Management's Discussion and Analysis (MD&A) is intended to facilitate an understanding of Intevac's business and results of operations. This MD&A should be read in conjunction with Intevac's Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this Form 10-K. The following discussion contains forward-looking statements and should also be read in conjunction with the cautionary statement set forth at the beginning of this Form 10-K. MD&A includes the following sections:

• Overview: a summary of Intevac's business, measurements and opportunities.

• Results of Operations: a discussion of operating results.

• Liquidity and Capital Resources: an analysis of cash flows, sources and uses of cash, contractual obligations and financial position.

• Critical Accounting Policies: a discussion of critical accounting policies that require the exercise of judgments and estimates.

Overview

Intevac provides manufacturing equipment and solutions to the hard disk drive industry and offers advanced etch technology systems to the semiconductor industry. Intevac's 200 Lean platform may be suitable to certain non-magnetic thin film applications such as optical coatings, photovoltaic and wear-resistant coatings although to date Intevac has not received revenues from such applications. Intevac also provides sensitive electro-optical devices used in high-performance digital cameras for military and commercial applications. Intevac's customers and potential customers include manufacturers of hard disk drives, semiconductor chips and wafers, as well as medical, scientific and security companies, law enforcement and the U.S. government and its contractors. Intevac reports two segments: Equipment and Intevac Photonics. Effective in the second quarter of 2008, Intevac renamed the Imaging Instrumentation segment to Intevac Photonics. During the third quarter of 2008, Intevac completed the acquisition of certain assets and liabilities of the magnetic media equipment business of OC Oerlikon Balzers Ltd. ("Oerlikon").

Product development and manufacturing activities occur in North America and Asia. Intevac's equipment and service products are highly technical and, with the exception of Japan, are sold primarily through a direct sales force. During the third quarter of 2008, Intevac entered into an alliance with a Korean equipment manufacturer and distributor, TES Co., Ltd. ("TES"). Under the agreement TES has the rights to manufacture and sell Intevac's Lean Etch system for the Korean and Chinese markets, and Intevac has the rights to manufacture and sell TES' chemical vapor deposition equipment for customers throughout the rest of the world. To date no sales have been made pursuant to this contract.

Intevac's results are driven primarily by worldwide demand for hard disk drives, which in turn depends on end-user demand for personal computers, enterprise data storage, personal audio and video players and video game platforms. Intevac's business is subject to cyclical industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for hard disk drives, chips, and other electronic devices, as well as other factors, such as global economic conditions and technological advances in fabrication processes.

                                                                                             % Change               % Change
Fiscal Year                              2008             2007             2006            2008 vs. 2007          2007 vs. 2006
                                                       (In thousands, except percentages and per share amounts)

Net revenues                          $ 110,307        $ 215,834        $ 259,875                (48.9 )%               (16.9 )%
Gross profit                             43,339           96,043          100,959                (54.9 )%                (4.9 )%
Gross margin percent                       39.3 %           44.5 %           38.8 %               (5.2 )%                 5.7 %
Net income (loss)                       (15,345 )         27,345           46,698               (156.1 )%               (41.4 )%
Earnings (loss) per diluted share     $   (0.71 )      $    1.23        $    2.13               (157.7 )%               (42.3 )%

During fiscal 2006 Intevac reported record revenues as increasing end-user demand for hard drives in the desktop PC market and in the non-desktop market, including mobile, and consumer electronic products drove

increased customer investments in hard disk drive manufacturing equipment as did the technology transition to perpendicular magnetic recording.

Fiscal 2007 financial results reflected continued good conditions in the hard disk drive industry. Revenues and net income were lower than 2006 levels and declined in the second half of 2007. During this period Intevac expanded its photonics product portfolio with the acquisitions of DeltaNu, LLC, ("Delta Nu") and Creative Display Systems, LLC ("CDS").

Fiscal 2008 financial results reflected a difficult environment as Intevac's customers reduced or delayed capital expenditures as a result of industry consolidation, price erosion and reduced demand as a result of global economic conditions. In this period, Intevac focused on lowering costs, improving efficiencies, and bringing new products to market. In 2008, Intevac acquired certain assets and liabilities of OC Oerlikon Balzers Ltd. ("Oerlikon")'s magnetic media equipment business. In the fourth quarter of fiscal 2008, in response to the deteriorating economic conditions, Intevac announced and executed a global cost reduction plan that reduced its cost structure and its cash burn, while still enabling Intevac to invest in products that will drive future growth. Also during the fourth quarter of fiscal 2008, Intevac's market capitalization and financial outlook were adversely impacted by the current macroeconomic business environment. This triggered Intevac's performing interim impairment tests on its goodwill and intangible assets; and as a result Intevac recorded non-cash goodwill and intangible impairment charges of $10.5 million.

