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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________
Commission file number 1-5631
WATKINS-JOHNSON COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
California 94-1402710
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3333 Hillview Avenue, Palo Alto, California 94304-1223
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(415) 493-4141
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------- ----------------
Common stock, no par value New York Stock Exchange
Pacific Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by 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. [X]
AS OF FEBRUARY 7, 1997
----------------------
Aggregate market value of the voting stock held
by non-affiliates of the registrant: ................. $181,172,000
Number of shares outstanding: Common stock,
no par value ......................................... 8,329,000 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Watkins-Johnson Company Notice of Annual Meeting of
Shareowners--April 5, 1997 and Proxy Statement filed with the commission
pursuant to Regulation 14A are incorporated by reference into Part III.
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<PAGE>
PART I
ITEM 1. BUSINESS
(a) General Development of Business
The company's structure during 1996 was unchanged from the previous year. In
1995, Watkins-Johnson divided its Electronics Group, recognizing the two
major markets that it served, into the Wireless Communication segment and
the Government Electronics segment for reporting purposes. Since the company
realigned its business between 1991 and 1993, operations had been reported
as three business segments: semiconductor equipment, electronics products
and environmental services. At the end of 1994, the environmental services
unit was divested. In 1993, the former Commercial and Defense segments were
renamed as the Semiconductor Equipment and Electronics segments.
No material reclassifications, mergers or consolidations of the company or
its subsidiaries occurred during 1996. Other than in the ordinary course of
business, there were no acquisitions or dispositions of material amounts of
assets during the year.
(b) Financial Information about Industry Segments
The company operates in three industry segments--semiconductor equipment,
wireless communications, and government electronics. The previously reported
environmental services segment was divested at the end of 1994. Financial
information covering these industry segments is included in Note 8 to the
consolidated financial statements contained in Part II, Item 8 of this
annual report on form 10-K.
(c) Narrative Description of Business
Watkins-Johnson Company is a high-technology corporation specializing in
semiconductor-manufacturing equipment, wireless communications products, and
radio-frequency electronics for government applications.
Semiconductor Equipment
The company's Semiconductor Equipment Group designs, develops and
manufactures equipment to deposit thin dielectric films by chemical vapor
deposition (CVD), using two fundamental CVD processes. The earlier process,
atmospheric-pressure CVD (APCVD), accounted for all of the equipment sold in
1996. This equipment functions by injecting the gases needed for the
reaction over the substrate material. The substrates are transported under
the injectors on a continuously moving conveyor belt through a resistance
heated muffle. This approach allows high deposition rates with a simpler
reactor design yielding higher reliability operation and high wafer
throughput.
The major market for the CVD equipment is the semiconductor industry where
the equipment is used to deposit thin films of doped and undoped silicon
dioxide used in the making of integrated circuits. The company's APCVD
process is highly productive and offers an attractive cost of ownership. The
equipment is sold world-wide to most of the major semiconductor
manufacturers, especially to those engaged in high volume integrated circuit
manufacturing. Customers include both firms that manufacture and sell their
own products and semiconductor foundry firms that contract manufacturing
services to "fabless" companies. As such the company's equipment is used in
the manufacture of all types of integrated circuits from logic circuits to
semiconductor memory chips.
The newer process, high density plasma (HDP) CVD, was first introduced to
the customers in July 1995 at the important SEMICON West exposition as the
WJ-2000. High density plasma is a variant of plasma-enhanced CVD which uses
an RF-induced glow discharge to transfer energy into the reactant gases.
This allows the substrate to remain at a lower temperature than in the APCVD
process. Improved generators allow higher density of plasmas which the
semiconductor industry expects to use for future integrated circuits with
smaller feature size transistors and
1
<PAGE>
conductors. These smaller (0.25 micron and below) features are needed to
fabricate devices such as the 256 megabit dynamic random access memory (256
Meg DRAM) and the seventh generation of microprocessors. Using the
philosophy developed with its APCVD equipment, WJ's HDP equipment is
designed for high productivity. Following the 1995 introduction, the company
concentrated on a series of tests in its Scotts Valley laboratory to verify
the production capabilities of the equipment with wafers provided by WJ and
customers. The company has successfully completed sample runs for various
customers and successive marathon runs for our first beta-test partner in
the HDP product line. Additional beta tests for the equipment at selected
customer facilities are continuing into 1997 prior to accepting orders.
The company markets the APCVD systems as the WJ-999 and the WJ-1000. The
WJ-999 and WJ-TEOS999 systems are for production lines using 150 mm (6-inch)
semiconductor wafers; they are capable of simultaneous processing of two
wafers in parallel. The WJ-1000 is also offered with either hydride or TEOS
reactant processes and is specifically designed for high productivity
processing on 200 mm (8-inch) semiconductor processing lines. The company's
APCVD process is mostly used in depositing doped oxide films,
boro-phosphoro-silicate glass (BPSG) and phosphoro-silicate-glass (PSG), for
the initial dielectric layers deposited on the wafers. These initial layers,
sometimes termed the premetal dielectric (PMD), are deposited prior to the
metal layers which are used to connect the transistors and provide the
circuit action. BPSG is a useful dielectric layer since it self-planarizes,
offering a smoother surface for the following metal and dielectric layers.
The WJ APCVD equipment is well suited for these applications and the company
believes it is the PMD equipment market leader. This market grew more
rapidly than the semiconductor equipment market in general in the period of
1992 through 1996, since the increased chip complexity is leading
semiconductor manufacturers to use more dielectric layers.
The smaller and smaller feature size used in the construction of integrated
circuits is opening a new application for the WJ APCVD equipment. Small
feature sizes allow smaller transistors to be defined and for them to be
located closer together in the circuits. The desired packing density is
making the naturally grown LOCOS (local oxide separation) step to become
difficult. The LOCOS step can be replaced with a STI (shallow trench
isolation) approach using CVD. WJ's APCVD approach is competitive for this
newer step.
As chip complexity increases, additional metal layers are required to
provide the circuit connections. Another growing market for dielectric
deposition equipment is inter-metal dielectric deposition (IMD) used for
insulation between the metal layers. The development of the new WJ-2000 HDP
equipment is aimed specifically at this market. WJ's APCVD equipment is not
intended to compete for the IMD market since the lower temperature required
is technically challenging for good films. The 1996 IMD equipment market was
estimated by Dataquest, a high technology market research firm, to be
roughly the same size as that for PMD at approximately $700 million each.
Thus, success in the IMD market will nearly double the company's served
available market. Additionally, the IMD equipment market is forecast to grow
more rapidly than the PMD equipment market. Dataquest forecast the PMD
market to grow to 60% of the total PMD/IMD dielectric equipment market which
is expected to approach $2.7 billion in the year 2001.
Sales in the Semiconductor Equipment segment were 62% of consolidated sales
in 1996, 57% in 1995 and 43% in 1994. The company recently changed its mode
of selling semiconductor equipment. In place of a network of manufacturers'
representatives and distributors, the company established a direct sales and
service force world-wide to better serve its customers. Currently, the
company has direct offices in the United States, Korea, Taiwan, Singapore,
Japan and Europe. During 1996, the Semiconductor Equipment Group completed
construction of a new headquarters and technology center in Japan.
The company sells capital equipment to a majority of the global
semiconductor manufacturers. Most of the sales are to makers of
semiconductor integrated circuits. Although there are many such customers, a
majority of the integrated circuits world-wide are produced by approximately
20 companies, with roughly two-thirds of the business outside the United
States. NEC (through
2
<PAGE>
Marubeni Hytech, the company's Japanese distributor), Hyundai Electronics
Ind. Co. Ltd. and Samsung Pacific International Inc. are significant
customers of the segment. There are several domestic and international
competitors (some of whom are larger than the company) and competition is
intense. In meeting the competition, emphasis is placed on selling quality
products with good technical performance and reliability with a competitive
cost of ownership. The company's growing global customer-support network is
a possible competitive advantage.
The Semiconductor Equipment Group's business depends upon the planned and
actual capital expenditures of the semiconductor manufacturers, who react to
the current and anticipated market demand for integrated circuits. This
demand has been growing over the years from 1992 through 1995, however in
1996 its history of cyclical variations returned with a market downturn.
Although the cyclical growth trend of the semiconductor integrated circuits
business is expected to return, it is recognized that the semiconductor
equipment business can vary rapidly in response to customer demand.
Following placement of orders, customers frequently seek either faster or
delayed delivery, based on their changing needs. Uncertainty increases
significantly when projecting product demand more than 6 months in the
future.
Wireless Communications
This business segment serves original equipment manufacturers in the rapidly
growing market for wireless communication equipment. The company's long time
leadership as a microwave-electronics manufacturer and its historic strength
in space communication components provide a competitive advantage in
offering unique solutions to requirements for wireless network
communications and satellite systems.
The company has entered two wireless communication business areas
paralleling the skills it had developed as a defense-electronics supplier.
In the Palo Alto facility the company is producing components and
subassemblies for cellular, personal communication services (PCS) and space
applications. At the Gaithersburg facility the company is successfully
adapting its communications-intelligence equipment technology to the design
and production of low-cost, sensitive receivers for cellular telephone fraud
detection and wideband transceivers for base station applications.
Both of these operations take advantage of the processes, devices and
monolithic microwave integrated circuits (MMIC) developed and manufactured
in the company's gallium-arsenide (GaAs) foundry. These proprietary devices
and circuits perform highly reliable signal-processing functions in the
various equipment and have enabled the company to capture programs over its
competition. Other strengths the company brings to this marketplace are
derived from the skills and technology developed over many years of
providing microwave components and communications receivers for
defense-electronics applications. The company is mining this technology to
take advantage of expected market growth in the wireless communications
sector. Substantial research and development efforts are being expended in
an attempt to take advantage of projected growth opportunities.
Sales by the Wireless Communications segment were 11% of consolidated sales
in 1996, 8% in 1995 and 7% in 1994. Although the business is international
in scope, present selling efforts are concentrated in the United States.
Marketing and sales are performed by company direct sales personnel and
distributors. Major accounts are handled by direct company sales and
service. Components, subassemblies, receivers and transceivers are primarily
sold to companies which manufacture base station equipment for various
wireless communication carriers. Although the customer community represents
a large business opportunity, the number of individual customer companies is
not large.
The telecommunications bill enacted in 1995 reorganizes the business
opportunities for the telecommunications industry. Although the company
believes the results of this reorganization will be positive for its
wireless communication business, its full effects are still not clear.
Various regulatory agencies of federal, state and local governments can also
affect the wireless communication market dynamics, causing unforeseen ebb
and flow of orders and delivery requirements.
