UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 1997
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 of (I.R.S. Employer Identification No.)
incorporation or organization)
3333 Hillview Avenue,
Palo Alto, California 94304-1223
---------------------------------- ----------------------------------
(Address of principal executive offices) (Zip Code)
(650) 493-4141
----------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on 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 9, 1998
Aggregate market value of the voting stock held ----------------------
by non-affiliates of the registrant: $160,863,000
Number of shares outstanding: Common stock, no par value 8,261,000 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Watkins-Johnson Company Notice of Annual Meeting of
Shareowners--April 18, 1998 and Proxy Statement filed with the commission
pursuant to Regulation 14A are incorporated by reference into Part III.
<PAGE>
Part I
Item 1. Business
(a) General Development of Business
Prior to 1997 the company operated in three industry segments:
Semiconductor Equipment, Government Electronics and Wireless
Communications. During 1997 the company's structure was realigned from
operating in three industry segments to a focus on its two high-growth
businesses: Semiconductor Equipment and Wireless Communications. In
October 1997, the company divested its Government Electronics
operations and reported such divestiture as discontinued operations,
restating all prior years' continuing operations results. This
realignment is more fully discussed in Note 8 to the consolidated
financial statements contained in Part II, Item 8 of this annual report
on Form 10-K.
Historically the company operated in a number of industry segments.
Beginning in 1993, operations were reported as three segments:
Semiconductor Equipment, Electronics and Environmental Services. At the
end of 1994, the Environmental Services unit was divested. In 1995,
Watkins-Johnson divided its former Electronics Group, recognizing the
two major markets that it served, into the Wireless Communications
segment and the Government Electronics segment for reporting purposes.
No other material reclassifications, mergers or consolidations of the
company or its subsidiaries occurred during 1997. Other than in the
ordinary course of business and the divestiture of the Government
Electronics segment, there were no acquisitions or dispositions of
material amounts of assets during the year.
(b) Financial Information about Industry Segments
The company now operates in two industry segments -- Semiconductor
Equipment and Wireless Communications. As discussed above, the
Government Electronics segment was divested in 1997. Financial
information covering these industry segments and the divestiture 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 and wireless communications
products.
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:
atmospheric-pressure CVD (APCVD) and high density plasma (HDP) CVD.
This equipment functions by injecting the gases needed for the reaction
over the substrate material.
Page 2
<PAGE>
Item 1. Business (continued)
The earlier process, atmospheric-pressure CVD (APCVD), accounted for
all of the equipment sold in 1997. Under this process, 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 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.
The newer process, high density plasma (HDP) CVD, 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 will assist the semiconductor
industry in the production of future integrated circuits with smaller
feature size transistors and conductors. These smaller (0.25 micron and
below) features are being accelerated on the new Semiconductor Industry
Association's road map for 64 megabit dynamic random access memory (64
Meg DRAM) and smaller chip size sixth generation microprocessors. The
company accomplished a major goal in 1997 when it shipped and installed
WJ-2000 HDP cluster platforms at two Asian locations. The company is
making good progress with the high-density plasma (HDP) equipment with
several customers in Asia and received acceptance of an additional
beta-site placement for 1998. The ability of the 200-mm HDP system to
perform superior intermetal-dielectric (IMD) deposition and
shallow-trench isolation (STI) processes is of keen interest to the
customers evaluating the system.
Single-wafer processing at 300 mm will be required for new fabrication
facilities and Watkins-Johnson is completing development of a variant
of its scalable cluster platform to perform premetal dielectric (PMD),
IMD, and STI deposition on these large wafers. The equipment--called
the WJ-3000 system--is expected to begin running customer samples
during 1998. Market researchers expect that a number of fabrication
facilities will be operating developmental and pilot 300-mm lines by
the year 2000.
Not only is WJ concentrating on employing its equipment to perform new
CVD processes, the company is also diligently working to perfect its
handling of new materials. As integrated-circuit designers employ
smaller geometries and multiple layers to address future performance
requirements, materials with improved dielectric performance--called
low-k--are being employed in new devices. Also, better conducting
metals--like copper--are being introduced to the production process.
Customer sample runs of low-k dielectric films are scheduled for 1998.
Future equipment must be compatible with these processes, and WJ is
collaborating with other companies to ensure that compatibility.
Page 3
<PAGE>
Item 1. Business (continued)
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 (IMD) deposition 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. Thus,
success in the IMD market would nearly double the company's served
available market. Additionally, the IMD equipment market is forecast to
grow more rapidly than the PMD equipment market.
The smaller and smaller feature sizes used in the construction of
integrated circuits are 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
process is competitive for this newer step. The company is finding high
interest in WJ equipment for STI applications. Both the atmospheric
pressure (AP) systems and the cluster-tool HDP are candidates.
Sales in the Semiconductor Equipment segment were 64% of consolidated
sales in 1997 and 78% in 1996 and 1995. Over the last three years the
company has changed its mode of selling and servicing 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. Near the end of 1996, the Semiconductor Equipment Group
completed construction of a new headquarters and technology center in
Japan.
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 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.
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 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
operational reliability with a competitive cost of ownership. The
company's growing global customer-support network is a possible
competitive advantage.
Page 4
<PAGE>
Item 1. Business (continued)
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 had been growing dramatically over the years from
1992 through 1995, however in 1996 its history of cyclical variations
returned with a market downturn which has persisted through 1997. 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.
Wireless Communications
This business segment serves original equipment manufacturers (OEM) in
the rapidly growing market for wireless communications equipment. The
company's long-time leadership as a microwave-electronics manufacturer
and its historic strength in space communications components provide a
competitive advantage in offering unique solutions to requirements for
wireless network communications.
The company has entered two wireless communications business areas
paralleling the skills it had developed as a former defense-electronics
supplier. In the Palo Alto, California facility, the company is
producing components and subassemblies for cellular and personal
communication services (PCS). At the Gaithersburg, Maryland facility,
the company has successfully adapted its communications-intelligence
equipment technology to the design and production of low-cost,
sensitive receivers 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 has mined 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.
The group's major technical accomplishment of the year was the
completion of the analog version of the Base2(TM) wideband cellular
base station design and its successful installation by Telos
Engineering, Ltd. in Dalian, China. This installation gives WJ an
excellent inroad to future base-station business in China and other
foreign markets. Although the initial Base2(TM) installation was an
analog system, in early 1998 WJ will introduce its new Base2(TM)
MacroCell, the first commercially available dual-mode AMPS/IS-136A
software-definable base station for both mobile and fixed-wireless
applications. The Base2(TM) MacroCell Base Station System provides a
seamless migration path from AMPS to TDMA by handling both protocols in
a single base station and by configuring system resources based on user
demand.
Page 5
<PAGE>
Item 1. Business (continued)
The company also is capitalizing on the healthy market for RF
components by expanding its gallium-arsenide (GaAs) integrated-circuit
fabrication capability and actively marketing WJ-manufactured devices
to the wireless industry. Historically, WJ has manufactured GaAs
devices for its own use only. These devices offer excellent
performance, and an updated and expanded fabrication facility can
enable WJ to sell them on the open market at competitive prices. As a
way to accelerate the expansion of its integrated-circuit capability,
the company at year-end purchased the assets of Samsung Microwave
Semiconductor, Inc., whose ultimate parent is Samsung Electronics
Company of Seoul, Korea. The company has now begun the gradual transfer
of its Palo Alto, California, GaAs and thin-film operations to the
newly acquired Milpitas, California facility.
Sales by the Wireless Communications segment were 36% of consolidated
sales in 1997 and 22% in 1996 and 1995. The business is international
in scope. 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.
Communications-intelligence receivers and tuners are sold to security
agencies of the U.S. and other governments. Although the customer
community represents a large business opportunity, the number of
individual customers is not large.
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 company
seeks to win competitions by excellent service and superior technical
performance. The group's customer, Lucent Technologies, recognized the
excellence of the company's products and services by naming
Watkins-Johnson Company its "Supplier of the Year for 1997." WJ seeks
to protect its intellectual property by an aggressive patent and trade
secret program as indicated below.
Other Business Items
Raw materials for the production of semiconductor equipment and
wireless communications products are acquired from a broad range of
suppliers. Because suppliers 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 significantly
seasonal.
With respect to trade receivables from semiconductor equipment systems
sales, generally 10% to 20% of the balance is collectible upon
acceptance of the equipment by the customer. Except for the use of
letters of credit on international sales and negotiated advance or
progress payments from customers on long-term contracts there are no
other 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.
Page 6
<PAGE>
Item 1. Business (continued)
Total company backlog at December 31, 1997 was $98,000,000 compared to
$152,000,000 at December 31, 1996. The percentage of backlog
attributable to the Semiconductor Equipment and Wireless Communications
were 39% and 61%, respectively, in 1997, compared to 60% and 40% in
1996. Approximately 93% of all backlog at year-end 1997 is shippable
within 12 months, compared to 99% at year-end 1996
Company-sponsored research and development expense was $50,182,000 in
1997, $53,175,000 in 1996, and $42,656,000 in 1995. Customer-sponsored
research and development for the continuing operations was not material
in 1997, 1996 and 1995. Customer-sponsored research and development in
prior years was performed mostly by the divested Government Electronics
segment.
The company's employment at December 31, 1997 was 1,520. 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
42% of the company's sales in 1997 and 59% in 1996 and 1995. Assets of
foreign operations accounted for 14% and 15% of consolidated totals at
December 31, 1997 and 1996, respectively, 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, currency fluctuations, and export license
cancellation. A portion of foreign product orders in the Wireless
Communications segment requires export licensing by the Department of
State prior to shipment. For international shipments for both company
business segments, the company purchases forward exchange contracts
and/or generally 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. The sale and exchange of a portion of the
company's Palo Alto lease interest was successfully completed in
December 1997. About 7 acres at the Palo Alto campus were turned back
for consideration. In addition, on December 31, 1997 the company
purchased the assets of Samsung Microwave Semiconductor and took over
its leased facility in Milpitas, California. Near the end of 1996, the
Semiconductor Equipment Group completed construction of a new
technology center in Japan.
At December 31, 1997, there were approximately 698,000 square feet of
plant space in California, 175,000 square feet in Maryland, and a
36,000 square foot facility in Kawasaki, Japan. Of the 698,000 square
feet of plant space in California, approximately 120,000 square feet is
subleased to Stellex Microwave Systems, Inc. for a period of up to
three years as part of the divestiture agreement. The space is leased
to Stellex at a price which recovers utilities, maintenance and other
services, and may be canceled by Stellex giving 6 months notice.
Excluding the plant space occupied by Stellex, approximately 85% of the
company's available 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. As part of this effort, approximately 15 acres of undeveloped
land adjacent to the San Jose facility was sold at the beginning of
1998.
Page 7
<PAGE>
Item 2. Properties (continued)
The Wireless Communications segment utilizes substantially all of the
Milpitas, Gaithersburg and remaining Palo Alto facilities. The Scotts
Valley, San Jose and Kawasaki facilities house the Semiconductor
Equipment Group.
The Palo Alto and Milpitas facilities, 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>
<CAPTION>
Executive Officers of the Registrant
Officer Business Experience
Name Age Office Held Since Last Five Years
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dr. Dean A. Watkins 75 Chairman of the Board 1957 Chairman of the Board
Dr. H. Richard Johnson 71 Vice Chairman of the Board 1957 Vice Chairman of the Board
Dr. W. Keith Kennedy, Jr. 54 President and Chief Executive 1977 President and Chief Executive
Officer Officer
Scott G. Buchanan 46 Vice President and Chief 1989 Vice President and Chief Financial
Financial Officer Officer
Dr. Patrick J. Brady 52 Vice President 1996 President, Semiconductor Equipment
Group; Prior to 1996, Vice
President of Engineering,
Semiconductor Equipment Group
Malcolm J. Caraballo 42 Vice President 1996 President, Microwave Products
Group; Prior to 1996, Vice
President, Microwave Products
Division
Robert G. Hiller 60 Vice President 1997 President, Telecommunications
Group, Prior to 1997, Vice
President, Telecommunications
Group, Prior to 1996, Director,
Engineering, Electronics
Equipment Division
Darryl T. Quan 43 Controller 1991 Controller
Claudia D. Kelly 57 Secretary 1996 Secretary; Prior to 1996, Manager,
Palo Alto Customer and Export
Services
</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.
Page 8
<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, 1997 there were approximately
6,500 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>
1997 Quarters 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dividends declared per share (in cents) 12 12 12 12
Stock price High 26 7/8 32 3/8 37 1/4 35 3/4
(NYSE-in dollars) Low 22 1/8 22 1/4 30 3/4 24 3/16
1997 Quarters 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------------------------
Dividends declared per share (in cents) 12 12 12 12
Stock price High 44 5/8 36 1/4 28 3/4 28 1/4
(NYSE-in dollars) Low 34 1/4 27 1/8 17 17 3/4
</TABLE>
<TABLE>
Item 6. Selected Financial Data
<CAPTION>
(Dollars in thousands,
except per share amounts) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Sales $ 291,271 $ 349,119 $ 284,335 $ 209,330 $ 150,303
Net Income (Loss) from
Continuing Operations (3,962) (1,321) 21,854 19,652 12,382
Basic Net Income (Loss) Per Share
From Continuing Operations (.48) (.16) 2.75 2.65 1.64
Diluted Net Income (Loss) Per Share
From Continuing Operations (.48) (.16) 2.49 2.41 1.56
Dividends Per Share .48 .48 .48 .48 .48
Basic Average Common Shares 8,258,000 8,265,000 7,938,000 7,425,000 7,558,000
Diluted Average Common Shares 8,258,000 8,265,000 8,776,000 8,153,000 7,925,000
FINANCIAL POSITION
Working Capital $ 153,607 $ 122,982 $ 124,796 $ 102,361 $ 95,206
Total Assets 358,212 293,744 269,565 220,223 206,728
Long-Term Obligations 33,234 37,801 20,469 21,332 24,997
Shareowners' Equity 220,392 194,711 191,253 149,626 133,888
</TABLE>
Page 9
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition and Liquidity
During 1997, cash and equivalents increased by $118.8 million, from
$15.7 million to $134.5 million. Net income for 1997 was $32.9 million,
while net cash provided by operations was $57.1 million. Net income was
$3.0 million and net cash provided by operations was $13.8 million in
1996, and net income was $31.4 million and net cash provided by
operations was $12.8 million in 1995. For 1997, net cash provided by
operating activities differed from net income for the period primarily
because of increases for: depreciation and amortization charges of
$13.1 million, $26.9 million of accounts receivables collections and
$39.6 million in non-cash increases in accruals and payables; and
decreases for: a $10.5 million net change in deferred taxes, $36.9
million for the gain and net income of discontinued operations
(discussed below) and $11.2 million for net cash used by discontinued
operations. For 1996, net cash provided by operating activities
differed from net income for the period primarily because of increases
for: depreciation and amortization charges of $9.0 million, net changes
in inventory of $16.9 million and provisions for warranties and losses
on contracts of $6.7 million; and decreases for: a $3.3 million net
change in deferred taxes, $4.4 million and $2.2 million for the net
income and cash used by discontinued operations, respectively, and $4.5
million and $4.3 million for net changes in receivables and accruals
and payables, respectively. For 1995, net cash provided by operating
activities differed from net income for the period primarily because of
increases for: depreciation and amortization charges of $7.3 million,
net changes in accruals and payables of $9.1 million and $25.7 million
in net cash provided by discontinued operations; and decreases for: the
net income of discontinued operations of $9.6 million, and $12.8
million and $35.6 million for net changes in receivables and inventory,
respectively.
Net cash provided by investing activities was $67.9 million in 1997
compared to net cash used by investing activities of $53.1 million and
$23.4 million in 1996 and 1995, respectively. In 1997, the company
received proceeds of $77.9 million and $8.5 million from the sale of
discontinued operations and asset retirements, respectively, offset in
part by investments of $22.2 million in new capital equipment. Cash
used for investing activities in 1996 and 1995 was primarily for
capital expenditures.
The company used $7.0 million in financing activities in 1997 compared
to cash provided by financing activities of $20.4 million and $10.7
million in 1996 and 1995, respectively. The company reactivated its
stock repurchase program during the first quarter of 1997 and during
the year repurchased 204,200 shares of its common stock for $5.7
million which was partially offset by $2.8 million in proceeds from
stock option exercises. The goal is to repurchase approximately the
same number of shares added by the exercise of options. During 1997,
the company paid approximately $4 million in dividends. The primary
source of cash provided by financing activities in 1996 was long-term
borrowings of about $20 million for the purchase and construction of a
new facility in Japan for the company's Semiconductor Equipment Group,
while the primary source of cash provided by financing activities in
1995 was proceeds from stock option exercises.