Intevac expects the difficult environment to continue into fiscal 2009. The global economic climate and constrained financing environment have caused a broad slowdown in capital equipment purchases by our customers, with uncertainty as to the depth and duration of the downturn. While the uncertainty of end market demand continues to dampen expectations for the hard drive market, Intevac expects that in 2009 demand for some equipment will occur due to the retirement of some legacy systems. In addition, Intevac believes that research and development activities, including patterned media, will require new equipment. Intevac does not expect any of its hard drive customers to add new systems for capacity in 2009. Intevac expects that in 2009, Intevac Photonics business will grow, driven by government spending plus incorporation of Intevac products into development, pre-production and some early stage production programs.

Results of Operations

Net revenues

                                          Years Ended December 31,                 % Change              % Change
                                     2008           2007           2006          2008 vs. 2007         2007 vs. 2006
                                                           (In thousands, except percentages)

Equipment                          $  87,469      $ 196,686      $ 248,482                (55.5 )%              (20.8 )%
Intevac Photonics                     22,838         19,148         11,393                 19.3 %                68.1 %

Total net revenues                 $ 110,307      $ 215,834      $ 259,875                (48.9 )%              (16.9 )%

Net revenues consist primarily of sales of equipment used to develop and manufacture thin-film disks, and, to a lesser extent, related equipment and system components; flat panel equipment technology license fees; contract research and development related to the development of sensors, cameras and systems; low-light imaging products and Raman spectrometers.

The decrease in Equipment revenues in 2008 was due primarily to a reduction in the number of 200 Lean systems delivered. In 2008 Intevac delivered eleven 200 Lean systems compared to twenty-nine 200 Lean systems in 2007 and forty-six 200 Lean systems in 2006. Equipment revenue in 2008 also included eleven disk lubrication systems compared to four disk lubrication systems in 2007 and thirteen disk lubrication in 2006. Revenues from disk equipment technology upgrades and spare part decreased significantly in 2008 versus 2007 and 2006. During 2007, Intevac sold a D-Star® flat panel technology license for $1.3 million.

Fiscal 2008 was a slow year for new system capacity additions in the hard disk drive market due to the upgrade and reuse of approximately twenty legacy tools previously in storage. This substantially met the incremental capacity requirements of one of our largest customers. Equipment revenues in 2009 are not expected to exceed 2008 levels, given the uncertainty in the market.

Intevac Photonics revenues increased by 19.3% to $22.8 million in 2008, which consisted of $8.5 million of product revenue and $14.3 million of contract research and development revenue. Intevac Photonics 2007 revenue of $19.1 million consisted of $5.2 million of product revenue and $13.9 million of contract research and development revenue. Intevac Photonics 2006 revenue of $11.4 million consisted of $1.7 million of product revenue and $9.7 million of contract research and development revenue. The increase in product revenues resulted from higher sales of low-light detection sensors and cameras used in military night vision surveillance and commercial applications as well as table-top and portable Raman instruments and Near-Eye Display products. The increase in contract research and development revenue was the result of a higher volume of contracts and incremental revenue generated from contract close-outs. In 2009, Intevac Photonics revenue is expected to grow, due primarily to increased product sales. During 2009, Intevac expects over 50% of Intevac's revenue to come from product sales. Substantial growth in future Intevac Photonics revenues is dependent on the proliferation of Intevac's technology into major military programs, continued defense spending, the ability to obtain export licenses for foreign customers, obtaining production subcontracts for these programs, and development and sale of commercial products.

Intevac's backlog of orders at December 31, 2008 was $20.2 million, as compared to $34.2 million at December 31, 2007 and $125.0 million at December 31, 2006. Equipment backlog at December 31, 2008 was $11.4 million compared to $28.4 at December 31, 2007 and $119.4 million at December 31, 2006. Intevac Photonics backlog at December 31, 2008 was $8.8 million compared to $5.8 million at December 31, 2007 and $5.6 million at December 31, 2006. Equipment backlog at December 31, 2008 includes one 200 Lean system for a non-magnetic media application, as compared to two 200 Lean systems at December 31, 2007, and twenty-four 200 Lean systems at December 31, 2006.

