Intevac
INTEVAC INC (Form: 10-Q, Received: 11/08/2007 13:48:22)
Table of Contents

 
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
Form 10-Q
 
 
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended September 29, 2007
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)
 
 
     
Delaware
  94-3125814
(State or other jurisdiction of
incorporation or organization)
  (IRS 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
 
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 check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer   o      Accelerated filer   þ      Non-accelerated filer   o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o      No  þ
 
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
On November 2, 2007, 21, 574,832 shares of the Registrant’s Common Stock, $0.001 par value, were outstanding.
 


 

 
INTEVAC, INC.
 
INDEX
 
             
No.
     
Page
 
  Financial Statements (unaudited)        
    Condensed Consolidated Balance Sheets     2  
    Condensed Consolidated Statements of Income and Comprehensive Income     3  
    Condensed Consolidated Statements of Cash Flows     4  
    Notes to Condensed Consolidated Financial Statements     5  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     17  
  Quantitative and Qualitative Disclosures About Market Risk     25  
  Controls and Procedures     26  
 
  Legal Proceedings     27  
  Risk Factors     28  
  Unregistered Sales of Equity Securities and Use of Proceeds     38  
  Defaults Upon Senior Securities     38  
  Submission of Matters to a Vote of Security Holders     38  
  Other Information     38  
  Exhibits     38  
    39  
  EXHIBIT 31.1
  EXHIBIT 31.2
  EXHIBIT 32.1


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Table of Contents

 
PART I. FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
INTEVAC, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
                 
    September 29,
    December 31,
 
    2007     2006  
    (Unaudited)
 
    (In thousands)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 34,412     $ 39,440  
Short term investments
    98,490       55,595  
Trade and other accounts receivable, net of allowances of $67 and $143 at September 29, 2007 and December 31, 2006
    18,553       39,927  
Inventories
    16,394       37,942  
Prepaid expenses and other current assets
    2,099       2,506  
Deferred tax assets
    4,100       3,269  
                 
Total current assets
    174,048       178,679  
Property, plant and equipment, net
    14,929       13,546  
Long term investments
    14,000       8,000  
Investment in 601 California Avenue LLC
    2,431       2,431  
Goodwill
    5,434        
Other intangible assets, net of amortization of $173
    227        
Deferred income taxes and other long term assets
    3,328       3,347  
                 
Total assets
  $ 214,397     $ 206,003  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Notes payable
  $ 1,968     $  
Accounts payable
    5,468       15,994  
Accrued payroll and related liabilities
    9,238       11,769  
Other accrued liabilities
    5,868       6,612  
Customer advances
    6,017       26,243  
                 
Total current liabilities
    28,559       60,618  
Other long-term liabilities
    622       1,075  
Long-term notes payable
    1,875        
Shareholders’ equity:
               
Common stock and capital in excess of par value
    103,085       99,468  
Additional paid in capital
    12,880       7,319  
Accumulated other comprehensive income
    446       354  
Retained earnings
    66,930       37,169  
                 
Total shareholders’ equity
    183,341       144,310  
                 
Total liabilities and shareholders’ equity
  $ 214,397     $ 206,003  
                 
 
Note:  Amounts as of December 31, 2006 are derived from the December 31, 2006 audited consolidated financial statements.
 
See accompanying notes.


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INTEVAC, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept. 29,
    Sept. 30,
 
    2007     2006     2007     2006  
    (Unaudited)
 
    (In thousands, except per share amounts)  
 
Net revenues:
                               
Systems and components
  $ 46,082     $ 52,089     $ 189,278     $ 157,006  
Technology development
    4,522       2,740       9,805       6,985  
                                 
Total net revenues
    50,604       54,829       199,083       163,991  
Cost of net revenues:
                               
Systems and components
    23,183       29,755       105,120       96,933  
Technology development
    2,425       1,673       5,315       4,534  
Inventory provisions
    381       121       424       676  
                                 
Total cost of net revenues
    25,989       31,549       110,859       102,143  
                                 
Gross profit
    24,615       23,280       88,224       61,848  
Operating expenses:
                               
Research and development
    9,437       8,571       31,277       20,422  
Selling, general and administrative
    7,062       5,565       22,414       15,683  
                                 
Total operating expenses
    16,499       14,136       53,691       36,105  
                                 
Operating profit
    8,116       9,144       34,533       25,743  
Interest income and other, net
    1,797       1,113       4,655       2,440  
                                 
Income before income taxes
    9,913       10,257       39,188       28,183  
Provision for income taxes
    1,549       1,244       9,427       2,826  
                                 
Net income
  $ 8,364     $ 9,013       29,761       25,357  
                                 
Other comprehensive income, net of income taxes:
                               
Foreign currency translation adjustments
    82       (6 )     92       57  
                                 
Total comprehensive income
  $ 8,446     $ 9,007     $ 29,853     $ 25,414  
                                 
Basic income per share:
                               
Net income
  $ 0.39     $ 0.43     $ 1.39     $ 1.21  
Shares used in per share amounts
    21,519       21,082       21,403       20,967  
Diluted income per share:
                               
Net income
  $ 0.38     $ 0.41     $ 1.34     $ 1.16  
Shares used in per share amounts
    22,130       21,899       22,155       21,888  
 
See accompanying notes.


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INTEVAC, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                 
    Nine Months Ended  
    Sept. 29,
    Sept. 30,
 
    2007     2006  
    (Unaudited)
 
    (In thousands)  
 
Operating activities
               
Net income
  $ 29,761     $ 25,357  
Adjustments to reconcile net income to net cash and cash equivalents used in operating activities:
               
Depreciation and amortization
    3,242       1,881  
Inventory provisions
    424       676  
Equity-based compensation
    4,608       2,119  
Loss on disposal of equipment
          30  
Changes in operating assets and liabilities
    7,537       12,311  
                 
Total adjustments
    15,811       17,017  
                 
Net cash and cash equivalents provided by operating activities
    45,572       42,374  
Investing activities
               
Purchases of investments
    (111,571 )     (135,275 )
Proceeds from maturities of investments
    62,700       89,925  
Acquisition of DeltaNu LLC, net of cash acquired
    (5,803 )      
Purchases of leasehold improvements and equipment
    (4,366 )     (5,462 )
                 
Net cash and cash equivalents used in investing activities
    (59,040 )     (50,812 )
Financing activities
               
Net proceeds from issuance of common stock
    3,591       3,028  
Issuance of notes payable
    3,843        
Tax benefit from equity-based compensation
    953        
                 
Net cash and cash equivalents provided by financing activities
    8,387       3,028  
Effect of exchange rate changes on cash
    53       45  
                 
Net decrease in cash and cash equivalents
    (5,028 )     (5,365 )
Cash and cash equivalents at beginning of period
    39,440       15,255  
                 
Cash and cash equivalents at end of period
  $ 34,412     $ 9,890  
                 
Supplemental Schedule of Cash Flow Information
               
Cash paid for:
               
Income taxes
  $ 8,044     $ 4,222  
 
See accompanying notes.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1.   Business Activities and Basis of Presentation
 
We are the world’s leading provider of disk sputtering equipment to manufacturers of magnetic media used in hard disk drives and a developer and provider of leading technology for extreme low light imaging sensors, cameras and systems. We operate two businesses: Equipment and Imaging.
 
Our Equipment business designs, manufactures, markets and services high-productivity manufacturing systems. We are the leading supplier of capital equipment used in the sputtering, or deposition, of highly engineered thin-films of material onto magnetic disks, which are used in hard disk drives. Hard disk drives are the primary storage medium for digital data and function by storing data on magnetic disks. These disks are created in a sophisticated manufacturing process involving a variety of steps, including plating, annealing, polishing, texturing, sputtering and lubrication. We are developing products for semiconductor manufacturing. In July 2007 we announced our new “Lean Etch” semiconductor manufacturing system for the dielectric etch market.
 
Our Imaging business develops, manufactures and markets leading-edge, high-sensitivity imaging products and miniature Raman instruments. We provide sensors, cameras and systems for military applications such as night vision and long-range target identification and we provide cameras and Raman spectrometers to the industrial, physical science and life science markets.
 
Most of our revenue is derived from our Equipment business, and we expect that the majority of our revenues for at least the next several years will continue to be derived from our Equipment business.
 
The financial information at September 29, 2007 and for the three- and nine-month periods ended September 29, 2007 and September 30, 2006 is unaudited, but includes all adjustments (consisting only of normal recurring accruals) that we consider necessary for a fair presentation of the financial information set forth herein, in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information and footnotes required by U.S. GAAP for annual financial statements. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
 
The results for the three- and nine-month periods ended September 29, 2007 are not considered indicative of the results to be expected for any future period or for the entire year.
 
“Intevac ® ,” “LIVAR ® ,” “D-STAR ® ,” “Lean Etch TM ” and “200 Lean ® ” are trademarks of Intevac, Inc.
 
2.   Concentrations
 
Historically, a significant portion of our revenues in any particular period has been attributable to sales to a limited number of customers. Our largest customers tend to change from period to period.
 
We evaluate the collectibility of trade receivables on an ongoing basis and provide reserves against potential losses when appropriate.
 
3.   New Accounting Pronouncements
 
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
at fair value. The fair value option established by SFAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting this standard.
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within that fiscal year. We are currently evaluating the impact of adopting SFAS 157.
 
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS 154), which requires retrospective application to prior periods’ financial statements of voluntary changes in accounting principle unless it is impracticable to do so. SFAS 154 is effective for accounting changes and corrections of errors beginning in fiscal 2007. The implementation of this standard did not have a material effect on our financial position or results of operations.
 
4.   Inventories
 
Inventories are priced using average actual costs, which approximate cost under the first-in, first-out method and are stated at the lower of cost or market. Inventories consist of the following:
 
                 
    September 29,
    December 31,
 
    2007     2006  
    (In thousands)  
 
Raw materials
  $ 11,935     $ 19,906  
Work-in-progress
    3,858       12,271  
Finished goods
    601       5,765  
                 
    $ 16,394     $ 37,942  
                 
 
Finished goods inventory consists primarily of completed systems awaiting shipment to customer sites for installation and acceptance testing.
 
Inventory reserves included in the above numbers were $7.6 million and $9.1 million at September 29, 2007 and December 31, 2006, respectively. Each quarter, we analyze our inventory (raw materials, work-in-progress and finished goods) against the forecast demand for the next 12 months. Raw materials with no forecast requirements in that period are considered excess and inventory provisions are established to write those items down to zero net book value. Work-in-progress and finished goods inventories with no forecast requirements in that period are typically written down to the lower of cost or market. During this process, some inventory is identified as having no future use or value to us and is disposed of against the reserves.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table displays the activity in the inventory provision account for the nine-month periods ending September 29, 2007 and September 30, 2006:
 
                 
    Nine Months Ended  
    September 29,
    September 30,
 
    2007     2006  
    (In thousands)  
 
Beginning balance
  $ 9,128     $ 10,988  
New provisions in cost of sales
    424       676  
New provisions for refurbishment of consigned products
    89       7  
Disposals of inventory
    (2,070 )     (2,873 )
Miscellaneous adjustments
    78       (42 )
                 
Ending balance
  $ 7,649     $ 8,756  
                 
 
5.   Stock-Based Compensation
 
At September 29, 2007, we had stock-based awards outstanding under the 2004 Equity Incentive Plan (the “2004 Plan”) and the 2003 Employee Stock Purchase Plan (the “ESPP”). Our shareholders approved both of these plans.
 
