FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 26, 1998
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
<TABLE>
WATKINS-JOHNSON COMPANY
(Exact name of registrant as specified in its charter)
<CAPTION>
CALIFORNIA 94-1402710
- -------------------------------------------------------------- -------------------------------------------------------------
<S> <C>
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
3333 Hillview Avenue, Palo Alto, California 94304-1223
- -------------------------------------------------------------- -------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(650) 493-4141
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(Registrant's telephone number, including area code)
</TABLE>
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 ___.
Common stock, no par value, outstanding as of June 26, 1998 8,258,000 shares
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
The interim financial statements are unaudited; however,
Watkins-Johnson Company believes that all adjustments
necessary for a fair statement of results for such interim
periods have been included and all such adjustments are of a
normal recurring nature. The results for the six months ended
June 26, 1998, are not necessarily indicative of the results
for the full year 1998.
The consolidated financial statements required by Rule 10-01
of Regulation S-X are included in this report beginning on the
next page.
2
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS*
For the periods ended June 26, 1998 and June 27, 1997
<CAPTION>
Three Months Ended Six Months Ended
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share 1998 1997 1998 1997
amounts)
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sales $ 53,739 $ 72,679 $ 122,461 $ 139,895
- -------------------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of goods sold 37,080 46,611 79,626 90,922
Selling and administrative 13,750 14,668 29,571 27,764
Research and development 13,335 10,428 26,543 20,874
- -------------------------------------------------------------------------------------------------------------------------------
64,165 71,707 135,740 139,560
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (10,426) 972 (13,279) 335
Interest and other income (expense)--net 1,836 625 4,071 1,083
Interest expense (277) (361) (583) (690)
Gain on real property 14,783
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations
before income taxes (8,867) 1,236 4,992 728
Income tax benefit (expense) 2,660 (350) (1,498) (160)
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (6,207) 886 3,494 568
Income from discontinued operations, net of
taxes 2,196 4,992
- -------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (6,207) $ 3,082 $ 3,494 $ 5,560
===============================================================================================================================
Basic per share amounts:
Income (loss) from continuing operations $ (.75) $ .11 $ .42 $ .07
Income from discontinued operations .26 .60
- -------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (.75) $ .37 $ .42 $ .67
===============================================================================================================================
Basic average common shares 8,257,000 8,258,000 8,259,000 8,278,000
Diluted per share amounts:
Income (loss) from continuing operations $ (.75) $ .10 $ .41 $ .07
Income from discontinued operations .26 .58
- -------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (.75) $ .36 $ .41 $ .65
===============================================================================================================================
Diluted average common shares 8,257,000 8,507,000 8,448,000 8,497,000
<FN>
*Unaudited
</FN>
</TABLE>
3
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME*
For the periods ended June 26, 1998 and June 27, 1997
<CAPTION>
Three Months Ended Six Months Ended
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) $ (6,207) $ 3,082 $ 3,494 $ 5,560
- -------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (expense), net of tax:
Foreign currency translation adjustments (242) 255 (258) 109
Net unrealized holding gains (losses) on
securities, net of reclassification
adjustment of $0 27 (59)
- -------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (expense) (215) 255 (317) 109
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ (6,422) $ 3,337 $ 3,177 $ 5,669
===============================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
4
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of June 26, 1998 and December 31, 1997
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1998* 1997
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 33,559 $ 134,462
Short-term investments 79,141
Receivables 40,853 45,690
Inventories:
Finished goods 5,354 9,283
Work in process 23,844 18,519
Raw materials and parts 16,249 18,873
Other 30,345 31,366
- ----------------------------------------------------------------------------------------------------------------------------
Total current assets 229,345 258,193
- ----------------------------------------------------------------------------------------------------------------------------
Property, plant, and equipment 185,335 178,795
Accumulated depreciation and amortization (88,480) (82,382)
- ----------------------------------------------------------------------------------------------------------------------------
Property, plant, and equipment--net 96,855 96,413
- ----------------------------------------------------------------------------------------------------------------------------
Other assets 3,795 3,606
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$ 329,995 $ 358,212
- ----------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREOWNERS'
