Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-26946

INTEVAC, INC.

Registrant’s telephone number, including area code:

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

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

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ         No o

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

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

     The aggregate market value of voting stock held by non-affiliates of the Registrant, as of June 28, 2003 was approximately $15,690,000 (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 3, 2004, 19,981,993 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 2004 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 hard disk drive market dynamics, our leadership position in thin-film disk manufacturing equipment, projected customer requirements for new capacity and for technology upgrades to their installed base of thin-film disk manufacturing equipment, as well as the ability of our products to meet these requirements; the timing of delivery and/or acceptance of our products for revenue; the expected features, performance and competitive advantages of products we are developing including LIVAR®, low light level sensors and cameras and 200 Lean systems; 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 thin-film disk sputtering equipment for the thin-film disk industry and a developer 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 disks used in hard disk drives. We believe we are the leading provider of disk sputtering systems. Our systems represent approximately half of the installed base of disk sputtering systems and produced approximately half of all thin-film disks made worldwide in 2003. Our customers include the world’s leading thin-film disk manufacturers, such as Hitachi Global Storage Technologies, or HGST, Komag, Maxtor and Seagate Technology. We believe the rapid growth of digital data, the transition from video cassette 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 systems for positive identification of targets at long range and sensors and cameras for use in extreme low light situations. 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 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,” “Intevac® MDP 250,” “Intevac® 200 Lean,” “LIVAR,” “D-STAR,” “EBAPS” and “NightVista™,” among others, are our registered trademarks.

1

Table of Contents

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 thin-film disks which are used in hard disk drives. Hard disk drives are the primary storage medium for digital data and function by magnetically storing data on thin-film disks. These thin-film disks are created in a sophisticated manufacturing process involving a variation of many steps, including plating, annealing, polishing, texturing, sputtering and lubrication.

     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 digital data. According to IDC, the total storage capacity of hard disk drives shipped grew from 5.2 billion gigabytes in 2001 to 8.8 billion gigabytes in 2002. Additionally, capacity is expected to grow at a 45.1% compounded annual growth rate from 2002 to 2007. We believe there are a number of emerging trends and applications that exploit these reduced storage costs and that require storage intensive solutions.

	•	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.
	•	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. IDC estimates personal computer growth of over 10.2% in 2004.
	•	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.
	•	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, IDC expects the total number of units of all hard disk drives to be shipped between 2002 and 2007 to grow at a compounded annual rate of approximately 10.7% from 219 million units to 365 million units.

     Hard Disk Drive Market Dynamics

      Areal Density Increasing. Areal density, the density of information stored on thin-film disks, continues to increase. Areal density is a function of how closely spaced the information bits are on the thin-film disk. Higher areal density means more information can be stored on a thin-film disk of the same size. Thin-film disk manufacturers compete by increasing the areal density of a hard disk, which enables them to provide more data storage capacity at a lower cost per gigabyte. As areal densities have increased, hard disk drive manufacturers have been able to reduce costs by reducing the number of disks per drive. In 2003, desktop personal computers included an average of 1.1 thin-film disks per drive whereas in 1998 there was an average of 2.2 thin-film disks per drive.

      Transition from Longitudinal to Perpendicular Recording. Historically, thin-film disk manufacturers have been able to increase the areal density of a thin-film disk by improving existing longitudinal recording processes, a storage method where magnetized data bits lie flat on the thin-film disk. However, the rate of increase in areal density 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 thin-film disk

2

Table of Contents

      New Equipment Required for Perpendicular Recording. The equipment that thin-film disk manufacturers purchased in the mid to late 1990s could generally accommodate up to 12 process steps, which has been sufficient to enable improvements in areal density using longitudinal recording. However, producing thin-film disks capable of perpendicular recording may require up to 18 to 24 process steps. As a result, in order to transition to perpendicular recording, thin-film disk manufacturers will most likely need to replace or retool their existing thin-film disk manufacturing equipment.

      Consolidation of Equipment Suppliers. The supplier base of disk sputtering equipment has consolidated. Beginning in 1995, many thin-film disk manufacturers undertook aggressive expansion plans. The reduction in thin-film 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 dramatically from 1997 to 2002, thin-film disk manufacturers did not make significant investments in new disk sputtering equipment. In fact, of the four leading providers of disk sputtering equipment, only two have announced new equipment platforms capable of perpendicular recording.

