-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A0v1hJPbRlGcTHI01bxsbW4/WAcZVaBt529SSoXjqqaiCzis1fBmNJQAQvhrfn7i rzlsgd9ifXarUccMjjxiVg== 0000950005-98-000638.txt : 19980803 0000950005-98-000638.hdr.sgml : 19980803 ACCESSION NUMBER: 0000950005-98-000638 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980626 FILED AS OF DATE: 19980731 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: WATKINS JOHNSON CO CENTRAL INDEX KEY: 0000105006 STANDARD INDUSTRIAL CLASSIFICATION: SPECIAL INDUSTRY MACHINERY, NEC [3559] IRS NUMBER: 941402710 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05631 FILM NUMBER: 98675342 BUSINESS ADDRESS: STREET 1: 3333 HILLVIEW AVE CITY: PALO ALTO STATE: CA ZIP: 94304-1223 BUSINESS PHONE: 4154934141 MAIL ADDRESS: STREET 1: 3333 HILLVIEW AVENUE CITY: PALO ALTO STATE: CA ZIP: 94304-1223 10-Q 1 FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 26, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission file number 1-5631 WATKINS-JOHNSON COMPANY (Exact name of registrant as specified in its charter)
CALIFORNIA 94-1402710 - -------------------------------------------------------------- ------------------------------------------------------------- (State or other jurisdiction of incorporation (I.R.S. Employer Identification No.) or organization) 3333 Hillview Avenue, Palo Alto, California 94304-1223 - -------------------------------------------------------------- ------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (650) 493-4141 --------------------------------------------------------------- (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 June 26, 1998 8,258,000 shares PART I--FINANCIAL INFORMATION Item 1. Financial Statements The interim financial statements are unaudited; however, Watkins-Johnson Company believes that all adjustments necessary for a fair statement of results for such interim periods have been included and all such adjustments are of a normal recurring nature. The results for the six months ended June 26, 1998, are not necessarily indicative of the results for the full year 1998. The consolidated financial statements required by Rule 10-01 of Regulation S-X are included in this report beginning on the next page. 2 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS* For the periods ended June 26, 1998 and June 27, 1997
Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share 1998 1997 1998 1997 amounts) - ------------------------------------------------------------------------------------------------------------------------------- Sales $ 53,739 $ 72,679 $ 122,461 $ 139,895 - ------------------------------------------------------------------------------------------------------------------------------- Costs and expenses: Cost of goods sold 37,080 46,611 79,626 90,922 Selling and administrative 13,750 14,668 29,571 27,764 Research and development 13,335 10,428 26,543 20,874 - ------------------------------------------------------------------------------------------------------------------------------- 64,165 71,707 135,740 139,560 - ------------------------------------------------------------------------------------------------------------------------------- Income (loss) from operations (10,426) 972 (13,279) 335 Interest and other income (expense)--net 1,836 625 4,071 1,083 Interest expense (277) (361) (583) (690) Gain on real property 14,783 - ------------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes (8,867) 1,236 4,992 728 Income tax benefit (expense) 2,660 (350) (1,498) (160) - ------------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations (6,207) 886 3,494 568 Income from discontinued operations, net of taxes 2,196 4,992 - ------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (6,207) $ 3,082 $ 3,494 $ 5,560 =============================================================================================================================== Basic per share amounts: Income (loss) from continuing operations $ (.75) $ .11 $ .42 $ .07 Income from discontinued operations .26 .60 - ------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (.75) $ .37 $ .42 $ .67 =============================================================================================================================== Basic average common shares 8,257,000 8,258,000 8,259,000 8,278,000 Diluted per share amounts: Income (loss) from continuing operations $ (.75) $ .10 $ .41 $ .07 Income from discontinued operations .26 .58 - ------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (.75) $ .36 $ .41 $ .65 =============================================================================================================================== Diluted average common shares 8,257,000 8,507,000 8,448,000 8,497,000 *Unaudited
3 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME* For the periods ended June 26, 1998 and June 27, 1997
Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (6,207) $ 3,082 $ 3,494 $ 5,560 - ------------------------------------------------------------------------------------------------------------------------------- Other comprehensive income (expense), net of tax: Foreign currency translation adjustments (242) 255 (258) 109 Net unrealized holding gains (losses) on securities, net of reclassification adjustment of $0 27 (59) - ------------------------------------------------------------------------------------------------------------------------------- Other comprehensive income (expense) (215) 255 (317) 109 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Comprehensive income $ (6,422) $ 3,337 $ 3,177 $ 5,669 =============================================================================================================================== *Unaudited