Significant portions of Intevac's revenues in any particular period have been attributable to sales to a limited number of customers. In 2008 sales to Seagate and Hitachi Global Storage Technologies each accounted for more than 10% of Intevac's revenues and in the aggregate sales to these customers accounted for 69% of revenues. In 2007 and 2006 sales to Seagate, Matsubo - Intevac's Japanese distributor, Hitachi Global Storage Technologies, and Fuji Electric each accounted for more than 10% of Intevac's revenues. In the aggregate sales to these customers accounted for 90% and 93% of revenues in 2007 and 2006, respectively. The magnetic disk manufacturing industry consists of a small number of large manufacturers. In 2006 Seagate acquired Maxtor, and in 2007, Western Digital acquired Komag, both of which further concentrated Intevac's customer base.

International sales totaled $76.5 million, $177.0 million, and $233.4 million in 2008, 2007, and 2006, respectively, accounting for 69%, 82%, and 90% of net revenues. The decreases in international sales in 2008 and 2007 was primarily due to decreases in net revenues from disk sputtering systems. Substantially all of Intevac's international sales are to customers in Asia, which includes products shipped to overseas operations of U.S. companies.

Gross margin

                                                Years Ended December 31,                    % Change               % Change
                                          2008            2007            2006            2008 vs. 2007          2007 vs. 2006
                                                                  (In thousands, except percentages)

Equipment gross profit                 $ 35,797        $ 87,885        $  97,161                (59.3 )%                (9.5 )%
% of Equipment net revenues                40.9 %          44.7 %           39.1 %
Intevac Photonics gross profit         $  7,542        $  8,158        $   3,798                 (7.6 )%               114.8 %
% of Intevac Photonics net revenues        33.0 %          42.6 %           33.3 %
Total gross profit                     $ 43,339        $ 96,043        $ 100,959                (54.9 )%                (4.9 )%
% of net revenues                          39.3 %          44.5 %           38.8 %

Cost of net revenues consists primarily of purchased materials and costs attributable to contract research and development, and also includes fabrication, assembly, test and installation labor and overhead, customer-specific engineering costs, warranty costs, royalties, provisions for inventory reserves and scrap. Cost of net revenues for

2008, 2007 and 2006 included $781,000, $638,000 and $428,000 of equity-based compensation expense, respectively.

Equipment gross margin was 40.9% in 2008 compared to 44.7% in 2007 and 39.1% in 2006. Lower volume, product mix, unabsorbed factory utilization and costs from acquired businesses, which were offset in part by cost reduction programs contributed to the lower gross margin for 2008. Higher gross margin in 2007 resulted from changes in product mix, higher average selling prices and cost reduction programs. Intevac expects the gross margin for the Equipment business in 2009 to be essentially the same as 2008 at similar revenue levels, and lower than 2008 at reduced revenue levels. Gross margins in the Equipment business will vary depending on a number of additional factors, including product mix, product cost, system configuration and pricing, factory utilization, and provisions for excess and obsolete inventory.

Intevac Photonics gross margin was 33.0% in 2008 compared 42.6% in 2007 and 33.3% in 2006. The decrease in gross margin in 2008 resulted primarily from increased provisions for inventory and warranty and increased costs from acquired businesses. Higher gross margin in 2007 resulted primarily from higher-margin development contracts, favorable adjustments from contract closeouts and increased product sales. Intevac expects the gross margin for the Intevac Photonics business in 2009 to improve over 2008, primarily as a result of the projected increase in product sales, which typically carry higher gross margins.

Research and development

                                               Years Ended December 31,                   % Change               % Change
                                         2008            2007            2006           2008 vs. 2007          2007 vs. 2006
                                                                 (In thousands, except percentages)

Research and development expense      $ 35,083        $ 40,137        $ 30,036                (12.6 )%                33.6 %
% of net revenues                         31.8 %          18.6 %          11.6 %

Research and development expense consists primarily of prototype materials, salaries and related costs of employees engaged in ongoing research, design and development activities for disk sputtering equipment, semiconductor equipment and Intevac Photonics products. Research and development costs for 2008, 2007 and 2006 included $2.0 million, $2.1 million and $1.4 million of equity-based compensation expense, respectively.

