth the name of the Securityholder, the principal amount of
the Security or portion thereof the Securityholder delivered for purchase and a
statement that such Securityholder is withdrawing his election to have the
Security or portion thereof purchased; and

                  (vii) that Securityholders whose Securities are being
purchased only in part will be issued new Securities equal in principal amount
to the unpurchased portion of the Securities surrendered, which unpurchased
portion must be equal to $1,000 in principal amount or an integral multiple
thereof.

      In addition, the notice shall contain all instructions and materials that
the Company shall reasonably deem necessary to enable such Securityholders to
tender Securities pursuant to the Designated Event Offer.

            (f) On or prior to the Designated Event Payment Date, the Company
shall irrevocably deposit with the Trustee or a Paying Agent in immediately
available funds an amount equal to the Offer Amount to be held for payment in
accordance with the terms of this Section 3.08. On the Designated Event Payment
Date, the Company shall, to the extent lawful, (i) accept for payment the
Securities or portions thereof tendered pursuant to the Designated Event Offer,
(ii) deliver or cause to be delivered to the Trustee Securities so accepted and
(iii) deliver to the Trustee an Officers' Certificate stating such Securities or
portions thereof have been accepted for payment by the Company in accordance
with the terms of this Section 3.08. The Paying Agent shall promptly (but in any
case not later than five calendar days after the Designated Event Payment Date)
mail or deliver to each tendering Securityholder an amount equal to the purchase
price of the Securities tendered by such Securityholder, and the Trustee shall
promptly authenticate and mail or deliver to such Securityholders a new Security
equal in principal amount to any unpurchased portion of the Security
surrendered, if any; provided, that each new Security shall be in a principal
amount of $1,000 or an integral multiple thereof. Any Securities not so accepted
shall be promptly mailed or delivered by or on behalf of the Company to the
holder thereof. The Company will publicly announce the results of the Designated
Event Offer on, or as soon as practicable after, the Designated Event Payment
Date.

            (g) The Designated Event Offer shall be made by the Company in
compliance with all applicable provisions of the Exchange Act, and all
applicable tender offer rules promulgated thereunder, and shall include all
instructions and materials that the Company shall reasonably deem necessary to
enable such Securityholders to tender their Securities.


                                      -17-

<PAGE>
      SECTION 3.09 Conversion Arrangement on Underwritten Call for Redemption.
In connection with any redemption of Securities, the Company may arrange for the
purchase and conversion of any Securities by an arrangement with one or more
investment bankers or other purchasers to purchase such Securities by paying to
the Trustee in trust for the holders, on or before the date fixed for
redemption, an amount not less than the applicable redemption price, together
with interest accrued to (but excluding) the date fixed for redemption, of such
Securities. Notwithstanding anything to the contrary contained in this Article
III, the obligation of the Company to pay the redemption price of such
Securities, together with interest accrued to (but excluding) the date fixed for
redemption, shall be deemed to be satisfied and discharged to the extent such
amount is so paid by the purchasers. If such an agreement is entered into, a
copy of which will be filed with the Trustee prior to the date fixed for
redemption, any Securities not duly surrendered for conversion by the holders
thereof may, at the option of the Company, be deemed, to the fullest extent
permitted by law, acquired by such purchasers from such holders and
(notwithstanding anything to the contrary contained in Article V) surrendered by
such purchasers for conversion, all as of immediately prior to the close of
business on the date fixed for redemption (and the right to convert any such
Securities shall be deemed to have been extended through such time), subject to
payment of the above amount as aforesaid. At the direction of the Company, the
Trustee shall hold and dispose of any such amount paid to it in the same manner
as it would monies deposited with it by the Company for the redemption of
Securities. Without the Trustee's prior written consent, no arrangement between
the Company and such purchasers for the purchase and conversion of any
Securities shall increase or otherwise affect any of the powers, duties,
responsibilities or obligations of the Trustee as set forth in this Indenture,
and the Company agrees to indemnify the Trustee from, and hold it harmless
against, any loss, liability or expense arising out of or in connection with any
such arrangement for the purchase and conversion of any Securities between the
Company and such purchasers to which the Trustee has not consented in writing,
including the costs and expenses incurred by the Trustee in the defense of any
claim or liability arising out of or in connection with the exercise or
performance of any of its powers, duties, responsibilities or obligations under
this Indenture.

                                   ARTICLE IV

                                    Covenants

      SECTION 4.01 Payment of Securities. The Company shall pay the principal
of, premium, if any, and interest on the dates and in the manner provided in the
Securities. Principal, premium, if any, and interest, shall be considered paid
on the date due if the Paying Agent (other than the Company or an Affiliate of
the Company) holds on that date money designated for and sufficient to pay all
principal, premium, if any, and interest, then due and such Paying Agent is not
prohibited from paying such money to the Securityholders on that date pursuant
to the terms of this Indenture. To the extent lawful, the Company shall pay
interest (including post-petition interest in any proceeding under any
Bankruptcy Law) on overdue installments of interest (without regard to any
applicable grace period) at the rate borne by the Securities, compounded
semiannually.


                                      -18-

<PAGE>
      SECTION 4.02 SEC Reports. Whether or not required by the rules and
regulations of the SEC, so long as any Securities are outstanding, the Company
will file with the SEC and the Trustee, and if requested by any holders of
Securities, the Trustee shall furnish to the holders of Securities all quarterly
and annual financial information required to be contained in a filing with the
SEC on Forms 10-Q and 10-K, including a "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" and, with respect to annual
information only, a report thereon by the Company's certified independent
accountants.

      SECTION 4.03 Compliance Certificate. The Company shall deliver to the
Trustee, within 120 days after the end of each fiscal year of the Company, an
Officers' Certificate stating that a review of the activities of the Company and
its subsidiaries during the preceding fiscal year has been made under the
supervision of the signing Officers with a view to determining whether the
Company has kept, observed, performed and fulfilled its obligations under, and
complied with the covenants and conditions contained in, this Indenture, and
further stating, as to each such Officer signing such certificate, that to the
best of such Officer's knowledge the Company has kept, observed, performed and
fulfilled each and every covenant, and complied with the covenants and
conditions contained in this Indenture and is not in default in the performance
or observance of any of the terms, provisions and conditions hereof (or if a
Default or Event of Default shall have occurred, describing all such Defaults or
Events of Default of which such Officer may have knowledge) and that to the best
of such Officer's knowledge no event has occurred and remains in existence by
reason of which payments on account of the principal or of interest are
prohibited.

      One of the Officers signing such Officers' Certificate shall be either the
Company's principal executive officer, principal financial officer or principal
accounting officer.

      The Company will, so long as any of the Securities are outstanding,
deliver to the Trustee, forthwith upon becoming aware of:

      (a) any Default, Event of Default or default in the performance of any
covenant, agreement or condition contained in this Indenture; or

      (b) any event of default under any other mortgage, indenture or instrument
as that term is used in Section 8.01(f), an Officers' Certificate specifying
such Default, Event of Default or default.

      SECTION 4.04 Stay, Extension and Usury Law. The Company covenants (to the
extent that it may lawfully do so) that it will not at any time insist upon,
plead, or in any manner whatsoever claim or take the benefit or advantage of,
any stay, extension or usury law wherever enacted, now or at any time hereafter
in force, which may affect the covenants or the performance of this Indenture;
and the Company (to the extent it may lawfully do so) hereby expressly waives
all benefit or advantage of any such law, and covenants that it will not, by
resort to any such law, hinder, delay or impede the execution of any power
herein granted to the Trustee, but will suffer and permit the execution of every
such power as though no such law has been enacted.


                                      -19-

<PAGE>
      SECTION 4.05 Corporate Existence. Except as provided in Article VII
hereof, the Company will do or cause to be done all things necessary to preserve
and keep in full force and effect its corporate existence and the corporate,
partnership or other existence of each Subsidiary of the Company in accordance
with the respective organizational documents of each Subsidiary and the rights
(charter and statutory), licenses and franchises of the Company and its
Subsidiaries; provided, however, that the Company shall not be required to
preserve any such right, license or franchise, or the corporate, partnership or
other existence of any Subsidiary, if the Company shall determine that the
preservation thereof is no longer desirable in the conduct of the business of
the Company and its Subsidiaries taken as a whole and that the loss thereof is
not adverse in any material respect to the Securityholders.

      SECTION 4.06 Maintenance of Properties. The Company will cause all
properties used or useful in the conduct of its business or the business of any
Subsidiary to be maintained and kept in good condition, repair and working order
and supplied with all necessary equipment and will cause to be made all
necessary repairs, renewals, replacements, betterments and improvements thereof,
all as in the judgment of the Company may be necessary so that the business
carried on in connection therewith may be properly and advantageously conducted
at all times; provided, however, that nothing in this Section shall prevent the
Company from discontinuing the operation or maintenance of any of such
properties if such discontinuance is, in the judgment of the Company, desirable
in the conduct of its business or the business of any Subsidiary and not
disadvantageous in any material respect to the holders.

      SECTION 4.07 Payment of Taxes and Other Claims. The Company will pay or
discharge, or cause to be paid or discharged, before the same may become
delinquent, (i) all taxes, assessments and governmental charges levied or
imposed upon the Company or any Subsidiary or upon the income, profits or
property of the Company or any Subsidiary, (ii) all claims for labor, materials
and supplies which, if unpaid, might by law become a lien or charge upon the
property of the Company or any Subsidiary, and (iii) all stamps and other
duties, if any, which may be imposed by the United States or any political
subdivision thereof or therein in connection with the issuance, transfer,
exchange or conversion of any Securities or with respect to this Indenture;
provided, however, that, in the case of clauses (i) and (ii), the Company shall
not be required to pay or discharge or cause to be paid or discharged any such
tax, assessment, charge or claim (A) if the failure to do so will not, in the
aggregate, have a material adverse impact on the Company, or (B) if the amount,
applicability or validity is being contested in good faith by appropriate
proceedings.

      SECTION 4.08 Designated Event. Upon the occurrence of a Designated Event,
each holder of Securities shall have the right, in accordance with this Section
4.08 and Section 3.08 hereof, to require the Company to repurchase all or any
part (equal to $1,000 or an integral multiple thereof) of such holder's
Securities pursuant to the terms of Section 3.08 (the "Designated Event Offer")
at a purchase price equal to 101% of the principal amount thereof, plus accrued
and unpaid interest to the Designated Event Payment Date (the "Designated Event
Payment").

      Within 30 days following any Designated Event, the Company shall mail to
each holder the notice provided by Section 3.08(e).


                                      -20-

<PAGE>
      SECTION 4.09 Triggering Distribution. Upon the occurrence of a Triggering
Distribution, each holder of Securities shall have the right, in accordance with
this Section 4.09 and Article XIII hereof, to require the Company to repurchase
all or any part (equal to $1,000 or an integral multiple thereof) of such
holder's Securities pursuant to the terms of Article XIII hereof (the
"Repurchase Offer") at a purchase price equal to 100% of the principal amount
thereof, together with any accrued and unpaid interest (the "Repurchase
Payment") to the repurchase date, which repurchase date shall be on or prior to
the distribution date for such Triggering Distribution (the "Repurchase Payment
Date"). Notwithstanding anything herein to the contrary, in the event that such
Triggering Distribution is not so paid or made, all of such holder's rights to
require the Company to repurchase their Securities pursuant to this Section 4.09
and Article XIII hereof as a result of such Triggering Distribution shall
terminate and any pending Repurchase Offer shall be rescinded.

      SECTION 4.10 Further Instruments and Acts. Upon request of the Trustee,
the Company will execute and deliver such further instruments and do such
further acts as may be reasonably necessary or proper to carry out more
effectively the purposes of this Indenture.

                                   ARTICLE V

                                   Conversion

      SECTION 5.01 Conversion Privilege. A holder of a Security may convert the
principal amount thereof (or any portion thereof that is an integral multiple of
$1,000) into fully paid and nonassessable shares of Common Stock of the Company
at any time prior to the close of business (New York time) on the maturity date
of the Security at the Conversion Price then in effect, except that, with
respect to any Security called for redemption, such conversion right shall
terminate at the close of business (New York time) on the Business Day
immediately preceding the redemption date (unless the Company shall default in
making the redemption payment when it becomes due, in which case the conversion
price shall terminate on the date such default is cured). A Security in respect
of which a holder has delivered an "Option of Securityholder to Elect Purchase"
form set forth on Exhibit A hereto exercising the option of such holder to
require the Company to purchase such Security may be converted only if the
notice of exercise is withdrawn as provided in accordance with Section 3.08
hereof. The number of shares of Common Stock issuable upon conversion of a
Security is determined by dividing the principal amount of the Security
converted by the conversion price in effect on the Conversion Date (the
"Conversion Price").

      The initial Conversion Price is stated in paragraph 10 of the Securities
and is subject to adjustment as provided in this Article V.

      Provisions of this Indenture that apply to conversion of all of a Security
also apply to conversion of a portion of it. A holder of Securities is not
entitled to any rights of a holder of Common Stock until such holder of
Securities has converted such Securities into Common Stock, and only to the
extent that such Securities are deemed to have been converted into Common Stock
under this Article V.


                                      -21-

<PAGE>
      SECTION 5.02 Conversion Procedure. To convert a Security, a holder must
satisfy the requirements in paragraph 10 of the Securities. The date on which
the holder satisfies all of those requirements is the conversion date (the
"Conversion Date"). As soon as practicable after the Conversion Date, the
Company shall deliver to the holder through the Conversion Agent a certificate
for the number of whole shares of Common Stock issuable upon the conversion and
a check for any fractional share determined pursuant to Section 5.03. The person
in whose name the certificate is registered shall become the shareholder of
record on the Conversion Date and, as of such date, such person's rights as a
Securityholder with respect to the converted Security shall cease; provided,
however, that no surrender of a Security on any date when the stock transfer
books of the Company shall be closed shall be effective to constitute the person
entitled to receive the shares of Common Stock upon such conversion as the
shareholder of record of such shares of Common Stock on such date, but such
surrender shall be effective to constitute the person entitled to receive such
shares of Common Stock as the shareholder of record thereof for all purposes at
the close of business on the next succeeding day on which such stock transfer
books are open; provided further, however, that such conversion shall be at the
Conversion Price in effect on the date that such Security shall have been
surrendered for conversion, as if the stock transfer books of the Company had
not been closed.

      No payment or adjustment will be made for accrued and unpaid interest on a
converted Security or for dividends or distributions on shares of Common Stock
issued upon conversion of a Security, but if any holder surrenders a Security
for conversion after the close of business on the record date for the payment of
an installment of interest and prior to the opening of business on the next
interest payment date, then, notwithstanding such conversion, the interest
payable on such interest payment date shall be paid to the holder of such
Security on such record date. In such event, unless such Security has been
called for redemption on or prior to such interest payment date, such Security,
when surrendered for conversion, must be accompanied by payment in funds
acceptable to the Company of an amount equal to the interest payable on such
interest payment date on the portion so converted.