At December 31, 1997, the company's principal source of liquidity
consisted of $134.5 million in cash and cash equivalents. The company
has arrangements with several banks to provide a $50,000,000 unsecured
credit facility. This facility expires on December 8, 1998. During
1997, the company incurred no borrowings under this credit facility.
Because of the operating loss reported in the fourth quarter of 1997
the company is not in compliance with certain terms under this credit
facility. The company is coordinating with its banks to re-establish a
compliant condition. Management does not anticipate any significant
near term borrowing requirements and does not expect the current
noncompliance condition to materially affect the company's liquidity or
financial position for 1998. From time to time the company may enter
Page 10
<PAGE>
into certain long-term borrowing arrangements with financial lending
institutions for capital acquisitions of property, plant and equipment.
At December 31, 1997, long-term borrowings consisted 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 $6.6 million is amortizable in monthly installments
through the year 2011, bears interest at 2.5%, and approximately $12
million requires a balloon payment due in the year 2006 and bears
interest at 3.1%, payable semiannually. At December 31, 1997 there were
no material commitments for capital expenditures.
Current Operations and Business Outlook
On October 31, 1997, the company completed the sale of its Palo Alto,
Calif.-based Tactical Subsystems and Microwave Devices sectors to an
affiliate of Mentmore Holdings Corporation for consideration of $103
million, consisting mostly of cash. The sale resulted in a pre-tax gain
of approximately $49.9 million. The divested businesses now operate as
Stellex Microwave Systems, Inc. (Stellex). In connection with the sale,
the company transferred approximately $77 million of Government
Electronics and Wireless Communications backlog to Stellex. Stellex
remains a WJ customer for GaAs devices and thin-film substrates. The
divestiture enables Watkins-Johnson to concentrate its resources on two
chosen areas of technology: semiconductor-manufacturing equipment and
wireless-infrastructure products.
In the fourth quarter of 1997 the company elected the early adoption of
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information," (SFAS 131), and
restated its reportable business segments accordingly. Prior to the
adoption of SFAS 131, the company reported operations in three industry
segments: Semiconductor Equipment, Wireless Communications, and
Government Electronics. The former Government Electronics segment was
redefined according to SFAS 131 to consist of the business sectors sold
to Stellex as described above. The divested business is reported as
discontinued operations in the financial statements. For further
information regarding discontinued operations and business segments,
see Note 8 to the consolidated financial statements contained in Part
II, Item 8 of this annual report on Form 10-K.
For 1997, the company reported sales and a net loss from continuing
operations of $291.3 million and $4.0 million, respectively. The
company ended the year with $98 million of backlog for the continuing
business compared to $152 million last year. The current backlog
excludes $19 million in semiconductor equipment backlog from Korea
which has been removed from the backlog until adequate financial terms
can be worked out. Comparative 1996 sales and net loss from continuing
operations were $349.1 million and $1.3 million, respectively.
The sale and exchange of a portion of the company's Palo Alto lease
interest was successfully completed in December 1997. About 7 acres at
the Palo Alto campus were turned back for consideration, resulting in a
$7.6 million pre-tax gain reflected as "Gain on real property" in the
statement of operations. As part of the deal the company was able to
extend the lease so that the remaining 16 acres are available for over
50 years without lease payments.
Looking forward, long-term growth for the continuing businesses appears
bright. The semiconductor equipment business is a cyclical business.
The company anticipates that overall revenues in calendar year 1998
will experience a slight decrease as the anticipated decline of the
semiconductor equipment business will more than offset the growth
expected in the wireless business. Even with heavy investment for
research and development, the Wireless Communications segment is
expected to make a profit. However, those Wireless profits are not
expected to overcome the losses anticipated in the Semiconductor
Equipment Group. In any event, the 1998 profitability of WJ will come
from the net interest on cash and the land sale in San Jose, which is
discussed below.
Page 11
<PAGE>
Semiconductor Equipment Group
Sales of semiconductor equipment in 1997 amounted to $186 million, down
32 percent from the $272 million recorded in 1996. The book-to-bill for
the fourth quarter was only 0.7-to-1 as a result of events relating to
Korea. Orders were $32 million during the fourth quarter of 1997, which
were flat with the third quarter's $32 million, but were down compared
to the $78 million of last year's fourth quarter. These order rates
mean that the group is below the long-term goal of a 5-month backlog.
At this level, the company is able to service the order requirements of
its customers rapidly, and they continue to take advantage of the
shorter lead time. This business segment is entering 1998 with a
backlog totaling approximately $38 million.
The worldwide oversupply of memory devices continued throughout 1997,
prompting DRAM manufacturers to expedite their transition to
smaller-geometry devices. The overall capital-equipment market remained
flat. Because the company's installed CVD equipment was adaptable to
the production of the newer-generation memory devices, the company did
not benefit from the retooling undertaken during the year. The general
market weakness was exacerbated at year-end as the magnitude of the
Asian economic crisis began to unfold, and IMF spending restrictions
increased the uncertainty surrounding any near-term business prospects
from Asian customers. As a result, the company took certain actions in
the fourth quarter of 1997 to minimize its financial exposure. The
company deferred shipment and revenue recognition with certain Asian
customers, and the business is being sized to reflect these market
changes. This resulted in certain non-performing assets being written
off which consist primarily of inventory, capital assets and a small
lease commitment in Scotts Valley, California. The effect of these
actions resulted in a pre-tax impact of approximately $17 million
during the fourth quarter of 1997. The group is reviewing its worldwide
infrastructure to reduce cost while still maintaining quality service
to its customers. The group is taking steps to insure that research and
development spending will result in higher potential for certain
projects, while other projects are to be either reduced or delayed. In
spite of these actions, fixed costs and what are considered to be
necessary development expenses will probably make the group
unprofitable in 1998 due to the lower anticipated revenues.
The company continues to believe the long-range industry forecasts for
the semiconductor industry remain bright. Current semiconductor
integrated circuit demand appears to be increasing in dollar terms over
last year. However, the industry is still in an overcapacity situation
and is purchasing less capital equipment. Unfortunately, the near-term
orders picture is lower than 1997's average run rate of about $47
million per quarter.
Wireless Communications
Wireless-communications sales in 1997 totaled $105 million, a
36-percent increase over the prior year's comparable $77 million for
this segment (as restated for the adoption of SFAS 131). Orders for the
fourth quarter 1997 totaled approximately $36 million, compared to $31
million for the same period last year, and $22 million for the third
quarter of 1997. The business segment is entering 1998 with a backlog
totaling approximately $60 million.
The segment achieved exceptional revenue growth during 1997 as its
radio-frequency assemblies for cellular and PCS systems gained
widespread acceptance. Orders were good for the CDMA and TDMA
assemblies, which are produced for Lucent Technologies. The company
believes that a good shipment rate will continue throughout 1998 for
these assemblies. The company is gaining business at other wireless
OEMs and is beginning to receive additional orders for volume GaAs
parts.
On December 31, the company purchased the assets of Samsung Microwave
Semiconductor, and its gallium-arsenide semiconductor business.
Although the company picked up a small
Page 12
<PAGE>
amount of business, the primary reason for this acquisition was the
in-process technology and equipment. Significant additional work will
be necessary to successfully bring these products to market. The
acquisition resulted in a $5.0 million pre-tax charge against
operations consisting principally of in-process R&D. The acquisition of
the Samsung facility and its GaAs capability enables the segment to
expand its existing capacity.
In 1997, the company completed its Base2TM cellular base station design
and the system was successfully installed in Dalian, China, by Telos
Engineering, Ltd. as part of its Sonata Wireless Telecommunications
System. There are several good opportunities for this equipment in
other Chinese cities and in South and Central America where the company
is supporting the work of its system integrator customers. Hopes for
major U.S. business for the Base2TM system did not come to fruition
when the customer was unable to get their major supplier to open their
switching specification to WJ. The company is re-emphasizing the
international marketing of the system. International customers seem
more willing to work with the open-systems switches. The company is
hopeful that these opportunities will materialize into orders in 1998.
1997 Compared to 1996
Wireless Communications sales increased 36% while Semiconductor
Equipment Group sales decreased 32%, resulting in an overall company
decrease of 17%. By the third quarter of 1996, the company began to
experience the drop in semiconductor equipment shipments. Gross margins
decreased from 34% to 32.5%. Gross margins in 1997 include the effects
of $15 million in fourth quarter Semiconductor Equipment Group
write-offs discussed above, compared to 1996 which included nearly $20
million in write-offs due mostly to slow-moving inventory and some
termination costs. Selling and administrative expenses decreased 12%,
due mostly to the decreased volume and cost-cutting efforts, but
increased slightly as a percentage of sales. Excluding a write-off of
$4.6 million for in-process research and development connected with the
Samsung GaAs acquisition, research and development expenses remained
relatively flat as a percentage of sales. Interest income increased
$1.4 million over the prior year due to the increase in cash and cash
equivalents. Other income decreased due primarily to about $1.4 million
in foreign currency translation losses in 1997 from the company's
Southeast Asian subsidiaries. The sale and exchange of a Palo Alto
lease interest was successfully completed in 1997, resulting in a $7.6
million pre-tax gain reflected as "Gain on real property" in the
consolidated financial statements. The effective tax rate for federal,
state and foreign income taxes on continuing operations resulted in a
tax benefit rate of about 43% compared to 37% in 1996. The 43% tax
benefit rate resulted mostly from the effect of the operating loss with
positive benefits from export sales and research credits, which were
offset by taxes incurred by foreign operations. Due to the above
factors, the net loss from continuing operations increased from $1.3
million for 1996 to about $4.0 million for 1997. Including the after
tax gain on the disposition and results of discontinued operations, net
income increased from $3.0 million for 1996 to $32.9 million for 1997.
1996 Compared to 1995
Semiconductor Equipment Group sales and Wireless Communications sales
both increased 23% over the prior year. Gross margins decreased from
46.2% to 34% due mostly to slow-moving inventory write-offs and
termination costs totaling nearly $20 million and an increased fixed
cost base associated with early 1996 expansion efforts in anticipation
of increased business by the Semiconductor Equipment Group. 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 remained flat at about 15% of sales due to
continuing efforts to develop next-generation products for both the
semiconductor equipment and wireless communications segments. Interest
expense increased
Page 13
<PAGE>
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,
state and foreign income taxes on continuing operations resulted in a
tax benefit rate of 37% in 1996 compared to a 28.5% tax expense rate in
1995. The 37% tax benefit rate resulted mostly from the effect of the
operating loss with positive benefits from export sales and research
credits, which were offset by taxes incurred by foreign operations. Due
to the above factors, results of continuing operations decreased from
income of $21.9 million for 1995 to a loss of $1.3 million for 1996.
Including the results of discontinued operations, net income decreased
from $31.4 million for 1995 to $3 million for 1996.
Subsequent Events
In January 1998, the company sold approximately 15 acres of undeveloped
land adjacent to its San Jose, California, facility for a net sales
price of about $16 million, resulting in a pre-tax gain of
approximately $15 million. The transaction will be reported in the
company's results for the first quarter ending March 27, 1998.
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 affect 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
Statements in this Annual Report, including this "Management's
Discussion and Analysis of Financial Condition and Results of
Operations" which are not historical facts are forward-looking
statements. The words "expect", "anticipate", "looking forward" and
other similar expressions are intended to identify forward-looking
statements that involve risks and uncertainties that may cause actual
results 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.
Item 7A. Quantitive and Qualitative Disclosures About Market Risks.
Disclosures under this item are not required for the current year.
Page 14
<PAGE>
Item 8. Financial Statements and Supplementary Data
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
Year Ended December 31
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales $ 291,271 $ 349,119 $ 284,335
- ------------------------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of goods sold 196,675 230,556 153,080
Selling and administrative 58,696 66,687 60,114
Research and development 50,182 53,175 42,656
- ------------------------------------------------------------------------------------------------------------------------------------
305,553 350,418 255,850
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (14,282) (1,299) 28,485
Other income (expense):
Interest income 2,198 789 2,400
Interest expense (1,425) (1,574) (873)
Other income (expense)--net (1,062) (12) 552
Gain on real property (Note 3) 7,609
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal, state and foreign income taxes (6,962) (2,096) 30,564
Federal, state and foreign income tax credits (expense) 3,000 775 (8,710)
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (3,962) (1,321) 21,854
Discontinued operations (Note 8):
Income from discontinued operations, net of taxes 7,210 4,355 9,574
Gain on disposition, net of taxes 29,677
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 32,925 $ 3,034 $ 31,428
====================================================================================================================================
Basic per share amounts:
Income (loss) from continuing operations $ (.48) $ (.16) $ 2.75
Income from discontinued operations .87 .53 1.21
Gain on disposition of discontinued operations 3.60
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 3.99 $ .37 $ 3.96
====================================================================================================================================
Basic average common shares 8,258,000 8,265,000 7,938,000
Diluted per share amounts:
Income (loss) from continuing operations $ (.48) $ (.16) $ 2.49
Income from discontinued operations .87 .53 1.09
Gain on disposition of discontinued operations 3.60
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 3.99 $ .37 $ 3.58
====================================================================================================================================
Diluted average common shares 8,258,000 8,265,000 8,776,000
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
Page 15
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts) 1997 1996
- --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 134,462 $ 15,702
Receivables (net of allowance for doubtful
accounts of $3,176 in 1997 and
$747 in 1996) 45,690 73,217
Inventories:
Finished goods 9,283 3,105
Work in process 18,519 24,000
Raw materials and parts 18,873 23,153
Deferred income taxes 24,830 14,395
Net assets of discontinued operations (Note 8) 25,717
Other 6,536 4,925
--------------------------------------------------------------------------
Total current assets 258,193 184,214
--------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT:
Land 12,102 13,075
Buildings and improvements 55,155 54,035
Plant facilities, leased 11,012 13,060
Machinery and equipment 100,526 106,648
--------------------------------------------------------------------------
178,795 186,818
Accumulated depreciation and amortization (82,382) (88,348)
--------------------------------------------------------------------------
Property, plant and equipment--net 96,413 98,470
--------------------------------------------------------------------------
OTHER ASSETS:
Net assets of discontinued operations (Note 8) 4,100
Other 3,606 6,960
--------------------------------------------------------------------------
Total other assets 3,606 11,060
- --------------------------------------------------------------------------------
$ 358,212 $ 293,744
================================================================================
LIABILITIES AND SHAREOWNERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 16,188 $ 16,560
Accrued expenses 23,209 10,362
Advances on contracts 1,867 1,432
Provision for warranties and losses on contracts 15,898 14,478
Payroll and profit sharing 15,825 10,094
Income taxes 31,599 8,306
--------------------------------------------------------------------------
Total current liabilities 104,586 61,232
--------------------------------------------------------------------------
LONG-TERM OBLIGATIONS 33,234 37,801
- --------------------------------------------------------------------------------
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: 1997,
8,261,036 shares; 1996, 8,329,248 shares 40,631 38,998
Retained earnings 179,761 155,713
--------------------------------------------------------------------------
Total shareowners' equity 220,392 194,711
- --------------------------------------------------------------------------------
$ 358,212 $ 293,744
================================================================================
See notes to consolidated financial statements.