EQUITY
Current liabilities:
Payables $ 10,229 $ 16,188
Accrued liabilities 66,873 88,398
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Total current liabilities 77,102 104,586
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Long-term obligations 31,722 33,234
- ----------------------------------------------------------------------------------------------------------------------------
Shareowners' equity:
Common stock 41,371 40,631
Retained earnings 180,712 180,356
Accumulated other comprehensive income (912) (595)
- ----------------------------------------------------------------------------------------------------------------------------
Total shareowners' equity 221,171 220,392
- ----------------------------------------------------------------------------------------------------------------------------
$ 329,995 $ 358,212
============================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
5
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS*
For the periods ended June 26, 1998 and June 27, 1997
<CAPTION>
Six Months Ended
- ----------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net Income $ 3,494 $ 5,560
Reconciliation of net income to cash flows
Depreciation and amortization 7,512 6,760
Gain on asset retirements (14,781)
Results of discontinued operations (4,992)
Net changes in:
Receivables 4,657 11,978
Inventories 936 (3,462)
Other assets 751 (189)
Accruals and payables (27,721) (3,515)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by continuing operating activities (25,152) 12,140
Net cash provided by discontinued operations 9,600
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities (25,152) 21,740
- ----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions of property, plant, and equipment (10,119) (7,691)
Purchase of short-term investments (85,243)
Proceeds from sale of short-term investments 6,005
Proceeds on asset retirements and other 15,932 303
Restricted plant construction funds 3,738
- ----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (73,425) (3,650)
- ----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Payments on long-term debt borrowing (272) (439)
Net borrowings (repayments) under line-of-credit (158) (317)
Proceeds from issuance of stock 992 557
Repurchase of common stock (1,408) (4,249)
Dividends paid (1,983) (1,994)
Other (71) (76)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (2,900) (6,518)
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- ----------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 574 1,114
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents (100,903) 12,686
Cash and equivalents at beginning of period 134,462 15,702
- ----------------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 33,559 $ 28,388
============================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
6
<PAGE>
Item 1. Financial Statements (continued)
Supplementary information to the financial statements:
A dividend of twelve cents per share was declared and paid
during the second quarter of 1998 and 1997.
<TABLE>
Per share amounts are computed based on the weighted average
number of basic and diluted (dilutive stock options) common
and common equivalent shares outstanding during the period.
Per share amounts from continuing operations were computed as
follows:
<CAPTION>
(Dollars in thousands, except per share amounts) Three Months Ended Six Months Ended
- -------------------------------------------------------------------------------------------------------------------------------
June 26, 1998 June 27, 1997 June 26, 1998 June 27, 1997
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Denominator for basic per share:
Weighted average shares
outstanding 8,257,000 8,258,000 8,259,000 8,278,000
================ ================== =================== ====================
Denominator for diluted per share:
Weighted average shares
outstanding 8,257,000 8,258,000 8,259,000 8,278,000
Effect of dilutive stock options 249,000 189,000 219,000
---------------- ------------------ ------------------- --------------------
Diluted average common shares 8,257,000 8,507,000 8,448,000 8,497,000
================ ================== =================== ====================
Net income (loss) from continuing
operations (numerator) $ (6,207) $ 886 $ 3,494 $ 568
================ ================== =================== ====================
Basic net income (loss) per share $ (.75) $ .11 $ .42 $ .07
================ ================== =================== ====================
Diluted net income (loss) per share $ (.75) $ .10 $ .41 $ .07
================ ================== =================== ====================
</TABLE>
7
<PAGE>
Item 1. Financial Statements (continued)
For the three months ended June 26, 1998 the incremental
shares from the assumed exercise of 181,000 stock options are
not included in computing the dilutive per share amounts
because continuing operations resulted in a loss and such
assumed conversion would be antidilutive. Additionally,
weighted average options outstanding to purchase 709,000 and
587,000 shares of common stock were not included in the
computation of diluted per share amounts for the three months
ended June 26, 1998 and June 27, 1997, respectively, and
666,000 and 603,000 shares of common stock were not included
in the computation of diluted per share amounts for the six
months ended June 26, 1998 and June 27, 1997, respectively,
because the weighted average exercise prices were greater than
the average market prices of the common shares. For the three
months ended June 26, 1998 and June 27, 1997, weighted average
exercise prices of $35.79 and $39.46, respectively, exceeded
the average market prices of $26.15 and $28.75, respectively.