      Industry Consolidation. Two types of companies purchase disk sputtering equipment. Vertically integrated companies manufacture both thin-film disks and the drives that use the disks. Thin-film disk manufacturing companies manufacture only thin-film disks and sell them to hard disk drive 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 IBM sold its hard disk drive business to Hitachi in 2002. In 2001, Fujitsu ceased manufacturing hard disk drives for the personal storage market. This consolidation has reduced the number of thin-film hard disk manufacturers able to respond to any increasing demand for digital data storage.

      Return to Industry Growth. According to IDC, hard disk drive demand will reach 365 million units by 2007. In 2003, hard disk drive manufacturers were expected to produce approximately 232 million units, according to IDC. Recently, HGST, Maxtor and Seagate, have announced significant thin-film disk manufacturing capacity expansions.

      To meet increasing demands, thin-film disk manufacturers are beginning to invest in new disk sputtering equipment that can accommodate the additional process steps required for perpendicular recording. To evaluate the performance of competing disk sputtering equipment, thin-film disk manufacturers consider the following criteria:

	•	Cost of Ownership. The factors that affect the cost of ownership of disk sputtering equipment include purchase price, yield, throughput, factory floor footprint, uptime and material utilization efficiency. A lower cost of ownership for disk sputtering equipment is a key factor in lowering the manufacturer’s product cost.
	•	Extendibility and Flexibility. We believe thin-film disk manufacturers need disk 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 thin-film 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.
	•	Compatibility with Existing Equipment. We believe thin-film disk manufacturers prefer to standardize their processes around one or two disk sputtering equipment suppliers. Once a thin-film 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.

3

Table of Contents

	•	Long-term Commitment of Supplier. We believe thin-film disk manufacturers need disk 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, thin-film disk manufacturers increasingly demand a supplier with the stability and capability to be a long-term technology partner.

     Our Competitive Strengths

      We are the leading provider of sputtering equipment to thin-film disk manufacturers. We believe that our industry leadership is the result of the following key competitive strengths:

	•	Broad Installed Base with Industry Leading Customers. Our MDP-250 disk sputtering system gained wide acceptance in the thin-film disk manufacturing industry and by the late 1990s was being used in the manufacture of approximately half of the thin-film disks used in hard disk drives worldwide. We believe that there are approximately 90 MDP-250s currently in use in production and research and development applications by customers such as HGST, 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. During 2003, we received orders for ten of our 200 Lean disk sputtering systems and delivered our first system in December 2003. The remaining systems are currently scheduled to be delivered in the first half of 2004. We believe this is the first production order from a major hard disk drive manufacturer for a new equipment platform capable of perpendicular recording.
	•	Technology Leadership with Modular Next Generation Advanced Platform. In 2003, we introduced 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 thin-film disks to be manufactured per square-foot of factory. The flexible design of the 200 Lean allows rapid reconfiguration to accommodate product changeovers and new thin-film disk technology. The modular design of the 200 Lean also allows thin-film disk manufacturers to add additional process steps, as advanced thin-film disk technologies, such as perpendicular recording, are introduced.
	•	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 announced next-generation disk sputtering equipment that can support perpendicular recording. We have continued to develop new technologies and have introduced the 200 Lean disk sputtering system to meet the needs for additional process steps needed to produce thin-film disks capable of perpendicular recording. In addition, our headquarters are strategically located in close proximity to our customers’ hard disk drive development centers, and we are expanding our support center in Singapore to provide greater service to our customers’ manufacturing facilities located in Southeast Asia.

      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.

     Our Equipment Strategy

      We believe we can leverage our leadership position in disk sputtering equipment to increase our sales to thin-film disk manufacturers and apply our technology to new markets. The key elements of our strategy are as follows:

	•	Become Preferred Solutions Provider in the Thin-Film Disk Industry. Our goal is to become a preferred solutions provider to thin-film disk manufacturers. We believe that our 200 Lean provides our customers with an advanced modular platform that can address their future disk sputtering needs. By working in close partnership with our customers, we believe we are well positioned to provide new manufacturing solutions for other hard disk drive components. We believe we can integrate additional capabilities into the 200 Lean, enabling our customers to eliminate other stand-alone disk manufactur-

4

Table of Contents

		ing equipment and reduce thin-film disk production time. We also believe we have an opportunity to develop and supply other equipment related to the manufacture of hard disk drives.
	•	Deliver Highest Customer Value Proposition. Our goal is to maintain our leadership in advanced disk sputtering equipment by providing 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.
	•	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.
	•	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 Equipment Products

