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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2004 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period
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Commission file number 0-26946
INTEVAC, INC.
(Exact name of registrant as specified in its charter)
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California
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94-3125814 |
(State or other jurisdiction of
incorporation or organization) |
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(I.R.S. Employer
Identification No.) |
3560 Bassett Street
Santa Clara, California 95054
(Address of
principal executive office, including Zip Code)
Registrant’s telephone number, including area code:
(408) 986-9888
Securities registered pursuant to Section 12(b) of the
Act:
None
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Name of Each Exchange on Which Registered |
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none |
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Securities registered pursuant to Section 12(g) of the
Act:
Common Stock (no par value)
Indicate by check mark whether the registrant: (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by a check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange
Act). Yes þ No o
The aggregate market value of voting stock held by
non-affiliates of the Registrant, as of June 26, 2004 was
approximately $122,256,000 (based on the closing price for
shares of the Registrant’s Common Stock as reported by the
NASDAQ National Market System for the last trading day prior to
that date). Shares of Common Stock held by each executive
officer, director, and holder of 5% or more of the outstanding
Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
On March 22, 2005, 20,299,505 shares of the
Registrant’s Common Stock, no par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Registrant’s Proxy Statement for the
2005 Annual Meeting of Shareholders are incorporated by
reference into Part III. Such proxy statement will be filed
within 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.
TABLE OF CONTENTS
This Annual Report on Form 10-K contains forward-looking
statements, which involve risks and uncertainties. Words such as
“believes,” “expects,” “plans,”
“anticipates” and the like indicate forward-looking
statements. These forward-looking statements include comments
related to technology and market trends in the data storage,
hard disk drive and magnetic disk market; comments related to
technology and market trends in military and commercial markets
for low light sensors, cameras and systems; projected
seasonality and cyclicality in the market for our equipment
products; projected sales of hard disk drives and magnetic disks
for hard disk drives; our leadership position in magnetic disk
manufacturing equipment; projected customer requirements for new
capacity and for technology upgrades, such as for perpendicular
recording, to their installed base of magnetic disk
manufacturing equipment, as well as the ability of our products
to meet these requirements; extended sales cycles for our
equipment and military products; projected technology roadmaps
and deployment schedules for our military customers; expected
features, performance, costs, and competitive advantages of
products we are developing, including 200 Lean systems, LIVAR
® cameras and systems, NightVista®
cameras, cameras for military head mounted applications and
commercial markets and low light level sensors; establishing
relationships with development and distribution partners for our
imaging products; development of manufacturing systems for entry
into new markets not previously addressed by us, and the cost of
complying with government regulations. 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 “Certain Factors Which May Affect
Future Operating Results.”
PART I
Overview
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 complex capital equipment which deposits, or sputters,
highly engineered thin-films onto magnetic disks used in hard
disk drives. We believe our systems represent approximately 60%
of the installed capacity of disk sputtering systems worldwide.
Our customers include the world’s leading manufacturers of
magnetic disks for hard disk drives, such as Hitachi Global
Storage Technologies, Komag, Maxtor and Seagate Technology. We
believe the rapid growth of digital data, the transition from
videocassette recorders to digital video recorders and the
growth of new consumer applications, such as personal video
recorders, video game consoles and MP3 players, along with new
technology advances in the industry, will provide us with a
significant growth opportunity.
Our Imaging business develops and manufactures electro-optical
sensors, cameras, and systems that permit highly sensitive
detection of photons in the visible and near infrared portions
of the spectrum, allowing vision in extreme low light
situations. We currently develop night-vision technology and
equipment for military and commercial applications. To date, our
revenues have been derived primarily from research and
development contracts funded by the U.S. government.
Applications for our imaging technology include sensors and
cameras for use in extreme low light situations and systems for
positive identification of targets at long range. More recently,
we began developing products for use in the commercial sector,
specifically the security, life science and physical science
markets.
Intevac was formed in 1990 and completed a leveraged buyout of a
number of divisions of Varian Associates in February 1991. The
technologies acquired from Varian formed the foundation for our
Equipment and Imaging businesses. We were incorporated in
October 1990 in California. Our principal executive offices are
located at 3560 Bassett Street, Santa Clara, California
95054, and our phone number is (408) 986-9888. Our Internet
home page is located at www.intevac.com; however the
information in, or that can be accessed through, our home page
is not part of this report. Our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to such reports are available,
free of
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charge, on or through our Internet home page as soon as
reasonably practicable after we electronically file such
material with, or furnish it to, the Securities and Exchange
Commission.
“Intevac”, “LIVAR®,”
“D-STAR®,” and “NightVista®,”
among others, are our registered trademarks.
Equipment Business
Our Equipment business designs, manufactures, markets and
services complex 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 magnetic disks
are created in a sophisticated manufacturing process involving
many steps, including plating, annealing, polishing, texturing,
sputtering and lubrication.
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Storage Market Growth Drivers |
Data storage requirements have rapidly increased from kilobytes
for documents, to megabytes for audio and still images, to
gigabytes for video. Hard disk drives are the primary devices
used for storing and retrieving large amounts of digital data.
We believe there are a number of emerging trends and
applications that exploit these reduced storage costs and that
require storage intensive solutions.
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New consumer electronics applications, such as digital video and
audio recorders, video game platforms, emerging HDTV
applications and streaming video require significant digital
data storage capability. |
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Personal computers have evolved from devices operating simple
applications such as word processing, to powerful machines that
are capable of playing, recording and creating multimedia
content, such as images, audio and video. These capabilities
have driven the demand for new personal computers and increasing
requirements for data storage. TrendFocus estimates annual
personal computer unit growth of 12.2% over the period from 2003
to 2007. |
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Enterprise data storage requirements are increasing, as
regulations and other business factors require companies to
archive more information, such as documents and email.
Additionally, companies are transitioning from paper-based
storage to digital data-based storage and digital backup. |
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Certain traditional analog storage applications are
transitioning to digital hard disk-based storage. For example,
the video surveillance industry, including home security, law
enforcement, private security services, retail, transportation
and government agencies, is transitioning from analog video
tapes to digital hard disk storage. |
As a result of these and other storage applications, TrendFocus
expects the total number of units of all hard disk drives
shipped to grow from 261 million units in 2003 to
429 million units in 2007, or an annual growth rate of
13.2% .
