BUSINESS

The following Business section contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Risk Factors" and elsewhere in this Prospectus.

INTRODUCTION

Intevac, Inc. ("Intevac" or the "Company") is a leading supplier of static sputtering systems and related manufacturing equipment used to manufacture thin-film disks for computer hard disk drives. Sputtering is a complex vacuum deposition process used to deposit multiple thin-film layers on a disk. The Company's principal product, the MDP-250B, was introduced in 1994 and is the fourth generation of the Company's Magnetic Disk Processing ("MDP") system. The MDP-250B system enables disk manufacturers to achieve high coercivities, high signal-to-noise ratios, minimal disk defects, durability and uniformity, all of which are necessary in the production of high performance, high capacity disks. Additionally, the Company's static systems allow disk manufacturers to achieve low production costs through high yield, high uptime, and low acquisition, operating and facilities costs. The Company's primary objective is to be the industry leader in supplying disk sputtering equipment by providing disk sputtering systems which have both the highest overall performance and the lowest cost of ownership in the industry.

INDUSTRY BACKGROUND

The market for computer disk drives is large and growing rapidly, driven primarily by the demand for new personal computers ("PCs") and upgrades to existing PCs. Requirements for data storage capacity are also increasing with the development of more memory intensive software, including complex operating systems such as Windows 95 and programs such as multimedia computing applications, and more powerful and faster microprocessors and other computer hardware. Because hard disk drives are the principal means for storing and rapidly retrieving large amounts of digital data, the market for hard disk drives has also grown at a rapid rate. According to International Data Corporation ("IDC"), hard disk drive shipments were 50 million units in 1993, are expected to reach 115 million units in 1996 and are projected to reach over 201 million units in 1999. IDC expects the worldwide market for hard disk drives to be $28 billion in 1996.

The disk drive industry is characterized by short product lives, frequent technological advances and intense competition. These technological advances have resulted in significant increases in disk storage capacity and lower cost per megabyte of storage. Typical disk drive storage capacity has increased more than tenfold in the last five years, from approximately 30 to 60 megabytes in 1989 to approximately 500 to 1,000 megabytes in 1995. While the amount of storage capacity has increased significantly during this period, typical disk drive form factors have decreased from 5.25 inches to 3.5 inches. Hard disk drive storage capacity can be increased by adding more disks to the disk drive or by increasing the areal density (the number of bits of data stored per unit of area)of the disks. Although the number of disks used in disk drives has begun to increase recently, it had remained approximately the same over the last five years while the areal density of the disks has increased rapidly during this period. The increase in disk drive capacity has therefore been primarily accomplished by increasing the storage capacity of the disks themselves. According to TrendFOCUS, an independent market research firm, the number of thin-film disks produced in 1993 was 134 million, is expected to be 336 million in 1996 and is projected to reach 609 million in 1999. TrendFOCUS expects the worldwide market for thin-film disks to be $4.2 billion in 1996.

The Company's business depends upon capital expenditures by manufacturers of thin-film disks, of which there are a limited number worldwide. According to TrendFOCUS, as of the end of 1995, there were 187 installed disk sputtering lines (sputtering systems and related equipment such as plating, polishing, texturing, lubrication and test equipment as well as related handling equipment)

worldwide and only 14 companies in the world with five or more installed disk sputtering lines. The Company's opportunities to sell its systems are limited by the fact many manufacturers of thin-film disks have adopted an in-line approach as opposed to the Company's static approach to thin-film disk manufacturing.

DISK MEDIA TECHNOLOGY

The disks in a hard disk drive are substrates that have been coated with several thin-film layers and are used as a storage medium for digital data. A thin magnetic film on the disk is capable of storing information in the form of magnetic patterns written and read by the disk drive recording head. The production of thin-film disks involves several complex process steps requiring specialized and expensive manufacturing equipment and facilities. The following briefly summarizes the steps in this manufacturing process:

- Plating, polishing and texturing. The disk substrate (typically aluminum), which must be flat, smooth and free of surface defects, is plated with a non-magnetic layer for strength and durability. The substrate is then polished and textured to produce a controlled roughness on the disk's surface. This improves the friction characteristics so that the disk drive head will not stick to the disk during operation.

- Sputtering. Sputtering is a complex vacuum deposition process used to deposit multiple thin-films on the disk. The initial thin-film layers are various alloys that produce the magnetic qualities of a disk. The final thin-film layer is a protective carbon overcoat. The layers vary in thickness but are all very thin, typically less than 1/2,000th the thickness of a piece of paper. The following diagram depicts the layering of the thin films on a disk substrate:

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- Lubrication. After thin-film sputtering, a microscopic layer of lubricant is applied to the disk's surface to improve durability and reduce surface friction.

- Test and certification. In the test and certification process, each disk is electronically scanned for both film integrity and asperity control and to ensure that the disk operates to the customer's specifications.

Improvements in the disk sputtering process have contributed significantly to increases in disk storage capacity through increasing areal density (the number of bits of data stored per unit of area). The most significant advances in disk media technology have been the achievement of better magnetic characteristics and improved mechanical properties permitting lower flying heights. Flying height, the distance between the head and the disk while the disk drive is operating, depends on the smoothness and flatness of the disk surface.

CHALLENGES FACING THIN-FILM DISK MANUFACTURERS

Because of the increasing demand for reliable, rapid access storage and the intense competitiveness in the disk drive industry, disk drive manufacturers continually seek to produce higher capacity disk drives at a lower cost per megabyte of storage. Many thin-film disk manufacturers address this requirement by producing higher capacity disks capable of higher areal densities. As thin-film disk manufacturers do this, they face technical and operational challenges that fall into two principal categories: the production of high performance disks and the control of disk production costs.

Production of high performance disks.

