-----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, AKTX7d3XeIIAdFDzz+a+aoflMcHfnPcFfw1WQnpqxiKGuLq20vZh3SN3mfXk+D1C 4Kz8eMXtTkJmjMU4l56DpQ== 0000950005-99-000253.txt : 19990315 0000950005-99-000253.hdr.sgml : 19990315 ACCESSION NUMBER: 0000950005-99-000253 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990312 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-K405 SEC ACT: SEC FILE NUMBER: 001-05631 FILM NUMBER: 99564119 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-K405 1 FORM 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 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 (I.R.S. Employer incorporation or organization) Identification No.) 3333 Hillview Avenue, Palo Alto, California 94304-1223 - ------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (650) 493-4141 ----------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common stock, no par value New York Stock Exchange Pacific Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ . No ___. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]. As of February 5, 1999 Aggregate market value of the voting stock held by ---------------------- non-affiliates of the registrant: $87,673,000 Number of shares outstanding: Common stock, no par value 6,561,000 shares DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Portions of the Watkins-Johnson Company Notice of Annual Meeting of Shareowners--April 29, 1999 and Proxy Statement filed with the commission pursuant to Regulation 14A are incorporated by reference into Part III. Page 1 Part I Item 1. Business The statements in this Annual Report on Form 10-K that relate to future plans, events or performance are forward-looking statements. Actual results could differ materially due to a variety of factors discussed under "Risks and Uncertainties that May Affect Future Results" and other risks described in this Annual Report on Form 10-K. The company undertakes no obligation to publicly update these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. (a) General Development of Business Watkins-Johnson Company (the company) had operated in three industry segments in 1993: Semiconductor Equipment, Electronics and Environmental Services. At the end of 1994, the Environmental Services unit was divested. In 1995, Watkins-Johnson divided its former Electronics Group, recognizing the two major markets that it served, into the Wireless Communications segment and the Government Electronics segment for reporting purposes. During 1997 the company's structure was realigned to focus on its two high-growth businesses: Wireless Communications and Semiconductor Equipment. In October 1997, the company divested its Government Electronics operations and reported such divestiture as discontinued operations as disclosed in Note 8 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Except for the land sale and write down of discontinued products and related restructuring discussed below, other than in the ordinary course of business there were no acquisitions or dispositions of material amounts of assets during 1998. No material reclassifications, mergers or consolidations of the company or its subsidiaries occurred during the year. During the third quarter of 1998, the company restructured its operations to focus on its core atmospheric-pressure chemical-vapor-deposition (APCVD) operations in the Semiconductor Equipment segment by discontinuing efforts on its high-density-plasma (HDP) initiative. Also, the company's Wireless Communications segment evaluated 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 discussed in Note 11 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Subsequent Events--On March 1, 1999, Watkins-Johnson announced that, after a strategic review performed by its investment banking firm, it would pursue a sale of the company, either in its entirety or through sales of its individual business segments. On March 4, 1999, Watkins-Johnson announced that it had signed a non-binding letter of intent to sell its Semiconductor Equipment Group, exclusive of its discontinued high-density-plasma and certain other assets, to Silicon Valley Group, Inc. (SVG). The sale is subject to customary due diligence, execution of a definitive acquisition agreement, Hart Scot Rodino filings, and the approval of the boards of directors of Watkins-Johnson and SVG. There can be no assurance that the sale of the Semiconductor Equipment Group to SVG will be completed, nor can there be any assurance that Watkins-Johnson will be able to complete its strategy for the sale of the entire company. Page 2 Item 1. Business (continued) (b) Financial Information about Industry Segments The company operates in two industry segments -- Wireless Communications and Semiconductor Equipment. Financial information covering these industry segments is included in Note 8 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. (c) Narrative Description of Business Watkins-Johnson Company is a high-technology corporation specializing in wireless communications and semiconductor-manufacturing equipment. Wireless Communications The company's Wireless Communications business designs and manufactures solid-state devices, single function components, subassemblies and equipment for the wireless telecommunications industry. The foundation of the company's wireless-communications strength lies in the company's more than 20 year history with gallium-arsenide (GaAs) technology. The company produces highly reliable proprietary chips that perform signal-processing functions in subassemblies and systems for PCS, GSM, cellular, and personal phone equipment. The company is capitalizing on the healthy market for RF components by expanding its gallium arsenide (GaAs) integrated-circuit fabrication capability and actively marketing company-manufactured devices to the wireless industry. Historically, the company has manufactured GaAs devices for its own use only. The WJ AH1 GaAs amplifier chip is achieving acceptance by base station manufacturers worldwide. The advantage of this amplifier is its ultralinear performance, which base station producers need for quality digital wireless performance. These devices offer excellent performance, and an updated and expanded fabrication facility enables the company to sell them on the open market at competitive prices. The relocation of the GaAs and thin film processing and design organization to the Milpitas, California, facility is on schedule and is expected to be completed early in 1999. In addition to follow-on orders for PCS converter assemblies, the company received several large orders in 1998 from Lucent Technologies, Inc. for a wireless-local-loop assembly. The company had previously signed a contract with Lucent for the design for a wireless-local-loop transceiver unit. The contract was for wireless-local-loop subscriber units, technical consultation and intellectual-property rights. Lucent is optimistic about the potential for its product and established a co-production relationship with the company to ensure adequate supply. Lucent is a major customer for the Wireless Communications segment, with approximately 29% of that segment's sales in 1998. The company has a second wireless-local-loop program, which is smaller than the Lucent program. In addition to the subscriber unit, the company is making assemblies that go in the transmitter. The company has a 5-year manufacturing exclusive on this program. Other products include high-dynamic range converters and terminals which are produced in high volume for PCS base-station and wireless-local-loop applications. Related subsystems and equipment perform signal-conversion, signal-reception, repeater and base-station functions by government agencies for signals-intelligence mission requirements. Page 3 Item 1. Business (continued) During 1998, the company discontinued its Base2 base-station product at its Gaithersburg plant as discussed in Part I, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and in Note 11 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Sales by the Wireless Communications segment were 54% of consolidated sales in 1998, 36% in 1997 and 22% in 1996. Marketing and sales are performed by company direct sales personnel and distributors. Major accounts are handled by direct company sales and service. Components, subassemblies, receivers and transceivers are primarily sold to companies which manufacture base station equipment for various wireless communication carriers. Communications-intelligence receivers and tuners are sold to security agencies of the U.S. and other governments. Lucent Technologies, Inc., Bartleys R.F. Systems Inc. (a Lucent sub-contractor), Nortel LTD and the United States Government are significant customers of this business segment. Although the customer community represents a large business opportunity, the number of individual customers is not significant. Approximately 19% of the segment's sales are to international customers. Domestic and international competition from a number of companies, some of which are much larger than Watkins-Johnson, is intense. The company seeks to win customers by excellent service and superior technical performance. The group's customer, Lucent Technologies, acknowledged the excellence of the company's products and services by recognizing Watkins-Johnson Company as a premier supplier for two consecutive years. The company seeks to protect its intellectual property by an aggressive patent and trade secret program. Additional information regarding the company's Wireless Communications segment along with a discussion risks and uncertainties that may affect future results is included in Part I, Item 7, of this annual report on Form 10-K. Semiconductor Equipment The company's Semiconductor Equipment segment designs, develops and manufactures equipment to deposit thin dielectric films by using the process of atmospheric-pressure chemical-vapor-deposition (APCVD). The company's products apply insulating, or dielectric, layers of silicon dioxide (glass) onto silicon wafers during the processing of integrated-circuit chips. This equipment functions by injecting the gases needed for the reaction over the substrate material. The company's APCVD process is mostly used in depositing doped oxide films, boro-phosphoro-silicate glass (BPSG) and phosphoro-silicate-glass (PSG), for the initial dielectric layers deposited on the wafers. These initial layers, sometimes termed the premetal dielectric (PMD), are deposited prior to the metal layers which are used to connect the transistors and provide the circuit action. BPSG is a useful dielectric layer since it self-planarizes, offering a smoother surface for the following metal and dielectric layers. The WJ APCVD equipment is well suited for these applications. Page 4 Item 1. Business (continued) The company has two proprietary approaches to the APCVD process. Under one approach, the substrates are transported under the injectors on a continuously moving conveyor belt through a resistance heated muffle. This approach allows high deposition rates with a simpler reactor design yielding higher reliability operation and high wafer throughput. The company markets these APCVD systems as the WJ-999, WJ-1000 and the recently introduced WJ-1500. The WJ-999 and WJ-TEOS999 systems are for production lines using 150-mm (6-inch) semiconductor wafers; they are capable of simultaneous processing of two wafers in parallel. The WJ-1000 and WJ-1500 are specifically designed for production lines using 200-mm (8-inch) semiconductor wafers. Under a second approach, the company's recently introduced WJ-3000A is a single wafer, multiprocessing system with both 300-mm and 200-mm capability. The semiconductor industry had significant over capacity and capital equipment investment continued to decline in 1998. The company took a number of actions to bring its cost structure into alignment with the extremely low conditions of this cyclical market. As part of the resizing, the high-density-plasma (HDP) chemical-vapor-deposition (CVD) system initiative was discontinued as discussed in Part I, Item 7 and in Note 11 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. The company will continue to offer its core APCVD product line to semiconductor manufacturers. It also intends to preserve its global service and key development activities to provide new equipment for the market applications in premetal dielectric and shallow trench isolation. Its future development activities will be focused on two recently announced systems, the WJ-1500 and the WJ-3200A which are described in Part I, Item 7, of this annual report on Form 10-K. The decreasing feature sizes used in the construction of integrated circuits are opening a new application for the company's APCVD equipment. Small feature sizes allow smaller transistors to be defined and located closer together in the circuits. The desired packing density is causing the naturally grown LOCOS (local oxide separation) step to become difficult. The LOCOS step can be replaced with a STI (shallow trench isolation) approach using CVD. The company believes its APCVD process is competitive for this more recent step. Sales in the Semiconductor Equipment segment were 46% of consolidated sales in 1998 and 64% in 1997 and 78% in 1996. Over the last three years the company has changed its method of selling and servicing semiconductor equipment. The company replaced a network of manufacturers' representatives and distributors, with a direct sales and service force world-wide to better serve its customers. Currently, the company has direct sales offices in the United States, Korea, Taiwan, Singapore, Japan and Europe. The company's equipment is sold world-wide to major semiconductor manufacturers, especially to those engaged in high-volume integrated circuit manufacturing. Customers include both firms that manufacture and sell their own products and semiconductor foundry firms that contract manufacturing services to "fabless" companies. As such the company's equipment is used in the manufacturing of all types of integrated circuits, from logic circuits to semiconductor memory chips. Although there are many such customers, a majority of the integrated circuits world-wide are produced by approximately 20 companies, with roughly two-thirds of the business outside the United States. Over a period of years, NEC, Hyundai Electronics Ind. Co. Ltd., Samsung Pacific International Inc., Motorola and Intel have been significant customers of the segment. There are several domestic and international competitors in this field (some of whom are larger than the company) and competition is intense. In meeting the competition, emphasis is placed on selling quality products with high technical performance Page 5 Item 1. Business (continued) and operational reliability with a competitive cost of ownership. The company's global customer-support network is expected to be a competitive advantage. Additional information regarding the company's Semiconductor Equipment segment along with a discussion of risks and uncertainties that may affect future results is included in Part I, Item 7, of this annual report on Form 10-K. Other Business Items Raw materials for the production of semiconductor equipment and wireless communications products are acquired from a broad range of suppliers. Because suppliers are numerous, dependence on any one supplier is kept to a minimum. On occasion, however, the failure of a supplier to deliver key parts can jeopardize the on-time shipment of company products. Business operations are not believed by management to be significantly seasonal. With respect to trade receivables from semiconductor equipment systems sales, generally 10% to 20% of the balance is collectible upon acceptance of the equipment by the customer. Except for the use of letters of credit on international sales and negotiated advance or progress payments from customers on long-term contracts, there are no other special working capital practices. The company has been active in securing patents and licensing agreements to protect certain proprietary technologies and know-how resulting from its ongoing research and development. The financial impact of the company's efforts to protect its intellectual property are unknown. Management believes that the company's competitive strength derives primarily from its core competence in engineering, manufacturing and understanding its customers and markets; therefore, aggressive steps to protect that knowledge are considered justifiable. Total company backlog at December 31, 1998 was $79.5 million compared to $98.2 million at December 31, 1997. The percentage of backlog attributable to the Wireless Communications and Semiconductor Equipment is 84% and 16%, respectively, in 1998, compared to 61% and 39% in 1997. The company includes in its backlog customer released orders with firm schedules for shipment. Approximately 98% of all backlog at December 31, 1998 is expected to be shipped within 12 months, compared to 93% at December 31, 1997. The company does not have any significant long-term purchase agreements with any of its customers, and customers can typically cancel or reschedule their orders without significant penalty. As a result, customers frequently revise production quantities and delivery schedules to reflect their changing needs. Since most of the company's backlog can be canceled or rescheduled, the company does not believe its backlog is a meaningful indicator of future revenue. Company-sponsored research and development expense was $49.9 million in 1998, $50.2 million in 1997, and $53.2 million in 1996. Customer-sponsored research and development was $3.2 million in 1998, $5.2 million in 1997 and $7.2 million in 1996. Customer-sponsored research and development was performed by the Wireless Communications segment. The company's headcount at December 31, 1998 was 990. None of the company's employees are covered by a collective-bargaining agreement. The company's relationship with its employees is generally good. Environmental issues are discussed in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. (d) Financial Information about Foreign and Domestic Operations and Export Sales. Page 6 Item 1. Business (continued) Combined export sales and sales from foreign operations accounted for 36% of the company's sales in 1998, 42% in 1997 and 59% in 1996. Assets of foreign operations accounted for 16%, 14% and 15% of consolidated assets at December 31, 1998, 1997 and 1996, respectively. The inherent risks of foreign business are similar to domestic business, with the additional risks of foreign government instability, currency fluctuations, and export license cancellation. A portion of foreign product orders in the Wireless Communications segment requires export licensing by the Department of State prior to shipment. For international shipments for both company business segments, the company purchases forward exchange contracts and/or generally obtains customer letters of credit to reduce foreign currency fluctuation and credit risks. For further information on foreign sales, see Note 8 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Item 2. Properties Watkins-Johnson Company and subsidiaries conduct their main operations at plants in Palo Alto, Scotts Valley and Milpitas, California and Gaithersburg, Maryland. The company also has a facility in Kawasaki, Japan, for its Semiconductor Equipment Group and leases several sales and service offices throughout the United States, Asia-Pacific and Europe. In 1998, approximately 15 acres of undeveloped land adjacent to the company's San Jose, California, facility was sold, and due to the downsizing discussed in Note 10 to the consolidated financial statements (contained in Part II, Item 8 of this annual report on Form 10-K), the company's 190,000 square foot San Jose facility was vacated and is currently for sale. The company expects to sell this property in 1999. The company is pursuing opportunities to realize the market value of its properties while ensuring efficient use of available space. In December 1997, the sale and exchange of a portion of the company's Palo Alto lease interest was successfully completed. About 7 acres of the Palo Alto campus were returned to the lessor for consideration as discussed in Note 10 to the consolidated financial statements (contained in Part II, Item 8 of this annual report on Form 10-K). Excluding the San Jose facility, at December 31, 1998, there were approximately 508,000 square feet of plant space in California, 175,000 square feet in Maryland, and a 36,000 square foot facility in Kawasaki, Japan. Of the 508,000 square feet of plant space in California, approximately 133,000 square feet in Palo Alto is subleased to Stellex Microwave Systems, Inc. (SMS) for a period through October 2000 as part of the stock purchase agreement included in Part II, Item 14(a)3, by reference as Exhibit 10.1l. The space is leased to SMS at a price which recovers utilities, maintenance and other services, and may be canceled by SMS with 6 months notice. In addition, a small portion of the Kawasaki, Japan, facility is leased to a tenant. Excluding the San Jose facility and the subleases discussed above, approximately 85% of the company's available plant space is occupied for the company's operations. The Wireless Communications segment utilizes substantially all of the Milpitas, Gaithersburg and available Palo Alto facilities. The Scotts Valley and Kawasaki facilities house the Semiconductor Equipment segment. The Palo Alto and Milpitas facilities and all sales office locations are leased. Information on long-term obligations is discussed in Note 3 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Item 3. Legal Proceedings Information required under this item is contained in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K. Page 7 Item 4. Submission of Matters to a Vote of Security Holders The company submitted no matters to a vote of the shareowners during the last quarter of the period covered by this report. Executive Officers of the Registrant
Officer Business Experience Name Age Office Held Since Last Five Years - ------------------------------------------------------------------------------------------------------------------------------------ Dr. Dean A. Watkins 76 Chairman of the Board 1957 Chairman of the Board Dr. H. Richard Johnson 72 Vice Chairman of the Board 1957 Vice Chairman of the Board Dr. W. Keith Kennedy, Jr. 55 President and Chief Executive 1977 President and Chief Executive Officer Officer Scott G. Buchanan 47 Vice President, Chief Financial 1989 Vice President, Chief Financial Officer and Officer and Treasurer Treasurer, Prior to 1998, Vice President and Chief Financial Officer Dr. Patrick J. Brady 53 Vice President 1996 President, Semiconductor Equipment Group; Prior to 1996, Vice President of Engineering, Semiconductor Equipment Group Malcolm J. Caraballo 43 Vice President 1996 President, Microwave Products Group; Prior to 1996, Vice President, Microwave Products Division Robert G. Hiller 61 Vice President 1997 President, Telecommunications Group, Prior to 1997, Vice President, Telecommunications Group, Prior to 1996, Director, Engineering, Electronics Equipment Division Dr. Frank E. Emery 62 Vice President 1998 Vice President, Corporate Planning and Communication, Prior to 1998, Manager, Corporate Planning and Communication Darryl T. Quan 44 Controller 1991 Controller Claudia D. Kelly 58 Secretary 1996 Secretary; Prior to 1996, Manager, Palo Alto Customer and Export Services
Dr. Watkins and Dr. Johnson have been directors of the company since its incorporation in 1957. Dr. Kennedy has been a Director since August 1987. None of the above officers is related to any other officer at Watkins-Johnson Company. Page 8 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The company's common stock is principally traded on the New York and Pacific stock exchanges. At December 31, 1998 there were approximately 8,500 shareowners, which included holders of record and beneficial owners. The company expects that comparable cash dividends will continue in the future. DIVIDENDS AND STOCK PRICES
1998 Quarters 1st 2nd 3rd 4th - --------------------------------------- ------------------------ ------------ ---------- ------------ ----------- Dividends declared per share (in cents) 12 12 12 12 Stock price High 28 1/2 28 1/2 29 1/2 22 9/16 (NYSE-in dollars) Low 22 13/16 23 5/16 17 9/16 16 3/8 1997 Quarters 1st 2nd 3rd 4th - --------------------------------------- ------------------------- ----------- ----------- ----------- ----------- Dividends declared per share (in cents) 12 12 12 12 Stock price High 26 7/8 32 3/8 37 1/4 35 3/4 (NYSE-in dollars) Low 22 1/8 22 1/4 30 3/4 24 3/16
Item 6. Selected Financial Data
(Dollars in thousands, except per share amounts) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING RESULTS Sales $ 212,200 $ 291,271 $ 349,119 $ 284,335 $ 209,330 Net income (loss) from continuing operations (49,208) (3,962) (1,321) 21,854 19,652 Basic net income (loss) per share from continuing operations (6.36) (0.48) (0.16) 2.75 2.65 Diluted net income (loss) per share from continuing operations (6.36) (0.48) (0.16) 2.49 2.41 Dividends per share $ 0.48 $ 0.48 $ 0.48 $ 0.48 $ 0.48 Basic average common shares 7,737,000 8,258,000 8,265,000 7,938,000 7,425,000 Diluted average common shares 7,737,000 8,258,000 8,265,000 8,776,000 8,153,000 FINANCIAL POSITION Working capital $ 91,018 $ 153,607 $ 122,982 $ 124,796 $ 102,361 Total assets 245,478 358,212 293,744 269,565 220,223 Long-term obligations 32,701 33,234 37,801 20,469 21,332 Shareowners' equity 131,699 220,392 194,711 191,253 149,626 Shareowners' equity per share $ 20.11 $ 26.68 $ 23.38 $ 23.54 $ 19.75 Number of shareowners 8,500 6,500 5,400 4,900 4,600