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Hard Disk Drive Market Dynamics |
Areal Density Increasing. Areal density, the density of
information stored on magnetic disks, continues to increase.
Higher areal density allows more information to be stored on
each magnetic disk. Magnetic disk manufacturers compete by
increasing areal density, which enables them to provide more
data storage capacity at a lower cost per gigabyte.
Transition from Longitudinal to Perpendicular Recording.
Historically, magnetic disk manufacturers have been able to
increase the areal density of a disk by improving existing
longitudinal recording processes, a storage method where
magnetized data bits are parallel to the disk. However, in the
past few years, the rate of increase in areal density for
longitudinal recording processes has slowed, as the magnetized
data bits are packed closer and closer together, which increases
instability. In order to increase the rate of areal density
expansion, we believe the magnetic disk industry will transition
to perpendicular recording. In perpendicular recording the data
bits are oriented perpendicular to the plane of the disk, which
enables the bits to be recorded at a higher density than in
longitudinal recording.
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New Equipment Required for Perpendicular Recording. The
equipment that magnetic disk manufacturers purchased in the mid
to late 1990s could generally accommodate up to 12 process
steps, which was sufficient to enable improvements in areal
density using longitudinal recording. However, economically
producing disks capable of perpendicular recording may require
as many as 20 or more process steps. As a result, in order to
transition to perpendicular recording, disk manufacturers will
most likely need to replace or retool their existing disk
manufacturing equipment. We also believe that the additional
process steps available on these perpendicular capable systems
add process flexibility which may enable further increases in
the areal density on longitudinal media.
Consolidation of Equipment Suppliers. The supplier base
of disk sputtering equipment has consolidated. Beginning in
1995, many magnetic disk manufacturers undertook aggressive
expansion plans. The reduction in disks per drive combined with
these capacity expansions resulted in substantial excess disk
production capacity in the late 1990s through 2002. As a result,
even as total storage capacity of all hard disk drives shipped
increased from 1997 to 2003, disk manufacturers did not make
significant investments in new disk sputtering equipment. As a
result, of the four leading providers of disk sputtering
equipment, only two have delivered new equipment platforms
capable of perpendicular recording.
Industry Consolidation. Two types of companies purchase
magnetic disk sputtering equipment; vertically integrated
companies that manufacture both disks and the hard drives that
use the disks, and merchant suppliers that manufacture magnetic
disks for sale to hard disk manufacturers. These companies were
also adversely affected by the overcapacity of 1997 through
2002, and as a result, the industry underwent significant
consolidation. For instance, in 2001 Maxtor acquired
Quantum’s hard disk drive operations, and Fujitsu ceased
manufacturing hard disk drives for the personal storage market.
In 2002, IBM sold its hard disk drive business to Hitachi. In
2004, Showa Denko acquired Trace Storage Technology. This
consolidation has reduced the number of magnetic disk
manufacturers able to respond to any increasing demand for disks
for hard disk drives.
Return to Industry Growth. In 2004, hard disk drive
manufacturers produced approximately 301 million units, up
from 261 million units in 2003, according to TrendFocus.
According to TrendFocus, hard disk drive demand will reach
429 million units by 2007, an annual growth rate of 13.2%.
To meet increasing demands, magnetic disk manufacturers are
beginning to invest in new disk sputtering equipment that can
accommodate the additional process steps required for
perpendicular recording. For example, in 2004 one of the
industry leaders opened a major new media production facility
utilizing Intevac’s 200 Lean systems. To evaluate the
performance of competing disk sputtering equipment, magnetic
disk manufacturers consider the following criteria:
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Cost of Ownership. Cost of ownership of disk sputtering
equipment includes factors such as equipment price,
manufacturing yield, throughput, factory floor footprint and
uptime. A lower cost of ownership for disk sputtering equipment
is a key factor in lowering the manufacturer’s product cost. |
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Extendibility and Flexibility. We believe magnetic disk
manufacturers need sputtering equipment that can address the
needs of their evolving technology roadmaps. This equipment must
be capable of incorporating new process steps and technical
capabilities, including the processes needed for producing
magnetic disks capable of perpendicular recording. Additionally,
these manufacturers are improving longitudinal processes and
further developing the processes necessary for perpendicular
recording, and as a result, they demand a modular, flexible
system that supports process reconfigurations and expansions
with a minimum of effort. |
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Compatibility with Existing Equipment. We believe
magnetic disk manufacturers prefer to standardize their
processes around one or two disk sputtering equipment suppliers.
Once a disk manufacturer has selected a particular
supplier’s equipment, that manufacturer generally relies
upon that supplier’s equipment for much of its production
capacity and frequently will continue to purchase any additional
equipment from the same supplier. There are significant
economies of scale related to the use of a single platform in
product design, product qualification, manufacturing and support. |
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Long-term Commitment of Supplier. We believe magnetic
disk manufacturers need sputtering equipment providers that are
committed to meeting current and future technology requirements
and to supporting this equipment throughout its useful life. As
a result, magnetic disk manufacturers increasingly demand a
supplier with the stability and capability to be a long-term
technology partner. |
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Our Competitive Strengths |
We are the leading provider of disk sputtering equipment to
manufacturers of magnetic media used in hard disk drives. We
believe that our industry leadership is the result of the
following key competitive strengths:
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Broad Installed Base with Industry Leading Customers. Our
MDP-250 disk sputtering system gained wide acceptance in the
magnetic disk manufacturing industry and by the late 1990s was
being used in the manufacture of approximately half of the
magnetic disks used in hard disk drives worldwide. We believe
that there are approximately 105 legacy MDP-250 systems and 12
next generation 200 Lean systems currently in use in production
and research and development applications by customers such as
Fuji Electric, Hitachi Global Storage Technology, Komag, Maxtor,
Seagate and Showa Denko. We believe the majority of our active
customers are now utilizing most of their capacity and that
there is significant potential for these customers to both
resume adding capacity and to upgrade the technical capability
of their installed base to permit production of higher density
disks capable of perpendicular recording. |
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Technology Leadership with Modular Next Generation Advanced
Platform. In December 2003, we first delivered our
latest-generation disk sputtering system, the 200 Lean, which
provides significantly enhanced capabilities relative to our
installed base of MDP-250 systems. The 200 Lean provides higher
throughput from a smaller footprint, which enables more disks to
be manufactured per square-foot of clean-room space. The
flexible design of the 200 Lean allows rapid reconfiguration to
accommodate product changeovers and new disk technology. The
modular design of the 200 Lean also allows disk manufacturers to
add additional process steps, as advanced magnetic disk
technologies, such as perpendicular recording, are introduced. |
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Long-Term Commitment to Hard Disk Drive Industry. We have
been a hard disk drive equipment provider since 1991. We are one
of only two companies that have delivered next-generation disk
sputtering equipment that can support perpendicular recording.