The 2004 Plan permits the grant of incentive or non-statutory stock options, restricted stock, stock appreciation rights, performance units and performance shares. Option price, vesting period, and other terms are determined by the administrator of the 2004 Plan, but the option price shall generally not be less than 100% of the fair market value per share on the date of the grant. Options granted under the 2004 Plan are exercisable upon vesting and vest over periods of up to 5 years. Options currently expire no later than ten years from the date of grant. During the nine months ended September 29, 2007, we granted 618,550 stock options with an estimated total grant-date fair value of $6.3 million. Of this amount, we estimated that the stock-based compensation for the awards not expected to vest was $1.4 million.
 
The ESPP provides that eligible employees may purchase our common stock through payroll deductions at a price equal to 85% of the lower of the fair market value at the beginning of the applicable offering period or at the end of each applicable purchase period. Offering periods are generally two years in length, and consist of a series of six-month purchase intervals. Eligible employees may join the ESPP at the beginning of any six-month purchase interval. During the nine months ended September 29, 2007, we granted purchase rights with an estimated total grant-date value of $2.0 million.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Compensation Expense
 
The effect of recording stock-based compensation for the three- and nine-month periods ended September 29, 2007 and September 30, 2006 was as follows:
 
                                 
          Nine Months
 
    Three Months Ended     Ended  
    Sept 29,
    Sept 30,
    Sept 29,
    Sept 30,
 
    2007     2006     2007     2006  
 
Stock-based compensation by type of award:
                               
Stock options
  $ 1,677     $ 791     $ 3,991     $ 1,687  
Employee stock purchase plan
    191       148       619       432  
Amounts capitalized as inventory
    (32 )     (61 )     (105 )     (85 )
                                 
Total stock-based compensation expense
    1,836       878       4,505       2,034  
Tax effect on stock-based compensation expense
    (285 )     (106 )     (1,081 )     (203 )
                                 
Net effect on net income
  $ 1,551     $ 772     $ 3,424     $ 1,831  
                                 
Effect on earnings per share:
                               
Basic
  $ 0.07     $ 0.04     $ 0.16     $ 0.09  
Diluted
  $ 0.07     $ 0.04     $ 0.15     $ 0.08  
 
Valuation Assumptions
 
The fair value of share-based payment awards is estimated at the grant date using the Black-Scholes option valuation model. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual employee stock option exercise behavior.
 
The weighted-average estimated value of employee stock options granted during the three months ended September 29, 2007 and September 30, 2006 was $9.01 per share and $9.77 per share, respectively. The weighted-average estimated value of employee stock options granted during the nine months ended September 29, 2007 and September 30, 2006 was $10.24 per share and $11.05 per share, respectively. The weighted-average estimated fair value of employee stock purchase rights granted pursuant to the ESPP during the three months ended September 29, 2007 and September 30, 2006 was $8.24 and $9.94 per share, respectively. The weighted-average estimated fair value of employee stock purchase rights granted pursuant to the ESPP during the nine months ended September 29, 2007 and September 30, 2006 was $8.23 and $9.68 per share, respectively. The fair value of each option and employee stock purchase right grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept 29,
    Sept 30,
    Sept 29,
    Sept 30,
 
    2007     2006     2007     2006  
Stock Options:
                               
Expected volatility
    66.51 %     72.34 %     66.91 %     74.82 %
Risk free interest rate
    4.13 %     4.54 %     4.26 %     4.69 %
Expected term of options (in years)
    4.51       4.55       4.49       4.73  
Dividend yield
    None       None       None       None  
 


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
                                 
          Nine Months
 
    Three Months Ended     Ended  
    Sept 29,
    Sept 30,
    Sept 29,
    Sept 30,
 
    2007     2006     2007     2006  
 
Stock Purchase Rights:
                               
Expected volatility
    63.14 %     59.12 %     63.15 %     59.25 %
Risk free interest rate
    3.92 %     4.67 %     3.94 %     4.67 %
Expected term of options (in years)
    2.00       2.00       1.97       1.92  
Dividend yield
    None       None       None       None  
 
The computation of the expected volatility assumptions used in the Black-Scholes calculations for new grants and purchase rights is based on the historical volatility of our stock price, measured over a period equal to the expected term of the grant or purchase right. The risk-free interest rate is based on the yield available on U.S. Treasury Strips with an equivalent remaining term. The expected life of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules. The expected life of purchase rights is the period of time remaining in the current offering period. The dividend yield assumption is based on our history of not paying dividends and the assumption of not paying dividends in the future.
 
As the stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations is based on awards ultimately expected to vest, such amount has been reduced for estimated forfeitures. Statement of Financial Accounting Standards No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on our historical experience, which we believe to be indicative of our future experience.
 
Stock Plan Activity
 
2004 Equity Incentive Plan
 
A summary of activity under the above captioned plan is as follows:
 
                                 
                Weighted
       
                Average
       
                Remaining
    Aggregate
 
          Weighted Average
    Contractual Term
    Intrinsic
 
    Shares     Exercise Price     (Years)     Value  
 
Options outstanding at December 31, 2006
    2,354,215     $ 11.47       7.93     $ 34,107,462  
Options granted
    618,550     $ 18.25                  
Options forfeited
    (163,858 )   $ 16.25                  
Options exercised
    (273,794 )   $ 8.10                  
Options outstanding at September 29, 2007
    2,535,113     $ 13.18       7.85     $ 9,156,996  
Vested and expected to vest at September 29, 2007
    2,156,082     $ 12.72       7.68     $ 8,522,932  
Options exercisable at September 29, 2007
    913,384     $ 9.06       6.23     $ 6,023,691  
Available to grant at September 29, 2007
    731,678                          
 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing stock price of $15.20 as of September 28, 2007, which would have been received by the option holders had all options holders exercised their options as of that date.

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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As of September 29, 2007, the unrecorded deferred stock-based compensation balance related to stock options was $11.0 million and will be recognized over an estimated weighted average recognition period of 1.8 years. The recognition period is based on the vesting periods of the options.
 
2003 Employee Stock Purchase Plan
 
During the nine months ended September 29, 2007, 90,018 shares were purchased at an average per share price of $15.27. At September 29, 2007, there were 297,919 shares available to be issued under the ESPP.
 
As of September 29, 2007, the unrecorded deferred stock-based compensation balance related to purchase rights was $1.8 million and will be recognized over an estimated weighted average recognition period of 1.2 years. The recognition period is based on the expected term of the purchase right, which is defined as the period from grant date to expiration of the offering period.
 
6.   Business Combinations
 
On January 31, 2007, we completed the acquisition of the assets and certain liabilities of DeltaNu, LLC (“DeltaNu”) for a total purchase price of $6 million. The purchase price was comprised of $2 million cash due at the close of the acquisition and $2 million due on each of January 31, 2008 and January 31, 2009, which is in the form of a note. DeltaNu is a Laramie, Wyoming company specializing in small footprint and handheld Raman spectrometry instruments. We believe that the combination of DeltaNu’s miniature Raman spectrometer designs with our capabilities in near-infrared sensors will enable a new class of portable instruments with greatly enhanced chemical detection capabilities.
 
We accounted for the acquisition as a taxable purchase transaction and, accordingly, the purchase price has been allocated to tangible assets, liabilities assumed, and identifiable intangible assets acquired based on their estimated fair values on the acquisition date. The excess of the purchase price over the aggregate fair values was recorded as goodwill. The fair value assigned to identifiable intangible assets acquired is determined using the income approach, which discounts expected future cash flows to present value using estimates and assumptions determined by management. Purchased intangible assets are amortized on a straight-line basis over the respective useful lives. Our allocation of the purchase price is summarized below (in thousands):
 
         
Net liabilities assumed, net of cash of $4
  $ (31 )
Goodwill
    5,434  
Backlog
    120  
Trademarks/Names
    120  
Customer relationships
    60  
Non-compete agreements
    100  
         
Total
  $ 5,803  
         
 
The $5.8 million allocated purchase price consists of $2.0 million paid in cash, $3.7 million in notes payable (present value at January 31, 2007) and $87,000 in acquisition-related expenses. The estimated useful economic lives of the identified intangible assets acquired are two years for the customer relationships and non-compete agreements and approximately four months for the backlog. The trademark/names asset has an indefinite life. Amortization of the identified intangible assets will be $193,000 in 2007, $80,000 in 2008 and $7,000 in 2009.
 
The results of operations for the acquired business have been included in our condensed consolidated statements of operations for the period subsequent to our acquisition of DeltaNu. DeltaNu’s results of operations for periods prior to this acquisition were not material to our condensed consolidated statement of operations and, accordingly, pro forma financial information has not been presented.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
7.   Warranty
 
We provide for the estimated cost of warranty when revenue is recognized. Our warranty is per contract terms and for our systems the warranty typically ranges between 12 and 24 months from customer acceptance. During this warranty period any defective non-consumable parts are replaced and installed at no charge to the customer. The warranty period on consumable parts is limited to their reasonable usable lives. We use estimated repair or replacement costs along with our historical warranty experience to determine our warranty obligation. We exercise judgment in determining the underlying estimates. We also provide for estimated retrofit costs, which typically relate to design changes or improvements we identify. On a case-by-case basis, we determine whether or not to retrofit systems in the field at no charge to the customer.
 
On the condensed consolidated balance sheet, the short-term portion of the warranty provision is included in other accrued liabilities, while the long-term portion is included in other long-term liabilities. The expense associated with product warranties issued or adjusted is included in cost of net revenues on the condensed consolidated statement of income.
 
The following table displays the activity in the warranty provision account for the three- and nine-month periods ending September 29, 2007 and September 30, 2006:
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept. 29,
    Sept. 30,
 
    2007     2006     2007     2006  
          (In thousands)        
 
Beginning balance
  $ 4,558     $ 4,044     $ 5,283     $ 3,399  
Expenditures incurred under warranties
    (983 )     (776 )     (3,406 )     (2,619 )
Accruals for product warranties issued during the reporting period
    243       888       1,990       2,974  
Adjustments to previously existing warranty accruals
    17       (20 )     (32 )     382  
                                 
Ending balance
  $ 3,835     $ 4,136     $ 3,835     $ 4,136  
                                 
 
The following table displays the balance sheet classification of the warranty provision account at September 29, 2007 and at December 31, 2006:
 
                 
    September 29,
    December 31,
 
    2007     2006  
    (In thousands)  
 
Other accrued liabilities
  $ 3,213     $ 4,208  
Other long-term liabilities
    622       1,075  
                 
Total warranty provision
  $ 3,835     $ 5,283  
                 
 
8.   Guarantees
 
We have entered into agreements with customers and suppliers that include limited intellectual property indemnification obligations that are customary in the industry. These obligations generally require us to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions. The nature of the intellectual property indemnification obligations prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay our customers and suppliers. Historically, we have not made any significant indemnification payments under such agreements, and no amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification obligations.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
9.  Cash, Cash Equivalents and Investments
 
Our investment portfolio consists of cash, cash equivalents and investments in debt securities and municipal bonds. We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Investments in debt securities and municipal bonds consist principally of highly rated debt instruments with maturities generally between one and 25 months.
 
We account for our investments in debt securities and auction rate securities in accordance with Statement of Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities,” which requires certain securities to be categorized as either trading, available-for-sale or held-to-maturity. Available-for-sale securities, consisting solely of Auction Rate Securities, are carried at fair value, with unrealized gains and losses recorded within other comprehensive income (loss) as a separate component of shareholders’ equity. Auction Rate Securities have long-term underlying maturities (ranging from 20 to 40 years), however the market is highly liquid and the interest rates reset every 7 or 28 days. Our intent is not to hold these securities to maturity, but rather to use the interest rate reset feature to sell securities to provide liquidity as needed. Our practice is to invest in these securities for higher yields compared to cash equivalents. Held-to-maturity securities are carried at amortized cost. We have no trading securities. The cost of investment securities sold is determined by the specific identification method. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to interest income. Realized gains and losses and declines in value judged to be other than temporary, if any, on available-for-sale securities are included in earnings. The table below presents the amortized principal amount, major security type and maturities for our investments in debt securities and auction rate securities.
 