Research and development spending decreased for Equipment during 2008 as compared to 2007 and increased in 2007 as compared to 2006. The decrease in Equipment spending during 2008 was due primarily to lower spending on the development of Intevac's Lean EtchTM product line, and to a lesser extent, reductions in incentive compensation expense. Increased Equipment spending in 2007 was due primarily to Lean Etch development and, to a lesser extent development of disk sputtering products. Intevac Photonics increased research and development spending levels in 2008 for sensor yield improvements, sensor development and digital night vision goggle development.

Intevac expects that research and development spending will decrease in 2009 primarily as a result of the lower level of spending on Intevac's Lean Etch product line. Engineering headcount grew from 129 at the end of 2006, to 141 at the end of 2007 and declined to 133 at the end of 2008.

Research and development expenses do not include costs of $8.5 million, $7.4 million, and $6.1 million, in 2008, 2007, and 2006, respectively, which are related to customer-funded contract research and development programs and included in cost of net revenues.

Selling, general and administrative

                                               Years Ended December 31,                   %Change               % Change
                                         2008            2007            2006          2008 vs. 2007          2007 vs. 2006
                                                                (In thousands, except percentages)

Selling, general and
administrative expense                $ 28,229        $ 28,470        $ 22,924                (0.9 )%                24.2 %
% of net revenues                         25.6 %          13.2 %           8.8 %

Selling, general and administrative expense consists primarily of selling, marketing, customer support, financial and management costs and also includes production of customer samples, travel, liability insurance, legal and professional services and bad debt expense. All domestic sales and international sales of disk sputtering products in Asia, with the exception of Japan, are typically made by Intevac's direct sales force, whereas sales in Japan of disk sputtering products and other products are typically made by Intevac's Japanese distributor, Matsubo, who provides services such as sales, installation, warranty and customer support. Intevac also has subsidiaries in Singapore and in Hong Kong, along with field offices in Japan, Malaysia, Korea and Shenzhen, China to support Intevac's equipment customers in Asia. Selling, general and administrative costs for 2008, 2007 and 2006 included $3.8 million, $3.5 million and $1.5 million of equity-based compensation expense, respectively.

Selling, general and administrative spending in 2008 was flat to 2007 levels as a result of cost reduction activities, and lower provisions for employee profit sharing and bonus plans, partially offset by increased costs related to business development, customer service and support in both the Equipment and Intevac Photonics businesses and higher equity-based compensation expense. Intevac's selling, general and administrative headcount increased from 77 at the end of 2006, to 111 at the end of 2007 and then decreased to 97 at the end of 2008. Intevac expects that selling, general and administrative expenses will decrease in 2009 over the amount spent in 2008 due primarily to a projected decrease in costs related to customer service and support for the Equipment business offset by the addition of key business development personnel in the Intevac Photonics business.

Global cost reduction plan

During the fourth quarter of fiscal 2008, Intevac announced a global cost reduction plan ("the Plan") to reduce the global workforce by fifteen percent. Implementation of the Plan was completed in the fourth quarter. The total cost of implementing the Plan was $386,000 and was reported under cost of products sold and operating expenses. Substantially all cash outlays in connection with the Plan occurred in the fourth quarter of fiscal 2008. Implementation of the Plan is expected to reduce expenses by approximately $10 million on an annual basis.

Impairment of goodwill and intangibles

In September 2008, Intevac performed its annual assessment of impairment for goodwill which did not result in an impairment of goodwill. In the fourth quarter of fiscal 2008, Intevac experienced a significant decline in its stock price and Intevac's market capitalization fell below the recorded value of its consolidated net assets. This required Intevac to perform an interim test of its goodwill and intangible assets for impairment. As a result of the goodwill impairment test, Intevac concluded that the carrying amount of the goodwill in the Equipment reporting unit exceeded its implied fair value and recorded an impairment charge of $9.7 million. The goodwill associated with the Intevac Photonics segment was not impaired. As a result of the intangible assets impairment test, Intevac recorded an $808,000 impairment charge related to the write-down to fair value of the net carrying value of certain purchased technology intangible assets in the Equipment and Intevac Photonics segments due to lower revenue expectations and future operating expectations.