Page 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the company's consolidated financial statements and related notes included elsewhere in this annual report. Except for historic actual results reported, the following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties. See "Risks and Uncertainties that May Affect Future Results" included below for a discussion of certain factors that could cause future actual results to differ from those described in the following discussion. Financial Condition and Liquidity At the end of 1998, cash and equivalents and short-term investments totaled $64.6 million, a decline of $69.9 million from the 1997 year-end cash and equivalent balance of $134.5 million. The decrease resulted primarily from the company's operating loss, working capital requirements, and repurchase of the company's common stock. A total of 1,795,800 shares were repurchased for $36.2 million. Proceeds from the sale of undeveloped land, as described in Note 10 to the consolidated financial statements, helped fund the company's 1998 capital acquisitions. In 1997, cash and equivalents increased $118.8 million from $15.7 million to $134.5 million. The increase was attributed to funds generated from continuing operations, gain from the sale of discontinued operations as described in Note 8 to the consolidated financial statements, and proceeds received from the exchange of a subleasehold interest as explained in Note 10 to the consolidated financial statements. The cash inflow from the above activities was sufficient to fund the acquisition of capital assets totaling $22.2 million in 1997. In 1996, cash and equivalents decreased $18.9 million, from $34.6 million to $15.7 million. Net cash provided by continuing operations was $16.0 million. This helped partially fund the company's capital asset acquisitions totaling $48.3 million, including a facility in Kawasaki Japan. The company completed the financing of 1996 capital asset acquisitions with long-term borrowings of $20.2 million as described in Note 3 to the consolidated financial statements. As of December 31, 1998, the company's principal source of liquidity consisted of $19.3 million in cash and equivalents plus short-term investments valued at $45.4 million. During 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 debt securities, are subject to interest rate risk and will rise and fall in value if market interest rates change. The company previously had arranged with several banks to provide a $50.0 million unsecured credit facility, which was scheduled to expire on March 31, 1999. During 1998, the company did not borrow under this credit facility. Due to the operating losses reported in 1998, the company was technically not in compliance with certain terms under this credit facility. The company evaluated the proposed revised terms and elected to terminate the facility based on the company's cash balances and short-term investments. Management does not anticipate any significant near term borrowing requirements and does not expect the termination of the credit facility to materially affect the company's liquidity or financial position. Page 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 December 31, 1998, long-term borrowings of $20.2 million consisted of three outstanding loans which are payable through the year 2011, as disclosed in Note 3 to the consolidated financial statements. At the end of 1998, there were no material commitments for capital expenditures. Based on current plans and business conditions, the Company believes that its existing cash and equivalents, short-term investments and cash generated from operations is expected to be sufficient to satisfy anticipated cash requirements for the next twelve months. Current Operations and Business Outlook For 1998, the company reported sales of $212.2 million and a net loss of $49.2 million, or $6.36 loss per share. This loss includes $44.4 million of pre-tax charges for the write down of discontinued products and related restructuring as discussed below and in the company's announcement on September 8, 1998 reported on Form 8-K. Also included in 1998 results is a $15.0 million pre-tax gain on the sale of undeveloped land. In 1997, sales were $291.3 million and net income was $32.9 million or $3.99 per share. The 1997 net income was comprised of a net loss from continuing operations of $4.0 million, or $0.48 loss per share, and a gain and net income related to discontinued operations of $36.9 million, or $4.47 per share. Firm backlog on December 31, 1998 stood at $79.5 million, compared to the 1997 backlog of $98.2 million. During the third quarter of 1998, the company restructured its operations to focus on its core atmospheric-pressure chemical-vapor-deposition (APCVD) operations in the Semiconductor Equipment segment by discontinuing efforts on its high-density-plasma initiative. Also, the company's Wireless Communications segment evaluated 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 and downsized its operations. The company recorded charges of $44.4 million of which $40.5 million relates to the write down of nonproductive facilities, equipment, and discontinued products; and $3.9 million relates to severance, benefits, and other exit costs as disclosed in Note 11 to the consolidated financial statements. As discussed above, the company faced some very difficult decisions throughout 1998, especially in the third quarter. The company took a number of actions required to bring its cost structure into alignment with the extremely poor market conditions. Looking forward, the company believes the realignment and refocusing will set the stage for future growth and profitability. Operations and business outlook for each of the company's business segments are discussed below. Page 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Wireless Communications Wireless Communications sales for 1998 totaled $115.2 million, a 10% increase from the prior year's $104.8 million. The business segment is entering 1999 with a backlog totaling approximately $67.1 million compared to $60.3 million on December 31, 1997. Aside from the restructuring activities discussed previously, the Wireless Communications segment experienced both positive and negative events in 1998. The segment sustained strong growth as a high-volume manufacturer of custom RF (radio frequency) subassemblies for PCS base-station and wireless-local-loop customer-premise equipment. Fourth quarter 1998 shipments included the first large order for outdoor repeaters from a major wireless carrier. However, 1998 revenues were adversely affected by the company's decision to discontinue marketing its wideband digital base station product directly to service providers and the smaller system integrator firms. Part of the difficulty the company experienced in the Wireless Communications segment stems from the delay of a major government order, which is budgeted and has funding established. The company is following this program closely and is hopeful it will be able to receive the order during 1999. Looking forward, it is too early to tell how strong the Wireless Communications shipment rate will be in 1999. However, the company expects this segment to continue growing. If the economy in general stays strong, the company expects the Wireless Communications segment to be profitable next year. The segment intends to focus on the following opportunities to continue its growth: gallium-arsenide (GaAs) semiconductor devices, repeaters, advanced RF technology subassemblies, and communications surveillance receiver programs with strong follow-on potential. The company accelerated its entry to the GaAs semiconductor market with the purchase of the assets and intellectual property of Samsung Microwave Semiconductor in December 1997. GaAs devices include low-noise and power amplifiers, mixers and doublers. The consolidation of the GaAs and Thin Film processing and design organization to the Milpitas facility is on schedule and is expected to be completed early in 1999. The company offers a line of "over-the-air" repeaters to PCS carriers to assist in extending cell size and broadening their signal coverage. The newest products are the PCS in-building repeaters for CDMA, TDMA and GSM air interfaces. These repeaters provide quick installation and easy coverage for indoor locations such as shopping malls, airports, convention centers and multistory office buildings. Continued worldwide growth of RF infrastructure for wireless telephone systems is expected. With its strong base in advanced RF technology, the segment is in an excellent position to participate in this growth. The communications surveillance receiver requirements and orders are expected to remain at a fairly steady level. Going forward, the segment intends to market communications systems, receiving equipment and sub-systems as a value added supplier to customers in the intelligence and military communities; and commercial original equipment manufacturers. The company intends to emphasize programs with strong follow-on potential, especially those which enhance the segments overall product strength for additional business opportunities. Page 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Semiconductor Equipment Sales of semiconductor equipment for 1998 amounted to $97.0 million, down 48% from the $186.5 million recorded for 1997, as customers dramatically reduced equipment orders. This business segment is entering 1999 with a backlog totaling approximately $12.4 million compared to $37.9 million at December 31, 1997. The semiconductor industry capital spending dramatically declined in 1998 and the company took a number of actions to bring its cost structure into line with the extremely unfavorable conditions of this cyclical market. The high-density-plasma chemical-vapor-deposition (HDPCVD) system initiative was discontinued, as previously discussed. The intellectual property relating to the high-density-plasma development effort is being offered to potential buyers. Employing an investment banking firm, Alliant Partners, the company continued its strategic partnering discussions with a number of parties in an effort to leverage the technology and business prospects of the Semiconductor Equipment Group. The group also reviewed the requirements for its global sales and service force. These operations were reduced in order to bring them in line with the lower business expectations. While the group is watching these expenses carefully, 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-3000A. The WJ-1500 extends the continuous processing APCVD to 0.15-micron design-rule fabrication capability. The system is an upgrade to the conveyor transport system with improved film capability and higher reliability for the smaller design rules (0.18 micron) now being employed. The company believes it will participate in the market as geometries are scaled down to 0.15 micron with the WJ-1500. In the third quarter of 1998, the company captured a multiple-system order for this tool, consisting of three systems and one upgrade kit, 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. The system has performed very narrow gap-fills to 50 nanometers. A number of customers are discussing beta site opportunities and the company expects to have a beta placement in 2000. Page 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Looking forward, the company believes that the Semiconductor Equipment segment is now sized to match the level of forecasted revenue for 1999. However, it is difficult to predict what the future might hold in the semiconductor equipment business. Current semiconductor integrated circuit demand appears to be increasing slightly in dollar terms over last year. The recent industry forecasts seem to be in line with the company's expectations, with demand increasing slightly each quarter as the year progresses. Based on its interactions with customers, the company believes that certain customers may be considering moving into the buying mode. The company believes the Semiconductor Equipment segment 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 into or beyond 1999. 1998 Compared to 1997 Wireless Communications sales increased 10% while Semiconductor Equipment sales decreased 48%, resulting in an overall company decrease of 27%. Gross margins decreased from 32% to 16%. The decrease in gross margins is due mostly to the lower sales volume and $17.1 million for the write down of discontinued products resulting from the restructuring. As previously discussed, the restructuring and other charges came primarily from the results of the semiconductor equipment market decline as the company worked to bring costs in line with revenues. Gross margins for the fourth quarter of 1998 improved to 33%. Excluding restructuring charges of $27.3 million, selling and administrative expenses increased to 24% of sales compared with 20% for 1997, due mostly to the lower sales volume. Actual selling and administrative expenses, excluding restructuring charges, decreased 13% from $58.7 million in 1997 to $51.0 million in 1998. Research and development expenses were $49.9 million in 1998, or 24% of sales, compared to $50.2 million, or 17% of sales in 1997. Although research and development is high as a percentage of sales due to the lower sales volume, spending remained high since the effect of the downsizing did not impact results until after the third quarter of 1998. 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 orders impact in 1999, and in September 1998 discontinued its efforts on the HDP initiative and the Base2 product. The pre-tax operating loss in 1998, before other income and a gain on the sale of undeveloped land, was $94.7 million compared with a loss from continuing operations of $14.3 million for 1997. Interest and other income (net of other expenses) increased to $6.7 million due primarily to interest income earned on the increased average cash balance and short-term investments. Also included in other income for 1998 is $1.2 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 the company's Japanese facility. In January 1998, the company concluded the sale of vacant land adjacent to its San Jose, California facility, resulting in a $15.0 million pre-tax gain reflected as "Gain on real property" in the consolidated financial statements. Page 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) For 1998, the effective tax benefit rate for federal, state and foreign income taxes was about 33% compared to a 43% tax benefit rate on continuing operations for 1997. The 33% tax benefit rate in 1998 is a result of the reported loss and is below the statutory rate primarily due to taxes accrued for certain profitable foreign operations offsetting benefits from federal and state research tax credits. The 43% tax benefit rate for 1997 resulted primarily from the effect of the operating loss with positive benefits from export sales and research credits, which were offset in part by taxes incurred by profitable foreign operations. As a result, the net loss from continuing operations was $49.2 million in 1998 compared to $4.0 million in 1997, or $6.36 loss per share compared to $0.48 loss per share, respectively. 1997 Compared to 1996 Wireless Communications sales increased 37% while Semiconductor Equipment Group sales decreased 32%, resulting in an overall company decrease of 17%. By the third quarter of 1996, the company began to experience significant decreases in semiconductor equipment shipments. Gross margins decreased from 34% to 32%. Gross margins in both years were adversely affected by write-offs of excess inventory and nonperforming assets. Selling and administrative expenses decreased 12%, due mostly to the decreased volume and cost-cutting efforts, but increased slightly as a percentage of sales. Research and development expenses remained above 15% of revenue due to continued emphasis on new product development in both business segments. Interest income increased $1.4 million over the prior year due to the increase in cash and cash equivalents. Other income decreased due primarily to about $1.4 million in foreign currency translation losses in 1997 from the company's Asia-Pacific subsidiaries. The sale and exchange of a Palo Alto lease interest was successfully completed in 1997, resulting in a $7.6 million pre-tax gain reflected as "Gain on real property" in the consolidated financial statements. The effective tax rate for federal, state and foreign income taxes on continuing operations resulted in a tax benefit rate of about 43% compared to 37% in 1996. The 43% tax benefit rate resulted mostly from the effect of the operating loss with positive benefits from export sales and research credits, which were offset by taxes incurred by foreign operations. Due to the above factors, the net loss from continuing operations increased from $1.3 million for 1996 to about $4.0 million for 1997, or $0.16 to $0.48 loss per share, respectively. Including the after tax gain on the disposition and results of discontinued operations, net income increased from $3.0 million for 1996 to $32.9 million for 1997. Page 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Risks and Uncertainties That May Affect Future Results All statements in this annual report, other than statements of historical facts, are 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 for the company's specific industries. The words "expect", "anticipate", "looking forward" and other similar expressions used in this annual 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, dependence on single large customers, the results of financing efforts, the results of the company's decision to pursue the sale of the company in its entirety or in separate transactions, actual purchases under agreements, the effect of the company's accounting policies, U.S. Government export policies, governmental budgeting and spending cycles, results of restructuring efforts, geographic market concentrations, natural disasters and other risks. 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. The wireless communications industry is subject to various regulatory agencies of federal, foreign, state and local governments which can affect market dynamics, causing unforeseen ebb and flow of orders and delivery requirements. Domestic and international competition from a number of wireless communications 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. 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. The market downturn continued in 1998. The semiconductor equipment business can vary rapidly in response to individual 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, these factors along with other factors could significantly affect the company's future operating results. Year 2000 Compatibility 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. Page 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 stated 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 mid 1999 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 segment has identified the issues, addressed the problems and developed solutions. The solutions have been tested and found to work satisfactorily. The Y2K issues do not affect the ability of the products to process wafers, but involve maintaining temporary 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 segment. 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 mid 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. 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 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, however, no absolute assurances can be given. 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 were $0.1 million in 1997, $0.2 million in 1998 and expected to be $0.2 million in 1999. Page 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 believes it has met the related legal requirements effective for January 1, 1999, and it expects to be able to meet the legal requirements 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. Item 7A. Quantitative and Qualitative Disclosures About Market Risks The following discussion about the company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The company is exposed to market risk related to changes in interest rates and foreign currency exchange rates. The company does not use derivative financial instruments for speculative or trading purposes. Short-Term Investments--The company maintains a short-term investment portfolio consisting mainly of debt securities with an average maturity of less than two years. These available-for-sale securities are subject to interest rate risk and will rise or fall in value if market interest rates change. The company has the ability to hold its fixed income investments until maturity, and therefore the company would not expect its operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its investment portfolio. The following table provides information about the company's investment portfolio and constitutes a "forward-looking statement." For investment securities, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. Expected Maturity Weighted Amounts Average Interest Expected Maturity Dates (in thousands) Rate ---------------------------- ---------------------- ----------------- Cash and equivalents: 1999 $19,271 4.41% Short-term investments: 1999 22,021 5.64% 2000 15,235 5.91% 2001 8,097 5.85% Fair value at December 31, 1998 $45,353 Page 18 Item 7A. Quantitative and Qualitative Disclosures About Market Risks (continued) Long-term Debt--On December 31, 1998, the company had fixed rate long-term debt of approximately $20.8 million (including the current portion of $615,000), which is denominated in Japanese Yen (113.45 yen per dollar at December 31, 1998). The company has not hedged any interest rate or foreign currency rate exposures on this loan. The table below provides information about the company's long-term debt and constitutes a "forward-looking statement." The table presents expected debt maturity by year and related weighted average interest rates. Expected Maturity Weighted Amounts Average Interest Expected Maturity Dates (in thousands) Rate --------------------------- --------------------- ----------------- 1999 (current) $ 615 2.50% 2000 615 2.50% 2001 615 2.50% 2002 615 2.50% 2003 615 2.50% Thereafter 17,764 2.87% Fair value at December 31, 1998 $20,839 Additional information regarding market risks with respect to company borrowings is disclosed in Note 3 to the consolidated financial statements. Foreign Exchange Risks--The company has limited involvement with derivative financial instruments and does not use such instruments for trading purposes. The derivative financial instruments are used to manage foreign currency exchange risk. The company enters into foreign exchange forward contracts to hedge certain balance sheet exposures and intercompany balances against future movements in foreign exchange rates. Gains and losses on the forward contracts are largely offset by gains and losses on the underlying exposure and consequently a sudden or significant change in foreign exchange rates is not expected to have a material impact on future net income or cash flows. The company is exposed to credit-related losses in the event of nonperformance by counter parties to these financial instruments, but does not expect any counter party to fail to meet its obligation. Page 19 Item 7A. Quantitative and Qualitative Disclosures About Market Risks (continued) The maturity of foreign currency exchange contracts held at December 31, 1998 is consistent with the contractual or expected timing of the transactions being hedged, principally receipt of customer payments in Japanese Yen. These foreign exchange contracts mature within 1 year and are as follows: CONTRACTS TO PURCHASE (Dollars in thousands) ----------------------------------------------------------------------- Currency At Contract At Market Type Contract Date Maturity Date Rate Rate ----------------------------------------------------------------------- Fourth Quarter First Yen 1998 Quarter 1999 $5,908 $5,972 ----------------------------------------------------------------------- CONTRACTS TO SELL (Dollars in thousands) ----------------------------------------------------------------------- Currency At Contract At Market Type Contract Date Maturity Date Rate Rate ----------------------------------------------------------------------- Fourth Quarter First Yen 1998 Quarter 1999 $13,813 $14,055 ----------------------------------------------------------------------- Additional information regarding market risks are disclosed in Notes 1, 2 and 3 to the consolidated financial statements. Page 20 Item 8. Financial Statements and Supplementary Data WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Sales $ 212,200 $ 291,271 $ 349,119 - ----------------------------------------------------------------------------------------------------------------------------------- Costs and expenses: Cost of goods sold 161,648 196,675 230,556 Cost of goods sold-write down of discontinued products 17,119 Selling and administrative 50,965 58,696 66,687 Restructuring charges 27,290 Research and development 49,871 50,182 53,175 - ----------------------------------------------------------------------------------------------------------------------------------- 306,893 305,553 350,418 - ----------------------------------------------------------------------------------------------------------------------------------- Loss from operations (94,693) (14,282) (1,299) Other income (expense): Interest income 5,681 2,198 789 Interest expense (1,168) (1,425) (1,574) Other income (expense)--net 2,199 (1,062) (12) Gain on real property (Note 10) 14,973 7,609 - ----------------------------------------------------------------------------------------------------------------------------------- Loss from continuing operations before income taxes (73,008) (6,962) (2,096) Income tax benefits 23,800 3,000 775 - ----------------------------------------------------------------------------------------------------------------------------------- Loss from continuing operations (49,208) (3,962) (1,321) Discontinued operations (Note 8): Income from discontinued operations, net of taxes 7,210 4,355 Gain on disposition, net of taxes 29,677 - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (49,208) $ 32,925 $ 3,034 =================================================================================================================================== Basic and diluted per share amounts: Loss from continuing operations $ (6.36) $ (0.48) $ (0.16) Income from discontinued operations 0.87 0.53 Gain on disposition of discontinued operations 3.60 - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (6.36) $ 3.99 $ 0.37 =================================================================================================================================== Basic and diluted average common shares 7,737,000 8,258,000 8,265,000 See notes to consolidated financial statements.
Page 21 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $(49,208) $ 32,925 $ 3,034 - ----------------------------------------------------------------------------------------------------------------------------------- Other comprehensive income (loss), net of tax: Foreign currency translation adjustments (1,385) (301) (294) Unrealized holding gains on securities-net of taxes of $97 152 - ----------------------------------------------------------------------------------------------------------------------------------- Other comprehensive loss (1,233) (301) (294) - ----------------------------------------------------------------------------------------------------------------------------------- Comprehensive income (loss) $(50,441) $ 32,624 $ 2,740 =================================================================================================================================== See notes to consolidated financial statements.
Page 22 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and equivalents $ 19,271 $ 134,462 Short-term investments 45,353 Receivables (net of allowance for doubtful accounts of $3,354 in 1998 and $3,176 in 1997) 31,942 45,690 Inventories: Finished goods 2,960 9,283 Work in process 11,954 18,519 Raw materials and parts 8,456 18,873 Deferred income taxes 32,288 24,830 Income taxes receivable 13,570 Other 6,302 6,536 - ----------------------------------------------------------------------------------------------------------------------------------- Total current assets 172,096 258,193 - ----------------------------------------------------------------------------------------------------------------------------------- PROPERTY, PLANT AND EQUIPMENT: Land 10,569 12,102 Buildings and improvements 32,733 55,155 Plant facilities, leased 11,184 11,012 Machinery and equipment 85,738 100,526 - ----------------------------------------------------------------------------------------------------------------------------------- 140,224 178,795 Accumulated depreciation and amortization (77,585) (82,382) - ----------------------------------------------------------------------------------------------------------------------------------- Property, plant and equipment--net 62,639 96,413 - ----------------------------------------------------------------------------------------------------------------------------------- OTHER ASSETS 10,743 3,606 - ----------------------------------------------------------------------------------------------------------------------------------- $ 245,478 $ 358,212 ==================================================================================================================================== LIABILITIES AND SHAREOWNERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 15,704 $ 16,188 Accrued expenses 31,104 23,209 Advances on contracts 2,074 1,867 Provision for warranties and losses on contracts 12,066 15,898 Payroll and profit sharing 10,742 15,825 Income taxes 9,388 31,599 - ----------------------------------------------------------------------------------------------------------------------------------- Total current liabilities 81,078 104,586 - ----------------------------------------------------------------------------------------------------------------------------------- LONG-TERM OBLIGATIONS 32,701 33,234 - ----------------------------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 3 and 6) SHAREOWNERS' EQUITY: Preferred stock, $1.00 par value--authorized and unissued, 500,000 shares Common stock, no par value--authorized, 45,000,000 shares; outstanding: 1998, 6,547,687 shares; 1997, 8,261,036 shares 34,454 40,631 Retained earnings 99,073 180,356 Accumulated other comprehensive income (loss) (1,828) (595) - ----------------------------------------------------------------------------------------------------------------------------------- Total shareowners' equity 131,699 220,392 - ----------------------------------------------------------------------------------------------------------------------------------- $ 245,478 $ 358,212 ==================================================================================================================================== See notes to consolidated financial statements.