The ability of thin-film disk manufacturers to produce disks capable of high areal density is directly related to the manufacturer's ability to consistently control disk attributes that are largely determined in the sputtering process. The disk attributes include the following:

- Coercivity. Coercivity, a measure of the magnetic strength of the disk, is expressed in Oersted ("Oe"). The magnetic strength of the disk is determined by the types of disk substrate and thin-film materials used; substrate surface conditions before disk sputtering; and the conditions that exist during the sputtering process, including temperature, vacuum and possible sources of disk contamination. Coercivity is increasingly important as areal density increases because higher coercivity permits sharper transitions between magnetized regions, essentially allowing bits of data to be closer together and therefore more data to be stored in the same disk area. Advanced drive designs today require coercivities in the range of 1800 to 2200 Oes compared to a range of 950 to 1,200 required five years ago. The Company believes coercivity requirements will continue to increase significantly over the next several years.

- Signal-to-noise ratio. The proper choice of magnetic alloy material and the uniform deposition of this material on the disk help to reduce "noise" (unwanted signals), thereby improving the signal-to-noise ratio of the data that is read from the disk. Higher signal-to-noise ratios permit higher recording density and better data rates.

- Defects. Suitability of the disks for use in disk drives with high areal density is dependent upon both the number and the size of surface imperfections on the disk. Surface imperfections result from a variety of factors, including preexisting substrate surface imperfections, minor damage, contaminants trapped in the sputtered film and non-uniform sputtering of the thin-film layers. As more data is stored in the same disk space, the number and size of disk defects that can be tolerated must be reduced.

- Smoothness and flatness. As areal density increases, a smaller magnetized region stores each bit of data. The lower the disk head flying height, the more accurately the head can read the magnetic signal. The smoother and flatter the disks, the lower the flying height that can be achieved without the head contacting the disk.

- Durability. Because the head and disk come into physical contact when the disk drive is turned off, a protective carbon overcoat is sputtered over the magnetic layer to minimize wear on the disk, to protect the information stored on the disk and to increase the useful life of the disk drive. The thickness of this overcoat must nevertheless be minimized in order to allow the head to fly as close as possible to the magnetic layer.

- Uniformity. The performance of a disk is affected by the uniformity of all of the above characteristics across the entire surface of the disk. Such uniformity is substantially affected by the quality of the disk sputtering process.

Control of disk production costs

It is important for thin-film disk manufacturers to control disk production costs in order to be competitive. Some of the most significant costs in the disk manufacturing process are influenced by the disk sputtering equipment. Disk manufacturers seek to lower their per disk manufacturing costs as part of the sputtering process by attention to:

- Yield. Overall yield significantly affects per disk manufacturing costs. The capability and performance of the sputtering equipment can significantly affect overall yield.

- Equipment acquisition and operating costs. Although acquisition costs are substantial, the cost of using the sputtering equipment, including operators, maintenance, spare parts and consumables over the life of the equipment is more significant.

- Increasing uptime and throughput. Operating cost per disk produced is directly related to the uptime and throughput realized from the equipment.

- Facilities costs. The loading and unloading portions of the sputtering machine must be in a clean room. Clean room space is very expensive to build, operate and maintain. Both the size and footprint of sputtering systems affect the amount of clean room space required to house them and the degree to which the manufacturing facility must be customized to accommodate the sputtering equipment.

- Time and cost of making process adjustments. At times during the production of disks it is necessary or desirable to add, remove or make adjustments to certain process steps. To the extent that process engineers are able to do so quickly and efficiently, the disk manufacturer is able to reduce equipment and line downtime and therefore reduce its per disk manufacturing cost.

- Flexible production scheduling. OEM customer specifications for disks and the mix of different disks produced by thin-film disk manufacturers vary. To the extent that the disk manufacturer has the flexibility to quickly and efficiently alter the product mix and volume of disks produced through its production lines, the disk manufacturer is able to rapidly respond to changing customer requirements.

THE TRADITIONAL "IN-LINE" THIN-FILM DISK SPUTTERING APPROACH

Traditionally, thin-film disk manufacturers typically used in-line systems for disk sputtering, and these systems continue to play a significant role in media manufacturing. An in-line machine involves the use of a pallet typically holding 16 or more disks. The pallet begins at one end of the machine and travels on a long conveyor through various chambers in which all of the disks in the pallet are processed while the pallet is moving. The following drawing depicts a typical in-line system:

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As the specifications and tolerances for media have become more demanding, several features typical of the in-line system architecture have created increasingly significant challenges for media manufacturers using in-line systems. These challenges include the following:

- Limited vacuum isolation. The architecture of typical in-line systems makes it very difficult to achieve optimum conditions for each process step because of imperfect vacuum isolation as disks move from one process step to the next.

- Contamination from the pallet. In an in-line system, disk substrates are processed while on the pallet. As the pallet goes through the machine repeatedly the pallet collects sputtered material (condensate). When the pallet is exposed to the atmosphere, the condensate absorbs gas which is partially released on the next cycle through the machine. This background gas degrades the properties of the magnetic film. In addition, condensate can flake off the pallet and contaminate disk surfaces, reducing yields.

- Spatial variations. The large size of the pallets and the movement of the pallets during sputtering both result in spatial variations in process conditions and disk temperatures. Even small temperature variations can cause a variation in magnetic properties, which may result in a lack of uniformity on a given disk or from disk to disk.

- Size of the machines. In-line machines are large (often more than 30 feet long), and the time required for the machine to reach stable operating conditions is longer than for smaller machines. In addition, the large size and linear configuration of in-line systems make it difficult to add process steps after installation.

