FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission file number 1-5631
WATKINS-JOHNSON COMPANY
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(Exact name of registrant as specified in its charter)
CALIFORNIA 94-1402710
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3333 Hillview Avenue, Palo Alto, California 94304-1223
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(Address of principal executive offices) (Zip Code)
(650) 493-4141
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes X . No .
--- ---
Common stock, no par value, outstanding as of September 25, 1998
7,249,000 shares
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
The interim financial statements are unaudited; however,
Watkins-Johnson Company believes that all adjustments
necessary for a fair statement of results for such interim
periods have been included and all such adjustments are of a
normal recurring nature. The results for the nine months ended
September 25, 1998, are not necessarily indicative of the
results for the full year ending December 31, 1998.
The consolidated financial statements required by Rule 10-01
of Regulation S-X are included in this report beginning on the
next page.
2
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS*
For the periods ended September 25, 1998 and September 26, 1997
<CAPTION>
Three Months Ended Nine Months Ended
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(Dollars in thousands, except per share amounts) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sales $ 26,257 $ 79,176 $ 148,718 $ 219,071
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Costs and expenses:
Cost of goods sold 39,776 48,741 119,402 139,663
Cost of goods sold-write down of
discontinued products 17,119 17,119
Selling and administrative 11,318 16,006 40,889 43,770
Restructuring charges 27,290 27,290
Research and development 12,611 11,548 39,154 32,422
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108,114 76,295 243,854 215,855
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Income (loss) from operations (81,857) 2,881 (95,136) 3,216
Interest and other income (expense)--net 1,712 (16) 5,783 1,067
Interest expense (283) (358) (866) (1,048)
Gain on real property 14,783
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Income (loss) from continuing operations before
income taxes (80,428) 2,507 (75,436) 3,235
Income tax benefit (expense) 26,014 (745) 24,516 (905)
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Income (loss) from continuing operations (54,414) 1,762 (50,920) 2,330
Income from discontinued operations,
net of taxes 1,828 6,820
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Net income (loss) $ (54,414) $ 3,590 $ (50,920) $ 9,150
==================================================================================================================================
Basic per share amounts:
Income (loss) from continuing operations $ (6.93) $ .21 $ (6.27) $ .28
Income from discontinued operations .23 .83
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Net income (loss) $ (6.93) $ .44 $ (6.27) $ 1.11
==================================================================================================================================
Basic average common shares 7,857,000 8,221,000 8,122,000 8,259,000
Diluted per share amounts:
Income (loss) from continuing operations $ (6.93) $ .21 $ (6.27) $ .27
Income from discontinued operations .21 .80
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Net income (loss) $ (6.93) $ .42 $ (6.27) $ 1.07
==================================================================================================================================
Diluted average common shares 7,857,000 8,528,000 8,122,000 8,513,000
<FN>
*Unaudited
</FN>
</TABLE>
3
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME*
For the periods ended September 25, 1998 and September 26, 1997
<CAPTION>
Three Months Ended Nine Months Ended
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(Dollars in thousands) 1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Net income (loss) $ (54,414) $ 3,590 $ (50,920) $ 9,150
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Other comprehensive income (expense),
net of tax:
Foreign currency translation
adjustments (273) (202) (531) (93)
Net unrealized holding gains on securities
arising during period 338 289
Less reclassification adjustment for gains
(losses) on securities included
in net income (10)
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Other comprehensive income (expense) 65 (202) (252) (93)
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Comprehensive income $ (54,349) $ 3,388 $ (51,172) $ 9,057
==================================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
4
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 25, 1998 and December 31, 1997
<CAPTION>
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(Dollars in thousands) 1998* 1997
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ASSETS
<S> <C> <C>
Current assets:
Cash and equivalents $ 17,276 $ 134,462
Short-term investments 62,945
Receivables 23,647 45,690
Inventories:
Finished goods 2,966 9,283
Work in process 13,546 18,519
Raw materials and parts 9,774 18,873
Other 42,514 31,366
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Total current assets 172,668 258,193
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Property, plant, and equipment 135,452 178,795
Accumulated depreciation and amortization (75,077) (82,382)
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Property, plant, and equipment--net 60,375 96,413
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Other assets 14,221 3,606
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$ 247,264 $ 358,212
==================================================================================================================================
LIABILITIES AND SHAREOWNERS'
EQUITY
Current liabilities:
Payables $ 12,419 $ 16,188
Accrued liabilities 57,801 88,398