Page 16
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
<CAPTION>
Total
Common Stock Share-
(Dollars in thousands, ----------------------- Retained owners'
except per share amounts) Shares Dollars Earnings Equity
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, January 1, 1995 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--$.48 per share (3,973) (3,973)
Stock option transactions 205,193 4,691 4,691
Cumulative translation adjustments (294) (294)
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 8,329,248 38,998 155,713 194,711
Net income for 1997 32,925 32,925
Dividends declared--$.48 per share (3,974) (3,974)
Stock option transactions 135,988 2,778 2,778
Repurchase of common stock (204,200) (1,145) (4,602) (5,747)
Cumulative translation adjustments (301) (301)
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 8,261,036 $ 40,631 $ 179,761 $ 220,392
===================================================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
Page 17
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Year Ended December 31
- -------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 32,925 $ 3,034 $ 31,428
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 13,112 8,996 7,341
Gain on disposal of property, plant and equipment (3,513)
Deferred income taxes (10,470) (3,280) (785)
Results of discontinued operations and
gain on disposal (36,887) (4,355) (9,574)
Net changes in:
Receivables 26,897 (4,506) (12,819)
Inventories 3,364 16,877 (35,636)
Other assets 1,584 (1,752) (1,733)
Accruals and payables 39,635 (4,257) 9,127
Advances on contracts 435 (1,114) (1,926)
Provision for warranties and losses on contracts 1,420 6,688 2,498
Environmental remediation (198) (327) (817)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by continuing operating activities 68,304 16,004 (12,896)
Net cash provided (used) by discontinued operations (11,180) (2,181) 25,670
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 57,124 13,823 12,774
- -------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions of property, plant and equipment (22,177) (48,303) (23,366)
Restricted plant construction funds 3,738 (3,738)
Proceeds from sale of discontinued operations 77,884
Proceeds on asset retirements and other 8,475 (1,070) (35)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 67,920 (53,111) (23,401)
- -------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Long-term borrowings 1,642 20,241
Payments on long-term borrowings (1,132) (135) (112)
Proceeds from issuance of common stock 2,778 4,691 14,028
Repurchase of common stock (5,747)
Dividends paid (3,974) (3,973) (3,829)
Other (531) (390) 627
- -------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (6,964) 20,434 10,714
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 680
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents 118,760 (18,854) 87
Cash and equivalents at beginning of year 15,702 34,556 34,469
===================================================================================================================
Cash and equivalents at end of year $134,462 $ 15,702 $34,556
===================================================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
Page 18
<PAGE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Year Ended December 31
- --------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Other cash flow information:
- --------------------------------------------------------------------------------
Income taxes paid-net of refunds $ 3,143 $ 5,700 $ 5,828
Interest paid 1,389 1,574 872
- --------------------------------------------------------------------------------
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)
- --------------------------------------------------------------------------------
See notes to consolidated financial statements.
Page 19
<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. In 1997, the company disposed of its Government Electronics
operating segment which has been reported as discontinued operations, as
described more fully in Note 8.
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 and cash equivalents totaled $134.5 million and $15.7 million in
1997 and 1996, respectively. The company's investment guidelines limit
investments with a single issuer, which is not the U.S. Government or any agency
thereof, to the greater of $5,000,000 or 10 percent of the investment portfolio.
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.
Provision for depreciation and amortization is primarily based on the
straight-line and sum-of-the-years'-digits methods. Leases which at inception
assure the lessor full recovery of the fair market value of the property over
the lease term are capitalized and amortized over the lease term in accordance
with Statement of Financial Accounting Standards No. 13 "Accounting for Leases."
The provisions of this Statement derive from the view that a lease that
transfers substantially all of the benefits and risks incidental to ownership
should be accounted for as the acquisition of an asset and the incurrence of an
obligation by the lessee.
Revenue Recognition--Revenues, from 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 retained earnings. For 1997 the company incurred a net translation
loss of approximately $1.4 million resulting primarily from its Southeast Asian
subsidiaries and is included in "Other income (expense)-net" in the Consolidated
Statements of Operations. Translation gains or losses are not material for any
prior years 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.
Page 20
<PAGE>
1. SIGNIFICANT ACCOUNTING POLICIES (continued)
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. Prior to 1997 state and local income taxes were
included in selling and administrative expenses. State taxes for 1996 and 1995
have been reclassified to conform to the 1997 presentation.
Per Share Information--Net income per share is computed using the basic and
diluted weighted average number of common shares outstanding during the year in
accordance with the recently issued Statement of Financial Accounting Standards
No. 128 (SFAS 128), "Earnings Per Share." Basic net income per share excludes
dilution and is computed using the weighted average number of common shares
outstanding for the period. Diluted net income per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
(dilutive stock options) were exercised or converted into common stock. Per
share amounts for prior periods have been restated in accordance with SFAS 128.
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.
Stock-Based Compensation--The company continues to account for stock-based
compensation granted to employees and directors under the intrinsic value method
as defined in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees."
Business Segment Reporting--The company has elected the early adoption of
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information." The Statement requires certain
expanded disclosures about operating segments and requires that an enterprise's
operating segments be determined in the manner in which management operates the
business. Specifically, financial information is to be reported on the basis
that is used internally by the chief operating decision maker in making
decisions related to resource allocation and segment performance.
Recently Issued Accounting Standard--In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 130 (SFAS
130), "Reporting Comprehensive Income." This Statement is effective for fiscal
years beginning after December 15, 1997. The company will be required to comply
with the provisions of this standard in 1998. The company has not assessed the
effect that this new standard will have on its consolidated financial statements
and or disclosures.
Reclassification--Certain amounts for 1996 and 1995 have been reclassified to
conform to the 1997 presentation.
2. FINANCIAL INSTRUMENTS
Financial instruments that potentially subject the company to concentrations of
credit risk consist principally of cash and equivalents, receivables, and
financial instruments used in hedging transactions. The company invests in a
variety of financial instruments such as commercial paper and municipal bond
funds, and, by policy, limits the amount of credit exposure with any one
financial institution or commercial issuer. Concentration of credit risk with
respect to trade receivables is limited due to the variety of customers and
market segments into which the company's products are sold, as well as their
dispersion across geographic areas. The company maintains an allowance for
doubtful accounts based upon the expected collectibility of receivables.
Page 21
<PAGE>
2. FINANCIAL INSTRUMENTS (continued)
The carrying value of cash and 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 these 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, 1997 and 1996, the company had forward exchange
contracts to sell Japanese Yen with a market value of approximately $12.4
million and $17.9 million, respectively, for a contract amount of $12.8 million
and $19.6 million, respectively. 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 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.
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) 1997 1996
- --------------------------------------------------------------------------------
Long-term borrowings $18,630 $20,241
Deferred compensation 1,977 2,360
Environmental remediation 7,437 7,635
Long-term leases 5,190 7,565
- --------------------------------------------------------------------------------
Total $33,234 $37,801
================================================================================
The current portion of long-term obligations is included in current liabilities.
The expected maturity amounts are as follows: 1998, $4,145,000; 1999,
$2,050,000; 2000, $2,040,000; 2001, $1,080,000; 2002, $1,200,000; thereafter,
$26,864,000.
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. Approximately $6.6 million is amortizable in monthly
installments through the year 2011, which bears interest at 2.5%. Approximately
$12 million requires a balloon payment due in the year 2006, which bears
interest at 3.1%, payable semiannually.
Deferred Compensation--The company has several nonqualified deferred
compensation and bonus plans covering selected members of management and key
technical employees. The purpose of these plans 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 its Scotts Valley and Palo Alto,
California, facilities. The portion expected to be paid within one year is
included in current liabilities.
Page 22
<PAGE>
3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT (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. Renewal options provide for lease extensions in which the leases expire
during the years 2029 to 2056. The company also has noncancellable operating
leases for plant facilities and equipment expiring through the year 2004. These
leases may be renewed for various periods after the initial term.
During 1997 the company exchanged a portion of its subleasehold interest at its
Palo Alto, California, facility for consideration consisting of cash and the
sublessor's leasehold rights in the remaining parcels under the lease. The
exchange resulted in a pretax gain of $7.6 million which is reported in the 1997
Consolidated Statements of Operations as "Gain on real property." The terms of
this lease now provide for no lease payments through the year 2029 with a
nominal bargain renewal option extending the terms through the year 2056. The
other Palo Alto lease provides for below market lease payments through the year
2014 with a renewal option extending the lease to the year 2029.
Payment obligations under existing capital and operating leases as of December
31, 1997 are as follows:
Capital Operating
(in thousands) Leases Leases
- ---------------------------------------------------------------------------
Lease payments:
1998 $ 635 $1,206
1999 635 808
2000 635 636
2001 635 547
2002 635 121
Remaining years 7,457 108
- ---------------------------------------------------------------------------
Total 10,632 $3,426
Imputed interest (5,294) ======
- ------------------------------------------------------------
Present value of lease payments
(including current portion of $148) $ 5,338
============================================================
Rent expense included in continuing operations for property and equipment
relating to operating leases is as follows:
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------------
Real property $2,446 $2,384 $1,195
Equipment 1,041 782 502
- ----------------------------------------------------------------------------
Total $3,487 $3,166 $1,697
============================================================================
Lines of Credit--The company 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 the prime rate or
London Interbank Offered Rates (LIBOR) plus 0.75%. During 1997, the company did
not borrow under this credit facility and renegotiated to reduce the credit
facility to $50,000,000. Because of the operating loss reported in the fourth
quarter of 1997 the company is not in compliance with certain terms under this
credit facility, and accordingly the banks are not required to fund requested
borrowings. The company is coordinating with its banks to re-establish a
compliant condition. Management does not anticipate any significant near term
borrowing requirements and does not expect the current noncompliance condition
to materially affect the company's liquidity or financial position.
The amount of outstanding letters of credit and other guarantees was not
material at December 31, 1997. In addition to the $50,000,000 unsecured credit
facility, the company's foreign subsidiaries maintain separate lines of credit
totaling approximately $500,000.
Page 23
<PAGE>
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,
1997, 1,704,200 shares have been repurchased, of which 204,200 were repurchased
in 1997. No shares were repurchased in 1996 and 1995. The program enables the
company to acquire its common stock from time to time when appropriate.
Common Share Purchase Rights--For each share of company common stock
outstanding, one Common Share Purchase Right (the Rights) is attached. The
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 a tender or exchange 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 Board of Directors
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 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.
Stock Option Plans--The Employee Stock Option Plans (the Plans) provide for
grants of nonqualifying and incentive stock options to certain key employees and
officers. The company may grant options to purchase up to 4,300,000 shares of
common stock. During 1997 the company increased the number of shares it may
grant from 3,900,000 shares to 4,300,000 shares through the adoption of a new
nonqualified stock option plan for nonofficer employees. The options are granted
at the market price on the date of grant and expire at the tenth anniversary
date. One-third of the options granted are exercisable on each of the second,
third and fourth anniversary dates following the grant. The Plans allow 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 Plans permit 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, 1997.
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 the date of grant and expire on 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 Plans. 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 $26.88 in 1997, 21,000 option shares were granted at $34.63 in 1996;
and 12,600 and 5,440 option shares were granted at $39.75 and $39.88,
respectively, in 1995.
Included in the Consolidated Statements of Shareowners' Equity are tax benefits
related to sales under stock option plans of $719,000, $1,161,000 and $4,735,000
for 1997, 1996 and 1995, respectively.
Page 24
<PAGE>
4. SHAREOWNERS' EQUITY (continued)
<TABLE>
Activity related to all stock option plans is as follows:
<CAPTION>
Weighted Average
1997 Shares Exercise Price
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Granted 242,000 $26.41
Exercised 135,988 $15.14
Terminated 191,309 $34.76
At December 31:
Outstanding 1,443,940 $27.33
Exercisable 693,966 $23.70
Reserved for future grants 1,147,282
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
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
</TABLE>
<TABLE>
The following table summarizes information concerning currently outstanding and
exercisable options at December 31, 1997:
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------- ----------------------------------
Weighted
Average Years Weighted Weighted
Range of Number of Remaining Average Number Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$10.00 to $21.63 362,410 5.86 $15.12 247,410 $12.12
$22.75 to $25.13 488,170 7.15 $23.66 218,155 $22.97
$25.50 to $36.75 456,157 7.35 $34.63 183,569 $34.01
$37.25 to $55.00 137,203 7.68 $48.35 44,832 $48.95
- --------------------------------------------------------------------------------------------------------------------
$10.00 to $55.00 1,443,940 6.94 $27.33 693,966 $23.70
====================================================================================================================
</TABLE>
Page 25
<PAGE>
4. SHAREOWNERS' EQUITY (continued)
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 1997, 1996 and 1995 would
have been $31,724,000, $1,256,000 and $29,849,000, respectively, or $3.84, $.15
and $3.76 per basic share, respectively, and $3.84, $.15 and $3.40 per diluted
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 1997, 1996 and 1995 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options. The weighted average fair value of options granted
during 1997, 1996 and 1995 is calculated as $8.02 per share, $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:
1997 1996 1995
- --------------------------------------------------------------------------------
Dividend yield 1.2% 1.5% 1.7%
Volatility 38.1% 37.5% 37.5%
Risk free interest rate at the time of grant 6.1% 6.2% 7.1%
Expected term to exercise (in months from the vest date) 4.5 3.5 3.5
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.
Page 26
<PAGE>
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 (loss)
from continuing operations before federal, state and foreign income taxes
consists of the following:
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
U.S. $(10,330) $ (4,662) $ 29,230
Foreign 3,368 2,566 1,334
- --------------------------------------------------------------------------------
Total $ (6,962) $ (2,096) $ 30,564
================================================================================
The provision for federal, state and foreign income tax expense (credits) on
income from continuing operations consists of the following:
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
Current:
U.S $ 425 $ 1,928 $ 9,230
State 1,275 (152) 300
Foreign 1,870 1,264 517
- --------------------------------------------------------------------------------
Total current 3,570 3,040 10,047
- --------------------------------------------------------------------------------
Deferred:
U.S (4,385) (3,497) (1,295)
State (2,185) (318) (42)
- --------------------------------------------------------------------------------
Total $ (3,000) $ (775) $ 8,710
================================================================================
Deferred foreign taxes were not significant for all years presented.
Deferred tax assets (liabilities) are comprised of the following at December 31:
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
Deferred compensation $ 2,556 $ 1,915 $ 2,859
Loss accruals 18,041 10,495 4,853
Environmental remediation 3,274 3,147 3,298
Uniform capitalization 1,212 1,007 1,356
Vacation accrual 1,663 1,580 1,594
Other 3,334 2,111 1,406
- --------------------------------------------------------------------------------
Gross deferred tax assets 30,080 20,255 15,366
- --------------------------------------------------------------------------------
Depreciation (2,610) (3,197) (2,097)
Other (58) (84)
- --------------------------------------------------------------------------------
Gross deferred tax liabilities (2,610) (3,255) (2,181)
- --------------------------------------------------------------------------------
Net deferred tax asset $ 27,470 $ 17,000 $ 13,185
================================================================================
Page 27
<PAGE>
5. INCOME TAXES (Continued)
<TABLE>
The differences between the effective income tax (benefit) rate and the
statutory federal income tax (benefit) rate are as follows:
<CAPTION>
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal tax (benefit) rate (35.0)% (34.0)% 35.0%
Export sales benefit (6.5) (10.0) (7.4)
Research credit (8.5) (14.6) (2.0)
Effect of foreign operations taxed at various rates 9.8 18.7 .2
State taxes (benefit) net of federal tax (8.4) (4.8) .6
Other 5.5 7.7 2.1
- -------------------------------------------------------------------------------------------------------------------
Effective tax (benefit) rate (43.1)% (37.0)% 28.5%
===================================================================================================================
</TABLE>
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 $198,000, $327,000 and
$778,000 for the years 1997, 1996 and 1995, 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. 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.
Page 28
<PAGE>
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 provides that the company
match employees' 401(k) salary deferrals up to 3% of eligible employee
compensation. The amount charged to income from continuing operations was
$2,001,000, $1,920,000 and $1,680,000 in 1997, 1996 and 1995, respectively.
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 discretionary contribution depending on the performance
and financial condition of the company. The contribution is consistently
determined as a percentage of eligible employee base compensation. All employees
on the U.S. payroll of the company are eligible to participate in the plan and
vesting is immediate. The Board approved a contribution equal to 1% of eligible
employee compensation for 1997, 1996, and 1995, which resulted in charges to
income from continuing operations of $657,000, $639,000 and $553,000,
respectively. The ESOP held 229,231 and 220,941 shares of common stock at
December 31, 1997 and 1996, respectively, and there are no unallocated or
unearned shares held by the plan. There are no material matters affecting
comparability of information for all years presented. Shares held by the ESOP
are included in the company's earnings per share computations. Dividends paid
with respect to common stock held by the ESOP are used to purchase additional
shares and were not material for all years presented. The ESOP is a qualified
defined contribution plan under ERISA and the Internal Revenue Code.
8. BUSINESS SEGMENT REPORTING
In the fourth quarter of 1997 the company elected the early adoption of
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information," (SFAS 131). The Statement requires
that an enterprise's operating segments be determined in the manner in which
management operates the business. Specifically, financial information is to be
reported on the basis that is used internally by the chief operating decision
maker in making decisions related to resource allocation and segment
performance. The company's reportable segments are operated and managed as
strategic business units and are organized based on products and services.
Business units operated at different locations are aggregated for reporting
purposes when their products and services are similar.
Under SFAS 131, the company's operations were divided into three industry
segments: Semiconductor Equipment, Wireless Communications, and Government
Electronics. As discussed below, the Government Electronics segment was divested
during 1997. At the end of 1997, the company's operations consist of two
industry segments: Semiconductor Equipment and Wireless Communications.