Those thin-film disk manufacturers that have adopted an in-line approach have typically made significant investments in manufacturing equipment and processes. Therefore, some have chosen to overcome the challenges outlined above by making extensive modifications to their equipment in order to extend its useful life. These challenges are increasingly difficult to overcome. For example, reduced bit sizes associated with increased coercivities and reduced flying heights substantially narrow the range of permissible defect levels and signal-to-noise ratios, which can require manufacturers using in-line systems to make substantial modifications to their manufacturing systems. In addition, as disk production evolves to require additional process steps, manufacturers using in-line systems may be required to add additional chambers and processes to their systems, which may be cumbersome, difficult and expensive. The technical challenges facing manufacturers using in-line systems may become even more difficult to address to the extent that new technological developments, such as magneto-resistive heads and alternative substrates such as glass and ceramics, emerge and gain market acceptance. While a number of disk media manufacturers are expected to continue to employ in-line systems, others have chosen to implement alternative approaches to disk media manufacturing.

INTEVAC'S STATIC MANUFACTURING APPROACH

In 1982, Varian formed a business unit to design a disk sputtering system to address the inherent limitations of the in-line sputtering architecture. That business, acquired by Intevac in 1991, developed a single disk, multiple chamber static sputtering system, similar in concept to the single wafer processing machines used by the semiconductor industry. The Company's static systems differ from in-line systems in that static sputtering provides for deposition with no relative movement between the sputtering source and the disk being coated. Each disk is placed sequentially in fully isolated chambers in which various process steps are performed. The initial, first-generation static system, introduced in 1985, produced high performance disks but had low throughput compared with in-line systems. The Company's current, fourth-generation static system has a throughput of approximately 450 disks per hour, more than three times the throughput of the first-generation system. The Company believes this system is competitive with in-line systems on a cost per disk basis. The capability for making high performance disks has also been improved. For example, the current system has twelve process chambers compared to six chambers for the initial model. These improvements have led to a number of thin-film disk manufacturers adopting the static sputtering approach much as semiconductor manufacturers have moved away from batch processing systems to single wafer multiple chamber processing systems. The following drawing depicts the Company's MDP-250B static sputtering system:

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The Company's static sputtering system enables manufacturers to achieve high coercivities, high signal-to-noise ratios, minimal defects, high durability and high uniformity, all of which are necessary in the production of high performance, high areal density disks. Additionally, Intevac's static system allows the disk manufacturer to achieve low production costs through high yield, low equipment acquisition and operating costs, high uptime and low facilities costs.

The key features and benefits of the Intevac static sputtering approach are:

- Isolated process chambers. The Company's sputtering systems have isolated vacuum process chambers which can be separately controlled and optimized for each process step, enabling manufacturers to more efficiently achieve high levels of coercivity.

- Single disk processing. Each disk substrate is individually processed under the same process parameters in the Company's system. Disk to disk repeatability is high in the Company's sputtering systems because every disk is subjected to nearly identical static process conditions, and the thin-film coating is uniform due to the cylindrical shape and other design features of the sputter sources.

- Reduced contamination. In an Intevac system there is no pallet that is exposed to the atmosphere and then introduced into the process chambers; thus no absorbed gas on a pallet from outside the vacuum system can contaminate the sputtering process. The short time intervals between process steps further minimizes contamination of the disk surface and makes it possible for the Company's disk sputtering systems to produce thin-film disks with high coercivity.

- Precise temperature control. Intevac's sputtering systems afford precise temperature control and rapid changes in substrate temperature. This permits optimization of the conditions for deposition of the magnetic film in order to achieve high coercivity, while creating different process conditions for the top coat deposition in order to maximize durability.

- Rapid process development. The Company's systems permit rapid and precise change in process parameters. Stability of process conditions is achieved quickly, which significantly shortens process development time and new product qualification as well as disk production ramp up.

- Cost-effective, high throughput. The Company's systems have short transport time intervals and high sputtering rates, which enable high disk production throughput. Intevac has designed its sputter sources for high target utilization; this feature, together with the ability to use either platinum or non-platinum alloy targets to produce high coercivity disks, significantly reduces operating costs.

- Flexible manufacturing. The Company's multi-chamber, static systems fit well into relatively small scale production lines that can be installed, modified or expanded relatively quickly and comparatively inexpensively. This allows the disk manufacturer to incrementally change production levels and mix, to rapidly adapt manufacturing equipment to new product technology and to achieve fast production ramp up. The Company's static manufacturing systems thus allow the thin-film disk manufacturer to meet its customers' increasingly rapid time-to-market demands.

- Reduced facilities costs. The Company's system occupies approximately 370 square feet of factory floor space, including less than 30 square feet of clean room space. A critical cost factor for disk manufacturers is clean room facility costs, which can cost several hundred dollars per square foot for initial construction and are very expensive to operate. The size of the Company's systems therefore reduces the cost of building and operating the manufacturing facilities.

The Company has continuously introduced static sputtering systems that give manufacturers more control of the disk manufacturing process thereby allowing manufacturers to produce high performance high density disks. The advanced technology incorporated in the static system design has allowed

Intevac to meet the rapidly changing needs of the disk drive industry. For instance, the design of the Intevac system allows the manufacture of disks that can be used with psuedo-contact recording and magneto-resistive disk drive heads as well as the sputtering of thin-films onto alternative substrates.

STRATEGY

The Company's primary objective is to be the industry leader in supplying disk sputtering equipment by providing disk sputtering systems which have both the highest overall performance and the lowest cost of ownership in the industry. Key elements of the Company's strategy include the following:

Maintain Industry Leadership. The Company is a leading supplier of static sputtering systems for thin-film disk manufacturing. Intevac intends to maintain this leadership position while continuing to advance the role of static sputtering in the thin-film disk manufacturing industry.

Advance Technology Leadership. The Company believes it is currently a technology leader in the design and manufacture of static sputtering systems for thin-film disks. The Company intends to leverage the static architecture of its products to enhance the functionality of its static sputtering systems through development of advanced process techniques, higher system performance and greater throughput, while lowering the overall cost of the sputtering process to disk manufacturers.