     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 90 MDP-250 systems. The 200 Lean provides higher throughput from a smaller footprint in a flexible modular system, which enables more thin-film 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:

	•	Modular Design. The 200 Lean’s modular design allows our customers to accommodate any number of thin-film disk manufacturing process steps required by their evolving technology roadmaps. The 200 Lean consists of a front-end robotic module that loads and unloads thin-film disks from the system, combined with any number of four-station process modules. Typical configurations of the 200 Lean have from three to six process modules, which results in systems capable of 12 to 24 process steps. Additional process modules can be easily added to already installed systems. For example, a customer could buy a 12-station 200 Lean to manufacture longitudinal media and at a later date upgrade the system to a 24-station system to manufacture perpendicular media.
	•	Easy to Reconfigure. Thin-film 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 thin-film disks with glass or aluminum substrates of varying diameters and thicknesses.
	•	Higher Throughput with Smaller Footprint. The 200 Lean offers higher throughput (over 700 thin-film disks per hour) and more process stations in a more compact package than our industry- leading 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.
	•	High Availability. The 200 Lean is designed to operate seven days a week, 24 hours a day with 95% availability.
	•	Single Disk Processing. The 200 Lean processes each disk sequentially through a series of single-disk process chambers. This eliminates interactions between adjacent process stations, providing a higher level of process control and thin-film uniformity.

5

Table of Contents

	•	High-Vacuum Capability. The 200 Lean operates at ten times the vacuum level of the installed base of MDP-250s. Higher vacuum levels lead to lower contamination and higher coating efficiency, as required to manufacture advanced media.
	•	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.

     MDP-250 Disk Sputtering System

      We believe that the MDP-250 is used to manufacture approximately half the thin-film disks used worldwide to manufacture hard disk drives. The MDP-250 has twelve process stations that are separately vacuum pumped and vacuum isolated. The MDP-250 has a number of process station options, including multiple options for the sputtering of thin-films and carbon overcoats, heating stations, cooling stations and cleaning stations. Furthermore, the MDP-250’s 12 process stations can be reconfigured to accommodate process changes.

     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. 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. Therefore, customers often require a significant number of product presentations and demonstrations before making a purchasing decision. Accordingly, our systems typically have a lengthy sales cycle, during which we may expend substantial funds and management time and effort with no assurance that a sale 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. We also 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 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.

     Equipment Business Customers

      Our disk sputtering equipment customers include thin-film disk manufacturers, such as Fuji Electric, Komag, Showa Denko and Trace Storage Technology, and vertically integrated hard disk drive manufacturers, such as HGST, 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, HGST is developing a new media facility in China.

     Equipment Business Customer Support

      We provide process and applications support, customer training, installation, start-up assistance and emergency service support to our equipment customers. Process and applications support is provided by our equipment process engineers, who also visit customers at their plants to assist in process development projects. 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.

6

Table of Contents

      We generally provide a warranty of at least one year on our equipment. 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.

     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. Currently Anelva and Intevac are the only companies that are offering products that address the sputtering requirements of advanced perpendicular recording. 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 thin-film 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.

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.

     Imaging Industry Overview

      Imaging is the capture and display of light or heat, which is infrared radiation, 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 that provides superiority in nighttime combat creates a significant tactical strategic advantage. Accordingly, the U.S. military has 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. However, the military is now funding the development of next generation extreme low light imaging technology that provides digital video output and is more cost-effective and portable.

      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.

7

Table of Contents

      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.

     Our Imaging Solution

      We have developed imaging technology that combines the low light capability of Generation-III 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. Our solution integrates three key elements into a compact sensor:

	•	a semiconductor photocathode, which converts incoming light into electrons,
	•	acceleration of those elections into a digital imaging chip, and
	•	conversion of those electrons into a digital signal.

      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. CMOS imaging chips are rapidly improving in power consumption, resolution and dynamic range. 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.

      Compact Ultra-High Vacuum Sensor Packaging — Our compact ultra-high vacuum sensor package enables us to combine a megapixel imaging chip with our photocathodes in a package approximately one inch square and one quarter inch thick. Our proprietary design maintains close spacing between the photocathode and the silicon sensor to further enhance resolution. Our small package is particularly well suited for portable applications where size and weight are critical.