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 radio-frequency products for commercial and
government communications requirements. The Wireless Communications segment is
composed of the Palo Alto, California-based Wireless Products Group and the
Gaithersburg, Maryland, Telecommunications Group, including that group's
communications-intelligence business.
Page 29
<PAGE>
8. BUSINESS SEGMENT REPORTING (continued)
Prior to the adoption of SFAS 131, the company reported segment information
under Statement of Financial Accounting Standards No. 14, "Financial Reporting
for Segments of a Business Enterprise," which required disclosures based on
identifiable industry segments. Accordingly, the company previously reported
operations in three industry segments: Semiconductor Equipment, Wireless
Communications, and Government Electronics. The former Government Electronics
segment was redefined according to SFAS 131 to be comprised of the company's
Palo Alto, Calif.-based Tactical Subsystems and Microwave Devices sectors. On
October 31, 1997 the company completed the sale of its Government Electronics
segment to an affiliate of Mentmore Holdings Corporation for consideration of
$103 million, consisting mostly of cash. The sale resulted in a pre-tax gain of
approximately $49.9 million. The divested business is reported as discontinued
operations in the accompanying financial statements. Operations of the divested
business included the design, development, manufacture and sale of advanced
microwave devices and tactical electronic systems and devices for guided-missile
programs and other government applications. The divested Government Electronics
business included some microwave devices business previously included as part of
the Wireless Communications segment. The communications-intelligence receivers
business now included in the Wireless Communications segment was formerly
reported as part of the company's Government Electronics segment. Amounts
reported for 1996 and 1995 have been restated to conform to the 1997
presentation.
<TABLE>
Management evaluates segment performance based primarily on segment revenues,
pre-tax operating profit or loss before interest and other nonoperating income
and expenses, and return on assets. Sales between continuing segments are not
significant for any year presented. Continuing operations by business segment
are as follows:
<CAPTION>
(in thousands) Year Ended December 31, 1997
- -------------------------------------------------------------------------------------------------------------------
Year-
Pre-tax End Capital
Sales Income Assets Additions Depreciation
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Semiconductor Equipment $ 186,454 $(13,328) $ 132,528 $ 15,152 $ 10,144
Wireless Communications 104,817 (954) 54,408 6,881 2,510
Corporate 171,276 144 458
- -------------------------------------------------------------------------------------------------------------------
Income from continuing operations (14,282)
Other income (expense)--net 7,320
- -------------------------------------------------------------------------------------------------------------------
Total $ 291,271 $ (6,962) $ 358,212 $ 22,177 $ 13,112
===================================================================================================================
Year Ended December 31, 1996
- -------------------------------------------------------------------------------------------------------------------
Semiconductor Equipment $ 272,436 $ 7,212 $ 174,549 $ 46,122 $ 7,231
Wireless Communications 76,683 (8,511) 50,754 1,941 1,252
Corporate 68,441 240 513
- -------------------------------------------------------------------------------------------------------------------
Income from continuing operations (1,299)
Other income (expense)--net (797)
- -------------------------------------------------------------------------------------------------------------------
Total $ 349,119 $ (2,096) $ 293,744 $ 48,303 $ 8,996
===================================================================================================================
Year Ended December 31, 1995
- -------------------------------------------------------------------------------------------------------------------
Semiconductor Equipment $ 222,212 $ 34,236 $ 147,051 $ 18,518 $ 4,687
Wireless Communications 62,123 (5,438) 42,644 4,522 2,253
Corporate (313) 79,870 326 401
- -------------------------------------------------------------------------------------------------------------------
Income from continuing operations 28,485
Other income (expense)--net 2,079
- -------------------------------------------------------------------------------------------------------------------
Total $ 284,335 $30,564 $ 269,565 $ 23,366 $ 7,341
===================================================================================================================
</TABLE>
Corporate assets consist primarily of cash, cash equivalents and deferred taxes,
and included in 1996 and 1995 balances are net assets of the discontinued
Government Electronics segment.
Page 30
<PAGE>
8. BUSINESS SEGMENT REPORTING (continued)
Sales to individual customers representing greater than 10% of company
consolidated sales are as follows:
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
Semiconductor Equipment:
Marubeni Hytech (a Japanese distributor) $21,000 $47,000 $61,000
Hyundai Electronics Industries Co., Ltd.
(and affiliates) 15,000 37,000 28,000
Wireless Communications:
United States Government 36,000 28,000 29,000
Sales from continuing operations to unaffiliated customers by geographic area
are as follows:
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
United States $169,001 $143,510 $116,479
Export sales from United States:
Europe 8,924 29,759 13,762
Japan 23,035 65,952 56,956
Korea 29,531 52,572 53,259
Other Asia-Pacific countries 13,955 35,767 28,980
Other 3,307 3,728 5,792
Europe 34,701 9,759 6,734
Japan 2,742 3,312
Other Asia-Pacific countries 6,075 4,760 2,373
- --------------------------------------------------------------------------------
Total $291,271 $349,119 $284,335
================================================================================
Intercompany transfers of products and services between geographic regions were
$59,040,000, $37,533,000 and $12,130,000 in fiscal years 1997, 1996 and 1995,
respectively, and are accounted for at prices the company believes to be arm's
length.
<TABLE>
Operating profit and year-end long-lived assets by geographic area are as
follows:
<CAPTION>
Year-end
Operating profit long-lived assets
(in thousands) 1997 1996 1997 1996
- ----------------------------------------------------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
United States $(19,385) $(4,231) $118,606 $121,483
Europe 3,640 700 1,729 2,290
Japan 185 952 26,493 30,076
Other Asia-Pacific countries 1,278 1,280 3,762 4,159
- ----------------------------------------------------------- ------------- -------------- ------------- -------------
Total $(14,282) $(1,299) $150,590 $158,008
=========================================================== ============= ============== ============= =============
</TABLE>
For 1995, foreign operations' sales, profits, and identifiable long-lived assets
are less than ten percent of consolidated totals. Long-lived assets exclude
financial instruments, deferred tax assets, and for 1996 exclude the net assets
of discontinued operations totaling $29,817,000.
Page 31
<PAGE>
8. BUSINESS SEGMENT REPORTING (continued)
<TABLE>
Summarized below are operating results and assets of the discontinued government
electronics business. Intersegment sales were transferred based on negotiated
prices.
<CAPTION>
Year Ended December 31
(in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 75,700 $ 89,200 $ 102,696
====================================================================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Gross profit $ 21,900 $ 21,100 $ 32,200
====================================================================================================================================
Income from operations before income taxes $ 11,500 $ 6,663 $ 15,189
Income taxes (4,290) (2,308) (5,615)
Gain on disposition-net of taxes of $20,219 29,677
- ------------------------------------------------------------------------------------------------------------------------------------
Net income from discontinued operations $ 36,887 $ 4,355 $ 9,574
====================================================================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Year-end net assets $ 29,817 $ 23,281
====================================================================================================================================
</TABLE>
9. EARNINGS PER SHARE
<TABLE>
Basic and diluted earnings per share from continuing operations were computed as follows:
<CAPTION>
Year Ended December 31
(In thousands, except per share amounts) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Basic per share amounts:
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income (loss) from continuing operations (numerator) $(3,962) $(1,321) $21,854
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (denominator) 8,258 8,265 7,938
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Basic income (loss) per share $ (.48) $ (.16) $ 2.75
====================================================================================================================================
Diluted per share amounts:
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (numerator) $(3,962) $(1,321) $21,854
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 8,258 8,265 7,938
Effect of dilutive stock options 838
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted shares outstanding (denominator) 8,258 8,265 8,776
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted income (loss) per share $ (.48) $ (.16) $ 2.49
====================================================================================================================================
</TABLE>
For 1997 and 1996 the incremental shares from the assumed exercise of 251,000
and 272,000 stock options, respectively, 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 564,000, 685,000 and 53,000 shares of common
stock were not included in the computation of diluted per share amounts in 1997,
1996 and 1995, respectively, because the weighted average exercise prices were
greater than the average market prices of the common shares. Weighted average
exercise prices of $39.61 in 1997, $39.62 in 1996 and $50.80 in 1995 exceeded
the average market prices of $29.75, $28.62 and $43.95, respectively.
Page 32
<PAGE>
10. SUBSEQUENT EVENTS
In January 1998, the company sold approximately 15 acres of undeveloped land
adjacent to its San Jose, California, facility for a net sales price of about
$16 million realizing a pre-tax gain of approximately $15 million. The
transaction will be reported in the company's results for the first quarter
ending March 27, 1998.
<TABLE>
11. QUARTERLY FINANCIAL DATA--UNAUDITED
Unaudited quarterly financial data are as follows:
<CAPTION>
(in thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
1997 Quarters 1st 2nd 3rd 4th
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sales $ 67,216 $72,679 $ 79,176 $ 72,200
Gross profit 22,905 26,068 30,435 15,188
Income (loss) from continuing operations (318) 886 1,762 (6,292)
Income from discontinued operations 2,796 2,196 1,828 30,067
Net income 2,478 3,082 3,590 23,775
Basic income (loss) per share from
continuing operations $ (.04) $ .11 $ .21 $ (.76)
Diluted income (loss) per share from
continuing operations $ (.04) $ .10 $ .21 $ (.76)
Basic net income per share $ .30 $ .37 $ .44 $ 2.88
Diluted net income per share $ .30 $ .36 $ .42 $ 2.88
- ------------------------------------------------------------------------------------------------------------------------------------
1996 Quarters 1st 2nd 3rd 4th
- ------------------------------------------------------------------------------------------------------------------------------------
Sales $ 99,642 $ 107,047 $ 76,162 $ 66,268
Gross profit 40,110 35,888 29,541 13,024
Income (loss) from continuing operations 5,220 (761) 2,116 (7,896)
Income from discontinued operations 1,214 1,119 716 1,306
Net income 6,434 358 2,832 (6,590)
Basic income (loss) per share from
continuing operations $ .64 $ (.09) $ .25 $ (.95)
Diluted income (loss) per share from
continuing operations $ .61 $ (.09) $ .25 $ (.95)
Basic net income per share $ .79 $ .04 $ .34 $ (.79)
Diluted net income per share $ .75 $ .04 $ .33 $ (.79)
</TABLE>
Page 33
<PAGE>
11. QUARTERLY FINANCIAL DATA--UNAUDITED (continued)
Due to the continued overcapacity in the semiconductor memory market, compounded
by the Asian financial crisis, the company took certain actions in the fourth
quarter of 1997 to minimize its financial exposure. The company deferred
shipment and revenue recognition with certain Asian customers as a result of
financing issues with these customers. The company's semiconductor equipment
business is being sized to reflect these market changes and resulted in certain
non-performing assets being written off which consist primarily of inventory and
capital assets. The effect of the above actions resulted in a pre-tax impact of
approximately $17 million during the fourth quarter.
The fourth quarter of 1997 also includes a pre-tax charge of $5 million related
to the acquisition of Samsung Microwave Semiconductor (of which $4.6 million is
for in-process research and development), and a $7.6 million pre-tax gain on the
sale and exchange of certain leasehold interests on the Palo Alto, California,
facility.
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 diluted net income per share will not
necessarily equal the annual amount. The computations exclude common equivalent
shares in loss periods since they are antidilutive, and the computations are
based on the average number of basic and diluted common shares outstanding
during each period.
Page 34
<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
Page 35
<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, 1997 and 1996, and the related
consolidated statements of operations, shareowners' equity, and cash flows for
each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
In 1997, the company adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information," as
described in Note 8 to the consolidated financial statements.
Deloitte & Touche LLP
San Jose, California
February 9, 1998
Page 36
<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.
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Consolidated Financial Statements Page
----
Consolidated Statements of Operations
For the Years Ended December 31, 1997, 1996 and 1995 15
Consolidated Balance Sheets
December 31, 1997 and 1996 16
Consolidated Statements of Shareowners' Equity
For the Years Ended December 31, 1997, 1996 and 1995 17
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1997, 1996 and 1995 18-19
Notes to Consolidated Financial Statements 20-34
Report of Management 35
Independent Auditors' Report 36
Page 37
<PAGE>
2. Financial Statement Schedules Page
----
Independent Auditors' Report 41
II Valuation and Qualifying Accounts and Reserves
For the Years Ended December 31, 1997, 1996 and 1995 42
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) Reports on Form 8-K and 8-K/A were filed on November 14, 1997 and
January 13, 1998, respectively. The reports are referrenced as Exhibits
10-w and 10-x, respectively, in the Exhibit Index. The reports contain
the required disclosures and pro forma financial statements regarding
the sale of the company's government electronics business on October
31, 1997. No other 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.
Page 38
<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)
Date: March 19, 1998 By /s/ Dean A. Watkins
-------------- -------------------------
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 March 19, 1998
- --------------------------------- Chief Executive Officer ---------------
W. Keith Kennedy, Jr.
Principal Financial and Accounting Officer:
/s/ Scott G. Buchanan Vice President and March 19, 1998
- --------------------------------- Chief Financial Officer --------------
Scott G. Buchanan
Page 39
<PAGE>
Signature Title Date
--------- ----- ----
/s/ H. Richard Johnson Director March 19, 1998
- ---------------------------------- --------------
H. Richard Johnson
/s/ John J. Hartmann Director March 19, 1998
- ---------------------------------- --------------
John J. Hartmann
/s/ Raymond F. O'Brien Director March 19, 1998
- ---------------------------------- --------------
Raymond F. O'Brien
/s/ William R. Graham Director March 19, 1998
- ---------------------------------- --------------
William R. Graham
/s/ Robert L. Prestel Director March 19, 1998
- ---------------------------------- --------------
Robert L. Prestel
/s/ Gary M. Cusumano Director March 19, 1998
- ---------------------------------- --------------
Gary M. Cusumano
</TABLE>
Page 40
<PAGE>
INDEPENDENT AUDITORS' REPORT
Watkins-Johnson Company:
We have audited the consolidated financial statements of Watkins-Johnson Company
and subsidiaries as of December 31, 1997 and 1996, and for each of the three
years in the period ended December 31, 1997, and have issued our report thereon
dated February 9, 1998; 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 Jose, California
February 9, 1998
Page 41
<PAGE>
<TABLE>
Schedule II
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
<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>
1997
Allowance for doubtful accounts $746,720 $2,467,656 $38,453 $3,175,923
======== ========== ======= ==========
1996
Allowance for doubtful accounts $633,798 $119,649 $6,727 $746,720
======== ======== ====== ========
1995
Allowance for doubtful accounts $614,898 $18,900 $ 0 $633,798
======== ======= ====== ========
<FN>
(1) Write-off of uncollectible accounts.
(2) Reduction of accounts receivable.
</FN>
</TABLE>
Page 42
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
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).
Page 43
<PAGE>
Exhibit
Number Description
------ -----------
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).
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).
Page 44
<PAGE>
Exhibit
Number Description
------ -----------
10-u *First Amendment to Watkins-Johnson Company Credit Agreement
covering the period of November 30, 1995 through December 8,
1998, ABN-AMRO BANK N.V. as Agent (original agreement filed as
Exhibit 10-a to the 1996 Third Quarter Form 10-Q, Commission File
No. 1-5631; first amendment filed as Exhibit 10-a to the 1997
First Quarter Form 10-Q, Commission File No. 1-5631).
10-v *Second Amendment to Watkins-Johnson Company Credit Agreement
covering the period of November 30, 1995 through December 8,
1998, ABN-AMRO BANK N.V. as Agent (original agreement filed as
Exhibit 10-a to the 1996 Third Quarter Form 10-Q, Commission File
No. 1-5631; second amendment filed as Exhibit 10-a to the 1997
Second Quarter Form 10-Q, Commission File No. 1-5631).
10-w *Stock Purchase Agreement dated as of as of August 29, 1997 by
and among Registrant and SMS and TSMD Acquisition Corp. (original
agreement filed as Exhibit 99.1 of Report on Form 8-K, filed on
November 14, 1997, reporting the disposition of assets effective
October 31, 1997, Commission File No.1-5631).
10-x *Watkins-Johnson Company Unaudited Pro Forma Condensed
Consolidated Financial Information filed as an amendment to
Report on Form 8-K, filed on November 14, 1997, reporting the
disposition of assets effective October 31, 1997 and Stock
Purchase Agreement dated as of as of August 29, 1997 by and among
Registrant and SMS and TSMD Acquisition Corp., Commission File
No.1-5631 (Exhibit 10-x originally filed as Report on Form 8-K/A,
filed on January 13, 1998, 1997, Commission File No.1-5631).
10-y Asset Purchase Agreement between Watkins-Johnson Company And
Samsung Semiconductor, Inc. dated as of December 31, 1997.