Page 23 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
Other Compre- Total Common Stock hensive- Share- (Dollars in thousands, --------------------------- Retained Income owners' except per share amounts) Shares Dollars Earnings (Loss) Equity - ----------------------------------------------------------------------------------------------------------------------------------- Balance, January 1, 1996 8,124,055 $ 34,307 $ 156,946 $ 0 $ 191,253 Net income for 1996 3,034 3,034 Dividends declared-$0.48 per share (3,973) (3,973) Stock option transactions 205,193 4,691 4,691 Foreign currency translation adjustment (294) (294) - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 8,329,248 38,998 156,007 (294) 194,711 Net income for 1997 32,925 32,925 Dividends declared-$0.48 per share (3,974) (3,974) Stock option transactions 135,988 2,778 2,778 Repurchases of common stock (204,200) (1,145) (4,602) (5,747) Foreign currency translation adjustment (301) (301) - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 8,261,036 40,631 180,356 (595) 220,392 Net loss for 1998 (49,208) (49,208) Dividends declared-$0.48 per share (3,685) (3,685) Stock option transactions 82,451 1,605 1,605 Repurchases of common stock (1,795,800) (7,782) (28,390) (36,172) Foreign currency translation adjustment (1,385) (1,385) Unrealized holding gains on securities-net of taxes of $97 152 152 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1998 6,547,687 $ 34,454 $ 99,073 $ (1,828) $ 131,699 =================================================================================================================================== See notes to consolidated financial statements.
Page 24 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income (loss) $ (49,208) $ 32,925 $ 3,034 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Depreciation and amortization 15,782 13,112 8,996 Gain on disposal of property, plant and equipment (10,876) (3,513) Deferred income taxes (8,597) (10,470) (3,280) Results of discontinued operations and gain on disposal (36,887) (4,355) Restructuring write-downs 40,489 Net changes in: Receivables 14,266 26,897 (4,506) Inventories 6,548 3,364 16,877 Other assets (12,737) 1,584 (1,752) Accruals and payables (22,822) 39,635 (4,257) Advances on contracts 207 435 (1,114) Provision for warranties and losses on contracts (3,832) 1,420 6,688 Environmental remediation (317) (198) (327) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by continuing operating activities (31,097) 68,304 16,004 Net cash used by discontinued operations (11,180) (2,181) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities (31,097) 57,124 13,823 - ----------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Additions of property, plant and equipment (15,079) (22,177) (48,303) Purchase of short-term investments (101,046) Proceeds from sale of short-term investments 55,943 Restricted plant construction funds 3,738 (3,738) Proceeds from sale of discontinued operations 77,884 Proceeds on real estate sales and assets retirements 16,718 8,475 (1,070) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by investing activities (43,464) 67,920 (53,111) - ----------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Long-term borrowings 1,642 20,241 Payments on long-term borrowings (544) (1,132) (135) Proceeds from issuance of common stock 1,605 2,778 4,691 Repurchase of common stock (36,172) (5,747) Dividends paid (3,685) (3,974) (3,973) Other (124) (531) (390) - ----------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities (38,920) (6,964) 20,434 - ----------------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash (1,710) 680 - ----------------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and equivalents (115,191) 118,760 (18,854) Cash and equivalents at beginning of year 134,462 15,702 34,556 - ----------------------------------------------------------------------------------------------------------------------------------- Cash and equivalents at end of year $ 19,271 $ 134,462 $ 15,702 ==================================================================================================================================== See notes to consolidated financial statements.
Page 25 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Year Ended December 31 - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Other cash flow information: - ------------------------------------------------------------------------------------------------------------------------------------ Income taxes paid-net of refunds $9,478 $3,143 $5,700 Interest paid 1,098 1,389 1,574 - ------------------------------------------------------------------------------------------------------------------------------------ Noncash investing and financing activities: - ------------------------------------------------------------------------------------------------------------------------------------ Reclassification of plant held for sale from "Property, Plant and Equipment" to "Other Assets", at book value which is below market $6,422 - ------------------------------------------------------------------------------------------------------------------------------------ See notes to consolidated financial statements.
Page 26 WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation--The consolidated financial statements include those of the company and its subsidiaries after elimination of intercompany balances and transactions. In 1997, the company disposed of its Government Electronics operating segment which has been reported as discontinued operations, as described more fully in Note 8. Cash Equivalents and Investments--Cash equivalents consist of municipal bond funds and commercial paper acquired with remaining maturity periods of 90 days or less and are stated at cost plus accrued interest which approximates market value. Investments consist of high-grade debt securities (AA rating or better) with maturities greater than 90 days from the date of acquisition and are classified as "available-for-sale." Investments classified as available-for-sale are reported at fair market value with unrealized gains or losses excluded from earnings and reported as a separate component of stockholders' equity, net of tax, until realized. The company's investment guidelines limit investments with a single issuer, excluding the U.S. Government or any agency thereof, to the greater of $5.0 million or 10 percent of the investment portfolio. Inventories--Inventories are stated at the lower of cost, using first-in, first-out and average-cost basis, or market. Cost of inventory items is based on purchase and production cost. Long-term contract costs and selling and administrative expenses are excluded from inventory. Progress payments are not netted against inventory. Property, Plant and Equipment--Property, plant and equipment are stated at cost. Provision for depreciation and amortization is primarily based on the straight-line method. Leases which at inception assure the lessor full recovery of the fair market value of the property over the lease term are capitalized and amortized over the lease term in accordance with Statement of Financial Accounting Standards ("SFAS") No. 13 "Accounting for Leases." Revenue Recognition--Revenues, other than from long-term contracts, are recorded upon shipment or completion of tasks as specified in the contract. Estimated product warranty costs are accrued at the time of shipment. Sales and allowable fees under cost-reimbursement contracts are recorded as costs are incurred. Long-term contract sales and cost of goods sold are recognized using the percentage-of-completion method based on the actual physical completion of work performed and the ratio of costs incurred to total estimated costs to complete the contract. Any anticipated losses on contracts are charged to earnings when identified. Foreign Currency Translation--The functional currency for all foreign operations is the U.S. dollar, with the exception of the company's subsidiary located in Japan, which uses the local functional currency. Gains or losses which result from the process of remeasuring foreign currency financial statements and transactions into U.S. dollars are included in other income (expense). For the Japanese subsidiary, the cumulative translation adjustments are recorded directly in retained earnings. The company incurred net translation gains of approximately $0.1 million in 1998 and net translation losses of $1.4 million in 1997, resulting primarily from its Asia-Pacific subsidiaries. Translation gains or losses were not material prior to 1997. Page 27 1. SIGNIFICANT ACCOUNTING POLICIES (continued) Forward Exchange Contracts--The company enters into forward exchange contracts to hedge sales transactions and firm commitments denominated in foreign currencies. Gains and losses on the forward contracts are recognized based on changes in exchange rates, as are offsetting foreign exchange gains and losses on the underlying transactions. Income Taxes--The consolidated statements of operations include provisions for deferred income taxes using the liability method for transactions that are reported in one period for financial accounting purposes and in another period for income tax purposes. Per Share Information--Basic earnings per share is computed using the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options) were exercised or converted into common stock, however, such adjustments are excluded when there is a loss from continuing operations, as they are considered antidilutive. Use of Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Stock-Based Compensation--The company continues to account for stock-based compensation granted to employees and directors under the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." 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. Management does not expect this Statement to have a significant impact on the company's financial condition or results of operations. Page 28 2. FINANCIAL INSTRUMENTS AND SHORT-TERM INVESTMENTS Financial instruments that potentially subject the company to concentrations of credit risk consist principally of cash and equivalents, short-term investments, receivables, and financial instruments used in hedging transactions. The company invests in a variety of financial instruments such as commercial paper and municipal bond funds, and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. Concentration of credit risk with respect to trade receivables is limited due to the variety of customers and market segments into which the company's products are sold, as well as their dispersion across geographic areas. The company maintains an allowance for doubtful accounts based upon the expected collectibility of receivables. The carrying value of cash and equivalents, short-term investments, receivables, accounts payable and short-term notes payable are a reasonable approximation of their fair market value due to the short-term maturities of those instruments. The carrying value of the company's long-term debt approximates fair value based on the interest rates currently available to the company for long-term debt with similar terms as those borrowings of the company. Considerable judgment is required in interpreting market data to develop estimates of fair value, so these estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. The company is a party to financial instruments with off-balance-sheet risk in the normal course of business to reduce its exposure to fluctuations in foreign exchange rates. At December 31, 1998 and 1997, the company had forward exchange contracts to sell Japanese Yen with a market value of approximately $14.1 million and $12.4 million, respectively, for a contract amount of $13.8 million and $12.8 million, respectively. Also at December 31, 1998 and 1997, the company had forward exchange contracts to purchase Japanese Yen with a market value of approximately $6.0 million and $1.7 million, respectively, for a contract amount of $5.9 million and $1.8 million, respectively. These contracts mature within one year. The market value of forward exchange contracts were obtained from published foreign exchange market rates. The company's risk in these contracts is the cost of replacing, at current market rates, these contracts in the event of default by the other party. Management believes the risk of incurring such losses is remote as the contracts are entered into with major financial institutions. The fair value and the amortized cost of available-for-sale securities at December 31, 1998, including unrealized holding gains, are presented in the table which follows. Fair values are based on quoted market prices obtained from an independent broker. Available-for-dale securities are classified as current assets and have an average maturity of less than two years. Gross proceeds from the sale of marketable securities were $55.9 million during 1998. Gross gains and losses realized on such sales or maturities were not material. For the purpose of determining gross realized gains and losses, the cost of securities sold is based upon specific identification. Unrealized (in thousands) Amortized cost Market value holding gains - -------------------------------------------------------------------------------- Corporate debt securities $45,104 $45,353 $249 ================================================================================ Page 29 3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT Long-term obligations, excluding amounts due within one year, consist of the following at December 31: (in thousands) 1998 1997 - ------------------------------------------------------------------------------- Long-term borrowings $ 20,224 $ 18,630 Deferred compensation 291 1,977 Environmental remediation 7,120 7,437 Long-term leases 5,066 5,190 =============================================================================== Total $ 32,701 $ 33,234 =============================================================================== The current portion of long-term obligations is included in current liabilities. The expected maturity amounts are as follows: 1999, $1,101,000; 2000, $1,231,000; 2001, $1,167,000; 2002, $1,197,000; 2003, $1,227,000; thereafter, $27,879,000. Long-term Borrowings--Consists of three unsecured loans used for the company's land, building and equipment located in Kawasaki, Japan. The loans are denominated in Yen. Approximately $6.8 million is payable in monthly installments through the year 2011, which bears interest at 2.5%. Approximately $11.7 million and $1.7 million require a balloon payment due in the year 2006 and 2007, respectively, which bear interest at 3.1% and 2.2%, respectively, payable semiannually. Deferred Compensation--The company has several nonqualified deferred compensation and bonus plans covering selected members of management and key technical employees. Substantially all these plans were terminated as of December 31, 1998, and the balances classified as currently payable. Environmental Remediation--As discussed in Note 6, the company is obligated to remediate groundwater contamination at its Scotts Valley and Palo Alto, California, facilities. The portion expected to be paid within one year is included in current liabilities. Leases--Certain long-term leases for plant facilities are treated as capital leases for financial statement purposes. The leases expire during the years 2029 to 2056. The company also has noncancellable operating leases for plant facilities and equipment expiring through the year 2004. These leases may be renewed for various periods after the initial term. Payment obligations under existing capital and operating leases as of December 31, 1998 are as follows: Capital Operating (in thousands) Leases Leases - ----------------------------------------------------------------- ----------- Lease payments: 1999 $ 635 $1,657 2000 635 1,326 2001 635 894 2002 635 311 2003 635 24 Remaining years 6,822 13 - ----------------------------------------------------------------------------- Total 9,997 $4,225 =========== Imputed interest (4,795) - ----------------------------------------------------------------- Present value of lease payments (including current portion of $136) $ 5,202 ================================================================= Page 30 3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT (continued) The company sub-leases a portion of its of its Palo Alto, California, facility under a short-term operating lease expiring October 2000. In addition, the company leases a portion of its facility in Kawasaki, Japan, under a short-term operating lease. Included in other income for 1998 is approximately $1.2 million of income after expenses from these rental agreements. Rental income was not material prior to 1998. Rent expense included in continuing operations for property and equipment relating to operating leases is as follows:
(in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Real property $ 1,129 $ 2,446 $ 2,384 Equipment 864 1,041 782 - ------------------------------------------------------------------------------------------------------ Total $ 1,993 $ 3,487 $ 3,166 ======================================================================================================
Credit Facility Termination--The company previously had arranged with several banks to provide a $50.0 million unsecured credit facility which was scheduled to expire on March 31, 1999. During 1998, the company did not borrow under this credit facility. Due to the operating loss reported in 1998, the company was technically not in compliance with certain terms under this credit facility. The company evaluated the proposed revised terms and elected to terminate the facility based on the company's cash balances and short-term investments. The Company has letters of credit of $2.1 million of which $0.9 million was outstanding at December 31, 1998, with approximately $0.6 million collateralized by specific cash balances. 4. SHAREOWNERS' EQUITY Stock Repurchase Program--During 1998, the Board of Directors increased its common stock repurchase authorization from 2,500,000 to 3,500,000 shares. By December 31, 1998, all 3,500,000 shares have been repurchased, of which 1,795,800 and 204,200 were repurchased in 1998 and 1997, respectively. No shares were repurchased in 1996. Common Share Purchase Rights--During 1998, the Board of Directors amended the company's Common Share Purchase Rights Plan to decrease from 15% to 10% the threshold level of common stock ownership that would trigger the exercisability of common share purchase rights under the Rights Plan. For each share of company common stock outstanding, one Common Share Purchase Right (the Rights) is attached. The Rights expire October 20, 2006, and may be redeemed by the company for $0.01 per Right at any time prior to 10 days after a person or group acquires 10% or more of the company's common stock. The Rights become exercisable and trade separately from the common stock if any person or group acquires 10% or more of the company's outstanding common stock, or announces a tender or exchange offer which would result in such person or group acquiring 10% or more of the company's common stock. When the Rights first become exercisable as a result of the announcement of a tender or exchange offer, a holder of a Right will be entitled to buy one share of the company's common stock for $160. If a person or group not previously approved by the Board of Directors acquires 10% or more of the company's shares, a holder of a Right (other than that person or group) will be entitled to buy that number of shares of common stock from the company which have a market value of twice the $160 exercise price of each Right. If the company is acquired in a merger or other business combination after any person or group acquires 10% or more of the company's common stock, each Right will entitle its holder to buy a number of shares of common stock of the surviving company having a market value of twice the $160 exercise price. After the acquisition by any person or group of 10% or more of the company's common stock and up to the time that such person or group acquires a 50% interest, the company will also have the ability to exchange some or all of the Rights (other than Rights held by the acquiror) for one share of common stock per Right at no expense to the holder. Page 31 4. SHAREOWNERS' EQUITY (Continued) Stock Option Plans--The Employee Stock Option Plans (the Plans) provide for grants of nonqualifying and incentive stock options to certain key employees and officers. The company may grant options to purchase up to 4,300,000 shares of common stock. Options are typically granted at the market price on the date of grant and expire at the tenth anniversary date. One-third of the options granted are exercisable on each of the second, third and fourth anniversary dates following the grant. The Plans allow those employees who are subject to the insider trading restrictions certain limited rights to receive cash in the event of a change in control. In addition, the Plans permit the award of restricted stock rights subject to a fixed vesting schedule. The holder of vested restricted stock has certain dividend, voting, and other shareowner rights. No restricted stock awards have been made through December 31, 1998. The Nonemployee Directors Stock Option Plan provides for a fixed schedule of options to be granted through the year 2005. Nonemployee directors of the company are automatically granted 3,000 shares of common stock each year that such person remains a director of the company. The options are granted at the market price on the date of grant and expire on the tenth anniversary date. The options granted become exercisable six months after the date of grant. The total number of shares to be issued under this plan may not exceed 350,000 shares. Included in the tables below, 21,000 option shares were granted at $26.50 in 1998, 21,000 option shares were granted at $26.88 in 1997 and 21,000 option shares were granted at $34.63 in 1996. Stock option transactions included in the Consolidated Statements of Shareowners' Equity are shown net of retirement of mature shares used in payment for options exercised and include tax benefits related to sales under stock option plans of $217,000, $719,000 and $1,161,000 for 1998, 1997 and 1996, respectively. Activity related to all stock option plans is as follows:
Weighted Average 1998 Shares Exercise Price - -------------------------------------------------------------------------------------------------------------------- Granted 242,000 $25.72 Exercised 82,451 $16.84 Terminated 151,427 $29.67 At December 31: Outstanding 1,452,062 $27.41 Exercisable 858,765 $26.57 Reserved for future grants 1,056,709 1997 - -------------------------------------------------------------------------------------------------------------------- Granted 242,000 $26.41 Exercised 135,988 $15.14 Terminated 191,309 $34.76 At December 31: Outstanding 1,443,940 $27.33 Exercisable 693,966 $23.70 1996 - -------------------------------------------------------------------------------------------------------------------- Granted 205,000 $25.54 Exercised 209,393 $17.57 Terminated 328,443 $29.39 At December 31: Outstanding 1,529,237 $27.32 Exercisable 463,119 $19.11
Page 32 4. SHAREOWNERS' EQUITY (continued) The following table summarizes information concerning currently outstanding and exercisable options at December 31, 1998:
Options Outstanding Options Exercisable ------------------------------------------------------- ---------------------------------- Weighted Average Years Weighted Weighted Range of Number of Remaining Average Number Average Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price - ----------------------- --------------- -------------------- ------------------ ---------------- ----------------- $10.00 to $21.63 319,946 5.3 $15.57 233,608 $13.61 $22.75 to $22.75 263,502 5.2 $22.75 263,502 $22.75 $22.81 to $26.88 395,000 8.7 $25.87 49,666 $26.66 $27.00 to $35.88 84,493 7.2 $32.88 52,326 $33.52 $36.75 to $36.75 259,415 6.2 $36.75 174,482 $36.75 $39.50 to $55.00 129,706 6.7 $48.55 85,181 $48.77 - ----------------------- --------------- -------------------- ------------------ ---------------- ----------------- $10.00 to $55.00 1,452,062 6.6 $27.41 858,765 $26.57 ======================= =============== ==================== ================== ================ =================
As discussed in Note 1, the company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans. Had compensation cost for the company's stock option plans been determined based upon the fair value at the grant date for awards under these plans, and amortized to expense over the vesting period of the awards consistent with the methodology prescribed under SFAS 123, "Accounting for Stock-Based Compensation," the company's pro forma net income (loss) for 1998, 1997 and 1996 would have been $(50,420,000), $31,724,000 and $1,256,000, respectively, or $(6.52), $3.84 and $0.15 per basic and diluted share, respectively. However, the impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro forma calculation; accordingly, the 1998, 1997 and 1996 pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all applicable stock options. The weighted average fair value of options calculated on the date of grant using the Black-Scholes option-pricing model along with the weighted average assumptions used are as follows:
1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Fair value $7.70 $8.02 $7.96 Dividend yield 2.1% 1.2% 1.5% Volatility 41.7% 38.1% 37.5% Risk free interest rate at the time of grant 5.4% 6.1% 6.2% Expected term to exercise (in months from the vest date) 4.9 4.5 3.5
The company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. The Black-Scholes model used by the company to calculate option values, as well as other currently accepted option valuation models, were developed to estimate the fair values of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the company's stock option awards. These models also require highly subjective assumptions, including future stock price volatility, and expected time until exercise, which greatly affect the calculated values. Page 33 5. INCOME TAXES The provision for income taxes includes deferred taxes reflecting the net tax effects of temporary differences that are reported in one period for financial accounting purposes and in another period for income tax purposes. Deferred tax assets are recognized when management believes realization of future tax benefits of temporary differences is more likely than not. In estimating future tax consequences, generally all expected future events are considered other than enactments of changes in the tax law or rates. The components of income (loss) from continuing operations before federal, state and foreign income taxes consists of the following:
(in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- U.S. $ (67,995) $ (10,330) $ (4,662) Foreign (5,013) 3,368 2,566 - -------------------------------------------------------------------------------------------------------------------- Total $ (73,008) $ (6,962) $ (2,096) ==================================================================================================================== The provision for federal, state and foreign income tax expense (benefits) on income (loss) from continuing operations consists of the following: (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Current: U.S. $(16,092) $ 425 $ 1,928 State 286 1,275 (152) Foreign 506 1,870 1,264 - -------------------------------------------------------------------------------------------------------------------- Total current (15,300) 3,570 3,040 - -------------------------------------------------------------------------------------------------------------------- Deferred: U.S. (6,273) (4,385) (3,497) State (2,227) (2,185) (318) - -------------------------------------------------------------------------------------------------------------------- Total $ (23,800) $ (3,000) $ (775) ==================================================================================================================== Deferred tax assets (liabilities) are comprised of the following at December 31: (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Deferred compensation $ 2,073 $ 2,556 $ 1,915 Loss accruals 20,147 18,041 10,495 Environmental remediation 3,172 3,274 3,147 Uniform capitalization 135 1,212 1,007 Vacation accrual 1,199 1,663 1,580 Net operating loss and tax credits carried forward 8,653 Other 782 3,334 2,111 - -------------------------------------------------------------------------------------------------------------------- Gross deferred tax assets 36,161 30,080 20,255 - -------------------------------------------------------------------------------------------------------------------- Depreciation (191) (2,610) (3,197) Other (58) - -------------------------------------------------------------------------------------------------------------------- Gross deferred tax liabilities (191) (2,610) (3,255) - -------------------------------------------------------------------------------------------------------------------- Net deferred tax asset $ 35,970 $ 27,470 $ 17,000 ====================================================================================================================