3
<PAGE>
Domestic and international competition from a number of companies, some of
which are much larger than Watkins-Johnson, is intense. The company seeks to
win competitions by excellent service and superior technical performance. It
seeks to protect its intellectual property by an aggressive patent and trade
secret program as indicated below.
Government Electronics
The Government Electronics segment designs, develops and manufactures
microwave components, subsystems, and receivers for a broad range of
applications. The segment supplies sophisticated electronic products for
defense-intelligence, missile-guidance, electronic-warfare and
space-communications missions.
Watkins-Johnson communication receivers and signal-analysis equipment are
used by military and other governmental agencies to perform
range-monitoring, frequency-measurement, signal localization and
interference-analysis functions, often in complex, high-signal-density
environments. The company continues to sustain its technological and
marketing leadership in communications intelligence equipment. Company
funded design and development efforts are producing advanced receivers and
related equipment featuring the small-size, light-weight and low-power-
consumption characteristics demanded by its customers at competitive prices.
This design effort is also serving the demand by government customers for
"commercial-off-the-shelf" (COTS) equipment.
The company is the largest merchant supplier of integrated microwave
subsystems to guided missile prime contractors. The company's integrated
capability provides a technological advantage, while its microwave hybrid
assembly and test capabilities give it a manufacturing edge over competing
suppliers (including the internal capabilities of customer companies). The
company is a subcontractor for certain key missile programs, such as the
Advanced Medium-Range Air-to-Air Missile (AMRAAM), the High-speed
Anti-Radiation Missile (HARM) and the Standard Missile Block IV which
continue to represent a substantial portion of the segment's core defense-
electronics business.
Government Electronics products are marketed through direct selling efforts
and distributor networks domestically and overseas. A small portion of the
sector's business is exported to customers similar to those in the United
States. Such sales are generally subject to U.S. Government export control
procedures.
Sales by the Government Electronics segment were 27% of consolidated sales
in 1996, 35% in 1995 and 50% in 1994. A majority of segment sales are to
government agencies and government prime contractors, such as Hughes
Aircraft Company and Raytheon Company, engaged in defense contracting. The
principal end user for such sales is the U.S. Department of Defense. Sales
contracts with the government are customarily subject to terms and
conditions which provide for renegotiation of profits and termination of the
contract at the election of the government. The right to terminate for
convenience has not had any significant effect on the company's financial
position or results of operations.
The Government Electronics segment has numerous competitors which include
large, diversified corporations and smaller specialty firms. In addition to
pressures from competing companies, the company's defense electronics
business is influenced by U.S. and foreign political activity and national
budgetary policies. In recent years, Department of Defense budget cutbacks
have had direct and indirect impacts on the company. The indirect impacts
had come about as large diversified customers retained, within their
companies, work which WJ had previously performed. The company has reduced
its work force and restructured its organization to better address the
changing business opportunities. Continued reductions in defense spending
could limit the demand for the company's products.
Other Business Items
Raw materials for the production of semiconductor equipment, wireless
communications and government electronic products are acquired from a broad
range of suppliers. Because suppliers
4
<PAGE>
are numerous, dependence on any one supplier is kept to a minimum. On
occasion, however, the failure of a supplier to deliver key parts can
jeopardize the on-time shipment of WJ products. Business operations are not
believed to be seasonal. Except for negotiated advance or progress payments
from customers on long-term contracts in the defense-electronics business,
there are no special working capital practices.
The company has been active in securing patents and licensing agreements to
protect certain proprietary technologies and know-how resulting from its
ongoing research and development. The financial impact of the company's
efforts to protect its intellectual property are unknown. Management
believes that the company's competitive strength derives primarily from its
core competence in engineering, manufacturing and understanding its
customers and markets; therefore, aggressive steps to protect that knowledge
are considered justifiable.
Total company backlog at December 31, 1996 was $228,397,000 compared to
$250,276,000 at December 31, 1995. The percentage of backlog attributable to
the Semiconductor Equipment, Wireless Communications and Government
Electronics segments were 40%, 17% and 43%, respectively, in 1996, compared
to 49%, 11% and 40% in 1995. Approximately 92% of all backlog at year-end
1996 is shippable within 12 months, compared to 97% at year-end 1995.
Company-sponsored research and development expense was $56,675,000 in 1996,
$47,629,000 in 1995, and $34,436,000 in 1994. Customer-sponsored research
and development was estimated to be approximately $17,000,000 in 1996,
$20,000,000 in 1995, and $24,000,000 in 1994, and was performed mostly by
the Government Electronics segment.
The company's employment at December 31, 1996 was 2,080. None of the
company's employees is covered by a collective-bargaining agreement. The
company's relationship with its employees is generally good.
Environmental issues are discussed in Note 6 to the consolidated financial
statements contained in Part II, Item 8 of this annual report on Form 10-K.
(d) Financial Information about Foreign and Domestic Operations and Export
Sales.
Combined export sales and sales from foreign operations accounted for 50% of
the company's sales in 1996, 47% in 1995, and 45% in 1994. Assets of foreign
operations accounted for 14% of consolidated totals at December 31, 1996 and
were less than 10% for all years prior to 1996. The inherent risks of
foreign business are similar to domestic business, with the additional risks
of foreign government instability and export license cancellation. A major
portion of foreign product orders in the Government Electronics segment
requires export licensing by the Department of State prior to shipment. For
international shipments for all company business segments, the company
purchases forward exchange contracts and/or obtains customer letters of
credit to reduce foreign currency fluctuation and credit risks. For further
information on foreign sales, see Note 8 to the consolidated financial
statements contained in Part II, Item 8 of this annual report on Form 10-K.
ITEM 2. PROPERTIES
Watkins-Johnson Company and subsidiaries conduct their main operations at
plants in Palo Alto, San Jose, and Scotts Valley, California and
Gaithersburg, Maryland. During 1996, the Semiconductor Equipment Group
completed construction of a new technology center in Japan. Space
limitations at the Semiconductor Equipment Group's headquarters in Scotts
Valley prompted the company to reopen the San Jose facility at the end of
1995 in order to accommodate the Group's expansion. Adjacent undeveloped
land at the San Jose site has been offered for sale.
At December 31, 1996, there were approximately 725,000 square feet of plant
space in California, and 175,000 square feet in Maryland, and a 36,000
square foot facility in Kawasaki, Japan. Approximately 77% of the company's
plant space is occupied for the company's operations. The company is
pursuing opportunities to realize the market value of its properties while
ensuring efficient use of available space.
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<PAGE>
The Government Electronics and Wireless Communications segments utilize
substantially all of the Palo Alto and Gaithersburg facilities. The Scotts
Valley, San Jose and Kawasaki facilities house the Semiconductor Equipment
Group.
The Palo Alto facility and sales office locations are leased. Information on
long-term obligations is in Note 3 to the consolidated financial statements
contained in Part II, Item 8 of this annual report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
Information required under this item is contained in Note 6 to the
consolidated financial statements contained in Part II, Item 8 of this
annual report on Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The company submitted no matters to a vote of the shareowners during the
last quarter of the period covered by this report.
<TABLE>
EXECUTIVE OFFICERS OF THE REGISTRANT
<CAPTION>
OFFICER BUSINESS EXPERIENCE
NAME AGE OFFICE HELD SINCE LAST FIVE YEARS
- -------------------------- ----- -------------------------- --------- -----------------------------------
<S> <C> <C> <C> <C>
Dr. Dean A. Watkins ......... 74 Chairman of the Board 1957 Chairman of the Board
Dr. H. Richard Johnson ..... 70 Vice Chairman of the Board 1957 Vice Chairman of the Board
Dr. W. Keith Kennedy, Jr. ... 53 President and Chief 1977 President and Chief Executive
Executive Officer Officer
Keith D. Gilbert ............ 55 Executive Vice President 1984* Executive Vice President; Prior to
1995, President, Electronics Group
(formerly Defense Group); Prior to
1993, Vice President, Defense Group
Scott G. Buchanan ........... 45 Vice President and Chief 1989 Vice President and Chief Financial
Financial Officer Officer; Prior to 1993, Chief
Financial Officer and Treasurer
Richard G. Bell ............. 49 Vice President and General 1990 Vice President and General Counsel
Counsel
Dr. Patrick J. Brady ....... 51 Vice President 1996 President, Semiconductor Equipment
Group; Prior to 1996, Vice
President of Engineering,
Semiconductor Equipment Group
Malcolm J. Caraballo ....... 41 Vice President 1996 President, Microwave Products
Group; Prior to 1996, Vice
President, Microwave Products
Division
Marc C. Elgaway ............. 42 Vice President 1995 President, Telecommunications
Group; Prior to 1995, Executive
Vice President, C-TEC Corporation
Darryl T. Quan .............. 42 Controller 1991 Controller
Claudia D. Kelly ............ 56 Secretary 1996 Secretary; Prior to 1996, Manager,
Palo Alto Customer and Export
Services
Joan M. Varrone ............. 45 Treasurer 1994 Treasurer; Prior to 1994, Assistant
Treasurer, Raychem Corporation
</TABLE>
Dr. Watkins and Dr. Johnson have been directors of the company since its
incorporation in 1957. Dr. Kennedy has been a Director since August 1987.
None of the above officers is related to any other officer at
Watkins-Johnson Company.
*From January 1995 until November 1995, Keith D. Gilbert served as a
consultant for the company, reporting to the President and Chief Executive
Officer. He was reelected as Executive Vice President by the Board of
Directors in November 1995.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The company's common stock is principally traded on the New York and Pacific
stock exchanges. At December 31, 1996 there were approximately 5,400
shareowners, which included holders of record and beneficial owners. The
company expects that comparable cash dividends will continue in the future.