      If a holder converts more than one Security at the same time, the number
of whole shares of Common Stock issuable upon the conversion shall be based on
the total principal amount of Securities converted.

      Upon surrender of a Security that is converted in part, the Trustee shall
authenticate for the holder a new Security equal in principal amount to the
unconverted portion of the Security surrendered.

      SECTION 5.03 Fractional Shares. The Company will not issue fractional
shares of Common Stock upon conversion of a Security. In lieu thereof, the
Company will pay an amount in cash based upon the Daily Market Price of the
Common Stock on the Trading Day prior to the date of conversion.

      SECTION 5.04 Taxes on Conversion. The issuance of certificates for shares
of Common Stock upon the conversion of any Security shall be made without charge
to the converting Securityholder for such certificates or for any tax in respect
of the issuance of such certificates, and such certificates shall be issued in
the respective names of, or in such names as may be directed by,


                                      -22-

<PAGE>
the holder or holders of the converted Security; provided, however, that in the
event that certificates for shares of Common Stock are to be issued in a name
other than the name of the holder of the Security converted, such Security, when
surrendered for conversion, shall be accompanied by an instrument of transfer,
in form satisfactory to the Company, duly executed by the registered holder
thereof or his duly authorized attorney; and provided further, however, that the
Company shall not be required to pay any tax which may be payable in respect of
any transfer involved in the issuance and delivery of any such certificates in a
name other than that of the holder of the converted Security, and the Company
shall not be required to issue or deliver such certificates unless or until the
person or persons requesting the issuance thereof shall have paid to the Company
the amount of such tax or shall have established to the satisfaction of the
Company that such tax has been paid or is not applicable.

      SECTION 5.05 Company to Provide Stock. The Company shall at all times
reserve and keep available, free from preemptive rights, out of its authorized
but unissued Common Stock, solely for the purpose of issuance upon conversion of
Securities as herein provided, a sufficient number of shares of Common Stock to
permit the conversion of all outstanding Securities for shares of Common Stock.

      All shares of Common Stock which may be issued upon conversion of the
Securities shall be duly authorized, validly issued, fully paid and
nonassessable when so issued.

      SECTION 5.06 Adjustment of Conversion Price. The Conversion Price shall be
subject to adjustment from time to time as follows:

            (a)   In case the Company shall (1) pay a dividend in shares of
Common Stock to holders of Common Stock, (2) make a distribution in shares of
Common Stock to holders of Common Stock, (3) subdivide its outstanding shares of
Common Stock into a greater number of shares of Common Stock or (4) combine its
outstanding shares of Common Stock into a smaller number of shares of Common
Stock, the Conversion Price in effect immediately prior to such action shall be
adjusted so that the holder of any Security thereafter surrendered for
conversion shall be entitled to receive the number of shares of Common Stock
which he would have owned immediately following such action had such Securities
been converted immediately prior thereto. Any adjustment made pursuant to this
subsection (a) shall become effective immediately after the record date in the
case of a dividend or distribution and shall become effective immediately after
the effective date in the case of a subdivision or combination.

            (b)   In case the Company shall issue rights or warrants to
substantially all holders of Common Stock entitling them (for a period
commencing no earlier than the record date for the determination of holders of
Common Stock entitled to receive such rights or warrants and expiring not more
than 45 days after such record date) to subscribe for or purchase shares of
Common Stock (or securities convertible into Common Stock) at a price per share
less than the Current Market Price (as determined pursuant to subsection (f)
below) of the Common Stock on such record date, the Conversion Price shall be
adjusted so that the same shall equal the price determined by multiplying the
Conversion Price in effect immediately prior to such record date by a fraction
of which the numerator shall be the number of shares of Common Stock outstanding
on such record date, plus the


                                      -23-

<PAGE>
number of shares of Common Stock which the aggregate offering price of the
offered shares of Common Stock (or the aggregate conversion price of the
convertible securities so offered) would purchase at such Current Market Price,
and of which the denominator shall be the number of shares of Common Stock
outstanding on such record date plus the number of additional shares of Common
Stock offered (or into which the convertible securities so offered are
convertible). Such adjustments shall become effective immediately after such
record date.

            (c)   In case the Company shall distribute to all holders of Common
Stock shares of any class of Capital Stock of the Company (other than Common
Stock referred to in subsection (a) above), evidences of indebtedness or other
assets (other than cash dividends out of current or retained earnings), or shall
distribute to substantially all holders of Common Stock rights or warrants to
subscribe for securities (other than those Securities referred to in subsection
(b) above), then in each such case the Conversion Price shall be adjusted so
that the same shall equal the price determined by multiplying the Conversion
Price in effect immediately prior to the date of such distribution by a fraction
of which the numerator shall be the Current Market Price (determined as provided
in subsection (f) below) of the Common Stock on the record date mentioned below
less the then fair market value (as determined by the Board of Directors, whose
determination shall be conclusive evidence of such fair market value and
described in a Board Resolution) of the portion of the assets so distributed or
of such subscription rights or warrants applicable to one share of Common Stock,
and of which the denominator shall be such Current Market Price of the Common
Stock. Such adjustment shall become effective immediately after the record date
for the determination of the holders of Common Stock entitled to receive such
distribution. Notwithstanding the foregoing, in case the Company shall issue
rights or warrants to subscribe for additional shares of the Company's capital
stock (other than those referred to in subsection (b) above) ("Rights") to
substantially all holders of Common Stock, the Company may, in lieu of making
any adjustment pursuant to this Section 5.06, make proper provision so that each
holder of a Security who converts such Security (or any portion thereof) after
the record date for such distribution and prior to the expiration or redemption
of the Rights shall be entitled to receive upon such conversion, in addition to
the shares of Common Stock issuable upon such conversion (the "Conversion
Shares"), a number of Rights to be determined as follows: (i) if such conversion
occurs on or prior to the date for the distribution to the holders of Rights of
separate certificates evidencing such Rights (the "Distribution Date"), the same
number of Rights to which a holder of a number of shares of Common Stock equal
to the number of Conversion Shares is entitled at the time of such conversion in
accordance with the terms and provisions of and applicable to the Rights; and
(ii) if such conversion occurs after the Distribution Date, the same number of
Rights to which a holder of the number of shares of Common Stock into which the
principal amount of the Security so converted was convertible immediately prior
to the Distribution Date would have been entitled on the Distribution Date in
accordance with the terms and provisions of and applicable to the Rights. In the
event the Company implements a shareholder rights plan, such rights plan must
provide that upon conversion of the Securities the holders will receive, in
addition to the Common Stock issuable upon such conversion, such rights (whether
or not such rights have separated from the Common Stock at the time of such
conversion).


                                      -24-

<PAGE>
            (d) In case the Company shall, by dividend or otherwise, at any time
distribute to all holders of its Common Stock cash (including any distributions
of cash out of current or retained earnings of the Company but excluding any
cash that is distributed as part of a distribution requiring a Conversion Price
adjustment pursuant to paragraph (c) of this Section) in an aggregate amount
that, together with the sum of (x) the aggregate amount of any other
distributions to all holders of its Common Stock made in cash plus (y) all
Excess Payments, in each case made within the 12 months preceding the date fixed
for determining the shareholders entitled to such distribution (the
"Distribution Record Date") and in respect of which no Conversion Price
adjustment pursuant to paragraphs (c) or (e) of this Section or this paragraph
(d) has been made, exceeds 15% of the product of the Current Market Price per
share (determined as provided in paragraph (f) of this Section) of the Common
Stock on the Distribution Record Date multiplied by the number of shares of
Common Stock outstanding on the Distribution Record Date (excluding shares held
in the treasury of the Company), the Conversion Price shall be reduced so that
the same shall equal the price determined by multiplying such Conversion Price
in effect immediately prior to the effectiveness of the Conversion Price
reduction contemplated by this paragraph (d) by a fraction of which the
numerator shall be the Current Market Price per share (determined as provided in
paragraph (f) of this Section) of the Common Stock on the Distribution Record
Date less the amount of such cash and other consideration (including any Excess
Payments) so distributed applicable to one share of Common Stock (equal to the
aggregate amount of such cash and other consideration (including any Excess
Payments) divided by the number of shares of Common Stock outstanding on the
Distribution Record Date) and the denominator shall be such Current Market Price
per share (determined as provided in paragraph (f) of this Section) of the
Common Stock on the Distribution Record Date, such reduction to become effective
immediately prior to the opening of business on the day following the
Distribution Record Date.

            (e) In case a tender offer or other negotiated transaction made by
the Company or any Subsidiary of the Company for all or any portion of the
Common Stock shall be consummated, if an Excess Payment is made in respect of
such tender offer or other negotiated transaction and the amount of such Excess
Payment, together with the sum of (x) the aggregate amount of all Excess
Payments plus (y) the aggregate amount of all distributions to all holders of
the Common Stock made in cash (including any distributions of cash out of
current or retained earnings of the Company), in each case made within the 12
months preceding the date of payment of such current negotiated transaction
consideration or expiration of such current tender offer, as the case may be
(the "Purchase Date"), and as to which no adjustment pursuant to paragraph (c)
or paragraph (d) of this Section or this paragraph (e) has been made, exceeds
15% of the product of the Current Market Price per share (determined as provided
in paragraph (f) of this Section) of the Common Stock on the Purchase Date
multiplied by the number of shares of Common Stock outstanding (including any
tendered shares but excluding any shares held in the treasury of the Company or
any Subsidiary of the Company) on the Purchase Date, the Conversion Price shall
be reduced so that the same shall equal the price determined by multiplying such
Conversion Price in effect immediately prior to the effectiveness of the
Conversion Price reduction contemplated by this paragraph (e) by a fraction of
which the numerator shall be the Current Market Price per share (determined as
provided in paragraph (f) of this Section) of the Common Stock on the Purchase
Date less the amount of such Excess Payments and such cash distributions, if
any, applicable to one share of Common Stock

                                      -25-

<PAGE>
(equal to the aggregate amount of such Excess Payments and such cash
distributions divided by the number of shares of Common Stock outstanding on the
Purchase Date) and the denominator shall be such Current Market Price per share
(determined as provided in paragraph (f) of this Section) of the Common Stock on
the Purchase Date, such reduction to become effective immediately prior to the
opening of business on the day following the Purchase Date.

      (f) The "Current Market Price" per share of Common Stock on any date shall
be deemed to be the average of the Daily Market Prices for the shorter of (i) 30
consecutive Business Days ending on the last full Trading Day on the exchange or
market referred to in determining such Daily Market Prices prior to the time of
determination or (ii) the period commencing on the date next succeeding the
first public announcement of the issuance of such rights or such warrants or
such other distribution or such negotiated transaction through such last full
Trading Day on the exchange or market referred to in determining such Daily
Market Prices prior to the time of determination.

      (g) In any case in which this Section 5.06 shall require that an
adjustment be made immediately following a record date for an event, the Company
may elect to defer, until such event, issuing to the holder of any Security
converted after such record date the shares of Common Stock and other Capital
Stock of the Company issuable upon such conversion over and above the shares of
Common Stock and other Capital Stock of the Company issuable upon such
conversion only on the basis of the Conversion Price prior to adjustment; and,
in lieu of the shares the issuance of which is so deferred, the Company shall
issue or cause its transfer agents to issue due bills or other appropriate
evidence of the right to receive such shares.

      SECTION 5.07 No Adjustment. No adjustment in the Conversion Price
shall be required until cumulative adjustments amount to 1% or more of the
Conversion Price as last adjusted; provided, however, that any adjustments which
by reason of this Section 5.07 are not required to be made shall be carried
forward and taken into account in any subsequent adjustment. All calculations
under this Article V shall be made to the nearest cent or to the nearest
one-hundredth of a share, as the case may be. No adjustment need be made for
rights to purchase Common Stock pursuant to a Company plan for reinvestment of
dividends or interest. No adjustment need be made for a change in the par value
or no par value of the Common Stock.

      SECTION 5.08 Other Adjustments. In the event that, as a result of an
adjustment made pursuant to Section 5.06 above, the holder of any Security
thereafter surrendered for conversion shall become entitled to receive any
shares of Capital Stock of the Company other than shares of its Common Stock,
thereafter the Conversion Price of such other shares so receivable upon
conversion of any Securities shall be subject to adjustment from time to time in
a manner and on terms as nearly equivalent as practicable to the provisions with
respect to Common Stock contained in this Article V.

      In the event that shares of Common Stock are not delivered after the
expiration of any of the rights or warrants referred to in Section 5.06(b) and
Section 5.06(c) hereof, the Conversion Price shall be readjusted to the
Conversion Price which would otherwise be in effect had the adjustment made upon
the issuance of such rights or warrants been made on the basis of delivery of
only the number of shares of Common Stock actually delivered.

                                      -26-

<PAGE>
      SECTION 5.09 Adjustments for Tax Purposes. The Company may, at its option,
make such reductions in the Conversion Price, in addition to those required by
Section 5.06 above, as it determines to be advisable in order that any stock
dividend, subdivision of shares, distribution of rights to purchase stock or
securities or distribution of securities convertible into or exchangeable for
stock made by the Company to its shareholders will not be taxable to the
recipients thereof

      SECTION 5.10 Adjustments by the Company. The Company from time to
time may, to the extent permitted by law, reduce the Conversion Price by any
amount for any period of at least 20 days, in which case the Company shall give
at least 15 days' notice of such reduction in accordance with Section 5.11, if
the Board of Directors has made a determination that such reduction would be in
the best interests of the Company, which determination shall be conclusive.

      SECTION 5.11 Notice of Adjustment. Whenever the Conversion Price is
adjusted, the Company shall promptly mail to Securityholders at the addresses
appearing on the Registrar's books a notice of the adjustment and file with the
Trustee an Officers' Certificate briefly stating the facts requiring the
adjustment and the manner of computing it. The certificate shall be conclusive
evidence of the correctness of such adjustment.

      SECTION 5.12 Notice of Certain Transactions. In the event that:

            (1) the Company takes any action which would require an adjustment
      in the Conversion Price;

            (2) the Company takes any action that would require a supplemental
      indenture pursuant to Section 5.13; or

            (3) there is a dissolution or liquidation of the Company; a holder
      of a Security may wish to convert such Security into shares of Common
      Stock prior to the record date for or the effective date of the
      transaction so that he may receive the rights, warrants, securities or
      assets which a holder of shares of Common Stock on that date may receive.
      Therefore, the Company shall mail a notice to Securityholders at the
      addresses appearing on the Registrar's books and deliver to the Trustee an
      Officers' Certificate, in each case stating the proposed record or
      effective date, as the case may be. The Company shall mail the notice and
      deliver such Officers' Certificate at least 15 days before such date;
      however, failure to mail such notice or any defect therein shall not
      affect the validity of any transaction referred to in clause (1), (2) or
      (3) of this Section 5.12.