4 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of June 26, 1998 and December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998* 1997 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and equivalents $ 33,559 $ 134,462 Short-term investments 79,141 Receivables 40,853 45,690 Inventories: Finished goods 5,354 9,283 Work in process 23,844 18,519 Raw materials and parts 16,249 18,873 Other 30,345 31,366 - ---------------------------------------------------------------------------------------------------------------------------- Total current assets 229,345 258,193 - ---------------------------------------------------------------------------------------------------------------------------- Property, plant, and equipment 185,335 178,795 Accumulated depreciation and amortization (88,480) (82,382) - ---------------------------------------------------------------------------------------------------------------------------- Property, plant, and equipment--net 96,855 96,413 - ---------------------------------------------------------------------------------------------------------------------------- Other assets 3,795 3,606 - ---------------------------------------------------------------------------------------------------------------------------- $ 329,995 $ 358,212 - ---------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREOWNERS' EQUITY Current liabilities: Payables $ 10,229 $ 16,188 Accrued liabilities 66,873 88,398 - ---------------------------------------------------------------------------------------------------------------------------- Total current liabilities 77,102 104,586 - ---------------------------------------------------------------------------------------------------------------------------- Long-term obligations 31,722 33,234 - ---------------------------------------------------------------------------------------------------------------------------- Shareowners' equity: Common stock 41,371 40,631 Retained earnings 180,712 180,356 Accumulated other comprehensive income (912) (595) - ---------------------------------------------------------------------------------------------------------------------------- Total shareowners' equity 221,171 220,392 - ---------------------------------------------------------------------------------------------------------------------------- $ 329,995 $ 358,212 ============================================================================================================================ *Unaudited
5 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS* For the periods ended June 26, 1998 and June 27, 1997
Six Months Ended - ---------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net Income $ 3,494 $ 5,560 Reconciliation of net income to cash flows Depreciation and amortization 7,512 6,760 Gain on asset retirements (14,781) Results of discontinued operations (4,992) Net changes in: Receivables 4,657 11,978 Inventories 936 (3,462) Other assets 751 (189) Accruals and payables (27,721) (3,515) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by continuing operating activities (25,152) 12,140 Net cash provided by discontinued operations 9,600 - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities (25,152) 21,740 - ---------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Additions of property, plant, and equipment (10,119) (7,691) Purchase of short-term investments (85,243) Proceeds from sale of short-term investments 6,005 Proceeds on asset retirements and other 15,932 303 Restricted plant construction funds 3,738 - ---------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (73,425) (3,650) - ---------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Payments on long-term debt borrowing (272) (439) Net borrowings (repayments) under line-of-credit (158) (317) Proceeds from issuance of stock 992 557 Repurchase of common stock (1,408) (4,249) Dividends paid (1,983) (1,994) Other (71) (76) - ---------------------------------------------------------------------------------------------------------------------------- Net cash used in financing activities (2,900) (6,518) - ---------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 574 1,114 - ---------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and equivalents (100,903) 12,686 Cash and equivalents at beginning of period 134,462 15,702 - ---------------------------------------------------------------------------------------------------------------------------- Cash and equivalents at end of period $ 33,559 $ 28,388 ============================================================================================================================ *Unaudited
6 Item 1. Financial Statements (continued) Supplementary information to the financial statements: A dividend of twelve cents per share was declared and paid during the second quarter of 1998 and 1997. 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:
(Dollars in thousands, except per share amounts) Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------------------- June 26, 1998 June 27, 1997 June 26, 1998 June 27, 1997 - ------------------------------------------------------------------------------------------------------------------------------- Denominator for basic per share: Weighted average shares outstanding 8,257,000 8,258,000 8,259,000 8,278,000 ================ ================== =================== ==================== Denominator for diluted per share: Weighted average shares outstanding 8,257,000 8,258,000 8,259,000 8,278,000 Effect of dilutive stock options 249,000 189,000 219,000 ---------------- ------------------ ------------------- -------------------- Diluted average common shares 8,257,000 8,507,000 8,448,000 8,497,000 ================ ================== =================== ==================== Net income (loss) from continuing operations (numerator) $ (6,207) $ 886 $ 3,494 $ 568 ================ ================== =================== ==================== Basic net income (loss) per share $ (.75) $ .11 $ .42 $ .07 ================ ================== =================== ==================== Diluted net income (loss) per share $ (.75) $ .10 $ .41 $ .07 ================ ================== =================== ====================