For the six months ended June 26, 1998 and June 27, 1997,
weighted average exercise prices of $36.42 and $39.46,
respectively, exceeded the average market prices of $26.23 and
$26.98, respectively.
This calculation is submitted in accordance with Regulation
S-K, Item 601(b)(11).
<TABLE>
Sales to external customers and pre-tax profit (loss) from
continuing operations by business segment are as follows:
Three months ended June 26,1998 and June 27, 1997
<CAPTION>
Sales Pre-tax income
------------------------- -------------------------
(in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Semiconductor Equipment $ 26,904 $ 47,991 $ (9,436) $ 400
Wireless Communications 26,835 24,688 (990) 572
- -------------------------------------------------------------------------------------------------------------
Income from continuing operations (10,426) 972
Other income (expense)-net 1,559 264
- -------------------------------------------------------------------------------------------------------------
Total $ 53,739 $ 72,679 $ (8,867) $ 1,236
=============================================================================================================
Six months ended June 26,1998 and June 27, 1997
Sales Pre-tax income
---------------------------------------------------
(in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------
Semiconductor Equipment $ 65,620 $ 92,153 $ (12,835) $ 259
Wireless Communications 56,841 47,742 (444) 76
- -------------------------------------------------------------------------------------------------------------
Income from continuing operations (13,279) 335
Other income (expense)-net 18,271 393
- -------------------------------------------------------------------------------------------------------------
Total $ 122,461 $ 139,895 $ 4,992 $ 728
=============================================================================================================
</TABLE>
8
<PAGE>
PART I--FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Financial Condition and Liquidity
At June 26, 1998, cash and equivalents and short-term
investments totaled $112.7 million. During the first half of
1998, cash and equivalents decreased by $100.9 million, from
$134.5 million to $33.6 million. The decrease in cash and
equivalents resulted primarily from the purchase of short-term
investments, as discussed below.
Net income for the first half of 1998 was $3.5 million, while
net cash used by operations was $25.2 million. For the
comparable period last year, net income was $5.6 million and
net cash provided by operations was $21.7 million. For the
first half of 1998, net cash used by operating activities
differed from net income for the period primarily because of
decreases for: a $14.8 million gain on disposal of property,
plant and equipment and a $27.7 million net change in accruals
and payables; and increases for: depreciation and amortization
charges of $7.5 million and a net change in receivables of
$4.7 million. The net change in accruals and payables was
partially due to income tax payments related to the fourth
quarter 1997 gain on discontinued operations. For the first
half of 1997, net cash provided by operating activities
differed from net income for the period primarily because of
increases for: depreciation and amortization charges of $6.8
million, net changes in receivables of $12 million, and cash
provided by discontinued operations of $9.6 million; and
decreases for: $5 million for the net income of discontinued
operations, a net change in inventory of $3.5 million and a
net change in accruals and payables of $3.5 million.
Net cash used in investing activities was $73.4 million in the
first half of 1998 compared to $3.7 million for the same
period in 1997. In 1998, the company purchased $85.2 million
in short-term investments and $10.1 million in new capital
equipment, and received proceeds of $15.9 million from the
sale of real property and asset retirements and $6 million
from the sale of short-term investments. During the first half
of 1998 the company invested its excess cash and equivalents
in securities with maturities exceeding 90 days to take
advantage of the higher yields. These short-term investments,
consisting mostly of high grade commercial paper, are subject
to interest rate risk and will rise and fall in value if
market interest rates change. Cash used in investing
activities in the first half of 1997 was for the purchase of
$7.7 million of new capital equipment which was offset by the
release of $3.7 million of restricted plant construction
funds.
The company used $2.9 million in financing activities in the
first half of 1998 compared to $6.5 million for the same
period last year. During the first half of 1998 the company
repurchased 52,608 shares of its common stock for $1.4 million
and paid approximately $2 million in dividends which was
offset in part by $1 million in proceeds from stock option
exercises. During the first half of 1997 the company
repurchased 193,000 shares of its common stock for $5.4
million and paid $2 million in dividends.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
As of June 26, 1998, the company's principal source of
liquidity consisted of $33.6 million in cash and equivalents
and short-term investments valued at $79.1 million. The
company has arrangements with several banks to provide a $50
million unsecured credit facility. This facility expires on
March 31, 1999. During the first half of 1998, the company
incurred no borrowings under this credit facility. Management
does not anticipate any significant near term borrowing
requirements under this credit facility.