<TABLE>
DIVIDENDS AND STOCK PRICES
<CAPTION>
1996 QUARTERS 1ST 2ND 3RD 4TH
------------- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Dividends declared per share (in cents) 12 12 12 12
Stock price (NYSE-in dollars) ........... High 44-5/8 36-1/4 28-3/4 28-1/4
Low 34-1/4 27-1/8 17 17-3/4
1995 QUARTERS 1ST 2ND 3RD 4TH
------------- ----- ----- ----- -----
Dividends declared per share (in cents) 12 12 12 12
Stock price (NYSE-in dollars) ........... High 40-1/4 48-3/8 57 54-7/8
Low 29-3/4 38-5/8 43-1/2 40-1/2
</TABLE>
<TABLE>
ITEM 6. SELECTED FINANCIAL DATA
<CAPTION>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Sales ............................... $ 438,319 $ 387,031 $ 332,606 $ 282,134 $ 255,485
Net Income .......................... 3,034 31,428 20,961 11,596 10,401(a)
Net Income Per Share ................ .36 3.54 2.56 1.45 1.38(a)
Dividends Per Share ................. .48 .48 .48 .48 .48
Average Shares Outstanding .......... 8,541,000 8,875,000 8,200,000 7,999,000 7,551,000
FINANCIAL POSITION
Working Capital ..................... $ 122,982 $ 142,213 $ 116,651 $ 108,497 $ 100,852
Total Assets ........................ 314,373 287,674 235,030 220,628 206,090
Long-Term Obligations ............... 38,801 21,669 22,583 26,463 28,644
Shareowners' Equity ................. 194,711 191,253 149,626 133,888 125,055
Firm Backlog ........................ $ 228,397 $ 250,276 $ 235,942 $ 221,437 $ 203,717
<FN>
- ---------------
(a) Includes a tax benefit of $5,438,000, or 72 cents per share, due to the
cumulative effect of a change in accounting for income taxes.
</FN>
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
During 1996, the company required additional cash to finance its foreign and
domestic infrastructure expansion. Although net cash provided by operations
was $14.2 million, cash and equivalents decreased $18.9 million from $34.6
million to $15.7 million. Despite the slowdown in business in the second half
of 1996, the company invested $50 million in new capital plant and equipment
in order to support long-term growth, primarily for the semiconductor
equipment and wireless communications operations. The slowdown in business in
the second half of 1996 caused working capital needs to decline from the peak
levels of the first half. As a result, the company paid off the $10 million
in short-term borrowings incurred during the first half of the year under the
company's $100 million line-of-credit. During 1996, $4.7 million was provided
by stock issuances from stock option exercises offsetting the $4 million in
dividends paid.
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<PAGE>
During the year, approximately $25 million was invested in a newly
constructed facility and related capital equipment in Kawasaki, Japan, for
the Semiconductor Equipment Group. Over $20 million in external financing was
funded for the land and completion of the building. The amount funded is
denominated in Yen, of which approximately $8.6 million is amortizable over
15 years, bearing interest at 2.5%. The additional funding requires a balloon
payment in 10 years, bearing interest at 3.1%.
CURRENT OPERATIONS AND BUSINESS OUTLOOK
Semiconductor Equipment Group
The Semiconductor Equipment Group began the year with an all-time-high
backlog, but shared the fate of the entire semiconductor capital-equipment
segment with the worldwide overcapacity of DRAMs, leading our customers to
stretch out or cancel orders for new equipment. Revenues declined to $100
million in the second half of 1996 compared to the $172 million record level
in the first half of the year. Starting in the second quarter of 1996,
management moved to realign costs more closely with revised revenue
projections, allowing the group to remain profitable for the year. Business
processes were streamlined, inventories scaled back, noncritical research and
development curtailed and headcount reduced by about 20% through normal
attrition and reductions in force. The company is poised to reduce costs
further if the market slump deepens, but will maintain the core strength
needed to respond quickly to increased demand when the market turns upward
again. Despite the downturn in the second half of 1996, the group ended the
year with revenues up 23% over 1995, accounting for 62% of total company
revenue compared to 57% in 1995. Orders for the fourth quarter of 1996
amounted to approximately $78 million including significant placements by
Hyundai Electronics and Anam Industrial Co. totaling more than $38 million.
Orders for the second half of 1996 totaled $104 million compared to $137
million in the first half. The group enters 1997 with a backlog of
approximately $91 million.
In November 1996, the group completed construction of a new
36,000-square-foot Asian headquarters and technology center in Japan. The
facility will serve primarily as an applications laboratory capable of
supporting up to six WJ dielectric-deposition systems for the cooperative
development of new deposition processes with all Asia-Pacific customers. From
this convenient new location, the group will provide its important Asian
market with system demonstrations, a spares depot, service support and
training. Looking forward, the company is reviewing the planned personnel and
equipment growth rate in light of the chip slowdown. We will keep expenses on
the facility to a minimum, yet consistent with the mission of establishing a
direct quality impact in Japan.
The recently introduced WJ-2000P high-density-plasma (HDP) process module is
the first of a series to be developed on a cluster platform for the company.
Our forward looking road map plans for additional process modules, adding to
the cluster tool platform capabilities. The WJ- 2000P high-density-plasma
reactor, first introduced in July 1995, is aimed at devices such as the 256
Megabit DRAM and 7th generation microprocessors expected to enter production
in the 1998-1999 timeframe. We are positioning this tool to expand our
overall semiconductor equipment market. The HDP tools are not intended to
replace current lines. The group believes their current continuous deposition
platform tools will have good sales performance into the quarter- micron
process era and beyond. WJ-999 and WJ-1000 atmospheric-pressure systems lead
the market for premetal dielectric films while the HDP systems are designed
to compete in the market for intermetal dielectric layer films, especially
for the smaller feature sizes expected for future chip designs. We have
successfully completed sample runs for various customers and successive
marathon runs for our first beta-site partner in the HDP product line.
Looking forward, we expect customers to be placing small orders for their
engineering efforts for late 1997 delivery.
Although the long range forecast for the semiconductor industry remains
bright, looking forward, management sees a continuing soft orders picture for
semiconductor equipment through the first half of 1997 with slight
improvement towards the end of the year. With the current DRAM
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<PAGE>
oversupply and sharp price declines, customers continue to carefully review
their capacity and capital expansion plans. Even for fabs where customers are
definitely moving forward, they appear to be delaying capital equipment
orders until they must be placed. It is recognized that the semiconductor
equipment business is cyclical, and uncertainty increases significantly when
projecting demand for semiconductor equipment products more than 6 months
into the future. The semiconductor market may slow more than currently
anticipated. In addition, inherent risks and uncertainties associated with
the development of the WJ-2000P could cause delays in its availability for
sale, thereby reducing expected revenues.
Wireless Communications
The wireless communications business segment presents the greatest growth
opportunity for the company today. The company's range of products for the
wireless telecommunications industry showed strength in 1996, with sales
increasing 53% over the prior year. The company's technological leadership in
microwave integrated circuits, multifunction assembly integration and
wideband receiver design gives its products a technical edge in many wireless
communications applications. Orders for our cellular fraud receivers and the
call-extender transceivers were stronger than expected. Early 1996 shipment
plans for wireless communications subassemblies were frustrated by problems
the PCS carrier companies experienced with cell site and tower permits.
However, customers requested increasingly higher shipment rates in the second
half of 1996.
Current research and development effort heavily funds the development of the
Base2(TM), a demonstration base station to exhibit wide-band DSP systems
technology. It is designed to meet cellular provider desires for an open
systems approach to the base station design. The Base2(TM) has been engaged
successfully in cellular laboratory trials with two customers and field-trial
plans are now being implemented.
Although our wireless communications segment showed strength in 1996,
customer demand for components and subassemblies were softer than first
expected due to a slower build-out of the PCS infrastructure. Orders for the
second half of 1996 were stronger than earlier expected. The group enters
1997 with a backlog of $39 million. Looking forward, the company expects the
wireless segment growth to continue at the recent pace, and for the
operational project income to overcome the admittedly high research and
development investments for a pre-tax break-even performance by the end of
1997.
Government Electronics
The company's government electronics business declined from the previous year
to $119 million in revenues due in part to divestitures of certain product
lines in the second quarter of 1995 which accounted for approximately $7
million in sales. Shipments and profit levels were adversely affected as the
company supported a higher than planned effort to convert to a new MRP
(materials requirement planning) computer system to improve efficiency and
profitability. The segment's excellent shipping rate in the fourth quarter,
coupled with profit improvement, shows that most of the conversion is
complete.
Although the government electronics segment revenues declined in 1996, orders
for communications-intelligence equipment and missile-guidance subsystems
showed solid orders performance. The government electronics segment enters
1997 with a $98 million backlog. The success of the company's microwave
subsystems production capabilities as demonstrated on the Advanced
Medium-Range Air-to-Air Missile project (AMRAAM), has led Raytheon Co., the
second AMRAAM prime contractor, to have the company take over the production
of modules which Raytheon previously produced internally. These new orders
will assist the government electronics segment in stabilizing future sales.
1996 COMPARED TO 1995
Semiconductor Equipment Group sales and wireless communications sales
increased 23% and 53%, respectively, while government electronics sales
decreased 11%, resulting in an overall
9
<PAGE>
company increase of 13%. The $15.1 million decrease in government electronics
sales was due in part to the divestiture of certain product lines in the
second quarter of 1995 and inefficiencies discussed below. Gross margins
decreased from 43% to 32% due mostly to slow-moving inventory write-offs and
termination costs totaling nearly $20 million; an increased fixed cost base
associated with early 1996 expansion efforts in anticipation of increased
business by the Semiconductor Equipment Group; and inefficiencies in the
government electronics segment stemming from the conversion to a new
materials planning computer system. Although selling and administrative
expenses decreased as a percentage of sales due mostly to cost cutting
efforts and lower foreign sales commissions resulting from direct sales
efforts, 1996 expenses were slightly higher due to the increased volume and
infrastructure development. Research and development expenses increased from
12% to 13% of sales due to continuing efforts to develop next-generation
products, particularly for the semiconductor equipment and wireless
communications segments. Although research and development costs are at a
historical high, the company is at critical points on key developmental
programs on which management believes the earnings growth opportunities
outweigh the near term benefits of slowing development efforts. Interest
expense increased over 1995 due to long-term borrowings. Other income
decreased as 1995 results included $1.3 million from a favorable insurance
settlement for certain environmental expenditures. The effective tax rate for
federal and foreign income taxes increased from 29% to 30% compared to last
year. The tax rate increase resulted mostly from the effect of foreign
operations taxed at various tax rates offsetting the benefits related to
export sales and research credits. Due to the above factors, net income for
1996 decreased 90% compared to 1995.
1995 COMPARED TO 1994
Semiconductor Equipment Group sales and wireless communications sales
increased 55% and 31%, respectively, while government electronics sales were
down 19%, resulting in an overall company increase of 16%. The $31.5 million
decrease in government electronics sales was due in part to the divestiture
of certain product lines in the second quarter of 1995 which accounted for
approximately $28 million of sales in 1994. Gross margins increased from 41%
to 43% due mostly to the revenue mix shifting towards more profitable
semiconductor equipment products and improved margins in the government
electronics segment. Although selling and administrative expenses as a
percentage of sales decreased slightly, expenses were up 5% due to the
increased volume. Research and development expenses increased from 10% to 12%
of sales due to the company's substantial efforts in developing next
generation products, particularly for the Semiconductor Equipment Group and
the development and commercialization of products for the wireless
communications segment. The effective tax rate for federal and foreign income
taxes decreased from 30% to 29% compared to the same period last year. The
tax rate decrease resulted mostly from tax benefits related to higher export
sales. Due to the combined effect of the above factors, net income increased
50% over 1994.
RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS
Statements included in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" which are not historical facts are
forward-looking statements that involve risks and uncertainties that may
materially affect future results, including but not limited to: product
demand and market acceptance risks, the effect of economic conditions, the
impact of competitive products and pricing, product development,
commercialization and technological difficulties, capacity and supply
constraints or difficulties, business cycles, the results of financing
efforts, actual purchases under agreements, the effect of the company's
accounting policies, U.S. Government export policies, geographic
concentrations, natural disasters and other risks.
10
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Sales ............................................................... $ 438,319 $ 387,031 $ 332,606
----------- ----------- -----------
Costs and expenses:
Cost of goods sold ................................................. 298,656 221,792 195,558
Selling and administrative ......................................... 78,075 75,738 72,033
Research and development ........................................... 56,675 47,629 34,436
----------- ----------- -----------
433,406 345,159 302,027
----------- ----------- -----------
Income from operations .............................................. 4,913 41,872 30,579
Other income (expense):
Interest income .................................................... 789 2,400 1,562
Interest expense ................................................... (1,574) (873) (1,141)
Other income (expense)--net ........................................ 191 618 (149)
----------- ----------- -----------
Income from continuing operations before Federal .................... 4,319 44,017 30,851
and foreign income taxes
Federal and foreign income taxes .................................... (1,285) (12,589) (9,200)
----------- ----------- -----------
Income from continuing operations ................................... 3,034 31,428 21,651
Discontinued operations (Note 8):
Loss from discontinued operations, net of taxes .................... -- -- (490)
Loss on disposition, net of taxes .................................. -- -- (200)
----------- ----------- -----------
Net income .......................................................... $ 3,034 $ 31,428 $ 20,961
=========== =========== ===========
Fully diluted per share amounts (difference between fully
diluted and primary earnings per share is not material):
Income from continuing operations ................................... $ .36 $ 3.54 $ 2.64
Discontinued operations ............................................. -- -- (.08)
----------- ----------- -----------
Net income .......................................................... $ .36 $ 3.54 $ 2.56
=========== =========== ===========
Average common and equivalent shares ................................ 8,541,000 8,875,000 8,200,000
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
11
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>
DECEMBER 31
----------------------------------
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents ................................................................ $ 15,702 $ 34,556
Receivables ......................................................................... 95,717 86,311
Inventories:
Finished goods .................................................................... 4,005 3,623
Work in process ................................................................... 35,000 45,092
Raw materials and parts ........................................................... 30,153 31,120
Deferred income taxes ............................................................... 17,795 11,725
Other ............................................................................... 5,471 4,538
--------- ---------
Total current assets .............................................................. 203,843 216,965
--------- ---------
PROPERTY, PLANT AND EQUIPMENT:
Land ................................................................................ 13,075 4,130
Buildings and improvements .......................................................... 54,035 37,046
Plant facilities, leased ............................................................ 13,060 13,060
Machinery and equipment ............................................................. 151,148 131,143
--------- ---------
231,318 185,379
Accumulated depreciation and amortization ........................................... (127,748) (120,243)
--------- ---------
Property, plant and equipment--net .................................................. 103,570 65,136
--------- ---------
OTHER ASSETS:
Deferred income taxes ............................................................... 2,290 4,880
Other ............................................................................... 4,670 693
--------- ---------
Total other assets ................................................................ 6,960 5,573
--------- ---------
$ 314,373 $ 287,674
========= =========
LIABILITIES AND SHAREOWNERS' EQUITY
CURRENT LIABILITIES:
Accounts payable .................................................................... $ 18,960 $ 23,162
Accrued expenses .................................................................... 12,791 11,899
Advances on contracts ............................................................... 8,932 4,446
Provision for warranties and losses on contracts .................................... 17,378 10,490
Payroll and profit sharing .......................................................... 14,494 14,602
Income taxes ........................................................................ 8,306 10,153
--------- ---------
Total current liabilities ......................................................... 80,861 74,752
--------- ---------
LONG-TERM OBLIGATIONS ................................................................ 38,801 21,669
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 3 and 6)
SHAREOWNERS' EQUITY:
Preferred stock, $1.00 par value--authorized and unissued,
500,000 shares
Common stock, no par value--authorized, 45,000,000 shares;
outstanding: 1996, 8,329,248 shares; 1995, 8,124,055 shares ........................ 38,998 34,307
Retained earnings ................................................................... 155,713 156,946
--------- ---------
Total shareowners' equity ......................................................... 194,711 191,253
--------- ---------
$ 314,373 $ 287,674
========= =========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
12
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>
COMMON STOCK TOTAL
--------------------------- RETAINED SHAREOWNERS'
SHARES DOLLARS EARNINGS EQUITY
-------- ------- -------- -----------
<S> <C> <C> <C> <C>
Balance, January 1, 1994 ........................... 7,598,290 $ 9,106 $ 124,782 $ 133,888
Net income for 1994 ............................... -- -- 20,961 20,961
Repurchase of common stock ........................ (564,200) (972) (12,833) (13,805)
Dividends declared--$.48 per share ................ -- -- (3,563) (3,563)
Stock option transactions ......................... 542,381 12,145 -- 12,145
---------- ---------- ---------- ----------
Balance, December 31, 1994 ......................... 7,576,471 20,279 129,347 149,626
Net income for 1995 ............................... -- -- 31,428 31,428
Dividends declared--$.48 per share ................ -- -- (3,829) (3,829)
Stock option transactions ......................... 547,584 14,028 -- 14,028
---------- ---------- ---------- ----------
Balance, December 31, 1995 ......................... 8,124,055 34,307 156,946 191,253
Net income for 1996 ............................... -- -- 3,034 3,034
Dividends declared--$.48 per share ................ -- -- (3,973) (3,973)
Stock option transactions ......................... 205,193 4,691 -- 4,691
Cumulative translation adjustments ................ -- -- (294) (294)
---------- ---------- ---------- ----------
Balance, December 31, 1996 ......................... 8,329,248 $ 38,998 $ 155,713 $ 194,711
========== ========== ========== ==========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
13
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1996 1995 1994
---------- ----------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income .................................................................. $ 3,034 $ 31,428 $ 20,961
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .............................................. 11,296 9,941 8,711
Deferred tax provisions .................................................... (3,480) (985) (695)
Net changes in:
Receivables ............................................................... (9,406) (5,884) (6,456)
Inventories ............................................................... 10,677 (28,180) (14,509)
Other assets .............................................................. (1,172) (2,625) 27
Accruals and payables ..................................................... (7,837) 11,148 9,550
Advances on contracts ..................................................... 4,486 (3,126) (4,248)
Provision for warranties and losses on contracts .......................... 6,888 3,298 1,208
Environmental remediation ................................................. (327) (817) (2,727)
-------- -------- --------
Net cash provided by operating activities ................................... 14,159 14,198 11,822
-------- -------- --------
INVESTING ACTIVITIES:
Additions of property, plant and equipment .................................. (50,003) (25,566) (12,526)
Restricted plant construction funds ......................................... (3,738) -- --
Other ....................................................................... 294 741 476
-------- -------- --------
Net cash used in investing activities ....................................... (53,447) (24,825) (12,050)
-------- -------- --------
FINANCING ACTIVITIES:
Long-term and line-of-credit borrowings ..................................... 30,241 -- --
Payments on long-term and line-of-credit borrowings ......................... (10,135) (112) (4,916)
Proceeds from issuance of common stock ...................................... 4,691 14,028 12,145
Repurchase of common stock .................................................. -- -- (13,805)
Dividends paid .............................................................. (3,973) (3,829) (3,563)
Other ....................................................................... (390) 627 (204)
-------- -------- --------
Net cash provided (used) by financing activities ............................ 20,434 10,714 (10,343)
-------- -------- --------
Net increase (decrease) in cash and equivalents .............................. (18,854) 87 (10,571)
Cash and equivalents at beginning of year .................................... 34,556 34,469 45,040
-------- -------- --------
Cash and equivalents at end of year .......................................... $ 15,702 $ 34,556 $ 34,469
======== ======== ========
Other cash flow information:
Income taxes paid-net of refunds ............................................ $ 5,700 $ 5,828 $ 9,003
Interest expense paid ....................................................... 1,574 872 1,143
Noncash investing and financing activities:
Noncash effect on "Property, Plant and Equipment" and
"Other Assets" due to a plant held for sale in 1994 and
returned to service in 1995. Plant transferred at book
value which is below market. ............................................... $ (5,107) $ 5,107
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
14
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation--The consolidated financial statements include those
of the company and its subsidiaries after elimination of intercompany balances
and transactions.
Cash Equivalents--Cash equivalents consist of municipal bond funds and
commercial paper acquired with remaining maturity periods of 90 days or less and
are stated at cost plus accrued interest which approximates market value.
Year-end cash equivalents totaled $13.4 million and $33.4 million in 1996 and
1995, respectively. The company's investment guidelines limit holdings in
commercial paper to $1,000,000 per issuer.
Inventories--Inventories are stated at the lower of cost, using first-in,
first-out and average-cost basis, or market. Cost of inventory items is based on
purchase and production cost. Long-term contract costs and selling and
administrative expenses are excluded from inventory. Progress payments are not
netted against inventory.
Property, Plant and Equipment--Property, plant and equipment are stated at cost.
Leases which at inception assure the lessor full recovery of the fair market
value of the property over the lease term are capitalized. Provision for
depreciation and amortization is primarily based on the sum-of-the-years'-digits
and straight-line methods.
Revenue Recognition--Revenues, other than long-term contracts, are recorded upon
shipment or completion of tasks as specified in the contract. Estimated product
warranty costs are accrued at the time of shipment. Sales and allowable fees
under cost-reimbursement contracts are recorded as costs are incurred. Long-term
contract sales and cost of goods sold are recognized using the
percentage-of-completion method based on the actual physical completion of work
performed and the ratio of costs incurred to total estimated costs to complete
the contract. Any anticipated losses on contracts are charged to earnings when
identified.
Foreign Currency Translation--The functional currency for all foreign operations
is the U.S. dollar with the exception of the company's subsidiary located in
Japan which uses the local functional currency. Gains or losses, which result
from the process of remeasuring foreign currency financial statements and
transactions into U.S. dollars, are generally included in net income. For the
Japanese subsidiary, the cumulative translation adjustments are recorded
directly in shareowners' equity. Translation gains or losses are not material in
any year presented.