      SECTION 5.13 Effect of Reclassifications, Consolidations, Mergers or Sales
on Conversion Privilege. If any of the following shall occur, namely: (i) any
reclassification or change of outstanding shares of Common Stock issuable upon
conversion of Securities (other than a change in par value, or from par value to
no par value, or from no par value to par value, or as a result of a subdivision
or combination), (ii) any consolidation or merger to which the Company is a
party other than a merger in which the Company is the continuing corporation and
which does not result in any reclassification of, or change (other than a change
in name, or par value, or from par value to no par value, or from no par value
to par value or as a result of a subdivision or combination) in,

                                      -27-

<PAGE>
outstanding shares of Common Stock or (iii) any sale or conveyance of all or
substantially all of the property or business of the Company as an entirety,
then the Company, or such successor or purchasing Corporate Entity, as the case
may be, shall, as a condition precedent to such reclassification, change,
consolidation, merger, sale or conveyance, execute and deliver to the Trustee a
supplemental indenture in form satisfactory to the Trustee providing that the
holder of each Security then outstanding shall have the right to convert such
Security into the kind and amount of shares of stock and other securities and
property (including cash) receivable upon such reclassification, change,
consolidation, merger, sale or conveyance by a holder of the number of shares of
Common Stock deliverable upon conversion of such Security immediately prior to
such reclassification, change, consolidation, merger, sale or conveyance. Such
supplemental indenture shall provide for adjustments of the Conversion Price
which shall be as nearly equivalent as may be practicable to the adjustments of
the Conversion Price provided for in this Article V. The foregoing, however,
shall not in any way affect the right a holder of a Security may otherwise have,
pursuant to clause (ii) of the last sentence of subsection (c) of Section 5.06,
to receive Rights upon conversion of a Security. If, in the case of any such
consolidation, merger, sale or conveyance, the stock or other securities and
property (including cash) receivable thereupon by a holder of Common Stock
includes shares of stock or other securities and property of a corporation other
than the successor or purchasing corporation, as the case may be, in such
consolidation, merger, sale or conveyance, then such supplemental indenture
shall also be executed by such other corporation and shall contain such
additional provisions to protect the interests of the holders of the Securities
as the Board of Directors shall reasonably consider necessary by reason of the
foregoing. The provision of this Section 5.13 shall similarly apply to
successive consolidations, mergers, sales or conveyances.

      In the event the Company shall execute a supplemental indenture pursuant
to this Section 5.13, the Company shall promptly file with the Trustee an
Officers' Certificate briefly stating the reasons therefor, the kind or amount
of shares of stock or securities or property (including cash) receivable by
holders of the Securities upon the conversion of their Securities after any such
reclassification, change, consolidation, merger, sale or conveyance and any
adjustment to be made with respect thereto.

      SECTION 5.14 Trustee's Disclaimer. The Trustee has no duty to
determine when an adjustment under this Article V should be made, how it should
be made or what such adjustment should be, but may accept as conclusive evidence
of the correctness of any such adjustment, and shall be protected in relying
upon the Officers' Certificate with respect thereto which the Company is
obligated to file with the Trustee pursuant to Section 5.11, 5.12 or 5.13.
Unless and until the Trustee receives any such Officers' Certificate, the
Trustee may assume without inquiry that none of the events described in Sections
5.11, 5.12 and 5.13 has occurred. The Trustee makes no representation as to the
validity or value of any securities or assets issued upon conversion of
Securities, and the Trustee shall not be responsible for the Company's failure
to comply with any provisions of this Article V.

      The Trustee shall not be under any responsibility to determine the
correctness of any provisions contained in any supplemental indenture executed
pursuant to Section 5.13, but may accept as conclusive evidence of the
correctness thereof, and shall be protected in relying upon, the

                                      -28-

<PAGE>
Officers' Certificate with respect thereto which the Company is obligated to
file with the Trustee pursuant to Section 5.13.

      SECTION 5.15 Automatic Conversion. The Company may elect to automatically
convert ("Automatic Conversion") the Securities on or prior to maturity if the
Daily Market Price of the Common Stock has exceeded 150% of the Conversion Price
for at least 20 Trading Days out of the 30 consecutive Trading Days ending
within five Trading Days prior to the date of (the "Notice Date") the notice of
automatic conversion (the "Automatic Conversion Notice").

      In order to effect an Automatic Conversion, the Company shall give to the
holder of each Security to be so converted an Automatic Conversion Notice. Such
Automatic Conversion Notice shall state:

            (i) the date on which the Securities identified in the Automatic
      Conversion Notice will be converted (the "Automatic Conversion Date");

            (ii) the CUSIP number or numbers of such Securities;

            (iii) the place or places where such Securities in certificated form
      are to be surrendered for exchange of the shares of Common Stock to be
      issued upon conversion thereof;

            (iv) the lowest Daily Market Price of the Common Stock for at least
      20 Trading Days out of the 30 consecutive Trading Days ending within five
      Trading Days prior to the giving of the Automatic Conversion Notice; and

            (v) the Conversion Price at which such Automatic Conversion is to be
      effected.

      If the Company elects to effect an Automatic Conversion Notice in respect
of fewer than all the Securities, the Automatic Conversion Notice relating to
such Automatic Conversion shall reference this Section 5.15 and shall identify
the Securities to be converted. In case any Security is to be converted in part
only, the Automatic Conversion Notice relating thereto shall state the portion
of the principal amount thereof to be converted and shall state that on and
after the date fixed for conversion, upon surrender of such Security, a new
Securities in principal amount equal to the portion thereof not converted will
be issued. In the case where the Company elects to effect an Automatic
Conversion in respect of any portion of the Security evidenced by the Global
Security, the beneficial interests in the Global Security to be subject to such
Automatic Conversion shall be selected by the Depositary in accordance with the
applicable standing procedures of the Depositary's book-entry conversion
program, and in connection with such Automatic Conversion the Depositary shall
arrange in accordance with such procedures for appropriate endorsements and
transfer documents, if required by the Company or the Trustee or conversion
agent, and payment of any transfer taxes if required hereunder.

      The Company or, at the request and expense of the Company, the Trustee
upon ten Business Days' notice prior to the date of the requested mailing (or
upon such shorter notice period as may be

                                      -29-

<PAGE>
reasonably acceptable to the Trustee), shall give to each holder of Securities
to be converted in an Automatic Conversion, at its last address as the same
shall appear on the Registrar, an Automatic Conversion Notice in respect
thereof. The date of Automatic Conversion of the Securities shall be not less
than 7 days nor more than 15 days from the Notice Date. Such Automatic
Conversion Notice shall be irrevocable and shall be mailed by first class mail
and, if mailed in the manner herein provided, shall be conclusively presumed to
have been given, whether or not the holder receives it. In any case, failure to
give such notice or any defect in the notice to the holder of any Security
designated for Automatic Conversion in whole or in part shall not affect the
validity of the proceedings for the Automatic Conversion of any such Security.
The Company shall also deliver a copy of each Automatic Conversion Notice given
by it to the Trustee.

                                   ARTICLE VI

                                  Subordination

      SECTION 6.01 Agreement to Subordinate. The Company, for itself and its
successors, and each Securityholder, by his acceptance of Securities, agree that
the payment of the principal of, premium, if any, or interest or any other
amounts due on the Securities is subordinated in right of payment, to the extent
and in the manner stated in this Article VI, to the prior payment in full of all
existing and future Senior Debt.

      SECTION 6.02 No Payment on Securities if Senior Debt in Default. Anything
in this Indenture to the contrary notwithstanding, no payment on account of
principal of, premium, if any, or interest, or any other amounts due on the
Securities (including, without limitation, any Designated Event Payments), and
no redemption, purchase, or other acquisition of the Securities (including,
without limitation, pursuant to a Designated Event Offer or Repurchase Offer),
shall be made by or on behalf of the Company (i) unless full payment of amounts
then due for principal and interest and of all other amounts then due on all
Senior Debt has been made or duly provided for pursuant to the terms of the
instrument governing such Senior Debt, (ii) if, at the time of such payment,
redemption, purchase or other acquisition, or immediately after giving effect
thereto, there shall exist under any Senior Debt, or any agreement pursuant to
which any Senior Debt is issued, any default, which default shall not have been
cured or waived and which default shall have resulted in the full amount of such
Senior Debt being declared due and payable or (iii) if, at the time of such
payment, redemption, purchase or other acquisition, the Trustee shall have
received written notice from the holders of Designated Senior Debt or a
Representative of such holders (a "Payment Blockage Notice") that there exists
under such Designated Senior Debt, or any agreement pursuant to which such
Designated Senior Debt is issued, any default, which default shall not have been
cured or waived, permitting the holders thereof to declare any amounts of such
Designated Senior Debt due and payable, but only for the period (the "Payment
Blockage Period") commencing on the date of receipt of the Payment Blockage
Notice and ending (unless earlier terminated by notice given to the Trustee by
the Representative of the holders of such Designated Senior Debt) on the earlier
of (a) the date on which such event of default shall have been cured or waived
or (b) 180 days from the receipt of the Payment Blockage Notice. Notwithstanding
the provisions described in the immediately preceding sentence (other than in
clauses (i) and (ii)), unless the holders of such Designated Senior

                                      -30-

<PAGE>
Debt or the Representative of such holders shall have accelerated the maturity
of such Designated Senior Debt, the Company may resume payments on the
Securities after the end of such Payment Blockage Period. Not more than one
Payment Blockage Notice may be given in any consecutive 360-day period,
irrespective of the number of defaults with respect to Senior Debt during such
period.

      In the event that, notwithstanding the provisions of this Section 6.02,
payments are made by or on behalf of the Company in contravention of the
provisions of this Section 6.02, such payments shall be held by the Trustee, any
Paying Agent or the holders, as applicable, in trust for the benefit of, and
shall be paid over to and delivered to the holders of Senior Debt or the
Representative under the indenture or other agreement (if any) pursuant to which
any instruments evidencing any Senior Debt may have been issued for application
to the payment of all Senior Debt ratably according to the aggregate amounts
remaining unpaid to the extent necessary to pay all Senior Debt in full in
accordance with the terms of such Senior Debt, after giving effect to any
concurrent payment or distribution to or for the holders of Senior Debt.

      The Company shall give prompt written notice to the Trustee and any Paying
Agent of any default or event of default under any Senior Debt or under any
agreement pursuant to which any Senior Debt may have been issued. The Trustee
and the Paying Agent may assume that all payments have been made with respect to
all Senior Debt unless the Trustee or the Paying Agent, as the case may be, has
received written notice that payment has not been made and three (3) Business
Days have expired.

      SECTION 6.03 Distribution on Acceleration of Securities; Dissolution and
Reorganization: Subrogation of Securities. (a) If the Securities are declared
due and payable because of the occurrence of an Event of Default, the Company
shall give prompt written notice to the holders of all Senior Debt or to the
trustee(s) for such Senior Debt of such acceleration. The Company may not pay
the principal of or interest or any other amounts due on the Securities until
five Business Days after such holders or trustee(s) of Senior Debt receive such
notice and, thereafter, the Company may pay the principal of or interest or any
other amounts due on the Securities only if the provisions of this Article VI
permit such payment.

      (b) Upon (i) any acceleration of the principal amount due on the
Securities because of an Event of Default or (ii) any direct or indirect
distribution of assets of the Company upon any dissolution, winding up,
liquidation or reorganization of the Company (whether in bankruptcy, insolvency
or receivership proceedings or upon an assignment for the benefit of creditors
or any other dissolution, winding up, liquidation or reorganization of the
Company):

                  (1) the holders of all Senior Debt shall first be entitled to
            receive payment in full of the principal thereof, the interest
            thereon and any other amounts due thereon before the holders are
            entitled to receive payment on account of the principal of or
            interest or any other amounts due on the Securities;

                  (2) any payment or distribution of assets of the Company of
            any kind or character, whether in cash, property or securities
            (other than securities of the Company as

                                      -31-

<PAGE>
            reorganized or readjusted or securities of the Company or any other
            corporation provided for by a plan of reorganization or readjustment
            the payment of which is subordinate, at least to the extent provided
            in this Article with respect to the Securities, to the payment in
            full without diminution or modification by such plan of all Senior
            Debt), to which the holders or the Trustee would be entitled except
            for the provisions of this Article, shall be paid by the liquidating
            trustee or agent or other person making such a payment or
            distribution, directly to the holders of Senior Debt (or
            Representative acting on their behalf), ratably according to the
            aggregate amounts remaining unpaid on account of the principal of or
            interest on and other amounts due on the Senior Debt held or
            represented by each, to the extent necessary to make payment in full
            of all Senior Debt remaining unpaid, after giving effect to any
            concurrent payment or distribution to the holders of such Senior
            Debt; and

                  (3) in the event that, notwithstanding the foregoing, any
            payment or distribution of assets of the Company of any kind or
            character, whether in cash, property or securities (other than
            securities of the Company as reorganized or readjusted, or
            securities of the Company or any other corporation provided for by a
            plan of reorganization or readjustment the payment of which is
            subordinate, at least to the extent provided in this Article with
            respect to the Securities, to the payment in full without diminution
            or modification by such plan of Senior Debt), shall be received by
            the Trustee or the holders before all Senior Debt is paid in full,
            such payment or distribution shall be held in trust for the benefit
            of, and be paid over to upon request by a holder of the Senior Debt,
            the holders of the Senior Debt remaining unpaid (or their
            Representative acting on their behalf), ratably as aforesaid, for
            application to the payment of such Senior Debt until all such Senior
            Debt shall have been paid in full, after giving effect to any
            concurrent payment or distribution to the holders of such Senior
            Debt.

      Subject to the payment in full of all Senior Debt, the holders shall be
subrogated to the rights of the holders of Senior Debt to receive payments or
distributions of cash, property or securities of the Company applicable to the
Senior Debt until the principal of and interest shall be paid in full and, for
purposes of such subrogation, no such payments or distributions to the holders
of Senior Debt of cash, property or securities which otherwise would have been
payable or distributable to holders shall, as among the Company, its creditors
other than the holders of Senior Debt, and the holders, be deemed to be a
payment by the Company to or on account of the Senior Debt, it being understood
that the provisions of this Article are and are intended solely for the purpose
of defining the relative rights of the holders, on the one hand, and the holders
of Senior Debt, on the other hand.