The company has federal and state operating loss carryforwards of approximately $10.0 million and $12.3 million, respectively, which expire through the year 2019. In addition, the company has federal and state tax credit carryforwards, related primarily to research credits, totaling approximately $3.7 million and $0.9 million, respectively. These tax credit carryforward benefits expire through the year 2019. Page 34 5. INCOME TAXES (Continued) The differences between the effective income tax (benefit) rate and the statutory federal income tax (benefit) rate are as follows:
1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Statutory federal tax (benefit) rate (35.0)% (35.0)% (34.0)% Export sales benefit (0.1) (6.5) (10.0) Research credit (0.7) (8.5) (14.6) Effect of foreign operations taxed at various rates 3.1 9.8 18.7 State taxes (benefit) net of federal tax (1.2) (8.4) (4.8) Other 1.3 5.5 7.7 ==================================================================================================================== Effective tax (benefit) rate (32.6)% (43.1)% (37.0)% ====================================================================================================================
6. ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES In 1991 the company recorded a $15.0 million charge for estimated remediation actions and cleanup costs. The company remains in compliance with the remedial action plans being monitored by various regulatory agencies at its Scotts Valley and Palo Alto sites and no additional provision has been recorded since 1991. Expenditures charged against the provision totaled $317,000, $198,000 and $327,000 for the years 1998, 1997 and 1996, respectively. While the timing and ultimate amount of expenditures of restoring the sites cannot be predicted with certainty, management believes that the provision taken is adequate based on facts known at this time. Changes in environmental regulations, improvements in cleanup technology and discovery of additional information concerning these sites and other sites could affect the estimated costs in the future. In addition to the above environmental matters, the company is involved in various legal actions which arose in the ordinary course of its business activities. Except for the environmental provision noted above, management believes the final resolution of these matters should not have a material impact on its results of operations, cash flows, and financial position. Page 35 7. EMPLOYEE BENEFIT PLANS Employees' Investment Plan--The Watkins-Johnson Employees' Investment Plan covers substantially all employees and provides that the company match employees' 401(k) salary deferrals up to 3% of eligible employee compensation. The amount charged to continuing operations was $1,903,000, $2,001,000 and $1,920,000 in 1998, 1997 and 1996, respectively. Employee Stock Ownership Plan (ESOP)--The ESOP was established to encourage employee participation and long-term ownership of company stock. The Board determines each year's discretionary contribution depending on the performance and financial condition of the company and is allocated as a percentage of eligible employee base compensation. All U.S. employees are eligible to participate in the plan and vesting is immediate. The Board approved a contribution equal to 1% of eligible employee compensation for 1998, 1997, and 1996, which resulted in charges to continuing operations of $378,000, $657,000 and $639,000, respectively. The ESOP held 181,624 and 229,231 shares of common stock at December 31, 1998 and 1997, respectively, and there are no unallocated or unearned shares held by the plan. Shares held by the ESOP are included in the company's earnings per share computations. Dividends paid with respect to common stock held by the ESOP are used to purchase additional shares and were not material for all years presented. 8. BUSINESS SEGMENT REPORTING In 1997 the company adopted SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." The Statement requires that an enterprise's operating segments be determined in the manner in which management operates the business. Specifically, financial information is to be reported on the basis that is used internally by the chief operating decision maker in making decisions related to resource allocation and segment performance. The company's reportable segments are operated and managed as strategic business units and are organized based on products and services. Business units operated at different locations are aggregated for reporting purposes when their products and services are similar. Under SFAS 131, the company's operations were divided into three industry segments: Semiconductor Equipment, Wireless Communications, and Government Electronics. As discussed below, the Government Electronics segment was divested during 1997. Operations in the Wireless Communications segment involve the development, manufacture and sale of advanced wireless telecommunication products for cellular service providers, personal communication systems, and other radio-frequency products for commercial and government communications requirements. The Wireless Communications segment is composed of the Palo Alto, California-based Wireless Products Group and the Gaithersburg, Maryland, Telecommunications Group, including that group's communications-intelligence business. Operations in the Semiconductor Equipment segment involve the development, manufacture, sale and service of chemical-vapor-deposition equipment used in the manufacture of semiconductor products. Page 36 8. BUSINESS SEGMENT REPORTING (continued) On October 31, 1997 the company completed the sale of its Government Electronics segment to Stellex Industries, Inc. for consideration of $103 million, consisting mostly of cash. The sale resulted in a pre-tax gain of approximately $49.9 million. The divested business is reported as discontinued operations in the accompanying financial statements. Operations of the divested business included the development, manufacture and sale of advanced microwave devices and tactical electronic systems and devices for guided-missile programs and other government applications. Management evaluates segment performance based primarily on segment revenues, pre-tax operating profit or loss before interest and other nonoperating income and expenses, and return on assets. Sales between continuing segments are not significant for any year presented. Continuing operations by business segment are as follows:
(in thousands) Year Ended December 31, 1998 - ------------------------------------------------------------------------------------------------------------------- Pre-tax Year- Income End Capital Sales (Loss) Assets Additions Depreciation - -------------------------------------------------------------------------------------------------------------------- Wireless Communications $ 115,219 $(13,697) $ 50,778 $ 7,324 $ 3,655 Semiconductor Equipment 96,981 (80,996) 67,496 7,742 11,664 Corporate 127,204 13 463 - -------------------------------------------------------------------------------------------------------------------- Loss from operations (94,693) Other income (expense)--net 21,685 - -------------------------------------------------------------------------------------------------------------------- Total $ 212,200 $(73,008) $ 245,478 $ 15,079 $ 15,782 ==================================================================================================================== Year Ended December 31, 1997 - -------------------------------------------------------------------------------------------------------------------- Wireless Communications $ 104,817 $ (954) $ 54,408 $ 6,881 $ 2,510 Semiconductor Equipment 186,454 (13,328) 132,528 15,152 10,144 Corporate 171,276 144 458 - -------------------------------------------------------------------------------------------------------------------- Loss from operations (14,282) Other income (expense)--net 7,320 - -------------------------------------------------------------------------------------------------------------------- Total $ 291,271 $ (6,962) $ 358,212 $ 22,177 $ 13,112 ==================================================================================================================== Year Ended December 31, 1996 - -------------------------------------------------------------------------------------------------------------------- Wireless Communications $ 76,683 $ (8,511) $ 50,754 $ 1,941 $ 1,252 Semiconductor Equipment 272,436 7,212 174,549 46,122 7,231 Corporate 68,441 240 513 - -------------------------------------------------------------------------------------------------------------------- Loss from operations (1,299) Other income (expense)--net (797) - -------------------------------------------------------------------------------------------------------------------- Total $ 349,119 $ (2,096) $ 293,744 $ 48,303 $ 8,996 ====================================================================================================================
Corporate assets consist primarily of cash, cash equivalents and deferred taxes, and included in the 1996 balance are net assets of the discontinued Government Electronics segment. Page 37 8. BUSINESS SEGMENT REPORTING (continued) Sales to individual customers representing greater than 10% of company consolidated sales during at least one of the past three years are as follows:
(in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Wireless Communications: Lucent Technologies, Inc. $ 33,000 $ 20,000 $ 11,000 United States Government 26,000 36,000 28,000 Semiconductor Equipment: Hyundai Electronics Industries Co., Ltd. (and affiliates) 11,000 15,000 37,000 Marubeni Hytech (a Japanese distributor) 5,000 21,000 47,000 Sales to unaffiliated customers by geographic area are as follows: (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- United States $ 135,692 $ 169,001 $ 143,510 Export sales from United States: Europe 6,479 8,924 29,759 Japan 10,770 23,035 65,952 Korea 5,095 29,531 52,572 Other Asia-Pacific countries 12,368 13,955 35,767 Other 9,753 3,307 3,728 Europe 21,429 34,701 9,759 Japan 4,510 2,742 3,312 Other Asia-Pacific countries 6,104 6,075 4,760 - -------------------------------------------------------------------------------------------------------------------- Total $ 212,200 $ 291,271 $ 349,119 ====================================================================================================================
Intercompany transfers of products and services between geographic regions were $43.2 million, $59.0 million and $37.5 million in fiscal years 1998, 1997 and 1996, respectively, and are accounted for at prices the company believes to be arm's length. Operating profit (loss) and year-end long-lived assets by geographic area are as follows:
Operating Profit (Loss) (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- United States $(89,302) $(19,385) $(4,231) Europe 300 3,640 700 Japan (6,376) 185 952 Other Asia-Pacific countries 685 1,278 1,280 - -------------------------------------------------------------------------------------------------------------------- Total $(94,693) $(14,282) $(1,299) ==================================================================================================================== Year-End Long-Lived Assets (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- United States $72,168 $118,606 $121,483 Europe 1,290 1,729 2,290 Japan 21,915 26,493 30,076 Other Asia-Pacific countries 3,999 3,762 4,159 - -------------------------------------------------------------------------------------------------------------------- Total $99,372 $150,590 $158,008 ====================================================================================================================
Long-lived assets exclude financial instruments, deferred tax assets, and for 1996 exclude the net assets of discontinued operations totaling $29.8 million. Page 38 8. BUSINESS SEGMENT REPORTING (continued) Summarized below are operating results of the discontinued government electronics business through its sale on October 31, 1997. Intersegment sales were transferred based on negotiated prices. Year Ended December 31 (in thousands) 1997 1996 - -------------------------------------------------------------------------------- Net sales $75,700 $89,200 ================================================================================ - -------------------------------------------------------------------------------- Gross profit $21,900 $21,100 ================================================================================ Income from operations before income taxes $11,500 $ 6,663 Income taxes (4,290) (2,308) Gain on disposition-net of taxes of $20,219 29,677 - -------------------------------------------------------------------------------- Net income from discontinued operations $36,887 $ 4,355 ================================================================================ 9. EARNINGS PER SHARE Basic and diluted earnings per share were computed based solely on the weighted average shares outstanding for each period. For 1998, 1997 and 1996 the incremental shares from the assumed exercise of 120,000, 251,000 and 272,000 stock options, respectively, are not included in computing the dilutive per share amounts because continuing operations resulted in a loss and such assumed conversion would be antidilutive. Additionally, weighted average options outstanding to purchase 887,000, 564,000 and 685,000 shares of common stock were not included in the computation of diluted per share amounts in 1998, 1997 and 1996, respectively, because the weighted average exercise prices were greater than the average market prices of the common shares. Weighted average exercise prices of $33.50 in 1998, $39.61 in 1997 and $39.62 in 1996 exceeded the average market prices of $23.28, $29.75 and $28.62, respectively. 10. REAL ESTATE TRANSACTIONS In 1998 the company sold approximately 15 acres of undeveloped land adjacent to its San Jose, California, facility for a net sales price of $16.0 million realizing a pre-tax gain of $15.0 million. Due to the downsizing described in Note 11, the balance of the San Jose facility was vacated and its carrying value of $6.4 million (which management believes to be less than market value) was reclassified as held for sale and included in "Other Assets" (long-term) in the December 31, 1998 Consolidated Balance Sheet. The company expects to sell this property in 1999. Any future gain associated with the sale of this property will be treated as from the sale of a corporate asset for segment reporting purposes. In 1997 the company exchanged a portion of its subleasehold interest at its Palo Alto, California, facility for consideration consisting of cash and the sublessor's leasehold rights in the remaining parcels under the lease. The exchange resulted in a pre-tax gain of $7.6 million. Page 39 11. DISCONTINUED PRODUCT LINES AND RELATED RESTRUCTURING CHARGES During the third quarter of 1998, the company restructured its operations to focus on its core atmospheric-pressure chemical-vapor-deposition (APCVD) operations in its Semiconductor Equipment segment by discontinuing efforts on its high-density-Plasma initiative. Also, the company's Wireless Communications segment evaluated its Base2(TM) base-station product, reassessing key customer needs and market conditions. Inventory, demo equipment, and specialized fixed assets associated with these discontinued products were written down in the restructuring. As a result, the company reduced its global work force 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 2,210 - --------------------------------------------------------------------- Balance at December 31, 1998 $1,711 =====================================================================
Included in the third-quarter 1998 asset write-downs is an approximately $6.0 million charge related to the Semiconductor Equipment segment's facility in Japan, which was written down to fair market value in accordance with SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." A portion of this facility is being leased to a tenant (see Note 3). The company anticipates substantially all accrued severance and benefits will be paid within a year. 12. SUBSEQUENT EVENTS On March 1, 1999, Watkins-Johnson announced that, after a strategic review performed by its investment banking firm, it would pursue a sale of the company, either in its entirety or through sales of its individual business segments. On March 4, 1999, Watkins-Johnson announced that it had signed a non-binding letter of intent to sell its Semiconductor Equipment Group, exclusive of its discontinued high-density-plasma and certain other assets, to Silicon Valley Group, Inc. (SVG). The sale is subject to customary due diligence, execution of a definitive acquisition agreement, Hart Scot Rodino filings, and the approval of the boards of directors of Watkins-Johnson and SVG. There can be no assurance that the sale of the Semiconductor Equipment Group to SVG will be completed, nor can there be any assurance that Watkins-Johnson will be able to complete its strategy for the sale of the entire company. Page 40 13. QUARTERLY FINANCIAL DATA--UNAUDITED Unaudited quarterly financial data are as follows:
(in thousands, except per share amounts) - ------------------------------------------------------------------------------------------------------------------------------------ 1998 Quarters 1st 2nd 3rd 4th - ------------------------------------------------------------------------------------------------------------------------------------ Sales $ 68,722 $ 53,739 $ 26,257 $ 63,482 Gross profit (loss) 26,176 16,659 (30,638) 21,236 Net income (loss) 9,701 (6,207) (54,414) 1,712 Basic net income (loss) per share 1.17 (0.75) (6.93) 0.26 Diluted net income (loss) per share $ 1.15 $ (0.75) $ (6.93) $ 0.25 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 Quarters 1st 2nd 3rd 4th - ------------------------------------------------------------------------------------------------------------------------------------ Sales $ 67,216 $ 72,679 $ 79,176 $ 72,200 Gross profit 22,905 26,068 30,435 15,188 Income (loss) from continuing operations (318) 886 1,762 (6,292) Income from discontinued operations 2,796 2,196 1,828 30,067 Net income 2,478 3,082 3,590 23,775 Basic income (loss) per share from continuing operations (0.04) 0.11 0.21 (0.76) Diluted income (loss) per share from continuing operations (0.04) 0.10 0.21 (0.76) Basic net income per share 0.30 0.37 0.44 2.88 Diluted net income per share $ 0.30 $ 0.36 $ 0.42 $ 2.88
The first quarter of 1998 includes a pre-tax gain on the sale of undeveloped land totaling about $15.0 million. The third quarter of 1998 includes pre-tax charges for discontinued product lines and related restructuring totaling $44.4 million, as described in Note 11. In the fourth quarter 1997, due to the continued overcapacity in the semiconductor memory market and the Asian financial crisis, the company took certain actions to minimize its financial exposure. The company deferred shipment and revenue recognition with certain Asian customers as a result of financing issues with these customers. The company's semiconductor equipment business was sized to reflect these market changes and resulted in certain non-performing assets being written off which consist primarily of inventory and capital assets. The effect of the above actions resulted in a pre-tax impact of approximately $17.0 million during the fourth quarter. The total of quarterly amounts for basic and diluted net income per share does not necessarily equal the annual amount. The computations exclude common equivalent shares in loss periods since they are antidilutive, and the computations are based on the average number of basic and diluted common shares outstanding during each period. Page 41 REPORT OF MANAGEMENT The consolidated financial statements of Watkins-Johnson Company and subsidiaries were prepared by management, which is responsible for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and, as such, include amounts that are based on the best judgments of management. The system of internal controls of the company is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorization and are reported properly. The most important safeguard for shareowners is the company's emphasis in the selection, training and development of professional accounting managers to implement and oversee the proper application of its internal controls and the reporting of management's stewardship of corporate assets and maintenance of accounts in conformity with generally accepted accounting principles. Deloitte & Touche LLP, independent auditors, are retained to provide an objective, independent review as to management's discharge of its responsibilities insofar as they relate to the fairness of reported operating results and financial position. They obtain and maintain an understanding of the company's accounting and financial controls, and conduct such tests and related procedures as they deem necessary to arrive at an opinion on the fairness of the financial statements. The Audit Committee of the Board of Directors, composed solely of Directors from outside the company, meets periodically, separately and jointly, with the independent auditors and representatives of management to review the work of each. The functions of the Audit Committee include recommending the engagement of the independent auditors, reviewing the scope and results of the audit and reviewing management's evaluation of the system of internal controls. W. Keith Kennedy, Jr. Scott G. Buchanan President and Vice President and Chief Executive Officer Chief Financial Officer Page 42 INDEPENDENT AUDITORS' REPORT The Shareowners and Board of Directors of Watkins-Johnson Company: We have audited the accompanying consolidated balance sheets of Watkins-Johnson Company and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Watkins-Johnson Company and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Deloitte & Touche LLP San Jose, California February 5, 1999 (March 4, 1999 as to Note 12) Page 43 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. Part III Item 10. Directors and Executive Officers of the Registrant The information required by this item concerning the company's directors is shown under the caption "Election of Directors" in the company's definitive proxy statement filed with the Commission pursuant to Regulation 14A. The information relating to the company's executive officers is presented in Part I of this Form 10-K under the caption "Executive Officers of the Registrant". Item 11. Executive Compensation See this caption in the definitive proxy statement which the company has filed with the Commission pursuant to Regulation 14A. Item 12. Security Ownership of Certain Beneficial Owners and Management This information is shown under the captions "Security Ownership of Certain Beneficial Owners & Management" in the company's definitive proxy statement filed with the Commission pursuant to Regulation 14A. Item 13. Certain Relationships and Related Transactions Information concerning certain business relationships is shown under the caption "Executive Compensation" in the definitive proxy statement which the company has filed with the Commission pursuant to Regulation 14A. There were no transactions with management for which disclosure would be required by Item 404 of Regulation S-K. Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) 1. Consolidated Financial Statements Page ---- Consolidated Statements of Operations For the Years Ended December 31, 1998, 1997 and 1996 21 Consolidated Statements of Comprehensive Income For the Years Ended December 31, 1998, 1997 and 1996 22 Consolidated Balance Sheets December 31, 1998 and 1997 23 Consolidated Statements of Shareowners' Equity For the Years Ended December 31, 1998, 1997 and 1996 24 Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996 25-26 Notes to Consolidated Financial Statements 27-41 Report of Management 42 Independent Auditors' Report 43 Page 44 2. Financial Statement Schedules Page ---- Independent Auditors' Report 48 II Valuation and Qualifying Accounts and Reserves For the Years Ended December 31, 1998, 1997 and 1996 49 Schedules not listed above are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or in the notes thereto. 3. Exhibits A list of the exhibits required to be filed as part of this report is set forth in the Exhibit Index, which immediately precedes such exhibits. The exhibits are numbered according to Item 601 of Regulation S-K. Exhibits incorporated by reference to a prior filing are designated by an asterisk. ------------------------ (b) Reports on Form 8-K and 8-A/A were filed on December 14, 1998. The reports are referenced as Exhibit 10.16 and Exhibit 10.17, respectively, in the Exhibit Index. The report 8-K contains disclosures regarding the December 10, 1998 Board of Director approval and execution of an amendment to the company by-laws and to the Rights Agreement, dated September 30, 1996, between the company and ChaseMellon. Form 8-A/A was filed for registration of the amended common stock purchase rights. No other reports on Form 8-K were required to be filed during the last quarter of the period covered by this report. (c) The exhibits required to be filed by Item 601 of Regulation S-K are the same as Item 14(a)3 above. (d) Financial statement schedules not included herein have been omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or in the notes thereto. Page 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. WATKINS-JOHNSON COMPANY ------------------------------- (Registrant) Date: March 8, 1999 By /s/ Dean A. Watkins -------------- --------------------- Dean A. Watkins Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- Principal Executive Officer: /s/ W. Keith Kennedy, Jr. President and March 8, 1999 - ---------------------------- Chief Executive Officer -------------- W. Keith Kennedy, Jr. Principal Financial and Accounting Officer: /s/ Scott G. Buchanan Vice President, March 8, 1999 - ---------------------------- Chief Financial Officer -------------- Scott G. Buchanan and Treasurer Page 46 Signature Title Date --------- ----- ---- /s/ H. Richard Johnson Director March 8, 1999 - ---------------------------- -------------- H. Richard Johnson /s/ John J. Hartmann Director March 11, 1999 - ---------------------------- -------------- John J. Hartmann /s/ Raymond F. O'Brien Director March 11, 1999 - ---------------------------- -------------- Raymond F. O'Brien /s/ William R. Graham Director March 11, 1999 - ---------------------------- -------------- William R. Graham /s/ Robert L. Prestel Director March 11, 1999 - ---------------------------- -------------- Robert L. Prestel /s/ Gary M. Cusumano Director March 11, 1999 - ---------------------------- -------------- Gary M. Cusumano Page 47 INDEPENDENT AUDITORS' REPORT The Shareowners and Board of Directors of Watkins-Johnson Company: We have audited the consolidated financial statements of Watkins-Johnson Company and subsidiaries as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated February 5, 1999 (March 4, 1999 as to Note 12); such consolidated financial statements and report are included elsewhere in this annual report on Form 10-K. Our audits also included the consolidated financial statement schedule of Watkins-Johnson Company and subsidiaries, listed in Item 14(a)2. This consolidated financial statement schedule is the responsibility of the company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule taken as a whole, presents fairly in all material respects the information set forth therein. Deloitte & Touche LLP San Jose, California February 5, 1999 (March 4, 1999 as to Note 12 of the Consolidated Financial Statements) Page 48 Schedule II WATKINS-JOHNSON COMPANY AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
Balance at Charged to Balance at Beginning Costs and End of Description of Period Expenses Deductions(1) Period - ----------- ----------- ----------- ------------ ----------- 1998 Allowance for doubtful accounts $ 3,175,923 $ 1,731,422 $ 1,553,090 $ 3,354,255 Product warranty reserve 13,423,700 6,168,000 13,299,600 6,292,100 1997 Allowance for doubtful accounts 746,720 2,467,656 38,453 3,175,923 Product warranty reserve 14,825,300 10,134,000 11,535,600 13,423,700 1996 Allowance for doubtful accounts 633,798 119,649 6,727 746,720 Product warranty reserve 7,193,500 20,095,300 12,463,500 14,825,300 (1) With respect to the allowance for doubtful accounts, deductions represent write-off of uncollectible accounts receivables. With respect to the product warranty reserve, deductions represent costs incurred for warranty repairs plus adjustments for expiring warranties.