From time to time the company may enter into certain long-term
borrowing arrangements with financial lending institutions for
capital acquisitions of property, plant and equipment. As of
June 26, 1998, long-term borrowings of $16.8 million consisted
of two unsecured loans used for the company's land, building
and equipment located in Kawasaki, Japan, and are payable
through the year 2011 as fully disclosed in the company's 1997
annual report filed on Form 10-K. At June 26, 1998, there were
no material commitments for capital expenditures.
Current Operations and Business Outlook
For the second quarter of 1998, the company reported sales of
$53.7 million and a net loss of $6.2 million, or $0.75 cents
per diluted share. In 1997, second-quarter sales from
continuing operations amounted to $72.7 million, with net
income of $0.9 million, or $0.10 cents per diluted share.
Sales for the first half of 1998 amounted to $122.5 million,
with net income of $3.5 million, or $0.41 cents per diluted
share. In 1997, first-half sales totaled $139.9 million, with
net income from continuing operations of $0.6 million, or
$0.07 cents per diluted share.
New and restated orders for the second quarter of 1998 were
$40 million or about 30% lower than the $57 million of the
first quarter of 1998 and about 35% lower than the $62 million
for the second quarter of 1997. Second quarter 1998 orders
include nearly $8 million of semiconductor equipment orders
which were dropped from the backlog in December 1997, as
discussed below. Firm backlog on June 26, 1998 stood at $68.6
million, compared to the June 27, 1997 backlog for continuing
operations of $136.5 million, and $82 million at March 27,
1998.
1998 is proving to be a difficult year. During the second
quarter, the market for semiconductor equipment continued to
decline and the company revised its expectations for 1998
downward. The company also reviewed the potential for its
wideband base station (Base2TM ) and decided to shift its
marketing of that product towards original equipment
manufacturers (OEM) rather than selling directly to carriers
and small system integrators. Communications intelligence
orders and shipments were also below plan.
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
To address the greater-than-expected losses associated with
these factors, the company took a number of steps to reduce
operating costs. Most significantly, the company reduced its
worldwide work force by 15% during the second quarter of 1998
and scheduled plant furloughs at all three U.S. facilities.
Adding the staff reductions of the first quarter of 1998,
brings the company work force reduction this year to 20%.
The company has also slowed research and development spending
on certain projects while maintaining prudent levels of
spending on key projects expected to improve 1998 and 1999
orders. The company believes the actions it has in place will
set the stage for future high growth and profitability when
market conditions improve. Operations and business outlook for
each of the company's business segments are discussed below.
Semiconductor Equipment Group
Sales of semiconductor equipment in the second quarter of 1998
amounted to $26.9 million, down 44% from the $48 million
recorded for the same period last year. Sales for the first
half of 1998 totaled $65.6 million compared to $92.2 million
for the same period last year. Orders were $26 million during
the second quarter of 1998, which were down 41% compared to
the $44 million of last year's second quarter and up 18% from
the $22 million reported in the first quarter of 1998. Second
quarter 1998 orders include nearly $8 million of orders from a
Korean customer which were dropped from the backlog in
December of 1997. The company was able to reach agreement on
the payment terms for this equipment, reinstated the order,
and shipped the systems. This business segment is entering the
third quarter of 1998 with a backlog totaling approximately
$16 million compared to $78 million at June 27, 1997, and $17
million at March 27, 1998.
Shipments were well below the first of the year expectations.
The company now expects orders for semiconductor equipment to
run significantly below plan for all of 1998. Much of the
third quarter planned shipments are expected to come from the
spares, service and training business. The company will
continue to take action to reduce operating costs, with the
goal of keeping the operating loss for the year at or better
than the loss budgeted as of the beginning of 1998. The
company is trimming unnecessary costs everywhere it can while
maintaining its development for the future.