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Total current liabilities 70,220 104,586
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Long-term obligations 32,227 33,234
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Shareowners' equity:
Common stock 37,732 40,631
Retained earnings 107,932 180,356
Accumulated other comprehensive income (847) (595)
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Total shareowners' equity 144,817 220,392
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$ 247,264 $ 358,212
==================================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
5
<PAGE>
<TABLE>
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS*
For the periods ended September 25, 1998 and September 26, 1997
<CAPTION>
Nine Months Ended
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(Dollars in thousands) 1998 1997
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OPERATING ACTIVITIES:
<S> <C> <C>
Net income (loss) $ (50,920) $ 9,150
Reconciliation of net income (loss) to cash flows
Depreciation and amortization 13,499 10,499
Gain on asset retirements (11,222)
Results of discontinued operations (6,820)
Restructuring 44,409
Net changes in:
Receivables 21,995 19,204
Inventories 3,160 (3,100)
Other assets (15,580) (795)
Accruals and payables (38,897) (117)
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Net cash provided (used) by continuing operating activities (33,556) 28,021
Net cash provided by discontinued operations 14,100
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Net cash provided (used) by operating activities (33,556) 42,121
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INVESTING ACTIVITIES:
Additions of property, plant, and equipment (12,745) (12,538)
Purchase of short-term investments (94,938)
Proceeds from sale of short-term investments 32,461
Proceeds on asset retirements and other 16,690 647
Restricted plant construction funds 3,738
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Net cash used in investing activities (58,532) (8,153)
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FINANCING ACTIVITIES:
Payments on long-term debt borrowing (395) (914)
Net borrowings (repayments) under line-of-credit 23
Proceeds from issuance of stock 1,459 2,339
Repurchase of common stock (22,963) (5,748)
Dividends paid (2,899) (2,973)
Other (103) (111)
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Net cash used in financing activities (24,878) (7,407)
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Effect of exchange rate changes on cash (220) 1,155
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Net increase (decrease) in cash and equivalents (117,186) 27,716
Cash and equivalents at beginning of period 134,462 15,702
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Cash and equivalents at end of period $ 17,276 $ 43,418
==================================================================================================================================
<FN>
*Unaudited
</FN>
</TABLE>
6
<PAGE>
Item 1. Financial Statements (continued)
Supplementary information to the financial statements:
A dividend of twelve cents per share was declared and paid
during the third quarter of 1998 and 1997.
<TABLE>
Per share amounts are computed based on the weighted average
number of basic and diluted (dilutive stock options) common
and common equivalent shares outstanding during the period.
Per share amounts from continuing operations were computed as
follows:
<CAPTION>
(Dollars in thousands, except per share amounts) Three Months Ended Nine Months Ended
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Sept 25, 1998 Sept 26, 1997 Sept 25, 1998 Sept 26, 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Denominator for basic per share:
<S> <C> <C> <C> <C>
Weighted average shares outstanding 7,857,000 8,221,000 8,122,000 8,259,000
================ ================ ================== ================
Denominator for diluted per share:
Weighted average shares outstanding 7,857,000 8,221,000 8,122,000 8,259,000
Effect of dilutive stock options 307,000 254,000
---------------- ---------------- ------------------ ----------------
Diluted average common shares 7,857,000 8,528,000 8,122,000 8,513,000
================ ================ ================== ================
Net income (loss) from continuing
operations (numerator) $ (54,414) $ 1,762 $ (50,920) $ 2,330
================ ================ ================== ================
Basic net income (loss) per share $ (6.93) $ .21 $ (6.27) $ .28
================ ================ ================== ================
Diluted net income (loss) per share $ (6.93) $ .21 $ (6.27) $ .27
================ ================ ================== ================
<FN>
This calculation is submitted in accordance with Regulation S-K, Item 601(b)(11).
</FN>
</TABLE>
7
<PAGE>
Item 1. Financial Statements (continued)
For the three months ended September 25, 1998 and nine months
ended September 25, 1998, the incremental shares from the
assumed exercise of 95,000 and 149,000 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
1,194,000 and 542,000 shares of common stock were not included
in the computation of diluted per share amounts for the three
months ended September 25, 1998 and September 26, 1997,
respectively, and 862,000 and 586,000 shares of common stock
were not included in the computation of diluted per share
amounts for the nine months ended September 25, 1998 and
September 26, 1997, respectively, because the weighted average
exercise prices were greater than the average market prices of
the common shares. For the three months ended September 25,
1998 and September 26, 1997, weighted average exercise prices
of $30.82 and $39.77, respectively, exceeded the average
market prices of $21.68 and $34.18, respectively. For the nine
months ended September 25, 1998 and September 26, 1997,
weighted average exercise prices of $33.84 and $39.55,
respectively, exceeded the average market prices of $24.64 and
$29.41, respectively.