We have continued to develop new technologies and introduced the
200 Lean disk sputtering system to meet the needs for additional
process steps necessary to economically produce magnetic disks
capable of perpendicular recording. In addition, our
headquarters are located in close proximity to many of our
customers’ hard disk drive development centers, and our
support center in Singapore services our customers’
Southeast Asia manufacturing facilities. |
Based on these competitive strengths, we believe that we are
well positioned to maintain and enhance our market leading
position in the disk sputtering equipment market. We believe our
new Intevac 200 Lean system accounts for the majority of
installed production capacity of next generation
perpendicular-capable systems.
We believe we can leverage our leadership position in disk
sputtering equipment to increase our sales to magnetic disk
manufacturers and apply our technology to new markets. The key
elements of our strategy are as follows:
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Become Preferred Solutions Provider in the Magnetic Disk
Industry. Our goal is to become a preferred solutions
provider to magnetic disk manufacturers. We believe that our 200
Lean provides our customers with an advanced modular platform
that can address their future disk sputtering needs. We believe
we can integrate additional capabilities into the 200 Lean, such
as automated handling of small-form-factor disks (disks of one
inch diameter or less). We believe we are also the leading |
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provider of disk lubrication equipment, the equipment that is
used to apply ultra-thin coatings of lubricant to magnetic disks
after sputtering. |
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Deliver Highest Customer Value Proposition. Our goal is
to maintain our leadership in advanced disk sputtering equipment
by providing flexible, extendable equipment with the lowest cost
of ownership. The 200 Lean’s modular design provides
customers the ability to reconfigure their disk manufacturing
systems for rapid technology shifts and evolving technology
roadmaps. The 200 Lean’s compact footprint and increased
throughput relative to the legacy MDP-250 systems enables
increased output per square foot of factory clean-room space. |
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Expand Consumables, Spare Parts and Service Offerings. We
plan to increase the sale of disk sputtering equipment
consumables, spare parts and service in order to increase our
revenue opportunity per customer. In addition, growing these
offerings will enable us to deepen and enhance our customer
relationships. We believe the expected revenue from these
offerings will help mitigate the impact of cyclical downturns in
the disk sputtering equipment business. We believe that the
close proximity of our service center in Singapore to a large
number of hard disk drive manufacturers’ facilities gives
us a competitive advantage. We are planning to add additional
support centers as required in order to maintain close proximity
to our customers’ media factories as they begin deployment
of 200 Lean systems. |
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Leverage Existing Technology into New Markets. In
addition to expansion within our existing customer base, we
intend to target other markets where we can apply our expertise
in complex manufacturing equipment. Our expertise includes the
ability to design and manufacture complex, highly automated
vacuum manufacturing systems. We are currently in the concept
and feasibility stage of developing a new manufacturing system
that addresses a market other than our traditional hard disk
drive manufacturing equipment market. We are devoting a
significant portion of our research and development resources to
this new system. If we conclude that this new system addresses a
sufficiently large market and that we can achieve significant
profitable market share, then we plan to manufacture and ship a
number of evaluation units to key customers. We do not expect
that these activities will result in any revenue during 2005 and
cannot accurately predict when, if ever, we will generate
significant revenue from these activities. |
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200 Lean Disk Sputtering System |
The 200 Lean is our latest generation disk sputtering system.
The 200 Lean provides significantly enhanced capabilities
relative to the installed base of approximately 105 MDP-250
systems. The 200 Lean provides higher throughput from a smaller
footprint in a flexible modular system, which enables more disks
to be manufactured per square-foot of factory floor space, and
is designed to lower overall cost of ownership.
The key features of the 200 Lean include:
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Modular Design. The 200 Lean’s modular design allows
our customers to accommodate any number of disk manufacturing
process steps required by their evolving technology roadmaps.
The 200 Lean consists of a front-end robotic module that loads
and unloads disks from the system, combined with any number of
four-station process modules. Typical configurations of the 200
Lean have from four to five of these four-station process
modules, which results in systems capable of 16 to 20 process
steps. Additional process modules can be easily added to already
installed systems. For example, a customer could buy a
three-module (12-station) 200 Lean to manufacture longitudinal
media and at a later date upgrade the system to a five-module
(20-station) system to manufacture perpendicular media. |
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Easy to Reconfigure. Magnetic disk manufacturers produce
many different designs that have short product life cycles,
leading to frequent reconfiguration of disk sputtering
equipment. The mechanical design and software control system of
the 200 Lean allows rapid reconfiguration of systems by our
customers. The 200 Lean is also easily reconfigured to process
disks with glass or aluminum substrates of varying diameters and
thicknesses. |
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Higher Throughput with Smaller Footprint. The 200 Lean
offers higher throughput (up to 800 disks per hour) and more
process stations in a more compact package than our previous
MDP-250 system. We believe that the 200 Lean has the highest
disk throughput per square foot of factory space for a system
capable of manufacturing perpendicular media. |
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High Availability. The 200 Lean is designed to operate
seven days a week, 24 hours a day with high availability.