With the exception of the promising very-low-k (VLK) program,
research and development has now been slowed for 1998 except
for those projects which should improve 1998 and 1999 orders.
WJ has continued to invest heavily in R&D, and recently
introduced two new products at the SEMICON West trade show in
San Francisco: the WJ-1500 and the WJ-3000 cluster platform.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The WJ-1500 extends the company's conveyorized CVD equipment
for customers using 0.15-micron design rules. The system is an
upgrade to the conveyor transport system with improved film
capability for the smaller design rules (0.18 micron) now
being employed, improved film uniformity, and higher
reliability. Several customers are discussing the purchase of
this new atmospheric pressure (AP) tool.
The second product family, the WJ-3000 cluster platform, is a
"bridge" product designed to facilitate chip makers'
transition from 200-mm to 300-mm wafer processing. The WJ-3000
is a single wafer, multiprocessing system with both 300mm and
200mm capability. In addition to the new high density process
module, the company has developed a single wafer module for
atmospheric pressure processing, called the WJ-3000A (or AP
Next). The company has been demonstrating its capability to
customers during 1998 with excellent results. A number of
customers are discussing beta site opportunities and the
company expects to have a beta placement in the first half of
1999.
Although the very long-range industry forecasts for the
semiconductor industry remain bright, the industry remains in
an overcapacity situation. Capital equipment decisions are
affected by a number of parameters and the company is watching
its customer's market dynamics closely. The industry is
confident of an upturn, but it appears to be beyond 1998.
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. In 1996 its history of
cyclical variations returned with a market downturn. That
downturn was exacerbated in the fourth quarter of 1997 by
financial-system collapses and currency devaluations in Asia,
the company's principal overseas market region for capital
equipment. 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 in the future. While the company cannot predict
what effect these various factors will have on operating
results, the effect of these and other factors could
significantly affect the company's future operating results
and stock market value.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Wireless Communications
Wireless communications sales in the second quarter of 1998
totaled $26.8 million, a 9% increase over the prior year's
second quarter comparable $24.7 million for this segment (as
restated for the adoption of Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information"). Sales for the first half
of 1998 totaled $56.8 million compared to $47.7 million for
the same period last year. Orders for the second quarter of
1998 totaled approximately $14 million, compared to $18
million for the same period last year, and $35 million
reported for the first quarter of 1998. As discussed last
quarter, the strong orders of the first quarter were unusually
high mostly because of some inventory filling at an
intermediate vendor inserted by a major customer, Lucent, in
the CDMA chain. The business segment is entering the third
quarter of 1998 with a backlog totaling approximately $53
million compared to $59 million at June 27, 1997.
At the close of 1997 the company purchased the assets of
Samsung Microwave Semiconductor. The company received its
first order based upon the combination of Watkins-Johnson and
Samsung technology. This order is for a handset amplifier
transistor with high efficiency for a handset design produced
for one of the low earth orbit satellites. Orders this year
are for prototypes and the initial production. If the system
succeeds, production is expected to last 5 years.
During the second quarter, Watkins-Johnson changed its
marketing approach for the Base2 base-station product. The
company reviewed the potential for this product and made the
decision to change its current approach of marketing the
system directly to carriers and the small integrators as a
stand-alone product. The new approach will market both the
system and wideband modules and subassemblies using Base2
technology to the same commercial OEM-manufacturer base
already served by the company. The product technology embodies
the proven receiver and digital signal-processing technologies
for which WJ is a recognized leader. To better work with this
customer base, the sales and marketing functions for all
commercial wireless-infrastructure products have been
consolidated into a single commercial wireless organization.
13
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
While the company's 1998 government-communications market is
slower than expected, the company's performance in recent
years demonstrates its ability to increase its market by
directing its unique technological strengths at appropriate
volume programs. Part of the difficulty being experienced in
the government communications side of the Wireless
Communications sector stems from the delay of a major order.
The company had expected the award of a major government
program early in the year, which is budgeted and has the funds
established, but has been delayed considerably as the using
agency works through implementation plans. The order has now
been delayed sufficiently, that it will likely have minimum
sales in 1998. The current picture for this business is
expected to improve by early 1999.