     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 to be $347 million in 2003.

      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. Thermal imaging systems become larger with increased range, which is problematic for aircraft and portable applications. Additionally, these systems only measure emitted heat and as a result produce relatively poor resolution images. Moreover, long range infrared imaging systems deployed by the U.S. military are not significantly superior to infrared imaging systems available to potential adversaries. The rules of engagement for U.S. military forces require positive identification prior to attack. This puts U.S. forces at a disadvantage to

8

Table of Contents

      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 2006.

      Security Cameras — The world is becoming more security-conscious and increasingly relies on cameras for surveillance. The majority of the security market is served by closed circuit television cameras, which work well when sufficient light is available. However, extreme low light cameras are needed when sufficient light is not available, when it is not economical to provide lighting or when stealth is required. Markets for this capability include surveillance of international borders, airport perimeters, military bases, pipelines and nuclear power plants.

      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. For example, defects on semiconductor wafers are getting increasingly smaller and require improved measurement accuracy. An example in the pharmaceutical industry is the growing need for near infrared spectrometer imaging to determine the composition of medicines in real time.

      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. Extreme low light cameras are required, because light can change the cells that are being imaged. High speed cameras are required, because changes happen very rapidly at the cellular level. Medical labs, hospitals and health research institutes also utilize these cameras for applications ranging from routine lab tests to advanced research.

 Our Imaging Strategy

      Collaborate with Leading Development Organizations — We collaborate with, and receive significant funding from, leading government research organizations on 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. We initially developed some of our sensors under a cost sharing agreement with the National Institute of Standards and Technology. More recently, we began working on a program with The Los Alamos National Laboratory to develop three-dimensional sensor 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 technology has been incorporated into 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 LIVAR technology to become the standard for long-range target identification and for our extreme low light sensors to become the standard for head-mounted displays.

9

Table of Contents

      Leverage Proprietary Sensor Technology to Address Emerging Commercial Markets — We are using our extreme low light imaging expertise to develop products for commercial markets. For example, in 2003 we completed development of our NightVista™ camera to address the security market. We believe the modular design of our NightVista platform, coupled with our use of standard silicon 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 commercially available sensors and development of wafer die level manufacturing, as opposed to single die level 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, to provide us with the scale and scope necessary to become a leading provider of imaging solutions in our target markets.

     Our Imaging Products

      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. Currently the military uses systems such as forward-looking infrared systems and radar to detect targets. While these systems can detect targets at relatively long ranges, the resolution is relatively poor, and positive identification is often difficult or impossible. 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 anticipate offering our LIVAR cameras and systems at prices that range from approximately $50,000 to $400,000. We do not expect significant revenues from deployment of LIVAR systems until 2006.

      Current LIVAR programs and products include:

	Cost Effective Targeting System — We are working under subcontract to DRS Sensor Systems to develop a LIVAR system for use on an unmanned surveillance vehicle being developed for the U.S. Army.
	Airborne Laser — LIVAR cameras are an enabling technology for the laser targeting in Lockheed Martin’s Airborne Laser program, in which a jumbo jet will use high-powered lasers to destroy ballistic missiles in flight.
	Classified Program — The first weapons platform slated for deployment of LIVAR is nearing the end of its product development. We expect prototypes to be fielded in 2004 and volume production to follow approximately two years later.
	SALSA Program — In the Systems for Airborne Laser Sensing and Analysis, or SALSA, program, we are working with the Air Force Research Laboratory and Kirkland Air Force Base to develop wafer level manufacturing to enable lower cost LIVAR sensors.
	Long Range Identification — We are working with Northrop Grumman to integrate a LIVAR camera into an existing laser illuminator used by Special Operations Forces to designate targets for laser-guided bombs. The integration of LIVAR into this system is designed to allow the Special Operations Forces to complete their missions at much longer ranges from the target.

10

Table of Contents

	LIVAR 2200 Portable System — The LIVAR 2200 is a prototype portable target identification system we developed for military use.
	LIVAR 120 Camera — The model 120 is a standalone LIVAR camera that we sell to developers of long-range imaging systems.
	NightVista Cameras — The NightVista camera is an extreme low light CMOS-based day/night video camera for security applications that currently offers up to 1.3 mega-pixel resolution. Its camera body is small enough to fit into a two-inch cube, and its power consumption is less than 1500 milliwatts. As a result, the NightVista is well suited for portable battery-powered applications. The NightVista outputs digital video in several standard formats and is easily integrated with other digital technologies. The NightVista reprocesses and optimizes extreme low light images and is configurable to end user requirements. We offer the NightVista at a list price of $5,000, less than the price of a Generation-III based security camera.