Provide the Lowest Overall Cost of Ownership. The Company has focused and will continue to focus on providing to its customers sputtering systems and related disk manufacturing equipment with the lowest overall cost of ownership in the industry. The Company intends to achieve this goal by continuously seeking to improve system performance, throughput, uptime and product yield and by reducing costs related to operating and maintaining its systems.

Leverage Strategic Customer Relationships. The Company's customers include many of the world's leading manufacturers of thin-film disks. The Company works and intends to continue to work closely with these customers to meet their current manufacturing needs, to develop future generations of disk sputtering systems and to improve fabrication processes and manufacturing costs while meeting performance expectations.

Achieve High Level of Customer Service. The Company will continue to place a strong emphasis on quickly responding to customer needs and supporting each customer from the initial contact through the delivery, installation, ramp up and operation of the Company's equipment. The Company seeks to provide the industry's highest level of service to its customers.

Minimize Manufacturing Cost. The Company's manufacturing strategy is to produce high quality, cost-effective systems and low cost replacement parts and to be able to respond effectively to changes in volume. To do this, the Company currently designs its products to use standard parts where possible. The Company performs manufacturing activities that add value or that require unique technology or specialized knowledge and, taking advantage of its Silicon Valley location, utilizes subcontractors to perform other manufacturing activities.

Expand Product Offerings. The Company believes that significant opportunities exist in the thin-film disk manufacturing industry. It intends to acquire technologies or businesses that enable it to expand its current product offerings to thin-film disk manufacturers. In this regard, the Company made three acquisitions in the first six months of 1996. The Company acquired certain advanced sputter source technology and products; a company that sells lubrication equipment used in the manufacture of thin-film disks; and a company that sells contact stop/start test equipment for computer hard disk drives and drive components. In addition, Intevac believes that its expertise and technology may have applications other than for thin-film disk manufacturing and intends to expand its product offerings to other applicable markets through internal development or acquisitions of products or technologies. In this regard, the Company is currently developing products for the flat panel display industry.

PRODUCTS AND TECHNOLOGY

HOW SPUTTERING WORKS

Sputtering is a vacuum deposition process for creating thin uniform layers of very pure materials by bombarding a target of the desired material with energetic ions of a noble gas, usually Argon. The Argon ions strike the surface of the target with sufficient energy to dislodge atoms from the target and propel them away from the target surface. These dislodged atoms coat the surface of the substrate and form the desired film. Conditions for sputtering are achieved through the proper combination of vacuum level, electric field and magnetic field. The following diagram depicts the sputtering of a thin-film layer on a disk:

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THE MDP-250B DISK SPUTTERING SYSTEM

The Company's principal product is the MDP-250B disk sputtering system, introduced in 1994, and is the fourth generation of the Company's "Magnetic Disk Processing" systems. The MDP-250B is fully automated, has 12 independent process stations and achieves throughput of approximately 450 disks per hour. Including sales by Varian prior to the acquisition, the Company has sold 80 MDP systems, of which 13 are MDP-250B systems. The Company's list prices for the MDP-250B range from $2.0 million to $4.0 million, depending upon configuration, with the most common configurations resulting in end user prices of $2.5 million to $3.0 million.

The MDP-250B was designed by the Company to meet current requirements for the production of media and to provide the capability to meet future requirements. The MDP-250B is capable of producing disks with coercivity in excess of 2,500 Oe with or without a costly platinum based magnetic layer. In addition, the MDP-250B has the capability to sputter multi-layers (multiple magnetic layers with interspersed non-magnetic layers) onto alternative substrates (such as glass and ceramic), as well as conventional aluminum substrates, and also to make media with the appropriate characteristics for use with MR heads.

The mechanical design of the MDP-250B has characteristics which are similar to the cluster tools which are widely used in semiconductor manufacturing since each process station is separately vacuum pumped and is vacuum isolated during processing. The MDP-250B does not require a carrier or pallet to transport disks through the system. Cassettes containing 25 substrates are automatically

moved one at a time to pedestals located on the rim of the disk transfer wheel. This wheel moves up and down and rotates, moving the disks sequentially into and out of the process chambers. When the wheel is in its up position, each process chamber is vacuum isolated from the transport chamber and from other process stations. The disks pass through up to 12 process stations, and are then placed in a cassette, which when full, moves into the exit load lock, from which it moves into the exit conveyor.

The following drawing shows the transport mechanism designed into the MDP-250B disk sputtering system:

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Any number of process steps, up to 12, can be outfitted as the customer requires. The process station options include the direct current ("DC") or radio frequency ("RF") sputter process stations, an infrared substrate heating station, a gas conduction substrate cooling station and a sputter etch cleaning station. The Company designed its MDP-250B with twelve stations, more than current needs require, in order to support future, more complex manufacturing processes. The 12 independent process stations make it possible to produce disks with multi-layers, which reduce noise and thereby increase the signal to noise level of the data stream that is read from the disk. This permits higher recording density and data rates. Furthermore, process stations can be moved from any machine process position to any other to easily accommodate process changes.

The sputtering sources have been designed to provide for high utilization of the target material thus reducing the cost of depositing the various thin films. The Company is currently redesigning its CM-GUN, the sputtering source currently used in the MDP-250B, to provide for greater target utilization and longer target life. The Company is planning to incorporate the ES-GUN sputtering source acquired from Cathode into the MDP-250B. The ES-GUN electrically sweeps plasma radially at the target which results in greater target utilization, longer target life and permits the deposition of two different materials sequentially in the same chamber. In addition, the Company is developing the RM-GUN sputtering source which uses a special rotating magnet assembly designed to achieve greater target utilization and longer target life for both magnetic and non-magnetic targets.