7 Item 1. Financial Statements (continued) For the three months ended June 26, 1998 the incremental shares from the assumed exercise of 181,000 stock options are not included in computing the dilutive per share amounts because continuing operations resulted in a loss and such assumed conversion would be antidilutive. Additionally, weighted average options outstanding to purchase 709,000 and 587,000 shares of common stock were not included in the computation of diluted per share amounts for the three months ended June 26, 1998 and June 27, 1997, respectively, and 666,000 and 603,000 shares of common stock were not included in the computation of diluted per share amounts for the six months ended June 26, 1998 and June 27, 1997, respectively, because the weighted average exercise prices were greater than the average market prices of the common shares. For the three months ended June 26, 1998 and June 27, 1997, weighted average exercise prices of $35.79 and $39.46, respectively, exceeded the average market prices of $26.15 and $28.75, respectively. For the six months ended June 26, 1998 and June 27, 1997, weighted average exercise prices of $36.42 and $39.46, respectively, exceeded the average market prices of $26.23 and $26.98, respectively. This calculation is submitted in accordance with Regulation S-K, Item 601(b)(11). Sales to external customers and pre-tax profit (loss) from continuing operations by business segment are as follows: Three months ended June 26,1998 and June 27, 1997
Sales Pre-tax income ------------------------- ------------------------- (in thousands) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------- Semiconductor Equipment $ 26,904 $ 47,991 $ (9,436) $ 400 Wireless Communications 26,835 24,688 (990) 572 - ------------------------------------------------------------------------------------------------------------- Income from continuing operations (10,426) 972 Other income (expense)-net 1,559 264 - ------------------------------------------------------------------------------------------------------------- Total $ 53,739 $ 72,679 $ (8,867) $ 1,236 ============================================================================================================= Six months ended June 26,1998 and June 27, 1997 Sales Pre-tax income --------------------------------------------------- (in thousands) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------- Semiconductor Equipment $ 65,620 $ 92,153 $ (12,835) $ 259 Wireless Communications 56,841 47,742 (444) 76 - ------------------------------------------------------------------------------------------------------------- Income from continuing operations (13,279) 335 Other income (expense)-net 18,271 393 - ------------------------------------------------------------------------------------------------------------- Total $ 122,461 $ 139,895 $ 4,992 $ 728 =============================================================================================================
8 PART I--FINANCIAL INFORMATION Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition and Liquidity At June 26, 1998, cash and equivalents and short-term investments totaled $112.7 million. During the first half of 1998, cash and equivalents decreased by $100.9 million, from $134.5 million to $33.6 million. The decrease in cash and equivalents resulted primarily from the purchase of short-term investments, as discussed below. Net income for the first half of 1998 was $3.5 million, while net cash used by operations was $25.2 million. For the comparable period last year, net income was $5.6 million and net cash provided by operations was $21.7 million. For the first half of 1998, net cash used by operating activities differed from net income for the period primarily because of decreases for: a $14.8 million gain on disposal of property, plant and equipment and a $27.7 million net change in accruals and payables; and increases for: depreciation and amortization charges of $7.5 million and a net change in receivables of $4.7 million. The net change in accruals and payables was partially due to income tax payments related to the fourth quarter 1997 gain on discontinued operations. For the first half of 1997, net cash provided by operating activities differed from net income for the period primarily because of increases for: depreciation and amortization charges of $6.8 million, net changes in receivables of $12 million, and cash provided by discontinued operations of $9.6 million; and decreases for: $5 million for the net income of discontinued operations, a net change in inventory of $3.5 million and a net change in accruals and payables of $3.5 million. Net cash used in investing activities was $73.4 million in the first half of 1998 compared to $3.7 million for the same period in 1997. In 1998, the company purchased $85.2 million in short-term investments and $10.1 million in new capital equipment, and received proceeds of $15.9 million from the sale of real property and asset retirements and $6 million from the sale of short-term investments. During the first half of 1998 the company invested its excess cash and equivalents in securities with maturities exceeding 90 days to take advantage of the higher yields. These short-term investments, consisting mostly of high grade commercial paper, are subject to interest rate risk and will rise and fall in value if market interest rates change. Cash used in investing activities in the first half of 1997 was for the purchase of $7.7 million of new capital equipment which was offset by the release of $3.7 million of restricted plant construction funds. The company used $2.9 million in financing activities in the first half of 1998 compared to $6.5 million for the same period last year. During the first half of 1998 the company repurchased 52,608 shares of its common stock for $1.4 million and paid approximately $2 million in dividends which was offset in part by $1 million in proceeds from stock option exercises. During the first half of 1997 the company repurchased 193,000 shares of its common stock for $5.4 million and paid $2 million in dividends. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) As of June 26, 1998, the company's principal source of liquidity consisted of $33.6 million in cash and equivalents and short-term investments valued at $79.1 million. The company has arrangements with several banks to provide a $50 million unsecured credit facility. This facility expires on March 31, 1999. During the first half of 1998, the company incurred no borrowings under this credit facility. Management does not anticipate any significant near term borrowing requirements under this credit facility. From time to time the company may enter into certain long-term borrowing arrangements with financial lending institutions for capital acquisitions of property, plant and equipment. As of June 26, 1998, long-term borrowings of $16.8 million consisted of two unsecured loans used for the company's land, building and equipment located in Kawasaki, Japan, and are payable through the year 2011 as fully disclosed in the company's 1997 annual report filed on Form 10-K. At June 26, 1998, there were no material commitments for capital expenditures. Current Operations and Business Outlook For the second quarter of 1998, the company reported sales of $53.7 million and a net loss of $6.2 million, or $0.75 cents per diluted share. In 1997, second-quarter sales from continuing operations amounted to $72.7 million, with net income of $0.9 million, or $0.10 cents per diluted share. Sales for the first half of 1998 amounted to $122.5 million, with net income of $3.5 million, or $0.41 cents per diluted share. In 1997, first-half sales totaled $139.9 million, with net income from continuing operations of $0.6 million, or $0.07 cents per diluted share. New and restated orders for the second quarter of 1998 were $40 million or about 30% lower than the $57 million of the first quarter of 1998 and about 35% lower than the $62 million for the second quarter of 1997. Second quarter 1998 orders include nearly $8 million of semiconductor equipment orders which were dropped from the backlog in December 1997, as discussed below. Firm backlog on June 26, 1998 stood at $68.6 million, compared to the June 27, 1997 backlog for continuing operations of $136.5 million, and $82 million at March 27, 1998. 1998 is proving to be a difficult year. During the second quarter, the market for semiconductor equipment continued to decline and the company revised its expectations for 1998 downward. The company also reviewed the potential for its wideband base station (Base2TM ) and decided to shift its marketing of that product towards original equipment manufacturers (OEM) rather than selling directly to carriers and small system integrators. Communications intelligence orders and shipments were also below plan. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) To address the greater-than-expected losses associated with these factors, the company took a number of steps to reduce operating costs. Most significantly, the company reduced its worldwide work force by 15% during the second quarter of 1998 and scheduled plant furloughs at all three U.S. facilities. Adding the staff reductions of the first quarter of 1998, brings the company work force reduction this year to 20%. The company has also slowed research and development spending on certain projects while maintaining prudent levels of spending on key projects expected to improve 1998 and 1999 orders. The company believes the actions it has in place will set the stage for future high growth and profitability when market conditions improve. Operations and business outlook for each of the company's business segments are discussed below. Semiconductor Equipment Group Sales of semiconductor equipment in the second quarter of 1998 amounted to $26.9 million, down 44% from the $48 million recorded for the same period last year. Sales for the first half of 1998 totaled $65.6 million compared to $92.2 million for the same period last year. Orders were $26 million during the second quarter of 1998, which were down 41% compared to the $44 million of last year's second quarter and up 18% from the $22 million reported in the first quarter of 1998. Second quarter 1998 orders include nearly $8 million of orders from a Korean customer which were dropped from the backlog in December of 1997. The company was able to reach agreement on the payment terms for this equipment, reinstated the order, and shipped the systems. This business segment is entering the third quarter of 1998 with a backlog totaling approximately $16 million compared to $78 million at June 27, 1997, and $17 million at March 27, 1998. Shipments were well below the first of the year expectations. The company now expects orders for semiconductor equipment to run significantly below plan for all of 1998. Much of the third quarter planned shipments are expected to come from the spares, service and training business. The company will continue to take action to reduce operating costs, with the goal of keeping the operating loss for the year at or better than the loss budgeted as of the beginning of 1998. The company is trimming unnecessary costs everywhere it can while maintaining its development for the future. With the exception of the promising very-low-k (VLK) program, research and development has now been slowed for 1998 except for those projects which should improve 1998 and 1999 orders. WJ has continued to invest heavily in R&D, and recently introduced two new products at the SEMICON West trade show in San Francisco: the WJ-1500 and the WJ-3000 cluster platform. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The WJ-1500 extends the company's conveyorized CVD equipment for customers using 0.15-micron design rules. The system is an upgrade to the conveyor transport system with improved film capability for the smaller design rules (0.18 micron) now being employed, improved film uniformity, and higher reliability. Several customers are discussing the purchase of this new atmospheric pressure (AP) tool. The second product family, the WJ-3000 cluster platform, is a "bridge" product designed to facilitate chip makers' transition from 200-mm to 300-mm wafer processing. The WJ-3000 is a single wafer, multiprocessing system with both 300mm and 200mm capability. In addition to the new high density process module, the company has developed a single wafer module for atmospheric pressure processing, called the WJ-3000A (or AP Next). The company has been demonstrating its capability to customers during 1998 with excellent results. A number of customers are discussing beta site opportunities and the company expects to have a beta placement in the first half of 1999. Although the very long-range industry forecasts for the semiconductor industry remain bright, the industry remains in an overcapacity situation. Capital equipment decisions are affected by a number of parameters and the company is watching its customer's market dynamics closely. The industry is confident of an upturn, but it appears to be beyond 1998. The Semiconductor Equipment Group's business depends upon the planned and actual capital expenditures of the semiconductor manufacturers, who react to the current and anticipated market demand for integrated circuits. In 1996 its history of cyclical variations returned with a market downturn. That downturn was exacerbated in the fourth quarter of 1997 by financial-system collapses and currency devaluations in Asia, the company's principal overseas market region for capital equipment. Although the cyclical growth trend of the semiconductor integrated circuits business is expected to return, it is recognized that the semiconductor equipment business can vary rapidly in response to customer demand. Following placement of orders, customers frequently seek either faster or delayed delivery, based on their changing needs. Uncertainty increases significantly when projecting product demand in the future. While the company cannot predict what effect these various factors will have on operating results, the effect of these and other factors could significantly affect the company's future operating results and stock market value. 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Wireless Communications Wireless communications sales in the second quarter of 1998 totaled $26.8 million, a 9% increase over the prior year's second quarter comparable $24.7 million for this segment (as restated for the adoption of Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information"). Sales for the first half of 1998 totaled $56.8 million compared to $47.7 million for the same period last year. Orders for the second quarter of 1998 totaled approximately $14 million, compared to $18 million for the same period last year, and $35 million reported for the first quarter of 1998. As discussed last quarter, the strong orders of the first quarter were unusually high mostly because of some inventory filling at an intermediate vendor inserted by a major customer, Lucent, in the CDMA chain. The business segment is entering the third quarter of 1998 with a backlog totaling approximately $53 million compared to $59 million at June 27, 1997. At the close of 1997 the company purchased the assets of Samsung Microwave Semiconductor. The company received its first order based upon the combination of Watkins-Johnson and Samsung technology. This order is for a handset amplifier transistor with high efficiency for a handset design produced for one of the low earth orbit satellites. Orders this year are for prototypes and the initial production. If the system succeeds, production is expected to last 5 years. During the second quarter, Watkins-Johnson changed its marketing approach for the Base2 base-station product. The company reviewed the potential for this product and made the decision to change its current approach of marketing the system directly to carriers and the small integrators as a stand-alone product. The new approach will market both the system and wideband modules and subassemblies using Base2 technology to the same commercial OEM-manufacturer base already served by the company. The product technology embodies the proven receiver and digital signal-processing technologies for which WJ is a recognized leader. To better work with this customer base, the sales and marketing functions for all commercial wireless-infrastructure products have been consolidated into a single commercial wireless organization. 