<TABLE>
Sales to external customers and pre-tax profit (loss) from
continuing operations by business segment are as follows:
<CAPTION>
Three months ended September 25,1998 and September 26, 1997
Sales Pre-tax income (loss)
---------------------------------------------------
(in thousands) 1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Wireless Communications $ 19,069 $ 28,853 $(14,751) $2,218
Semiconductor Equipment 7,188 50,323 (67,106) 663
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Income from continuing operations (81,857) 2,881
Other income (expense)-net 1,429 (374)
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Total $ 26,257 $ 79,176 $(80,428) $2,507
==================================================================================================
Nine months ended September 25,1998 and September 26, 1997
Sales Pre-tax income (loss)
---------------------------------------------------
(in thousands) 1998 1997 1998 1997
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Wireless Communications $ 75,910 $76,595 $(15,195) $2,294
Semiconductor Equipment 72,808 142,476 (79,941) 922
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Income from continuing operations (95,136) 3,216
Other income (expense)-net 19,700 19
--------------------------------------------------------------------------------------------------
Total $148,718 $219,071 $(75,436) $3,235
==================================================================================================
</TABLE>
8
<PAGE>
Item 1. Financial Statements (continued)
Total assets at September 25, 1998 and December 31, 1997 by business segment are
as follows:
(in thousands) September 25, 1998 December 31, 1997
- -------------------------------------------------------------------------------
Wireless Communications $ 44,211 $ 54,408
Semiconductor Equipment 65,484 132,528
Corporate 137,569 171,276
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Total $ 247,264 $ 358,212
===============================================================================
Corporate assets consist primarily of cash and equivalents,
short-term investments, and deferred taxes.
Recently Issued Accounting Standard--In June 1998, the FASB
issued SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities." This Statement requires companies to
record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains and losses
resulting from changes in the fair market values of those
derivative instruments would be accounted for depending on
the use of the instrument and whether it qualifies for hedge
accounting. SFAS 133 will be effective for the company's year
ending December 31, 2000. The company enters into forward
exchange contracts to hedge sales transactions and firm
commitments denominated in foreign currencies. The company
does not engage in foreign currency speculation. Management
believes that this Statement or volatility in derivative
instruments will not have a significant impact on the
company's financial condition or results of operations.
Discontinued Product Lines and Related Restructuring
Charges--During the third quarter of 1998, the company
announced restructurings of its operations to focus on its
core chemical vapor deposition (CVD) operations in the
Semiconductor Equipment Group by discontinuing efforts on its
High-Density Plasma initiative. Also, the company's Wireless
Communications business reevaluated its Base2(TM) base-station
product, reassessing key customer needs and market conditions.
Inventory, demo equipment, and customized fixed assets
associated with these products were written down in the
restructuring. As a result, the company reduced its global
work force during the quarter by approximately 19% and
downsized its operations. The company recorded charges of
$44.4 million related to facilities and fixed assets,
inventory, severance and other exit costs as follows:
Accrued
severance, Write down of
benefits, and facilities and Write down
(in thousands) other costs fixed assets of inventory
- --------------------------------------------------------------------------------
Restructuring provision $3,921 $23,370 $17,119
=============================
Amounts paid against restructuring provision 0
- --------------------------------------------------
Balance at September 25, 1998 $3,921
==================================================
9
<PAGE>
Item 1. Financial Statements (continued)
Included in the third-quarter 1998 asset write downs is an
approximately $5.9 million charge related to the Semiconductor
Equipment Group's facility in Japan, which was written down to
fair market value in accordance with Statement of Financial
Accounting Standards No. 121, "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed
Of."
The company anticipates substantially all severance and
benefits will be paid during the remainder of 1998 as the
company completes its restructuring program. Restructuring
charges are further discussed in Part I, Item 2 of this
quarterly report on Form 10-Q.
Credit Facility Noncompliance--The company has arrangements
with several banks to provide a $50 million unsecured credit
facility. Because of the operating loss reported in the third
quarter of 1998, 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.
10
<PAGE>
PART I--FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Financial Condition and Liquidity
At September 25, 1998, cash and equivalents and short-term
investments totaled $80.2 million. During the first three
quarters of 1998, cash and equivalents decreased by $117.2
million, from $134.5 million to $17.3 million. The decrease in
cash and equivalents resulted primarily from the purchase of
short-term investments and repurchase of Watkins-Johnson
Company (the company) common stock, as discussed below.
The company reported a net loss of $50.9 million for the first
three quarters of 1998, while net cash used by operations was
$33.6 million. For the comparable period last year, net income
was $9.2 million and net cash provided by operations was $42.1
million. For the first three quarters of 1998, net cash used
by operating activities differed from net income for the
period primarily because of decreases for: a $14.8 million
gain on real property, a $15.6 million net change in other
assets and a $38.9 million net change in accruals and
payables; and increases for: depreciation and amortization
charges of $13.5 million, restructuring charges of $44.4
million, and a net change in receivables of $22 million. The
net change in accruals and payables was partially due to
income tax payments related to the fourth quarter 1997 gain on
discontinued operations as well as accrued tax benefits
related to the current year loss. For the first three quarters
of 1997, net cash provided by operating activities differed
from net income for the period primarily because of increases
for: depreciation and amortization charges of $10.5 million,
net changes in receivables of $19.2 million, and cash provided
by discontinued operations of $14.1 million; and decreases
for: $6.8 million for the net income of discontinued
operations and a net change in inventory of $3.1 million.