The 200 Lean can be run continuously for a week or more between
preventative maintenance cycles. |
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Single Disk Processing. The 200 Lean processes each
individual disk sequentially through a series of single-disk,
vacuum-isolated, process chambers. “Single-disk”
processing assures that each individual disk follows an
identical path through the system, which leads to disk-to-disk
uniformity since each disk sees the same process conditions. The
vacuum-isolated “single-disk” process also eliminates
the disk-to-disk interaction that can occur in systems that
process more than one disk in each process chamber. |
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High-Vacuum Capability. The 200 Lean operates at
significantly better vacuum levels compared to the installed
base of MDP-250s. Better vacuum levels generally lead to
improved magnetic media performance. |
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Suite of Process Station Options. The 200 Lean offers a
wide range of process stations, providing capabilities such as
metal deposition, heating, cooling and carbon overcoating onto
both aluminum and glass disks. The 200 Lean is also easily
configurable to manufacture disks in a variety of diameters and
thicknesses. |
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MDP-250 Disk Sputtering System |
Intevac’s legacy MDP-250 system is the most widely used
disk sputtering system in world. We believe that the MDP-250 is
used to manufacture approximately half the magnetic disks used
in hard disk drives. The MDP-250 system offers a maximum of
twelve process stations.
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Equipment Business Sales and Marketing |
Our Equipment business sales are made primarily through our
direct sales force, although in Japan, we sell our products
through a distributor, Matsubo. The selling process for our
equipment products is a multi-level and long-term process,
involving individuals from marketing, engineering, operations,
customer service and senior management. The process involves
making samples for the prospective customer and responding to
their needs for moderate levels of machine customization.
Customers often require a significant number of product
presentations and demonstrations before making a purchasing
decision.
Installing and integrating new equipment requires a substantial
investment by a customer. Sales of our systems depend, in
significant part, upon the decision of a prospective customer to
replace obsolete equipment or to increase manufacturing capacity
by upgrading or expanding existing manufacturing facilities or
by constructing new manufacturing facilities, all of which
typically involve a significant capital commitment. After making
a decision to select our equipment, our customers typically
purchase one or more engineering systems to develop and qualify
their production process prior to ordering and taking delivery
of multiple production systems. Accordingly, our systems have a
lengthy sales cycle, during which we may expend substantial
funds and management time and effort with no assurance that a
sale of one or more will result.
The production of large complex systems requires us to make
significant investments in inventory both to fulfill customer
orders and to maintain adequate supplies of spare parts to
service previously shipped systems. In some cases we manufacture
subsystems and/or complete systems prior to receipt of a
customer order to smooth our production flow and/or reduce our
lead time. We maintain an inventory of spare parts at our
Singapore subsidiary to support our customers in Singapore and
Malaysia. We typically require our customers to pay for systems
in three installments, with a portion of the system price billed
upon receipt of an order, a portion of the system price billed
upon shipment, and the balance of the system price and any sales
tax due
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upon completing installation and acceptance of the system at the
customer’s factory. All customer product payments are
recorded as customer advances pending revenue recognition.
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Equipment Business Customers |
Our disk sputtering equipment customers include magnetic disk
manufacturers, such as Fuji Electric, Komag and Showa Denko and
vertically integrated hard disk drive manufacturers, such as
Hitachi Global Storage Technology, Maxtor and Seagate. The
majority of our customers’ product development programs are
located in the United States. Our customers’ manufacturing
facilities are located in California, Singapore, Malaysia, Japan
and Taiwan. In addition, Hitachi Global Storage Technology is
opening a new media facility in China.
Our customers’ business tends to be cyclical, with their
peak sales occurring during the second half of the year. As a
result, our customers have a tendency to order equipment for
delivery and installation by midyear, so that they have new
capacity in place for their peak production period. For example,
our third quarter 2004 revenues totaled $34.9 million, and
accounted for 50% of our revenues for the entire year of 2004.
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Equipment Business Customer Support |
We provide process and applications support, customer training,
installation, start-up assistance and emergency service support
to our equipment customers. We conduct training classes for our
customers’ process engineers, machine operators and machine
service personnel. Additional training is also given to our
customers during the machine installation. We have a subsidiary
in Singapore to support our customers in Southeast Asia. We are
planning to add additional support centers to maintain close
proximity to our customers’ factories as they deploy our
systems.
We generally offer a one year warranty on our equipment. In some
cases we market extended warranty periods beyond 12 months
to our customers. During this warranty period any necessary
non-consumable parts are supplied and installed without charge.
Our employees provide field service support primarily in the
United States, Singapore and Malaysia. In Japan, field service
support is provided by our distributor, Matsubo, supplemented by
our factory support. We and Matsubo stock consumables and spare
parts to support the installed base of systems. These parts are
generally available on a 24-hour per day basis.
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Equipment Business Competition |
The principal competitive factors affecting the markets for our
equipment products include price, product performance and
functionality, integration and manageability of products,
customer support and service, reputation and reliability. We
have historically experienced intense competition worldwide from
competitors including Anelva Corporation, Ulvac and Unaxis
Holdings, Ltd., each of which has sold substantial numbers of
systems worldwide. Anelva, Ulvac and Unaxis all have
substantially greater financial, technical, marketing,
manufacturing and other resources than we do. To our knowledge,
Intevac and Anelva are the only companies that have delivered
products that economically address the sputtering requirements
for manufacture of advanced perpendicular magnetic disks.
However, there can be no assurance that any of our competitors
will not develop enhancements to, or future generations of,
competitive products that offer superior price or performance
features or that new competitors will not enter our markets and
develop such enhanced products.
Given the lengthy sales cycle and the significant investment
required to integrate equipment into the manufacturing process,
we believe that once a magnetic disk manufacturer has selected a
particular supplier’s equipment for a specific application,
that manufacturer generally relies upon that supplier’s
equipment and frequently will continue to purchase any
additional equipment for that application from the same
supplier. Accordingly, competition for customers in the
equipment industry is intense, and suppliers of equipment may
offer substantial pricing concessions and incentives to attract
new customers or retain existing customers.