Page 49 EXHIBIT INDEX Exhibit Number Description ------ ----------- 3.1 *Articles of Incorporation of Watkins-Johnson Company, as amended May 8, 1989. 3.2 *By-Laws of Watkins-Johnson Company, as amended and restated on December 10, 1998 (Exhibit 3(ii) to Form 8-K filed on December 14, 1998, Commission File No. 1-5631). 4.1 *Shareowners' Rights Agreement dated as of September 30, 1996 Between Watkins-Johnson Company and ChaseMellon Shareholder Services, L.L.C., as Rights Agent (Report on Form 8-K, filed on October 1, 1996, Commission File No.1-5631). 4.2 *Amendment No. 1 to Rights Agreement, dated as of December 10, 1998, to Rights Agreement, dated as of September 30, 1996, between the Watkins-Johnson Company ChaseMellon Shareholder Services, L.L.C., as Rights Agent. (Filed as Exhibit 4.1 to Form 8-K filed on December 14, 1998, Commission File No. 1-5631). 10 Material Contracts 10.1 *Lease and Agreement between Lindco Properties Company and Watkins-Johnson Company commencing May 1, 1969 (Exhibit (b) I to Form 10-K for 1969, Commission File No. 2-22436). 10.2 *Lease and Agreement between Morrco Properties Company and Watkins-Johnson Company dated October 31, 1975 (Exhibit 2(c) to Form 10-K for 1976, Commission File No. 1-5631). 10.3 *Watkins-Johnson Company 1976 Stock Option Plan, as amended September 28, 1987 (Appendix A to the company's definitive proxy statement dated March 1, 1988 filed with the Commission pursuant to Regulation 14A). 10.4 *Watkins-Johnson Company 1989 Stock Option Plan for nonemployee directors (Appendix A to the company's definitive proxy statement dated February 28, 1990 filed with the Commission pursuant to Regulation 14A). 10.5 *Watkins-Johnson Company 1976 Stock Option Plan amended and renamed as the 1991 Stock Option and Incentive plan (Appendix A to the company's definitive proxy statement dated February 28, 1991 filed with the commission pursuant to Regulation 14A). 10.6 *Watkins-Johnson Company Credit Agreement covering the period of November 30, 1995 through December 8, 1998, ABN-AMRO BANK N.V. as Agent (Exhibit 10-a to the 1996 Third Quarter Form 10-Q, Commission File No. 1-5631). 10.7 *Loan Agreement dated as of February 9, 1996 (English Translation) between Watkins-Johnson International Japan K.K. and The Bank of Yokohama, LTD, including Loan Guaranty Agreement with Watkins-Johnson Company dated January 31, 1996 (Exhibit 10-b to the 1996 Third Quarter Form 10-Q, Commission File No. 1-5631). Page 50 Exhibit Number Description ------ ----------- 10.8 *Loan Agreement dated as of June 12, 1996 (English Translation) between Watkins-Johnson International Japan K.K. and The Japan Development Bank, including Loan Guaranty Agreement with Watkins-Johnson Company dated June 12, 1996 (Exhibit 10-c to the 1996 Third Quarter Form 10-Q, Commission File No. 1-5631). 10.9 *First Amendment to Watkins-Johnson Company Credit Agreement covering the period of November 30, 1995 through December 8, 1998, ABN-AMRO BANK N.V. as Agent (original agreement filed as Exhibit 10-a to the 1996 Third Quarter Form 10-Q, Commission File No. 1-5631; first amendment filed as Exhibit 10-a to the 1997 First Quarter Form 10-Q, Commission File No. 1-5631). 10.10 *Second Amendment to Watkins-Johnson Company Credit Agreement covering the period of November 30, 1995 through December 8, 1998, ABN-AMRO BANK N.V. as Agent (original agreement filed as Exhibit 10-a to the 1996 Third Quarter Form 10-Q, Commission File No. 1-5631; second amendment filed as Exhibit 10-a to the 1997 Second Quarter Form 10-Q, Commission File No. 1-5631). 10.1l *Stock Purchase Agreement dated as of August 29, 1997 by and among Registrant and SMS and TSMD Acquisition Corp. (original agreement filed as Exhibit 99.1 of Report on Form 8-K, filed on November 14, 1997, reporting the disposition of assets effective October 31, 1997, Commission File No. 1-5631). 10.12 *Watkins-Johnson Company Unaudited Pro Forma Condensed Consolidated Financial Information filed as an amendment to Report on Form 8-K, filed on November 14, 1997, reporting the disposition of assets effective October 31, 1997 and Stock Purchase Agreement dated as of August 29, 1997 by and among Registrant and SMS and TSMD Acquisition Corp., Commission File No. 1-5631 (Exhibit 10-x originally filed as Report on Form 8-K/A, filed on January 13, 1998, Commission File No. 1-5631). 10.13 *Asset Purchase Agreement between Watkins-Johnson Company And Samsung Semiconductor, Inc. dated as of December 31, 1997. (Filed as Exhibit 10-y to the 1997 Form 10-K, Commission File No. 1-5631). 10.14 *Assignment of Lease Agreement by and between Taylor Woodrow Property Company, Inc. ("Assignor") and Watkins-Johnson Company ("Assignee") dated as of December 30, 1997. (Filed as Exhibit 10-z to the 1997 Form 10-K, Commission File No. 1-5631). 10.15 *Form 8-K filed on September 10, 1998. The report contains disclosures regarding the company's announcement of restructuring plans and related third quarter 1998 charges. (Commission File No. 1-5631). 10.16 *Form 8-K filed on December 14, 1998. The report contains disclosures regarding the December 10, 1998 Board of Director approval to amend and restate the company By-Laws and to amend the Rights Agreement, dated September 30, 1996, between the company and ChaseMellon.(Commission File No. 1-5631). 10.17 *Form 8-A/A filed on December 14, 1998. Form 8-A/A was filed for the registration of the amended common stock purchase rights approved by the Board of Directors on December 10, 1998 (Commission File No. 1-5631). Page 51 Exhibit Number Description ------ ----------- 10.18 Purchase and Sale Agreement, dated May 2, 1997, by and among Watkins-Johnson Company and CarrAmerica Realty for sale of undeveloped land in San Jose, California, including the August 15, 1997 First Amendment to and Reaffirmation of Purchase and Sale Agreement. 10.19 Resolution of the Board of Directors of Watkins-Johnson, effective December 31, 1998, for the termination of the company's 1994 Top Management Deferred Compensation Plan and the company's Annual Top Management Incentive Bonus Plan. 10.20 Form of Severance Agreement, dated September 28, 1998, by and between Watkins-Johnson Company and the following officers of the company: Dr. Patrick J. Brady, Malcolm J. Caraballo, and Robert G. Hiller. 10.21 Amended and Restated Employment Agreement made as of March 2, 1998 and amended and restated in its entirety effective as of January 25, 1999 by and between W. Keith Kennedy and Watkins-Johnson Company. 10.22 Form of employment Agreement, dated February 22, 1999, by and between Watkins-Johnson Company and the following officers of the company: Scott G. Buchanan, Dr. Frank E. Emery, Darryl T. Quan and Claudia D. Kelly. 10.23 Form of Amended and Restated Severance Agreement originally dated September 28, 1998 and amended and restated in its entirety effective as of January 25, 1999 by and between Watkins-Johnson Company and the following officers of the company: Dr. Frank E. Emery, Darryl T. Quan and Claudia D. Kelly. 10.24 Amended and Restated Severance Agreement originally dated September 28, 1998 and amended and restated in its entirety effective as of January 25, 1999 by and between Watkins-Johnson Company and Scott G. Buchanan. 10.25 Terms of Employee Retention Program dated March 1, 1999. 21 Subsidiaries of Watkins-Johnson Company. 23 Consent of Independent Auditors. 27 Financial Data Schedule. * Incorporated by reference to exhibit indicated for each item. Page 52 EX-10.18 2 PURCHASE AND SALE AGREEMENT Exhibit 10.18 PURCHASE AND SALE AGREEMENT This Agreement is entered into as of the 2nd day of May 1997, by and among Watkins-Johnson Company, a California corporation ("Seller"), and CarrAmerica Realty Corporation, a Maryland corporation and/or its assigns ("Buyer") and is as follows: Terms and Conditions of Sale 1. Sale. Seller agrees to sell and convey to Buyer "As Is" (defined below), and Buyer agrees to purchase from Seller "As Is", for the purchase price (set forth below), approximately 14.6 net acres of raw land, located at Trimble Road and Orchard Parkway, in San Jose, California, as shown on Parcel Map, filed in Book 415 of Maps, pages 40 and 41, Parcel B in Santa Clara County Records, (the "Property") on all of the terms and conditions set forth in this Agreement. 2. Purchase Price and Terms of Payment. The Purchase Price for the Property shall be Seventeen Million One Hundred Seventy Thousand and no/100 Dollars ($17,170,000.00) (the "Purchase Price"). 2.1. Within three (3) business days after execution of this Agreement by both parties, Buyer shall deposit with Escrow Holder (defined below) the amount of $500,000 as a deposit against the Purchase Price (the "Deposit"). Said amount shall be placed into an interest-bearing account, with interest for the benefit of Buyer. 2.3 On or before the Closing Date (as defined below), Buyer shall deposit with Escrow Holder the balance of the Purchase Price, as well as Buyer's share of closing costs. 3. Escrow and Closing. 3.1. Opening of Escrow. Within one (1) business day after the date hereof Buyer shall open escrow (unless previously opened by Seller) with Santa Clara Land Title, 701 Miller Street, San Jose, California 95110 (the "Escrow Holder"), escrow officer Linda Tugade, by the deposit of the Deposit and a copy of this Agreement with the Escrow Holder. Escrow Holder shall place the Deposit in an interest bearing account, with said interest for the benefit of Buyer. Seller and Buyer agree to prepare and execute such joint escrow instructions as may be necessary and appropriate to close the transaction in accordance with the terms of this Agreement. Should said instructions fail to be executed as required, Escrow Holder shall be and hereby is directed to close escrow pursuant to the terms and conditions of this Agreement. 3.2. Close of Escrow. The closing of the escrow ("Close of Escrow"), which shall mean the date on which the deed transferring title is recorded, shall occur within one (1) business day of the satisfaction of the conditions stated in Paragraphs 5 and 6, but in no event 1 later than June 10, 1997 (the "Closing Date"), unless the parties mutually agree otherwise in writing. 3.3. Delivery of Seller's Documents. On or before Closing Date, Seller shall deposit with Escrow Holder all of the following: (i) the fully executed and acknowledged grant deed described in subparagraph 5.2 hereof; (ii) Seller's escrow instructions sufficient to enable Escrow Holder to close the escrow in accordance with the terms of this Agreement, (iii) the affidavits described in subparagraph 5.4 hereof; and (iv) any other documents, records, or agreements called for hereunder that have not previously been delivered. 3.4. Delivery of Buyer's Documents and Funds. On or before Closing Date, Buyer shall deposit with Escrow Holder all of the following: (i) the balance of the Purchase Price, as well as Buyer's share of closing costs; (ii) Buyer's escrow instructions sufficient to enable Escrow Holder to close the escrow in accordance with the terms of this Agreement; and (iii) any other documents, records, agreements, or funds called for hereunder that have not previously been delivered. 3.5. Prorations. Real property taxes of the Property shall be prorated as of the Closing Date. 3.6. Closing Costs. Each party shall pay their own attorney's fees associated with the negotiation of this Agreement. Recording and Escrow fees shall be paid by Seller. The County transfer tax shall be paid by Seller and the city transfer tax shall be paid 50% each by Buyer and Seller. All other closing costs not specifically allocated herein to Buyer or Seller, shall be divided and paid 50% each by Buyer and Seller. 3.7 Traffic Mitigation Costs. At the Close of Escrow, $1,000,000 of the Purchase Price will be retained by Escrow Holder in an interest-bearing account for the benefit of Seller ("Traffic Mitigation Account") to be drawn from by Buyer for any reasonable traffic mitigation costs attributed directly to the Property being developed by Buyer at a .40 FAR ratio or less ("Traffic Mitigation Costs") where the Traffic Mitigation Costs exceed $1,000,000. Buyer is to pay for the first $1,000,000 of Traffic Mitigation Costs before drawing any money from the Traffic Mitigation Account. Traffic Mitigation Costs shall mean any onsite and offsite transportation roadway improvements and traffic impact fees attributed directly to the development of the Property. Traffic Mitigation Costs for either the first $1,000,000 or from the Traffic Mitigation Account shall not include any onsite traffic and transportation roadway improvements. For purposes of this paragraph, "onsite" shall mean improvements to be located exclusively within the boundaries of the property. All requests for any draws on the Traffic Mitigation Account by Buyer shall also be copied to Seller. On October 21, 1997, the remaining balance of funds in the Traffic Mitigation Account along with any interest earned shall be released to Seller except to the extent Buyer can establish at that time from a traffic mitigation plan approved by the City of San Jose for the Property that additional Traffic Mitigation Costs eligible from the Traffic Mitigation Account as defined above will be required. Then a sum equal to the reasonable estimate by Buyer of those Traffic Mitigation Costs not yet expended shall remain in the Traffic Mitigation Account for draws by Buyer, up to May 1, 1998, at which time the remaining balance of funds in the Traffic Mitigation Account along with any interest earned 2 thereon shall be released to Seller. Seller shall also have the right to audit Buyer's requests for draws from the Traffic Mitigation Account to determine that: (a) Buyer has expended its first $1,000,000 on Traffic Mitigation Costs and those expenditures are for only Traffic Mitigation Costs required by the City of San Jose related directly to the development of the Property; and (b) any draws from the Traffic Mitigation Account are only for legitimate Traffic Mitigation Costs as defined in (a) above. Seller shall not be responsible for any Traffic Mitigation Costs or claims for costs over and above the $1,000,000 placed in the Traffic Mitigation Account. 4. Title and Other Contingencies. 4.1. Title to be Conveyed. Seller shall convey a fee title interest in the Property, by grant deed to Buyer at Close of Escrow, subject only to the Approved Exceptions (as hereinafter defined). 4.2. Title Insurance. Seller, at Seller's expense, shall deliver to Buyer not later than five (5) calendar days from the date hereof a preliminary report (the "Preliminary Report") issued by Escrow Holder ("Title Company") and dated no earlier than as of fifteen (15) days prior to the date of this Agreement, together with legible copies of all documents constituting exceptions to title referred to in the Preliminary Report. Buyer shall have a period of fifteen (15) days ("Acceptance Period") after Seller's delivery of the Preliminary Report in which to review and approve same. Buyer shall advise Seller within the Acceptance Period as to any exceptions to title that are acceptable to Buyer. If Buyer fails to give notice of any exceptions to the Preliminary Report within the Acceptance Period, this will be deemed acceptance of the Preliminary Report by Buyer. Upon receipt of notice of Buyer's approval and objections to title, Seller may elect to remove any exceptions to title objected to by Buyer prior to Closing Date, by giving notice to Buyer within two (2) business days after delivery to Seller of Buyer's objections. If Seller does not so notify Buyer within such period, Buyer may elect either (i) to proceed with the purchase and waive its title objections, or (ii) to terminate this Agreement and receive back any deposits made by Buyer. All exceptions to title set forth in the Preliminary Report that are approved by Buyer pursuant to this subparagraph 4.2 shall be hereinafter collectively referred to as the "Approved Exceptions." 4.3. Form of Title Policy. Upon Close of Escrow, Title Company shall issue at Seller's expense a standard coverage CLTA owner's policy of title insurance without extended coverage (the "Title Policy") in the amount of the Purchase Price, insuring that title to the Property is vested in Buyer, subject only to the Approved Exceptions. Buyer shall pay for the cost of any title insurance in excess of the cost(s) of the Title Policy and the cost of all endorsements requested by Buyer including any additional premium charge(s) imposed by any title company in the event the Title Policy is not issued, unless caused by willful default of Seller. Notwithstanding the foregoing, Buyer may, in its sole discretion, elect to obtain ALTA extended coverage, which shall be at Buyer's sole expense, together with such endorsements as Buyer may reasonably require. 4.4. Inspection and Feasibility. Buyer shall have from the date of this Agreement until close of business on June 6, 1997 (the "Inspection Period") in which to conduct inspections and feasibility studies of the Property which may include, but not be limited to, 3 surveyors, soils inspections, environmental site assessment, engineering, and any other physical and environmental tests and inspections which Buyer may elect to undertake, all at Buyer's sole cost. Buyer shall provide Seller with a plan outlining the particulars of its proposed inspection of the Property ("Work Plan"). Buyer shall not proceed with implementing the Work Plan without first obtaining Seller's written approval, which shall not be unreasonably withheld. If within the Inspection Period, Buyer for any reason determines that the Property is not appropriate for its purposes, Buyer shall notify Seller in writing, and escrow shall be terminated in accordance with subparagraph 5.7 hereof. Failure of written notice of rejection of the Property by Buyer within the Inspection Period shall be deemed acceptance by Buyer. For said Inspection Period, Seller grants Buyer and/or Buyer's nominees or consultants, engineers, and other agents and contractors the right to enter upon the Property during reasonable business hours for the purpose of conducting such examinations and tests as approved in the Work Plan. Buyer shall keep the Property free and clear of any mechanic's liens arising out of Buyer's entry on the Property. Buyer represents and warrants that Buyer carries not less than $1,000,000 commercial general liability insurance with contractual liability endorsement to cover this Agreement which will also cover any person accessing the Property for Buyer's inspection and feasibility hereunder. Buyer shall deliver evidence of such insurance coverage to Seller before any such access. Seller shall cooperate with Buyer in facilitating Buyer's investigation at no cost to Seller, including obtaining information from and approvals for testing from governmental authorities. Buyer shall indemnify Seller and hold Seller harmless from the negligence or willful misconduct of Buyer or Buyer's agents on the Property or any damage, loss, claim, lien cost or expense including attorneys' fees and costs arising from the exercise by Buyer or its employees, consultants, agents, or representatives of access to the Property for inspection and feasibility under this Agreement. Any inspection, test or other study or analysis of the Property under this paragraph shall be performed at Buyer's expense and in strict accordance with applicable law. Buyer agrees at its expense to restore the Property from any damage or material alteration caused by any inspections or tests ordered by Buyer or its agents or consultants. Buyer agrees to provide Seller, upon Seller's request, with a copy of any written inspection or test report or summary Buyer has caused to have done or received regarding the Property, provided such material shall be delivered to Seller without any representations or warranties from Buyer, and Seller agrees it shall not rely on such material without the prior written consent of the party preparing same. 4.5. Documents. Upon execution of this Agreement, unless provided earlier Seller shall provide the following documents to Buyer: 1. Post-Closure Report To San Jose Fire Department Permit No. CR361012595, prepared by C.H.A.S.E. dated July 1995, covering Seller's neighboring property. 2. Phase II Investigation dated September 11, 1992 by Watkins-Johnson Environmental, covering Seller's neighboring property. In addition to the above, Seller shall make a reasonable effort to gather documents it may have regarding the Property and give to Buyer access at Seller's Palo Alto offices to those documents for inspection and copying at Buyer's expense. These documents are provided by Seller for informational purposes only, and Seller makes no representation or warranty with respect to the truth, accuracy or completeness of any matter or information set forth in such documents and only represents that it has not knowingly falsified the documents. 4.6 Hewlett-Packard and Watkins-Johnson Exchange of Easements Agreement. On or about February 8, 1994, Seller entered into a road extension and exchange of 4 easements agreement with Hewlett-Packard Company, a copy of which is attached hereto as Exhibit A ("Hewlett-Packard Agreement") whereby Seller agreed to exchange easements and property interests, cooperate in the application for land use approvals, dedication of land to the City of San Jose, and Hewlett-Packard Company's payment of all costs associated with this agreement including, inter alia, improving Orchard Parkway along Seller's frontage, costs incurred in completing the dedications described in the Hewlett-Packard Agreement, including engineering, mapping and title processing costs, the physical realignment of Seller's driveways to Orchard Parkway and Trimble Road, and to provide in kind and at its cost the paving and other improvements necessary to match the existing and no changed driveway. Seller also agrees to cooperate in applications to the City for the proposed land use approvals. Seller does hereby assign to Buyer, Seller's rights and obligations it has pursuant to the Hewlett-Packard Agreement as it pertains to the Property, and as part of Exhibit A hereto is providing a written statement from Hewlett-Packard acknowledging (a) that the Hewlett-Packard Agreement is in the form attached as Exhibit A and has not been changed; (b) the Hewlett-Packard Agreement is still in full force and effect; and (c) Hewlett-Packard consents to the assignment set forth in this sentence. Seller retains any rights and obligations it has pursuant to the Hewlett-Packard Agreement as it pertains to contiguous property owned by Seller and represent that the retained rights are not in conflict with or interfere with the rights being assigned to Buyer in this subparagraph 4.6, and will cooperate regarding the retained rights in the contiguous property so the Hewlett-Packard Agreement can be fulfilled in all respects. 5. Buyer's Conditions to Close. For Buyer's sole benefit, Buyer's obligation to complete the purchase of the Property is subject to satisfaction of the following conditions at or prior to the Closing Date, unless waived by Buyer in writing: 5.1. Delivery of Documents, Etc. Seller shall have timely performed its obligations under subparagraph 3.3 hereof. 5.2. Delivery of Deed. Seller shall have executed, acknowledged, and delivered into Escrow for recording and subsequent delivery to Buyer, a grant deed ("Deed") to the Property in recordable form in the form attached hereto as Exhibit B, conveying Seller's title to the Property to Buyer subject only to the Approved Exceptions. 5.3. Title Policy. Title Company shall be ready, willing, and able to issue the Title Policy. 5.4. Affidavit. Seller shall have executed and delivered to Escrow Holder an affidavit or affidavits satisfying the requirements of Section 1445 of the Internal Revenue Code of 1986, as amended, as well as California Revenue and Taxation Code Sections 18661, et seq. 5.5. Condition of the Property. Except as referenced in paragraph 10, there shall not be any material change in the Property from the end of the Inspection Period to the Close of Escrow unless caused by Buyer or its agents. 5 5.6. Seller's Performance. Seller shall have performed all of the other material terms and conditions to be performed by Seller prior to the Closing Date under the terms of this Agreement, including but not limited to that Seller's representations and warranties in Paragraph 8 are true and correct as of the Close of Escrow. 