Net cash used in investing activities was $58.5 million in the
first three quarters of 1998 compared to $8.2 million for the
same period in 1997. In 1998, the company purchased $94.9
million in short-term investments and $12.7 million in new
capital equipment, and received proceeds of $15.9 million from
the sale of real property and $32.5 million from the sale of
short-term investments. During the first three quarters of
1998, the company invested its excess cash and equivalents in
securities with maturities exceeding 90 days to take advantage
of the higher yields. These short-term investments, consisting
mostly of high grade commercial paper, are subject to interest
rate risk and will rise and fall in value if market interest
rates change. Cash used in investing activities in the first
three quarters of 1997 was for the purchase of $12.5 million
of new capital equipment which was partially offset by the
release of $3.7 million of restricted plant construction
funds.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The company used $24.9 million in financing activities in the
first three quarters of 1998 compared to $7.4 million for the
same period last year. During the first three quarters of 1998
the company repurchased 1,082,908 shares of its common stock
for $23 million and paid approximately $2.9 million in
dividends which was offset in part by $1.5 million in proceeds
from stock option exercises. During the first three quarters
of 1997 the company repurchased 204,000 shares of its common
stock for $5.7 million and paid $3.0 million in dividends
which was offset in part by $2.3 million in proceeds from
stock option exercises.
As of September 25, 1998, the company's principal source of
liquidity consisted of $17.3 million in cash and equivalents
and short-term investments valued at $62.9 million. The
company has arrangements with several banks to provide a $50
million unsecured credit facility. This facility expires on
March 31, 1999. During the first three quarters of 1998, the
company did not incur borrowings under this credit facility.
Because of the operating loss reported in the third quarter of
1998 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.
From time to time the company may enter into certain long-term
borrowing arrangements with financial lending institutions for
capital acquisitions of property, plant and equipment. As of
September 25, 1998, long-term borrowings of $17.4 million
consisted of two outstanding loans which are payable through
the year 2011 as fully disclosed in the company's 1997 annual
report filed on Form 10-K. At September 25, 1998, there were
no material commitments for capital expenditures.
Current Operations and Business Outlook
For the third quarter of 1998, the company reported sales of
$26.3 million and a net loss of $54.4 million, or $6.93 per
diluted share. This loss includes charges for restructuring,
down-sizing and other operating charges as discussed below and
in the company's announcement on September 8, 1998 as reported
on Form 8-K which was filed on September 10, 1998. In 1997,
third-quarter sales from continuing operations were $79.2
million, with net income from continuing operations of $1.8
million, or $0.21 per diluted share. Sales for the first three
quarters of 1998 were $148.7 million, with a net loss of $50.9
million, or $6.27 per diluted share. For the same period in
1997, sales from continuing operations totaled $219.1 million,
with net income from continuing operations of $2.3 million, or
$0.27 per diluted share.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
New orders for the third quarter of 1998 were $47 million,
about 18% higher than the $40 million in the second quarter of
1998 and about 15% lower than the $55 million for the third
quarter of 1997. Firm backlog on September 25, 1998 stood at
$86 million, compared to the September 26, 1997 backlog for
continuing operations of $113 million, and $69 million at June
26, 1998.
On September 8, Watkins-Johnson Company announced a
restructuring and cost-reduction plan. Third-quarter 1998
results include asset write downs and related restructuring
costs of $44.4 million, including termination charges of
approximately $2.9 million. A reduction of the company's
global work force by about 220 people was completed in
September 1998 reducing the company staff approximately 19%.
Added to the reductions of the first half of 1998, this brings
the company staff reduction this year to 36%.
Market weakness for semiconductor capital equipment is the
primary reason for the restructuring action. The company sized
its Semiconductor Equipment Group to match a reduced level of
forecasted revenue, reducing staff and inventory. As part of
the resizing, the high-density plasma (HDP)
chemical-vapor-deposition (CVD) system initiative was
discontinued. The group has ceased all activities associated
with the HDP program, and reduced the engineering and support
staff. Inventory, facilities and capital equipment associated
with this project were written down. The company is continuing
to support its customers with installed HDP systems, to permit
them time to transition to other alternatives. The
intellectual property generated by the plasma development
effort is being offered to potential buyers.
Included in the third-quarter 1998 asset write downs is an
approximately $5.9 million charge related to the Semiconductor
Equipment Group's facility in Japan, which was written down to
fair market value in accordance with Statement of Financial
Accounting Standards No. 121, "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed
Of."
The company's Wireless Communications business reevaluated its
Base2(TM) base-station product, reassessing key customer needs
and market conditions. As a result, specific assets associated
with this product with no future use were written down.