MDP-250B operation is controlled by a computer program which displays commands and process information on a color monitor. A user interface is provided which allows an operator to monitor process and to access the programmable controller. A color display unit and a keyboard located in the clean room enable an operator or engineer to access the computer program to control deposition or other processes through appropriate menu choices, to monitor deposition data, or to call up certain access-protected service mode subroutines. A data logging feature of the system enables users to transmit to a host computer the values of the parameters existing at each process station, providing valuable quality control information.

A "top coat" is sputtered onto the disk immediately over the magnetic recording layer to protect the recording layer from corrosion and mechanical damage due to head contact and to provide a surface condition that in conjunction with the lubrication layer minimizes "stiction," the tendency of the head to stick to the disk surface. The top coat is typically carbon or a carbon based substance. The Company believes that optimum deposition of carbon occurs at a lower temperature than is required for the magnetic layer. The MDP-250B incorporates a patented cooling station which permits the required reduction of disk temperature to be achieved within a few seconds. The Company believes that this feature plus the capability to sputter carbon in conjunction with hydrogen or nitrogen makes it possible for the MDP-250B to produce disks that are highly durable.

The MDP-250B sputters 3 1/4 inch and smaller diameter disks. The Company is currently developing the MDP-250C sputtering system which will have all the features of the MDP-250B but will sputter 5 1/4 inch diameter disks.

RELATED DISK MANUFACTURING AND TEST EQUIPMENT

The Company has recently acquired two companies with product lines that complement the MDP-250B. In May 1996, the Company acquired San Jose Technology Corp. ("SJT"), a leading supplier of systems used to lubricate thin-film disks. Lubrication is the production step that typically follows disk sputtering in the manufacture of thin-film disks. During lubrication, a microscopic layer of lubricant is applied to the disk's surface to improve durability and reduce surface friction. SJT's products allow thin-film disk manufacturers to uniformly lubricate disks in a temperature controlled, low vibration, contamination free environment with a minimal amount of solvent loss. In June 1996, the Company acquired Lotus Technologies, Inc. ("Lotus"), a leading manufacturer of contact stop/ start ("CSS") test equipment for hard disk drives and drive components. The Lotus family of PC-based CSS test equipment performs precise measurements of disk wear, friction, stiction and start-stop torques related to the interface of the read-write head with the thin-film disk. The Company intends to use the Lotus expertise in head-disk interface and CSS testing to further improve the Company's disk sputtering and disk lubrication equipment.

- - Sputtering processes              - Thermal systems design
- - Sputter source design             - Design of complex electromechanical systems
- - Thin film characterization        - Material transport systems and robotics
- - Vacuum system design              - Computer based control systems

The Company's scientists and engineers are knowledgeable about disk manufacturing processes and work with the Company's customers to design hardware and software systems to meet the customers' requirements. The Company has a MDP-250B in its laboratories to run various process tests for customers to determine the suitability of the machine for their production process, and also for the Company's design engineering department to test newly designed process capabilities. The Company

believes that its process expertise, and the ability to communicate with its customer's process scientists, gives it an important competitive advantage.

The Company has the expertise to design apparatus for rapid, uniform substrate heating and cooling, substrate cleaning using glow discharge and sputter etch techniques, as well as both DC and RF sputtering. A particular area of Company expertise is computer modeling, as well as practical design of the electromagnetic magnetron sputtering sources which are at the heart of the system. The Company believes that the ability to control magnetic field strength using electromagnetic magnetrons is an advantage in maintaining tight process control. The Company's computer programs also are used to calculate the uniformity of sputtered film thickness and magnetic characteristics and the overall utilization of target materials.

NEW BUSINESS PROJECT: FPD MANUFACTURING EQUIPMENT

In recent years, flat panel displays ("FPDs") have emerged as a display technology for a variety of applications such as PCs, workstations and video displays. The manufacture of several types of flat panel displays such as STN, AMLCD and FED require the use of a sputtering process to deposit thin-film layers of different materials onto a glass substrate.

In 1992, after evaluating the dynamics of the FPD market and the technical requirements of meeting that market need, the Company initiated a program to develop a sputtering system for this market as the first step to enter this business area. The Company believes that the skills and technologies that it has developed for the thin-film disk manufacturing industry are directly applicable to the FPD manufacturing industry. These skills and technologies include its expertise and experience in sputtering, rapid heating, high vacuum, isolated process chambers and material handling. In addition, as with the thin-film disk manufacturing industry, the FPD industry involves providing complex, expensive capital equipment to a small number of customers worldwide.

Since inception, the Company has invested approximately $8.6 million in the flat panel sputtering development effort, of which approximately half has been paid by Ebara Corporation ("Ebara"). The Company entered into its agreement with Ebara in September 1992. Under the agreement, as amended, Ebara has agreed to pay one-half of the development costs of the flat panel sputtering system, up to a maximum amount of $5.5 million, in exchange for joint ownership of the intellectual property rights, the exclusive right to manufacture flat panel sputtering systems in Japan and the exclusive right to market and sell such systems in the Far East. Under the agreement, the Company has retained the exclusive right to manufacture flat panel sputtering systems in the United States and the exclusive right to market and sell such systems in the United States and Europe. Each party is required to pay royalties to the other party on its flat panel sputtering system sales. The agreement expires five years following completion of the joint development project. The Company has not yet completed development of its flat panel sputtering systems.

In 1994, the Company identified an additional opportunity in the FPD market. Certain advanced FPDs require amorphous silicon deposited on the substrate to be converted into poly-silicon. An effective way to accomplish this is to rapidly heat the amorphous silicon to a high temperature. In 1994, the Company acquired certain assets of Aktis Corporation and certain patents from Baccarat Electronics, Inc. and continued a project to develop a rapid thermal processing ("RTP") system for converting amorphous silicon into poly-silicon. The Company has sold two RTP systems. Also in 1994, ARPA awarded the Company a contract to develop an "All Sputtered Thin Film Transistor."