10-z Assignment of Lease Agreement by and between Taylor Woodrow
Property Company, Inc. ("Assignor") and Watkins-Johnson Company
("Assignee") dated as of December 30, 1997.
Page 45
<PAGE>
Exhibit
Number Description
------ -----------
21 Subsidiaries of Watkins-Johnson Company.
23 Consent of Independent Auditors.
27 Financial Data Schedule.
Page 46
ASSET PURCHASE AGREEMENT
between
WATKINS-JOHNSON COMPANY
and
SAMSUNG SEMICONDUCTOR, INC.
dated as of December 31, 1997
<PAGE>
ASSET PURCHASE AGREEMENT
THIS IS AN ASSET PURCHASE AGREEMENT dated as of December 31,
1997 by and between WATKINS-JOHNSON COMPANY, a California corporation ("Buyer"),
and SAMSUNG SEMICONDUCTOR, INC., a California corporation ("Seller").
B A C K G R O U N D
Through its Samsung Microwave Semiconductor Division, Seller
owns and operates a gallium arsenide wafer and semiconductor devices business.
Buyer and Seller desire that Buyer purchase substantially all the tangible and
certain other assets of that business. The purpose of this Agreement is to
memorialize the terms and conditions under which that will take place.
ACCORDINGLY, THE PARTIES HEREBY AGREE AS FOLLOWS:
<PAGE>
ARTICLE I
CERTAIN DEFINITIONS
As used in this Agreement and in addition to the other terms
defined before and after this Article I, where they appear with initial capital
letters these terms have these meanings:
"Affiliate" means, as to any entity, any other entity that
directly or indirectly Controls, is Controlled by or is under common Control
with, such entity.
"Agreement" means this Asset Purchase Agreement (including all
its Schedules and Exhibits), as it (and they) may be amended in accordance with
Section 9.6.
"Ancillary Agreements" means the License Agreement and the New
Sublease.
"Assets" has the meaning set forth in Section 2.3.
"Assumed Obligations" means the obligations of Seller under
the Executory Contracts, to the extent those obligations are first required to
be performed by Seller after the Closing under the terms of those agreements.
2
<PAGE>
"Buyer Indemnitee" has the meaning set forth in Section 7.1.
"Closing" has the meaning set forth in Section 2.8.
"Closing Date" has the meaning set forth in Section 2.8.
"Control" and correlative terms mean, with respect to an
entity, the direct or indirect power (whether through the ownership of
securities, by contract or otherwise) to elect more than 50 percent of the
directors or similar functionaries of that entity.
"Current Sublease" means the Sublease under which Seller
currently leases the Property from Harris Corporation.
"Customer Agreements" means all the agreements (including all
amendments) to which Seller is a party respecting the sale of Products (i.e.,
backlog), by Seller to customers of Seller (including agreements or arrangements
with Affiliates of Seller and with divisions and business units of Seller other
than the GaAs Business), that are wholly or partially executory as of the
Closing.
3
<PAGE>
"Employees" means the employees of Seller whose sole or
principal responsibilities with Seller relate to Seller's GaAs Business, as
opposed to one or more of the other divisions or businesses of Seller.
"Environmental Laws" means all laws, rules, regulations,
standards, permits, licenses and orders, whether legislative, judicial or
administrative, that relate to the condition of the air, ground or surface
water, land or other parts of the environment; to the Release or potential
Release of any Hazardous Substance into the air, ground or surface water, land
or other parts of the environment; to the presence of any Hazardous Substance or
of any substance that could become a Hazardous Substance; or to the manufacture,
processing, distribution, use, treatment, storage, disposal, transportation or
other handling of any Hazardous Substance.
"Environmental Liability" means any violation of any
Environmental Law arising from any act, omission, condition or circumstance that
occurred during the period indicated in the phrase or sentence in which the term
"Environmental Liability" is used, as well as any claim by any Governmental
Authority or other "third party" asserting any such violation.
4
<PAGE>
"Equipment Leases" means all the leases (including all
amendments), under which Seller leases the Leased Tangible Property, that are
wholly or partially executory as of the Closing.
"ERISA" means the Employee Retirement Income Security Act of
1974, as amended.
"Escrow Agreement" means the escrow agreement among Buyer,
Seller and Escrow Holder dated as of December 10, 1997 respecting Buyer's
$500,000 deposit.
"Escrow Holder" means Union Bank of California, a National
Association.
"Excluded Assets" has the meaning set forth in Section 2.4.
"Executory Contracts" means the Customer Agreements, the
Equipment Leases, the Supply Agreements and the Other Executory Contracts.
"Expense Statements" has the meaning set forth in Section 3.4.
5
<PAGE>
"Expiration Date" has the several meanings set forth in
Section 7.4.
"GaAs Business" means the design, development, manufacture and
marketing of Products.
"Governmental Authority" means any body or instrumentality of
any government.
"Hazardous Substance" means any hazardous, toxic or dangerous
waste, substance, pollutant, contaminant, radiation or material defined or
effectively characterized as such in any Environmental Law or other requirement
of any Governmental Authority relating to, or imposing liability or standards of
or for conduct concerning, any hazardous, toxic or dangerous waste, substance,
pollutant, contaminant, radiation or material, or any petroleum or
petroleum-based products.
"Indemnitee" has the meaning set forth in Section 7.3.
"Indemnitor" has the meaning set forth in Section 7.3.
"Inventories" means all supplies, materials, parts and
components that were acquired by Seller for use in, or in the
6
<PAGE>
normal course of Seller's business are held by Seller for use in, Seller's GaAs
Business, all work-in-process of Seller's GaAs Business and all finished
Products.
"Knowledge" means the actual knowledge of any management
Employee, as well as knowledge that such an Employee could reasonably be
expected to have. However, "Knowledge" as used in the License Agreement refers
only to the actual knowledge of at least one management Employee.
"Leased Tangible Property" means the equipment, furniture,
other tangible personal property and fixtures leased by Seller and used or
usable solely or primarily in Seller's GaAs Business.
"License Agreement" means a license agreement between Buyer
and Seller in the form of Exhibit A.
"Lien" means any mortgage, deed of trust, pledge, assessment,
security interest, lease, adverse claim, levy, charge or other encumbrance of
any kind, or any conditional sale contract, title retention contract or other
contract to grant or create any of the foregoing.
7
<PAGE>
"Losses" means any and all claims, losses, judgments,
liabilities, settlements, fines, penalties, interest, costs and expenses
(including all reasonable attorneys' fees and disbursements incurred in
defending third-party claims). "Losses" include a diminution in value of any
Asset or the GaAs Business, even absent a claim by a third party.
"Material Adverse Effect" means any fact, circumstance, event
or occurrence that materially and adversely affects or might materially and
adversely affect the Property or the Assets, or the results of operations or
condition of Seller's GaAs Business.
"New Sublease" means a sublease agreement respecting the
Property between Buyer and Seller in the form of Exhibit B.
"Offerees" has the meaning set forth in Section 5.5.
"Other Executory Contracts" means all the agreements
(including all amendments) of Seller that are not Customer Agreements, Supply
Agreements or Equipment Leases, which relate solely or primarily to the Assets
or the conduct of Seller's GaAs Business, that are wholly or partially executory
as of the Closing. However, "Other Executory Contracts" does not include
8
<PAGE>
the agreements that would meet this definition but which are included among the
Excluded Assets. See Section 2.4.
"Owned Tangible Property" means the equipment, furniture,
other tangible personal property and fixtures owned by Seller and used or usable
solely or primarily in Seller's GaAs Business, except for the Leased Tangible
Property and the Inventories.
"Parties" means Buyer and Seller. See also Section 9.5.
"Permits" has the meaning set forth in Section 3.14.
"Person" means any individual or entity including, without
limitation, any Governmental Authority.
"Plan" has the meaning set forth in Section 3.11.
"Products" means all gallium arsenide products designed,
developed, manufactured or marketed by Seller including, without limitation, all
wafers, transistors, monolithic microwave integrated circuits and other
semiconductor devices, as well as combinations of such devices and other
9
<PAGE>
electronic components that form integrated components or assemblies.
"Property" means the real estate, improvements and fixtures
consisting of or located on the premises leased by Seller under the Current
Sublease.
"Regional Board" means the California Regional Water Quality
Control Board.
"Release" means any spill, leak, pumping, pouring, emitting,
emptying, discharge, injection, escape, leaching, dumping or other disposal in
any amount.
"Seller Indemnitees" has the meaning set forth in Section 7.2.
"Seller's Consultant" has the meaning set forth in Section
5.9.
"SHN" means SHN Consulting Engineers and Geologists.
"Supply Agreements" means all the agreements (including all
amendments) to which Seller is a party (including agreements or arrangements
with Affiliates of Seller and divisions and
10
<PAGE>
business units of Seller other than the GaAs Business), respecting any supplies,
materials, parts or components that are acquired by Seller for use in, or in the
normal course of Seller's GaAs Business are held for use in, Seller's GaAs
Business, that are wholly or partially executory as of the Closing.
"Tangible Property" means the Owned Tangible Property and the
Leased Tangible Property.
"Tax Code" means the Internal Revenue Code of 1986, as
amended.
"Taxes" means all taxes and governmental levies, however
denominated, including any additions to tax, interest and penalties that may
become payable in respect thereof, imposed by any Governmental Authority,
including all income taxes, payroll and employee withholding taxes, other
withholding taxes, backup withholding taxes, unemployment insurance, social
security, sales and use taxes, excise taxes, gross receipts taxes, occupation
taxes, real, tangible and intangible property taxes, transfer taxes, penalties
and taxes related to information reporting with respect to taxes, workers'
compensation and other obligations of the same or similar nature.
11
<PAGE>
"Third-Party Claim" has the meaning set forth in Section 7.3.
The definitions assigned to the terms in this Article I apply to both the
singular and plural of such terms. Except as otherwise expressly provided in
this Agreement, all references in this Agreement to Articles, Sections,
Subsections, Schedules and Exhibits are to Articles, Sections, Subsections,
Schedules and Exhibits of or to this Agreement. All dollar figures in this
Agreement refer to U.S. dollars.
ARTICLE II
PURCHASE, SALE AND CLOSING
2.1 Purchase and Sale. At the Closing: (a) Buyer shall purchase all the
Assets from Seller; (b) Seller shall sell all the Assets to Buyer; (c) Buyer
shall pay for the Assets as provided in Section 2.2 and (d) Buyer shall assume
all the Assumed Obligations. At the Closing, the Parties shall exchange
appropriate bills of sale and assumption documents to memorialize these events.
2.2 Purchase Price. The purchase price payable by Buyer to Seller for
the Assets shall be $6 million. Buyer shall pay that purchase price at the
Closing as follows: (a) pursuant to
12
<PAGE>
joint written instructions by Buyer and Seller to Escrow Holder, Escrow Holder
shall wire transfer the $500,000 deposited with Escrow Holder under the Escrow
Agreement, together with all interest accrued on that deposit, to an account of
Seller designated by Seller and (b) Buyer shall pay the balance of the $6
million (i.e., $6 million minus the amount of that deposit and interest) by
means of a wire transfer to that same account or, if time does not permit, by
check.
2.3 Description of the Assets. The "Assets" consist of all the assets
(other than the Excluded Assets) of any and every type whatsoever that are
solely or primarily used or usable by Seller in conducting its GaAs Business
including, without limitation:
(a) all the Owned Tangible Property (including, without
limitation, the waste water treatment equipment that Seller had been leasing but
which Seller purchased on December 31, 1997);
(b) all of Seller's rights under the Executory Contracts;
(c) all the Inventories as of the Closing;
13
<PAGE>
(d) all of Seller's rights under all insurance policies, other
rights to indemnification or contribution, and warranty rights, in each such
case relating to any of the Assets not described in this paragraph (d);
(e) the Permits, to the extent they are transferable (but not
to the extent they are not transferable);
(f) a set of originals or copies of all of Seller's records
and documents, including computerized records, used solely or primarily in or in
connection with Seller's GaAs Business (including, without limitation, all
management information systems data that are currently embodied in software),
except for personnel records relating to (i) Employees who do not become
employees of Buyer and (ii) Employees who do become employees of Buyer but which
cannot be lawfully disclosed to Buyer (it being understood that Seller may
retain originals or copies of all such items and may make reasonable use of the
information contained in those items) and
(g) the "deliverables" specified in the License Agreement (it
being understood that the rights to intellectual property embodied by or
reflected in those deliverables or in the items referenced in paragraph (f)
above are not Assets and
14
<PAGE>
instead are being addressed in, and shall be governed by, the License
Agreement).
2.4 Excluded Assets. The Assets do not include the Excluded Assets. The
Excluded Assets consist of Seller's:
(a) cash, cash equivalents and receivables;
(b) rights to the "Samsung" name, as well as all names that
use that name or could reasonably be expected to be confused with that name;
(c) rights under the Current Sublease, except that virtually
all of those rights are being conferred on Buyer by the New Sublease;
(d) assets that are not used or usable by Seller solely or
primarily in Seller's GaAs Business;
(e) distributorship agreements or sales representative
agreements;
(f) rights under the Asset Purchase Agreement dated April 26,
1993 between Samsung Electronics Co., Ltd. and Harris Corporation and the
agreements entered into in connection
15
<PAGE>
with the signing of, and closing under, that Asset Purchase Agreement and
(g) the intellectual property and similar rights addressed in
the License Agreement.
2.5 No Other Assumptions. Except for the Assumed Obligations, Buyer
shall not assume any obligations or liabilities of Seller of any nature
whatsoever.
2.6 Prorations. All expenses (including, without limitation, all
prepaid expenses) associated with the Assets (for example, for utilities
consumed at the Property) shall be prorated, as between Seller and Buyer, as of
the close of business on the Closing Date. The prorations shall be based on the
number of days elapsed during the relevant period that includes the close of
business on the Closing Date, unless that methodology would be manifestly
unfair.
2.7 Transfer Taxes. Seller shall pay any and all sales and other
transfer Taxes resulting from Seller's sale of the Assets to Buyer. Buyer shall
exercise reasonable efforts to assist Seller in minimizing those Taxes.
16
<PAGE>
2.8 Closing. The closing of the purchase and sale of the Assets (the
"Closing") shall take place as soon as possible after this Agreement is signed
and each of the conditions set forth in Article VI shall have been satisfied or
waived by the appropriate Party. The date the Closing takes place is referred to
in this Agreement as the "Closing Date". The Closing shall take place at the
offices of Heller Ehrman White & McAuliffe, 525 University Avenue, Palo Alto,
California, unless otherwise agreed by the Parties.
2.9 Allocation of Purchase Price. The Parties have allocated the
purchase price for the Assets among the various classes of the Assets and have
initialed that allocation. The Parties have negotiated that allocation in good
faith. They shall file their respective tax returns in accordance with that
allocation.
ARTICLE III
REPRESENTATIONS AND WARRANTIES
OF
SELLER
Seller hereby represents and warrants to Buyer that, except as
specifically set forth as an exception to one or more
17
<PAGE>
representations or warranties in one or more of the Schedules to this Agreement:
3.1 Due Organization. Seller is a California corporation duly
organized, validly existing and in good standing under the laws of the State of
California and has all requisite power and authority to own and operate the
Assets and to carry the GaAs Business as it is now being conducted.
3.2 Authority and Enforceability. Seller has all requisite power and
authority to enter into and perform this Agreement and the Ancillary Agreements.
The signing, delivery and performance of this Agreement and the Ancillary
Agreements by Seller have been duly and validly authorized by Seller's board of
directors. Seller's sole shareholder need not approve the signing, delivery or
performance of this Agreement or any of the Ancillary Agreements. This Agreement
constitutes a valid and binding obligation of Seller enforceable against Seller
in accordance with its terms, except as enforcement may be limited by
bankruptcy, insolvency, reorganization, moratorium or other laws relating to or
affecting creditors' rights generally and except as such enforcement may be
limited by general principles of equity. When signed and delivered by Seller,
the Ancillary Agreements will also constitute valid and binding obligations of
Seller enforceable against Seller in accordance with their terms,
18
<PAGE>
except as enforcement may be limited by bankruptcy, insolvency, reorganization,
moratorium or other laws relating to or affecting creditors' rights generally
and except as enforcement may be limited by general principles of equity. Except
as shown on Schedule 3.3, the signing, delivery and performance of this
Agreement and the Ancillary Agreements by Seller does not and will not: (a)
violate or conflict with the Articles of Incorporation or Bylaws of Seller; (b)
violate, conflict with, result in a breach or termination of, otherwise give any
other Person the right to terminate, constitute a default under or result in the
loss of any benefit or right under, the terms of any of the Executory Contracts
or any other agreement or instrument under which any of the Assets is bound; (c)
violate, conflict with, result in a breach or termination of, otherwise give any
other Person the right to terminate, constitute a default under or result in the
loss of any benefit or right under, the terms of any contract or instrument
(other than the Executory Contracts) to which Seller is a party or by which
Seller is bound if such violation, conflict, breach or other consequence would
or could have a Material Adverse Effect; (d) result in the creation of any Lien
upon any of the Assets; (e) violate any judgment, order, injunction, decree or
award of any Governmental Authority binding upon any of the Assets or any
19
<PAGE>
aspect of Seller's GaAs Business or (f) constitute a violation of law by Seller.