      Nothing contained in this Article or elsewhere in this Indenture or in the
Securities is intended to or shall (i) impair, as between the Company and its
creditors other than the holders of Senior Debt, the obligation of the Company,
which is absolute and unconditional, to pay to the holders the principal of, and
interest as and when the same shall become due and payable in accordance with
the terms of the Securities, (ii) affect the relative rights of the holders and
creditors of the Company other than holders of Senior Debt or, as between the
Company and the Trustee, the obligations of the Company to the Trustee, or (iii)
prevent the Trustee or the holders from exercising all remedies otherwise
permitted by applicable law upon default under this Indenture, subject to the


                                      -32-

<PAGE>
rights, if any, under this Article of the holders of Senior Debt in respect of
cash, property and securities of the Company received upon the exercise of any
such remedy.

         Upon distribution of assets of the Company referred to in this Article,
the Trustee, subject to the provisions of Section 9.01 hereof, and the holders
shall be entitled to rely upon a certificate of the liquidating trustee or agent
or other person making any distribution to the Trustee or to the holders for the
purpose of ascertaining the persons entitled to participate in such
distribution, the holders of the Senior Debt and other indebtedness of the
Company, the amount thereof or payable thereon, the amount or amounts paid or
distributed thereon and all other facts pertinent thereto or to this Article.
The Trustee, however, shall not be deemed to owe any fiduciary duty to the
holders of Senior Debt. Nothing contained in this Article or elsewhere in this
Indenture, or in any of the Securities, shall prevent the good faith application
by the Trustee of any moneys which were deposited with it hereunder, prior to
its receipt of written notice of facts which would prohibit such application,
for the purpose of the payment of or on account of the principal of, or interest
unless, prior to the date on which such application is made by the Trustee, the
Trustee shall be charged with actual notice under Section 6.03(d) hereof of the
facts which would prohibit the making of such application.

      (c) The provisions of this Article shall not be applicable to any cash,
properties or securities received by the Trustee or by any holder when received
as a holder of Senior Debt and nothing in Section 9.11 hereof or elsewhere in
this Indenture shall deprive the Trustee or such holder of any of its rights as
such holder of Senior Debt.

      (d) The Company shall give prompt written notice to the Trustee of any
fact known to the Company which would prohibit the making of any payment of
money to or by the Trustee in respect of the Securities pursuant to the
provisions of this Article. The Trustee, subject to the provisions of Section
9.01 hereof, shall be entitled to assume that no such fact exists unless the
Company or any holder of Senior Debt or any Representative therefor has given
written notice thereof to the Trustee. Notwithstanding the provisions of this
Article or any other provisions of this Indenture, the Trustee shall not be
charged with knowledge of the existence of any fact which would prohibit the
making of any payment of moneys to or by the Trustee in respect of the
Securities pursuant to the provisions in this Article, unless, and until three
Business Days after, the Trustee shall have received written notice thereof from
the Company or any holder or holders of Senior Debt or from any Representative
therefor; and, prior to the receipt of any such written notice, the Trustee,
subject to the provisions of Section 9.01 hereof, shall be entitled in all
respects conclusively to assume that no such facts exist; provided that if on a
date not less than three Business Days immediately preceding the date upon
which, by the terms hereof, any such moneys may become payable for any purpose
(including, without limitation, the principal of or interest), the Trustee shall
not have received with respect to such moneys the notice provided for in this
Section 6.03(d), then anything herein contained to the contrary notwithstanding,
the Trustee shall have full power and authority to receive such moneys and to
apply the same to the purpose for which they were received, and shall not be
affected by any notice to the contrary which may be received by it on or after
such prior date.

                                      -33-

<PAGE>
         The Trustee shall be entitled to conclusively rely on the delivery to
it of a written notice by a person representing himself to be a holder of Senior
Debt (or a Representative on behalf of such holder) to establish that such
notice has been given by a holder of Senior Debt (or a Representative on behalf
of any such holder or holders). In the event that the Trustee determines in good
faith that further evidence is required with respect to the right of any person
as a holder of Senior Debt to participate in any payment or distribution
pursuant to this Article, the Trustee may request such person to furnish
evidence to the reasonable satisfaction of the Trustee as to the amount of
Senior Debt held by such person, the extent to which such person is entitled to
participate in such payment or distribution and any other facts pertinent to the
rights of such person under this Article, and, if such evidence is not
furnished, the Trustee may defer any payment to such person pending judicial
determination as to the right of such person to receive such payment; nor shall
the Trustee be charged with knowledge or the curing or waiving of any default of
the character specified in Section 6.02 hereof or that any event or any
condition preventing any payment in respect of the Securities shall have ceased
to exist, unless and until the Trustee shall have received written notice to
such effect.

      (e) The provisions of this Section 6.03 applicable to the Trustee shall
(unless the context requires otherwise) also apply to any Paying Agent for the
Company.

      SECTION 6.04 Reliance by Holders of Senior Debt on Subordination
Provisions. Each holder of any Security by his acceptance thereof acknowledges
and agrees that the foregoing subordination provisions are, and are intended to
be, an inducement and a consideration for each holder of any Senior Debt,
whether such Senior Debt was created or acquired before or after the issuance of
the Securities, to acquire and continue to hold, or to continue to hold, such
Senior Debt, and such holder of Senior Debt shall be deemed conclusively to have
relied on such subordination provisions in acquiring and continuing to hold, or
in continuing to hold, such Senior Debt. Notice of any default in the payment of
any Senior Debt, except as expressly stated in this Article, and notice of
acceptance of the provisions hereof are hereby expressly waived. Except as
otherwise expressly provided herein, no waiver, forbearance or release by any
holder of Senior Debt under such Senior Debt or under this Article shall
constitute a release of any of the obligations or liabilities of the Trustee or
holders of the Securities provided in this Article.

      SECTION 6.05 No Waiver of Subordination Provisions. Except as
otherwise expressly provided herein, no right of any present or future holder of
any Senior Debt to enforce subordination as herein provided shall at any time in
any way be prejudiced or impaired by any act or failure to act on the part of
the Company or by any act or failure to act, in good faith, by any such holder,
or by any noncompliance by the Company with the terms, provisions and covenants
of this Indenture, regardless of any knowledge thereof any such holder may have
or be otherwise charged with.

      Without in any way limiting the generality of the foregoing paragraph, the
holders of Senior Debt may, at any time and from time to time, without the
consent of, or notice to, the Trustee or the holders of the Securities, without
incurring responsibility to the holders of the Securities and without impairing
or releasing the subordination provided in this Article VI or the obligations
hereunder of the holders of the Securities to the holders of Senior Debt, do any
one or more of the following:

                                      -34-


<PAGE>
(i) change the manner, place or terms of payment of, or renew or alter, Senior
Debt, or otherwise amend or supplement in any manner Senior Debt or any
instrument evidencing the same or any agreement under which Senior Debt is
outstanding; (ii) sell, exchange, release or otherwise dispose of any property
pledged, mortgaged or otherwise securing Senior Debt; (iii) release any person
liable in any manner for the collection of Senior Debt; and (iv) exercise or
refrain from exercising any rights against the Company or any other person.

      SECTION 6.06      Trustee's Relation to Senior Debt. The Trustee in its
individual capacity shall be entitled to all the rights set forth in this
Article in respect of any Senior Debt at any time held by it, to the same extent
as any holder of Senior Debt, and nothing in Section 9.11 hereof or elsewhere in
this Indenture shall deprive the Trustee of any of its rights as such holder.

      With respect to the holders of Senior Debt, the Trustee undertakes to
perform or to observe only such of its covenants and obligations, as are
specifically set forth in this Article, and no implied covenants or obligations
with respect to the holders of Senior Debt shall be read into this Indenture
against the Trustee. The Trustee shall not owe any fiduciary duty to the holders
of Senior Debt but shall have only such obligations to such holders as are
expressly set forth in this Article.

      Each holder of a Security by his acceptance thereof authorizes and directs
the Trustee on his behalf to take such action as may be necessary or appropriate
to effectuate the subordination provided in this Article and appoints the
Trustee his attorney-in-fact for any and all such purposes, including, in the
event of any dissolution, winding up or liquidation or reorganization under any
applicable bankruptcy law of the Company (whether in bankruptcy, insolvency or
receivership proceedings or otherwise), the timely filing of a claim for the
unpaid balance of such holder's Securities in the form required in such
proceedings and the causing of such claim to be approved. If the Trustee does
not file a claim or proof of debt in the form required in such proceedings prior
to 30 days before the expiration of the time to file such claims or proofs, then
any holder or holders of Senior Debt or their Representative or Representatives
shall have the right to demand, sue for, collect, receive and receipt for the
payments and distributions in respect of the Securities which are required to be
paid or delivered to the holders of Senior Debt as provided in this Article and
to file and prove all claims therefor and to take all such other action in the
name of the holders or otherwise, as such holders of Senior Debt or
Representative thereof may determine to be necessary or appropriate for the
enforcement of the provisions of this Article.

      SECTION 6.07      Other Provisions Subject Hereto. Except as expressly
stated in this Article, notwithstanding anything contained in this Indenture to
the contrary, all the provisions of this Indenture and the Securities are
subject to the provisions of this Article. However, nothing in this Article
shall apply to or adversely affect the claims of, or payment to, the Trustee
pursuant to Section 9.07. Notwithstanding the foregoing, the failure to make a
payment on account of principal of or interest by reason of any provision of
this Article VI shall not be construed as preventing the occurrence of an Event
of Default under Section 8.01.

      SECTION 6.08      Certain Conversions and Repurchases Deemed Payment. For
the purposes of this Article only, (i) the issuance and delivery of junior
securities upon conversion of Securities in accordance with Article V shall not
be deemed to constitute a payment or distribution

                                      -35-

<PAGE>
on account of the principal of or premium or interest or on account of the
purchase or other acquisition of Securities, and (ii) the payment, issuance or
delivery of cash (except in satisfaction of fractional shares pursuant to
Section 5.03), property or securities (other than junior securities) upon
conversion of a Security shall be deemed to constitute payment on account of the
principal of such Security. For the purposes of this Section, the term "junior
securities" means (a) shares of any stock of any class of the Company and
securities into which the Securities are convertible pursuant to Article V and
(b) securities of the Company which are subordinated in right of payment to all
Senior Debt which may be outstanding at the time of issuance or delivery of such
securities to substantially the same extent as, or to a greater extent than, the
Securities are so subordinated as provided in this Article. Nothing contained in
this Article or elsewhere in this Indenture or in the Securities is intended to
or shall impair, as among the Company, its creditors other than holders of
Senior Debt and the holders of the Securities, the right, which is absolute and
unconditional, of the holder of any Security to convert such Security in
accordance with Article V.

                                  ARTICLE VII

                                   Successors

      SECTION 7.01      Merger, Consolidation or Sale of Assets. The Company may
not consolidate or merge with or into any person (whether or not the Company is
the surviving entity), or sell, assign, transfer, lease, convey or otherwise
dispose of all or substantially all of its properties or assets unless:

            (a)   the Company is the surviving Corporate Entity or the Corporate
Entity formed by or surviving any such consolidation or merger (if other than
the Company) or to which such sale, assignment, transfer, lease, conveyance or
other disposition shall have been made is a Corporate Entity organized or
existing under the laws of the United States, any state thereof or the District
of Columbia;

            (b)   the Corporate Entity formed by or surviving any such
consolidation or merger (if other than the Company) or the Corporate Entity to
which such sale, assignment, transfer, lease, conveyance or other disposition
will have been made assumes all the Obligations of the Company, pursuant to a
supplemental indenture in a form reasonably satisfactory to the Trustee, under
the Securities and the Indenture;


            (c)   immediately after such transaction no Default or Event of
Default exists; and

            (d)   the Company or such person shall have delivered to the Trustee
an Officers' Certificate and an Opinion of Counsel, each stating that such
transaction and the supplemental indenture comply with the Indenture and that
all conditions precedent in the Indenture relating to such transaction have been
satisfied.

      SECTION 7.02      Successor Corporate Entity Substituted. Upon any
consolidation or merger, or any sale, assignment, transfer, lease, conveyance or
other disposition of all or substantially all of the assets of the Company in
accordance with Section 7.01 hereof, the successor

                                      -36-

<PAGE>
Corporate Entity formed by such consolidation or into or with which the Company
is merged or the person to which such sale, assignment, transfer, lease,
conveyance or other disposition is made shall succeed to, and be substituted for
and may exercise every right and power of, the Company under this Indenture with
the same effect as if such successor Corporate Entity has been named as the
Company herein; provided, however, that the predecessor Company in the case of a
sale, assignment, transfer, lease, conveyance or other disposition shall not be
released from the obligation to pay the principal of and interest.

                                  ARTICLE VIII

                              Defaults and Remedies

      SECTION 8.01      Events of Default. An "Event of Default" occurs if:

            (a)   the Company defaults in the payment of interest when the same
becomes due and payable, and the Default continues for a period of 30 days after
the date due and payable;

            (b)   the Company defaults in the payment of the principal of any
Security when the same becomes due and payable at maturity, upon redemption or
otherwise;

            (c)   the Company defaults in the payment of the Designated Event
Payment when the same becomes due and payable, whether or not such payment may
be prohibited by Article VI;

            (d)   the Company fails to provide timely notice of any Designated
Event in accordance with Section 4.08;

            (e)   the Company fails to observe or perform any other covenant or
agreement contained in this Indenture or the Securities required by it to be
performed and the Default continues for a period of 60 days after the receipt of
written notice from the Trustee to the Company or from the holders of 25% in
aggregate principal amount of the then outstanding Securities to the Company and
the Trustee stating that such notice is a "Notice of Default";

            (f)   there is a default under any mortgage, indenture or instrument
under which there may be issued or by which there may be secured or evidenced
any Indebtedness for money borrowed by the Company or any Subsidiary of the
Company (or the payment of which is guaranteed by the Company or any Subsidiary
of the Company), whether such Indebtedness or guarantee now exists or is created
after the Issuance Date, which default (i) is caused by a failure to pay when
due principal of or interest on such Indebtedness within the grace period
provided for in such Indebtedness (which failure continues beyond any applicable
grace period) (a "Payment Default") or (ii) results in the acceleration of such
Indebtedness prior to its express maturity (without such acceleration being
rescinded or annulled) and, in each case, the principal amount of any such
Indebtedness, together with the principal amount of any other such Indebtedness
under which there is a Payment Default or the maturity of which has been so
accelerated, aggregates $10 million or more;

                                      -37-

<PAGE>
            (g)   a final non-appealable judgment or final non-appealable
judgments (other than any judgment as to which a reputable insurance company has
accepted full liability) for the payment of money are entered by a court or
courts of competent jurisdiction against the Company or any Subsidiary of the
Company and remain undischarged for a period (during which execution shall not
be effectively stayed) of 60 days, provided that the aggregate of all such
judgments exceeds $10 million;

            (h)   the Company or any Material Subsidiary pursuant to or within
the meaning of any Bankruptcy Law: (i) commences a voluntary case, (ii) consents
to the entry of an order for relief against it in an involuntary case in which
it is the debtor, (iii) consents to the appointment of a Bankruptcy Custodian of
it or for all or substantially all of its property, (iv) makes a general
assignment for the benefit of its creditors, or (v) makes the admission in
writing that it generally is unable to pay its debts as the same become due; or

            (i)   a court of competent jurisdiction enters an order or decree
under any Bankruptcy Law that: (i) is for relief against the Company or any
Material Subsidiary in an involuntary case, (ii) appoints a Bankruptcy Custodian
of the Company or any Material Subsidiary or for all or substantially all of its
property, and the order or decree remains unstayed and in effect for 60 days or
(iii) orders the liquidation of the Company or any Material Subsidiary, and the
order or decree remains unstayed and in effect for 60 days.