5.7. Termination of Escrow. If any condition described in this Paragraph 5 is not timely satisfied (or waived by Buyer in writing) on or prior to the Closing Date, then (i) the Escrow shall terminate immediately upon receipt by Escrow Holder of notification from Buyer of the failure of such condition, and Buyer and Seller shall share equally any applicable escrow cancellation fees, (ii) Escrow Holder shall return all instruments and documents deposited into the Escrow to the parties depositing the same, (iii) Escrow Holder shall return to Buyer any funds deposited by Buyer, less only Buyer's share of applicable escrow cancellation fees, if any, and (iv) neither party shall have any further rights or obligations under this Agreement, except to the extent that the failure of a condition also constitutes a default by Seller with respect to any of Seller's covenants or obligations under this Agreement. 6. Seller's Conditions to Close. For Seller's sole benefit, Seller's obligation to complete the sale of the Property is subject to satisfaction of the following conditions at or prior to the Closing Date, unless waived by Seller in writing: 6.1. Delivery of Documents, Etc. Buyer shall have timely performed its obligations under Subparagraph 3.4 hereof. 6.2. Receipt of Purchase Price. Title Company shall have received the Purchase Price for the Property. 6.3. Buyer's Performance. Buyer shall have performed all of the other terms and conditions to be performed by Buyer prior to the Closing under the terms of this Agreement, including but not limited to that Buyer's representations and warranties in Paragraph 7 are true and correct as of the Close of Escrow. 6.4. Termination of Escrow. If any condition described in this Paragraph 6 is not timely satisfied (or waived by Seller in writing) on or prior to Closing Date and the Paragraph 5 conditions have been satisfied, (i) the Escrow shall terminate immediately upon receipt by Escrow Holder of notification from Seller of the failure of such condition, (ii) Escrow Holder shall return all instruments and documents deposited into the Escrow to the parties depositing the same, and (iii) neither party shall have any further rights or obligations to the other under this Agreement, except to the extent that a failure of a condition also constitutes a default by Buyer with respect to any of Buyer's covenants or obligations under this Agreement. 7. Buyer's Representations and Warranties. Buyer hereby represents and warrants to Seller, effective both as of the date of this Agreement and as of Close of Escrow: 7.1. Buyer's Due Organization and Authorization. Buyer and those individuals and entities signing this Agreement on behalf of Buyer, respectively have the right, power, and authority to make and perform their obligations under this Agreement. The 6 execution, delivery, and performance of this Agreement does not violate any contract, agreement, or commitment to which any party comprising Buyer is a party or by which any party comprising Buyer is bound. 8. Seller's Representations and Warranties. Seller hereby represents and warrants to Buyer, effective both as of the date of this Agreement and as of Close of Escrow: 8.1. Seller's Due Organization and Authorization. Seller and those individuals and entities signing this Agreement on behalf of Seller, respectively have the right, power, and authority to make and perform their obligations under this Agreement. The execution, delivery, and performance of this Agreement does not violate any contract, agreement, judicial order, or commitment to which any party comprising Seller is a party or by which any party comprising Seller is bound which affect the Property. 8.2. No Litigation or Proceeding. Seller represents and warrants that there is, to its knowledge, no litigation or governmental or agency investigation or governmental or agency proceeding including condemnation pending, nor, to the knowledge of Seller, threatened against Seller or the Property which would impair or adversely affect Seller's ability to perform its obligations under this Agreement. 8.3. Documents. All documents delivered to Buyer by Seller pursuant to this Agreement are or will be to Seller's knowledge true and correct copies of originals, to the extent not the originals thereof, and any and all information supplied to Buyer by Seller in accordance with this Agreement and all statements or representations made by Seller herein are and will be to Seller's reasonable knowledge true, complete, and accurate in all material respects except as specifically qualified otherwise in this Agreement. 8.4. Tax Withholding. Seller is not subject to tax withholding in connection with this transaction under the Internal Revenue Code or other federal or state law. 8.5. Bankruptcy or Insolvency. Seller has not made a general assignment for the benefit of creditors, filed any voluntary petition in bankruptcy or suffered the filing of an involuntary petition by its creditors, suffered the appointment of a receiver to take possession of substantially all of its assets, suffered the attachment or other judicial seizure of substantially all of its assets, admitted its inability to pay its debts as they come due, or made an offer of settlement, extension, or compromise to its creditors generally. 8.6. No Leases, etc. To Seller's knowledge there are no leases, contracts or permits that affect the Property other than those disclosed in this Agreement. 8.7. Hazardous Materials. To Seller's knowledge there are no Hazardous Materials (as defined in Paragraph 26 below) located on the Property in violation of applicable laws in existence. The term "Seller's knowledge" or similar phrases, as used in this Agreement, shall refer to the actual, present knowledge of David M. Burnham, Director of Treasury and 7 Corporate Real Estate for Seller, as of the date of this Agreement without any duty of investigation or inquiry of any kind or nature whatsoever. Buyer agrees that if, at any time prior to the Closing Date, it has knowledge of any information which would require the qualification of any of the above representations and warranties for such representation and warranty to be trued, it shall immediately notify Seller in writing of such information. If Buyer has knowledge of the incorrectness of any representation or warranty made by Seller in the Agreement prior to Close of Escrow and fails to so notify Seller prior to the Closing Date, then such representation or warranty shall be deemed to be stricken from this Agreement ab initio and shall be of no further force or effect. Seller shall have the right to qualify such representations and warranties with any information it receives concerning such representations and warranties after the date of this Agreement; but if it does so then Buyer shall have three (3) business days from such notice to elect to either terminate this Agreement and the Escrow pursuant to subparagraph 5.7 herein or agree to proceed with the Close of Escrow, in which event the above representations and warranties shall be qualified as noticed by Seller. In the event Buyer fails to give notice of its election within the three (3) business day period, then Buyer will be deemed to have elected to terminate this Agreement. 9. Indemnity. Each party hereby agrees to indemnify, defend, and hold the other party harmless from and against any and all claims, demands, liabilities, costs, expenses, damages, and loss (including, without limitation, attorneys' fees and costs) resulting from any misrepresentation, breach of warranty, or breach of covenant made by such party in this Agreement. This indemnity shall continue in effect and survive Close of Escrow, the waiver of any conditions to Closing set forth herein, and the conveyance and delivery of title, or, if title is not transferred pursuant to this Agreement, beyond any termination of this Agreement, except as otherwise provided in Paragraph 12. 10. Risk of Loss. The parties agree in the event that, prior to Closing, any improvements located on the Property, or any part thereof, are destroyed or materially damaged, the transaction shall go forward without any adjustment to the Purchase Price, but Buyer shall be entitled to any available insurance proceeds resulting from such damage or destruction. If there is any material condemnation or threatened condemnation of the property prior to Close of Escrow, either party may terminate the Agreement, and it will so terminate as set forth in paragraph 5.7. 11. Possession. Seller shall deliver possession of the Property to Buyer, free and clear of any tenancies or contracts or rights of third parties not previously approved in writing by Buyer as a part of this Agreement such as Paragraph 4.6, as well as cleared of all equipment, vehicles, materials, and other personal property, upon Close of Escrow. 12. Default. In the event that the sale of the Property fails to close as a result of a default of Seller, Buyer may, as its sole and exclusive remedy, elect to either: (a) enforce the terms of this Agreement by action for specific performance, but with no reduction in the Purchase Price; provided, however, that no action for specific performance shall compel Seller to commence litigation or cure or deal with any matters outside of its reasonable control or expend funds as to such matters; or (b) terminate this Agreement, in which event the Deposit shall be returned to Buyer, and the parties shall be released from all further obligations and liability under 8 this Agreement except as otherwise specifically provided in this Agreement. Under no circumstances of any nature whatsoever shall Buyer have any right to collect damages, whether actual, punitive, consequential or otherwise, from Seller under this Agreement. In the event that the sale of the Property fails to close as a result of a default by Buyer, Seller's sole remedy (except as otherwise specifically provided hereunder) shall be to declare a forfeiture and retain the Deposit and all interest earned thereon as liquidated damages, it being understood that Seller's actual damages in the event of such default are difficult to ascertain and that such proceeds represent the parties' best current estimate of such damages. Pending the full and final resolution of any specific performance or other litigation or disputes instituted by Buyer, Escrow Holder shall continue to hold the Deposit. 13. Liquidated Damages. BY PLACING THEIR INITIALS IMMEDIATELY BELOW, BUYER AND SELLER AGREE THAT IT WOULD BE IMPRACTICABLE OR EXTREMELY DIFFICULT TO FIX ACTUAL DAMAGES IN THE EVENT OF A DEFAULT BY BUYER, THAT THE SUM OF BUYER'S INITIAL AND ADDITIONAL DEPOSITS IS THE PARTIES' REASONABLE ESTIMATE OF SELLER'S DAMAGES IN THE EVENT OF BUYER'S DEFAULT, AND THAT IN THE EVENT BUYER FAILS TO TIMELY PURCHASE THE PROPERTY IN ACCORDANCE WITH THE TERMS OF THIS AGREEMENT BECAUSE OF A DEFAULT BY BUYER, SELLER SHALL BE RELEASED FROM ITS OBLIGATION TO SELL THE PROPERTY, AND, AT SELLER'S SOLE ELECTION, SELLER SHALL BE ENTITLED TO RETAIN BUYER'S INITIAL AND ADDITIONAL DEPOSITS AND ALL INTEREST EARNED THEREON AS LIQUIDATED DAMAGES. SELLER'S INITIALS /s/SGB BUYER'S INITIALS /s/RGS 14. No Commissions. Except as to Mark T. Ziemendorf and Rod Shepard, of Cornish & Carey Commercial, Santa Clara, California, representing both Buyer and Seller, whose commission (collectively) in the amount of three percent (3%) of the Purchase Price Seller agrees to pay at its cost, neither party has had any contact or dealings regarding the Property, or any communication in connection with the subject matter of this transaction, through any licensed real estate broker or other person who can claim a right to a commission or finder's fee as a procuring cause of the sale contemplated herein. In the event that any broker or finder perfects a claim for a commission or a finder's fee based upon any contract, dealings, or communication, the party through whom the broker or finder makes his claim shall be responsible for said commission or fee and shall indemnify and hold harmless as to all claims, liabilities, costs, and expenses (including without limitation as to attorneys' fees and court costs) suffered or incurred by the other party in defending against same. 15. Assignment. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns. Notwithstanding the foregoing, neither party may assign this Agreement without the other party's prior written consent, except Seller hereby consents to Buyer assigning this Agreement to a related entity such as a Buyer managed LLC. 9 16. Attorneys' Fees. In the event either party hereto fails to perform any of its obligations under this Agreement or in the event a dispute arises concerning the meaning or interpretation of any provision of this Agreement, the defaulting party or the party not prevailing in such dispute, as the case may be, shall pay any and all costs and expenses incurred by the other party in enforcing or establishing its rights hereunder, including, without limitation, court costs and attorneys' fees. 17. Time. Time is of the essence of this Agreement as to each and every provision hereof. 18. Notices. All notices or other communications to be given hereunder shall be in writing and shall be deemed received when personally delivered by commercial courier including an overnight courier such as Federal Express, or upon confirmation of receipt when given by telecopy or facsimile to the address and facsimile number(s) set forth below, or three (3) business days after deposit in the United States certified mail, return receipt requested, postage prepaid, addressed as follows: If to Seller: Watkins-Johnson Company Stanford Research Park 3333 Hillview Avenue Palo Alto, CA 94304-1223 Attn: David M. Burnham Tel: (415) 813-2990 Fax: (415) 813-2545 Copy to: Garth E. Pickett, Esq. Hopkins & Carley, A Law Corporation Ten Almaden Boulevard, Eighth Floor San Jose, CA 95113-2228 Tel: (408) 286-9800 Fax: (408) 998-4790 If to Buyer: Hunter Barrier CarrAmerica Realty Corporation 1700 Pennsylvania Avenue, NW Washington, DC 20006 Tel: (202) 639-3867 Fax: (202) 737-2147 10 Copy to: Caroline Brower Mayer, Brown & Platt 141 East Palace Avenue Santa Fe, NM 87501 Tel: (505) 820-8186 Fax: (505) 820-7334 Any party may change its address for the purpose of this paragraph by giving written notice of such change to the other party in the manner herein provided. 19. Entire Agreement. This Agreement expresses the entire agreement of the parties and supersedes any and all previous agreements between the parties with regard to the Property. There are no other understandings, oral or written, which in any way alter or enlarge its terms, and there are no warranties or representations of any nature whatsoever, either express or implied, except as set forth herein. Any future modification of this Agreement will be effective only if it is in writing and signed by the party to be charged. 20. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 21. Waiver. The waiver by either party of a breach of any provision of this Agreement shall not be deemed a continuing waiver or a waiver of any subsequent breach, whether of a like nature or otherwise. 22. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, but such counterparts together shall constitute only one agreement. 23. Headings. The Paragraph and Subparagraph headings throughout this Agreement are for convenience and reference only, and the words contained therein shall not be held to expand, modify, amplify or aid in the interpretation, construction or meaning of this Agreement. 24. Survival. All representations and warranties by the respective parties contained herein or made in writing pursuant to this Agreement are intended to and shall remain true and correct as of the Closing, shall be deemed material and shall survive the execution and delivery of this Agreement, the Closing, the delivery of the Grant Deed and the transfer of title, or, if title is not transferred pursuant to this Agreement, beyond any termination of this Agreement. 25. Further Assurances. Each party hereto agrees to execute such other documents or instruments as are necessary or appropriate to effectuate this Agreement and consummate the transaction provided herein promptly upon request therefor. 11 26. "As Is" Clause. EXCEPT AS TO THOSE SPECIFIC REPRESENTATIONS AND WARRANTIES BY SELLER IN THIS AGREEMENT, BUYER SPECIFICALLY ACKNOWLEDGES THAT SELLER IS SELLING AND BUYER IS PURCHASING THE PROPERTY ON AN "AS IS WITH ALL FAULTS" BASIS AND THAT BUYER IS NOT RELYING ON ANY REPRESENTATIONS OR WARRANTIES OF ANY KIND WHATSOEVER, EXPRESS OR IMPLIED, FROM SELLER, ITS AGENTS, OR BROKERS AS TO ANY MATTERS CONCERNING THE PROPERTY, INCLUDING WITHOUT LIMITATION: (i) the quality, nature, adequacy, and physical condition of the Property, including, but not limited to, the quality, nature, adequacy, and physical condition of soils, geology and any groundwater, (ii) the existence, quality, nature, adequacy, and physical condition of utilities serving the Property, (iii) the development potential of the Property, and the Property's use, habitability, merchantability, or fitness, suitability, value or adequacy of the Property for any particular purpose, (iv) the zoning or other legal status of the Property or any other public or private restrictions on use of the Property, (v) the compliance of the Property or its operation with any applicable codes, laws, regulations, statutes, ordinances, covenants, conditions and restrictions of any governmental or quasi-governmental entity or of any other person or entity, (vi) the presence or removal of Hazardous Materials under or about the Property or the adjoining or neighboring property; and (vii) the condition of title to the Property. The term "Hazardous Materials" shall mean any hazardous or toxic materials, substances or wastes, such as (A) those materials identified in Sections 66680 through 66685 and Sections 66693 through 66740 of Title 22 of the California Administrative Code, Division 4, Chapter 30, as amended from time to time, (B) those materials defined in Section 255010) of the California Health and Safety Code, (C) any materials, substances or wastes which are toxic, ignitable, corrosive or reactive and which are regulated by any local governmental authority, any agency of the state of California or any agency of the United States Government, (D) asbestos, (E) petroleum and petroleum based products, (F) urea formaldehyde foam insulation, (G) polychlorinated biphenyls (PCBs), and (H) freon and other chlorofluorocarbons. 27. Condition of Property. Buyer acknowledges and understands that Seller's Broker has disclosed that the Property may be situated within (i) an Earthquake Fault Zone as so designated under the Alquist-Priolo Earthquake Fault Zoning Act, Section 2621 et. seq. of the California Public Resources Code; and/or (ii) a Seismic Hazards Zone as so designated under the Seismic Hazards Mapping Act, Section 2690 et. seq. of the California Public Resources Code (collectively herein referred to as the "Seismic Disclosure Acts"); and (iii) a 100 year flood zone or potentially other special flood hazard area. Buyer acknowledged that it has had delivered by Seller's agents the Commercial Property Owner's Guide to Earthquake Safety, published by the State of California Seismic Safety Commission. Buyer hereby waives any seismic or flood zone disclosure requirements imposed on Seller by California law. 28. Approval. Upon Buyer's execution of this Agreement, Seller shall have two (2) business days in which to approve this Agreement. Failure of timely delivery of an executed agreement by Seller to Buyer shall be deemed rejection and Buyer's offer will be deemed withdrawn as of the rejection by Seller if so elected by Buyer within two (2) business days thereafter. Executed as of the date first set forth above. 12 "BUYER" "SELLER" CARRAMERICA REALTY, WATKINS-JOHNSON COMPANY, CORPORATION a California corporation a Maryland corporation By: /s/ Robert G. Stuckey By: /s/ Scott G. Buchanan Its: Managing Director Its: Vice President & CFO FIRST AMENDMENT TO AND REAFFIRMATION OF PURCHASE AND SALE AGREEMENT This First Amendment to and Reaffirmation of Purchase Agreement ("First Amendment") is made as of August 15, 1997 by and between Watkins-Johnson Company, a California corporation ("Seller"), and CarrAmerica Realty Corporation, a Maryland corporation ("Buyer"). RECITALS A. Seller and Buyer have previously entered into that certain Purchase and Sale Agreement dated as of the 2nd day of May 1997 (the "Agreement"). Capitalized items not otherwise defined herein shall have the meaning assigned to them in the Agreement. B. Seller and Buyer hereby acknowledge that the Agreement was terminated at the end of the Inspection Period by Buyer. Notwithstanding the foregoing, Buyer and Seller hereby elect to revive and reaffirm the Agreement and all the terms thereof, and to amend the Agreement in certain respects, including to: (i) clarify the description of the Property; (ii) establish an additional contingency related to receiving a Site Development Permit; (iii) extend the date for close of escrow; (iv) revise the amount of the Deposit; (v) give Seller the right to participate in the Site Development Permit Application and to take over such Application process in the event Buyer terminates the Agreement; and (vi) Buyer grant to Seller a certain easement to be recorded at close of escrow, all as hereinafter provided. AGREEMENT NOW, THEREFORE, in consideration of the foregoing recitals, the mutual covenants and agreements contained in this agreement and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Seller and Buyer hereby agree to amend the Agreement as follows: 13 1. Reaffirmation of Agreement. Seller and Buyer hereby agree that not withstanding anything to the contrary contained in the Agreement, effective as of the date hereof, the Agreement shall be in full force and effect and Seller and Buyer hereby reaffirm the Agreement in accordance with its terms except as amended by this First Amendment. 2. The Property is more particularly described in Exhibit "A" attached hereto. 3. Deposit. The Deposit as set forth in Paragraph 2.1 of the Agreement shall be $1,000,000 with any additional sums necessary to bring the Deposit to $1,000,000 to be deposited with the escrow holder by close of business on the third (3rd) business day after the date of this First Amendment. The Deposit may be increased or decreased by (Delay Damages) as hereafter defined prior to close of escrow as set forth in Paragraph 5 hereafter. All reference in the Agreement and this First Amendment to the Deposit shall mean and refer to the amount of $1,000,000 as may be changed pursuant to Paragraph 6(b) hereafter. 4. Escrow and Closing: (a) Closing Date. Paragraph 3.2 of the Agreement is amended to change the Closing Date to three (3) business days after receipt of a Site Development Permit Approval from the City of San Jose or Buyer's waiver of this contingency, but in no event later than October 21, 1997 unless the Approval Date is extended pursuant to Paragraph 6(b) below. All references in the Agreement to the Closing Date shall mean the above. (b) Traffic Mitigation Costs. The October 21, 1997 date in Paragraph 3.7 of the Agreement is changed to the earlier of thirty (30) days after the "Approval" as hereinafter defined or March 15, 1998. The May 1, 1998 date in Paragraph 3.7 of this Agreement is changed to August 3, 1998. 5. Title Insurance and Inspection Period. Buyer hereby acknowledges that the Preliminary Report dated July 14, 1997 is acceptable and that the Acceptance Period has expired, and that the Inspection Period is deemed to have expired and all inspections satisfied. The Approved Exceptions are those listed in Exhibit "B" attached hereto. The issuance of the ALTA title policy pursuant to Paragraph 4.3 of the Agreement is a condition to the Closing with the endorsements identified in Exhibit "C" attached hereto. At the Closing, Seller shall execute a standard affidavit or declaration that Seller has not done or caused to be done any work of improvement on the Property that could create a mechanic's lien(s) and has been in possession of the Property with no leases or right of possession having been given to any other party as set forth in the Approved Exceptions. A new contingency shall be established regarding the approval of a "Site Development Permit Application" by the City of San Jose Planning Department (the "City") as set forth below. 