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) While the company's 1998 government-communications market is slower than expected, the company's performance in recent years demonstrates its ability to increase its market by directing its unique technological strengths at appropriate volume programs. Part of the difficulty being experienced in the government communications side of the Wireless Communications sector stems from the delay of a major order. The company had expected the award of a major government program early in the year, which is budgeted and has the funds established, but has been delayed considerably as the using agency works through implementation plans. The order has now been delayed sufficiently, that it will likely have minimum sales in 1998. The current picture for this business is expected to improve by early 1999. In July 1998 Lucent experienced a local strike at their Columbus Ohio plant, stopping production for some of the systems where Watkins-Johnson's parts are used. The Lucent strike affected the Palo Alto plant staffing. However, to allow for quick response to demand, much of the production activity for products produced is outsourced. In addition, the test labor is employed on a contract basis. This practice allows the direct product cost to respond quickly to news such as the strike as well as demand increases. Looking forward, the combination of these events has led the company to reduce 1998 shipment expectations for the Wireless Communications segment. It is now expected that the revenues for 1998 will only slightly exceed the $105 million of last year. Actions to reduce cost have been taken. The staff has been reduced in line with the business now expected. Also, the Gaithersburg plant has added three weeks of furlough scheduled around the holiday periods July 4, Labor Day and Christmas, while the Palo Alto plant has required seven days of furlough for the manufacturing staff in the second half of 1998. Corporate staff are also required to take 16 days time off over the second half of the year. Including the approximately $4 million expenses for the transfer of the GaAs operations from Palo Alto to Milpitas, it is now anticipated that the segment's operating losses will be more than double the $1 million pretax operating loss of last year. Various regulatory agencies of federal, foreign, state and local governments can affect the wireless communication market dynamics, causing unforeseen ebb and flow of orders and delivery requirements. Domestic and international competition from a number of companies, some of which are much larger than Watkins-Johnson, is intense. The effect of these and other factors could significantly affect the company's future operating results. 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Second Quarter of 1998 Compared to Second Quarter of 1997 Wireless Communications sales increased 9% while Semiconductor Equipment Group sales dropped 44%, resulting in an overall company decrease from continuing operations of 26 %. Gross margins decreased from 36% to 31%. The decrease in gross margins is due mostly to the lower sales volume. Also, approximately $1 million of the $1.6 million severance costs of the second quarter are included in the cost of goods sold. Selling and administrative expenses increased to 26% of sales compared with 20% for the same period last year, due mostly to the lower sales volume. Actual selling and administrative expenses decreased 6% from $14.7 million to $13.8 million due mostly to the work force reduction and cost cutting efforts. Included in second quarter 1998 selling and administrative expenses are $0.6 million of severance costs. Research and development expenses were $13.3 million during the second quarter of 1998, or 25% of sales, compared to $10.4 million, or 14% of sales, for the same period last year. Although research and development is high as a percentage of sales due to the lower sales volume, spending was 10% below the second quarter budget due to the company's focus of second quarter research and development efforts on certain key projects. As previously discussed, the company began to curtail research and development efforts on certain projects which are not expected to have orders impact in 1999. The operating loss in the second quarter of 1998, before other income, was $6.2 million compared with the $0.9 million of income for the same period last year. Other income (net of other expenses) increased $1.3 million over the prior year due mostly to interest income earned on the increased cash balance and short-term investments. Also included in other income for the second quarter of 1998 is $0.4 million of net income from two leases, the sub-lease of part of our Palo Alto facility to Stellex and a lease of a portion of our Japanese facility. For the second quarter of 1998, the effective tax benefit rate for federal, state and foreign income taxes was about 30% compared to a 28% tax expense rate on continuing operations for the same period last year. The 30% tax benefit rate in 1998 is a result of the loss reported during the second quarter and is below the statutory rate mostly because of taxes accrued for some profitable foreign operations offsetting benefits from federal and state research tax credits. Net income from continuing operations decreased from $0.9 million net income in the second quarter of 1997 to a $6.2 million loss for the same period this year. Including after tax income of $2.2 million reported from discontinued operations in the second quarter of 1997, net income decreased from $3.1 million in the second quarter of 1997 to a $6.2 million loss reported for the current period. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Second Quarter Year-to-Date 1998 Compared to Second Quarter Year-to-Date 1997 Wireless Communications sales increased 19% while Semiconductor Equipment Group sales decreased 29%, resulting in an overall company decrease from continuing operations of 12%. Gross margins remained flat at 35% and include approximately $1.2 million of the $2.2 million of year-to-date severance costs. Selling and administrative expenses increased $1.8 million to 24% of sales compared with 20% for the same period last year. The higher percentage for the first half of 1998 resulted primarily from severance charges of $1 million and an additional reserve of $1.6 million taken on receivables during the first quarter of 1998. Research and development expenses were $26.5 million during the first half of 1998, or 22% of sales, compared to $20.9 million, or 15% of sales, for the same period last year. Although research and development is high as a percentage of sales due to the lower sales volume, spending was below budget due to the focus of research and development efforts on certain key projects, as previously discussed. The operating loss in the first half of 1998, before other income and a gain on the sale of real property, was $13.3 million compared with income of $0.3 million for the same period last year. Interest and other income (net of other expenses) increased $3 million over the prior year due mostly to interest income earned on the increased cash balance and short-term investments. Also included in other income for the first half of 1998 is $0.9 million of net income from two leases, as discussed above. In January 1998, the company concluded the sale of vacant land adjacent to its San Jose, California facility, resulting in a $14.8 million pre-tax gain reflected as "Gain on real property" in the consolidated financial statements. For the first half of 1998, the effective tax rate for federal, state and foreign income taxes was about 30% compared to 22% on continuing operations for the same period last year. The 30% tax rate in 1998 is below the statutory rate mostly because of federal and state research tax credits and export sales benefits. The low 22% tax rate for 1997 resulted mostly from the effect of the low level of income with positive benefits from export sales and research credits, which were offset by taxes incurred by foreign operations. Including the $14.8 million 1998 gain on the sale of land, net income from continuing operations increased from $0.6 million in the first half of 1997 to $3.5 million for the same period this year. Including after tax income of $5 million reported from discontinued operations in the first half of 1997, net income decreased from $5.6 million in the first half of 1997 to $3.5 million reported for the first half of 1998. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Year 2000 Computer Software Conversion The company regularly updates its information systems capabilities, and has evaluated all significant computer software applications for compatibility with the year 2000. With the system changes implemented to date and other planned changes, the company anticipates that its computer software applications will be compatible with the year 2000. Expenditures specifically related to software modifications for year 2000 compatibility are not expected to have a material effect on the company's operations or financial position. However, the company is dependent on numerous vendors and customers which may incur disruptions as a result of year 2000 software issues. Accordingly, no assurance can be given that the company's results of operations will not be impacted by this industry-wide issue. Risks and Uncertainties That May Affect Future Results All statements in this report, other than statements of historical facts, should be considered forward-looking statements. By way of example only, those include statements about the company's strategies, objectives, plans, expectations and anticipated results, and expectations for the economy generally or specific industries. The words "expect", "anticipate", "looking forward" and other similar expressions used in this report are intended to identify forward-looking statements that involve risks and uncertainties that may cause actual results and expectations to differ materially from those expressed. Such risks and uncertainties include, but are not limited to: product demand and market acceptance risks, the effect of economic conditions, the impact of competitive products and pricing, product development, commercialization and technological difficulties, capacity and supply constraints or difficulties, business cycles, the results of financing efforts, actual purchases under agreements, the effect of the company's accounting policies, U.S. Government export policies, geographic concentrations, natural disasters and other risks detailed in the company's 1997 Form 10-K filed with the Securities and Exchange Commission. Investors and prospective investors are cautioned not to place undue reliance on these forward-looking statements. The company undertakes no obligation to announce any revisions to its forward-looking statements to reflect events or circumstances as they actually develop or occur in the future. 17 PART II--OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K a. A list of the exhibits required to be filed as part of this report is set forth in the Exhibit Index, which immediately precedes such exhibits. The exhibits are number according to Item 601 of Regulation S-K. b. No reports on Form 8-K were required to be filed during the quarter. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WATKINS-JOHNSON COMPANY (Registrant) Date: July 31, 1998 By: /s/ W. Keith Kennedy, Jr. ----------------- ----------------------------------- W. Keith Kennedy, Jr. President and Chief Executive Officer Date: July 31, 1998 By: /s/ Scott G. Buchanan ----------------- --------------------------------- Scott G. Buchanan Vice President and Chief Financial Officer 19 EXHIBIT INDEX The Exhibits below are numbered according to Item 601 of Regulation S-K. Exhibit Number Exhibit ------ ------- 27 Financial Data Schedule 20 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 MAR-28-1998 JUN-26-1998 33,559 79,141 40,853 0 45,447 229,345 185,335 88,480 329,995 77,102 31,722 0 0 41,371 179,800 329,995 53,739 53,739 37,080 37,080 25,249 0 277 (8,867) (2,660) (6,207) 0 0 0 (6,207) (0.75) (0.75)
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