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Imaging Business
Our Imaging business develops and manufactures electro-optical
sensors, cameras, and systems that permit highly sensitive
detection of photons in the visible and near infrared portions
of the spectrum, allowing vision in extreme low light situations.
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Imaging Industry Overview |
Imaging is the capture and display of light or heat, emitted or
reflected from an object. A segment of the imaging market has
evolved into specialized technology for the capture of low light
images. Low light imaging involves the capture and display of
light at intensities of approximately one millionth, or less, of
daytime light levels.
The U.S. military has determined that low light imaging
technology which provides superior vision in nighttime combat
creates a significant tactical advantage. The U.S. military
funded the development of night vision technology, which has
evolved through three generations to today’s widely
deployed “Generation-III” night vision tubes.
Typically, Generation-III night vision tubes are placed in front
of a user’s eyes, like a pair of binoculars, and produce a
direct-view, “green glow” image. The military is now
funding the development of compact next generation extreme low
light imaging technology that also provides digital video output
The commercial sector has taken a different approach to extreme
low light imaging than the military. The initial extreme low
light cameras for the commercial sector were based on charged
coupled device, or CCD, technology, which is able to produce a
digital output. CCD technology relies on long exposure times for
its sensitivity, and as a result the initial cameras were used
for static applications, like astronomy. Other commercial
markets, such as metrology, life sciences and industrial process
monitoring, adopted CCD technology. However, cameras for these
new markets compromised sensitivity for dynamic applications
with motion or short measurement times.
As a result, two distinct forms of low light level imaging have
evolved: the Generation-III night vision tube technology
developed by the military, which provides direct-view analog
imagery; and CCD technology, which can provide digital imagery,
but is not well suited to dynamic applications.
We have developed imaging technology that combines the low light
capability of Generation-III night vision technology with
silicon-based digital video technology that we believe will
enable us to provide a family of portable, cost-effective low
light sensors and cameras. Elements of our proprietary solutions
include:
Advanced Photocathode Technology — A
photocathode is a semiconductor compound with the ability to
convert light into electrons. We are developing a family of
photocathodes that are engineered to optimize sensitivity at
specific wavelengths ranging from the visible (0.40 microns) to
the near infrared (1.65 microns). Our photocathodes have high
quantum efficiencies (the efficiency with which incoming light
photons are converted to electrons) and are extremely sensitive
to incoming light. Some of our detectors, incorporating such
photocathodes, can detect incoming light at levels as low as a
single photon, which is the ultimate level of sensitivity.
Use of Low Power CMOS Imaging Chips —
Historically, CCD sensors were the primary technology used in
digital imaging. Recently, Complementary Metal Oxide
Semiconductor, or CMOS sensors, which are generally lower cost
and require less power than comparable CCD sensors, have been
developed for consumer imaging applications. We have developed
proprietary technologies and capabilities to incorporate CMOS
sensors into our products to take advantage of these
improvements. As a result, we believe we will be able to offer
low cost, low power, extreme low light imaging sensors for
portable applications in price sensitive markets.
Increased Silicon Sensor Sensitivity — We have
developed proprietary technology to enable CMOS and CCD sensors
to capture the accelerated electrons emitted from the
photocathode more efficiently. Increasing the electron capture
efficiency directly increases extreme low light imaging
performance.
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Compact Ultra-High Vacuum Sensor Packaging —
Our compact ultra-high vacuum sensor package enables us to
combine an imaging chip with our photocathodes in a thin package
which is particularly well suited for portable applications
where size and weight are critical.
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Low Light Imaging Market Opportunity |
We are designing our imaging solutions to address next
generation military requirements and the dynamic applications of
the commercial markets. Forecast International estimated the
military market for legacy night vision systems and research
programs was $347 million in 2003.
Head Mounted Night Vision Systems —
Generation-III based night vision goggles, which have excellent
extreme low light imaging performance, were widely deployed by
the U.S. military for use by soldiers during the
1990’s. However, these goggles are relatively large, heavy
and lack video output. Additionally, potential adversaries are
now deploying Generation-II+ goggles manufactured outside the
United States with performance levels approaching that of
Generation-III. Accordingly, the U.S. Army has developed a
roadmap to maintain extreme low light imaging dominance for the
individual soldier. A key element of this roadmap includes a
transition from bulky direct-view night vision goggles to a
miniature head mounted imaging system, including an extreme low
light camera and video display. This approach addresses size and
weight issues and enables connectivity to a wireless network for
distribution of the imagery and other information. These
improvements need to be realized while minimizing the cost of
each soldier’s system. The U.S. Army plans to begin
deployment of this type of system by 2009.
Military Long Range Target Identification —
Current long-range nighttime surveillance systems are based on
expensive thermal imaging camera systems, which image the
thermal profile of a target. These systems produce relatively
poor resolution images since they only measure emitted heat.
Long range thermal systems are also relatively large, which is a
disadvantage for airborne and portable applications.
Accordingly, there is a need for a cost effective, compact,
long-range imaging solution that identifies targets at a
distance that is greater than an adversary’s detection
range capability.
Physical Sciences — Companies in the physical
sciences use extreme low light imaging to investigate the
chemistry and physics of a wide variety of substances such as
foods, medicines, materials and biological compounds. They need
high sensitivity and increased speed and resolution to increase
the accuracy of their measurements and the productivity of their
measurement tools.
Life Sciences — The life sciences market
focuses on increasing the understanding of biology at the
cellular level to improve health and quality of life. To image
single living cells this market needs extreme low light cameras
that operate at speeds significantly higher than cameras that
are available today.
Collaborate with Leading Development
Organizations — We collaborate with, and receive
significant funding from, leading government research
organizations for the development of our extreme low light
technology. These organizations strongly influence development
and procurement of advanced technologies by the
U.S. military. For example, we have collaborated with the
U.S. Army Night Vision Labs, the world leader in night
vision technology, to facilitate the development and adoption of
our night vision technology.