                 
    September 29,
    December 31,
 
    2007     2006  
    (In thousands)  
 
Amortized Principal Amount:
               
Debt securities issued by the US government and its agencies
  $ 19,000     $ 8,000  
Auction rate securities
    81,750       53,595  
Corporate debt securities
    11,740       2,000  
                 
Total investments in debt securities
  $ 112,490     $ 63,595  
                 
Short-term investments
  $ 98,490     $ 55,595  
Long-term investments
    14,000       8,000  
                 
Total investments in debt securities
  $ 112,490     $ 63,595  
                 
Approximate fair value of investments in debt securities
  $ 112,504     $ 63,585  
                 
 
The change in the fair value of our investments from the principal amount is attributable to changes in interest rates and not credit quality. In accordance with EITF 03-01, we have the ability and intent to hold these investments until fair value recovers, which may be maturity, and we do not consider these investments to be other-than-temporarily impaired at September 29, 2007.
 
Cash and cash equivalents represent cash accounts, money market funds and investments with a duration of 90 days or less at purchase. Cash balances held in foreign bank accounts totaled $2.8 million and $1.6 million at September 29, 2007 and December 31, 2006, respectively. Included in accounts payable is $1.7 million and $2.4 million of book overdraft at September 29, 2007 and December 31, 2006, respectively.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
10.   Net Income Per Share
 
The following table sets forth the data used in the computations of basic and diluted earnings per share:
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept. 29,
    Sept. 30,
 
    2007     2006     2007     2006  
          (In thousands)        
 
Numerator:
                               
Numerator for diluted earnings per share — income available to common stockholders
  $ 8,364     $ 9,013     $ 29,761     $ 25,357  
                                 
Denominator:
                               
Denominator for basic earnings per share — weighted-average shares
    21,519       21,082       21,403       20,967  
Effect of dilutive securities:
                               
Employee stock options(1)
    611       817       752       921  
                                 
Dilutive potential common shares
    611       817       752       921  
                                 
Denominator for diluted earnings per share — adjusted
    22,130       21,899       22,155       21,888  
                                 
 
 
(1) Potentially dilutive securities, consisting of shares issuable upon exercise of employee stock options and weighted-average unamortized compensation expense, are excluded from the calculation of diluted EPS when their effect is anti-dilutive. The weighted average number of employee stock options excluded for the three-month periods ended September 29, 2007 and September 30, 2006 was 1,151,016 and 566,079, respectively, and the number of employee stock options excluded for the nine-month periods ended September 29, 2007 and September 30, 2006 and was 619,884 and 319,786, respectively.
 
11.   Segment Reporting
 
We have two reportable operating segments: Equipment and Imaging. Our reportable segments are business units that offer different products and are each managed separately, under the direction of our Chief Executive Officer. Our Equipment business designs, manufactures, markets and services capital equipment used in the sputtering, or deposition, of highly engineered thin-films of material onto magnetic disks, which are used in hard disk drives. The Equipment business is also developing products for semiconductor manufacturing. In July 2007 we announced our new “Lean Etch” semiconductor manufacturing system for the dielectric etch market. Our Imaging business, which includes the acquisition of DeltaNu, develops, manufactures and markets leading-edge, high-sensitivity imaging products and miniature Raman instruments. We provide sensors, cameras and systems for military applications such as night vision and long-range target identification and we provide cameras and Raman spectrometers to the industrial, physical science and life science markets.
 
Included in corporate activities are general corporate expenses, less an allocation of corporate expenses to operating units equal to 3% of net revenues. Assets of corporate activities include unallocated cash and short-term investments, deferred income tax assets and other assets.
 
Segment Profit or Loss and Segment Assets
 
We evaluate performance and allocate 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.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Business Segment Net Revenues
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept. 29,
    Sept. 30,
 
    2007     2006     2007     2006  
          (In thousands)        
 
Equipment
  $ 44,920     $ 51,625     $ 185,885     $ 155,663  
Imaging
    5,684       3,204       13,198       8,328  
                                 
Total
  $ 50,604     $ 54,829     $ 199,083     $ 163,991  
                                 
 
Business Segment Profit & Loss
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept. 29,
    Sept. 30,
 
    2007     2006     2007     2006  
          (In thousands)        
 
Equipment
  $ 8,477     $ 9,833     $ 39,308     $ 29,287  
Imaging
    35       (673 )     (3,080 )     (3,701 )
Corporate activities
    (396 )     (16 )     (1,695 )     157  
                                 
Operating income
    8,116       9,144       34,533       25,743  
Interest income and other, net
    1,797       1,113       4,655       2,440  
                                 
Income before income taxes
  $ 9,913     $ 10,257     $ 39,188     $ 28,183  
                                 
 
Business Segment Assets
 
                 
    September 29,
    December 31,
 
    2007     2006  
    (In thousands)  
 
Equipment
  $ 38,281     $ 84,366  
Imaging
    17,453       7,379  
Corporate activities
    158,663       114,258  
                 
Total
  $ 214,397     $ 206,003  
                 
 
Geographic Area Net Trade Revenues
 
                                 
    Three Months Ended     Nine Months Ended  
    Sept. 29,
    Sept. 30,
    Sept.29,
    Sept. 30,
 
    2007     2006     2007     2006  
          (In thousands)        
 
United States
  $ 15,558     $ 5,665     $ 31,460     $ 22,294  
Asia
    34,692       48,937       166,764       141,453  
Europe
    350       227       816       244  
Rest of World
    4             43        
                                 
Total
  $ 50,604     $ 54,829     $ 199,083     $ 163,991  
                                 
 
12.   Income Taxes
 
For the nine months ended September 29, 2007, we accrued income tax using an effective tax rate of 24.0% of pretax income. This rate is based on an estimate of our annual tax rate calculated in accordance with Statement of


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Financial Accounting Standards No. 109, “Accounting for Income Taxes”. Our effective tax rate is highly dependent on the availability of tax credits and the geographic composition of our worldwide earnings. Our deferred tax asset is partially offset by a valuation allowance, resulting in a net deferred tax asset of $5.4 million at September 29, 2007.
 
For the nine months ended September 30, 2006, we accrued income tax using an effective tax rate of 10.0% of pretax income. Our tax rate differed from applicable statutory rate due primarily to the utilization of net operating loss carry-forwards and deferred credits.
 
We adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation Number 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) on January 1, 2007. As required by FIN 48, which clarifies SFAS No. 109, “Accounting for Income Taxes,” we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. At January 1, 2007, we applied FIN 48 to all tax positions for which the statute of limitations remained open and determined there are no material unrecognized tax benefits as of that date. In addition, there have been no material changes in unrecognized benefits since January 1, 2007. As a result, the adoption of FIN 48 did not have a material effect on our financial condition, or results of operation.
 
We are subject to income taxes in the U.S. federal jurisdiction, and various states and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2000.
 
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in the provision for income taxes for all periods presented, which were not significant.
 
13.   Contingencies
 
From time to time, we may have certain contingent liabilities that arise in the ordinary course of our business activities. We account for contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.
 
On July 7, 2006, we filed a patent infringement lawsuit against Unaxis USA, Inc. and its affiliates, Unaxis Balzers AG and Unaxis Balzers, Ltd., in the United States District Court for the Central District of California. Our lawsuit against Unaxis asserts infringement by Unaxis of United States Patent 6,919,001, which relates to our 200 Lean system. Our complaint seeks monetary damages and an injunction that would bar Unaxis from making, using, offering to sell or selling in the United States, or importing into the United States, Unaxis’ allegedly infringing product. We believe we have meritorious claims, and we intend to pursue them vigorously.
 
On September 12, 2006, Unaxis filed a response to our lawsuit in which it asserted non-infringement, invalidity of our patent, inequitable conduct by Intevac, patent misuse by Intevac, and lack of jurisdiction by the Court as defenses. Additionally, Unaxis requested a declaratory judgment of patent non-infringement, invalidity and unenforceability; asserted that Intevac violated the California Business and Professional Code; requested that we be enjoined from engaging in any unfair competition; and requested that we be required to pay Unaxis’ attorney fees. We believe such claims lack merit, and we intend to defend ourselves vigorously.
 
We replied to Unaxis’ response on October 3, 2006, denying the assertions of non-infringement, invalidity and unenforceability of the Intevac patent, and denying any unfair competition. With the approval of the Court, we amended our complaint on February 6, 2007 to assert an additional ground for our infringement claim and to add a request for a declaratory judgment of infringement. Unaxis filed a response on February 21, 2007, in which it repeated the assertions of its September 12, 2006 response.


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INTEVAC, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
On May 21, 2007, the Court granted Unaxis’ request to stay the litigation pending reexamination of our United States Patent 6,919,001, after the U.S. Patent Office granted Unaxis’ February 27, 2007 reexamination request and issued an initial office action rejecting the claims of the patent. The Court also ordered the parties to file a joint report every 120 days to keep it appraised of the reexamination status. Intevac had no input to the initial office action determination by the U.S. Patent Office.
 
On June 20, 2007, we filed a reply to the initial office action reexamination. Our reply addresses the office action’s rejections of the patent’s original claims and proposes amended claims that we believe are supported by the original patent’s specification. Unaxis has the opportunity to respond, after which the U.S. Patent Office will consider both parties’ submissions. During the reexamination process, the patent remains valid.
 
14.   Capital Transactions
 
During the nine-month period ending September 29, 2007, we sold stock to our employees under Intevac’s Stock Option and Employee Stock Purchase Plans. A total of 363,000 shares were issued under these plans, for which Intevac received $3.6 million.
 
15.   Financial Presentation
 
Certain prior year amounts in the Condensed Consolidated Financial Statements have been reclassified to conform to 2007 presentation. The reclassifications had no effect on total assets, liabilities, equity, revenue, net income or comprehensive income as previously reported.
 
16.   Subsequent Events
 
On October 29, 2007 we signed a definitive asset purchase agreement to acquire Creative Display Systems, LLC (“CDS”), a Carlsbad, California company that specializes in high-performance micro-display products for near-eye and portable applications in defense and commercial markets. CDS will be operated as a division of Intevac based in Carlsbad, California. The transaction, which is subject to certain closing conditions, is anticipated to close within 30 days.


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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This Quarterly Report on Form 10-Q contains forward-looking statements, which involve risks and uncertainties. Words such as “believes,” “expects,” “anticipates” and the like indicate forward-looking statements. These forward looking statements include comments related to our shipments, projected revenue recognition, product costs, gross margin, operating expenses, interest income, income taxes, cash balances and financial results in 2007; projected customer requirements for our new and existing products, and when, and if, our customers will place orders for these products; Imaging’s ability to proliferate its technology into major military weapons programs and to develop and introduce commercial imaging products; and the timing of delivery and/or acceptance of the systems and products that comprise our backlog for revenue; legal proceedings; and internal controls. Our actual results may differ materially from the results discussed in the forward-looking statements for a variety of reasons, including those set forth under “Risk Factors” and in other documents we file from time to time with the Securities and Exchange Commission, including Intevac’s Annual Report on Form 10-K filed in March 2007, Form 10-Q’s and Form 8-K’s.
 
Critical Accounting Policies and Estimates
 
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make judgments, assumptions and estimates that affect the amounts reported. Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of our Annual Report on Form 10-K. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.
 
A critical accounting policy is defined as one that is both material to the presentation of our financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial conditions and results of operations. Specifically, critical accounting estimates have the following attributes: 1) We are required to make assumptions about matters that are highly uncertain at the time of the estimate; and 2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on our financial condition or results of operations.
 