      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.

     Our Imaging 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 security market, we face competition from companies such as ElectroPhysics, ITT and Texas Instruments. These competitors’ products are based on image intensifier tubes manufactured by ITT and Northrop Grumman and by foreign suppliers. Electron multiplying CCDs manufactured by Texas Instruments and E2V also are used in cameras that compete with our low light level security products. In the physical and life sciences market, companies such as Andor, E2V, Hamamatsu and Roper Scientific offer competitive products. In the security product area, competitive products to our NightVista camera based on electron multiplying CCDs and image intensifier tubes are offered by a number of companies.

Manufacturing

      We conduct all of our Equipment business manufacturing 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.

11

Table of Contents

      Our Imaging business manufacturing includes the manufacture 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. As with our Equipment business, we make use of the supplier infrastructure serving the semiconductor, camera and optics manufacturing industries for our Imaging business. 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 28 patents issued in the United States and 34 patents issued in foreign countries, and have patent applications pending in the United States and foreign countries. Of the 28 U.S. patents, 15 relate to our Equipment business, and 13 relate to our Imaging business. Of the foreign patents, 13 relate to our Equipment business, and 21 relate to our Imaging business. In addition, we have the right to utilize certain patents under licensing arrangements with Litton Industries, Stanford University 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.

      We have executed a strategy to protect our intellectual property investment by using internal company funds for development of new concepts and inventions. This minimizes customer ownership of new intellectual property that we develop. This is particularly important due to the large amount of government-funded research and development in our Imaging business.

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 2003, Komag, Seagate, Lockheed Martin and equipment sales through Matsubo, our Japanese distributor, 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. In 2001, equipment sales through Matsubo, our Japanese distributor, accounted for 49% 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 64% of revenues in 2003, 52% of revenues in 2002 and 73% of revenues in 2001. The majority of our foreign sales are to companies in the Far East, and we anticipate that sales to customers in the Far East will continue to be a significant portion of our equipment revenues.

Employees

      At December 31, 2003, we had 180 employees, including 29 contract employees. Of these 180 employees, 85 were in research and development, 58 in manufacturing, and 37 in administration, customer support and marketing. Of the 180 employees, 106 were in the Equipment business, 49 were in the Imaging business, and 25 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 are rigorous and set

12

Table of Contents

Certain Factors Which May Affect Future Operating Results

      The majority of our revenues and gross profit has historically been derived from sales of disk sputtering equipment. Sales of our disk sputtering equipment have been severely depressed since the middle of 1998. 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. For fiscal 2003, our operating loss was $10.7 million, and as of December 31, 2003, we had an accumulated deficit of $21.3 million. To regain profitability, we will need to 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.

      Since the middle of 1998, there has been virtually no demand for new disk sputtering systems, as thin-film disk manufacturers have been burdened with overcapacity and have not been investing in new disk sputtering equipment. Recently, however, overcapacity has diminished, and three of our customers have announced plans for major capacity expansions. 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 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 any 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.

      Over the last 8 quarters, our revenues per quarter have fluctuated between $12.1 million and $4.6 million. Over the same period our operating loss as a percentage of revenues has fluctuated between approximately 90% and 5% of revenues. We anticipate that our revenues and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:

	•	changes in the demand, due to seasonality and other factors, for the computer systems, storage subsystems and consumer electronics that contain the thin-film disks that our customers produce using our systems;
	•	delays or problems in the introduction of our new products; and
	•	announcements of new products, services or technological innovations by us or our competitors.

13

Table of Contents

      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. 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.

      Historically, a significant portion of our revenue in any particular period has been attributable to sales to a limited number of customers. In 2003, three of our customers, in the aggregate, accounted for 75% of our equipment revenues. In addition, our backlog of 200 Lean systems at December 31, 2003 is from a single customer. Orders from a relatively limited number of thin-film 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. Furthermore, the concentration of our customer base may lead customers to demand pricing and other terms unfavorable to us.