Forward Exchange Contracts--The company enters into forward exchange contracts
to hedge sales transactions and firm commitments denominated in foreign
currencies. Gains and losses on the forward contracts are recognized based on
changes in exchange rates, as are offsetting foreign exchange gains and losses
on the underlying transactions. The company does not engage in foreign currency
speculation.
Income Taxes--The consolidated statements of operations include provisions for
deferred income taxes using the liability method for transactions that are
reported in one period for financial accounting purposes and in another period
for income tax purposes. State and local income taxes are included in selling
and administrative expenses.
Per Share Information--Net income per share is computed using the weighted
average number of common and common equivalent shares (dilutive stock options)
outstanding during the year. The difference between fully diluted earnings per
share and primary earnings per share is not significant.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
15
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock-Based Compensation--The company continues to account for stock-based
compensation under the intrinsic value method as defined in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
(APB 25).
Reclassification--Certain amounts for 1995 and 1994 have been reclassified to
conform to the 1996 presentation.
2. RECEIVABLES AND FINANCIAL INSTRUMENTS
Receivables consist of the following at December 31:
(IN THOUSANDS)
-------------------
1996 1995
------- -------
Trade receivables ................................. $90,196 $84,304
------- -------
Long-term contracts:
Billed ........................................... 1,448 875
Unbilled ......................................... 4,073 1,132
------- -------
Total long-term contract receivables .............. 5,521 2,007
------- -------
Total receivables, less allowance of $1,247 in
1996 and $1,034 in 1995 .......................... $95,717 $86,311
======= =======
Unbilled receivables represent revenue recognized for long-term contracts not
yet billable based on the terms of the contract. These amounts are billable upon
shipment of the product, achievement of milestones, or completion of the
contract. Unbilled receivables are expected to be billed and collected within
one year. Receivables representing retainage not collectible within one year are
not material. There are no significant billed or unbilled receivables subject to
future negotiation.
Government contracts have provisions for audit, price redetermination and other
profit and cost limitations. Contracts may be terminated without prior notice at
the Government's convenience. In the event of such termination, the company may
be compensated for work performed, a reasonable allowance for profit, and
commitments at the time of termination. The right to terminate for convenience
has not had any significant effect on the company's financial position or
results of operations.
Financial instruments that potentially subject the company to concentrations of
credit risk consist principally of cash equivalents, trade receivables, and
financial instruments used in hedging transactions. Concentration of credit risk
with respect to trade receivables are limited due to the variety of customers
and markets segments into which the company's products are sold, as well as
their dispersion across geographic areas. The carrying value of cash and cash
equivalents, receivables, accounts payable and short-term notes payable are a
reasonable approximation of their fair market value due to the short-term
maturities of those instruments. The carrying value of the company's long-term
debt approximates fair value based on the interest rates currently available to
the company for long-term debt with similar terms as those borrowings of the
company. Considerable judgment is required in interpreting market data to
develop estimates of fair value, so the estimates are not necessarily indicative
of the amounts that could be realized or would be paid in a current market
exchange.
The company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to reduce its exposure to fluctuations in foreign
exchange rates. At December 31, 1996, the company had forward exchange contracts
to sell Japanese Yen with a market value of approximately $16.7 million for a
contract amount of $16.3 million. These contracts mature within one year. The
market value of forward exchange contracts were obtained from published foreign
exchange market rates. The company's risk in these contracts is the cost of
replacing, at current market rates, these contracts in the event
16
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of default by the other party. Management believes the risk of incurring such
losses is remote as the contracts are entered into with major financial
institutions. Prior to 1996 forward exchange contracts held by the company were
not material.
3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT
Long-term obligations, excluding amounts due within one year, consist of the
following at December 31:
(IN THOUSANDS)
----------------------
1996 1995
------- -------
Long-term borrowings ................... $20,241 $ 0
Deferred compensation .................. 3,360 6,356
Environmental remediation .............. 7,635 7,613
Long-term leases ....................... 7,565 7,700
------- -------
Total .................................. $38,801 $21,669
======= =======
The current portion of long-term obligations is included in current liabilities.
The expected maturity amounts are as follows: 1997, $1,997,000; 1998,
$1,950,000; 1999, $1,965,000; 2000, $1,981,000; 2001, $1,999,000; thereafter,
$28,909,000.
Long-term Borrowings--Consists of two unsecured loans used for the company's
land, building and equipment located in Kawasaki, Japan. The loans are
denominated in Yen, of which approximately $8.6 million is amortizable in
monthly installments over 15 years, bears interest at 2.5%, and approximately
$11.6 million requires a balloon payment due in 10 years and bears interest at
3.1%, payable semiannually.
Deferred Compensation--The company has deferred compensation plans covering
selected members of management and key technical employees. The purpose is to
reward and encourage talented employees to remain with the company. Such amounts
are payable in accordance with various fixed payment schedules.
Environmental Remediation--As discussed in Note 6, the company is obligated to
remediate groundwater contamination at the Scotts Valley and Palo Alto
facilities. The portion expected to be paid within one year is included in
current liabilities.
17
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Leases--Certain long-term leases for plant facilities are treated as capital
leases for financial statement purposes. The leases expire during the years 2014
to 2029, and renewal options do not provide for lease extensions beyond the year
2029. The company also has noncancellable operating leases for plant facilities
and equipment expiring through the year 2001. The leases may be renewed for
various periods after the initial term. Payment obligations under these capital
and operating leases as of December 31, 1996 are as follows:
(IN THOUSANDS)
---------------------------
CAPITAL OPERATING
LEASES LEASES
--------- --------
Lease payments:
1997 ............................... $ 848 $ 1,420
1998 ............................... 848 636
1999 ............................... 848 417
2000 ............................... 848 344
2001 ............................... 848 50
Remaining years .................... 14,024 --
------- -------
Total .............................. 18,264 $ 2,867
=======
Imputed interest ................... (10,564)
-------
Present value of lease payments
(current portion, $135) ........... $ 7,700
=======
Rent expense included in continuing operations for property and equipment
relating to operating leases is as follows:
(IN THOUSANDS)
----------------------------------
1996 1995 1994
------ ------ -------
Real property .............. $2,388 $1,202 $ 774
Equipment .................. 1,029 665 626
------ ------ ------
Total ...................... $3,417 $1,867 $1,400
====== ====== ======
Lines of Credit--The company has arranged with several banks to provide a
$100,000,000 unsecured credit facility. This facility expires on December 8,
1998. No material compensating balances are required or maintained. Borrowings
under this facility generally bear interest at the lower of prime rate or London
Interbank Offered Rates (LIBOR) plus .75%. During 1996, the company borrowed
approximately $10 million under this facility, of which the full amount was
repaid. The amount of outstanding letters of credit and other guarantees was not
material at December 31, 1996. In addition to the $100,000,000 unsecured credit
facility, the company's foreign subsidiaries maintain separate lines of credit
totaling approximately $500,000.
4. SHAREOWNERS' EQUITY
Stock Repurchase Program--The Board of Directors has authorized the company to
repurchase a maximum of 2,500,000 shares of company stock. Through December 31,
1996, 1,500,000 shares have been repurchased. No shares were repurchased in 1995
and 1996. The program enables the company to acquire its common stock from time
to time when appropriate.
Common Share Purchase Rights--On September 20, 1996, the company declared a
dividend of one Common Share Purchase Right on each outstanding share of common
stock. The Rights were distributed on October 20, 1996 to shareowners of record
on October 10, 1996. The Rights extend and replace the
18
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Common Share Purchase Rights distributed in October of 1986 which expired on
October 20, 1996. The new Rights expire October 20, 2006, and may be redeemed by
the company for $.01 per Right at any time prior to 10 days after a person or
group acquires 15% or more of the company's common stock. The Rights become
exercisable and trade separately from the common stock if any person or group
acquires 15% or more of the company's outstanding common stock, or announces an
offer which would result in such person or group acquiring 15% or more of the
company's common stock. When the Rights first become exercisable as a result of
the announcement of a tender or exchange offer, a holder of a Right will be
entitled to buy one share of the company's common stock for $160. If, instead or
thereafter, a person or group not previously approved by the company acquires
15% or more of the company's shares, a holder of a Right (other than that person
or group) will be entitled to buy that number of additional shares of common
stock from the company which have a market value of twice the $160 exercise
price of each Right. If the company is acquired in a merger or other business
combination after any person or group acquires 15% or more of the company's
common stock, each Right will entitle its holder to buy a number of shares of
common stock of the surviving company having a market value of twice the $160
exercise price. After the acquisition by any person or group of 15% or more of
the company's common stock and up to the time that such person or group acquires
a 50% interest, the company will also have the ability to exchange some or all
of the Rights (other than Rights held by the acquiror) for one share of common
stock per Right at no expense to the holder. The Rights also provide for
protection against self-dealing transactions by a controlling shareowner. The
company reserves and keeps available out of its authorized and unissued shares
of common stock, the number of shares of common stock that will be sufficient to
permit the exercise in full of all outstanding Rights.
Stock Option Plans--The Employee Stock Option Plan provides for grants of
nonqualifying and incentive stock options to certain key employees and officers.
The company may grant options to purchase up to 3,900,000 shares of common
stock. The options are granted at the market price on date of grant and expire
at the tenth anniversary date. One-third of the options granted are exercisable
in each of the third, fourth and fifth succeeding years. The Plan allows those
employees who are subject to the insider trading restrictions certain limited
rights to receive cash in the event of a change in control. Shares issued are
net of retirement of shares used in payment for options exercised. In addition,
the Plan permits the award of restricted stock rights subject to a fixed vesting
schedule. The holder of vested restricted stock has certain dividend, voting,
and other shareowner rights. No restricted stock awards have been made through
December 31, 1996.
The Nonemployee Directors Stock Option Plan provides for a fixed schedule of
options to be granted through the year 2005. Nonemployee directors of the
company are automatically granted 3,000 shares of common stock each year that
such person remains a director of the company. The options are granted at the
market price on date of grant and expire at the tenth anniversary date. The
options granted become exercisable after six months from the date of grant.
Prior to 1996, options granted were exercisable similarly to the Employee Stock
Option Plan. The total number of shares to be issued under this plan may not
exceed 350,000 shares. Included in the tables below, 21,000 option shares were
granted at $34.63 in 1996; 12,600 and 5,440 option shares were granted at $39.75
and $39.88, respectively, in 1995; and 16,320 option shares were granted at
$29.00 in 1994.