Estimates and assumptions about future events and their effects cannot be determined with certainty. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. These changes have historically been minor and have been included in the consolidated financial statements as soon as they become known. In addition, management is periodically faced with uncertainties, the outcomes of which are not within its control and will not be known for prolonged periods of time. Many of these uncertainties are discussed in the section below entitled “Risk Factors.” Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that our consolidated financial statements are fairly stated in accordance with US GAAP, and provide a meaningful presentation of our financial condition and results of operation.
 
We believe the following critical accounting policies affect the more significant judgments and estimates we make in preparing our consolidated financial statements. We also have other key accounting policies and accounting estimates related to the collectibility of trade receivables and prototype product costs. We believe that these other accounting policies and other accounting estimates either do not generally require us to make estimates and judgments that are as difficult or subjective, or are less likely to have a material impact on our reported results of operation for a given period.
 
Revenue Recognition
 
Certain of our system sales with customer acceptance provisions are accounted for as multiple-element arrangements. If we have previously met defined customer acceptance levels with the specific type of system, then we recognize revenue for the fair market value of the system upon shipment and transfer of title, and recognize revenue for the fair market value of installation and acceptance services when those services are completed. We estimate the fair market value of the installation and acceptance services based on our actual historical experience. For systems that have generally not been demonstrated to meet a particular customer’s product specifications prior


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to shipment, revenue recognition is typically deferred until customer acceptance. For example, while initial shipments of our 200 Lean System were recognized for revenue upon customer acceptance during 2004, revenue was recognized upon shipment for the majority of 200 Leans shipped in 2005, 2006 and 2007 to date. The system in backlog at September 29, 2007 is for a customer where we have met defined customer acceptance levels, and we expect to recognize revenue upon shipment for this system.
 
In some instances, hardware that is not essential to the functioning of the system may be delivered after acceptance of the system. In these cases, we estimate the fair market value of the non-essential hardware as if it had been sold on a stand-alone basis, and defer recognizing revenue on that value until the hardware is delivered.
 
Revenue from technology upgrades, spare parts, consumables and products built by the Imaging business are typically recognized when title passes to our customer. In certain cases, technology upgrade sales are accounted for as multiple-element arrangements, usually split between delivery of the parts and installation on the customer’s systems. In these cases, we recognize revenue for the fair market value of the parts upon shipment and transfer of title, and recognize revenue for the fair market value of installation services when those services are completed.
 
In certain cases, we sell limited rights to our intellectual property. Revenue from the sale of any intellectual property license will generally be recognized at the inception of the license term.
 
We perform best efforts research and development work under various government-sponsored research contracts. These contracts are a mixture of cost-plus-fixed-fee (“CPFF”) and firm fixed-price (“FFP”). Revenue on CPFF contracts is recognized in accordance with contract terms, typically as costs are incurred. Revenue on FFP contracts is generally recognized on the percentage-of-completion method based on costs incurred in relation to total estimated costs. Provisions for estimated losses on government-sponsored research contracts are recorded in the period in which such losses are determined.
 
Inventories
 
Inventories are priced using average actual costs, which approximate first-in, first-out, and are stated at the lower of cost or market. The carrying value of inventory is reduced for estimated excess and obsolescence by the difference between its cost and the estimated market value based on assumptions about future demand. We evaluate the inventory carrying value for potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. In addition, inventories are evaluated for potential obsolescence due to the effect of known and anticipated engineering change orders and new products. If actual demand were to be substantially lower than estimated, additional inventory adjustments would be required, which could have a material adverse effect on our business, financial condition and results of operation. A cost-to-market reserve is established for work-in-progress and finished goods inventories when the value of the inventory plus the estimated cost to complete exceeds the net realizable value of the inventory.
 
Warranty
 
We provide for the estimated cost of warranty when revenue is recognized. Our warranty is per contract terms and for our systems the warranty typically ranges between 12 and 24 months from customer acceptance. We use estimated repair or replacement costs along with our actual warranty experience to determine our warranty obligation. We exercise judgment in determining the underlying estimates. Should actual warranty costs differ substantially from our estimates, revisions to the estimated warranty liability would be required, which could have a material adverse effect on our business, financial condition and results of operations.
 
Income Taxes
 
We account for income taxes in accordance with Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes,” (“SFAS 109”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. Based on our history of losses through 2004, our deferred tax asset was fully offset by a valuation allowance as of December 31, 2005. During 2006, the deferred tax


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asset and the related valuation allowance were both reduced due to the usage of our remaining NOL and credit carry-forwards. As of December 31, 2006, $4.6 million of the deferred tax asset was valued on the balance sheet, net of a valuation allowance of $2.8 million. This represents the amount of the deferred tax asset from which we expect to realize a benefit. We cannot predict with certainty when, or if, we will realize the benefit of the portion of the deferred tax asset currently offset with a valuation allowance.
 
On a quarterly basis, we provide for income taxes based upon an annual effective income tax rate. The effective tax rate is highly dependent upon the level of our projected earnings, the geographic composition of worldwide earnings, tax regulations governing each region, net operating loss carry-forwards, availability of tax credits and the effectiveness of our tax planning strategies. We carefully monitor the changes in many factors and adjust our effective income tax rate on a timely basis. If actual results differ from the estimates, this could have a material effect on our business, financial condition and results of operations. For example, as our projected level of earnings increased throughout 2006, we increased the annual effective tax rate from 3.0% at the end of the first quarter, to 8.8% at the end of the second quarter, to 10.0% at the end of the third quarter and to 12% at the end of the fourth quarter. Similarly, as we reduced our projected level of earnings for 2007, we decreased our effective tax rate at the end of the third quarter of 2007 to 24.0% from 26.9% at the end of the second quarter of 2007 and from 31.6% at the end of the first quarter of 2007.
 
The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material effect on our business, financial condition and results of operations.
 
Results of Operations
 
Three Months Ended September 29, 2007 and September 30, 2006.
 
Net revenues
 
                                 
          Change over
 
    Three Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Equipment net revenues
  $ 44,920     $ 51,625     $ (6,705 )     (13 )%
Imaging net revenues
    5,684       3,204       2,480       77 %
                                 
Total net revenues
  $ 50,604     $ 54,829     $ (4,225 )     (8 )%
                                 
 
Net revenues consist primarily of sales of equipment used to manufacture thin-film disks, related equipment and system components, flat panel equipment technology license fees, contract research and development related to the development of electro-optical sensors, cameras and systems and low light imaging products.
 
Equipment revenues for the three months ended September 29, 2007 included revenue recognition for four 200 Lean systems and a significant quarter over quarter increase in revenue from disk equipment technology upgrades and spare parts. Revenue for the three months ended September 30, 2006 included revenue recognition of nine 200 Lean systems and three disk lubrication systems. We expect Equipment revenues in the fourth quarter of 2007 will be significantly lower than the comparable period of 2006, due primarily to a slowdown in orders for new 200 Lean systems. Additionally, shipments of disk equipment technology upgrades are expected to decline relative to the third quarter. We have limited visibility into 2008.
 
Imaging revenue for the three months ending September 29, 2007 consisted of $4.5 million of research and development contract revenue and $1.2 million of product sales. Revenue for the three months ended September 30, 2006 consisted of $2.7 million of contract research and development revenue and $465,000 of product sales. Product revenue included contributions from our new DeltaNu subsidiary, which was acquired on January 31, 2007. Substantial growth in future Imaging revenues is dependent on proliferation of our technology into major military weapons programs, the ability to obtain export licenses for foreign customers, obtaining production subcontracts for these programs, and development and sale of commercial products.


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Our backlog of orders at September 29, 2007 was $31.2 million, as compared to $57.5 million at June 30, 2007 and $129.7 million at September 30, 2006. Backlog as of September 29, 2007 includes one 200 Lean system, as compared to four on June 30, 2007 and twenty-four on September 30, 2006. Our outlook for orders for new systems in the second half of 2007 has been negatively impacted by Western Digital’s announced acquisition of Komag and the decision of one of our customers to use legacy systems for the production of first generation perpendicular media. We include in backlog the value of purchase orders for our products that have scheduled delivery dates. We do not recognize revenue on this backlog until we have met the criteria contained in our revenue recognition policy, including customer acceptance of newly developed systems.
 
International sales decreased by 29% to $35.0 million for the three months ended September 29, 2007 from $49.2 million for the three months ended September 30, 2006. International revenues include products shipped to overseas operations of U.S. companies. The decrease in international sales was primarily due to a decrease in net revenues from disk sputtering systems. Substantially all of our international sales are to customers in Asia. International sales constituted 69% of net revenues for the three months ended September 29, 2007 and 90% of net revenues for the three months ended September 30, 2006.
 
Gross margin
 
                         
    Three Months Ended        
    Sept. 29,
    Sept. 30,
       
    2007     2006     % Change  
    (In thousands, except percentages)  
 
Equipment gross profit
  $ 21,988     $ 21,916       0 %
% of Equipment net revenues
    48.9 %     42.5 %        
Imaging gross profit
  $ 2,529     $ 1,316       92 %
% of Imaging net revenues
    44.5 %     41.1 %        
Total gross profit
  $ 24,615     $ 23,280       6 %
% of net revenues
    48.6 %     42.5 %        
 
Cost of net revenues consists primarily of purchased materials and costs attributable to contract research and development, and also includes fabrication, assembly, test and installation labor and overhead, customer-specific engineering costs, warranty costs, royalties, provisions for inventory reserves and scrap. Cost of net revenues for the three months ended September 29, 2007 and September 30, 2006 included $168,000 and $70,000, respectively, of equity-based compensation expense.
 
Equipment gross margin improved to 48.9% in the three months ended September 29, 2007 from 42.5% in the three months ended September 30, 2006. The increase in gross margin was due primarily to cost reduction programs and product mix. We expect the gross margin for the Equipment business in the fourth quarter of 2007 to be lower than in the third quarter and the comparable quarter of 2006, primarily as a result of lower revenue. Gross margins in the Equipment business will vary depending on a number of factors, including product mix, product cost, system configuration and pricing, factory utilization, and provisions for excess and obsolete inventory.
 
Imaging gross margin improved to 44.5% in the three months ended September 29, 2007 from 41.1% in the three months ended September 30, 2006. The increase in gross margin resulted primarily from higher margins on development contracts, favorable adjustments related to contract closeouts and contributions from our DeltaNu subsidiary. We expect Imaging gross margin in the fourth quarter of 2007 will be higher than in the fourth quarter of 2006, but lower than in the third quarter due primarily due the elimination of one-time adjustments recognized in the three months ended September 29, 2007.


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Research and development
 
                                 
          Change over
 
    Three Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Research and development expense
  $ 9,437     $ 8,571     $ 866       10 %
% of net revenues
    18.6 %     15.6 %                
 
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 sputtering equipment, semiconductor equipment and Imaging products. Research and development expense for the three months ended September 29, 2007 and September 30, 2006 included $556,000 and $376,000, respectively, of equity-based compensation expense.
 
Research and development spending increased in Equipment during the three months ended September 29, 2007 as compared to the three months ended September 30, 2006, while spending in Imaging declined quarter over quarter. The increase in Equipment was due primarily to spending on the development of our Lean EtchTM product line to serve the semiconductor market and, to a lesser extent, spending for continuing development of our disk sputtering products. Engineering headcount increased from 115 at September 30, 2006 to 135 at September 29, 2007. We expect that research and development spending in the fourth quarter of 2007 will be at approximately the same level as incurred in the third quarter.
 
Research and development expenses do not include costs of $2.4 million and $1.7 million for the three-month periods ended September 29, 2007 and September 30, 2006, respectively, which are related to contract research and development and included in cost of net revenues.
 