13
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
During the third quarter of 1998, Watkins-Johnson's Board of
Directors increased the share repurchase authorization by
1,000,000 shares to a maximum of 3,500,000 shares. Through
September 25, 1998 approximately 2,787,300 shares have been
repurchased by the company under this repurchase
authorization. During the third quarter of 1998 the company
repurchased 1,030,300 shares bringing the total repurchased
during 1998 to 1,082,908 shares. At the end of the third
quarter of 1998 there were approximately 7,249,000 shares
outstanding. Subsequent to September 25, 1998, an additional
712,000 shares were repurchased by the company, as discussed
below.
1998 is turning out to be a weak year for Watkins-Johnson.
The company faced some very difficult decisions as the
third-quarter events continued the tough times of the first
half of the year. Semiconductor equipment customers'
investment in capital equipment declined each quarter as the
year progressed. The company took the strong actions required
to bring its cost structure into alignment with the extremely
poor conditions of this cyclical market. The company believes
the actions it has in place will set the stage for future
growth and profitability when market conditions improve. The
operations and business outlook for each of the company's
business segments are discussed below.
Wireless Communications
Wireless communications sales in the third quarter of 1998
totaled $19.1 million, a 34% decrease from the prior year's
third quarter comparable sales of $28.9 million for this
segment. Sales for the first three quarters of 1998 totaled
$75.9 million compared to $76.6 million for the same period
last year. Orders for the third quarter of 1998 totaled
approximately $32 million, compared to $22 million for the
same period last year, and $14 million for the second quarter
of 1998. Major production orders for wireless local loop
assemblies were received this quarter from Lucent
Technologies, a key customer. The business segment is entering
the fourth quarter of 1998 with a backlog totaling
approximately $66 million compared to $53 million at September
26, 1997.
The company began to evaluate its marketing approach for the
Base2 base-station product during the second quarter of 1998.
At that time, the company decided to drop marketing directly
to service providers and the smaller system integrator firms.
For the Base2, the company decided to parallel the successful
marketing approach of the Palo Alto facility operations to the
major wireless original equipment manufacturers (OEM). During
the third quarter, management made several visits to all the
key OEM customers to test the market conditions for the Base2.
It became clear that the design philosophy and intellectual
property of the system will be salable in the future, but the
current design did not fit the OEM needs. As a result, the
company wrote down approximately $6 million of special
inventory and test equipment, and incurred some termination
costs.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Part of the difficulty the company is experiencing in the
Wireless Communications segment stems from the delay of a
major order. The major government program discussed in the
company's second-quarter 1998 Form 10-Q, which is budgeted and
has established funding, has now been delayed to mid-1999. The
company is following it closely.
Looking forward, it appears as though the Wireless
Communications shipping rate for the fourth quarter of 1998
will nearly double that of the third quarter. However, it is
expected that the revenues for 1998 will only slightly exceed
the $105 million of last year. The strong fourth quarter
anticipated shipments should allow the segment to be
profitable in the fourth quarter.
Various regulatory agencies of federal, foreign, state and
local governments can affect the wireless communication market
dynamics, causing unforeseen ebb and flow of orders and
delivery requirements. Domestic and international competition
from a number of companies, some of which are much larger than
Watkins-Johnson, is intense. The effect of these and other
factors could significantly affect the company's future
operating results.
Semiconductor Equipment Group
Sales of semiconductor equipment in the third quarter of 1998
were $7.2 million, down 86% from the $50.3 million recorded
for the same period last year. All of the third quarter
planned shipments came from the spares, service and training
business that the company gets and ships monthly. That
business runs between $3 million and $5 million a month. Sales
for the first three quarters of 1998 totaled $72.8 million
compared to $142.5 million for the same period last year.
This business segment is entering the fourth quarter of 1998
with a backlog totaling approximately $20 million compared to
$60 million at September 26, 1997, and $16 million at June 26,
1998.
The semiconductor industry plant investment has dramatically
declined and the company believes decisive actions were
required to bring its cost structure into alignment with the
extremely poor conditions of this cyclical market. As part of
the resizing, the high-density plasma (HDP)
chemical-vapor-deposition (CVD) system initiative was
discontinued. The business goal for the HDP system was to
achieve a 25 to 30 percent market share. The company believes
the performance of the current system is technically
competitive with the competitors' systems. However, the
product was very late to market and the severity of the
semiconductor business downturn exacerbated the lateness. The
company
15
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
determined that it probably would not meet the market share
goal and decided it was time to discontinue this project. The
intellectual property generated by the plasma development
effort is being offered to potential buyers. Several
interested parties contacted the company and exploratory
discussions have started.
The group also reviewed the requirements for its global sales
and service force. These operations were reduced in line with
the lower business expectations. While the group is watching
its expenses, the company believes it is taking the proper
steps to assure effective support of customers for both
service and new orders.