The Company currently has contracts with ARPA providing for maximum funding over the lives of the contracts of approximately $3.3 million. As of March 30, 1996, the cumulative billings were approximately $1.1 million, unspent backlog under these contracts was approximately $1.3 million and approximately $0.9 million had not yet been funded under the contracts. In 1995, the Company spent $4.6 million on research and development, which included $2.5 million that was spent on research and development related to the Company's FPD efforts. Of the amounts spent on FPD projects during

1995, approximately 72% of the funding was provided by customer sponsored research and development contracts and/or cost sharing agreements.

The Company has limited experience in the development, manufacture, sale and marketing of flat panel display manufacturing equipment, having sold only two RTP systems to date and having not yet completed development of its FPD sputtering system. There can be no assurance that the market for flat panel display manufacturing equipment targeted by the Company will develop as quickly or to the degree the Company currently anticipates, or that the Company's proposed FPD manufacturing equipment will achieve customer acceptance or that the Company will achieve any net revenues from the sale of its proposed FPD manufacturing equipment. There can be no assurance the Company will receive additional customer sponsored research and development funding in the future. The failure to receive additional customer sponsored research and development funds could result in the Company internally funding the development of such FPD manufacturing equipment, and the costs of such research and development may have a material adverse effect on the Company's results of operations. There can be no assurance that the Company in any event will continue to fund research and development in the of FPD area. See "Risk Factors -- Flat Panel Display Manufacturing Equipment Risks."

SALES CHANNEL, CUSTOMERS AND MARKETING

The selling process for the Company's products is often a multi-level and long-term process involving individuals from marketing, engineering, operations, customer service and senior management. The process is lengthy and involves making sample thin-film disks for the prospective customer and responding to individual needs for moderate levels of machine customization. The Company sells and markets its products directly in the United States, and through exclusive distributors in Japan (Matsubo), Taiwan (Scientek) and Korea (Chung Song). The Company has established a subsidiary in Singapore to support its customers in Southeast Asia. The Company is also in the process of increasing its sales and marketing efforts by expanding its marketing and technical support staff. See "Risk Factors -- Management of Expanding Operations."

Historically, a significant portion of the Company's revenues in any particular period have been attributable to sales to a limited number of customers. For example, Western Digital, Matsubo and Trace accounted for 21%, 14% and 11%, respectively, of the Company's total net revenues during 1993, and Trace, Matsubo, Seagate, Varian Associates and Komag accounted for 25%, 15%, 13%, 12% and 10%, respectively, of the Company's total net revenues during 1994. Seagate, HMT Technology and Matsubo accounted for 40%, 20% and 17%, respectively, of the Company's total net revenues during 1995. International sales accounted for 32% of revenue in 1993, 40% in 1994, and 20% in 1995. The Company expects that international sales will continue to be a significant portion of its revenues in the foreseeable future.

Intevac sells static sputtering systems to both captive and merchant thin-film disk manufacturers. Captive thin-film disk manufacturers produce disks to be used in disk drives they manufacture, and merchant thin-film disk manufacturers produce disks to be included in disk drives manufactured by third parties. Since 1991 Intevac systems have been installed for or ordered by the following customers:

Akashic Memories
Fuji Electric
Hitachi
HMT Technology
IBM
Komag
Mitsubishi
Seagate
Trace
Western Digital

The Company participates in trade shows, publishes articles, makes presentations at technical meetings, participates in industry trade groups and consortiums, and distributes promotional literature. See "Risk Factors -- Customer Concentration" and "-- Limited Number of Opportunities."

CUSTOMER SUPPORT

Since media production lines are often operated 24 hours per day, seven days per week, continuing service support is of vital importance and thus the Company provides process and applications support, customer training, installation and start-up assistance and emergency service support to its customers. Over the past 18 months the Company has taken several steps to substantially improve customer support including expanding the training program, increasing the number of service engineers, adding product support engineering capability, reducing delivery times for spare parts and providing 24 hour per day response.

Process and applications support is provided by equipment process scientists who have access to a dedicated MDP-250B in the Company's applications laboratory, and who also visit customers at their plants to assist in process development projects.

The Company conducts training classes for process scientists, machine operators and machine service personnel. Additional training is also given during the machine installation.

Installation and start up of the sputtering systems are provided within the United States by the Intevac customer service organization. This group also assists with the installation and start up of sputtering systems in overseas locations as required.

The Company provides a standard warranty for up to twelve months from customer acceptance or 2,000 hours of operation, whichever occurs first. During this warranty period any necessary non-consumable parts are supplied and installed. Currently the Company has seven full time trained servicemen to provide service to United States customers. Overseas service is provided by the Company's distributor and representatives using personnel who have received training at Intevac. Intevac stocks consumables and spare parts to support the installed base of systems. These parts are available on a 24 hour per day basis. Intevac distributors provide a similar service for overseas customers.

Consistent with the Company's strategy to provide the industry's highest level of service to its customers, the Company is currently establishing operations in Singapore. The subsidiary Intevac is establishing in Singapore will provide customer training, installation, start-up assistance, spare parts and service support to customers in Southeast Asia.

BACKLOG

The Company's backlog was $45.6 million and $25.2 million at March 30, 1996 and April 1, 1995, respectively. The Company includes in its backlog only those customer orders for systems, component parts and contract research and development for which it has accepted signed purchase orders with assigned delivery dates. In the case of a cancellation of a system order, the Company's system sales contracts generally provide for a non-refundable deposit, depending upon when the order is cancelled, typically 30%. The equipment requirements for thin-film disk manufacturers cannot be determined with accuracy, and therefore the Company's backlog at any certain date may not be indicative of future demand for the Company's manufacturing systems. See "Risk Factors -- Customer Concentration."