3.3 Consents and Approvals. Except as shown on Schedule 3.3, no consent
or approval of, or filing or registration with, any Governmental Authority or
any other Person, by Seller, is or will be necessary in connection with the
signing, delivery or performance by Seller of this Agreement or any of the
Ancillary Agreements or the use of the Assets by Buyer after the Closing, it
being understood that this Section 3.3 does not address any consents or
approvals that might be required under agreements to which Buyer is a party.
3.4 Expense Statements and Changes. Schedule 3.4 includes statements of
the "external" expenses incurred by Seller in conducting its GaAs Business
during each of the 21 months beginning with January 1996 and ending with
September 1997 (the "Expense Statements"). The Expense Statements were prepared
on an accrual basis and correctly reflect such external expenses. The references
in this Section 3.4 to "external" are intended to exclude payments or payment
obligations for goods and services obtained by Seller for its GaAs Business from
other business units of Seller or from Affiliates of Seller. However, salary and
other compensation paid or payable to employees and
20
<PAGE>
consultants are not considered "external" for this purpose and thus are
reflected on the Expense Statements.
3.5 Taxes. Neither Buyer nor any Affiliate of Buyer shall have any
liability for any Taxes payable by Seller or any entity that filed, files, was
required to file or is required to file a consolidated or combined Tax Return
with Seller.
3.6 Litigation. Except as shown on Schedule 3.6, to the Knowledge of
Seller, there is no legal, administrative, governmental or other suit, action,
arbitration, proceeding or investigation pending or threatened against or
affecting Seller, which alone or in the aggregate for all such matters could, if
adversely determined, have a Material Adverse Effect. Schedule 3.6 sets forth a
summary description of all legal, administrative, governmental and other suits,
actions, arbitrations, proceedings and investigations pending or threatened
against or affecting Seller in connection with Seller's GaAs Business or any
Asset and of which Seller has Knowledge. Except as disclosed on Schedule 3.6,
there is no judgment, decree, injunction or order of any Governmental Authority
outstanding applicable to Seller in connection with Seller's GaAs Business or
any Asset.
21
<PAGE>
3.7 Title and Condition. Seller has good title to all the Assets, in
each case free and clear of all Liens, and Buyer will have such title to the
Assets immediately after the Closing. Schedule 3.7(a) contains a complete and
accurate list, as of July 31, 1997, of all the Tangible Assets that had an
original cost, in each case in excess of $1,000. Since July 31, 1996, Seller has
not transferred or disposed of any Inventories or Tangible Property, or shipped
or removed any Inventories or Tangible Property from the Property (in each such
case, including to other business units of Seller or to any Affiliates of
Seller), except in the ordinary course of Seller's business. The equipment
listed on Schedule 3.7(b) is in good working order and repair, ordinary wear and
tear excepted.
3.8 Compliance With Laws. Seller has conducted and is currently
conducting the GaAs Business in material compliance with all applicable laws.
3.9 Brokers' and Finders' Fees. No agent, broker, finder or other
Person acting on behalf of Seller or any Affiliate of Seller is or will be
entitled to any commission or brokers' or finders' fee in connection with this
Agreement or any
22
<PAGE>
of the transactions it contemplates by reason of the conduct of Seller or any
such Affiliate.
3.10 Employee Matters. Schedule 3.10 sets forth the current rate of
compensation paid to each Employee and the amount and medium of any bonuses or
other special compensation paid to each Employee since 1995. Seller is not a
party to any collective bargaining agreement respecting any of the Employees. To
Seller's Knowledge, no labor union organizing activities have occurred or are
occurring among any of the Employees.
3.11 Employee Benefits. Schedule 3.11 sets forth a list of each
employee benefit plan within the meaning of ERISA Section 3(3) that is or was
maintained or contributed to by or on behalf of Seller for the benefit of any of
the Employees (a "Plan"). To the Knowledge of Seller, each Plan has been
operated in material compliance with its terms and materially complies with all
requirements applicable to that Plan under the Tax Code and ERISA. No Plan is or
was subject to Title IV of ERISA.
3.12 Environmental Matters. Except as shown on Schedule 3.12, Seller
has no knowledge of any condition or circumstance present at or arising out of
the Property (including, but not limited to, the presence of asbestos-
23
<PAGE>
containing materials, the presence of underground storage tanks or a Release of
any Hazardous Substance) which, individually or in the aggregate, could have a
Material Adverse Effect. Seller has not received notification (and has no
Knowledge that any other Person has received notification) from any Governmental
Authority that, as to the Property or any business or activities ever conducted
on the Property, there exists or has occurred a violation of any applicable
Environmental Laws or a condition or circumstance that requires a response,
removal or remedial action. Except as shown on Schedule 3.12, Seller has no
Knowledge of any circumstance or condition present at or arising out of the
Property that may give rise to any Environmental Liabilities. Seller is in
material compliance with all applicable Environmental Laws. Except as shown on
Schedule 3.12, to Seller's Knowledge, the Property is not or was not formerly
the site of a gasoline service station, automotive repair facility or other
commercial or industrial facility involving the use, storage, handling or
disposal of any Hazardous Substance.
3.13 Executory Contracts. Schedule 3.13 contains a complete list of all
the Executory Contracts. Seller has furnished Buyer with true and complete
copies of all the Executory Contracts, as well as the Current Sublease. All the
Executory Contracts are binding and enforceable obligations of Seller and,
24
<PAGE>
to the Knowledge of Seller, the other parties thereto, except (with respect to
enforcement) as enforcement may be limited by bankruptcy, insolvency,
reorganization, moratorium or other laws relating to or affecting creditors'
rights generally and except as enforcement may be limited by general principles
of equity. Seller and, to the Knowledge of Seller, all other parties to all the
Executory Contracts and the Current Sublease have in all material respects
performed all obligations required to be performed by them and are not in
material default thereunder.
3.14 Permits. Schedule 3.14 sets forth a complete and accurate list of
all material permits, licenses, waivers, exemptions and other governmental
authorizations and approvals required or used primarily or solely in connection
with the conduct of Seller's GaAs Business (the "Permits"). All the Permits have
been duly obtained and are in full force and effect. Except as shown on Schedule
3.14, Seller is in material compliance with the requirements, terms and
conditions of all the Permits.
3.15 Inventories. Schedule 3.15 consists of a summary of the
Inventories, by type of item and quantity, as of October 31, 1997. That summary
is substantially accurate. Buyer acknowledges that the Inventories are being
sold to Buyer "as is"
25
<PAGE>
and that the only representations and warranties Buyer is making with respect to
the Inventories are as set forth in the previous sentence and in Schedule 3.15.
3.16 Intellectual Property. Representations and warranties of Seller
regarding patents, other "intellectual property" and related matters appear in
the License Agreement. This Agreement contains no such representations or
warranties. However, as indicated in the License Agreement, Article VII of this
Agreement provides remedies regarding any breach of any of those representations
and warranties.
3.17 Other Material Information. There is no fact or circumstance
which, to the Knowledge of Seller, has or would be likely to have a Material
Adverse Effect which has not been set forth in this Agreement or the License
Agreement and is not otherwise generally known or knowable by the public or by
Buyer from sources other than Seller or the due diligence materials and
information made available by Seller to Buyer in connection with the
transactions contemplated by this Agreement.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER
26
<PAGE>
Buyer hereby represents and warrants to Seller that the
following representations and warranties are true, accurate and complete as of
the date of this Agreement:
4.1 Due Organization. Buyer is a corporation duly organized, validly
existing and in good standing under the laws of the State of California and has
all requisite power and authority to own, lease and operate its properties and
to carry on its business as it is now being conducted.
4.2 Authority. Buyer has all requisite power and authority to enter
into and perform this Agreement and the Ancillary Agreements. The signing,
delivery and performance of this Agreement and the Ancillary Agreements by Buyer
have been duly and validly authorized by all necessary corporate action on the
part of Buyer. This Agreement constitutes a valid and binding obligation of
Buyer enforceable against Buyer in accordance with its terms, except as such
enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium
or other laws relating to or affecting creditors' rights generally and except as
such enforcement may be limited by general principles of equity. When signed and
delivered by Buyer, the Ancillary Agreements will also constitute valid and
binding obligations of Buyer enforceable against Buyer in accordance with their
terms, except as enforcement may be limited by bankruptcy,
27
<PAGE>
insolvency, reorganization, moratorium or other laws relating to or affecting
creditors' rights generally and except as enforcement may be limited by general
principles of equity. The signing, delivery and performance of this Agreement
and the Ancillary Agreements by Buyer do not and will not: (a) violate or
conflict with the Articles of Incorporation or Bylaws of Buyer; (b) violate,
conflict with, result in a breach or termination of, otherwise give any other
Person the right to terminate, constitute a default under or result in the loss
of any benefit or right under, the terms of any contract or other instrument to
which Buyer is a party or by which Buyer or any of its assets is bound; (c)
violate any judgment, order, injunction, decree or award of any Governmental
Authority binding upon Buyer or any of its assets or (d) constitute a violation
of any law by Buyer.
4.3 Financial Resources. Buyer has sufficient cash resources to pay the
entire purchase price for the Assets.
4.4 Consents and Approvals No consent or approval of, or filing or
registration with any Governmental Authority or any other Person, by Buyer, is
or will be necessary in action with the signing, delivery or performance by
Buyer of this Agreement or any of the Ancillary Agreements.
28
<PAGE>
4.5 Brokers' and Finders' Fees. Except for Alliant Partners, no agent,
broker, finder or other Person acting on behalf of Buyer or any Affiliate of
Buyer is or will be entitled to any commission or brokers' or finders' fee in
connection with this Agreement or the transactions it contemplates by reason of
the conduct of Buyer or any Affiliate of Buyer. Buyer shall pay the fee of
Alliant Partners.
ARTICLE V
CERTAIN COVENANTS
5.1 Access to Information. Seller shall afford Buyer and its
representatives full access, during normal business hours on reasonable notice,
to the Property, the Assets and Seller's reports, books and records relating
solely or primarily to the Assets and Seller's GaAs Business. Subject to
reasonable limitations imposed by Seller and to any confidentiality obligations
of Seller to other Persons, Buyer shall have the right to make copies, extracts
and summaries of all such reports, books and records. Each Party shall keep
confidential all non-public information obtained from the other Party and shall
not disclose or use any such information for any purpose other than in
connection with the transactions contemplated by this Agreement. However,
subject to Section 8 of the License Agreement, nothing in this Section 5.1 or
elsewhere shall
29
<PAGE>
prohibit any use or disclosure by Buyer of any confidential information about
the Assets or the GaAs Business as conducted by Buyer after the Closing.
5.2 Conduct of the Business. Before the Closing, Seller shall use its
best efforts: (a) to conduct the GaAs Business only in the ordinary course
consistent with past practice and applicable law; (b) to preserve the goodwill
of the Employees and Seller's suppliers, customers and others with whom Seller
has relationships in connection with the GaAs Business and (c) to preserve the
value of the Assets and the GaAs Business.
5.3 Certain Actions Prohibited. Before the Closing, except as expressly
permitted or required by this Agreement or as consented to in writing by Buyer,
Seller shall refrain from:
(a) hiring any employees, agents or consultants for the GaAs
Business or increasing the salary of, or benefits of or any other compensation
payable to, any Employees;
(b) creating or suffering any Lien on any of the Assets;
30
<PAGE>
(c) selling, transferring or otherwise disposing of any
Assets, except Inventories in the ordinary course of Seller's GaAs Business;
(d) modifying, cancelling or waiving any claims or rights of
substantial value relating to any Asset or the GaAs Business;
(e) otherwise entering into any transaction relating to the
GaAs Business, except in the usual and ordinary manner and in the ordinary
course of that business or
(f) agreeing, in writing or otherwise, to do any of the
foregoing.
If and to the extent there is a perceived conflict between
this Section 5.3 and Section 5.2, this Section 5.3 shall prevail.
5.4 Public Announcements. Any press releases or other public
announcements before or in connection with the Closing by either Party regarding
this Agreement or any of the transactions it contemplates will be submitted to
the other Party for comment at least two business days before it is released or
made.
31
<PAGE>
5.5 Employees. Prior to, but in connection with, the Closing, Seller
shall permit Buyer to offer employment to those Employees whom Buyer indicates
it wishes to employ after the Closing (the "Offerees"). Seller shall encourage
those Employees to accept employment with Buyer. Seller in all events shall be
responsible for and pay all obligations and liabilities to or respecting all
Offerees and other Employees, including any and all severance obligations and
liabilities resulting from their termination of employment with Seller, except
that Buyer shall be responsible for all obligations and liabilities of Buyer to
the Offerees that accept employment with Buyer and which first accrue after (but
not as a result of) the Closing.
5.6 Future Employment. Without Buyer's prior written consent: (a)
during the 12 months after the Closing, Seller shall not, and Seller shall cause
its Affiliates not to, directly or indirectly employ or otherwise purchase the
services of any Offeree hired by Buyer and (b) during the two years thereafter
(in other words, during the 24 months beginning 12 months after the Closing),
Seller shall not solicit any such Offeree to become an employee or otherwise
render services to Seller or any Affiliate of Seller. However, nothing in the
previous sentence shall prevent Seller or any Affiliate of Seller from employing
or otherwise purchasing services from any Offeree who, at that time,
32
<PAGE>
has not been an employee of and has not otherwise rendered services to Buyer or
any Affiliate of Buyer during any six consecutive months beginning on the
Closing Date.
5.7 Warranties
(a) Division of Responsibilities. Subject to Subsection
5.7(b), Seller shall be responsible for all customer warranties respecting all
Products shipped by Seller before the Closing. Buyer shall be responsible for
all customer warranties respecting all Products shipped by Buyer after the
Closing.
(b) Warranty Work by Buyer for Seller. After the Closing,
Buyer shall discharge Seller's warranty obligations described in the first
sentence of Subsection 5.7(a) by repairing or (more likely) replacing defective
Products. For performing this function, Seller shall pay Buyer an amount equal
to Buyer's direct costs for time and materials and shall reimburse Buyer for
those costs monthly within 30 days after Buyer submits an invoice. Seller shall
have reasonable access to Buyer's cost records in order to verify those costs.
33
<PAGE>
5.8 Special Decommissioning, Closure and Equipment Obligations
(a) Storage Area. Seller has used a metal shed in a fenced-off
area located at the rear of the Property adjacent to the parking lot to store
arsenic. Promptly after the Closing, Seller, at Seller's expense, shall take all
steps necessary to decommission that storage area in accordance with applicable
law. Decommissioning may require submission of a decommissioning plan for
approval by the City of Milpitas. After Seller obtains any necessary approvals
from the City, Seller shall promptly decommission the storage area, including in
accordance with the City-approved decommissioning plan if there is such a plan.
If the storage area has not been decommissioned to the City's satisfaction by
May 1, 1998, Buyer, at Buyer's option, may complete the decommissioning at any
time thereafter, in which case Seller shall pay all of Buyer's reasonable costs
and expenses of doing so. However, Buyer's failure to exercise that option shall
not relieve Seller of the obligation to decommission the storage area.
34
<PAGE>
(b) Old Waste Water Treatment System. An acid neutralization
system was located in a below-ground vault to the rear of the main building
constituting part of the Property. Promptly after the Closing, Seller, at
Seller's expense, shall take all steps necessary to complete the closure of that
acid neutralization system in accordance with applicable law. Closure may
require submission of a closure plan for approval by the City of Milpitas. After
Seller obtains any necessary approvals from the City, Seller shall promptly
implement the closure of the system, including in accordance with the
City-approved closure plan if there is such a plan. However, Seller shall not
fill the below-ground vault unless the City requires that it be filled. If the
acid neutralization system has not been closed to the City's satisfaction by May
1, 1998, Buyer, at Buyer's option, may complete the closure at any time
thereafter, in which case Seller shall pay all of Buyer's reasonable costs and
expenses of doing so. However, Buyer's failure to exercise that option shall not
relieve Seller of the obligation to close the acid neutralization system.