The company intends to preserve its global service and key
development activities to provide new equipment for the market
applications in premetal dielectric, shallow trench isolation
and very-low dielectric constant (VLK) films. The company will
continue to offer its core atmospheric pressure
chemical-vapor-deposition (APCVD) product line to
semiconductor manufacturers. Its future development activities
will be focused on two recently announced systems, the WJ-1500
and the WJ-3200A.
The WJ-1500 extends the continuous processing APCVD to
0.15-micron design-rule fabrication plants. The system is an
upgrade to the conveyor transport system with improved film
capability for the smaller design rules (0.18 micron) now
being employed, improved film uniformity, and higher
reliability. The company recently announced a multiple-system
order from Samsung Electronics Company.
The WJ-3000A (or AP Next) cluster platform is a "bridge"
product designed to facilitate chip makers' transition from
200-mm to 300-mm wafer processing. The WJ-3000A is a single
wafer, multiprocessing system with both 300-mm and 200-mm
capability. The company has been demonstrating its capability
to customers during 1998 with excellent results. A number of
customers are discussing beta site opportunities and the
company expects to have a beta placement in the first half of
1999.
Looking forward, the Semiconductor Equipment Group is now
sized to match a reduced level of forecasted revenue for the
balance of this year and for 1999. The company is reasonably
hopeful of fourth-quarter orders, which will allow the first
quarter of 1999 to also run at the planned rate. The company
expects its semiconductor equipment business to have flat
sales next year. However, it is difficult to predict what the
future might hold in the semiconductor equipment business and
it is certainly difficult to tell when an upturn might start.
The company has been encouraged in the last few months that
its customers have started asking questions again. They are
requesting evaluations, asking for
16
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
performance figures, and other information. This is a sign
that they might be moving into the buying mode. The company
believes the Semiconductor Equipment Group will be
appropriately positioned as the industry recovers.
Although the very long-range industry forecasts for the
semiconductor industry remain bright, the industry remains in
an overcapacity situation. Capital equipment decisions are
affected by a number of parameters and the company is watching
its customers' market dynamics closely. The industry is
confident of an upturn, but it appears to be well beyond 1998.
The Semiconductor Equipment Group's business depends upon the
planned and actual capital expenditures of the semiconductor
manufacturers, who react to the current and anticipated market
demand for integrated circuits. In 1996 its history of
cyclical variations returned with a market downturn. That
downturn was exacerbated in the fourth quarter of 1997 by
financial-system collapses and currency devaluations in Asia,
the company's principal overseas market for capital equipment.
Although the cyclical growth trend of the semiconductor
integrated circuits business is expected to return, it is
recognized that the semiconductor equipment business can vary
rapidly in response to customer demand. Following placement of
orders, customers frequently seek either faster or delayed
delivery, based on their changing needs. Uncertainty increases
significantly when projecting product demand in the future.
While the company cannot predict what effect these various
factors will have on operating results, the effect of these
and other factors could significantly affect the company's
future operating results.
Third Quarter of 1998 Compared to Third Quarter of 1997
Wireless Communications sales decreased 34% while
Semiconductor Equipment Group sales dropped 86%, resulting in
an overall company decrease from continuing operations of 67%.
Gross margins were negative in the third quarter of 1998
compared to gross margins of 38% for the same period last
year. The decrease in gross margins is due mostly to the lower
sales volume against fixed costs as well as the write down of
HDP and Base2 inventories. The company expects margins to
improve as a result of its resizing the operations to be in
line with the forecasted lower business volume.
17
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Excluding restructuring charges, selling and administrative
expenses increased to 43% of sales compared with 20% for the
same period last year, due mostly to the lower sales volume.
Actual selling and administrative expenses decreased 29% from
$16 million to $11.3 million due mostly to the work force
reduction and cost cutting efforts. Included in third quarter
operating results are $27.3 million in restructuring charges.
Research and development expenses were $12.6 million during
the third quarter of 1998, or 48% of sales, compared to $11.5
million, or 15% of sales, for the same period last year.
Although research and development is high as a percentage of
sales due to the lower sales volume, spending remained high
since the downsizing was not completed until September. As
previously discussed, earlier in the year the company began to
curtail research and development efforts on certain projects
which are not expected to have an impact on orders in 1999 and
in September 1998 discontinued its efforts on the HDP
initiative.
The pre-tax operating loss in the third quarter of 1998,
before other income, was $81.9 million compared with the $2.9
million of income for the same period last year. Interest and
other income (net of other expenses) increased $1.7 million
over the prior year due mostly to interest income earned on
the increased cash balance and short-term investments.