In July 1998 Lucent experienced a local strike at their
Columbus Ohio plant, stopping production for some of the
systems where Watkins-Johnson's parts are used. The Lucent
strike affected the Palo Alto plant staffing. However, to
allow for quick response to demand, much of the production
activity for products produced is outsourced. In addition, the
test labor is employed on a contract basis. This practice
allows the direct product cost to respond quickly to news such
as the strike as well as demand increases.
Looking forward, the combination of these events has led the
company to reduce 1998 shipment expectations for the Wireless
Communications segment. It is now expected that the revenues
for 1998 will only slightly exceed the $105 million of last
year. Actions to reduce cost have been taken. The staff has
been reduced in line with the business now expected. Also, the
Gaithersburg plant has added three weeks of furlough scheduled
around the holiday periods July 4, Labor Day and Christmas,
while the Palo Alto plant has required seven days of furlough
for the manufacturing staff in the second half of 1998.
Corporate staff are also required to take 16 days time off
over the second half of the year. Including the approximately
$4 million expenses for the transfer of the GaAs operations
from Palo Alto to Milpitas, it is now anticipated that the
segment's operating losses will be more than double the $1
million pretax operating loss of last year.
Various regulatory agencies of federal, foreign, state and
local governments can affect the wireless communication market
dynamics, causing unforeseen ebb and flow of orders and
delivery requirements. Domestic and international competition
from a number of companies, some of which are much larger than
Watkins-Johnson, is intense. The effect of these and other
factors could significantly affect the company's future
operating results.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Second Quarter of 1998 Compared to Second Quarter of 1997
Wireless Communications sales increased 9% while Semiconductor
Equipment Group sales dropped 44%, resulting in an overall
company decrease from continuing operations of 26 %. Gross
margins decreased from 36% to 31%. The decrease in gross
margins is due mostly to the lower sales volume. Also,
approximately $1 million of the $1.6 million severance costs
of the second quarter are included in the cost of goods sold.
Selling and administrative expenses increased to 26% of sales
compared with 20% for the same period last year, due mostly to
the lower sales volume. Actual selling and administrative
expenses decreased 6% from $14.7 million to $13.8 million due
mostly to the work force reduction and cost cutting efforts.
Included in second quarter 1998 selling and administrative
expenses are $0.6 million of severance costs.
Research and development expenses were $13.3 million during
the second quarter of 1998, or 25% of sales, compared to $10.4
million, or 14% of sales, for the same period last year.
Although research and development is high as a percentage of
sales due to the lower sales volume, spending was 10% below
the second quarter budget due to the company's focus of second
quarter research and development efforts on certain key
projects. As previously discussed, the company began to
curtail research and development efforts on certain projects
which are not expected to have orders impact in 1999.
The operating loss in the second quarter of 1998, before other
income, was $6.2 million compared with the $0.9 million of
income for the same period last year. Other income (net of
other expenses) increased $1.3 million over the prior year due
mostly to interest income earned on the increased cash balance
and short-term investments. Also included in other income for
the second quarter of 1998 is $0.4 million of net income from
two leases, the sub-lease of part of our Palo Alto facility to
Stellex and a lease of a portion of our Japanese facility.
For the second quarter of 1998, the effective tax benefit rate
for federal, state and foreign income taxes was about 30%
compared to a 28% tax expense rate on continuing operations
for the same period last year. The 30% tax benefit rate in
1998 is a result of the loss reported during the second
quarter and is below the statutory rate mostly because of
taxes accrued for some profitable foreign operations
offsetting benefits from federal and state research tax
credits.
Net income from continuing operations decreased from $0.9
million net income in the second quarter of 1997 to a $6.2
million loss for the same period this year. Including after
tax income of $2.2 million reported from discontinued
operations in the second quarter of 1997, net income decreased
from $3.1 million in the second quarter of 1997 to a $6.2
million loss reported for the current period.
15
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Second Quarter Year-to-Date 1998 Compared to Second Quarter
Year-to-Date 1997
Wireless Communications sales increased 19% while
Semiconductor Equipment Group sales decreased 29%, resulting
in an overall company decrease from continuing operations of
12%. Gross margins remained flat at 35% and include
approximately $1.2 million of the $2.2 million of year-to-date
severance costs.