Intevac will continue to evaluate the carrying value of goodwill and intangible assets and if it is determined that there is a potential impairment, Intevac may record additional charges to earnings which would adversely affect its financial results. For further details, see Note 6 of Notes to Consolidated Financial Statements.

Interest income and other, net.

Years Ended December 31, % Change % Change 2008 2007 2006 2008 vs. 2007 2007 vs. 2006

Interest income and other, net $ 3,932 $ 8,142 $ 3,778 (51.7 )% 115.5 %

Interest income and other, net in 2008 included $4.0 million of interest income on investments, and $84,000 in net other income, partially offset by $120,000 in interest expense. Interest income and other, net in 2007 included a $1.5 million gain on the redemption of Intevac's preferred interest in 601 California Avenue LLC, $6.5 million of interest income on investments and $129,000 in net other income. The decrease in interest income in 2008 was driven by lower interest rates on Intevac's investments and lower average invested balances. Interest income and

other, net in 2006 consisted of $390,000 of dividends from 601 California Avenue LLC, $3.5 million of interest income on investments and $113,000 in net other expense. Intevac expects interest income and other, net to decrease in 2009 due to a reduction in interest income due primarily to a reduction in interest rates and lower average invested balances.

Provision for (benefit from) income taxes

Years Ended December 31, % Change % Change 2008 2007 2006 2008 vs. 2007 2007 vs. 2006

Provision for (benefit from) income taxes $ (11,194 ) $ 8,233 $ 5,079 (236.0 )% 62.1 %

Intevac's effective income tax provision rate was 42.2% for fiscal 2008, 23.1% for fiscal 2007, and 9.8% for fiscal 2006. Intevac's tax rate differs from the applicable statutory rates due primarily to the utilization of deferred and current credits and the effect of permanent differences and adjustments of prior permanent differences. Intevac's future effective income tax rate depends on various factors including, the level of Intevac's projected earnings, the geographic composition of worldwide earnings, tax regulations governing each region, net operating loss carry-forwards, availability of tax credits and the effectiveness of Intevac's tax planning strategies. Management carefully monitors these factors and timely adjusts the effective income tax rate accordingly. Management believes that the valuation allowances for Intevac's deferred tax assets are adequate based on several factors including: (1) degree to which Intevac's 2008 loss was attributable to unusual items or charges;
(2) long duration of Intevac's deferred tax assets; and (3) expectation of improved earnings in the long term.

Business Combinations

On July 14, 2008, Intevac acquired certain assets and liabilities of OC Oerlikon Balzers Ltd. ("Oerlikon")'s magnetic media equipment business for a purchase price of $15.1 million in cash, net of cash acquired. In addition Intevac agreed to pay contingent consideration to Oerlikon in the form of a royalty on Intevac's net revenue from commercial sales of certain products. This agreement terminates on July 13, 2011. Intevac has made no payments to Oerlikon under this agreement through December 31, 2008. As part of the acquisition, Intevac also entered into a settlement agreement with Oerlikon related to a patent infringement lawsuit filed by Intevac against Unaxis USA, Inc., a wholly owned subsidiary of Oerlikon, and all claims in the litigation were dismissed.

On November 9, 2007, Intevac acquired the assets and certain liabilities of Creative Display Systems, LLC ("CDS") for a purchase price of $6.0 million in cash, net of cash acquired. The acquired business is a supplier of high-performance micro-display products for near-eye and portable applications in defense and commercial markets.

On January 31, 2007, Intevac acquired the assets and certain liabilities of DeltaNu, LLC ("DeltaNu") for a purchase price of $5.8 million of which $2 million was paid in cash at the close of the acquisition, $2 million was paid on January 31, 2008 and $2 million was paid on January 31, 2009, which is in the form of a non interest-bearing note. Interest is imputed, and the related note payable is recorded at a discount in the accompanying Consolidated Balance Sheets. The acquired business is a supplier of small footprint and handheld Raman spectrometry instruments.

For further details, see Note 7 of Notes to Consolidated Financial Statements.

Recent Accounting Pronouncements

In May 2008, the Financial Accounting Standard Board ("FASB") issued Statement on Financial Accounting Standards ("SFAS") No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles ("GAAP") in the United States. SFAS 162 is effective sixty days following the SEC's . . .