For the third quarter of 1998, the effective tax benefit rate
for federal, state and foreign income taxes was 32.3% compared
to a 29.7% tax expense rate on continuing operations for the
same period last year. The 32.3% tax benefit rate in 1998 is a
result of the loss reported and is below the statutory rate
mostly because of taxes accrued for some profitable foreign
operations offsetting benefits from federal and state research
tax credits.
Net income from continuing operations decreased from $1.8
million net income in the third quarter of 1997 to a $54.4
million loss for the same period this year. Including after
tax income of $1.8 million reported from discontinued
operations in the third quarter of 1997, net income decreased
from $3.6 million in the third quarter of 1997 to a $54.4
million loss reported for the current period.
18
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Third Quarter Year-to-Date 1998 Compared to Third Quarter
Year-to-Date 1997
Wireless Communications sales decreased 1% while Semiconductor
Equipment Group sales decreased 49%, resulting in an overall
company decrease from continuing operations of 32%. The
decrease in gross margins is due mostly to the lower sales
volume and the $17.1 million third quarter 1998 charges
related to discontinued products.
Excluding restructuring charges, selling and administrative
expenses decreased $2.9 million to 28% of sales compared with
20% for the same period last year. The higher percentage for
the first three quarters of 1998 resulted primarily from the
lower sales volume. Included in year-to-date 1998 operating
results are $27.3 million in restructuring charges.
Research and development expenses were $39.2 million during
the first three quarters of 1998, or 26% of sales, compared to
$32.4 million, or 15% of sales, for the same period last year.
Although research and development is high as a percentage of
sales due to the lower sales volume, spending was below budget
due to the focus of research and development efforts on
certain key projects, as previously discussed.
The pre-tax operating loss in the first three quarters of
1998, before other income and a gain on the sale of real
property, was $95.1 million compared with income from
continuing operations of $3.2 million for the same period last
year. Interest and other income (net of other expenses)
increased $4.7 million over the prior year due mostly to
interest income earned on the increased cash balance and
short-term investments. Also included in other income for the
first three quarters of 1998 is $1 million of net income from
two leases. In January 1998, the company concluded the sale of
vacant land adjacent to its San Jose, California facility,
resulting in a $14.8 million pre-tax gain reflected as "Gain
on real property" in the consolidated financial statements.
For the first three quarters of 1998, the effective tax
benefit rate for federal, state and foreign income taxes was
32.5% compared to a 28% tax expense rate on continuing
operations for the same period last year. The 32.5% tax
benefit rate in 1998 is below the statutory rate mostly
because of the year-to-date loss reported and is below the
statutory rate mostly because of taxes accrued for some
profitable foreign operations offsetting benefits from federal
and state research tax credits. The 28% tax rate for 1997
resulted mostly from the effect of the low level of income
with positive benefits from export sales and research credits,
which were offset by taxes incurred by foreign operations.
19
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Including the $14.8 million 1998 gain on the sale of land, net
income from continuing operations decreased from $2.3 million
in the first three quarters of 1997 to a $50.9 million net
loss for the same period this year. Including after tax income
of $6.8 million reported from discontinued operations in the
first three quarters of 1997, net income decreased from $9.2
million in the first three quarters of 1997 to a $50.9 million
net loss reported for the first three quarters of 1998.
Subsequent Events
Subsequent to September 25, 1998 and through October 21, 1998,
the company repurchased an additional 712,000 shares of its
common stock for $13.2 million, bringing the total number of
shares outstanding on October 21, 1998 to 6,537,000.
Risks and Uncertainties That May Affect Future Results
All statements in this report, other than statements of
historical facts, should be considered forward-looking
statements. By way of example only, those include statements
about the company's strategies, objectives, plans,
expectations and anticipated results, and expectations for the
economy generally or specific industries. The words "expect",
"anticipate", "looking forward" and other similar expressions
used in this report are intended to identify forward-looking
statements that involve risks and uncertainties that may cause
actual results and expectations to differ materially from
those expressed. Such risks and uncertainties include, but are
not limited to: product demand and market acceptance risks,
the effect of economic conditions, the impact of competitive
products and pricing, product development, commercialization
and technological difficulties, capacity and supply
constraints or difficulties, business cycles, the results of
financing efforts, actual purchases under agreements, the
effect of the company's accounting policies, U.S. Government
export policies, geographic concentrations, natural disasters
and other risks, including those detailed in the company's
1997 Form 10-K filed with the Securities and Exchange
Commission. Investors and prospective investors are cautioned
not to place undue reliance on these forward-looking
statements. The company undertakes no obligation to announce
any revisions to its forward-looking statements to reflect
events or circumstances as they actually develop or occur in
the future.
20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Year 2000 Compliance
The Year 2000 (Y2K) issue involves the ability of computer
software to properly utilize dates for years after the year
1999. Computers have traditionally used the last two digits of
the year for date calculations and could interpret the year
2000 as the year 1900. The critical areas being addressed by
the company are its internal computer systems, products made
by the company and relationships with external organizations.