5.9 Special Environmental Covenant
(a) Preliminary Findings. On behalf of Buyer in connection
with Buyer's due diligence relating to Buyer's
35
<PAGE>
purchase of the Assets, SHN has identified the presence of acetone, ethyl
benzene, freon 113 and two isomers of xylene (the "four chemicals") in shallow
soil and/or shallow groundwater at the easterly area of the Property, based on
SHN's sampling at that location during December 1997. However, owing to the
preliminary nature of SHN's investigation and the limited data SHN has acquired
to date, SHN has indicated it has not been able to reach reliable conclusions
regarding the source of the Release of the four chemicals, the direction of
groundwater movement beneath the Property or whether such chemicals might be
found in other concentrations and locations beneath or adjacent to the Property
as a result of Releases, if any, originating at the Property. The purpose of
this Section 5.9 is to set forth an action plan intended to resolve those
uncertainties and to take remedial action if and to the extent appropriate under
applicable law.
(b) Further Investigation. After the Closing, SHN, as Buyer's
consultant, and an environmental consultant selected by Seller ("Seller's
Consultant") shall jointly develop a report of the data SHN has developed to
date and a proposed work plan designed to determine, to a reasonable degree of
certainty as may be required by the Regional Board, the possible sources of the
Releases of the four chemicals and the concentrations and approximate locations
of each at or near the
36
<PAGE>
Property. SHN and Seller's Consultant shall submit their joint report and work
plan to the Regional Board for the Regional Board's approval and shall make
whatever modifications to, or extensions of, that work plan that the Regional
Board may require from time to time. After the Regional Board approves the plan,
Seller's Consultant shall implement the work plan subject to reasonable
oversight by SHN. If implementation reveals the presence, in the soil, surface
water or groundwater at the Property, of detectable quantities of any Hazardous
Substances in addition to the four chemicals, SHN and Seller's Consultant shall
report that presence to the Regional Board and shall extend their investigation
to include those additional Hazardous Substances in order to ascertain their
sources, concentrations and locations if and as may be required by the Regional
Board. The investigation may also extend off-site of the Property if the
Regional Board so requires. Seller and Buyer, with the assistance, respectively,
of Seller's Consultant and SHN, shall be entitled to contest or appeal the
Regional Board's conclusions or requirements consistent with the principles and
purposes set forth in this Section 5.9.
(c) Repair and Remediation. Following completion of the
investigation (or before completion if SHN and Seller's Consultant conclude that
is preferable or if they are so directed by the Regional Board), in accordance
with a work plan
37
<PAGE>
jointly prepared and submitted to and approved by the Regional Board, Seller
shall cause whatever steps are required by the Regional Board to be taken to:
(i) remediate the presence of any Hazardous Substances (whether consisting of
any of the four chemicals, other Hazardous Substances or both), which the
investigation has indicated are present at the Property or have migrated from
the Property to off-site locations and (ii) complete any monitoring that the
Regional Board may require. Seller shall also obtain a "no further action"
letter from the Regional Board with respect to the Property. Seller's
remediation obligations under this paragraph shall extend to any of the four
chemicals and any other Hazardous Substances released after the Closing pending
completion of any repairs or replacements required by the next sentence,
provided that, at Seller's expense, Buyer takes such reasonable steps to
mitigate those further Releases as Seller and Buyer agree. If the investigation
indicates that the source of any Release at the Property of any of the four
chemicals or other Hazardous Substance is or was broken or otherwise defective
equipment, piping or other improvements at the Property, then, irrespective of
whether those four chemicals or other Hazardous Substances are being released in
quantities that have resulted in identified concentrations exceeding maximum
concentration levels, Seller shall cause that broken or otherwise defective
equipment, piping or other improvements to be repaired or replaced, so that they
38
<PAGE>
will no longer be a source of such Releases. All such steps shall be taken in a
manner designed to minimize the disruption to Buyer's operations at the
Property.
(d) Costs and Expenses. Except as provided in the last
sentence of this paragraph, Seller shall pay all the reasonable costs and
expenses incurred in implementing this Section 5.9 including, without
limitation, all fees and costs of Seller's Consultant, and the investigation,
remediation and repair contemplated by this Section 5.9. Seller shall fund all
such costs and expenses on a current basis rather than reimburse Buyer after
Buyer advances funds. Buyer shall pay the fees and costs of SHN.
(e) Relationship to Article VII. Nothing in this Section 5.9
or in Section 5.8 shall in any manner diminish Seller's obligations under
Article VII.
5.10 Good Faith Efforts. Buyer and Seller shall use their respective
good faith efforts to cause each condition precedent to the completion of the
transactions contemplated by this Agreement over which they have control or
influence to be satisfied as soon as is reasonably practicable after this
Agreement is signed. However, such efforts need not include the payment of money
or other consideration to other Persons or
39
<PAGE>
require that any Party waive any condition to its obligation to complete the
Closing set forth in Article VI.
5.11 Further Assurances. At any time after the Closing and without
payment of any additional consideration by Buyer, Seller shall sign and deliver
such further documents as may be reasonably requested by Buyer in order to give
effect to the provisions of this Agreement and the Ancillary Agreements and
shall also assist Buyer in obtaining any of the consents or approvals listed or
required to be listed on Schedule 3.3 that have not been obtained by the
Closing. In the meantime, if any such consents or approvals have not been
obtained by the Closing, Seller shall exercise its reasonable good faith efforts
to assure that Buyer enjoys the full economic benefits of the Assets and the
Executory Contracts that it would have enjoyed if such consents and approvals
had been obtained by the Closing. In addition, during the 12 months after the
Closing but subject to reasonable limitations and reimbursement by Buyer for
Seller's reasonable, documented, out-of-pocket expenses, Seller shall assist
Buyer in connection with any lawsuit, tax audit, other inquiry, accounting
review or audit, proceeding or other matter, whether or not currently pending,
which to any extent arises out of events or circumstances that precede the
Closing.
40
<PAGE>
ARTICLE VI
CONDITIONS PRECEDENT TO THE CLOSING
6.1 Condition to the Obligation of Each Party. The obligation of each
Party to this Agreement to complete the Closing is subject to the condition that
neither Party is subject to any order, decree or injunction of any Governmental
Authority of competent jurisdiction that enjoins or prohibits the completion of
any of the transactions contemplated by this Agreement.
6.2 Additional Conditions to the Obligation of Buyer. The obligation of
Buyer to complete the Closing is further subject to the fulfillment of all the
following conditions (in addition to the condition set forth in Section 6.1),
unless waived in writing by Buyer:
(a) Accuracy of Representations and Warranties. Each
representation and warranty in Article III and in the License Agreement shall
have been true and correct in all material respects on the date of this
Agreement and as of the Closing Date, with the same force and effect as though
made as of the Closing Date, provided that the reference in this sentence to
"material" shall be disregarded with respect to any
41
<PAGE>
representation or warranty that is already expressly qualified in some manner by
materiality.
(b) Compliance with Agreement. All the covenants in this
Agreement required to be performed by Seller before the Closing shall have been
performed in all material respects.
(c) Compliance Certificate. Seller shall have delivered a
certificate to Buyer, signed by Seller's President, dated the Closing Date,
certifying to the satisfaction, as of the Closing Date, of the conditions set
forth in Subsections 6.2(a) and (b).
(d) Consents. Seller shall have received the consents and
approvals listed or required to be listed on Schedule 3.3.
(e) Opinion of Counsel. Buyer shall have received an opinion
of Claudia Carrington or Gray Cary Ware & Freidenrich, counsel to Seller,
addressed to Buyer, dated the Closing Date and containing the conclusions set
forth on Exhibit C.
42
<PAGE>
(f) Ancillary Agreements. Seller shall have signed and
delivered the Ancillary Agreements and Oak Creek Delaware, Inc. shall have
consented in writing to the New Sublease.
(g) Absence of Litigation. No action, suit or proceeding shall
be completed, pending or threatened before any Governmental Authority wherein an
unfavorable judgment, order, decree, stipulation, injunction or charge which, in
the exercise of Buyer's good faith judgment, does or could: (i) prevent
completion of the Closing; (ii) cause Buyer's purchase of the Assets from Seller
to be rescinded or reversed after the Closing or (iii) adversely affect the
legal right or practical ability of Buyer to operate the Assets or the GaAs
Business in substantially the same manner they were operated before the Closing.
6.3 Additional Conditions to the Obligations of Seller. The obligation
of Seller to complete the Closing is further subject to the fulfillment of all
the following conditions (in addition to the condition set forth in Section
6.1), unless waived in writing by Seller:
(a) Accuracy of Representations and Warranties. Each
representation and warranty in Article IV shall have been
43
<PAGE>
true and correct in all material respects on the date of this Agreement and as
of the Closing Date with the same force and effect as though made on and as of
the Closing Date.
(b) Compliance with Agreement. All the covenants in this
Agreement required to be performed by Buyer before the Closing shall have been
performed in all material respects.
(c) Compliance Certificate. Buyer shall have furnished a
certificate to Seller, signed by Buyer's President and Chief Executive Officer,
dated the Closing Date, certifying to the satisfaction, as of the Closing Date,
of the conditions set forth in Subsections 6.3(a) and (b).
(d) Opinion of Counsel. Seller shall have received an opinion
from Heller Ehrman White & McAuliffe, counsel to Buyer, addressed to Seller,
dated the Closing Date, containing the conclusions set forth on Exhibit D.
(e) Ancillary Agreements. Buyer shall have signed and
delivered the Ancillary Agreements and Oak Creek Delaware, Inc. shall have
consented in writing to the New Sublease.
44
<PAGE>
(f) Absence of Litigation. No action, suit or proceeding shall
be completed, pending or threatened before any Governmental Authority wherein an
unfavorable judgment, order, decree, stipulation, injunction or charge which, in
the exercise of Seller's good faith judgment, does or could: (i) prevent
completion of the Closing or (ii) cause Seller's sale of the Assets to Buyer to
be rescinded or reversed after the Closing.
ARTICLE VII
INDEMNIFICATION
7.1 By Seller.
(a) In General. Subject to the balance of this Article VII,
Seller shall indemnify Buyer and Buyer's Affiliates (collectively "Buyer
Indemnitees") and hold them harmless from and against any and all Losses that
constitute, result from, arise out of or are otherwise connected with: (i) any
Environmental Liabilities, any obligations or liabilities of Seller relating to
Taxes and any other obligations or liabilities of Seller, other than the Assumed
Obligations, arising out of or otherwise connected with any event, occurrence or
condition preceding the Closing (including preceding the date of this
Agreement), whether or not accrued, absolute, contingent, known, unknown,
asserted or unasserted; (ii) any breach of any
45
<PAGE>
representation or warranty set forth in Article III, in the License Agreement or
in any certificate submitted to Buyer in connection with the Closing; (iii) any
claim by any "third party" which, if true, would demonstrate a breach of any
representation or warranty set forth in Article III or in any certificate
submitted to Buyer in connection with the Closing (but not, in the case of this
clause (iii), any breach of any representation or warranty set forth in the
License Agreement) or (iv) any (A) claim or assertion by Oak Creek Delaware,
Inc. or Harris Corporation that the New Sublease resulted in the termination of,
or otherwise impaired, the five-year extension option in the Current Sublease,
as made available to Buyer under the New Sublease (the "Extension Option"); (B)
failure by Harris Corporation to give Oak Creek Delaware, Inc. a timely notice
of Buyer's exercise of that option if Seller or Buyer timely notifies Harris
Corporation that Harris Corporation should give such a notice (but not if Harris
Corporation is the subject of a chapter proceeding under the United States
Bankruptcy Code and the Bankruptcy Court has confirmed a rejecton of the Master
Lease or the Sublease by Harris Corporation; (C) breach of the Master Lease by
Harris Corporation not caused by Buyer that results in the termination of the
Master Lease or loss of the Extension Option or (D) loss of the Extension Option
due to Harris Corporation no longer being a validly existing corporation or the
guaranty being unenforceable against Harris Corporation for any
46
<PAGE>
reason. Seller shall have no obligation under clause (i) of this Subsection
7.1(a) with respect to any of the subjects addressed in Seller's representations
or warranties set forth in the License Agreement that arise from Buyer's use of
the "intellectual property" and other rights licensed by Seller to Buyer under
the License Agreement.
(b) Threshold. Notwithstanding paragraph (a) of this Section
7.1, Seller shall not be required to indemnify the Buyer Indemnitees under that
paragraph unless and until the total Losses under that paragraph exceed $25,000.
If that total does exceed $25,000, Seller shall indemnify the Buyer Indemnitees
for all such Losses, not just the amount in excess of $25,000.
(c) Cap. Notwithstanding paragraph (a) of this Section 7.1,
Seller shall not be required to indemnify the Buyer Indemnitees under that
paragraph for any Losses in excess of a total of $3 million, provided, however,
that the limitations set forth in this sentence shall not apply to: (i) any
obligation or liability of Seller under clause (i) of that paragraph with
respect to any Taxes or Environmental Liabilities or (ii) any breach of any of
Seller's representations or warranties set forth in Section 3.12. The "cap"
specified in this paragraph shall also apply to any "off-contract" remedies
available to any Buyer Indemnitee in connection with this Agreement or any of
the
47
<PAGE>
transactions to which it relates. Except with respect to fraud and the matters
covered by Section 7.5, that "cap" shall be the limit of Seller's obligations to
all the Buyer Indemnitees under any contractual or other theories or causes of
action with respect to this Agreement or any of the transactions to which it
relates.
48
<PAGE>
7.2 By Buyer.
(a) In General. Subject to the balance of this Article VII,
Buyer shall indemnify Seller and Seller's Affiliates (the "Seller Indemnitees")
and hold them harmless from and against any and all Losses that constitute,
result from, arise out of or are otherwise connected with: (i) the Assumed
Obligations; (ii) any Environmental Liabilities or any other obligations or
liabilities of Buyer arising out of or otherwise connected with any event,
occurrence or condition after the Closing relating to Seller's GaAs Business as
conducted at the Property and whether or not accrued, absolute, contingent,
known, unknown, asserted or unasserted or (iii) any breach (or any claim by a
"third party" which, if true, would demonstrate a breach) of any representation
or warranty of Buyer set forth in Article IV.
(b) Threshold. Notwithstanding paragraph (b) of this Section
7.2, Buyer shall not be required to indemnify the Seller Indemnitees under that
paragraph unless and until the total Losses under that paragraph exceed $25,000.
If that total does exceed $25,000, Buyer shall indemnify the Seller Indemnitees
for all such Losses, not just the amount in excess of $25,000.
49
<PAGE>
(c) Cap. Notwithstanding paragraph (a) of this Section 7.2,
Buyer shall not be required to indemnify the Seller Indemnitees under that
paragraph for any Losses in excess of a total of $3 million, provided, however,
that the limitation set forth in this sentence shall not apply to any obligation
or liability of Buyer under clause (ii) of that paragraph with respect to any
Environmental Liabilities. The "cap" specified in this paragraph shall also
apply to any "off-contract" remedies available to any Seller Indemnitee in
connection with this Agreement or any of the transactions to which it relates.
Except with respect to fraud and the matters covered by Section 7.5, that "cap"
shall be the limit of Buyer's obligations to all the Seller Indemnitees under
any contractual or other theories or causes of action with respect to this
Agreement or any of the transactions to which it relates.
7.3 Indemnification Procedure for Third-Party Claims. If any action or
claim (a "Third-Party Claim") is commenced against any Buyer Indemnitee or
Seller Indemnitee (in any case, an "Indemnitee"), by a Person other than an
Indemnitee, for which an Indemnitee is entitled to seek and does seek
indemnification from one or more of the Indemnitors under Section 7.1 or 7.2
(collectively, as appropriate, the "Indemnitors"), the Indemnitee shall notify
the Indemnitor in writing and summarize the nature
50
<PAGE>
of the Third-Party Claim and the basis upon which it appears to have been
asserted. Any delay in giving such a notice shall not affect the rights of the
Indemnitee under this Article VII, unless and then only to the extent the
Indemnitor demonstrates that such delay prejudiced the rights of the Indemnitor
with respect to the Third-Party Claim. Within 10 days after an Indemnitee gives
such a notice, the Indemnitor shall notify the Indemnitee in writing whether the
Indemnitor elects to defend the Third-Party Claim. If the Indemnitor so elects
to defend, it shall do so but shall not settle or compromise the Third-Party
Claim without the Indemnitee's prior written consent. If the Indemnitor does not
so elect to defend or fails to defend, the Indemnitee shall be entitled, but not
obligated, to defend. Irrespective of whether the Indemnitor defends or the
Indemnitee defends, the Indemnitor shall pay and currently fund all costs and
expenses of the defense. Moreover, if the Indemnitor does not so elect to defend
or fails to defend, the Indemnitee, after giving the Indemnitor at least five
days' prior written notice of its intention to proceed with a settlement, need
not consult the Indemnitor regarding any settlement and shall nevertheless
retain all rights to indemnification with respect to that settlement that are
otherwise provided in this Article VII.