Due to recent increases in demand, the average time between order and shipment of the Company's systems may increase substantially in the future. The Company's ability to quickly increase its manufacturing capacity in response to short-term increases in demand, if any, could be limited given the complexity of the manufacturing process, the lengthy lead times necessary to obtain critical components and the need for highly skilled personnel. The failure of the Company to satisfy any such short-term increases in demand and to keep pace with customer demand would lead to further extensions of delivery times, which could deter customers from placing additional orders, and could adversely affect product quality, which could have a materially adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Manufacturing Risks."

RESEARCH AND DEVELOPMENT

The disk drive industry in general, and the thin film disk manufacturing industry in particular, are characterized by rapid technological change and evolving industry standards. The Company has invested substantial amounts in research and development for its disk sputtering systems and flat panel display manufacturing equipment. The Company's research and development expenses in 1993, 1994, 1995 and the first three months of 1996 were $3.1 million, $3.5 million, $2.6 million, and $1.4 million respectively, and represented 14.0%, 17.2%, 6.1% and 9.1%, respectively, of net revenues. Research and development expenses do not include costs of $1.1 million, $2.0 million and $0.9 million that were incurred by the Company in 1995, 1994 and 1993, respectively, reimbursed under the terms of a research and development cost sharing agreement with the Company's Japanese development partner. In addition, research and development expenses do not include expenditures in connection with contract research and development activities since these are charged to cost of sales.

The Company expects to continue an active development program to make sputter system improvements to increase machine throughput, add additional capabilities that will improve disk performance, permit optimum utilization of alternative substrates, lower cost of ownership and respond to future market requirements. The Company's ability to remain competitive has required and will continue to require substantial investments in research and development to advance its technologies. The failure to develop, manufacture and market new systems, or to enhance existing systems, would have a material adverse effect on the Company's business, financial condition and results of operations. In the past, the Company has experienced delays from time to time in the introduction of, and certain technical difficulties with, certain of its systems and enhancements. In addition, the Company's competitors can be expected to continue to develop and introduce new and enhanced products, any of which could cause a decline in market demand for the Company's systems or a reduction in the Company's margins as a result of intensified price competition. With respect to the Company's research and development activities related to flat panel display manufacturing equipment, See "-- New Business Project: FPD Manufacturing Equipment." See also, "Risk Factors -- Flat Panel Display Manufacturing Equipment Risks."

Changes in the manufacturing processes for thin-film disks could also have a material adverse effect on the Company's business, financial condition and results of operations. The Company anticipates continued changes in the requirements of the disk drive industry and thin-film disk manufacturing technologies. There can be no assurance that the Company will be able to develop, manufacture and sell systems that respond adequately to such changes. In addition, the data storage industry is subject to constantly evolving technological standards. There can be no assurance that future technological innovations will not reduce demand for thin-film disks. The Company's business, financial condition and results of operations could be materially adversely affected by any trend toward technology that would replace thin-film disks as a storage medium.

The Company's success in developing and selling new and enhanced systems depends upon a variety of factors, including accurate prediction of future customer requirements, technology advances, cost of ownership, introduction of new products on schedule, cost-effective manufacturing and product performance in the field. The Company's new product decisions and development commitments must anticipate the requirements for the continuously evolving disk drive industry approximately two or more years in advance of sales. Any failure to accurately predict customer requirements and to develop new generations of products to meet those requirements would have a sustained material adverse effect on the Company's business, financial condition and results of operations. New product transitions could adversely affect sales of existing systems, and product introductions could contribute to quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline. There can be no assurance that the Company will be successful in

selecting, developing, manufacturing and marketing new products or enhancements of existing products. See "Risk Factors -- Rapid Technological Change."

MANUFACTURING

Substantially all of the Company's manufacturing is conducted at its headquarters facility in Santa Clara, California. The Company's manufacturing operations include electromechanical assembly, mechanical and vacuum assembly, fabrication of the sputter sources, and system assembly, alignment and testing. The Company makes extensive use of the infrastructure serving the semiconductor equipment business. The Company purchases vacuum pumps, valves, instrumentation and fittings, power supplies, printed wiring board assemblies, computers and control circuitry and specialized mechanical parts made by forging, machining and welding. The Company has a well-equipped fabrication center that is capable of producing most of the fabricated metal parts. This capability is used primarily for quick reaction requirements for design work or to cover shortages and most of the parts required for production are purchased from outside suppliers.

The Company's manufacturing strategy is to produce high quality, cost-effective systems and low cost replacement parts and to be able to respond effectively to changes in volume. To do this, the Company currently designs its products to use standard parts where possible. The Company performs manufacturing activities that add value or that require unique technology or specialized knowledge and, taking advantage of its Silicon Valley location, utilizes subcontractors to perform other manufacturing activities.

In certain instances, the Company is dependent upon a sole supplier or a limited number of suppliers, or has qualified only a single or limited number of suppliers, for certain complex components or sub-assemblies utilized in its products. In addition, the Company makes extensive use of suppliers serving the semiconductor equipment business and such suppliers may choose to give priority to their semiconductor equipment customers that are much larger than the Company. Any prolonged inability to obtain adequate deliveries could require the Company to pay more for inventory, parts and other supplies, seek alternative sources of supply, delay its ability to ship its products and damage relationships with current and prospective customers. Any such delay or damage could have a material adverse effect on the Company's business, financial condition and results of operations.

The Company's systems have a large number of components and are highly complex. The Company may experience delays and technical and manufacturing difficulties in future introductions or volume production of new systems or enhancements. In addition, some of the systems built by the Company must be customized to meet individual customer site or operating requirements. The Company has limited manufacturing capacity and may be unable to complete the development or meet the technical specifications of its new systems or enhancements or to manufacture and ship these systems or enhancements in a timely manner. Such an occurrence would materially adversely affect the Company's business, financial condition and results of operations as well as its relationships with customers. In addition, the Company may incur substantial unanticipated costs early in a product's life cycle, such as increased cost of materials due to expediting charges, other purchasing inefficiencies and greater than expected installation and support costs which cannot be passed on to the customer. Any of such events could materially adversely affect the Company's business, financial condition and results of operations. See "Risk Factors -- Manufacturing Risks."