Become Leading Provider of Extreme Low Light Imaging
Technology for the Military — We are actively
marketing our extreme low light imaging technology to the
military. Our extreme low-light sensor was selected in 2004 for
use in digital head mounted system for the military of a NATO
ally. We believe this system, which is scheduled to begin
deployment in mid 2006, will be the first digital based military
head mounted low light system to be deployed on a large scale.
Our LIVAR technology has been incorporated into
U.S. weapons development programs such as the Airborne
Laser (“ABL”), the Cost Effective Targeting System
(“CETS”), and the Long-Range Identification System
(“LRID”) programs. Our objective is for our extreme
low light sensors to become the standard for military
head-mounted systems and for our LIVAR technology to become the
standard for long-range target identification.
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Leverage Proprietary Sensor and Camera Technology to Address
Emerging Commercial Markets — We are using our
extreme low light imaging expertise to develop products for
commercial markets. We believe the modular design of our
NightVista platform, coupled with our use of CMOS chips in our
configurable sensors, will help to decrease our development time
and cost to enter the physical and life sciences markets.
Lower Manufacturing Costs — The market for our
cameras and sensors is price elastic, and low cost manufacturing
will be critical to the rapid proliferation of our products. Our
use of low-cost CMOS sensors and development of wafer level die
manufacturing, as opposed to single die manufacturing, are
elements of our strategy to reduce product cost. Additionally,
we have developed proprietary ultra-high vacuum assembly
equipment to automate the assembly of the photocathode and the
imaging chip. In developing this system, we utilized our
expertise in the design and manufacture of complex, high
throughput production equipment. This system is designed to
decrease unit costs by increasing throughput and improving
process controls and yields.
Build Relationships with Strategic Sales Partners to
Accelerate Access to End Markets — We are focusing
on the development and manufacture of extreme low light sensors
and cameras. Our products are designed to be enabling technology
for larger systems. As a result, we are developing relationships
with leading systems manufacturers such as Boeing, Lockheed
Martin Corporation and Northrop Grumman Corporation, in the
military market, and distributors and value added resellers in
commercial markets.
NightVista Cameras — The NightVista camera is
an extreme low light CMOS-based day/night video camera for
security applications that currently offers VGA resolution. Its
camera body is small enough to fit into a two-inch cube, and its
power consumption is less than 2 watts. As a result, the
NightVista is well suited for portable battery-powered
applications.
LIVAR Camera and System Products — Our Laser
Illuminated Viewing and Ranging, or LIVAR, target identification
system consists of a near infrared extreme low light camera
integrated with an eye-safe laser illuminator. LIVAR uses a
laser to illuminate a target and a camera to capture the
reflected light and display an image. Our LIVAR system is
designed to identify targets initially detected by
forward-looking infrared or radar technology. Depending on the
application, LIVAR can be used to identify targets at distances
of up to 20 kilometers. We do not expect significant revenues
from deployment of LIVAR systems in 2005
Our Imaging business generally invoices its research and
development customers either as costs are incurred, or as
program milestones are achieved, depending upon the particular
contract terms. As a government contractor, we invoice customers
using estimated annual rates approved by the Defense Contracts
Audit Agency (“DCAA”). A majority of our contracts are
Cost Plus Fixed Fee (“CPFF”) contracts. On any CPFF
contract, 15% of the fee is withheld pending completion of the
program and DCAA’s annual audit of our actual rates. The
withheld portion of the fee is included in accounts receivable
until paid.
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Imaging Sales and Marketing |
Sales of our military products are made primarily through our
direct sales force. We are subject to long sales cycles because
many of our products, such as our LIVAR system, typically 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 customer
successfully integrating our product into their product,
completing development of their product and then obtaining
production orders for their product. Sales of these products are
also often dependent on ongoing government funding of defense
programs by the U.S. government and its allies.
Sales of our commercial products, which have not been
significant to date, will be made through a combination of
system integrators, distributors and value added resellers and
can also be subject to long sales cycles. We also plan to market
some lower cost products, such as NightVista cameras, directly
to end users.
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Imaging Business Competition |
The principal competitive factors affecting our products include
price, extreme low light sensitivity, signal to noise ratio,
power consumption, resolution, size, integratability,
reliability, reputation and customer support and service. We
face substantial competition for our imaging products and many
of our competitors have greater resources than we do.
In the military market, ITT Industries and Northrop Grumman, who
are large and well-established defense contractors, are the
primary U.S. manufacturers of image intensifier tubes used
in Generation-III night vision devices and their derivative
products. Our extreme low light cameras are intended to displace
Generation-III night vision based products, and we expect that
ITT and Northrop Grumman will continue to enhance the
performance of their products and aggressively promote their
sales. Furthermore, CMC Electronics, DRS, FLIR Systems and
Raytheon manufacture cooled infrared sensors and cameras which
are presently used in long-range target identification systems,
with which our LIVAR target identification sensors and cameras
compete.
In the physical and life sciences market, companies such as
Andor, E2V, Hamamatsu and Roper Scientific offer competitive
products. In the security market, competitive products to our
NightVista camera based on electron multiplying CCDs and image
intensifier tubes are offered by a number of companies. Electron
multiplying CCDs manufactured by Texas Instruments and E2V also
are used in cameras that compete with our low light level
security products.
Manufacturing
We manufacture our Equipment products at our facility in
Santa Clara, California. Our equipment manufacturing
operations include electromechanical assembly, mechanical and
vacuum assembly, fabrication of sputter sources, and system
assembly, alignment and testing. We make extensive use of the
local supplier infrastructure serving the semiconductor
equipment business. We purchase vacuum pumps, valves,
instrumentation and fittings, power supplies, printed wiring
board assemblies, computers and control circuitry, and custom
mechanical parts made by forging, machining and welding. We also
have our own small fabrication center that supports our
engineering departments and makes some of the machined parts
used in our products.
We manufacture our Imaging products at our facilities in
Santa Clara, California and Fremont, California. Imaging
business manufacturing includes production of advanced
photocathodes and sensors, lasers, cameras and integrated camera
systems. We make extensive use of advanced manufacturing
techniques and equipment, and our operations include vacuum,
electromechanical and optical system assembly. We make use of
the supplier infrastructure serving the semiconductor, camera
and optics manufacturing industries. In manufacturing our
sensors, we purchase wafers, components, processing supplies and
chemicals. In manufacturing our camera systems, we purchase
printed circuit boards, electromechanical components and
assemblies, mechanical components and enclosures, optical
components and computers.