The company is addressing both information technology ("IT")
and non-IT systems which typically include embedded technology
such as microcontrollers.
The company regularly updates its information systems
capabilities, and has evaluated significant computer software
applications for compatibility with the year 2000. Several
years ago the company adopted a strategic plan for its
internal computer systems with the goal of going to an
off-the-shelf real time system. As a result, the company's
domestic operations run all financial and manufacturing
business applications on an Oracle data base with the
associated Oracle application modules. Oracle's solution to
Y2K is its version 10.7 of the application software. As of
June 1998, the company's domestic operations are on Oracle
version 10.7. The company's international operations run all
business applications on SunSystems software which is deemed
Y2K compliant. There are other software implementations that
are minor in nature that may take until December 1998 to be
completed. There are no known non-IT issues that will
adversely impact the company's information systems
capabilities. With the system changes implemented to date and
other planned changes, the company anticipates that its
internal computer software applications will be compatible
with the year 2000. In the event of any Y2K disruptions, the
company will follow the software vendors' contingency
directives.
The Y2K issue (both IT and non-IT) for company products is
being addressed by the respective business units. The
Semiconductor Equipment Group has identified the issues,
addressed the problems and developed solutions. The solutions
have been tested by third parties and found to work
satisfactorily. The date issues do not affect the production
of wafers, but involve temporarily maintaining manual records
of wafer production history on systems produced prior to 1998.
The Y2K situation is an issue for only some of the products in
the Wireless Communications Group. The group is in the process
of identifying which products are affected. If a product is
affected, the group will seek to develop a solution and then
communicate it to customers. The current schedule is to
identify all affected products and develop solutions by late
1998 or early 1999 to ensure timely communication to the
customers. The respective business units have also addressed
non-IT issues with respect to their manufacturing facilities
and there are no known non-IT issues that will adversely
impact the company's operations.
21
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
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 operations will not be impacted by this
industry-wide issue. The company is perpetually addressing the
Y2K issues with external organizations. This involves
customers, suppliers and service providers. Although the
initial review does not indicate any significant risk, this
will be an ongoing effort. The company is considering
alternative vendors as a contingency plan.
With the actions that have been taken and the other planned
activities, the company is not anticipating any significant
disruption of business. The most likely disruption that could
occur is where the company uses wire transfers to move funds
to vendors and subsidiaries, some of which are located in
foreign countries. Since the status of all banking systems in
the world cannot be determined in advance, there may be minor
disruption in the ability to transfer funds in real time along
the current routes. Contingency plans, which include
alternative banks and standby letters of credit, are in place
to address what is needed to minimize any business
interruption.
Expenditures specifically related to software modifications
for year 2000 compatibility are not expected to have a
material effect on the company's operations or financial
position. The cost to address and remedy the company's Y2K
issues is estimated to be $0.1 million in 1997, $0.2 million
in 1998 and $0.2 million in 1999.
Single European Currency Conversion
The company has established a team to address issues raised by
the introduction of the Single European Currency (Euro) for
initial implementation as of January 1, 1999, and through the
transition period to January 1, 2002. The company expects to
be able to meet related legal requirements by January 1, 1999,
and through the transition period. The company does not expect
the cost of any system modifications to be material and does
not currently expect that introduction and use of the Euro
will materially affect its foreign exchange and hedging
activities or will result in any material increase in costs to
the company. While the company will continue to evaluate the
impact over time of the introduction of the Euro; based on
currently available information management does not believe
that the introduction of the Euro will have a material adverse
impact on the company's financial condition or the overall
trends in results of operations.
22
<PAGE>
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. A list of the exhibits required to be filed as part
of this report is set forth in the Exhibit Index,
which immediately precedes such exhibits. The
exhibits are numbered according to Item 601 of
Regulation S-K.
b. A report on Form 8-K was filed on September 10, 1998.
The report is referenced as Exhibit 10-a, in the
Exhibit Index. The report contains disclosures
regarding the company's announcement of restructuring
plans and related third quarter 1998 charges. No
other reports on Form 8-K were required to be filed
during the quarter.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WATKINS-JOHNSON COMPANY
-----------------------
(Registrant)
Date: November 5, 1998 By: /s/ W. Keith Kennedy, Jr.
--------------------- ---------------------------------------------
W. Keith Kennedy, Jr.
President and Chief Executive Officer
Date: November 5, 1998 By: /s/ Scott G. Buchanan
--------------------- ---------------------------------------------
Scott G. Buchanan
Vice President and Chief Financial Officer
24
<PAGE>
EXHIBIT INDEX
The Exhibits below are numbered according to Item 601 of Regulation S-K.
Exhibit
Number Exhibit
*10-a Form 8-K filed September 10, 1998
27 Financial Data Schedule
*Incorporated by reference.
25
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