      The term "Bankruptcy Law" means Title 11, U.S. Code or any similar Federal
or state law for the relief of debtors. The term "Bankruptcy Custodian" means
any receiver, trustee, assignee, liquidator or similar official under any
Bankruptcy Law.

      SECTION 8.02      Acceleration. If an Event of Default (other than an
Event of Default specified in clauses (h) and (i) of Section 8.01 hereof with
respect to the Company) occurs and is continuing, the Trustee by notice to the
Company, or the Securityholders of at least 25% in principal amount of the
then-outstanding Securities by notice to the Company and the Trustee, may
declare all the Securities to be due and payable. Upon such declaration, the
principal of, premium, if any, and accrued and unpaid interest shall be due and
payable immediately. If an Event of Default specified in clause (h) or (i) of
Section 8.01 hereof occurs with respect to the Company, such an amount shall
ipso facto become and be immediately due and payable without any declaration or
other act on the part of the Trustee or any Securityholder. The Securityholders
of a majority in aggregate principal amount of the then-outstanding Securities
by notice to the Trustee may rescind an acceleration and its consequences if the
rescission would not conflict with any judgment or decree, if all amounts
payable to the Trustee pursuant to Section 9.07 hereof have been paid and if all
existing Events of Default have been cured or waived except nonpayment of
principal or interest that has become due solely because of the acceleration.

      SECTION 8.03      Other Remedies. If an Event of Default occurs and is
continuing, the Trustee may pursue any available remedy to collect the payment
of principal or interest or to enforce the performance of any provision of the
Securities or this Indenture.

                                      -38-

<PAGE>
      The Trustee may maintain a proceeding even if it does not possess any of
the Securities or does not produce any of them in the proceeding. A delay or
omission by the Trustee or any Securityholder in exercising any right or remedy
accruing upon an Event of Default shall not impair the right or remedy or
constitute a waiver of or acquiescence in the Event of Default. All remedies are
cumulative to the extent permitted by law.

      SECTION 8.04      Waiver of Past Defaults. The Securityholders of a
majority in aggregate principal amount of the then-outstanding Securities by
notice to the Trustee may waive an existing Default or Event of Default and its
consequences except a continuing Default or Event of Default in the payment of
the Designated Event Payment or the principal of, or interest. When a Default or
Event of Default is waived, it is cured and ceases; but no such waiver shall
extend to any subsequent or other Default or impair any right consequent
thereon.

      SECTION 8.05      Control by Majority. The Securityholders of a majority
in principal amount of the then-outstanding Securities may direct the time,
method and place of conducting any proceeding for any remedy available to the
Trustee or exercising any trust or power conferred on it. However, the Trustee
may refuse to follow any direction that conflicts with law or this Indenture, is
unduly prejudicial to the rights of other Securityholders, or would involve the
Trustee in personal liability.

      SECTION 8.06      Limitation on Suits. A Securityholder may pursue a
remedy with respect to this Indenture or the Securities only if:

            (a)   the Securityholder gives to the Trustee notice of a continuing
Event of Default;

            (b)   the Securityholders of at least 25% in principal amount of the
then-outstanding Securities make a request to the Trustee to pursue the remedy;

            (c)   such Securityholder or Securityholders offer to the Trustee
indemnity satisfactory to the Trustee against any loss, liability or expense;

            (d)   the Trustee does not comply with the request within 60 days
after receipt of the request and the offer of indemnity; and

            (e)   during such 60-day period the Securityholders of a majority in
principal amount of the then-outstanding Securities do not give the Trustee a
direction inconsistent with the request.

      A Securityholder may not use this Indenture to prejudice the rights of
another Securityholder or to obtain a preference or priority over another
Securityholder.

      SECTION 8.07      Rights of Securityholders to Receive Payment.
Notwithstanding any other provision of this Indenture, the right of any
Securityholder of a Security to receive payment of principal and interest on or
after the respective due dates expressed in the Security, or to bring suit for
the enforcement of any such payment on or after such respective dates, shall not
be impaired or affected without the consent of the Securityholder made pursuant
to this Section.

                                      -39-

<PAGE>
      SECTION 8.08      Collection Suit by Trustee. If an Event of Default
specified in Section 8.01 (a), (b) or (c) occurs and is continuing, the Trustee
may recover judgment in its own name and as trustee of an express trust against
the Company for the whole amount of principal and interest and such further
amount as shall be sufficient to cover the costs and, to the extent lawful,
expenses of collection, including the reasonable compensation, expenses,
disbursements and advances of the Trustee, its agents and counsel.

      SECTION 8.09      Trustee May File Proofs of Claim. The Trustee may file
such proofs of claim and other papers or documents as may be necessary or
advisable in order to have the claims of the Trustee and the Securityholders
allowed in any judicial proceedings relative to the Company, its creditors or
its property. Nothing contained herein shall be deemed to authorize the Trustee
to authorize or consent to or accept or adopt on behalf of any Securityholder
any plan of reorganization, arrangement, adjustment or composition affecting the
Securities or the rights of any Securityholder thereof, or to authorize the
Trustee to vote in respect of the claim of any Securityholder in any such
proceeding.

      SECTION 8.10      Priorities. If the Trustee collects any money pursuant
to this Article, it shall pay out the money in the following order:

      First: to the Trustee for amounts due under Section 9.07 hereof;

      Second: to the holders of Senior Debt to the extent required by Article
VI;

      Third: to the Securityholders, for amounts due and unpaid on the
Securities for principal and interest, ratably, according to the amounts due and
payable on the Securities for principal and interest, respectively; and

      Fourth: to the Company.

      Except as otherwise provided in Section 2.12 hereof, the Trustee may fix a
record date and payment date for any payment to Securityholders made pursuant to
this Section.

      SECTION 8.11      Undertaking for Costs. In any suit for the enforcement
of any right or remedy under this Indenture or in any suit against the Trustee
for any action taken or omitted by it as a Trustee, a court in its discretion
may require the filing by any party litigant in the suit of an undertaking to
pay the costs of the suit, and the court in its discretion may assess reasonable
costs, including reasonable attorneys' fees, against any party litigant in the
suit, having due regard to the merits and good faith of the claims or defenses
made by the party litigant. This Section does not apply to a suit by the
Trustee, a suit by a holder pursuant to Section 8.07 hereof, or a suit by
Securityholders of more than 10% in principal amount of the then-outstanding
Securities.

                                   ARTICLE IX

                                     Trustee

                                      -40-

<PAGE>
      SECTION 9.01      Duties of Trustee.

            (a)   If an Event of Default has occurred and is continuing, the
Trustee shall exercise such of the rights and powers vested in it by this
Indenture, and use the same degree of care and skill in their exercise, as a
prudent man would exercise or use under the circumstances in the conduct of his
own affairs.

            (b)   Except during the continuance of an Event of Default: (i) the
Trustee need perform only those duties that are specifically set forth in this
Indenture and no others and (ii) in the absence of bad faith on its part, the
Trustee may conclusively rely, as to the truth of the statements and the
correctness of the opinions expressed therein, upon certificates or opinions
furnished to the Trustee and, if required by the terms hereof, conforming to the
requirements of this Indenture. However, the Trustee shall examine the
certificates and opinions to determine whether or not they conform to the
requirements of this Indenture.

            (c)   The Trustee may not be relieved from liability for its own
negligent action, its own negligent failure to act, or its own willful
misconduct, except that: (i) this paragraph does not limit the effect of
paragraph (b) of this Section 9.01; (ii) the Trustee shall not be liable for any
error of judgment made in good faith by a Trust Officer, unless it is proved
that the Trustee was negligent in ascertaining the pertinent facts and (iii) the
Trustee shall not be liable with respect to any action it takes or omits to take
in good faith in accordance with a direction received by it pursuant to Section
8.05 hereof.

            (d)   Every provision of this Indenture that in any way relates to
the Trustee is subject to paragraphs (a), (b) and (c) of this Section 9.01. No
provision of this Indenture shall require the Trustee to expend or risk its own
funds or otherwise incur any financial liability in the performance of any of
its duties hereunder, or in the exercise of any of its rights or powers, if it
shall have reasonable grounds for believing that repayment of such funds or
adequate indemnity against such risk or liability is not reasonably assured to
it.

            (e)   The Trustee may refuse to perform any duty or exercise any
right or power unless it receives indemnity satisfactory to it against any loss,
liability or expense.

            (f)   The Trustee shall not be liable for interest on any money
received by it except as the Trustee may agree in writing with the Company.
Money held in trust by the Trustee need not be segregated from other funds
except to the extent required by law.

      SECTION 9.02      Rights of Trustee.

            (a)   The Trustee may rely on any document believed by it to be
genuine and to have been signed or presented by the proper person. The Trustee
need not investigate any fact or matter stated in the document.

            (b)   Before the Trustee acts or refrains from acting, it (unless
other evidence be herein specifically prescribed) may require an Officers'
Certificate or an Opinion of Counsel, or both. The

                                      -41-

<PAGE>
Trustee shall not be liable for any action it takes or omits to take in good
faith in reliance on such Officers' Certificate or Opinion of Counsel.

            (c)   The Trustee may act through agents and nominees and shall not
be responsible for the misconduct or negligence of any agent appointed with due
care.

            (d)   The Trustee shall not be liable for any action it takes or
omits to take in good faith which it believes to be authorized or within its
rights or powers.

            (e)   The Trustee shall not be charged with knowledge of any Event
of Default under subsection (d), (e), (f), (g), (h) or (i) of Section 8.01
unless either (1) a Trust Officer assigned to its Corporate Trust Department
shall have actual knowledge thereof, or (2) the Trustee shall have received
notice thereof in accordance with Section 12.02 hereof from the Company or any
holder.

      SECTION 9.03      Individual Rights of Trustee. The Trustee in its
individual or any other capacity may become the owner or pledgee of Securities
and may otherwise deal with the Company or an Affiliate with the same rights it
would have if it were not Trustee. Any Agent may do the same with like rights.
However, the Trustee is subject to Sections 9.10 and 9.11 hereof.

      SECTION 9.04      Trustee's Disclaimer. The Trustee makes no
representation as to the validity or adequacy of this Indenture or the
Securities, it shall not be accountable for the Company's use of the proceeds
from the Securities, and it shall not be responsible for any statement of the
Company in the Indenture or any statement in the Securities other than its
authentication.

      SECTION 9.05      Notice of Defaults. If a Default or Event of Default
occurs and is continuing and if it is known to the Trustee, the Trustee shall
mail to Securityholders a notice of the Default or Event of Default within 90
days after it occurs. Except in the case of a Default or Event of Default in
payment on any Security, the Trustee may withhold the notice if and so long as a
committee of its Trust Officers in good faith determines that withholding the
notice is in the interests of Securityholders.

      SECTION 9.06      Reports by Trustee to Securityholders. Within 60 days
after the reporting date stated in Section 12.10, the Trustee shall mail to
Securityholders a brief report dated as of such reporting date that complies
with TIA Section 313(a) if and to the extent required by such Section 313(a).
The Trustee also shall comply with TIA Section 313(b)(2). The Trustee shall also
transmit by mail all reports as required by TIA Section 313(c).

      A copy of each report at the time of its mailing to Securityholders shall
be filed with the SEC and each stock exchange on which the Securities are
listed. The Company shall notify the Trustee when the Securities are listed on
any stock exchange or automated quotation system.

      SECTION 9.07      Compensation and Indemnity. The Company shall pay to the
Trustee from time to time reasonable compensation for its services hereunder.
The Trustee's compensation shall not be limited by any law on compensation of a
trustee of an express trust. The Company shall reimburse the Trustee upon
request for all reasonable disbursements, expenses and advances

                                      -42-

<PAGE>
incurred or made by it. Such disbursements and expenses may include the
reasonable disbursements, compensation and expenses of the Trustee's agents and
counsel.

      The Company shall indemnify the Trustee and its officers, directors,
employees and agents against any loss or liability incurred by it except as set
forth in the next paragraph. The Trustee shall notify the Company promptly of
any claim for which it may seek indemnity. The Company shall defend the claim
and the Trustee shall cooperate in the defense. The Trustee may have separate
counsel and the Company shall pay the reasonable fees, disbursements and
expenses of such counsel. The Company need not pay for any settlement made
without its consent, which consent shall not be unreasonably withheld.

      The Company need not reimburse any expense or indemnify against any loss
or liability incurred by the Trustee through negligence, bad faith or willful
misconduct.

      To secure the Company's payment obligations in this Section, the Trustee
shall have a lien prior to the Securities on all money or property held or
collected by the Trustee, except money or property held in trust to pay
principal and interest.

      When the Trustee incurs expenses or renders services after an Event of
Default specified in Section 8.01(h) or (i) occurs, the expenses and the
compensation for the services are intended to constitute expenses of
administration under any Bankruptcy Law.

      The provisions of this Section 9.07 shall survive the termination of this
Indenture, as provided by Section 10.01 hereof.

      SECTION 9.08      Replacement of Trustee. A resignation or removal of the
Trustee and appointment of a successor Trustee shall become effective only upon
the successor Trustee's acceptance of appointment as provided in this Section.

      The Trustee may resign by so notifying the Company. The Securityholders of
a majority in principal amount of the then-outstanding Securities may remove the
Trustee by so notifying the Trustee and the Company. The Company may remove the
Trustee if:

            (a)   the Trustee fails to comply with Section 9.10 hereof, unless
the Trustee's duty to resign is stayed as provided in TIA Section 310(b);

            (b)   the Trustee is adjudged a bankrupt or an insolvent or an order
for relief is entered with respect to the Trustee under any Bankruptcy Law;

            (c)   a Bankruptcy Custodian or public officer takes charge of the
Trustee or its property, or

            (d)   the Trustee becomes incapable of acting.

                                      -43-

<PAGE>
      If the Trustee resigns or is removed or if a vacancy exists in the office
of Trustee for any reason, the Company shall promptly appoint a successor
Trustee. Within one year after the successor Trustee takes office, the
Securityholders of a majority in principal amount of the then-outstanding
Securities may appoint a successor Trustee to replace the successor Trustee
appointed by the Company.