Intellectual Property
We currently hold 29 patents issued in the United States and 44
patents issued in foreign countries, and have patent
applications pending in the United States and foreign countries.
Of the 29 U.S. patents, 15 relate to our Equipment
business, and 14 relate to our Imaging business. Of the foreign
patents, 16 relate to our Equipment business, and 28 relate to
our Imaging business. In addition, we have the right to utilize
certain patents under licensing arrangements with Litton
Industries, Stanford University, The Charles Stark Draper
Laboratory and Alum Rock Technology. We hold substantial trade
secrets in the imaging area related to photocathode fabrication
and processing and to silicon chip packaging for vacuum
compatibility and high electron sensitivity. We also have
significant process integration intellectual property related to
vacuum packaging of a photocathode and a silicon semiconductor
chip.
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Customer Concentration
Historically, a significant portion of our revenue in any
particular period has been attributable to sales to a limited
number of customers. In 2004, Seagate and our Japanese equipment
distributor, Matsubo, each accounted for more than 10% of our
revenues, and in aggregate accounted for 73% of revenues. In
2003, Komag, Seagate, Lockheed Martin and Matsubo, each
accounted for more than 10% of our revenues, and in aggregate
accounted for 66% of revenues. In 2002, Seagate, Toppoly and the
U.S. Army Communications-Electronics Command each accounted
for more than 10% of our revenues, and in aggregate accounted
for 74% of revenues. Our largest customers change from period to
period, and it is expected that sales of our products to
relatively few customers will continue to account for a high
percentage of our revenues in the foreseeable future.
Foreign sales accounted for 68% of revenues in 2004, 64% of
revenues in 2003 and 52% of revenues in 2002. The majority of
our foreign sales are to companies in the Far East or to
U.S. companies for use in Far East operations. We
anticipate that sales to these international customers will
continue to be a significant portion of our Equipment revenues.
Employees
At December 31, 2004, we had 191 employees, including 17
contract employees. Of these 191 employees, 68 were in research
and development, 85 in manufacturing, and 38 in administration,
customer support and marketing. Of the 191 employees, 114 were
in the Equipment business, 50 were in the Imaging business, and
27 were in corporate.
Compliance with Environmental Regulations
We are subject to a variety of governmental regulations relating
to the use, storage, discharge, handling, emission, generation,
manufacture, treatment and disposal of toxic or otherwise
hazardous substances, chemicals, materials or waste. We treat
the cost of complying with government regulations and operating
a safe workplace as a normal cost of business and allocate the
cost of these activities to all functions, except where the cost
of those activities can be isolated and charged to a specific
function. The environmental standards and regulations
promulgated by government agencies in Santa Clara,
California and Fremont, California are rigorous and set a high
standard of compliance. We believe our costs of compliance with
these regulations and standards are comparable to other
companies operating similar facilities in Santa Clara,
California and Fremont, California.
Certain Factors Which May Affect Future Operating Results
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Our operating results fluctuate significantly from quarter
to quarter, which may cause the price of our stock to
decline. |
Over the last 8 quarters, our revenues per quarter have
fluctuated between $34.9 million and $4.6 million.
Over the same period our operating income as a percentage of
revenues has fluctuated between approximately 4% and (90%) 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:
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delays or problems in the introduction and acceptance of our new
products, or delivery of existing products; |
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changes in the demand, due to seasonality and other factors, for
the computer systems, storage subsystems and consumer
electronics containing disks our customers produce with our
systems; and |
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announcements of new products, services or technological
innovations by us or our competitors. |
Additionally, because our systems are priced in the millions of
dollars and we sell a relatively small number of systems, our
business is inherently subject to fluctuations in revenue from
quarter to quarter due to factors such as timing of orders,
acceptance of new systems by our customers or cancellation of
those orders. For example, we do not currently anticipate
resuming volume system deliveries in our equipment business
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until the second quarter of 2005 although we recognized
significant revenue in the third quarter of 2004 as a result of
customer acceptance of eight 200 Lean systems and the sale of
one MDP-250 system. As a result, we believe that
quarter-to-quarter comparisons of our revenues and operating
results may not be meaningful and that these comparisons 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.
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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 the middle of 1998 until mid-2003, there was very little
demand for new disk sputtering systems, as magnetic disk
manufacturers were burdened with overcapacity and were not
investing in new disk sputtering equipment. By 2003, however,
overcapacity had diminished, three of our customers announced
plans for major capacity expansions, and we shipped our first
next generation 200 Lean system. In 2004, one of those customers
took delivery of ten new 200 Leans and another of those
customers took delivery of a 200 Lean to evaluate its
capabilities.
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. Furthermore, if hard
disk drives were to be replaced by an alternative technology as
a primary method of digital storage, demand for our products
would decrease.
Sales of our new 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 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 have a
material adverse effect on our operating results.
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We have a recent history of significant losses and may not
regain annual profitability. If we do not establish profitable
operations in the future, then our share price is likely to
decline. |
The majority of our revenues and gross profit have historically
been derived from sales of disk sputtering equipment. Sales of
our disk sputtering equipment were severely depressed from the
middle of 1998 until mid-2003. Also, our Imaging business has
yet to earn an annual profit. We have experienced an operating
loss in each of the last five fiscal years. Our operating loss
in 2004 was $5.2 million, and as of December 31, 2004,
we had an accumulated deficit of $25.7 million. To regain
and sustain profitability, we will need to increase gross
margins and generate and sustain substantially higher revenue
while maintaining reasonable cost and expense levels. We cannot
assure you that we will regain profitability in the near future,
or at all, and if we do regain profitability we cannot assure
you that we will be able to sustain profitability on a
going-forward basis. If we fail to regain profitability within
the time frame expected by securities analysts or investors,
then the market price of our common stock will likely decline.