Selling, general and administrative
 
                                 
          Change over
 
    Three Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Selling, general and administrative expense
  $ 7,062     $ 5,565     $ 1,497       27 %
% of net revenues
    14.0 %     10.1 %                
 
Selling, general and administrative expense consists primarily of selling, marketing, customer support, financial and management costs and also includes production of customer samples, travel, liability insurance, legal and professional services and bad debt expense. All domestic sales and international sales of disk sputtering products in Asia, with the exception of Japan, are typically made by Intevac’s direct sales force, whereas sales in Japan of disk sputtering products and other products are typically made by our Japanese distributor, Matsubo, who provides services such as sales, installation, warranty and customer support. We also have offices in China, Japan, Korea, Malaysia, and Singapore to support our equipment customers in Asia. Selling, general and administrative expense for the three months ended September 29, 2007 and September 30, 2006 included $1,112,000 and $432,000, respectively, of equity-based compensation expense.
 
The increase in selling, general and administrative spending in the three months ended September 29, 2007 as compared to the three months ended September 30, 2006 was primarily the result of increases in costs related to business development, customer service and support in both the Equipment and Imaging businesses and higher equity-based compensation expense. Our selling, general and administrative headcount increased from 71 at September 30, 2006 to 97 at September 29, 2007. We expect that selling, general and administrative expenses will be lower in the fourth quarter of 2007 due primarily to lower provisions for employee profit-sharing and bonus plans, as a result of our decreased profits.


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Interest income and other, net
 
                                 
          Change over
 
    Three Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Interest income and other, net
  $ 1,797     $ 1,113     $ 684       61 %
 
Interest income and other, net consists primarily of interest and dividend income on investments and foreign currency gains and losses. The increase in the three months ended September 29, 2007 was driven by higher interest rates on our investments and a higher average invested balance. We expect this trend to continue in the fourth quarter of 2007, resulting in increased interest income and other, net over the fourth quarter of 2006.
 
Provision for income taxes
 
                                 
          Change over
 
    Three Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Provision for income taxes
  $ 1,549     $ 1,244     $ 305       25 %
 
For the three months ended September 29, 2007, we accrued income tax using an effective tax rate of 15.5% of pretax income. This rate is based on an estimate of our annual tax rate calculated in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”. Our effective tax rate is highly dependent on our projected level of earnings, the availability of tax credits and the geographic composition of our worldwide earnings. Our deferred tax asset is partially offset by a valuation allowance, resulting in a net deferred tax asset of $5.4 million at September 29, 2007.
 
For the three months ended September 30, 2006, we accrued income tax using an effective tax rate of 12.1% of pretax income. Our tax rate differs from the applicable statutory rates due to the utilization of net operating loss carry-forwards and deferred credits.
 
Nine Months Ended September 29, 2007 and September 30, 2006
 
Net revenues
 
                                 
          Change over
 
    Nine Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Equipment net revenues
  $ 185,885     $ 155,663     $ 30,222       19 %
Imaging net revenues
    13,198       8,328       4,870       58 %
                                 
Total net revenues
  $ 199,083     $ 163,991     $ 35,092       21 %
                                 
 
The increase in Equipment revenue was the result of higher sales of disk equipment technology upgrades and spare parts. We recognized revenue on twenty-nine 200 Leans systems in both the nine-month periods ended September 29, 2007 and September 30, 2006. The increase in Imaging revenues was the result of both increased contract research and development work and a 153% increase in product sales, partly attributable to our acquisition of DeltaNu in the first quarter of 2007.
 
International sales increased by 18% to $167.6 million for the nine months ended September 29, 2007 from $141.7 million for the nine months ended September 30, 2006. The increase in international sales was due to higher shipments of disk equipment technology upgrades and spare parts to customers in Asia. International sales constituted 84% of net revenues for the nine months ended September 29, 2007 and 86% of net revenues for the nine months ended September 30, 2006. International revenues include products shipped to overseas operations of US companies.


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Gross margin
 
                         
    Nine Months Ended        
    Sept. 29,
    Sept. 30,
       
    2007     2006     % Change  
    (In thousands, except percentages)  
 
Equipment gross profit
  $ 82,842     $ 59,213       40 %
% of Equipment net revenues
    44.6 %     38.0 %        
Imaging gross profit
  $ 5,382     $ 2,635       104 %
% of Imaging net revenues
    40.8 %     31.6 %        
Total gross profit
  $ 88,224     $ 61,848       43 %
% of net revenues
    44.3 %     37.7 %        
 
Gross margin in Equipment for the nine months ended September 29, 2007 increased relative to the comparable 2006 period primarily due to cost reduction programs, increased volume and product mix. The increase in Imaging was primarily a result of higher margins on development contracts, favorable adjustments related to contract closeouts and increased product sales. Cost of net revenues for the nine months ended September 29, 2007 and September 30, 2006 included $460,000 and $242,000, respectively, of equity-based compensation expense.
 
Research and development
 
                                 
          Change over
 
    Nine Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)        
 
Research and development expense
  $ 31,277     $ 20,422     $ 10,855       53 %
% of net revenues
    15.7 %     12.5 %                
 
Research and development spending increased in Equipment and was essentially flat in Imaging during the nine months ended September 29, 2007 as compared to the nine months ended September 30, 2006. The increase in Equipment was due primarily to spending on the development of our Lean EtchTM product line to serve the semiconductor market and, to a lesser extent, spending for continuing development of our disk sputtering products. Research and development spending for the nine months ended September 29, 2007 and September 30, 2006 included $1,506,000 and $908,000, respectively of equity-based compensation expense.
 
Research and development expenses do not include costs of $5.3 million and $4.5 million for the nine-month periods ended September 29, 2007 and September 30, 2006, respectively, which are related to contract research and development and included in cost of net revenues.
 
Selling, general and administrative
 
                                 
          Change over
 
    Nine Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Selling, general and administrative expense
  $ 22,414     $ 15,683     $ 6,731       43 %
% of net revenues
    11.3 %     9.6 %                
 
The increase in selling, general and administrative expense for the nine months ending September 29, 2007 was primarily the result of increases in costs related to business development, customer service and support in both the Equipment and Imaging businesses and legal expenses associated with the Unaxis litigation. Included in selling, general and administrative spending for the nine months ended September 29, 2007 and September 30, 2006 was $2,539,000 and $883,000, respectively, of equity-based compensation expense.


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Interest income and other, net
 
                                 
                Change over
 
    Nine Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Interest income and other, net
  $ 4,655     $ 2,440     $ 2,215       91 %
 
Interest income and other, net in both 2007 and 2006 consisted primarily of interest and dividend income on investments. The increase in the nine months ended September 29, 2007 was the driven by higher interest rates on our investments and a higher average invested balance.
 
Provision for income taxes
 
                                 
                Change over
 
    Nine Months Ended     Prior Period  
    Sept. 29,
    Sept. 30,
             
    2007     2006     Amount     %  
    (In thousands, except percentages)  
 
Provision for income taxes
  $ 9,427     $ 2,826     $ 6,601       234 %
 
For the nine months ended September 29, 2007, we accrued income tax using an effective tax rate of 24.0% of pretax income. This rate is based on an estimate of our annual tax rate calculated in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”. Our effective tax rate is highly dependent on our projected level of earnings, the availability of tax credits and the geographic composition of our worldwide earnings.
 
For the nine months ended September 30, 2006, we accrued income tax using an effective tax rate of 10.0% of pretax income.
 
Stock-Based Compensation
 
During the three and nine months ended September 29, 2007, we recorded stock-based compensation expense related to stock options of $1.7 million and $4.0 million, respectively. As of September 29, 2007, the unrecorded deferred stock-based compensation balance related to stock options was $11.0 million and will be recognized over an estimated weighted average amortization period of 1.8 years.
 
The compensation cost associated with the employee stock purchase plan for the three and nine months ended September 29, 2007 was $191,000 and $619,000, respectively. There were 90,018 shares purchased under the employee stock purchase plan during the nine months ended September 29, 2007.
 
Approximately $105,000 and $69,000 of stock-based compensation was capitalized as inventory at September 29, 2007 and December 31, 2006, respectively.
 
Liquidity and Capital Resources
 
During the first nine months of 2007, cash and cash equivalents decreased by $5.0 million, from $39.4 million at December 31, 2006 to $34.4 million as of September 29, 2007.
 
Operating activities provided cash of $45.6 million during the nine months ended September 29, 2007. The cash provided from operating activities was due primarily to net income, adjusted to exclude the effect of non-cash charges including depreciation and equity-based compensation, and to decreases in accounts receivable and inventories. This was partially offset by decreases in accounts payable, customer advances and accrued payroll. Accounts receivable totaled $18.0 million at September 29, 2007, compared to $39.9 million at December 31, 2006, a decrease of $21.9 million. This was due to collections of $65 million during the three months ended September 29, 2007 and lower billings resulting from a reduction in sales compared to the first two quarters of 2007. Net inventories decreased by $21.5 million during the nine months ended September 29, 2007 due to a reduction in material receipts and production levels in anticipation of a slower second half of 2007. Accounts payable decreased $10.5 million to $5.5 million at September 29, 2007. The decrease was a result of the lower level of material receipts


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in the quarter. Accrued payroll and related liabilities decreased by $2.5 million during the nine months ended September 29, 2007 due primarily to bonuses and profit sharing payments. Other accrued liabilities totaled $5.8 million at September 29, 2007 compared to $6.6 million at December 31, 2006. The decrease of $0.8 million is due to a reduction in accrued warranty, partially offset by an increase in income tax accruals. Customer advances decreased by $20.2 million during the nine months ended September 29, 2007, due to the number of systems shipped and accepted during the first nine months of the year.
 
Investing activities in the first nine months of 2007 used cash of $59.0 million. Purchases of investments, net of proceeds from sales and maturities, totaled $48.9 million and our acquisition of DeltaNu, LLC used cash of $5.8 million during the first three quarters of 2007. Capital expenditures for the nine months ended September 29, 2007 were $4.4 million.
 
Financing activities provided cash of $8.4 million during the nine months ended September 29, 2007 due in part to the issuance of $3.8 million in notes payable related to the acquisition of DeltaNu, LLC. We also sold $3.6 million of Intevac common stock to our employees through our employee benefit plans and recognized $953,000 in tax benefits from equity-based compensation.
 
We have generated operating income since the second quarter of 2005, after incurring annual operating losses from 1998 through 2004. We currently expect to lose money in the fourth quarter of 2007. Our level of profitability in 2008 is highly dependent on the capacity expansion plans of our disk sputtering equipment customers.
 
We believe that our existing cash, cash equivalents and short-term investments, combined with the cash we anticipate generating from operating activities will be sufficient to meet our cash requirements for the foreseeable future. We intend to undertake approximately $9 million to $11 million in capital expenditures during the next twelve months.
 
Contractual Obligations
 
In the normal course of business, we enter into various contractual obligations that will be settled in cash. These obligations consist primarily of operating lease and purchase obligations. The expected future cash flows required to meet these obligations as of September 29, 2007 are shown in the table below.
 
                                         
          Payments Due by Period  
    Total     < 1 Year     1-3 Years     3-5 Years     > 5 Years  
    (In thousands)  
 
Operating lease obligations
  $ 10,563     $ 2,277     $ 4,639     $ 3,558     $ 89  
Purchase obligations
    10,133       10,133                    
                                         
Total
  $ 20,696     $ 12,410     $ 4,639     $ 3,558     $ 89  
                                         
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
 
Interest rate risk.   Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We place our investments with high quality credit issuers and, by policy, limit the amount of credit exposure to any one issuer. Short-term investments typically consist of investments in commercial paper, auction rate securities and debt instruments issued by the US government and its agencies.


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The table below presents principal amounts and related weighted-average interest rates by year of maturity for our investment portfolio at September 29, 2007.
 