Selling and administrative expenses increased $1.8 million to
24% of sales compared with 20% for the same period last year.
The higher percentage for the first half of 1998 resulted
primarily from severance charges of $1 million and an
additional reserve of $1.6 million taken on receivables during
the first quarter of 1998.
Research and development expenses were $26.5 million during
the first half of 1998, or 22% of sales, compared to $20.9
million, or 15% of sales, for the same period last year.
Although research and development is high as a percentage of
sales due to the lower sales volume, spending was below budget
due to the focus of research and development efforts on
certain key projects, as previously discussed.
The operating loss in the first half of 1998, before other
income and a gain on the sale of real property, was $13.3
million compared with income of $0.3 million for the same
period last year. Interest and other income (net of other
expenses) increased $3 million over the prior year due mostly
to interest income earned on the increased cash balance and
short-term investments. Also included in other income for the
first half of 1998 is $0.9 million of net income from two
leases, as discussed above. In January 1998, the company
concluded the sale of vacant land adjacent to its San Jose,
California facility, resulting in a $14.8 million pre-tax gain
reflected as "Gain on real property" in the consolidated
financial statements.
For the first half of 1998, the effective tax rate for
federal, state and foreign income taxes was about 30% compared
to 22% on continuing operations for the same period last year.
The 30% tax rate in 1998 is below the statutory rate mostly
because of federal and state research tax credits and export
sales benefits. The low 22% tax rate for 1997 resulted mostly
from the effect of the low level of income with positive
benefits from export sales and research credits, which were
offset by taxes incurred by foreign operations.
Including the $14.8 million 1998 gain on the sale of land, net
income from continuing operations increased from $0.6 million
in the first half of 1997 to $3.5 million for the same period
this year. Including after tax income of $5 million reported
from discontinued operations in the first half of 1997, net
income decreased from $5.6 million in the first half of 1997
to $3.5 million reported for the first half of 1998.
16
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Year 2000 Computer Software Conversion
The company regularly updates its information systems
capabilities, and has evaluated all significant computer
software applications for compatibility with the year 2000.
With the system changes implemented to date and other planned
changes, the company anticipates that its computer software
applications will be compatible with the year 2000.
Expenditures specifically related to software modifications
for year 2000 compatibility are not expected to have a
material effect on the company's operations or financial
position. However, the company is dependent on numerous
vendors and customers which may incur disruptions as a result
of year 2000 software issues. Accordingly, no assurance can be
given that the company's results of operations will not be
impacted by this industry-wide issue.
Risks and Uncertainties That May Affect Future Results
All statements in this report, other than statements of
historical facts, should be considered forward-looking
statements. By way of example only, those include statements
about the company's strategies, objectives, plans,
expectations and anticipated results, and expectations for the
economy generally or specific industries. The words "expect",
"anticipate", "looking forward" and other similar expressions
used in this report are intended to identify forward-looking
statements that involve risks and uncertainties that may cause
actual results and expectations to differ materially from
those expressed. Such risks and uncertainties include, but are
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 detailed in the company's 1997 Form 10-K filed
with the Securities and Exchange Commission. Investors and
prospective investors are cautioned not to place undue
reliance on these forward-looking statements. The company
undertakes no obligation to announce any revisions to its
forward-looking statements to reflect events or circumstances
as they actually develop or occur in the future.
17
<PAGE>
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. 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 number according to Item 601 of
Regulation S-K.
b. No reports on Form 8-K were required to be filed
during the quarter.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WATKINS-JOHNSON COMPANY
(Registrant)
Date: July 31, 1998 By: /s/ W. Keith Kennedy, Jr.
----------------- -----------------------------------
W. Keith Kennedy, Jr.
President and Chief Executive Officer
Date: July 31, 1998 By: /s/ Scott G. Buchanan
----------------- ---------------------------------
Scott G. Buchanan
Vice President and Chief Financial Officer
19
<PAGE>
EXHIBIT INDEX
The Exhibits below are numbered according to Item 601 of Regulation S-K.
Exhibit
Number Exhibit
------ -------
27 Financial Data Schedule
20
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> MAR-28-1998
<PERIOD-END> JUN-26-1998
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<SECURITIES> 79,141
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<INCOME-PRETAX> (8,867)
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