Included in the Consolidated Statements of Shareowners' Equity are tax benefits
related to sales under stock option plans of $1,161,000, $4,735,000 and
$2,327,000 for 1996, 1995 and 1994, respectively.
19
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Activity related to all stock option plans is as follows:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
----------- --------------
1996
Granted ............................... 205,000 $25.54
Exercised ............................. 209,393 $17.57
Terminated ............................ 328,443 $29.39
At December 31:
Outstanding .......................... 1,529,237 $27.32
Exercisable .......................... 463,119 $19.11
Reserved for future grants ........... 797,973 --
1995
Granted ............................... 680,290 $40.13
Exercised ............................. 566,198 $17.81
Terminated ............................ 87,346 $24.35
At December 31:
Outstanding .......................... 1,862,073 $26.79
Exercisable .......................... 249,704 $21.25
1994
Granted ............................... 577,320 $24.25
Exercised ............................. 573,842 $17.84
Terminated ............................ 28,641 $17.86
At December 31:
Outstanding .......................... 1,835,327 $18.96
Exercisable .......................... 458,022 $23.96
<TABLE>
The following table summarizes information concerning currently outstanding and
exercisable options at December 31, 1996:
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ----------------- ------------ ---------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
$10.00 to $21.63 477,066 6.7 $14.64 247,121 $11.85
$22.75 to $26.13 390,505 7.1 $23.03 123,483 $23.13
$26.50 to $35.88 100,126 6.3 $31.97 65,515 $31.66
$36.75 to $55.00 561,540 8.0 $40.26 27,000 $36.75
- ---------------- --------- ------ -------- --------- -------
$10.00 to $55.00 1,529,237 7.2 $27.32 463,119 $19.11
================ ========= ====== ======== ========== =======
</TABLE>
As discussed in Note 1, the company applies Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations
in accounting for its plans. Accordingly, no compensation expense has been
recognized for its stock-based compensation plans. Had compensation cost for the
company's stock option plans been determined based upon the fair value at the
grant date for awards under these plans, and amortized to expense over the
vesting period of the awards consistent with the methodology prescribed under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," the company's pro forma net income for 1996 and 1995 would have
been $1,256,000 and $29,849,000, respectively, or $.15 and $3.42 per share,
respectively. However, the impact of outstanding non-vested stock options
granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1996 and 1995 pro forma adjustments are not indicative of
future period pro
20
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
forma adjustments, when the calculation will apply to all applicable stock
options. The weighted average fair value of options granted during 1996 and 1995
is calculated as $7.96 per share and $13.96 per share, respectively, on the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions: dividend yield of 1.5% for 1996 grants and 1.7%
for 1995 grants, volatility of 37.5%, risk-free interest rate at the time of
grant of 6.2% for 1996 and 7.1% for 1995, and an expected term to exercise of
approximately 3.5 months from the vest date. The company's calculations are
based on a multiple option valuation approach and forfeitures are recognized as
they occur.
The Black-Scholes model used by the company to calculate option values, as well
as other currently accepted option valuation models, were developed to estimate
the fair values of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the company's stock option awards.
These models also require highly subjective assumptions, including future stock
price volatility, and expected time until exercise, which greatly affect the
calculated values. Assuming expected future volatility decreases to 25% over a
shorter expected term which assumes immediate exercise upon vesting, the
weighted average fair value of options granted during 1996 and 1995 would have
been $5.79 per share and $10.49 per share, respectively, on the date of grant.
Pro forma net income for 1996 and 1995 would have been lower than actual net
income by $1,305,000 and $1,178,000, respectively, or $.15 and $.08 per share,
respectively. Assuming expected future volatility increases to 50% over a longer
expected term to exercise of approximately 12 months from the vest date, the
weighted average fair value of options granted during 1996 and 1995 is
calculated as $10.98 per share and $18.65 per share, respectively, on the date
of grant. Pro forma net income for 1996 and 1995 would have been lower than
actual net income by $2,439,000 and $2,132,000, respectively, or $.29 and $.16
per share, respectively.
5. INCOME TAXES
The provision for income taxes includes deferred taxes reflecting the net tax
effects of temporary differences that are reported in one period for financial
accounting purposes and in another period for income tax purposes. Deferred tax
assets are recognized when management believes realization of future tax
benefits of temporary differences is more likely than not. In estimating future
tax consequences, generally all expected future events are considered other than
enactments of changes in the tax law or rates. The components of income from
continuing operations before Federal and foreign income taxes consists of the
following:
(IN THOUSANDS)
----------------------------------------
1996 1995 1994
--------- --------- --------
U.S ................. $ 1,590 $ 43,133 $ 31,010
Foreign ............. 2,729 884 (159)
-------- -------- --------
Total ............... $ 4,319 $ 44,017 $ 30,851
======== ======== ========
21
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision for Federal and foreign income taxes on income from continuing
operations consists of the following:
(IN THOUSANDS)
---------------------------------------
1996 1995 1994
--------- --------- ---------
Current:
U.S .................... $ 3,333 $ 13,057 $ 9,855
Foreign ................ 1,432 517 40
-------- -------- --------
Total current .......... 4,765 13,574 9,895
-------- -------- --------
Deferred ................ (3,480) (985) (695)
-------- -------- --------
Total ................... $ 1,285 $ 12,589 $ 9,200
======== ======== ========
Deferred foreign taxes were not significant for all years presented.
Deferred tax assets (liabilities) are comprised of the following at December 31:
(IN THOUSANDS)
-------------------------------------
1996 1995 1994
-------- -------- ---------
Deferred compensation ................ $ 2,115 $ 3,259 $ 3,251
Loss accruals ........................ 13,195 6,753 6,295
Environmental remediation ............ 3,147 3,298 3,490
Uniform capitalization ............... 1,207 1,456 1,273
Vacation accrual ..................... 1,780 1,794 1,724
Other ................................ 2,396 2,426 1,307
-------- -------- --------
Gross deferred tax assets .......... 23,840 18,986 17,340
-------- -------- --------
Depreciation ......................... (3,697) (2,297) (1,562)
Other ................................ (58) (84) (158)
-------- -------- --------
Gross deferred tax liabilities ..... (3,755) (2,381) (1,720)
-------- -------- --------
Net deferred tax asset ............... $ 20,085 $ 16,605 $ 15,620
======== ======== ========
The differences between the effective income tax rate and the statutory Federal
income tax rate are as follows:
1996 1995 1994
---- ---- ----
Statutory Federal tax rate ................ 34.0% 35.0% 35.0%
Export sales benefit ...................... (7.8) (6.0) (5.5)
Research credit ........................... (13.8) (1.4) (2.3)
Effect of foreign operations taxed at
various rates ............................ 11.6 .5 .3
Other ..................................... 5.8 .5 2.3
---- ---- ----
Effective rate ............................ 29.8% 28.6% 29.8%
==== ==== ====
Domestic state and local income taxes included in selling and administrative
expenses totaled $248,000 in 1996, $1,670,000 in 1995, and $1,813,000 in 1994.
22
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES
The company remains in compliance with the remedial action plans being monitored
by various regulatory agencies at its Scotts Valley and Palo Alto sites. In 1991
the company recorded a $15 million charge for estimated remediation actions and
cleanup costs. No additional provision has been recorded since 1991.
Expenditures charged against the provision totaled $327,000, $778,000 and
$2,727,000 for the years 1996, 1995 and 1994, respectively. While the timing and
ultimate amount of expenditures of restoring the sites cannot be predicted with
certainty, management believes that the provision taken is adequate based on
facts known at this time. In 1994 the company reached agreement with the other
potentially responsible parties regarding allocations of the remediation costs
at the Palo Alto site. Included in other income for 1995 are recoveries from
insurers totaling $1,331,000. The company will continue to vigorously pursue any
potential recoveries from insurers or other responsible parties. Changes in
environmental regulations, improvements in cleanup technology and discovery of
additional information concerning these sites and other sites could affect the
estimated costs in the future.
In addition to the above environmental matters, the company is involved in
various legal actions which arose in the ordinary course of its business
activities. Except for the environmental provision noted above, management
believes the final resolution of these matters should not have a material impact
on its results of operations, cash flows, and financial position.
7. EMPLOYEE BENEFIT PLANS
Employees' Investment Plan--The Watkins-Johnson Employees' Investment Plan
conforms to the requirements of the Employee Retirement Income Security Act of
1974 (ERISA) and the Internal Revenue Code as a qualified defined contribution
plan. The Plan covers substantially all employees and for 1996 and 1995 provided
that the company match employees' 401(k) salary deferrals up to 3% of eligible
employee compensation. Prior to 1995, the plan provided for company
contributions equal to 9% of the net pretax earnings. The amount charged to
income was $2,724,000 in 1996, $2,577,000 in 1995, and $3,190,000 in 1994.
Employee Stock Ownership Plan (ESOP)--The ESOP was established to encourage
employee participation and long-term ownership of company stock. The Board
determines each year's contribution depending on the performance and financial
condition of the company. The Board approved a contribution equal to 1% of
eligible employee compensation for 1996, 1995, and 1994, which resulted in
charges to income of $883,000, $839,000, and $894,000, respectively. The ESOP
held 220,941 and 197,000 shares of common stock at December 31, 1996 and 1995,
respectively. The ESOP is a qualified defined contribution plan under ERISA and
the Internal Revenue Code.
8. BUSINESS SEGMENT REPORTING
The company operates in three industry segments. Operations in the Semiconductor
Equipment segment involve the development, production, sales and service of
chemical-vapor-deposition equipment used in the manufacture of semiconductor
products. Operations in the Wireless Communications segment involve the design,
development, manufacture and sale of advanced wireless telecommunication
products for cellular service providers, personal communication systems, and
other wireless product manufacturers. Operations in the Government Electronics
segment include the design, development, manufacture and sale of advanced
electronic systems and devices for guided-missile programs, communications
intelligence, and other government agency applications. The Environmental
Services business was divested at the end of 1994 and is reported as a
discontinued business in the financial statements.