                                                 
                                  Fair
 
    2007     2008     2009     Beyond     Total     Value  
 
Cash equivalents
                                               
Fixed rate amounts
  $ 8,971                       $ 8,971     $ 8,971  
Weighted-average rate
    5.37 %                                        
Variable rate amounts
  $ 8,322                       $ 8,322     $ 8,322  
Weighted-average rate
    5.24 %                                        
Short-term investments
                                               
Fixed rate amounts
  $ 91,689     $ 6,801                 $ 98,490     $ 98,490  
Weighted-average rate
    5.95 %     5.24 %                                
Long-term investments
                                               
Fixed rate amounts
        $ 6,000     $ 8,000           $ 14,000     $ 14,014  
Weighted-average rate
            5.23 %     5.40 %                        
Total investment portfolio
  $ 108,982     $ 12,801     $ 8,000           $ 129,783     $ 129,797  
 
Due to the short-term nature of the substantial portion of our investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates.
 
Foreign exchange risk.   From time to time, we enter into foreign currency forward exchange contracts to economically hedge certain of our 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 our operating results. At September 29, 2007, we had no foreign currency forward exchange contracts.
 
Item 4.    Controls and Procedures
 
Evaluation of disclosure controls and procedures.
 
We maintain a set of disclosure controls and procedures that are designed to ensure that information relating to Intevac, Inc. required to be disclosed in periodic filings under Securities Exchange Act of 1934, or Exchange Act, is recorded, processed, summarized and reported in a timely manner under the Exchange Act. In connection with the filing of this Form 10-Q for the quarter ended September 29, 2007, as required under Rule 13a-15(b) of the Exchange Act, an evaluation was carried out under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 29, 2007.
 
Attached as exhibits to this Quarterly Report are certifications of the CEO and the CFO, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (Exchange Act). This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
 
Definition of Disclosure Controls
 
Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of


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financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of our internal control over financial reporting are included within our Disclosure Controls, they are included in the scope of our quarterly controls evaluation.
 
Limitations on the Effectiveness of Controls
 
Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
Changes in internal controls over financial reporting
 
There were no changes in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
PART II. OTHER INFORMATION
 
Item 1.    Legal Proceedings
 
Patent Infringement Complaint against Unaxis
 
On July 7, 2006, we filed a patent infringement lawsuit against Unaxis USA, Inc. and its affiliates, Unaxis Balzers AG and Unaxis Balzers, Ltd., in the United States District Court for the Central District of California. Our lawsuit against Unaxis asserts infringement by Unaxis of United States Patent 6,919,001, which relates to our 200 Lean system. Our complaint seeks monetary damages and an injunction that would bar Unaxis from making, using, offering to sell or selling in the United States, or importing into the United States, Unaxis’ allegedly infringing product. We believe we have meritorious claims, and we intend to pursue them vigorously.
 
On September 12, 2006, Unaxis filed a response to our lawsuit in which it asserted non-infringement, invalidity of our patent, inequitable conduct by Intevac, patent misuse by Intevac, and lack of jurisdiction by the Court as defenses. Additionally, Unaxis requested a declaratory judgment of patent non-infringement, invalidity and unenforceability; asserted that Intevac violated the California Business and Professional Code; requested that we be enjoined from engaging in any unfair competition; and requested that we be required to pay Unaxis’ attorney fees. We believe such claims lack merit, and we intend to defend ourselves vigorously.
 
We replied to Unaxis’ response on October 3, 2006, denying the assertions of non-infringement, invalidity and unenforceability of the Intevac patent, and denying any unfair competition. With the approval of the Court, we amended our complaint on February 6, 2007 to assert an additional ground for our infringement claim and to add a request for a declaratory judgment of infringement. Unaxis filed a response on February 21, 2007, in which it repeated the assertions of its September 12, 2006 response.
 
On May 21, 2007, the Court granted Unaxis’ request to stay the litigation pending reexamination of our United States Patent 6,919,001, after the U.S. Patent Office granted Unaxis’ February 27, 2007 reexamination request and issued an initial office action rejecting the claims of the patent. The Court also ordered the parties to file


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a joint report every 120 days to keep it appraised of the reexamination status. Intevac had no input to the initial office action determination by the U.S. Patent Office.
 
On June 20, 2007, we filed a reply to the initial office action reexamination. Our reply addresses the office action’s rejections of the patent’s original claims and proposes amended claims that we believe are supported by the original patent’s specification. Unaxis has the opportunity to respond, after which the U.S. Patent Office will consider both parties’ submissions. During the reexamination process, the patent remains valid.
 
Other Legal Matters
 
From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. We expect that the number and significance of these matters will increase as our business expands. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all. We are not presently party to any lawsuit or proceeding that, in our opinion, is likely to seriously harm our business.
 
Item 1A.    Risk Factors
 
Demand for capital equipment is cyclical, which subjects our business to long periods of depressed revenues interspersed with periods of unusually high revenues.
 
Our Equipment business sells equipment to capital-intensive industries, which sell commodity products such as disk drives. When demand for these commodity products exceeds capacity, demand for new capital equipment such as ours tends to be amplified. Conversely, when supply of these commodity products exceeds demand, the demand for new capital equipment such as ours tends to be depressed. The hard disk drive industry has historically been subject to multi-year cycles because of the long lead times and high costs involved in adding capacity, and to seasonal cycles driven by consumer purchasing patterns, which tend to be heaviest in the third and fourth quarters of each year.
 
The cyclical nature of the capital equipment industry means that in some years we will have unusually high sales of new systems, and that in other years our sales of new systems will be severely depressed. The timing, length and volatility of these cycles are difficult to predict. These cycles have affected the timing and amounts of our customers’ capital equipment purchases and investments in new technology. For example, sales of systems for magnetic disk production were severely depressed from mid-1998 until mid-2003 and grew rapidly from 2004 through 2006. The number of new systems delivered or scheduled for delivery in the second half of 2007 is significantly lower than the number of systems delivered in the first half of the year, which may indicated a slowing in the cycle or a downturn in the market. We cannot predict with any certainty when these cycles will begin and end.
 
If the projected growth in demand for hard disk drives does not materialize and our customers do not replace or upgrade their installed base of disk sputtering systems, then future sales of our disk sputtering systems will suffer.
 
From mid-1998 until mid-2003, there was very little demand for new disk sputtering systems, as magnetic disk manufacturers were burdened with over-capacity and were not investing in new disk sputtering equipment. By 2003, however, over-capacity had diminished, and orders for our 200 Lean began to increase.
 
Sales of our equipment for capacity expansions are dependent on the capacity expansion plans of our customers and upon whether our customers select our equipment for their capacity expansions. We have no control over our customers’ expansion plans, and we cannot assure you that they will select our equipment if they do expand their capacity. Our customers may not implement capacity expansion plans, or we may fail to win orders for equipment for those capacity expansions, which could have a material adverse effect on our business and our operating results. In addition, some manufacturers may choose to purchase used systems from other manufacturers or customers rather than purchasing new systems from us.
 
Sales of our 200 Lean disk sputtering systems are also dependent on obsolescence and replacement of the installed base of disk sputtering equipment. If technological advancements are developed that extend the useful life


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of the installed base of systems, then sales of our 200 Lean will be limited to the capacity expansion needs of our customers, which would significantly decrease our revenue. For example, during 2007 one of our customers decided to use legacy systems for the production of first generation perpendicular media, which delayed the purchase of new 200 Lean systems.
 
Our customers have experienced competition from companies that produce alternative storage technologies like flash memory, where increased capacity, improving cost, lower power consumption and performance ruggedness have resulted in competition with lower capacity, smaller form factor disk drives in handheld applications. While this competition has traditionally been in the markets for handheld consumer electronics applications like personal media players, these competitors have recently announced products for notebook and enterprise computer applications. If alternative technologies, such as flash memory, replace hard disk drives as a primary method of digital storage, demand for our products would decrease.
 
We are exposed to risks associated with a highly concentrated customer base.
 
Historically, a significant portion of our revenue in any particular period has been attributable to sales of our disk sputtering systems to a limited number of customers. In 2006, one of our customers accounted for 52% of our revenues, and three customers in the aggregate accounted for 93% of our revenues. The same three customers, in the aggregate, accounted for 86% of our net accounts receivable at December 31, 2006. During 2006, Seagate acquired Maxtor, and in June 2007, Western Digital announced the acquisition of Komag. This consolidation in the industry limits the potential customers for our products. Orders from a relatively limited number of magnetic disk manufacturers have accounted for, and likely will continue to account for, a substantial portion of our revenues. The loss of, or delays in purchasing by, any one of our large customers would significantly reduce potential future revenues. The concentration of our customer base may enable customers to demand pricing and other terms unfavorable to us, and makes us more vulnerable to any changes in demand by a given customer. Furthermore, the concentration of customers can lead to extreme variability in revenue and financial results from period to period. For example, during 2006 revenues ranged between $49.6 million in the first quarter and $95.9 million in the fourth quarter.
 
Our operating results fluctuate significantly from quarter to quarter, which may cause the price of our stock to decline.
 
Over the last 11 quarters, our revenues per quarter have fluctuated between $10.6 million and $95.9 million. Over the same period our operating income (loss) as a percentage of revenues has fluctuated between approximately 23% and (41%) of revenues. We anticipate that our revenues and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:
 
  •  changes in the demand, due to seasonality, cyclicality and other factors, for computer systems, storage subsystems and consumer electronics containing disks our customers produce with our systems;
 
  •  delays or problems in the introduction and acceptance of our new products, or delivery of existing products;
 
  •  timing of orders, acceptance of new systems by our customers or cancellation of those orders; and
 
  •  new products, services or technological innovations by our competitors or us.
 
Additionally, because our systems are priced in the millions of dollars and we sell a relatively small number of systems, we believe that quarter-to-quarter comparisons of our revenues and operating results may not be an accurate indicator of our future performance. Our operating results in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the trading price of our common shares.
 
Our long-term revenue growth is dependent on new products. If these new products are not successful, then our results of operations will be adversely affected.
 
We have invested heavily, and continue to invest, in the development of new products. Our success in developing and selling new products depends upon a variety of factors, including our ability to predict future


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customer requirements accurately, technological advances, total cost of ownership of our systems, our introduction of new products on schedule, our ability to manufacture our products cost-effectively and the performance of our products in the field. Our new product decisions and development commitments must anticipate continuously evolving industry requirements significantly in advance of sales.
 
The majority of our revenues in both fiscal 2006 and fiscal 2005 were from sales of our 200 Lean disk sputtering system, which was first delivered in December 2003. When first introduced, advanced vacuum manufacturing equipment, such as the 200 Lean, is subject to extensive customer acceptance tests after installation at the customer’s factory. These acceptance tests are designed to validate reliable operation to specifications in areas such as throughput, vacuum level, robotics, process performance and software features and functionality. These tests are generally more comprehensive for new systems than for mature systems, and are designed to highlight problems encountered with early versions of the equipment. For example, initial builds of the 200 Lean experienced high production and warranty costs in comparison to our more established product lines. Failure to promptly address any of the problems uncovered in these tests could have adverse effects on our business, including rescheduling of backlog, failure to achieve customer acceptance and therefore revenue recognition as anticipated, unanticipated product rework and warranty costs, penalties for non-performance, cancellation of orders, or return of products for credit.
 
We are making a substantial investment to develop our new Lean Etch system for semiconductor manufacturing. We spent a substantial portion of our research and development costs on this new product in 2006 and increased our level of spending on this project in 2007. Intevac has not developed or sold products for this market previously. Failure to correctly assess the size of the market, to successfully develop a cost effective product to address the market, or to establish effective sales and support of the new product would have a material adverse effect on our future revenues and profits, including loss of the Company’s entire investment in the project.
 