      In the market for our disk sputtering systems, we have experienced competition from competitors such as Anelva Corporation, a subsidiary of NEC Corporation, Ulvac Technologies, Inc. and Unaxis Holdings, Ltd, each of which has sold substantial numbers of systems worldwide. In the market for our imaging products, we experience competition from companies such as ITT Industries, Inc. and Northrop Grumman Corporation, the primary U.S. manufacturers of Generation-III night vision devices and their derivative products. 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 will 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.

      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. We have invested heavily, and continue to invest, in the development of new products. Our 200 Lean disk sputtering system is designed to address the demand for increased areal density in hard disk drives and our customers’ concurrent need to produce more complex thin-film disks. Our future revenues depend on the industry recognizing the need for improved recording methodologies and the need for disk sputtering systems that facilitate manufacturing of advanced media with technologies such as perpendicular recording. Our future revenues also depend significantly on the market acceptance of our 200 Lean disk sputtering system, which we have only recently introduced and which competes against a product that has been on the market longer. Our new products will typically bear higher production and warranty costs in comparison to our more established product lines. Additionally, our gross margins on our new products may be lower and more difficult to predict. We continue to invest heavily to develop products for the thin-film disk manufacturing industry. In addition, 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

14

Table of Contents

      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.

      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 thin-film disk production have been severely depressed since the middle of 1998. In addition, our thin-film disk manufacturing customers are generally more sensitive to the cyclical nature of the hard disk drive industry, because many of their customers have internal thin-film 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.

      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. Additionally, our Imaging business is subject to long sales cycles as a result of government procurement cycles. As a result, we may not recognize revenue from efforts to sell particular products for extended periods of time, during which we may expend substantial funds and management time and effort with no assurance that a sale will result.

      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 or volume production of new systems or enhancements. In addition, some of the systems that we manufacture must be customized to meet individual customer site or operating requirements. 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

15

Table of Contents

      We sell our products 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 Congress 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.

      Our customers must make extremely large capital expenditures in order to purchase our systems and other related equipment and facilities. These costs are far in excess of the cost of our systems alone. The magnitude of such capital expenditures requires that our customers have access to large amounts of capital and that they be willing to invest that capital over long periods of time to be able to purchase our equipment. The thin-film disk manufacturing industry has not made significant additions to its production capacity until recently. Some of our potential customers may not be willing or able to make the magnitude of capital investment required, especially during a downturn in either the overall economy or the hard disk drive industry.

      The market price and trading volume of our common stock has been subject to significant volatility, and this trend may continue. In particular, our historical trading volume has been low, and the market price of our common stock has increased dramatically in recent months. Over the past 12 months, the closing price of our common stock, as traded on The Nasdaq National Market, has fluctuated from a low of $3.52 to a high of $17.92 per share. Our stock price is currently trading at or near its seven-year high. The value of our common

16

Table of Contents

	•	our perceived prospects;
	•	variations in our operating results and whether we achieve our key business targets;
	•	the limited number of shares of our common stock available for purchase or sale in the public markets;
	•	sales or purchases of large blocks of our stock;
	•	changes in, or our failure to meet, our earnings estimates;
	•	changes in securities analysts’ buy or sell recommendations;
	•	differences between our reported results and those expected by investors and securities analysts;
	•	announcements of new contracts, products or technological innovations by us or our competitors;
	•	market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors;
	•	our high fixed operating expenses, including research and development expenses;
	•	developments in the financial markets; and
	•	general economic, political or stock market conditions in the United States and other major regions in which we do business.

      Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.

      We are a manufacturing business. Purchased parts constitute the largest component of our product cost. Our ability to manufacture depends on the timely delivery of parts, components, and subassemblies from suppliers. We obtain some of the key components and sub-assemblies used in our products from a single supplier or a limited group of suppliers. If any of our suppliers fail to deliver quality parts on a timely basis, we may experience delays in manufacturing, which could result in delayed product deliveries or increased costs to expedite deliveries or develop alternative suppliers. Development of alternative suppliers could require redesign of our products. Any or all of these factors could have a material adverse effect on our business and operating results.

      The success of our business depends upon integrity of our intellectual property rights and we cannot assure you that:

	•	any of our pending or future patent applications will be allowed or that any of the allowed applications will be issued as patents;
	•	any of our patents will not be invalidated, deemed unenforceable, circumvented or challenged;
	•	the rights granted under our patents will provide competitive advantages to us;

17

Table of Contents

	•	any of our pending or future patent applications will issue with claims of the scope that we sought, if at all;
	•	other parties will not develop similar products, duplicate our products or design around our patents; or
	•	our patent rights, intellectual property laws or our agreements will adequately protect our intellectual property or competitive position.