      If a successor Trustee does not take office within 60 days after the
retiring Trustee resigns or is removed, the retiring Trustee, the Company or the
Securityholders of at least 10% in principal amount of the then-outstanding
Securities may petition any court of competent jurisdiction for the appointment
of a successor Trustee.

      If the Trustee fails to comply with Section 9.10 hereof, unless the
Trustee's duty to resign is stayed as provided in TIA Section 310(b), any
Securityholder who has been a bona fide holder of a Security for at least six
months may petition any court of competent jurisdiction for the removal of the
Trustee and the appointment of a successor Trustee.

      A successor Trustee shall deliver a written acceptance of its appointment
to the retiring Trustee and to the Company. Thereupon the resignation or removal
of the retiring Trustee shall become effective, the Company shall promptly pay
all amounts due and payable to the retiring Trustee, and the successor Trustee
shall have all the rights, powers and duties of the Trustee under this
Indenture. The successor Trustee shall mail a notice of its succession to
Securityholders. The retiring Trustee shall promptly transfer all property held
by it as Trustee to the successor Trustee, subject to the lien provided for in
Section 9.07 hereof. Notwithstanding the resignation or replacement of the
Trustee pursuant to this Section 9.08, the Company's obligations under Section
9.07 hereof shall continue for the benefit of the retiring Trustee with respect
to expenses and liabilities incurred by it prior to such resignation or
replacement.

      SECTION 9.09      Successor Trustee by Merger, Etc. If the Trustee
consolidates, merges or converts into, or transfers all or substantially all of
its corporate trust business (including the administration of the Indenture) to,
another corporation, the successor corporation without any further act shall be
the successor Trustee.

      SECTION 9.10      Eligibility; Disqualification. This Indenture shall
always have a Trustee who satisfies the requirements of TIA Section 310(a)(1)
and (5). The Trustee (or if the Trustee is a member of a bank holding system,
its bank holding company) shall always have a combined capital and surplus as
stated in Section 12.10 hereof. The Trustee is subject to TIA Section 310(b).

      SECTION 9.11      Preferential Collection of Claims Against Company. The
Trustee is subject to TIA Section 311(a), excluding any credit or relationship
listed in TIA Section 311(b). A Trustee who has resigned or been removed shall
be subject to TIA Section 311(a) to the extent indicated therein.

      SECTION 9.12      Sections Applicable to Registrar, Paying Agent and
Conversion Agent.

      The term "Trustee" as used in Sections 6.3, 9.1, 9.2, 9.3, 9.4 and 9.7
hereof shall (unless the

                                      -44-

<PAGE>
context requires otherwise) be construed as extending to and including the
Trustee acting in its capacity, if any, as Registrar, Paying Agent and
Conversion Agent.

                                    ARTICLE X

                             Discharge of Indenture

      SECTION 10.01     Termination of Company's Obligation. This Indenture
shall cease to be of further effect (except that the Company's obligations under
Sections 9.07 and 10.02 hereof shall survive) when all outstanding Securities
theretofore authenticated and issued have been delivered to the Trustee for
cancellation and the Company has paid all sums payable hereunder.

      Thereupon, the Trustee upon request of the Company, shall acknowledge in
writing the discharge of the Company's obligations under this Indenture, except
for those surviving obligations specified above.

      SECTION 10.02     Repayment to Company. The Trustee and the Paying Agent
shall promptly pay to the Company upon request any excess money or securities
held by them at any time.

      The Trustee and the Paying Agent shall pay to the Company upon request any
money held by them for the payment of principal or interest that remains
unclaimed for two years after the date upon which such payment shall have become
due; provided, however, that the Company shall have first caused notice of such
payment to the Company to be mailed to each Securityholder entitled thereto no
less than 30 days prior to such payment. After payment to the Company, the
Trustee and the Paying Agent shall have no further liability with respect to
such money and Securityholders entitled to the money must look to the Company
for payment as general creditors unless any applicable abandoned property law
designates another person.

                                   ARTICLE XI

                       Amendments, Supplements and Waivers

      SECTION 11.01     Without Consent of Securityholders. The Company and the
Trustee may amend or supplement this Indenture or the Securities without the
consent of any Securityholder:

            (a)   to cure any ambiguity, defect or inconsistency;

            (b)   to comply with Sections 5.13 and 7.01 hereof;

            (c)   to provide for uncertificated Securities in addition to
certificated Securities;

            (d)   to make any change that does not adversely affect the legal
rights hereunder of any Securityholder;

                                      -45-

<PAGE>
            (e)   to qualify this Indenture under the TIA or to comply with the
requirements of the SEC in order to maintain the qualification of the Indenture
under the TIA; or

            (f)   to make any change that provides any additional rights or
benefits to the holders of Securities.

      An amendment under this Section may not make any change that adversely
affects the rights under Article VI of any holder of Senior Debt then
outstanding unless the holders of such Senior Debt (or any group or
Representative thereof authorized to give a consent) consent to such change.

      SECTION 11.02     With Consent of Securityholders. Subject to Section 8.07
hereof, the Company and the Trustee may amend or supplement this Indenture or
the Securities with the written consent (including consents obtained in
connection with any tender or exchange offer for Securities) of the
Securityholders of at least a majority in principal amount of the
then-outstanding Securities. Subject to Sections 8.04 and 8.07 hereof, the
Securityholders of a majority in principal amount of the Securities then
outstanding may also by their written consent (including consents obtained in
connection with any tender offer or exchange offer for Securities) waive any
existing Default as provided in Section 8.04 or waive compliance in a particular
instance by the Company with any provision of this Indenture or the Securities.
However, without the consent of each Securityholder affected, an amendment,
supplement or waiver under this Section may not (with respect to any Securities
held by a nonconsenting Securityholder):

            (a)   reduce the amount of Securities whose Securityholders must
consent to an amendment, supplement or waiver;

            (b)   reduce the rate of or change the time for payment of interest
on any Security;

            (c)   reduce the principal of or change the fixed maturity of any
Security or alter the redemption provisions with respect thereto;

            (d)   make any Security payable in money other than that stated in
the Security;

            (e)   make any change in Section 8.04, 8.07 or 11.02 hereof (this
sentence);

            (f)   waive a default in the payment of principal of, premium, if
any, or interest (other than as provided in Section 8.04);

            (g)   waive a redemption payment payable on any Security;

            (h)   make any change that impairs the right of Securityholders to
convert Securities into Common Stock of the Company; or

            (i)   modify the conversion or subordination provisions set forth in
Article V and Article VI, respectively, in a manner adverse to the holders of
the Securities.

                                      -46-

<PAGE>
      To secure a consent of the Securityholders under this Section 11.02, it
shall not be necessary for the Securityholders to approve the particular form of
any proposed amendment, supplement or waiver, but it shall be sufficient if such
consent approves the substance thereof.

      An amendment under this Section may not make any change that adversely
affects the rights under Article VI of any holder of Senior Debt then
outstanding unless the holders of such Senior Debt (or any group or
Representative thereof authorized to give a consent) consent to such change.

      Neither the Company nor any of its Subsidiaries shall, directly or
indirectly, pay or cause to be paid any consideration, whether by way of
interest, fee or otherwise, to any holder of Securities or as an inducement to
any consent, waiver or amendment of any of the terms or provisions of this
Indenture or the Securities unless such consideration is offered to be paid or
agreed to be paid to all holders of the Securities that consent, waive or agree
to amend in the time frame set forth in the solicitation documents relating to
such consent, waiver or agreement.

      After an amendment, supplement or waiver under this Section becomes
effective, the Company shall mail to Securityholders a notice briefly describing
the amendment or waiver.

      SECTION 11.03     Compliance with Trust Indenture Act. Every amendment to
this Indenture or the Securities shall be set forth in a supplemental indenture
that complies with the TIA as then in effect.

      SECTION 11.04     Revocation and Effect of Consents. Until an amendment,
supplement or waiver becomes effective, a consent to it by a Securityholder of a
Security is a continuing consent by the Securityholder and every subsequent
Securityholder of a Security or portion of a Security that evidences the same
debt as the consenting Securityholder's Security, even if notation of the
consent is not made on any Security. However, any such Securityholder or
subsequent Securityholder may revoke the consent as to such Securityholder's
Security or portion of a Security if the Trustee receives the notice of
revocation before the date on which the Trustee receives an Officers'
Certificate certifying that the Securityholders of the requisite principal
amount of Securities have consented to the amendment, supplement or waiver.

      The Company may, but shall not be obligated to, fix a record date for the
purpose of determining the Securityholders entitled to consent to any amendment,
supplement or waiver. If a record date is fixed, then notwithstanding the
provisions of the immediately preceding paragraph, those persons who were
Securityholders at such record date (or their duly designated proxies), and only
those persons, shall be entitled to consent to such amendment, supplement or
waiver or to revoke any consent previously given, whether or not such persons
continue to be Securityholders after such record date. No consent shall be valid
or effective for more than 90 days after such record date unless consents from
Securityholders of the principal amount of Securities required hereunder for
such amendment or waiver to be effective shall have also been given and not
revoked within such 90-day period.

      After an amendment, supplement or waiver becomes effective it shall bind
every Securityholder, unless it is of the type described in any of clauses (a)
through (i) of Section 11.02

                                      -47-

<PAGE>
hereof. In such case, the amendment or waiver shall bind each Securityholder who
has consented to it and every subsequent Securityholder that evidences the same
debt as the consenting Securityholder's Security.

      SECTION 11.05     Notation on or Exchange of Securities. The Trustee may
place an appropriate notation about an amendment or waiver on any Security
thereafter authenticated. The Company in exchange for all Securities may issue
and the Trustee shall authenticate new Securities that reflect the amendment or
waiver.

      SECTION 11.06     Trustee Protected. The Trustee shall sign all
supplemental indentures, except that the Trustee may, but need not, sign any
supplemental indenture that adversely affects its rights. As a condition to
executing, or accepting the additional trusts created by, any supplemental
indenture permitted by this Article or the modifications thereby of the trust
created by this Indenture, the Trustee shall be entitled to receive (in addition
to those documents required by Section 12.04), and (subject to Section 315 of
the TIA) shall be fully protected in relying upon, an Opinion of Counsel stating
that the execution of such supplemental indenture is authorized or permitted by
this Indenture.

                                   ARTICLE XII

                                  Miscellaneous

      SECTION 12.01     Trust Indenture Act Controls. If any provision of this
Indenture limits, qualifies or conflicts with another provision which is deemed
to be incorporated in this Indenture by the TIA, the incorporated provision
shall control.

      SECTION 12.02     Notices. Any notice or communication by the Company or
the Trustee to the other is duly given if in writing and delivered in person or
mailed by first-class mail or overnight delivery to the other's address stated
in Section 12.10 hereof. The Company or the Trustee by notice to the other may
designate additional or different addresses for subsequent notices or
communications.

      Any notice or communication to a Securityholder shall be mailed by
first-class mail or overnight delivery to his address shown on the register kept
by the Registrar. Failure to mail a notice or communication to a Securityholder
or any defect in it shall not affect its sufficiency with respect to other
Securityholders.

      If a notice or communication is mailed in the manner provided above within
the time prescribed, it is duly given, whether or not the addressee receives it.

      If the Company mails a notice or communication to Securityholders, it
shall mail a copy to the Trustee and each Agent at the same time.

      All other notices or communications shall be in writing.

                                      -48-

<PAGE>
      In case by reason of the suspension of regular mail service, or by reason
of any other cause, it shall be impossible to mail any notice as required by the
Indenture, then such method of notification as shall be made with the approval
of the Trustee shall constitute a sufficient mailing of such notice.

      SECTION 12.03     Communication by Securityholders with Other
Securityholders.

      Securityholders may communicate pursuant to TIA Section 312(b) with other
Securityholders with respect to their rights under this Indenture or the
Securities. The Company, the Trustee, the Registrar and anyone else shall have
the protection of TIA Section 312(c).

      SECTION 12.04     Certificate and Opinion as to Conditions Precedent. Upon
any request or application by the Company to the Trustee to take any action
under this Indenture, the Company shall furnish to the Trustee:

            (a)   an Officers' Certificate stating that, in the opinion of the
signers, all conditions precedent, if any, provided for in this Indenture
relating to the proposed action have been complied with; and

            (b)   an Opinion of Counsel stating that, in the opinion of such
counsel, all such conditions precedent have been complied with.

      SECTION 12.05     Statements Required in Certificate or Opinion. Each
certificate or opinion with respect to compliance with a condition or covenant
provided for in this Indenture (other than pursuant to Section 4.03) shall
include:

            (a)   a statement that the person signing such certificate or
rendering such opinion has read such covenant or condition;

            (b)   a brief statement as to the nature and scope of the
examination or investigation upon which the statements or opinions contained in
such certificate or opinion are based;

            (c)   a statement that, in the opinion of such person, such person
has made such examination or investigation as is necessary to enable such person
to express an informed opinion as to whether or not such covenant or condition
has been complied with; and

            (d)   a statement as to whether or not, in the opinion of such
person, such condition or covenant has been complied with.

      SECTION 12.06     Rules by Trustee and Agents. The Trustee may make
reasonable rules for action by, or a meeting of, the Securityholders. The
Registrar or Paying Agent may make reasonable rules and set reasonable
requirements for its functions.

      SECTION 12.07     Legal Holidays. A "Legal Holiday" is a Saturday, a
Sunday or a day on which banking institutions in the State of New York or the
State of California are not required to be open. If a payment date is a Legal
Holiday at a place of payment, payment may be made at that

                                      -49-

<PAGE>
place on the next succeeding day that is not a Legal Holiday, and no interest
shall accrue for the intervening period. If any other operative date for
purposes of this Indenture shall occur on a Legal Holiday then for all purposes
the next succeeding day that is not a Legal Holiday shall be such operative
date.

      SECTION 12.08     No Recourse Against Others. A director, officer,
employee or shareholder, as such, of the Company shall not have any liability
for any obligations of the Company under the Securities or the Indenture or for
any claim based on, in respect of or by reason of such obligations or their
creation. Each Securityholder by accepting a Security waives and releases all
such liability. The waiver and release are part of the consideration for the
issue of the Securities.

      SECTION 12.09     Counterparts. This Indenture may be executed in any
number of counterparts and by the parties hereto in separate counterparts, each
of which when so executed shall be deemed to be an original and all of which
taken together shall constitute one and the same agreement.

      SECTION 12.10     Variable Provisions. "Officer" means the Chairman of the
Board, the President, any Vice-President (whether or not designated by a number
or a word or words added before or after the title "Vice President"), the Chief
Financial Officer, the Treasurer, the Secretary, any Assistant Treasurer or any
Assistant Secretary of the Company.

      The first certificate pursuant to Section 4.03 hereof shall be for the
fiscal year ending on December 31, 2002.

      The reporting date for Section 9.06 hereof is March 15 of each year. The
first reporting date is March 15, 2003.