COMPETITION

The Company believes that the principal competitive factors are system performance and features, reliability and uptime, overall cost of ownership and customer support. The Company believes that it competes favorably with respect to each of these factors. The Company believes it is the principal United States-based supplier of sputtering systems for thin-film disks.

The Company experiences intense competition worldwide from three principal competitors, Ulvac, Leybold and Anelva, each of which is a large manufacturer of complex vacuum equipment and

thin-film disk manufacturing systems and has sold a substantial number of thin-film disk sputtering machines worldwide. Leybold is a manufacturer of static and in-line sputtering systems, Ulvac is a manufacturer of in-line systems and Anelva is a manufacturer of static systems, and each has substantially greater financial, technical, marketing, manufacturing and other resources than the Company. The Company also experiences competition from other manufacturers of in-line sputtering systems used in thin-film disk fabrication facilities as well as the manufacturers of thin-film disks that have developed the capability to manufacture their own sputtering systems. There can be no assurance that the Company's competitors will not develop enhancements to, or future generations of, competitive products that will offer superior price or performance features or that new competitors will not enter the Company's markets and develop such enhanced products. Furthermore, the failure of manufacturers of thin-film disks currently using in-line machines and manufacturers using internally developed sputtering systems to switch to static sputtering systems in the future could adversely affect the Company's ability to increase its sputtering system market share.

In addition, the Company's three principal competitors are based in foreign countries and have cost structures and system prices based on foreign currencies. Accordingly, currency fluctuations could cause the Company's dollar-priced products to be less competitive than its competitors' products priced in other currencies. Currency fluctuations could also increase the Company's cost structure relative to those of its competitors, which could make it more difficult for the Company to maintain its competitiveness.

Given the lengthy sales cycle and the significant investment required to integrate a disk sputtering system into the manufacturing process, the Company believes that once a thin-film disk manufacturer has selected a particular supplier's disk sputtering equipment, the manufacturer generally relies upon that equipment for the specific production line application and frequently will continue to purchase its other disk sputtering equipment from the same supplier. The Company expects to experience difficulty in selling to a particular customer for a significant period of time if that customer selects a competitor's disk sputtering equipment. Accordingly, competition for customers in the disk sputtering equipment industry is particularly intense, and suppliers of disk sputtering equipment may offer pricing concessions and incentives to attract new customers, which could adversely affect the Company's business, financial condition and results of operations. Because of these competitive factors, there can be no assurance that the Company will be able to compete successfully in the future.

PATENTS AND INTELLECTUAL PROPERTY

The Company places a high value on intellectual property and has an active program to seek patent coverage for discoveries and designs that are believed to have significant value. The Company recognizes patentable inventions by employees through incentive payments to inventors. The Company currently has 23 patents issued in the United States, and has patent applications in the United States and foreign countries. Of the 23 patents, seven relate to sputtering, 11 relate to RTP, one relates to lubrication and four relate to other areas not in Intevac's mainstream business. The Company has the right to utilize certain patents under licensing arrangements with Litton Industries, Varian Associates, Stanford University, Lawrence Livermore Laboratories and Alum Rock Technology.

There can be no assurance that any of the Company's patent applications will be allowed or that any of the allowed applications will be issued as patents. There can be no assurance that any patent owned by the Company will not be invalidated, deemed unenforceable, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with claims of the scope sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop similar products, duplicate the Company's products or design around the patents owned by the Company. In addition, there can be no assurance that foreign patent rights, intellectual property laws or the Company's agreements will protect the Company's intellectual property rights. Failure to protect the

Company's intellectual property rights could have a material adverse effect upon the Company's business, financial condition and results of operations.

There have also been substantial amounts of litigation in the technology industry regarding intellectual property rights. The Company has from time to time received claims that it is infringing third parties' intellectual property rights. In August 1993, Rockwell International Corporation ("Rockwell") sued the Federal government alleging infringement of certain patent rights with respect to the contracts the Federal government has had with a number of companies, including Intevac. The Federal government has notified Intevac that it may be liable to the Federal government in connection with contracts for certain products from the Company's discontinued night vision business. Although the Company believes it will have no material liability to the Federal government under these contracts, there can be no assurance that the resolution of the claims by Rockwell with the Federal government will not have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company has recently become aware that a third party has sent correspondence to a consortium, of which the Company is a party, in a proposed government sponsored research and development program claiming that the work to be done under this program may infringe patents owned by third party. The Company and its subcontractors have reviewed the correspondence and patents and believe these claims are without merit; however, there can be no assurance that litigation will not result from such development program. There can be no assurance that other third parties will not in the future claim infringement by the Company with respect to current or future patents, trademarks or other proprietary rights relating to the Company's disk sputtering systems, flat panel display manufacturing equipment or other products. Any present or future claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all. Any of the foregoing could have a material adverse effect upon the Company's business, operating results and financial condition. In addition, the Company believes that one of its competitor's may be infringing the Company's patent rights in connection with products currently being offered by this competitor. Although the Company has not undertaken formal legal proceedings, the Company has informed its competitor that the Company believes its patents are being infringed and that the Company may undertake litigation to protect its patent rights if necessary. If undertaken, such litigation could be expected to be costly, time-consuming and result in legal claims being made against the Company. This could have a material adverse effect on the Company's business, operating results and financial condition, and, in addition, there could be no assurance that the Company would ultimately prevail in any such litigation. See "Risk Factors -- Patents and Other Intellectual Property."