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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 magnetic
media sputtering systems to a limited number of customers. In
2004, two of our customers, in the aggregate, accounted for 73%
of our revenues. 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
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and other terms unfavorable to us. Furthermore, the
concentration of customers can lead to extreme variability in
revenue and financial results from period to period. For
example, during 2004 revenues ranged between $6.5 million
in the first quarter and $34.9 million in the third
quarter. These factors could have a material adverse effect on
our business, financial condition and results of operations.
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The majority of our future revenue is dependent on new
products. If these new products are not successful, then our
results of operations will be 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 customer requirements
accurately, technological advances, total cost of ownership of
our systems, our introduction of new products on schedule, our
ability to manufacture our systems cost-effectively and the
performance of our systems in the field. Our new product
decisions and development commitments must anticipate
continuously evolving industry requirements significantly in
advance of sales.
Our future revenues depend significantly on the market
acceptance of our 200 Lean disk sputtering system, which was
first delivered in December 2003. Initial builds of the 200 Lean
experienced high production and warranty costs in comparison to
our more established product lines. Although we believe our
margins will improve in the future on our 200 Lean systems, the
timing and amount of such improvements are difficult to predict.
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
specification in areas such as throughput, vacuum level,
robotics, process performance and software features and
functionality. These tests are generally more comprehensive for
new systems, like the 200 Lean, than for mature systems, such as
the MDP-250, and are designed to highlight problems encountered
with early versions of the equipment. 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 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 a new
manufacturing system to address markets other than magnetic disk
manufacturing. Failure to correctly assess the size of the new
market, or to successfully develop a product to cost effectively
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.
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 based on the technology we have developed in
our Imaging business. None of our Imaging products is 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 cannot assure you that we will succeed
in these activities or generate significant sales of these new
products. Failure of any of these 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.
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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.
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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 changes 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 the middle of 1998 until mid-2003. In addition, our disk
manufacturing customers are generally more sensitive to the
cyclical nature of the hard disk drive industry, because many of
their customers have internal magnetic disk manufacturing
operations and will cut back their purchases of disks from
outside suppliers first in an industry downturn. If we fail to
anticipate or respond quickly to the industry business cycle, it
could have a material adverse effect on our business.
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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
(Section 404), beginning with this Annual Report on
Form 10-K for the fiscal year ended December 31, 2004,
we are required to furnish a report by our management on our
internal control over financial reporting. Such report contains,
among other matters, an assessment of the effectiveness of our
internal control over financial reporting as of the end of our
fiscal year, including a statement as to whether or not our
internal control over financial reporting is effective. This
assessment must include disclosure of any material weaknesses in
our internal control over financial reporting identified by
management. The report must also contain a statement that our
auditors have issued an attestation report on management’s
assessment of our internal controls.
The Committee of Sponsoring Organizations of the Treadway
Commission (COSO) provides a framework for companies to
assess and improve their internal control systems. Auditing
Standard No. 2 provides the professional standards and
related performance guidance for auditors to attest to, and
report on, management’s assessment of the effectiveness of
internal control over financial reporting under
Section 404. Management’s assessment of internal
controls over financial reporting requires management to make
subjective judgments, and, particularly because Section 404
and Auditing Standard No. 2 are newly effective, some of
the judgments will be in areas that may be open to
interpretation. Therefore the report is especially difficult to
prepare.
We were not able to assert, in our management certifications
filed with this Annual Report on Form 10-K, that our
internal control over financial reporting is effective as of
December 31, 2004, as our management identified three
material weaknesses in our internal control over financial
reporting. This or any future inability to assert that our
internal controls over financial reporting are effective for any
given reporting period (or if our auditors are unable to attest
that our management’s report is fairly stated or if they
are unable to express an opinion on the effectiveness of our
internal controls), could cause us to lose investor confidence
in the accuracy and completeness of our financial reports, which
would have an adverse effect on our stock price.
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Recently enacted and proposed changes in securities laws
and regulations will increase our costs. |
The Sarbanes-Oxley Act of 2002 has required changes in some of
our corporate governance, securities disclosure and/or
compliance practices. As part of the Act’s requirements,
the Securities and Exchange Commission has promulgated new rules
on a variety of subjects, in addition to other rule proposals,
and the NASDAQ Stock Market has enacted new corporate governance
listing requirements. These developments have and will continue
to increase our accounting and legal compliance costs, and could
also expose us to additional liability.
Costs of compliance were significantly larger in 2004 than
originally anticipated, and costs of compliance in future
periods may continue to be unpredictable, which could have an
adverse effect on our financial results. In addition, we were
unable to complete the efforts required in order to comply with
Section 404 in a timely
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manner this year, which impacted our ability to make a timely
filing of our Report on Form 10-K. There can be no
guarantee that we will not face similar issues in future filings.
In addition, such developments may make retention and
recruitment of qualified persons to serve on our board of
directors or executive management more difficult. We continue to
evaluate and monitor regulatory and legislative developments and
cannot reliably estimate the timing or magnitude of all costs we
may incur as a result of the Act or other related legislation or
regulation.
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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 highly 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. Any of these factors could
have a material adverse effect on our business.
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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 includes the production of samples and
customization of products for our prospective customers.
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 customer
successfully integrating our product into their product,
completing development of their product and then obtaining
production orders for their product.
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.
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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 NEC Corporation and Unaxis
Holdings, Ltd, each of which has sold substantial numbers of
systems worldwide. Up to 1998, we also experienced competition
from Ulvac Technologies, Inc. In the market for our Imaging
products, we experience competition from companies such
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as ITT Industries, Inc. and Northrop Grumman Corporation, the
primary U.S. manufacturers of Generation-III night vision
devices and their derivative 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. Accordingly, 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.
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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. 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 we or our customers 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. The loss of one or more
government contracts by us or our customers could have a
material adverse effect on our operating results.
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 government program
would result in a loss of anticipated future revenues
attributable to that program. That could increase our overall
costs of doing business and have a material adverse effect on
our operating results.
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
and the occurrence of cost overruns would have a material
adverse effect on our business.