      The Trustee (or if the Trustee is a member of a bank holding company
system, its bank holding company) shall always have a combined capital and
surplus of at least $50,000,000 as set forth in its most recent published annual
report of condition.

      The Company's address for purposes of the Indenture is:

            Chief Financial Officer
            Intevac, Inc.
            3550 Bassett Street
            Santa Clara, California 95054
            Telephone Number: (408) 986-9888
            Telefax Number: (408) 988-8145

      The Trustee's address is:

            State Street Bank and Trust Company of California, N. A.
            633 West 5th Street, 12th Floor
            Los Angeles, CA 90071


                                      -50-

<PAGE>
            Attention: Corporate Trust Administration
            (Intevac, Inc. 6-1/2% Convertible Subordinated Notes due 2009)
            Telephone Number: (213) 362-7334
            Telefax Number: (213) 362-7357

      The Company or the Trustee may change its address for purposes of this
Indenture by written notice to the other.

      SECTION 12.11     GOVERNING LAW. THIS INDENTURE AND THE SECURITIES ISSUED
HEREUNDER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE
STATE OF NEW YORK.

      SECTION 12.12     No Adverse Interpretation of Other Agreements. This
Indenture may not be used to interpret another indenture, loan or debt agreement
of the Company or an Affiliate. Any such indenture, loan or debt agreement may
not be used to interpret this Indenture.

      SECTION 12.13     Successors. All agreements of the Company in this
Indenture and the Securities shall bind its successor. All agreements of the
Trustee in this Indenture shall bind its successor.

      SECTION 12.14     Severability. In case any provision in this Indenture or
in the Securities shall be invalid, illegal or unenforceable, the validity,
legality and enforceability of the remaining provisions shall not in any way be
affected or impaired thereby.

      SECTION 12.15     Table of Contents, Headings, Etc. The Table of Contents
and headings of the Articles and Sections of this Indenture have been inserted
for convenience of reference only, are not to be considered a part hereof, and
shall in no way modify or restrict any of the terms or provisions hereof.

                                  ARTICLE XIII

                                Repurchase Offer

      SECTION 13.01     Repurchase Offer.

            (a)   In the event that, pursuant to Section 4.09 hereof, the
Company shall commence a Repurchase Offer, the Company shall follow the
procedures in this Section 13.01.

            (b)   The Repurchase Offer shall remain open for a period specified
by the Company which shall be no less than 30 calendar days and no more than 40
calendar days prior to the Repurchase Payment Date, except to the extent that a
longer period is required by applicable law. The first day of such period is
referred to as the "Repurchase Commencement Date". On the Repurchase Payment
Date the Company shall purchase the principal amount of any Securities required
to be purchased pursuant to Section 4.09 hereof (the "Repurchase Offer Amount").

                                      -51-

<PAGE>
            (c)   If the Repurchase Payment Date is on or after an interest
payment record date and on or before the related interest payment date, any
accrued interest, to the related interest payment date will be paid to the
person in whose name a Security is registered at the close of business on such
record date, and no additional interest, will be payable to Securityholders who
tender Securities pursuant to the Repurchase Offer.

      SECTION 13.02     Repurchase Notice.

            (a)   The Company shall provide the Trustee with written notice of
the Repurchase Offer at least 10 Business Days prior to the mailing of the
notice of the Repurchase Offer to the Securityholders.

            (b)   On or before the date that is 90 days prior to the Repurchase
Payment Date, the Company or the Trustee (at the request and expense of the
Company) shall send, by first class mail, a notice to each of the
Securityholders, which shall govern the terms of the Repurchase Offer and shall
state:

                  (i)   that the Repurchase Offer is being made pursuant to
Section 13.01 and Section 4.09 hereof and that all Securities tendered will be
accepted for payment;

                  (ii)  the Repurchase Payment (as determined in accordance with
Section 4.09 hereof), the length of time the Repurchase Offer will remain open
and the Repurchase Payment Date;

                  (iii) that any Security or portion thereof not tendered or
accepted for payment will continue to accrue interest;

                  (iv)  that, unless the Company defaults in the payment of the
Repurchase Payment, any Security or portion thereof accepted for payment
pursuant to the Repurchase Offer shall cease to accrue interest after the
Repurchase Payment Date;

                  (v)   that Securityholders electing to have a Security or
portion thereof purchased pursuant to any Repurchase Offer will be required to
surrender the Security, with the form entitled "Option of Securityholder To
Elect Purchase" on the reverse of the Security completed, to the Paying Agent at
the address specified in the notice prior to the close of business on the third
Business Day preceding the Repurchase Payment Date;

                  (vi)  that Securityholders will be entitled to withdraw their
election if the Paying Agent receives, not later than the close of business on
the second Business Day preceding the Repurchase Payment Date, or such longer
period as may be required by law, a letter or a telegram, telex, facsimile
transmission (receipt of which is confirmed and promptly followed by a letter)
setting forth the name of the Securityholder, the principal amount of the
Security or portion thereof the Securityholder delivered for purchase and a
statement that such Securityholder is withdrawing his election to have the
Security or portion thereof purchased; and

                                      -52-

<PAGE>
                  (vii) that Securityholders whose Securities are being
purchased only in part will be issued new Securities equal in principal amount
to the unpurchased portion of the Securities surrendered, which unpurchased
portion must be equal to $1,000 in principal amount or an integral multiple
thereof.

      In addition, the notice shall contain all instructions and materials that
the Company shall reasonably deem necessary to enable such Securityholders to
tender Securities pursuant to the Repurchase Offer.

      SECTION 13.03     Deposit of Repurchase Offer Amount.

      On or prior to the Repurchase Payment Date, the Company shall irrevocably
deposit with the Trustee or a Paying Agent in immediately available funds an
amount equal to the Repurchase Payment to be held for payment in accordance with
the terms of this Section13.03. On the Repurchase Payment Date, the Company
shall, to the extent lawful, (i) accept for payment the Securities or portions
thereof tendered pursuant to the Repurchase Offer, (ii) deliver or cause to be
delivered to the Trustee Securities so accepted and (iii) deliver to the Trustee
an Officers' Certificate stating that such Securities or portions thereof have
been accepted for payment by the Company in accordance with the terms of this
Section13.03. The Paying Agent shall promptly (but in any case not later than
five calendar days after the Repurchase Payment Date) mail or deliver to each
tendering Securityholder an amount equal to the Repurchase Payment of the
Securities tendered by such Securityholder, and the Trustee shall promptly
authenticate and mail or deliver to such Securityholders a new Security equal in
principal amount to any unpurchased portion of the Security surrendered, if any;
provided, that each new Security shall be in a principal amount of $1,000 or an
integral multiple thereof. Any Securities not so accepted shall be promptly
mailed or delivered by or on behalf of the Company to the holder thereof. The
Company will publicly announce the results of the Repurchase Offer on, or as
soon as practicable after, the Repurchase Payment Date.

      SECTION 13.04     Compliance with Applicable Laws.

      The Repurchase Offer shall be made by the Company in compliance with all
applicable provisions of the Exchange Act, and all applicable tender offer rules
promulgated thereunder, and shall include all instructions and materials that
the Company shall reasonably deem necessary to enable such Securityholders to
tender their Securities.


                  [Remainder of page intentionally left blank]


                                      -53-

<PAGE>
      IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be
duly executed, all as of the date first written above.

                                              INTEVAC, INC.,
                                              AS COMPANY,

                                              By:  /s/ Charles B. Eddy III
                                              ----------------------------------
                                              Name: Charles Eddy
                                              Title: CFO

                                              STATE STREET BANK AND TRUST
                                              COMPANY OF CALIFORNIA, N.A.,
                                              AS TRUSTEE,

                                              By:  /s/ Joni D'Amico
                                              ----------------------------------
                                              Name:  Joni D'Amico
                                              Title:  Vice President

<PAGE>
                                    EXHIBIT A

                      FORM OF CONVERTIBLE SUBORDINATED NOTE

                             [FORM OF FACE OF NOTE]

                           [GLOBAL SECURITIES LEGEND]

      UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF
THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE COMPANY OR
ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND ANY CERTIFICATE
ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR SUCH OTHER NAME AS IS
REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO
CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED
REPRESENTATIVE OF DTC) ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR
OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER
HEREOF, CEDE & CO., HAS AN INTEREST HEREIN.

      TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS IN WHOLE,
BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR THEREOF OR SUCH
SUCCESSOR'S NOMINEE AND TRANSFERS OF PORTIONS OF THIS GLOBAL SECURITY SHALL BE
LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN THE
INDENTURE REFERRED TO ON THE REVERSE HEREOF.


                                      A-1


<PAGE>



No. _______                                                            Cusip No.

                                  INTEVAC, INC.

                 6-1/2% CONVERTIBLE SUBORDINATED NOTE DUE 2009

      Intevac, Inc., a California corporation (the "Company") for value received
promises to pay to _____________________________________________________ or its
registered assigns, the principal sum [indicated on Schedule A hereof]* [of
________ Dollars]** on March 1, 2009 at the office or agency of the Company
maintained for that purpose in the Borough of Manhattan, The City of New York,
State of New York, and to pay interest on said principal sum at the rate of
6-1/2% per annum, as more specifically described on the reverse hereof.

Interest Payment Dates:   March 1 and September 1, commencing September 1, 2002.
Record Dates:             February 15 and August 15.

      Reference is hereby made to the further provisions of this Note set forth
on the reverse hereof, which further provisions shall for all purposes have the
same effect as if set forth at this place.



_____________
  * Applicable to Global Securities only.


 ** Applicable to certificated Securities only.



                                       A-2


<PAGE>


      IN WITNESS WHEREOF, Intevac, Inc. has caused this Note to be signed
manually or by facsimile by its duly authorized Officers.

Dated: ____________________________


                                            INTEVAC, INC.


                                            By: ____________________________



                                            By: ____________________________




TRUSTEE'S CERTIFICATE OF AUTHENTICATION

This is one of the 6-1/2% Convertible Subordinated Notes
due 2009 described in the within-mentioned Indenture.

State Street Bank and Trust Company of California, N.A.,
as Trustee


By: ________________________

    Authorized Officer


                                      A-3

<PAGE>



                                  INTEVAC, INC.

                  6-1/2% CONVERTIBLE SUBORDINATED NOTE DUE 2009

      1. Interest. INTEVAC, INC., a California corporation (the "Company"), is
the issuer of the 6-1/2% Convertible Subordinated Notes due 2009 (the "Notes"),
of which this Note is a part. The Company promises to pay interest on the Notes
in cash semiannually on each March 1 and September 1, commencing on September 1,
2002, to holders of record on the immediately preceding February 15 and August
15.

      Interest on the Notes will accrue from the most recent date to which
interest has been paid or duly provided for, or if no interest has been paid or
duly provided for, from July 12, 2002 until payment of said principal sum has
been made or duly provided for. Interest will be computed on the basis of a
360-day year of twelve 30-day months. To the extent lawful, the Company shall
pay interest (including post-petition interest in any proceeding under any
Bankruptcy Law) on overdue installments of interest (without regard to any
applicable grace period) at the rate borne by the Notes, compounded annually.

      2. Method of Payment. The Company will pay interest on the Notes (except
defaulted interest) to the persons who are registered holders of the Notes at
the close of business on the record date for the next interest payment date even
though Notes are canceled after the record date and on or before the interest
payment date. The Securityholder hereof must surrender Notes to a Paying Agent
to collect principal payments. The Company will pay principal and interest in
money of the United States that at the time of payment is legal tender for
payment of public and private debts. However, the Company may pay principal and
interest by check payable in such money. It may mail a check for interest to a
holders' registered address; provided that a holder of Notes with an aggregate
principal amount in excess of $2,000,000 will be paid by wire transfer in
immediately available funds at the election of the holder.

      3. Paying Agent and Registrar. The Trustee will act initially as Paying
Agent, Registrar and Conversion Agent. The Company may change any Paying Agent,
Registrar, co-registrar or Conversion Agent without prior notice. The Company or
any of its Affiliates may act in any such capacity.

      4. Indenture. The Company issued the Notes under an indenture, dated as of
July 12, 2002 (the "Indenture"), between the Company and State Street Bank and
Trust Company of California, N.A., as Trustee. The terms of the Notes include
those stated in the Indenture and those incorporated into the Indenture from the
Trust Indenture Act of 1939, and rules and regulations thereunder. The Notes are
subject to, and qualified by, all such terms, certain of which are summarized
hereon, and Securityholders are referred to the Indenture and such Act for a
statement of such terms. The Notes are general unsecured obligations of the
Company limited to an aggregate principal amount at maturity of $29,543,000. The
Indenture does not limit the ability of the Company or any of its Subsidiaries
to incur indebtedness or to grant security interests or liens in respect of
their assets.

                                      A-4

<PAGE>

      5. Optional Redemption. The Notes are subject to redemption at the option
of the Company, in whole or from time to time in part (in any integral multiple
of $1,000), on any date on or after March 1, 2005 at 100% of the principal
amount, but excluding the redemption date (subject to the right of holders of
record on the relevant record date to receive interest due on an interest
payment date). On or after the redemption date, interest will cease to accrue on
the Notes, or portion thereof, called for redemption.

      6. Notice of Redemption. Notice of redemption will be mailed at least 15
days but not more than 60 days before the redemption date to each holder of the
Notes to be redeemed at his address of record. The Notes in denominations larger
than $1,000 may be redeemed in part but only in integral multiples of $1,000. In
the event of a redemption of less than all of the Notes, the Notes will be
chosen for redemption by the Trustee in accordance with the Indenture. Unless
the Company defaults in making such redemption payment, or the Paying Agent is
prohibited from making such payment pursuant to the Indenture, by law or
otherwise, interest shall cease to accrue on the Notes or portions of them
called for redemption on and after the redemption date. If this Note is redeemed
subsequent to a record date with respect to any interest payment date specified
above and on or prior to such interest payment date, then any accrued interest
will be paid to the person in whose name this Note is registered at the close of
business on such record date.

      7. Mandatory Redemption. The Company will not be required to make
mandatory redemption payments with respect to the Notes. There are no sinking
fund payments with respect to the Notes.

      8. Repurchase at Option of Holder. If there is a Designated Event, the
Company shall be required to offer to purchase on the Designated Event Payment
Date all outstanding Notes at a purchase price equal to 101% of the principal
amount thereof on the date of purchase, plus accrued and unpaid interest to the
Designated Event Payment Date. Holders of Notes that are subject to an offer to
purchase will be mailed a Designated Event Offer from the Company prior to any
related Designated Event Payment Date and may elect to have such Notes or
portions thereof in authorized denominations purchased by completing the form
entitled "Option of Securityholder To Elect Purchase" appearing below.
Securityholders have the right to withdraw their election by delivering a
written notice of withdrawal to the Company or the Paying Agent in accordance
with the terms of the Indenture.