7.4 Survival. Except as provided in the balance of this Section 7.4,
the indemnification obligations set forth in this
51
<PAGE>
Article VII shall survive for two years after the Closing. The indemnification
obligations relating to Taxes in clause (i) of Section 7.1 and the
representations and warranties set forth in Section 3.5 shall survive for seven
years after the Closing. The indemnification obligations relating to
Environmental Liabilities (clause (i) of Sections 7.1 and clause (ii) of Section
7.2) and the representations and warranties set forth in Section 3.12 shall
survive for ten years after the Closing. The indemnification obligations
relating to the representations and warranties set forth in the License
Agreement shall survive for five years after the Closing. The last date of the
two-year, five-year, seven-year and ten-year periods specified above are
referred to as "Expiration Dates". The indemnification obligations shall be of
no further force and effect after the relevant Expiration Date, unless and then
only to the extent that a claim or claims for indemnification have been asserted
in writing to the Indemnitor on or before the relevant Expiration Date.
7.5 Covenants Not Covered. The rules regarding indemnification set
forth in this Article VII (including, for example, the thresholds, caps and
survival periods) shall not govern any breach of any covenant of either Party
set forth in Article V or any other Article or in the License Agreement. Rather,
in the event of any such breach, the non-breaching Party
52
<PAGE>
shall have its normal remedies for breach of contract subject, however, to
Sections 9.4 and 9.5.
7.6 Irrelevance of Due Diligence. Nothing that Buyer or its
representatives learn in the course of their due diligence, whether before or
after the date of this Agreement, that is not expressly set forth in this
Agreement including the Schedules, shall diminish or otherwise affect any of the
representations or warranties, or any of the indemnification or other
obligations, of Seller contained in this Agreement or in any document delivered
by Buyer in connection with the Closing.
ARTICLE VIII
TERMINATION
8.1 Grounds for Termination. This Agreement may be terminated at any
time before the Closing:
(a) by the mutual written consent of the Parties or
(b) at any time on or after December 31, 1997, by Buyer alone,
if Buyer determines, in the exercise of its good faith judgment, that any
condition set forth in Section 6.1 or
53
<PAGE>
6.2 has not been satisfied or waived, unless Buyer has materially breached this
Agreement or
(c) at any time on or after December 31, 1997, by Seller
alone, if Seller determines, in the exercise of its good faith judgment, that
any condition set forth in Section 6.1 or 6.3 has not been satisfied or waived,
unless Seller has materially breached this Agreement.
8.2 Certain Effects of Termination. Following any termination of this
Agreement under Section 8.1, neither Party shall have any liability to the other
Party for any breach of any representation, warranty or covenant contained in
this Agreement unless that breach was willful.
54
<PAGE>
ARTICLE IX
MISCELLANEOUS
9.1 Notices. All notices and other communications required by or made
in connection with this Agreement shall be in writing and shall be deemed to
have been duly given on the date of delivery, if delivered in person or by
courier, or three days after mailing, if mailed by first class mail, postage
prepaid, addressed as follows:
If to Buyer: Watkins-Johnson Company
333 Hillview Avenue
Palo Alto, California 94304
Attention: Mr. Frank Emery
with a copy to: Heller Ehrman White & McAuliffe
333 Bush Street
San Francisco, California 94104
Attention: Daniel E. Titelbaum, Esq.
If to Seller: Samsung Semiconductor, Inc.
3655 North First Street
San Jose, California 95134
Attention: Mr. Y.B. Rha
with a copy to: Samsung Semiconductor, Inc.
3655 North First Street
San Jose, California 95134
Attention: Claudia Carrington, Esq.
The names and addresses specified in this Section may be changed by means of a
notice given in accordance with this Section.
55
<PAGE>
9.2 Governing Law. This Agreement shall be governed by the laws of the
State of California but without regard to its laws regarding conflicts of laws.
9.3 Expenses. Each Party shall pay all the costs and expenses incurred
by it in connection with the negotiation and drafting of this Agreement and the
Ancillary Agreements, and the completion of the Closing.
9.4 Arbitration. Any and all disputes arising under or otherwise
connected with this Agreement shall be finally settled by arbitration under the
commercial rules of the American Arbitration Association. There shall be three
arbitrators, one appointed by Seller, one appointed by Buyer and the third
appointed by the two arbitrators so selected. If a third arbitrator has not been
appointed by the 15th day after the first arbitrator has been appointed, the
American Arbitration Association shall select that third arbitrator. The Parties
shall have all rights to discovery provided by Section 1283.05 of the California
Code of Civil Procedure. All awards and orders of the arbitration panel shall be
final and binding on both Parties. Judgment upon any arbitration award or order
may be entered in any court having jurisdiction. The arbitrators shall not have
the power to award punitive damages, treble damages or any other
56
<PAGE>
damages that are not compensatory even if permitted under the laws of California
or any other applicable law. The arbitration shall be conducted in Palo Alto,
California.
9.5 Costs of Enforcement. In the event of any arbitration respecting
this Agreement or any of the matters to which it relates (see Section 9.4) or
any litigation respecting this Agreement or any such matters, the Party or
Parties that substantially prevail in that arbitration or litigation shall be
entitled to recover their reasonable costs and expenses incurred in connection
with that proceeding (including their attorneys' fees and costs) from the Party
or Parties that did not substantially prevail. In the event of "crossing"
indemnity claims regarding similar subject matter (for example, Environmental
Liabilities regarding or allegedly regarding events that occurred both before
and after the Closing and, in the case of the latter, for which Seller is not
otherwise responsible under Section 5.9), such costs and expenses shall be
reasonably apportioned based on the outcome of those crossing claims. The
reference in this Section 9.5 to litigation shall not affect the interpretation
of Section 9.4. The third party beneficiaries of this Agreement (see Section
9.9) shall be considered "Parties" for purposes of Section 9.4 and this Section
9.5.
57
<PAGE>
9.6 Amendment. This Agreement may be amended only by means of a written
instrument signed by each Party.
9.7 Assignment. Except as provided in the next two sentences, no Party
to this Agreement may assign or delegate all or any portion of its rights or
obligations under this Agreement without the prior written consent of the other
Party. However, before or after the Closing, without the need for any further
consent, Buyer may assign its rights under this Agreement to any direct or
indirect wholly-owned subsidiary of Buyer, it being understood that any such
assignment shall not relieve Buyer of any obligation under this Agreement. Also,
after the Closing, without the need for any further consent, Buyer may assign
its rights under Article VII to any Person that acquires all or a substantial
portion of the Assets or Buyer's GaAs Business, it being understood, again, that
any such assignment shall not relieve Buyer of any obligation under this
Agreement.
58
<PAGE>
9.8 Counterparts. For convenience, this Agreement may be signed in
counterparts which together shall constitute one instrument.
9.9 Third Party Beneficiaries. Buyer's Affiliates and Seller's
Affiliates shall be third party beneficiaries of Article VII. Otherwise, this
Agreement is for the sole benefit of the Parties and not for the benefit of any
other Person.
9.10 Entire Agreement. This Agreement and the Ancillary Agreements
contain the entire agreement and understanding between
59
<PAGE>
Buyer and Seller regarding their subject matter.
IN WITNESS WHEREOF, the Parties have signed and delivered this
Agreement as of the date that appears in its first paragraph.
WATKINS-JOHNSON COMPANY
By s/W. Keith Kennedy
-------------------
W. Keith Kennedy,
President and Chief
Executive Officer
By s/Scott Buchanan
-------------------
Scott Buchanan,
Vice President and Chief
Financial Officer
SAMSUNG SEMICONDUCTOR, INC.
By s/Y.B. Rha
-------------------
Y.B. Rha,
President
By s/B.S. Cho
-------------------
B.S. Cho
Vice President of Finance
60
<TABLE>
<CAPTION>
<S> <C> <C>
FIRST AMERICAN TITLE
ESCROW No, 512581
RECORDING REQUESTED BY, AND DOCUMENT 13993076 Titles: / Pages: 9
WHEN RECORDED, MAIL TO: [BAR CODE}
0013993076 Fees .... 51.00*
WATKINS-JOHNSON COMPANY Taxes.... **Conf **
c/o HOPKINS & CARLEY Copies...
TEN ALMADEN BLVD. AMT PAID 51.00
EIGHT FLOOR ---------------------------------------------------
SAN JOSE, CA 95111 BRENDA DAVIS RDE # 002
ATTN: GARTH E. PICKETT SANTA CLARA COUNTY RECORDER 12/30/1997
Recorded at the request of 8:00 AM
First American Title Company
FOR RECORDER USE ONLY
- ----------------------------------------------------------------------------------------
</TABLE>
Exhibit 10.Z
ASSIGNMENT OF LEASES
THIS ASSIGNMENT OF LEASES ("Assignment") is made as of the 30th day of
December, 1997, by and between Taylor Woodrow Property Company (California),
Inc., a California corporation ("Assignor") and Watkins-Johnson Company, a
California corporation ("Assignee"), and shall become effective upon the date of
recordation hereof. This Assignment is entered into on the basis of the
following facts, understandings and intentions of the parties:
R E C I T A L S:
A. The Board of Trustees of The Leland Stanford Junior University
("Stanford"), as Lessor, and Kern County Land Company, as Lessee, entered into a
Lease ("Stanford Lease"), dated as of November 1, 1959, a memorandum of which
was recorded on December 8, 1959 in Book 4630, Page 286 of the Official Records
of Santa Clara County.
B. The Stanford Lease has been amended by amendments dated as of August
1, 1963, April 22, 1969, May 31, 1984, and two amendments, each dated as of
September 15, 1997, as more fully described in Recital C below.
C. Pursuant to the Agreement Amending Ground Lease (Property 1) dated
September 15, 1997, recorded on October 8, 1997 under Series No. 13890986 of the
Official Records of Santa Clara County and the Agreement Amending Ground Lease
(Property 2) dated September 15, 1997, recorded on October 8, 1997 under Series
No. 13890987 of the Official Records of Santa Clara County, the Stanford Lease
was divided into two separate leases, defined therein and referred to in this
Assignment as the Property 1 Ground Lease and the Property 2 Ground Lease. The
Property 2 Ground Lease covers that certain real property described as Property
2 ("Property 2") in Exhibit A attached hereto and incorporated herein by this
reference.
D. By mesne assignments, Assignor is the lessee under the Stanford Lease,
as so amended.
1
<PAGE>
E. Pursuant to a Lease and Agreement ("Watkins-Johnson Lease"), dated
as of April 22, 1969, Lindco Properties Company, as successor lessee under the
Stanford Lease, subleased all of the real property covered by the Stanford Lease
to Assignee. The Watkins-Johnson Lease has been amended by amendments dated
August 15, 1969 and October 31, 1994.
F. By mesne assignments, Assignor is the lessor under the
Watkins Johnson Lease, as amended.
G. Pursuant to that certain Lease Termination and Assignment of
Leasehold Interest Agreement and Joint Escrow Instructions ("Transfer
Agreement"), between Assignor and Assignee, dated as of March 31, 1997, Assignor
agreed to assign to Assignee (i) its interest as lessee under the Property 2
Ground Lease and (ii) its interest as lessor under the Watkins-Johnson Lease, as
amended, to the extent the same relates to Property 2 (the "Watkins-Johnson
Property 2 Lease"), and Assignee agreed to accept such assignments, and such
assignment is pursuant to an exchange of leasehold interests between the parties
and payment of additional Consideration to Assignee.
NOW, THEREFORE, in consideration of the mutual covenants and promises
of the parties provided for in the Transfer Agreement and herein, the parties
agree as follows:
1. Assiqnment and Assumption. Assignor hereby assigns all of its right,
title and interest in the Property 2 Ground Lease and the Watkins-Johnson
Property 2 Lease to Assignee, and Assignee hereby accepts such assignments and
agrees to be bound by the terms, covenants and conditions of the Property 2
Ground Lease and the Watkins-Johnson Property 2 Lease, and assumes all of
Assignor's obligations and duties under the Property 2 Ground Lease and the
Watkins-Johnson Property 2 Lease.
2. No Assignments. Except for the easements, access agreements and
other encumbrances which have been recorded (or memoranda of which have been
recorded) in the Official Records of Santa Clara County, Assignor represents and
warrants to Assignee that: Assignor has not sublet, assigned, conveyed,
encumbered or otherwise transferred all or any portion of its right, title or
interest under the Property 2 Ground Lease or the Watkins-Johnson Property 2
Lease or any claim, demand, obligation, liability, action or cause of action
arising thereunder.
3. No Merqer. The parties do not intend any merger of the Property 2
Ground Lease and the Watkins-Johnson Property 2 Lease by virtue of the
assignments set forth herein. Further, Assignee's indemnification obligations
pursuant to Paragraph 10 of the Watkins-Johnson Property 2 Lease shall survive
this Assignment with respect to acts, events, conditions (including without
2
<PAGE>
limitation environmental conditions) or circumstances occurring or arising prior
to the date hereof.
4. Attorneys' Fees. If any party commences an action against the other
party arising out of or in connection with this Assignment, the prevailing party
shall be entitled to recover from the losing party the costs and expenses of
such action, including reasonable attorneys' fees and court costs.
5. Time. Time is of the essence of every provision of this Assignment.
6. Applicable Law. This Assignment shall be construed in accordance and
governed by the laws of the State of California.
7. Successors and Assiqns. The terms, covenants and conditions
contained in this Assignment shall be binding upon and inure to the benefit of
the heirs, successors and assigns of the parties hereto.
8. Authority. Each party represents and warrants to the other that it
has full right, power and authority to enter into this Assignment, and has
obtained all necessary consents and resolutions required under the documents
governing its affairs in order to consummate this transaction, and the persons
executing this Assignment have been duly authorized to do so.
3
<PAGE>
9. Counterparts. This Assignment may be executed in multiple
counterparts, each of which shall be deemed a duplicate original, but all of
which taken together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have executed this Assignment as of the
day and year first above written.
"Assignor"
TAYLOR WOODROW PROPERTY
COMPANY (CALIFORNIA), INC.,
a California corporation
By: /s/ Tom Redwitz
--------------------------------
Tom Redwitz
--------------------------------
(type or print name)
Its: Vice President
--------------------------------
"Assignee"
WATKINS-JOHNSON COMPANY,
a California corporation
By: /s/ W. Keith Kennedy
--------------------------------
W. Keith Kennedy
--------------------------------
(type or print name)
Its: President and CEO
--------------------------------
4
Exhibit 21
SUBSIDIARIES OF WATKINS-JOHNSON COMPANY
Jurisdiction of
Subsidiary Incorporation
- --------------------------------------------------------------- ----------------
WJ Semiconductor Equipment Group, Inc. California
WJ Telecommunications Group, Inc. California
WJ Wireless Products Group, Inc. California
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 Europe, Limited United Kingdom
Page 47
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 9, 1998 appearing in your
Annual Report on Form 10-K for the year ended December 31, 1997.
Deloitte & Touche LLP
San Jose, California
March 19, 1998
Page 48
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 134,462
<SECURITIES> 0
<RECEIVABLES> 45,690
<ALLOWANCES> 0
<INVENTORY> 46,675
<CURRENT-ASSETS> 258,193
<PP&E> 178,795
<DEPRECIATION> 82,382
<TOTAL-ASSETS> 358,212
<CURRENT-LIABILITIES> 104,586
<BONDS> 33,234
0
0
<COMMON> 40,631
<OTHER-SE> 179,761
<TOTAL-LIABILITY-AND-EQUITY> 358,212
<SALES> 291,271
<TOTAL-REVENUES> 291,271
<CGS> 196,675
<TOTAL-COSTS> 196,675
<OTHER-EXPENSES> 100,133
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,425
<INCOME-PRETAX> (6,962)
<INCOME-TAX> (3,000)
<INCOME-CONTINUING> (3,962)
<DISCONTINUED> 36,887
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32,925
<EPS-PRIMARY> 3.99
<EPS-DILUTED> 3.99
</TABLE>