23
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
Continuing operations by business segment are as follows:
<CAPTION>
(IN THOUSANDS) YEAR ENDED DECEMBER 31, 1996
-------------- -------------------------------------------------------------------------------
YEAR-
PRE-TAX END CAPITAL
SALES INCOME ASSETS ADDITIONS DEPRECIATION
--------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C>
Semiconductor Equipment ..................... $ 272,436 $ 7,089 $ 174,549 $ 46,122 $ 7,231
Wireless Communications ..................... 46,571 (5,793) 28,307 1,536 793
Government Electronics ...................... 119,312 3,617 72,893 2,105 2,759
Corporate ................................... 38,624 240 513
--------- --------- --------- --------- ---------
Income from continuing operations ........... 4,913
Other income (expense)--net ................. (594)
--------- --------- --------- --------- ---------
Total ....................................... $ 438,319 $ 4,319 $ 314,373 $ 50,003 $ 11,296
========= ========= ========= ========= =========
YEAR ENDED DECEMBER 31, 1995
-------------------------------------------------------------------------------
Semiconductor Equipment ..................... $ 222,212 $ 33,062 $ 147,051 $ 18,518 $ 4,687
Wireless Communications ..................... 30,446 (1,796) 19,530 1,258 436
Government Electronics ...................... 134,373 10,919 64,504 5,464 4,417
Corporate ................................... (313) 56,589 326 401
--------- --------- --------- --------- ---------
Income from continuing operations ........... 41,872
Other income (expense)--net ................. 2,145
--------- --------- --------- --------- ---------
Total ....................................... $ 387,031 $ 44,017 $ 287,674 $ 25,566 $ 9,941
========= ========= ========= ========= =========
YEAR ENDED DECEMBER 31, 1994
----------------------------------------------------------------------------
Semiconductor Equipment ..................... $ 143,536 $ 22,185 $ 68,270 $ 7,649 $ 2,993
Wireless Communications ..................... 23,196 307 10,365 135 273
Government Electronics ...................... 165,874 8,087 98,291 4,465 4,999
Corporate ................................... 58,104 277 446
--------- --------- --------- --------- ---------
Income from continuing operations ........... 30,579
Other income (expense)--net ................. 272
--------- --------- --------- --------- ---------
Total ....................................... $ 332,606 $ 30,851 $ 235,030 $ 12,526 $ 8,711
========= ========= ========= ========= =========
</TABLE>
Sales to individual customers representing greater than 10% of company
consolidated sales are as follows:
(IN THOUSANDS)
------------------------------
1996 1995 1994
------- ------- -------
Semiconductor Equipment:
Marubeni Hytech (a Japanese
distributor) ..................... $47,000 $61,000 $39,000
Government Electronics:
United States Government .......... 32,000 42,000 57,000
Hughes Aircraft Company ........... 30,000 40,000 35,000
In January 1997, Raytheon Co. announced plans to acquire the defense holdings of
Hughes Aircraft Company in a merger. Raytheon has also been a customer of the
company for many years. It is unknown what effect, if any, such a merger may
have on the company at this time.
24
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Sales from continuing operations to unaffiliated customers by geographic area
are as follows:
(IN THOUSANDS)
-------------------------------
1996 1995 1994
-------- -------- --------
United States ....................... $219,060 $203,460 $183,963
Export sales from United States:
Europe ............................. 35,141 19,958 26,534
Japan .............................. 69,181 60,674 43,544
Korea .............................. 52,755 53,470 32,292
Other Asia-Pacific countries ....... 36,990 30,388 23,088
Other .............................. 7,361 9,975 12,385
Europe .............................. 9,759 6,734 10,800
Japan ............................... 3,312
Other Asia-Pacific countries ........ 4,760 2,372
-------- -------- --------
Total ............................... $438,319 $387,031 $332,606
======== ======== ========
Intercompany transfers of products and services between geographic regions were
$37,533,000, $12,130,000 and $2,809,000 in fiscal years 1996, 1995 and 1994,
respectively, and are accounted for at prices the company believes to be arm's
length.
Operating profit and year-end assets by geographic area for 1996 are as follows:
(IN THOUSANDS)
-------------------------
OPERATING YEAR-END
PROFIT ASSETS
-------- --------
United States .......................... $ 1,981 $269,609
Europe ................................. 700 6,476
Japan .................................. 952 32,074
Other Asia-Pacific countries ........... 1,280 6,214
-------- --------
Total .................................. $ 4,913 $314,373
======== ========
For all years prior to 1996, foreign operations' sales, profits, and
identifiable assets are less than ten percent of consolidated totals.
Summarized below are operating results and assets of the discontinued
Environmental Services business. Intersegment sales were transferred based on
negotiated prices.
(IN THOUSANDS)
YEAR ENDED
DECEMBER 31, 1994
-----------------
Sales ................................................... $ 4,911
Intersegment sales ...................................... (1,294)
-------
Net sales ............................................... $ 3,617
=======
Loss before income taxes ................................ $ (690)
Income tax benefit ...................................... 200
Loss on disposition net of $100 income tax benefit ...... (200)
-------
Net loss ................................................ $ (690)
=======
Year-end assets ......................................... $ 2,281
=======
25
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. QUARTERLY FINANCIAL DATA--UNAUDITED
Unaudited quarterly financial data are as follows:
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
-----------------------------------------
1996 QUARTERS 1ST 2ND 3RD 4TH
--------------------- -------- -------- -------- --------
Sales ................... $122,742 $126,447 $ 94,962 $ 94,168
Gross profit ............ 45,910 41,488 34,041 18,224
Net income .............. 6,434 358 2,832 (6,590)
Net income per share .... $ .75 $ .04 $ .33 $ (.77)
1995 QUARTERS 1ST 2ND 3RD 4TH
--------------------- -------- -------- -------- --------
Sales .................... $ 92,983 $102,004 $ 95,550 $ 96,494
Gross profit ............. 39,877 41,649 40,572 43,141
Net income ............... 5,353 7,776 8,910 9,389
Net income per share ..... $ .63 $ .88 $ .98 $ 1.04
The fourth quarter of 1996 includes a charge of $11 million relating to
slow-moving inventories and severance costs.
The total of quarterly amounts for net income per share will not necessarily
equal the annual amount, since the computations are based on the average number
of common and common equivalent shares outstanding during each period.
26
<PAGE>
REPORT OF MANAGEMENT
The consolidated financial statements of Watkins-Johnson Company and
subsidiaries were prepared by management, which is responsible for their
integrity and objectivity. The statements were prepared in conformity with
generally accepted accounting principles and, as such, include amounts that are
based on the best judgments of management.
The system of internal controls of the company is designed to provide reasonable
assurance that assets are safeguarded and that transactions are executed in
accordance with management's authorization and are reported properly. The most
important safeguard for shareowners is the company's emphasis in the selection,
training and development of professional accounting managers to implement and
oversee the proper application of its internal controls and the reporting of
management's stewardship of corporate assets and maintenance of accounts in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP, independent auditors, are retained to provide an
objective, independent review as to management's discharge of its
responsibilities insofar as they relate to the fairness of reported operating
results and financial position. They obtain and maintain an understanding of the
company's accounting and financial controls, and conduct such tests and related
procedures as they deem necessary to arrive at an opinion on the fairness of the
financial statements.
The Audit Committee of the Board of Directors, composed solely of Directors from
outside the company, meets periodically, separately and jointly, with the
independent auditors and representatives of management to review the work of
each. The functions of the Audit Committee include recommending the engagement
of the independent auditors, reviewing the scope and results of the audit and
reviewing management's evaluation of the system of internal controls.
W. Keith Kennedy, Jr. Scott G. Buchanan
President and Vice President and
Chief Executive Officer Chief Financial Officer
27
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareowners and Board of Directors
of Watkins-Johnson Company:
We have audited the accompanying consolidated balance sheets of Watkins-Johnson
Company and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, shareowners' equity, and cash flows for
each of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Watkins-Johnson Company and
subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
San Francisco, California
February 7, 1997
28
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning the company's directors is
shown under the caption "Election of Directors" in the company's definitive
proxy statement filed with the Commission pursuant to Regulation 14A.
The information relating to the company's executive officers is presented in
Part I of this Form 10-K under the caption "Executive Officers of the
Registrant".
ITEM 11. EXECUTIVE COMPENSATION
See this caption in the definitive proxy statement which the company has
filed with the Commission pursuant to Regulation 14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is shown under the captions "Security Ownership of Certain
Beneficial Owners & Management" in the company's definitive proxy statement
filed with the Commission pursuant to Regulation 14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain business relationships is shown under the
caption "Executive Compensation" in the definitive proxy statement which the
company has filed with the Commission pursuant to Regulation 14A. There were
no transactions with management for which disclosure would be required by
Item 404 of Regulation S-K.
29
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PAGE
----
(a) 1. Consolidated Financial Statements
Consolidated Statements of Operations
For the Years Ended December 31, 1996, 1995 and 1994 11
Consolidated Balance Sheets
December 31, 1996 and 1995 12
Consolidated Statements of Shareowners' Equity
For the Years Ended December 31, 1996, 1995 and 1994 13
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1996, 1995 and 1994 14
Notes to Consolidated Financial Statements 15-26
Report of Management 27
Independent Auditors' Report 28
PAGE
----
2. Financial Statement Schedules
Independent Auditors' Report 32
II Valuation and Qualifying Accounts and Reserves
For the Years Ended December 31, 1996, 1995 and
1994 33
Schedules not listed above are omitted because of the absence of
conditions under which they are required or because the required
information is included in the financial statements or in the notes
thereto.
3. Exhibits
A list of the exhibits required to be filed as part of this report is set
forth in the Exhibit Index, which immediately precedes such exhibits. The
exhibits are numbered according to Item 601 of Regulation S-K. Exhibits
incorporated by reference to a prior filing are designated by an
asterisk.
- -------------
(b) No reports on Form 8-K were required to be filed during the last quarter of
the period covered by this report.
(c) The exhibits required to be filed by Item 601 of Regulation S-K are the same
as Item 14(a)3 above.
(d) Financial statement schedules not included herein have been omitted because
of the absence of conditions under which they are required or because the
required information is included in the financial statements or in the notes
thereto.
30
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this annual report to be
signed on its behalf by the undersigned, thereunto duly authorized.