We are jointly developing a next generation head mounted night-vision system with another defense contractor. This system is planned for sale to the U.S. military and will compete with head-mounted systems developed by our competitors. The US military does not intend to initiate production of this system until 2010. We plan to make a significant investment in this product and cannot be assured when, or if, we will be awarded any production contracts for these night vision systems.
 
We have developed a night-vision sensor and camera module for use in a NATO customer’s digital head-mounted and rifle-sight system. In 2006, we entered into a purchasing agreement with our customer to deliver up to 32,000 camera modules over seven years. We cannot guarantee that we will achieve the yield improvements and cost reductions necessary for this program to be successful. Shipments under this program are subject to export approval from the U.S. government.
 
Our LIVAR target identification and low light level camera technologies are designed to offer significantly improved capability to military customers. We are also developing commercial products in our Imaging business. None of our Imaging products are currently being manufactured in high volume, and we may encounter unforeseen difficulties when we commence volume production of these products. Our Imaging business will require substantial further investment in sales and marketing, in product development and in additional production facilities in order to expand our operations. We may not succeed in these activities or generate significant sales of these new products. In 2006, sales of our Imaging products totaled $1.7 million.
 
Failure of any of these new products to perform as intended, to penetrate their markets and develop into profitable product lines or to achieve their production cost objectives would have a material adverse effect on our business.
 
We may not be successful in maintaining and obtaining the necessary export licenses to conduct operations abroad, and the United States government may prevent proposed sales to foreign customers.
 
Many of our Imaging products require export licenses from United States Government agencies under the Export Administration Act, the Trading with the Enemy Act of 1917, the Arms Export Act of 1976 and the International Traffic in Arms Regulations. This limits the potential market for our products. We can give no assurance that we will be successful in obtaining all the licenses necessary to export our products. Recently,


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heightened government scrutiny of export licenses for products in our market has resulted in lengthened review periods for our license applications. Export to countries, which are not considered by the United States Government to be allies, is likely to be prohibited, and even sales to U.S. allies may be limited. Failure to obtain, delays in obtaining, or revocation of previously issued licenses would prevent us from selling our products outside the United States, may subject us to fines or other penalties, and would have a material adverse effect on our business, financial condition and results of operations.
 
Our products are complex, constantly evolving and often must be customized to individual customer requirements.
 
The systems we manufacture and sell in our Equipment business have a large number of components and are complex, which require us to make substantial investments in research and development. If we were to fail to develop, manufacture and market new systems or to enhance existing systems, that failure would have an adverse effect on our business. We may experience delays and technical and manufacturing difficulties in future introduction, volume production and acceptance 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. In some cases, we market and commit to deliver new systems, modules and components with advanced features and capabilities that we are still in the process of designing. 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. Failure to deliver these products on time, or failure to deliver products that perform to all contractually committed specifications, could have adverse effects on our business, including rescheduling of backlog, failure to achieve customer acceptance and therefore revenue recognition as anticipated, unanticipated rework and warranty costs, penalties for non-performance, cancellation of orders, or return of products for credit. 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 and that may affect our gross margins. Sometimes we work closely with our customers to develop new features and products. In connection with these transactions, we sometimes offer a period of exclusivity to these customers.
 
Our sales cycle is long and unpredictable, which requires us to incur high sales and marketing expenses with no assurance that a sale will result.
 
The sales cycle for our equipment systems can be a year or longer, involving individuals from many different areas of our company and numerous product presentations and demonstrations for our prospective customers. Our sales process for these systems also commonly includes production of samples, customization of our product and installation of evaluation systems in the factories of our prospective customers. We do not enter into long-term contracts with our customers and therefore until an order is actually submitted by a customer there is no binding commitment to purchase our systems.
 
Our Imaging business is also subject to long sales cycles because many of our products, such as our LIVAR system, often must be designed into our customers’ products, which are often complex state-of-the-art products. These development cycles are often multi-year, and our sales are contingent on our customers successfully integrating our product into their product, completing development of their product and then obtaining production orders for their product from the U.S. government or its allies.
 
As a result, we may not recognize revenue from our products for extended periods of time after we have completed development, and made initial shipments of our products, during which time we may expend substantial funds and management time and effort with no assurance that a sale will result.
 
We operate in an intensely competitive marketplace, and our competitors have greater resources than we do.
 
In the market for our disk sputtering systems, we have experienced competition from competitors such as Anelva Corporation, which is a subsidiary of Canon, and Oerlikon, each of which has sold substantial numbers of systems worldwide. In the market for semiconductor equipment, we expect to experience competition from


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competitors such as Applied Materials, LAM Research and Tokyo Electron, Ltd. In the market for our military Imaging products, we experience competition from companies such as ITT Industries, Inc. and Northrop Grumman Corporation, the primary U.S. manufacturers of Generation-III night vision devices and their derivative products. In the markets for our commercial Imaging products, we compete with companies such as Andor, E2V, Hamamatsu, Texas Instruments and Roper Scientific for sensor and camera products, and with companies such as Ahura, B&W Tek, Horiba — Jobin Yvon, InPhotonics, Ocean Optics, and Smiths Detection for portable Raman spectrometer products. Our competitors have substantially greater financial, technical, marketing, manufacturing and other resources than we do. We cannot assure you that our competitors will not develop enhancements to, or future generations of, competitive products that offer superior price or performance features. Likewise, we cannot assure you that new competitors will not enter our markets and develop such enhanced products. Moreover, competition for our customers is intense, and our competitors have historically offered substantial pricing concessions and incentives to attract our customers or retain their existing customers.
 
We experienced significant growth in our business and operations and if we do not appropriately manage this growth and any future growth, our operating results will be negatively affected.
 
Our business has grown significantly in recent years in both operations and headcount, and this growth or continued growth may cause a significant strain on our infrastructure, internal systems and managerial resources. To manage our growth effectively, we must continue to improve and expand our infrastructure, including information technology and financial operating and administrative systems and controls, and continue managing headcount, capital and processes in an efficient manner. Our productivity and the quality of our products may be adversely affected if we do not integrate and train our new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations, all of which add to the complexity of our organization and increase our operating expenses. We also may be less able to predict and effectively control our operating expenses due to the growth and increasing complexity of our business. In addition, our information technology systems may not grow at a sufficient rate to keep up with the processing and information demands placed on them by a much larger company. The efforts to continue to expand our information technology systems or our inability to do so could harm our business. Further, revenues may not grow at a sufficient rate to absorb the costs associated with a larger overall headcount.
 
Our future growth may require significant additional resources, given that, as we increase our business operations in complexity and scale, we may have insufficient management capabilities and internal bandwidth to manage our growth and business effectively. We cannot assure you that resources will be available when we need them or that we will have sufficient capital to fund these potential resource needs. Also, growth in the number of orders received in our Equipment business may require additional physical space and headcount, and our ability to fulfill such orders may be constrained if we are unable to effectively grow our business. If we are unable to manage our growth effectively or if we experience a shortfall in resources, our results of operations will be harmed.
 
Our Imaging business depends heavily on government contracts, which are subject to immediate termination and are funded in increments. The termination of or failure to fund one or more of these contracts could have a negative impact on our operations.
 
We sell many of our Imaging products and services directly to the U.S. government, as well as to prime contractors for various U.S. government programs. Our revenues from government contracts totaled $10.2 million, $6.9 million, and $8.2 million in 2006, 2005, and 2004, respectively. Generally, government contracts are subject to oversight audits by government representatives and contain provisions permitting termination, in whole or in part, without prior notice at the government’s convenience upon the payment of compensation only for work done and commitments made at the time of termination. We cannot assure you that one or more of the government contracts under which our customers or we operate will not be terminated under these circumstances. Also, we cannot assure you that we or our customers would be able to procure new government contracts to offset the revenues lost as a result of any termination of existing contracts, nor can we assure you that we or our customers will continue to remain in good standing as federal contractors.
 
Furthermore, the funding of multi-year government programs is subject to congressional appropriations, and there is no guarantee that the U.S. government will make further appropriations. The loss of funding for a


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government program would result in a loss of anticipated future revenues attributable to that program. That could increase our overall costs of doing business.
 
In addition, sales to the U.S. government and its prime contractors may be affected by changes in procurement policies, budget considerations and political developments in the United States or abroad. The influence of any of these factors, which are beyond our control, could also negatively impact our financial condition. We also may experience problems associated with advanced designs required by the government, which may result in unforeseen technological difficulties and cost overruns. Failure to overcome these technological difficulties or occurrence of cost overruns would have a material adverse effect on our business.
 
Unexpected increases in the cost to develop or manufacture our products under fixed-price contracts may cause us to experience un-reimbursed cost overruns.
 
A portion of our revenue is derived from fixed-price development and production contracts. Under fixed-price contracts, unexpected increases in the cost to develop or manufacture a product, whether due to inaccurate estimates in the bidding process, unanticipated increases in material costs, inefficiencies or other factors, are borne by us. We have experienced cost overruns in the past that have resulted in losses on certain contracts, and may experience additional cost overruns in the future. We are required to recognize the total estimated impact of cost overruns in the period in which they are first identified. Such cost overruns could have a material adverse effect on our results of operation and financial condition.
 
Our sales of equipment products are dependent on substantial capital investment by our customers, far in excess of the cost of our products.
 
Our customers must make extremely large capital expenditures in order to purchase our systems and other related equipment and facilities. 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. The magnetic disk and semiconductor manufacturing industries have made significant additions to their production capacity in the last few years. Our customers may not be willing or able to continue this level of capital investment, especially during a downturn in the overall economy, the hard disk drive industry, or the semiconductor industry.
 
Our stock price is volatile.
 
The market price and trading volume of our common stock has been subject to significant volatility, and this trend may continue. Over the last 12 months, the closing price of our common stock, as traded on The Nasdaq National Market, fluctuated from a low of $13.23 per share to a high of $30.57 per share. The value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:
 
  •  our perceived prospects;
 
  •  hard disk drive market expectations;
 
  •  variations in our operating results and whether we achieve our key business targets;
 
  •  sales or purchases of large blocks of our stock;
 
  •  changes in, or our failure to meet, our revenue and earnings estimates;
 
  •  changes in securities analysts’ buy or sell recommendations;
 
  •  differences between our reported results and those expected by investors and securities analysts;
 
  •  announcements of new contracts, products or technological innovations by us or our competitors;
 
  •  market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors;
 
  •  our high fixed operating expenses, including research and development expenses;


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  •  developments in the financial markets; and
 
  •  general economic, political or stock market conditions in the United States and other major regions in which we do business.
 
In addition, the general economic, political, stock market and hard drive industry conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.
 
Changes in tax rates or tax liabilities could affect future results.
 
As a global company, we are subject to taxation in the United States and various other countries. Significant judgment is required to determine and estimate worldwide tax liabilities. Our future tax rates could be affected by changes in the applicable tax laws, composition of earnings in countries with differing tax rates, changes in the valuation of our deferred tax assets and liabilities, or changes in the tax laws. Although we believe our tax estimates are reasonable, there can be no assurance that any final determination will not be materially different from the treatment reflected in our historical income tax provisions and accruals, which could materially and adversely affect our results of operations.
 
Our effective tax rate in both 2006 and 2005 was well below the applicable statutory rates due primarily to the utilization of net operating loss carry-forwards and deferred credits. We are currently projecting an effective tax rate of 24.0% for 2007.
 
Our future success depends on international sales and the management of global operations.
 