      Failure to protect our intellectual property rights adequately could have a material adverse effect on our business.

      We provide products that are expected to have long useful lives and that are critical to our customers’ operations. From time to time, as part of business agreements, we place portions of our intellectual property into escrow to provide assurance to our customers that our technology will be available to them in the event that we are unable to support them at some point in the future.

      From time to time, we have received claims that we are infringing third parties’ intellectual property rights. We cannot assure you that third parties will not in the future claim that we have infringed current or future patents, trademarks or other proprietary rights relating to our products. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us. Any of the foregoing could have a material adverse effect on our business.

      Our U.S. operations are located in Santa Clara, California, where the cost of doing business is extremely high. Failure to manage these costs well could have a material adverse effect on our operating results. Additionally, our operating results depend, in part, upon our ability to retain and attract qualified management, engineering, marketing, manufacturing, customer support, sales and administrative personnel. The cost of living in Northern California is also extremely high, which increases the cost and difficulty of recruiting new employees. Furthermore, we compete with various similar industries, such as the semiconductor industry, for the same pool of skilled employees. Failure to attract and retain qualified personnel could have a material adverse effect on our business.

      Our U.S. facilities are located in an area of California that has experienced power outages and earthquakes and is considered seismically active. Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, unauthorized intrusion and other catastrophic events beyond our control. Our contingency plans for addressing these kinds of events may not be sufficient to prevent system failures and other interruptions in our operations that have a material adverse effect on our business. Additionally, our suppliers’ suffering similar business interruptions could have an adverse effect on our manufacturing ability. If any natural or man-made disasters do occur, our operations could be disrupted for prolonged periods, which could have a material adverse effect on our business.

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

18

Table of Contents

      We currently quote and sell the majority of our products in U.S. dollars. From time to time, we may enter into foreign currency contracts in an effort to reduce the overall risk of currency fluctuations to our business. However, there can be no assurance that the offer and sale of products denominated in foreign currencies, and the related foreign currency hedging activities, will not adversely affect our business.

      Our principal competitor for disk sputtering equipment is based in Japan and has a cost structure based on the Japanese yen. Accordingly, currency fluctuations could cause the price of our products to be more or less competitive than our principal competitor’s products. Currency fluctuations will decrease or increase our cost structure relative to those of our competitors, which could lessen the demand for our products and affect our competitive position.

      We have completed a number of acquisitions as part of our efforts to expand and diversify our business. For example, our business was initially acquired from Varian Associates in 1991. We acquired our gravity lubrication and rapid thermal processing product lines in two acquisitions. We sold the rapid thermal processing product line in November 2002. We also acquired our RPC electron beam processing business in late 1997, and subsequently closed this business. We intend to continue to evaluate new acquisition candidates, divestiture and diversification strategies. Any acquisition involves numerous risks, including difficulties in the assimilation of the acquired company’s employees, operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company’s key employees. Additionally, unanticipated expenses, difficulties and consequences may be incurred relating to the integration of technologies, research and development, and administrative and other functions. Any future acquisitions may also result in potentially dilutive issuance of equity securities, acquisition- or divestiture-related write-offs or the assumption of debt and contingent liabilities. Any of the above factors could have a material adverse effect on our business.

      We are subject to a variety of governmental regulations relating to the use, storage, discharge, handling, emission, generation, manufacture, treatment and disposal of toxic or otherwise hazardous substances, chemicals, materials or waste. If we fail to comply with current or future regulations, such failure could result in suspension of our operations, alteration of our manufacturing process, or substantial civil penalties or criminal fines against us or our officers, directors or employees. Additionally, these regulations could require us to acquire expensive remediation or abatement equipment or to incur substantial expenses to comply with them. Failure to properly manage the use, disposal or storage of, or adequately restrict the release of, hazardous or toxic substances could subject us to significant liabilities.

      Based on the shares outstanding on December 31, 2003, our current directors, executive officers and affiliates, in the aggregate, beneficially owned 41.2% of our outstanding shares of common stock (26.4% after completion of our secondary offering in February 2004). These shareholders, acting together, are able to exert significant control on matters requiring approval by our shareholders, including the election of directors and approval of significant corporate transactions.