      If there is a Triggering Distribution (as defined in the Indenture), the
Company shall be required to offer to purchase on the Repurchase Payment Date
all outstanding Notes at a purchase price equal to 100% of the principal amount
thereof together with any accrued and unpaid interest to the Repurchase Payment
Date. Holders of Notes that are subject to an offer to purchase will be mailed a
Repurchase Offer from the Company on or before the date that is 90 days prior to
any related Repurchase Payment Date and may elect to have such Notes or portions
thereof in authorized denominations purchased by completing the form entitled
"Option of Securityholder To Elect Purchase" appearing below. Securityholders
have the right to withdraw their election by delivering a written notice of
withdrawal to the Company or the Paying Agent in accordance with the terms of
the Indenture.
                                      A-5


<PAGE>

      9. Subordination. The payment of the principal of, interest on or any
other amounts due on the Notes is subordinated in right of payment to all
existing and future Senior Debt of the Company, as described in the Indenture.
Each Securityholder, by accepting a Note, agrees to such subordination and
authorizes and directs the Trustee on its behalf to take such action as may be
necessary or appropriate to effectuate the subordination so provided and
appoints the Trustee as its attorney-in-fact for such purpose.

      10. Conversion. The holder of any Note has the right, exercisable at any
time prior to the close of business on the Note's maturity, to convert the
principal amount thereof (or any portion thereof that is an integral multiple of
$1,000) into shares of Common Stock at the initial Conversion Price of $7.00 per
share, subject to adjustment under certain circumstances, except that if a Note
is called for redemption, the conversion right will terminate at the close of
business (New York time) on the Business Day immediately preceding the date
fixed for redemption.

      To convert a Note, a holder must (1) complete and sign a notice of
election to convert substantially in the form set forth below, (2) surrender the
Note to a Conversion Agent, (3) furnish appropriate endorsements or transfer
documents if required by the Registrar or Conversion Agent and (4) pay any
transfer or similar tax, if required. Upon conversion, no adjustment or payment
will be made for interest or dividends, but if any Securityholder surrenders a
Note for conversion after the close of business on the record date for the
payment of an installment of interest and prior to the opening of business on
the next interest payment date, then, notwithstanding such conversion, the
interest payable on such interest payment date will be paid to the registered
holder of such Note on such record date. In such event, such Note, when
surrendered for conversion, must be accompanied by payment in funds acceptable
to the Company of an amount equal to the interest payable on such interest
payment date on the portion so converted, unless such Security has been called
for redemption on or prior to such interest payment date. The number of shares
of Common Stock issuable upon conversion of a Note is determined by dividing the
principal amount of the Note converted by the Conversion Price in effect on the
Conversion Date. No fractional shares will be issued upon conversion but a cash
adjustment will be made for any fractional interest.

      A Note in respect of which a holder has delivered an "Option of
Securityholder to Elect Purchase" form appearing below exercising the option of
such holder to require the Company to purchase such Note may be converted only
if the notice of exercise is withdrawn as provided above and in accordance with
the terms of the Indenture. The above description of conversion of the Notes is
qualified by reference to, and is subject in its entirety by, the more complete
description thereof contained in the Indenture.

      11. Automatic Conversion. The Company may elect to automatically convert
the Notes on or prior to maturity if the Daily Market Price of the Common Stock
has exceeded 150% of the Conversion Price for at least 20 Trading Days out of
the 30 consecutive Trading Days ending within five Trading Days prior to the
Automatic Conversion Notice.

      12. Denominations Transfer, Exchange. The Notes are in registered form,
without coupons, in denominations of $1,000 and integral multiples of $1,000.
The transfer of Notes may be registered, and Notes may be exchanged, as provided
in the Indenture. The Registrar may require a

                                      A-6

<PAGE>

Securityholder, among other things, to furnish appropriate endorsements and
transfer documents and to pay any taxes and fees required by law or permitted by
the Indenture. The Company is not required to exchange or register the transfer
of (i) any Note for a period of 15 days next preceding any selection of Notes to
be redeemed, (ii) any Note or portion thereof selected for redemption or (iii)
any Note or portion thereof surrendered for repurchase (and not withdrawn) in
connection with a Designated Event.

      13. Persons Deemed Owners. Except as provided in paragraph 2 of this Note,
the registered Securityholder of a Note may be treated as its owner for all
purposes.

      14. Unclaimed Money. If money for the payment of principal or interest
remains unclaimed for two years, the Trustee and the Paying Agent shall pay the
money back to the Company at its request. After that, Securityholders of Notes
entitled to the money must look to the Company for payment, unless an abandoned
property law designates another person, and all liability of the Trustee and
such Paying Agent with respect to such money shall cease.

      15. Defaults and Remedies. The Notes shall have the Events of Default as
set forth in Section 8.01 of the Indenture. Subject to certain limitations in
the Indenture, if an Event of Default occurs and is continuing, the Trustee by
notice to the Company or the Securityholders of at least 25% in aggregate
principal amount of the then-outstanding Notes by notice to the Company and the
Trustee may declare all the Notes to be due and payable immediately, except that
in the case of an Event of Default arising from certain events of bankruptcy or
insolvency, Notes shall become due and payable immediately without further
action or notice. Upon acceleration as described in either of the preceding
sentences, the subordination provisions of the Indenture preclude any payment
being made to Securityholders for at least 5 Business Days after holders of
Senior Debt receive notice of such acceleration except as otherwise provided in
the Indenture.

      The Securityholders of a majority in principal amount of the Notes then
outstanding by written notice to the Trustee may rescind an acceleration and its
consequences if the rescission would not conflict with any judgment or decree
and if all existing Events of Default have been cured or waived except
nonpayment of principal or interest that has become due solely because of the
acceleration. Securityholders may not enforce the Indenture or the Notes except
as provided in the Indenture. Subject to certain limitations, Securityholders of
a majority in principal amount of the then-outstanding Notes issued under the
Indenture may direct the Trustee in its exercise of any trust or power. The
Company must furnish compliance certificates to the Trustee annually. The above
description of Events of Default and remedies is qualified by reference to, and
subject in its entirety by, the more complete description thereof contained in
the Indenture.

      16. Amendments, Supplements and Waivers. Subject to certain exceptions,
the Indenture or the Notes may be amended or supplemented with the consent of
the Securityholders of at least a majority in principal amount of the
then-outstanding Notes (including consents obtained in connection with a tender
offer or exchange offer for Notes), and any existing default may be waived with
the consent of the Securityholders of a majority in principal amount of the
then-outstanding Notes, including consents obtained in connection with a tender
offer or exchange offer for Notes. Without the consent of any Securityholder,
the Indenture or the Notes may be amended, among other

                                      A-7

<PAGE>

things, to cure any ambiguity, defect or inconsistency, to provide for
assumption of the Company's obligations to Securityholders in the case of a
merger, consolidation or sale or transfer of all or substantially all of the
Company's properties or assets pursuant to Article VII of the Indenture, to make
any change that would provide any additional rights or benefits to
Securityholders or that does not adversely affect the legal rights under the
Indenture of any Securityholder, to qualify the Indenture under the TIA, or to
comply with the requirements of the SEC in order to maintain the qualification
of the Indenture under the TIA.

      17. Trustee Dealings with the Company. The Trustee, in its individual or
any other capacity, may become the owner or pledgee of the Notes and may
otherwise deal with the Company or an Affiliate with the same rights it would
have, as if it were not Trustee, subject to certain limitations provided for in
the Indenture and in the TIA. Any Agent may do the same with like rights.

      18. No Recourse Against Others. A director, officer, employee or
shareholder, as such, of the Company shall not have any liability for any
obligations of the Company under the Notes or the Indenture or for any claim
based on, in respect of or by reason of such obligations or their creation. Each
Securityholder, by accepting a Note, waives and releases all such liability. The
waiver and release are part of the consideration for the issue of the Notes.

      19. Governing Law. THE INDENTURE AND THE SECURITIES ISSUED HEREUNDER SHALL
BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW
YORK.

      20. Authentication. The Notes shall not be valid until authenticated by
the manual signature of an authorized officer of the Trustee or an
authenticating agent.

      21. Abbreviations. Customary abbreviations may be used in the name of a
Securityholder or an assignee, such as: TEN COM (for tenants in common), TENANT
(for tenants by the entireties), JT TEN (for joint tenants with right of
survivorship and not as tenants in common), CUST (for Custodian), and U/G/M/A
(for Uniform Gifts to Minors Act).

      22. Definitions. Capitalized terms not defined in this Note have the
meaning given to them in the Indenture.

The Company will furnish to any
Securityholder of the Notes upon written request and without charge a copy of
the Indenture and the Registration Agreement. Request may be made to:

        Investor Relations
        Intevac, Inc.
        3560 Bassett Street
        Santa Clara, California 95054
        Telephone Number: (408) 986-9888


                                       A-8


<PAGE>
                  ASSIGNMENT AND CERTIFICATE OF TRANSFER FORM

                  To assign this Note, fill in the form below:

                  (I) or (we) assign and transfer this Note to


________________________________________________________________________________
               (Insert assignee's social security or tax I.D. no.)


________________________________________________________________________________

________________________________________________________________________________

________________________________________________________________________________
            (Print or type assignee's name, address and zip code)

and irrevocably appoint ________________  agent to transfer this Note on the
books of the Company.  The agent may substitute another to act for him.

      Your Signature: __________________________________________________________
                               (Sign exactly as your name appears
                                 on the other side of this Note)
      Date: _________________________

      Signature Guarantee***: __________________________________________________




_____________
*** Signature must be guaranteed by a commercial bank, trust company or member 
    firm of the New York Stock Exchange.


                                      A-9

<PAGE>


                      [TO BE ATTACHED TO GLOBAL SECURITIES]

                                   SCHEDULE A
   The initial principal amount at maturity of this Global Security shall be
  $29,543,000. The following increases or decreases in the principal amount of
                      this Global Security have been made:


<TABLE>
<CAPTION>


             AMOUNT OF
             INCREASE IN
              PRINCIPAL                         PRINCIPAL
            AMOUNT OF THIS                   AMOUNT OF THIS
           GLOBAL SECURITY     AMOUNT OF         GLOBAL
            INCLUDING UPON    DECREASE IN       SECURITY         SIGNATURE OF
             EXERCISE OF       PRINCIPAL     FOLLOWING SUCH   AUTHORIZED OFFICER
            OVERALLOTMENT    AMOUNT OF THIS    DECREASE OR       OF TRUSTEE OR
DATE MADE       OPTION      GLOBAL SECURITY     INCREASE           CUSTODIAN
<S>        <C>              <C>               <C>             <C>    
---------       ------      ---------------     --------           ---------
---------       ------      ---------------     --------           ---------
---------       ------      ---------------     --------           ---------
---------       ------      ---------------     --------           ---------
</TABLE>



                                      A-10

<PAGE>






                   OPTION OF SECURITYHOLDER TO ELECT PURCHASE

       If you want to elect to have this Note or a portion thereof repurchased
by the Company pursuant to Section 3.08 or 4.08 of the Indenture, check the 
box: / /

      If you want to elect to have this Note or a portion thereof repurchased by
the Company pursuant to Article XIII and Section 4.09 of the Indenture, check
the box: / /

      If the puirchase is in part, indicate the portion ($1,000 or any integral
multiple thereof) to be purchased:

      Your Signature: __________________________________________________________
                               (Sign exactly as your name appears
                                 on the other side of this Note)

      Date: _________________________

      Signature Guarantee*: ________________________________



_________
* Signature must be guaranteed by a commercial bank, trust company or member
  firm of the New York Stock Exchange.





                                      A-11

<PAGE>


                               ELECTION TO CONVERT

To: Intevac, Inc.

      The undersigned owner of this Note hereby irrevocably exercises the option
to convert this Note, or the portion below designated, into Common Stock of
Intevac, Inc. in accordance with the terms of the Indenture referred to in this
Note, and directs that the shares issuable and deliverable upon conversion,
together with any check in payment for fractional shares, be issued in the name
of and delivered to the undersigned, unless a different name has been indicated
in the assignment below. If shares are to be issued in the name of a person
other than the undersigned, the undersigned will pay all transfer taxes payable
with respect thereto.

Date: ____________________________


      In whole ________      Or            Portion of Note to be converted
                                           ($1,000 or any integral multiple
                                           thereof):
                                                  $________________

      Your Signature:___________________________________________________________
                               (Sign exactly as your name appears
                                 on the other side of this Note)

      Please print or typewrite name and address, including zip code, and Social
      Security or other identifying number

      Signature Guarantee*: ____________________________________________________



________________
  * Signature must be guaranteed by a commercial bank, trust company or member
    firm of the New York Stock Exchange.



                                      A-12


Exhibit 21.1
 

Exhibit 21.1

SUBSIDIARIES OF THE REGISTRANT

      1. Lotus Technologies, Inc. — California

      2. Intevac Foreign Sales Corporation — Barbados

      3. Intevac Asia Private Limited — Singapore

      4. Intevac Malaysia Sdn Bhd — Malaysia

      5. IRPC, Inc. — California Exhibit 23.1

 

Exhibit 23.1

CONSENT OF GRANT THORNTON LLP, INDEPENDENT AUDITORS

      We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-99648, 333-35801, 333-65421, 333-96529 and 333-50166) pertaining to the 1995 Stock Option/ Stock Issuance Plan and the Employee Stock Purchase Plan and in the Registration Statement (Form S-3 No. 333-24275) of Intevac, Inc. of our report dated January 29, 2003, with respect to the consolidated financial statements and schedule of Intevac, Inc. included in the Annual Report on Form 10-K for the year ended December 31, 2002.

/s/ GRANT THORNTON LLP

San Jose, California

March 11, 2003
<PAGE>

                                                                    Exhibit 99.1


      CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
                                   PURSUANT TO
                             18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


      I, Kevin Fairbairn, certify, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the
Annual Report of Intevac, Inc. on Form 10-K for the fiscal year ended December
31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and that information contained in such Form 10-K
fairly presents in all material respects the financial condition and results of
operations of Intevac, Inc.

                        By:      /s/   KEVIN FAIRBAIRN            
                              ------------------------------------
                        Name: Kevin Fairbairn
                        Title: President, Chief Executive Officer and Director


      I, Charles B. Eddy III, certify, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the
Annual Report of Intevac, Inc. on Form 10-K for the fiscal year period ended
December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934 and that information contained in such
Form 10-K fairly presents in all material respects the financial condition and
results
 of operations of Intevac, Inc.

                        By:      /s/   CHARLES B. EDDY III        
                              ------------------------------------
                        Name:  Charles B. Eddy III
                        Title: Vice President, Finance and Administration,
                               Chief Financial Officer, Treasurer and Secretary