In 2006, approximately 90% of our revenues came from regions outside the United States. We currently have international customer support offices in Singapore, China, Malaysia, Korea and Japan. We expect that international sales will continue to account for a significant portion of our total revenue in future years. Certain manufacturing facilities and suppliers are also located outside the United States. Managing our global operations presents challenges including, but not limited to, those arising from:
 
  •  varying regional and geopolitical business conditions and demands;
 
  •  global trade issues;
 
  •  variations in protection of intellectual property and other legal rights in different countries;
 
  •  rising raw material and energy costs;
 
  •  variations in the ability to develop relationships with suppliers and other local businesses;
 
  •  changes in laws and regulations of the United States (including export restrictions) and other countries, as well as their interpretation and application;
 
  •  fluctuations in interest rates and currency exchange rates;
 
  •  the need to provide sufficient levels of technical support in different locations;
 
  •  political instability, natural disasters (such as earthquakes, hurricanes or floods), pandemics, terrorism or acts of war where we have operations, suppliers or sales;
 
  •  cultural differences; and
 
  •  shipping delays.


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Changes in existing financial accounting standards or practices or taxation rules or practices may adversely affect our results of operations.
 
Changes in existing accounting or taxation rules or practices, new accounting pronouncements or taxation rules, or varying interpretations of current accounting pronouncements or taxation practice could have a significant adverse effect on our results of operations or the manner in which we conduct our business. Further, such changes could potentially affect our reporting of transactions completed before such changes are effective. In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48, which was effective January 1, 2007, clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” We adopted FIN 48 in the first quarter of fiscal year 2007.
 
We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002, and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.
 
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management must perform evaluations of our internal control over financial reporting. Beginning in 2004, our Form 10-K has included a report by management of their assessment of the adequacy of such internal control. Additionally, our independent registered public accounting firm must publicly attest to the adequacy of management’s assessment and the effectiveness of our internal control.
 
We have completed the evaluation of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act. Although our assessment, testing, and evaluation resulted in our conclusion that as of December 31, 2006, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future periods. If our internal controls are ineffective in future periods, our financial results or the market price of our shares could be adversely affected. We will incur additional expenses and commitment of management’s time in connection with further evaluations.
 
Our dependence on suppliers for certain parts, some of them sole-sourced, makes us vulnerable to manufacturing interruptions and delays, which could affect our ability to meet customer demand.
 
We are a manufacturing business. Purchased parts constitute the largest component of our product cost. Our ability to manufacture depends on the timely delivery of parts, components and subassemblies from suppliers. We obtain some of the key components and sub-assemblies used in our products from a single supplier or a limited group of suppliers. If any of our suppliers fail to deliver quality parts on a timely basis, we may experience delays in manufacturing, which could result in delayed product deliveries or increased costs to expedite deliveries or develop alternative suppliers. Development of alternative suppliers could require redesign of our products.
 
Our business depends on the integrity of our intellectual property rights and failure to protect our intellectual property rights adequately could have a material adverse effect on our business.
 
The success of our business depends upon integrity of our intellectual property rights, and we cannot assure you that:
 
  •  any of our pending or future patent applications will be allowed or that any of the allowed applications will be issued as patents or will issue with claims of the scope we sought;
 
  •  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;
 
  •  other parties will not develop similar products, duplicate our products or design around our patents; or
 
  •  our patent rights, intellectual property laws or our agreements will adequately protect our intellectual property or competitive position.


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We may be subject to claims of intellectual property infringement.
 
From time to time, we have received claims that we are infringing third parties’ intellectual property rights or seeking to invalidate our rights. We cannot assure you that third parties will not in the future claim that we have infringed current or future patents, trademarks or other proprietary rights relating to our products. Any 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.
 
Our success is dependent on recruiting and retaining a highly talented work force.
 
Our employees are vital to our success, and our key management, engineering and other employees are difficult to replace. We generally do not have employment contracts with our key employees. Further, we do not maintain key person life insurance on any of our employees. The expansion of high technology companies worldwide has increased demand and competition for qualified personnel, and has made companies increasingly protective of prior employees. It may be difficult for us to locate employees who are not subject to non-competition and other restrictions.
 
Our U.S. operations are primarily located in Santa Clara, California and Fremont, California, where the cost of living and recruiting employees is high. Additionally, our operating results depend, in large part, upon our ability to retain and attract qualified management, engineering, marketing, manufacturing, customer support, sales and administrative personnel. Furthermore, we compete with similar industries, such as the semiconductor industry, for the same pool of skilled employees. If we are unable to retain key personnel, or if we are not able to attract, assimilate or retain additional highly qualified employees to meet our needs in the future, our business and operations could be harmed.
 
Changes in demand caused by fluctuations in interest and currency exchange rates may reduce our international sales.
 
Sales and operating activities outside of the United States are subject to inherent risks, including fluctuations in the value of the U.S. 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 ability to sell our products or operate outside the United States.
 
We currently quote and sell the majority of our products in U.S. dollars. From time to time, we may enter 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 principal competitor for disk sputtering equipment is based in Japan and has a cost structure based on the Japanese yen. Accordingly, currency fluctuations could cause the price of our products to be more or less competitive than our principal competitor’s products. Currency fluctuations will decrease or increase our cost structure relative to those of our competitors, which could lessen the demand for our products and affect our competitive position.
 
Difficulties in integrating past or future acquisitions could adversely affect our business.
 
We have completed a number of acquisitions during our operating history. In early 2007, we announced the acquisition of certain assets of DeltaNu, LLC, and we recently announced the acquisition of certain assets of Creative Display Systems, LLC, subject to normal closing conditions. We have spent and will continue to spend significant resources identifying and acquiring businesses. The efficient and effective integration of our acquired businesses into our organization is critical to our growth. Any future acquisitions involve numerous risks including difficulties in integrating the operations, technologies and products of the acquired companies, the diversion of our management’s attention from other business concerns and the potential loss of key employees of the acquired


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companies. Failure to achieve the anticipated benefits of these and any future acquisitions or to successfully integrate the operations of the companies we acquire could also harm our business, results of operations and cash flows. Any future acquisitions may also result in potentially dilutive issuance of equity securities, acquisition- or divestiture-related write-offs or the assumption of debt and contingent liabilities.
 
We use hazardous materials and are subject to risks of non-compliance with environmental and safety 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. If we fail to comply with current or future regulations, such failure could result in suspension of our operations, alteration of our manufacturing process, or substantial civil penalties or criminal fines against us or our officers, directors or employees. Additionally, these regulations could require us to acquire expensive remediation or abatement equipment or to incur substantial expenses to comply with them. Failure 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.
 
Future sales of shares of our common stock by our officers, directors and affiliates could cause our stock price to decline.
 
Substantially all of our common stock may be sold without restriction in the public markets, although shares held by our directors, executive officers and affiliates may be subject to volume and manner of sale restrictions. Sales of a substantial number of shares of common stock in the public market by our officers, directors or affiliates or the perception that these sales could occur could materially and adversely affect our stock price and make it more difficult for us to sell equity securities in the future at a time and price we deem appropriate.
 
Anti-takeover provisions in our charter documents and under Delaware law could prevent or delay a change in control, which could negatively impact the value of our common stock by discouraging a favorable merger or acquisition of us.
 
Our articles of incorporation authorize our board of directors to issue up to 10,000,000 shares of preferred stock and to determine the powers, preferences, privileges, rights, including voting rights, qualifications, limitations and restrictions of those shares, without any further vote or action by the shareholders. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue in the future. The issuance of preferred stock could have the effect of delaying, deterring or preventing a change in control and could adversely affect the voting power of your shares. In addition, provisions of Delaware law and our bylaws could make it more difficult for a third party to acquire a majority of our outstanding voting stock by discouraging a hostile bid, or delaying or deterring a merger, acquisition or tender offer in which our shareholders could receive a premium for their shares or a proxy contest for control of our company or other changes in our management.
 
We could be involved in litigation.
 
From time to time we may be involved in litigation of various types, including litigation alleging infringement of intellectual property rights and other claims. For example, in July 2006, we filed a patent infringement lawsuit against Unaxis USA, Inc. and its affiliates Unaxis Balzers AG and Unaxis Balzers, Ltd. alleging infringement by Unaxis of a patent relating to our 200 Lean system. See Part II, Item 1 of this Form 10-Q for further information regarding this lawsuit. Litigation tends to be expensive and requires significant management time and attention and could have a negative effect on our results of operations or business if we lose or have to settle a case on significantly adverse terms.
 
Business interruptions could adversely affect our operations.
 
Our operations are vulnerable to interruption by fire, earthquake or other natural disaster, quarantines or other disruptions associated with infectious diseases, national catastrophe, terrorist activities, war, disruptions in our


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computing and communications infrastructure due to power loss, telecommunications failure, human error, physical or electronic security breaches and computer viruses, and other events beyond our control. We do not have a fully implemented detailed disaster recovery plan. Despite our implementation of network security measures, our tools and servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems and tools located at customer sites. Political instability could cause us to incur increased costs in transportation, make such transportation unreliable, increase our insurance costs and cause international currency markets to fluctuate. This same instability could have the same effects on our suppliers and their ability to timely deliver their products. In addition, we do not carry sufficient business interruption insurance to compensate us for all losses that may occur, and any losses or damages incurred by us could have a material adverse effect on our business and results of operations. For example, we self-insure earthquake risks, because we believe this is the prudent financial decision based on the high cost of the limited coverage available in the earthquake insurance market. An earthquake could significantly disrupt our operations, most of which are conducted in California. It could also significantly delay our research and engineering effort on new products, most of which is also conducted in California. We take steps to minimize the damage that would be caused by an earthquake, but there is no certainty that our efforts will prove successful in the event of an earthquake.
 
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
 
None.
 
Item 3.   Defaults upon Senior Securities
 
None.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
None.
 
Item 5.    Other Information
 
None.
 
Item 6.    Exhibits
 
The following exhibits are filed herewith:
 
         
    Exhibit
Number
 
Description
 
  31 .1   Certification of President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Certification of Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32 .1   Certification Pursuant to U.S.C. 1350 adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
INTEVAC, INC.
 
  By: 
/s/   KEVIN FAIRBAIRN
Kevin Fairbairn
President, Chief Executive Officer and Director
(Principal Executive Officer)
 
Date: November 8, 2007
 
  By: 
/s/   JEFFREY ANDRESON
Jeffrey Andreson
Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)
 
Date: November 8, 2007


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EXHIBIT INDEX
 
         
    Exhibit
Number
 
Description
 
  31 .1   Certification of President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Certification of Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32 .1   Certification Pursuant to U.S.C. 1350 adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.

 

Exhibit 31.1
I, Kevin Fairbairn certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q of Intevac, Inc.;
 
2.   Based on my knowledge, this 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 report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this 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 report;
 
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: November 8, 2007
         
     
  /s/ KEVIN FAIRBAIRN    
  Kevin Fairbairn   
  President, Chief Executive Officer and Director    

 

 

         
Exhibit 31.2
I, Jeffrey Andreson certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q of Intevac, Inc.;
 
2.   Based on my knowledge, this 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 report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this 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 report;
 
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: November 8, 2007
         
     
  /s/ JEFFREY ANDRESON    
  Jeffrey Andreson  
  Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary    
 

 

 

         
Exhibit 32.1
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 Quarterly Report of Intevac, Inc. on Form 10-Q for the quarterly period ended September 29, 2007 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-Q fairly presents in all material respects the financial condition and results of operations of Intevac, Inc.
             
 
  By:
Name:
  /s/ KEVIN FAIRBAIRN
 
Kevin Fairbairn
   
 
  Title:   President, Chief Executive Officer and Director    
     I, Jeffrey Andreson, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Intevac, Inc. on Form 10-Q for the quarterly period ended September 29, 2007 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-Q fairly presents in all material respects the financial condition and results of operations of Intevac, Inc.
             
 
  By:
Name:
  /s/ JEFFREY ANDRESON
 
Jeffrey Andreson
   
 
  Title:   Vice President, Finance and Administration,    
 
      Chief Financial Officer, Treasurer and Secretary    
     A signed original of this written statement required by Section 906 has been provided to Intevac, Inc. and will be retained by Intevac, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.