WATKINS-JOHNSON COMPANY
---------------------------
(Registrant)
/s/ DEAN A. WATKINS
Date: February 24, 1997 By ---------------------------
DEAN A. WATKINS
CHAIRMAN OF THE BOARD
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- -----
<S> <C> <C>
Principal Executive Officer:
/s/ W. Keith Kennedy, Jr. President and Chief Executive Officer February 24, 1997
--------------------------------
W. KEITH KENNEDY, JR.
Principal Financial and
Accounting Officer:
/s/ Scott G. Buchanan Vice President and February 24, 1997
-------------------------------- Chief Financial Officer
SCOTT G. BUCHANAN
/s/ H. Richard Johnson Director February 24, 1997
--------------------------------
H. RICHARD JOHNSON
/s/ John J. Hartmann Director February 24, 1997
--------------------------------
JOHN J. HARTMANN
/s/ Raymond F. O'Brien Director February 24, 1997
--------------------------------
RAYMOND F. O'BRIEN
/s/ William R. Graham Director February 24, 1997
--------------------------------
WILLIAM R. GRAHAM
/s/ Robert L. Prestel Director February 24, 1997
--------------------------------
ROBERT L. PRESTEL
/s/ Gary M. Cusumano Director February 24, 1997
--------------------------------
GARY M. CUSUMANO
</TABLE>
31
<PAGE>
INDEPENDENT AUDITORS' REPORT
Watkins-Johnson Company:
We have audited the consolidated financial statements of Watkins-Johnson Company
and subsidiaries as of December 31, 1996 and 1995, and for each of the three
years in the period ended December 31, 1996, and have issued our report thereon
dated February 7, 1997; such consolidated financial statements and report are
included in Item 8 of this annual report on Form 10-K. Our audits also included
the consolidated financial statement schedule of Watkins-Johnson Company and
subsidiaries, listed in Item 14. This consolidated financial statement schedule
is the responsibility of the company's management. Our responsibility is to
express an opinion based on our audits. In our opinion, such consolidated
financial statement schedule taken as a whole, presents fairly in all material
respects the information set forth therein.
Deloitte & Touche LLP
San Francisco, California
February 7, 1997
32
<PAGE>
<TABLE>
SCHEDULE II
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) PERIOD(2)
-------------------------------- ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
1996
Allowance for doubtful accounts .................... $1,033,798 $ 219,649 $ 6,727 $1,246,720
========== ========== ========== ==========
1995
Allowance for doubtful accounts .................... $1,014,898 $ 18,900 $ 0 $1,033,798
========== ========== ========== ==========
1994
Allowance for doubtful accounts .................... $ 998,998 $ 16,900 $ 1,000 $1,014,898
========== ========== ========== ==========
<FN>
- --------------
(1) Write-off of uncollectible accounts.
(2) Reduction of accounts receivable.
</FN>
</TABLE>
33
<PAGE>
<TABLE>
EXHIBIT INDEX
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------
<S> <C>
3-a *Articles of Incorporation of Watkins-Johnson Company, as amended May 8, 1989.
3-b *By-Laws of Watkins-Johnson Company, as amended April 27, 1989 (Exhibit 3-b to Form 10-K for
1980, Commission File No. 1-5631).
10 Material Contracts
10-a *Lease and Agreement between Lindco Properties Company and Watkins-Johnson Company commencing
May 1, 1969 (Exhibit (b) I to Form 10-K for 1969, Commission File No. 2-22436).
10-b *Lease and Agreement between Morrco Properties Company and Watkins-Johnson Company dated October
31, 1975 (Exhibit 2(c) to Form 10-K for 1976, Commission File No. 1-5631).
10-c *Lease and Agreement between Danac Real Estate Investment Corporation and Watkins-Johnson
Company (Exhibit 6 to Form 10-K for 1972, Commission File No. 2-22436) and the amendments
thereto (Exhibit 1(b) to Form 10-K for 1976, Commission File No. 1-5631).
10-d *Building and Loan Agreement and Deed of Trust Note between Danac Real Estate Investment
Corporation and Watkins-Johnson Company (Exhibit 7 to Form 10-K for 1972, Commission File No.
2-22436).
10-e *Promissory Note and Deed of Trust Agreement entered into between the New England Mutual Life
Insurance Company and Watkins-Johnson Company dated May, 1978 (Exhibit 2 to Form 10-K for 1978,
Commission File No. 1-5631).
10-f *Promissory Note and Deed of Trust entered into by the Wake County Industrial Facilities and
Pollution Control Financing Authority, the NCNB National Bank of North Carolina and
Watkins-Johnson Company dated December 28, 1984 (Exhibit 10-f to Form 10-K for 1984, Commission
File No. 1-5631).
10-g *Deferred Compensation Plan effective November 29, 1979 (Exhibit 10-g to Form 10-K for 1984,
Commission File No. 1-5631).
10-h *Key Top-Management Incentive Bonus Plan Summary (Exhibit 10-h to Form 10-K for 1985, Commission
File No. 1-5631).
10-i *Employment Agreement Form, in effect for those employees listed in the company's definitive
proxy statement filed with the Commission pursuant to Regulation 14A (Exhibit 10-i to Form 10-K
for 1984, Commission File No. 1-5631).
10-j *Deferred Compensation Plan effective November 29, 1979 as amended March 31, 1986 (Exhibit 10-j
to Form 10-K for 1986, Commission File No. 1-5631).
10-k *Lease and Agreement between Seagate Technology and Watkins-Johnson Company dated September 19,
1986 (Exhibit 10-k to Form 10-K for 1986, Commission File No. 1-5631).
10-k(1) *Termination of Lease and Agreement between Seagate Technology and Watkins-Johnson Company dated
September 22, 1987 (Exhibit 10-k(1) to Form 10-K for 1987, Commission File No. 1-5631).
10-l *Severance Agreement Form, in effect for those employees listed in the company's definitive
proxy statement filed with the Commission pursuant to Regulation 14A (Exhibit 10-l to Form 10-K
for 1986, Commission File No. 1-5631).
10-m *Form of Rights Agreement between Watkins-Johnson Company and Bank of America National Trust and
Savings Association (Exhibit 4 to the 1986 Third Quarter Form 10-Q, Commission File No. 1-5631).
10-n *Watkins-Johnson Company 1976 Stock Option Plan, as amended September 28, 1987 (Appendix A to
the company's definitive proxy statement dated March 1, 1988 filed with the Commission pursuant
to Regulation 14A).
35
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------
10-o *Watkins-Johnson Company 1989 Stock Option Plan for nonemployee directors (Appendix A to the
company's definitive proxy statement dated February 28, 1990 filed with the Commission pursuant
to Regulation 14A).
10-p *Watkins-Johnson Company 1976 Stock Option Plan amended and renamed as the 1991 Stock Option and
Incentive plan (Appendix A to the company's definitive proxy statement dated February 28, 1991
filed with the commission pursuant to Regulation 14A).
10-q *Watkins-Johnson Company Credit Agreement covering the period of November 30, 1995 through
December 8, 1998, ABN-AMRO BANK N.V. as Agent (Exhibit 10-a to the 1996 Third Quarter Form 10-Q,
Commission File No. 1-5631).
10-r *Loan Agreement dated as of February 9, 1996 (English Translation) between Watkins-Johnson
International Japan K.K. and The Bank of Yokohama, LTD, including Loan Guaranty Agreement with
Watkins-Johnson Company dated January 31, 1996 (Exhibit 10-b to the 1996 Third Quarter Form
10-Q, Commission File No. 1-5631).
10-s *Loan Agreement dated as of June 12, 96 (English Translation) between Watkins-Johnson
International Japan K.K. and The Japan Development Bank, including Loan Guaranty Agreement with
Watkins-Johnson Company dated June 12, 1996 (Exhibit 10-c to the 1996 Third Quarter Form 10-Q,
Commission File No. 1-5631).
10-t *Shareowners' Rights Agreement dated as of September 30, 1996 Between Watkins-Johnson Company
and ChaseMellon Shareholder Services, L.L.C., as Rights Agent (Report on Form 8-K, filed on
October 1, 1996, Commission File No.1-5631).
11 Statement re Computation of Per Share Earnings.
21 Subsidiaries of Watkins-Johnson Company.
23 Consent of Independent Auditors.
27 Financial Data Schedule.
</TABLE>
35
<TABLE>
EXHIBIT 11
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER COMMON SHARE
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
For primary net income per share:
Weighted average shares outstanding ............................. 8,265,000 7,938,000 7,425,000
Equivalent shares--dilutive stock
options--based on treasury stock method
using average market price...................................... 272,000 838,000 728,000
---------- ---------- ----------
Total ....................................................... 8,537,000 8,776,000 8,153,000
========== ========== ==========
For fully diluted net income per share:
Weighted average shares outstanding ............................. 8,265,000 7,938,000 7,425,000
Equivalent shares--dilutive stock
options--based on treasury stock method
using greater of average or ending
market price.................................................... 276,000 937,000 775,000
---------- ---------- ----------
Total ....................................................... 8,541,000 8,875,000 8,200,000
========== ========== ==========
Net income ....................................................... $3,034 $31,428 $20,961
====== ======= =======
Primary net income per share ..................................... $ 0.36 $ 3.58 $ 2.57
====== ======= =======
Fully diluted net income per share ............................... $ 0.36 $ 3.54 $ 2.56
====== ======= =======
<FN>
This calculation is submitted in accordance with Regulation S-K, Item
601(b)(11).
</FN>
</TABLE>
36
EXHIBIT 21
SUBSIDIARIES OF WATKINS-JOHNSON COMPANY
JURISDICTION OR
SUBSIDIARY INCORPORATION
------------------ ---------------
Watkins-Johnson FSC ...................................... Guam
Watkins-Johnson International ............................ California
Watkins-Johnson International Japan, K.K. ................ Japan
Watkins-Johnson International Korea, Limited ............. Korea
Watkins-Johnson International Singapore PTE, Limited .... Singapore
Watkins-Johnson International Taiwan ..................... Taiwan
Watkins-Johnson Italiana, S.p.A. ......................... Italy
Watkins-Johnson Europe, Limited .......................... United Kingdom
37
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
Watkins-Johnson Company:
We hereby consent to the incorporation by reference in Registration
Statement No. 33-21142 on Form S-8 of our reports dated February 7, 1997
appearing in your Annual Report on Form 10-K for the year ended December 31,
1996.
Deloitte & Touche LLP
San Francisco, California
March 7, 1997
38
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 15,702
<SECURITIES> 0
<RECEIVABLES> 95,717
<ALLOWANCES> 0
<INVENTORY> 69,158
<CURRENT-ASSETS> 203,843
<PP&E> 231,318
<DEPRECIATION> 127,748
<TOTAL-ASSETS> 314,373
<CURRENT-LIABILITIES> 80,861
<BONDS> 38,801
<COMMON> 38,998
0
0
<OTHER-SE> 155,713
<TOTAL-LIABILITY-AND-EQUITY> 314,373
<SALES> 438,319
<TOTAL-REVENUES> 438,319
<CGS> 298,656
<TOTAL-COSTS> 298,656
<OTHER-EXPENSES> 133,770
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,574
<INCOME-PRETAX> 4,319
<INCOME-TAX> 1,285
<INCOME-CONTINUING> 3,034
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,034
<EPS-PRIMARY> .36
<EPS-DILUTED> .36
</TABLE>