6. Site Development Permit Contingency. Section 4 of the Agreement shall be amended to add as a contingency the City granting approval of the Site Development Permit Application as set forth herein ("Approval"). The Approval shall mean the granting of the Site Development Permit, subject to the minimum acceptable requirements as set forth in Paragraph 6(b) below (the "Permit") plus the running of any applicable appeal period for appealing to the City Council. The terms of this contingency are more particularly as follows: 14 (a) Site Development Permit Application. Buyer shall submit to the City a substantially complete Site Development Permit Application (the "Substantial Application") for the Property no later than August 15, 1997 ("Permit Application Date"). A substantially complete application means one that includes the completed City application form, a Traffic Study and Site Plan architectural drawings. Buyer shall submit to the City a complete Site Development Permit Application (the "Application") for the Property no later than August 22, 1997 ("2nd Permit Application Date"). A complete Application means one that is intended to include all submittal items that the City requires, although the City may require further submittals. The Application shall be a joint application on behalf of the Buyer as the purchaser and developer and Seller as the owner of the property. Seller will cooperate with submitting the Application as reasonably requested by Buyer at no cost to Seller. In the event Buyer fails to submit the Substantial Application by the Permit Application Date and/or the Application by the 2nd Permit Application Date, Seller shall be entitled to withdraw from escrow $100,000.00 of the Deposit as liquidated damages for such delay in filing the Application by Buyer ("Delay Damages"), unless Buyer establishes that the delay is beyond the reasonable control of Buyer and through no fault of Buyer. The payment of the Delay Damages shall be applicable to the Purchase Price and Buyer shall not be required to replace it in the Deposit. If Buyer fails to submit the Substantial Application by the Permit Application Date and/or the Application by the 2nd Permit Application Date, Seller shall either terminate the Agreement and the Deposit less the Delay Damages shall be released to Buyer, or be deemed to have extended (after payment of the Delay Damages, if applicable), the Permit Application Date to August 29, 1997 ("Extended Permit Application Date"). If the Application is not filed by the Extended Permit Application Date, the Agreement is deemed terminated and the Deposit less the Delay Damages if applicable will be returned to Buyer. (b) Approval ("Approval Date") of Application. Buyer shall have until October 15, 1997 in which to receive the Approval ("Approval Date"). If Approval from the City is not received by the Approval Date, Buyer shall (i) waive in writing the Approval contingency; or (ii) extend the Approval Date to December 15, 1997 ("Extended Approval Date") upon placing into escrow an additional $250,000 to be added to the Deposit. Thereafter, Deposit shall mean $1,250,000 less the Delay Damages, if applicable. If Approval is not received by the Extended Approval Date, Buyer shall (i) waive in writing the Approval contingency, or (ii) extend the Approval Date to February 15, 1998 (the "Final Approval Date") upon placing an additional $250,000 into escrow and the Deposit shall mean $1,500,000 less the Delay Damages, if applicable. If the Final Approval Date is reached, or Buyer fails to extend the Approval Date as allowed above and Buyer has not in either case waived in writing the Approval contingency, the Buyer will be deemed in default, the Agreement shall terminate and Seller will be entitled to the entire Deposit in escrow pursuant to Paragraph 13 of the Agreement. The Approval Contingency shall be met if, on or before the Final Approval Date, the City approves the Application and the supporting plans, studies and other components of the Application. Approval includes all administrative action required to make such approval final and binding under applicable law. Buyer may by written notice to Seller and the Escrow Agent terminate the Agreement and receive a refund of the Deposit if any of the following occurs prior to the Final Approval Date: 15 (i) the City requires a project specific environmental impact report ("EIR"), or the City delays approval pending the preparation of a new or updated EIR for the Rincon De Los Estros Redevelopment area by either the City or some other party or entity; or (ii) the City denies the Application substantially as submitted by Buyer. The City shall be deemed to have denied the Application substantially submitted by Buyer thereby allowing Buyer to terminate the Agreement and receive a refund of the Deposit, less Delay Damages, if any, if the approval requires any of the following: (1) Traffic Mitigation Costs, as defined in Paragraph 3.7 of the Agreement that exceeds $3 million in the aggregate, and Watkins-Johnson has not agreed, in writing, to cover any Traffic Mitigation Costs in excess of $3 million in the aggregate; (2) Failure to give fully permitted ingress and egress access to either Trimble Road or Orchard Parkway from the Property; (3) An FAR that is less than the smaller of 0.4 or Buyer's submittal of FAR in the Application for less than 0.4, and Watkins-Johnson does not agree, in writing, to reduce the purchase price by the same percentage that the approved FAR is below the above standard. For example, if the submitted FAR is a 0.4 and the approved FAR is a 0.35, this is a 12-1/2 percent reduction which would be a 12-1/2 percent reduction in the Purchase Price by Watkins-Johnson for this contingency to be met. Buyer may terminate the Agreement and receive a refund of the Deposit less Delay Damages, if applicable, if the approval requires a FAR less than 0.35. Buyer shall not submit in the Application for an FAR greater than 0.4. (c) Buyer's Diligent Efforts During Application Period. Buyer shall diligently, adequately, timely, and in good faith respond to inquiries and requests from the City during the approval process for the Application ("Standard of Conduct"). However, Buyer may reasonably object to City imposed requirements, conditions or restrictions and negotiate with the City to secure favorable approval terms. If Buyer does not meet this Standard of Conduct and as a result the City denies the Application, then Seller shall be entitled to retain the Deposit. (d) Seller's Rights Upon Termination to the Application. Buyer hereby covenants and agrees to cooperate in the event Buyer terminates this Agreement pursuant to Paragraph 6(b) above by assigning to Seller all of Buyer's rights and interest in the Application, and to furnish to Seller, at no cost to Seller, copies of the traffic studies and any other studies and information compiled by Seller in preparation of the Application or any other information requested by the City pursuant to the Application and to turn such over to the Seller for its use in continuing to pursue the Application in Seller's name. Buyer agrees at no additional cost to Buyer to cooperate with Seller in the transfer of Buyer's rights and obligations in the Application to Seller as reasonably requested by Seller. 16 7. Grant of Easement By Buyer To Seller: Section 6 of the Agreement is amended to add the following: 6.5. Grant Of Easement. Buyer hereby agrees and covenants to grant, at the close of escrow, to Seller for the benefit of Parcel A a non-exclusive easement for ingress and egress along the roadway being conveyed to Buyer as the Property's access to Component Drive, and in the form and description as attached hereto as Exhibit C. 8. Miscellaneous. (a) Effect of First Amendment. Except to the extent the Agreement is modified by this First Amendment, the remaining terms and conditions of the Agreement shall remain unmodified and in full force and effect. In the event of conflict between the terms and conditions of the Agreement and the terms and conditions of this First Amendment, the terms and conditions of the First Amendment shall prevail and control. (b) Entire Agreement. The Agreement, together with this First Amendment, embodies the entire understanding between Seller and Buyer with respect to its subject matter and supersedes all other prior agreements, representations and covenants, written or oral, with respect thereto; and can be changed only by an instrument in writing signed by Seller and Buyer. (c) Counterparts. This First Amendment may be executed in one or more counterparts, each of which shall be deemed an original but all of which, taken together, shall constitute one and the same amendment. IN WITNESS WHEREOF, this First Amendment has been executed as of the day and year first set forth above. "BUYER" "SELLER" CARRAMERICA REALTY, WATKINS-JOHNSON COMPANY, CORPORATION, a California corporation a Maryland corporation By: /s/ Robert G. Stuckey By: /s/ W. Keith Kennedy Its: Managing Director Its: President & CEO 17 EX-10.19 3 RESOLUTION OF THE BOARD OF DIRECTORS Exhibit 10.19 RESOLUTION OF THE BOARD OF DIRECTORS OF WATKINS-JOHNSON COMPANY WHEREAS, it has been proposed (the "Proposal") that (i) all existing deferrals of compensation under the Company's 1994 Top Management Deferred Compensation Plan ("Deferred Compensation Plan"), (ii) all existing deferrals of bonuses under the Company's Annual Top Management Incentive Bonus Plans ("Incentive Bonus Plans") and (iii) all future opportunities to defer under such plans, be eliminated effective as of December 31, 1998, and all existing deferrals paid as soon as practical on or after January 1, 1999, and WHEREAS, the Proposal has been submitted to the Compensation Committee and approved by the Committee for submission to the Board for final action, and WHEREAS, the Board deems that this action is in the best interests of the Company; NOW THEREFORE BE IT RESOLVED, that (i) the Deferred Compensation Plan be terminated in accordance with Section 9(a) of the Plan effective as of December 31, 1998, (ii) the balance of all accounts on December 31, 1998, be paid as a lump sum to all participants as soon as practical on or after January 1, 1999, and (iii) no future deferrals shall be allowed after December 31, 1998, and FURTHER RESOLVED, that (i) all outstanding deferrals under all Incentive Bonus Plans for years on or before 1998 be terminated effective as of December 31, 1998, (ii) as soon as practical on or after January 1, 1999, the participants be paid a lump sum equal to the balances determined under the Plans on December 31, 1997, or December 31, 1998, whichever is greater, and FURTHER RESOLVED, that the officers of the Company are hereby authorized, directed and empowered in the name of the Company, to prepare, execute and deliver all such documents and instruments and to take all such actions in the name of the Company as they deem necessary, advisable, convenient, proper or appropriate in order to carry out and perform the purposes of the foregoing resolutions. EX-10.20 4 SEVERANCE AGREEMENT Exhibit 10.20 SEVERANCE AGREEMENT ------------------- THIS SEVERANCE AGREEMENT (the "Agreement"), dated___________________is entered into by and between Watkins-Johnson Company, a California corporation ("the Company"), and __________________________("Employee"). The Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of members of the Company's management, including Employee, to their assigned duties without distraction in potentially disturbing circumstances arising from the possibility of a Change in Control (as defined herein) of the Company. This Agreement sets forth the severance compensation which the Company agrees to pay to Employee if Employee's employment with the Company terminates under one of the circumstances described herein. 1. Term. (a) This Agreement shall terminate, except for any unpaid obligation of the Company, upon the earliest of (i) three years from the date hereof if a Change in Control of the Company has not occurred within such three-year period; (ii) the termination of the Employee's employment based on death, disability (as defined in Section 3(b)) or cause (as defined in Section 3(c)) or by the Employee other than for Good Reason (as defined in Section 3(d)); or (iii) three years from the date of a Change in Control of the Company. (b) Nothing in this Agreement shall confer upon Employee any right to continue in the employ of the Company prior to a Change in Control of the Company or shall in any way limit the rights of the Company, which are hereby expressly reserved, to discharge the Employee at any time prior to the date of a Change in Control of the Company for any reason whatsoever, with or without cause. 2. Change in Control. (a) No compensation shall be payable under this Agreement unless and until there shall have been a Change in Control of the Company while the Employee is still an employee of the Company, and the Employee's employment by the Company thereafter shall have been terminated by the Company other than pursuant to Sections 3(b) or 3(c) or by the Employee for Good Reason (as defined in Section 3(d) below), or by the Employee pursuant to Section 3(g). 1 (b) Definition of Change in Control. A Change in Control shall be deemed to have occurred if (i) there shall be consummated any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's Common Stock would be converted into cash, securities or other property, other than a merger of the Company in which the holders of the Company's Common Stock immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger, or any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company, or (ii) the stockholders of the Company approve a plan or proposal for the liquidation or dissolution of the Company, or (iii) any "person" (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, shall become the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of 30% or more of the Company's outstanding Common Stock, or (iv) during any period of two consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors of the Company shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. 3. Termination Following Change in Control. (a) Termination of Employment. If a Change in Control occurs while Employee is still an employee of the Company, Employee shall be entitled to the compensation provided in Section 4 upon the subsequent termination of the Employee's employment with the Company unless the termination is a result of Employee's (i) death; (ii) Disability (Section 3(b)); (iii) termination by the Company for Cause (Section 3(c)); or (iv) Employee's decision to terminate employment with the Company other than for Good Reason (Section 3(d)), or pursuant to Section 3(g). (b) Disability. If, as a result of the Employee's incapacity due to physical or mental illness, the Employee shall have been absent from duties with the Company on a full-time basis for six consecutive months and within 30 days after written notice of termination is thereafter given by the Company, the Employee shall not have returned to the full-time performance of the Employee's duties, the Company may terminate this Agreement for "Disability." 2 (c) Cause. For purposes of this Agreement only, the Company shall have "Cause" to terminate Employee's employment hereunder only on the basis of fraud, misappropriation, embezzlement or willful engagement by the Employee in misconduct which is demonstrably and materially injurious to the Company and its subsidiaries taken as a whole. An act, or omission of the Employee shall not be considered "willful" unless done, or omitted to be done, by the Employee without good faith and a reasonable belief that the act or omission was in the best interests of the Company and its subsidiaries. The Employee may not be terminated for Cause unless and until there shall have been delivered to Employee a copy of a resolution duly adopted by affirmative vote of not less than three-quarters of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for the purpose (after reasonable notice to the Employee and an opportunity for the Employee, together with the Employee's counsel, to be heard before the Board), finding the Employee was guilty of the conduct set forth in the first sentence of this Section, and specifying the particulars thereof in detail. Notwithstanding the foregoing, the Employee shall have the right to contest such termination for Cause (for purposes of this Agreement) by arbitration in accordance with the provisions of Section 7. (d) Good Reason. After a Change in Control of the Company, the Employee may terminate employment for Good Reason at any time during the term of this Agreement. For purposes of this Agreement, "Good Reason" shall mean any of the following (without the Employee's express written consent): (i) the assignment to the Employee by the Company of duties inconsistent with, or a substantial alteration in the nature or status of, Employee's responsibilities immediately prior to a Change in Control of the Company other than any such alteration primarily attributable to the fact that the Company's securities are no longer publicly traded; (ii) a reduction by the Company in the Employee's base salary in effect on the date of a Change in Control of the Company or as the same may be increased from time to time during the term of this Agreement; (iii) failure by the Company to continue in effect without substantial change any compensation, incentive, welfare or benefit plan or arrangement, as well as any plan or arrangement whereby the Employee may acquire securities of the Company, in which the Employee is participating at the time of a Change in Control of the Company (or any other plans providing the Employee with substantially similar benefits, hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect the Employee's participation in or materially reduce the Employee's benefits under any such Benefit Plan or deprive the Employee of any material fringe benefit enjoyed by the Employee at the time of a Change in Control of the Company; unless an equitable substitute arrangement 3 (embodied in an ongoing substitute or alternative Benefit Plan) has been made for the benefit of Employee with respect to the Benefit Plan in question. For purposes of the foregoing, Benefit Plans shall include, but not be limited to, the Company's Employee Stock Ownership Plan, Employees' Profit Sharing and Investment Plan, Deferred Compensation (401K) Plan, 1991 Stock Option and Incentive Plan, Top Management Incentive Bonus Plan, and/or any other plan or arrangement to receive and exercise stock options or stock appreciation rights, incentive, bonus or other award plans, group life insurance plans, medical, dental, accident and disability plans; (iv) a relocation of the Company's principal executive offices to a location outside the San Francisco-Oakland-San Jose Bay Area, or the Employee's relocation to any place other than the principal executive offices of the Company, except for required travel by the Employee on Company business to an extent substantially consistent with the Employee's business travel obligations at the time of a Change in Control of the Company; (v) any material breach by the Company of any provision of this Agreement; (vi) any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company as required in paragraph 6; or (vii) any purported termination of the Employee's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 3(e) below. For purposes of this Agreement, no such purported termination shall be effective. (e) Notice of Termination. Any purported termination of employment shall be communicated by a written Notice of Termination to Employee in accordance with Section 8, and shall state the specific termination provisions in this Agreement relied upon, and set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment. (f) Date of Termination. "Date of Termination" shall mean (a) for Disability, 30 days after Notice of Termination is given to the Employee (provided the Employee has not returned to the performance of the Employee's duties on a full-time basis during such 30-day period), or (b) if the Employee's employment is terminated by the Company for any other reason, the date on which notice is given. 4 (g) Notwithstanding any other provision of this Agreement, if a Change in Control occurs while Employee is still an employee of the Company, Employee may, after 90 days and within 120 days of the Change in Control, terminate employment without Good Reason, and shall thereupon be entitled to one-half (1/2) of the compensation, described in paragraph 4. 4. Severance Compensation upon Termination of Employment. If the Employee's employment shall be terminated (a) by the Company other than pursuant to Sections 3(b) or 3(c), or (b) by the Employee for Good Reason, the Company shall: (a) pay to the Employee as severance pay in a lump sum, in cash, on the fifth day following the Date of Termination, an amount equal to 299.999% of the Employee's "Base Compensation" (as defined below); provided, however, that if the lump sum severance payment under this Section 4, either alone or together with other payments which the Employee has the right to receive from the Company, would not be deductible (in whole or in part) by the Company as a result of such lump sum payment constituting a "parachute payment" (as defined in Section 28OG of the Internal Revenue Code of 1986, as amended (collectively the "Code")), such lump sum severance payment shall be reduced to the largest amount as will result in no portion of the lump sum severance payment under this Section 4 not being fully deductible by the Company as a result of Section 28OG of the Code. The determination of any reduction in the lump sum severance payment under this Section 4 pursuant to the foregoing provision shall be made exclusively by the Company's auditors prior to the Change in Control (whose fees and expenses shall be born by the Company), and such determination shall be conclusive and binding. The term "Base Compensation" shall mean an average of the annual cash compensation paid to the Employee by the Company and any of its subsidiaries in the form of salary or bonuses during the five taxable years (or such lesser period as Employee was employed by the Company or any of its subsidiaries) immediately preceding the Change in Control of the Company which was includable in gross income by the Employee for federal income tax reporting purposes; and (b) arrange to provide Employee, for a six-month period (or such shorter period as Employee may elect), with disability, accident, group life, medical and dental insurance substantially similar to those insurance benefits which Employee is receiving immediately prior to the Notice of Termination. Benefits otherwise receivable by Employee pursuant to this Section 4(b) shall be reduced to the extent comparable benefits are actually received by the Employee during such six-month period following termination (or such shorter period elected by the Employee), and any such benefits actually received by Employee shall be reported by Employee to the Company. 5 5. No Obligation to Mitigate Damages. The Employee shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Employee as a result of employment by another employer or by retirement benefits after the Date of Termination, or otherwise, except to the extent provided in Section 4 above. (a) No Effect on Other Contractual Rights. The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish the Employee's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, employment agreement or other contract, plan or arrangement, except that the provisions of this Agreement and any payment provided for hereunder, shall be in lieu of payments otherwise due to the Employee under any of the Company's severance pay policies. 6. Successor to the Company. (a) The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement satisfactory to Employee, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 6 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) Heirs of the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devises and legatees. If the Employee should die while any amounts are still payable to Employee hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Employee's devisee, legatee, or other designee or, if there be no such designee, to the Employee's estate. 7. Arbitration. Any dispute, controversy or claim arising under or in connection with this Agreement, or the breach hereof, shall be settled exclusively by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. Judgment upon the award rendered by Arbitrator(s) may be entered in any court having jurisdiction thereof. Any arbitration held pursuant to this Section 7 shall take place in San Francisco, California. 6 8. Notice. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: If to the Company: Watkins-Johnson Company 3333 Hillview Avenue Palo Alto, California 94304-1223 Attention: President of the Company If to the Employee: ___________________ ___________________ ___________________ ___________________ or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 9. Nonwaiver, Complete Agreement, Governing Law. No provisions of this Agreement may be modified, waived or discharged unless in writing signed by both parties. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 10. Legal Fees and Expenses. The Company shall pay all reasonable legal fees and expenses which the Employee may incur as a result of the Company's contesting the validity, enforceability or the Employee's good faith interpretation of, or good faith determinations under, this Agreement; provided, however, that the Company shall not pay any legal fees and expenses incurred by Employee in contesting the termination of Employee's employment for Cause if, as a result of such contest, it is determined that the Employee was in fact terminated for Cause. 7 11. Confidentiality. The Employee shall retain in confidence any and all confidential information known to the Employee concerning the Company and its business so long as such information is not otherwise publicly disclosed. 12. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 13. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. WATKINS-JOHNSON COMPANY, a California corporation By_____________________ Title:__________________ Title:__________________ 8 EX-10.21 5 AMENDED AND RESTATED EMPLOYMENT AGREEMENT Exhibit 10.21 AMENDED AND RESTATED EMPLOYMENT AGREEMENT THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (this "Agreement") is made as of March 2, 1998, and amended and restated in its entirety effective as of January 25, 1999, by and between W. Keith Kennedy (hereinafter called "Employee") and WATKINS-JOHNSON COMPANY, a California corporation (hereinafter called the "Company"). In consideration of the mutual covenants herein contained the parties hereto agree as follows: 1. Term and Scope of Employment. (a) The Company agrees to employ Employee in Palo Alto, California for a period of thirty-six (36) months, commencing March 9, 1998, and ending March 9, 2001, for the purpose of rendering services in connection with the Company's business. Employee agrees to accept employment with the Company for such purpose. In performing his duties hereunder, Employee shall observe and comply with all directions given by the Board of Directors of the Company or by his superiors. (b) Employee shall devote his full time, attention, and effort to the business of the Company, and shall not during the term of this Agreement engage in any other business (whether as an employee, partner, consultant or otherwise) without the consent of the Company; but this shall not be construed as preventing Employee from investing his assets in such form or manner as will not interfere with the services he agreed to render to the Company hereunder. (c) Employee agrees to inform the Board of Directors of the Company, or his superiors, of all of his work and transactions on behalf of the Company, and to disclose to them his knowledge of the Company's business and affairs. 2. Salary. For his services the Company agrees to pay Employee an annual salary of not less than Four Hundred and Sixty-Five Thousand Dollars ($465,000) payable in equal biweekly installments. In addition to the above amount, at the sole discretion of the Board of Directors, Employee may be granted bonuses or other compensation in an amount to be determined in accordance with Board policy. 3. Termination. (a) For Cause. During the term of this Agreement, Employee's employment may be terminated by the Company for Cause (as defined below), effective immediately upon the day it sends Notice of Termination (as required by Section 10(b)) to Employee, at which time compensation will cease. "Cause" for this purpose, shall mean fraud, misappropriation, embezzlement or willful engagement by Employee in misconduct which is demonstrably and materially injurious to the Company and its subsidiaries taken as a whole. An act or omission of Employee shall not be considered "willful" unless done, or omitted to be done, by Employee without good faith and a reasonable belief that the act or omission was in the best interests of the Company and its subsidiaries. Employee may not be terminated for Cause unless and until there shall have been delivered to Employee a copy of a resolution duly adopted by affirmative vote of not less than three-quarters of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for that purpose (after reasonable notice to Employee and an opportunity for Employee, together with Employee's counsel, to be heard before the Board), finding Employee was guilty of the conduct set forth in the first sentence of this Section 3(a), and specifying the particulars thereof in detail. Notwithstanding the foregoing, Employee shall have the right to contest such termination for Cause (for purposes of this Agreement) by arbitration in accordance with the provisions of Section 9. 2 (b) Without Cause. Company may terminate Employee's employment without Cause. In the event Company terminates Employee's employment without Cause, in addition to the entire compensation provided for hereunder for the remainder of the term specified in Section 1(a) (which shall be paid in a lump sum), Employee shall be entitled to receive upon such termination without Cause (in a lump sum) severance compensation equal to six (6) month's base salary, less all amounts required by law to be withheld and deducted; provided, however, that if the Company terminates Employee's employment other than for death, Disability or Cause, or Employee terminates his Employment for Good Reason, prior to the date of occurrence of a Change in Control if such termination is effected by the Company (or the actions or decisions giving rise to Employee's termination for Good Reason are taken or made by the Company) in anticipation of a Change of Control such termination shall for all purposes hereunder have the same consequences as a termination by Employee under subparagraph (c) of this Section 3 (any such termination, action or decision effected, taken or made within 90 days prior to the date of any such Change in Control shall be conclusively deemed to be in anticipation of a Change in Control). (c) Change in Control. This Agreement shall not be terminated upon a Change in Control, as defined in subparagraph (d) of this Section 3. In the event of a Change in Control, the provisions of this Agreement shall be binding on and shall inure to the benefit of the surviving or resulting corporation, or (in the case of a Change in Control of the kind referred to in Section 3(c)(i)(z)) the corporation to which the applicable assets of the Company have been transferred; provided, however, that (a) Employee may treat the occurrence of a Change in Control as a material breach of this Agreement and may terminate this Agreement upon written notice given (in accordance with Section 10(b)) within 120 days of the occurrence of a Change in Control, unless Employee's employment has theretofore been terminated in accordance with any other provisions of this Agreement, and (b) Employee may terminate this Agreement for Good Reason at any time following the occurrence of a Change in Control and during the remainder of the term of this Agreement as specified in Section 1(a). Upon such termination, or upon a 3 termination of Employee by the Company without Cause at any time following the occurrence of a Change in Control, the Company shall: (i) pay to Employee as severance pay in a lump sum, in cash, on the fifth day following the Date of Termination (as defined in subparagraph (g) of this Section 3), an amount equal to the aggregate of (x) 299.999% of Employee's "Base Compensation" (as defined below), plus (y) an amount equal to (A) the amount previously determined by the Board as Employee's target bonus for the calendar year in which Notice of Termination is given by Employee or the Company, as the case may be, multiplied by (B) a fraction, the numerator of which shall be the number of days that have elapsed during such calendar year, through and including the date on which such Notice of Termination is given, and the denominator of which shall be 365; provided, however, that if the lump sum severance payment under this Section 3, either alone or together with other payments (or the value of other benefits) which Employee has the right to receive from the Company in connection with a Change in Control, would not be deductible (in whole or in part) by the Company as a result of such lump sum payment constituting a "parachute payment" (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (collectively, the "Code")), such lump sum severance payment (or, at Employee's election, such other payments and/or benefits, or a combination of such other payments and/or benefits and such lump sum severance payment) shall be reduced to the largest amount as will result in no portion of the lump sum severance payment under this Section 3 not being fully deductible by the Company as a result of Section 280G of the Code. The determination of the amount of any such required reduction pursuant to the foregoing provision, and the valuation of any non-cash benefits for purposes of such determination, shall be made exclusively by the firm that was acting as the Company's auditors prior to the Change in Control (whose fees and expenses shall be borne by the Company), and such determination shall be conclusive and binding. The term "Base Compensation" shall mean an average of the annual cash compensation paid to Employee by the Company and any of its subsidiaries in the form of salary or bonuses (including any amount that is the subject of an 4 elective deferral by Employee) during the five taxable years immediately preceding the Change in Control which was includable in gross income (or would have been so included but for any such elective deferral) by Employee for federal income tax reporting purposes; and (ii) arrange to provide Employee, for a thirty-six month period (or such shorter period as Employee may elect), with disability, accident, group life, medical and dental insurance, all of which shall be prepaid, substantially similar to those insurance benefits which Employee is receiving immediately prior to a termination by Employee under this Section 3(c). Benefits otherwise receivable by Employee pursuant to this Section 3(c) shall be reduced to the extent comparable benefits are actually received by Employee during such thirty-six month period (or such shorter period elected by Employee), and any such benefits actually received by Employee shall be reported by Employee to the Company. (d) Definition of Change in Control. A Change in Control shall be deemed to have occurred if (i) there shall be consummated (x) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation, (y) any other consolidation or merger to which the Company is a party, regardless of whether shares of the Company's Common Stock would be converted into cash, securities or other property, other than a merger of the Company in which the holders of the Company's Common Stock immediately prior to the merger have the same proportionate ownership of common stock (or the equivalent fully voting securities) of the surviving corporation or other entity immediately after the merger, or (z) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company, or (ii) the Company consummates (in one or a series of transactions) the disposition of substantially all of its business operations, or (iii) any "person" (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, shall become the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of 30% or more of the Company's outstanding Common Stock, or (iv) during any period of two consecutive years, individuals who at the beginning of such period constitute the entire Board 5 of Directors of the Company shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. (e) Disability. If, as a result of Employee's incapacity due to physical or mental illness, Employee shall have been absent from his duties with the Company on a full-time basis for six consecutive months and within 30 days after written Notice of Termination is thereafter given by the Company Employee shall not have returned to the full-time performance of Employee's duties, the Company may terminate this Agreement for "Disability." (f) Good Reason. For purposes of this Agreement, "Good Reason" shall mean any of the following (without Employee's express written consent): (A) the assignment to Employee by the Company of duties inconsistent with, or a substantial alteration in the nature or status of, Employee's responsibilities immediately prior to a Change in Control other than any such alteration primarily attributable to the fact that the Company's securities are no longer publicly traded; (B) a reduction by the Company in Employee's base salary in effect on the date of a Change in Control or as the same may be increased from time to time during the term of this Agreement; (C) failure by the Company to continue in effect without substantial change any compensation, incentive, welfare or benefit plan or arrangement, as well as any plan or arrangement whereby Employee may acquire securities, in which Employee is participating at the time of a Change in Control (or any other plans providing Employee with substantially similar benefits, hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect Employee's 6 participation in or materially reduce Employee's benefits under any such Benefit Plan or deprive Employee of any material fringe benefit enjoyed by Employee at the time of a Change in Control; unless an equitable substitute arrangement (embodied in an ongoing substitute or alternative Benefit Plan) has been made for the benefit of Employee with respect to the Benefit Plan in question. For purposes of the foregoing, Benefit Plans shall include, but not be limited to, the Company's Employee Stock Ownership Plan, Employees' Profit Sharing and Investment Plan, Deferred Compensation (401K) Plan, 1991 Stock Option and Incentive Plan, Top Management Incentive Bonus Plan, and/or any other plan or arrangement to receive and exercise stock options or stock appreciation rights, incentive, bonus or other award plans, group life insurance plans, medical, dental, accident and disability plans; (D) a relocation of the Company's principal executive offices to a location outside the San Francisco-Oakland-San Jose Bay Area, or Employee's relocation to any place other than the principal executive offices of the Company, except for required travel by Employee on Company business to an extent substantially consistent with Employee's business travel obligations at the time of a Change in Control; (E) any material breach by the Company of any provision of this Agreement; (F) any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company as required in Section 7; or (G) any purported termination of Employee's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 10(b) below. For purposes of this Agreement, no such purported termination shall be effective. (g) Date of Termination. "Date of Termination" shall mean (a) for Disability, 30 days after Notice of Termination is given to Employee (provided Employee has not returned to the 7 performance of Employee's duties on a full-time basis during such 30-day period), or (b) if Employee's employment is terminated for any other reason, the date on which Notice of Termination is given by the Company or Employee, as the case may be. 4. Nondisclosure and Assignment of Rights in Company Data. "Company Data" is hereby defined to mean for purposes of this Agreement, programs, improvements, records, ideas, files, drawings, documents, customer lists, investment opportunities, sales and marketing techniques and devices, formulae, specifications, research, studies, investigations, processes, data, and information disclosed to or known by Employee as a consequence, whether directly or indirectly, of his employment by Company which is not generally known in the industry in which the Company is or may become engaged and which involves special techniques or know-how in connection with the industry in which the Company is or may become engaged, and, without limiting the generality of the foregoing, anything not within the public domain and public knowledge, whether or not patentable or copyrightable. The parties hereto acknowledge that in the course of his employment, Employee will himself, or with others, have access to, use, come in contact with, obtain, make, evolve or conceive Company Data. As further consideration for Company's entering into this Agreement, Employee hereby sells, assigns and transfers to Company all right, title, and interest he has or at any time may have to Company Data, and to any and all other Company Data at any time used in the business of Company in which Employee may have a right, title, or interest, and such Company Data shall be the sole and exclusive property of Company. 5. Assignment. The rights and obligations of Employee hereunder shall not be assignable and any attempted assignment shall be void. The rights and obligations of Company hereunder may be assigned as a part of any transaction which includes the transfer of all or substantially all of the assets of the Company, whether such transfer is made pursuant to a sale of assets or stock, or a merger, reorganization, or otherwise. 8 6. No Obligation to Mitigate Damages. Employee shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by Employee as a result of employment by another employer or by retirement benefits after the Date of Termination, or otherwise, except to the extent provided in Section 3 above. 7. Successor to the Company. The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement satisfactory to Employee, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 7 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 8. Heirs of Employee. This Agreement shall inure to the benefit of and be enforceable by Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Employee should die while any amounts are still payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Employee's devisees, legatee, or other designee or, if there be no such designee, to Employee's estate. 9. Arbitration. Any dispute, controversy or claim arising under or in connection with this Agreement, or the breach hereof, shall be settled exclusively by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. Judgment upon the 9 award rendered by Arbitrator(s) may be entered in any court having jurisdiction thereof. Any arbitration held pursuant to this Section 9 shall take place in San Francisco, California. 10. Notice. (a) General. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: If to the Company: Watkins-Johnson Company 3333 Hillview Avenue Palo Alto, California 94304 Attention: Corporate Secretary If to Employee: W. Keith Kennedy 26955 Orchard Hill Lane Los Altos Hills, California 94022 or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of address shall be effective only upon receipt. (b) Notice of Termination. Any purported termination of employment shall be communicated by a written Notice of Termination to Employee in accordance with paragraph (a) of this Section 10, and shall state the specific termination provisions in this Agreement relied upon, and set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment. 11. Nonwaiver, Complete Agreement, Governing Law. No provisions of this Agreement may be modified, waived or discharged unless in writing signed by both parties. No waiver by either party 10 hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 12. Legal Fees and Expenses. The Company shall pay all reasonable legal fees and expenses which Employee may incur as a result of the Company's contesting the validity, enforceability or Employee's good faith interpretation of, or good faith determinations under, this Agreement; provided, however, that the Company shall not pay any legal fees and expenses incurred by Employee in contesting the termination of Employee's employment for Cause if, as a result of such contest, it is determined that Employee was in fact terminated for Cause. 13. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 14. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. 11 WATKINS-JOHNSON COMPANY By /s/ Dean A. Watkins ------------------- Title: Chairman /s/ Keith Kennedy ------------------- Keith Kennedy 12 EX-10.22 6 EMPLOYMENT AGREEMENT Exhibit 10.22 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is made as of February 22, 1999, by and between ________________ (hereinafter called "Employee") and WATKINS-JOHNSON COMPANY, a California corporation (hereinafter called the "Company"). WHEREAS, Employee and the Company have entered into that certain Amended and Restated Severance Agreement, dated as of January 25, 1999 (the "Severance Agreement"); and WHEREAS, Employee and the Company now desire to enter into an agreement providing for Employee's continued employment by the Company upon the terms and subject to the conditions set forth herein, which agreement shall, except as otherwise set forth herein, apply cumulatively with the Severance Agreement. In consideration of the mutual covenants herein contained the parties hereto agree as follows: 1. Term and Scope of Employment. (a) The Company agrees to continue to employ Employee in Palo Alto, California for a period of twelve (12) months, commencing on the date hereof and ending on the first anniversary of the date hereof, for the purpose of rendering services in connection with the Company's business. Employee agrees to accept employment with the Company for such purpose. In performing his/her duties hereunder, Employee shall observe and comply with all directions given by the Board of Directors of the Company or by his/her superiors. (b) Employee shall devote his/her full time, attention, and effort to the business of the Company, and shall not during the term of this Agreement engage in any other business (whether as an employee, partner, consultant or otherwise) without the consent of the Company; but this shall not be construed as preventing Employee from investing his/her assets in such form or manner as will not interfere with the services Employee agreed to render to the Company hereunder. (c) Employee agrees to inform the Board of Directors of the Company, or his/her superiors, of all of his/her work and transactions on behalf of the Company, and to disclose to them his/her knowledge of the Company's business and affairs. 2. Salary. For his/her services the Company agrees to pay Employee an annual salary of not less than ________________________________________________ Dollars ($_________) payable in equal biweekly installments. In addition to the above amount, at the sole discretion of the Board of Directors, Employee may be granted bonuses or other compensation in an amount to be determined in accordance with Board policy. 3. Termination. (a) For Cause. During the term of this Agreement, Employee's employment may be terminated by the Company for Cause, effective immediately upon the day it sends Notice of Termination (as required by Section 10(b)) to Employee, at which time compensation will cease. Notwithstanding the foregoing, Employee shall have the right to contest such termination for Cause (for purposes of this Agreement) by arbitration in accordance with the provisions of Section 9. (b) Without Cause. The Company may terminate Employee's employment without Cause. In the event the Company terminates Employee's employment without Cause, in addition to the 2 entire compensation provided for hereunder for the remainder of the term specified in Section 1(a) (which shall be paid in a lump sum), Employee shall be entitled to receive upon such termination without Cause (in a lump sum) severance compensation equal to six (6) months' base salary, less all amounts required by law to be withheld and deducted. (c) Change in Control. This Agreement shall not be terminated upon a Change in Control. In the event of a Change in Control: (i) the provisions of this Agreement shall be binding on and shall inure to the benefit of the surviving or resulting corporation, or (in the case of a Change in Control of the kind referred to in Section 2(a)(i)(z) of the Severance Agreement) the corporation to which the applicable assets of the Company have been transferred, and (ii) all of the provisions of the Severance Agreement shall apply in accordance with its terms. In the event of any inconsistency between the provisions of the Severance Agreement and this Agreement, the provisions of the Severance Agreement shall govern. Except to the extent of any such inconsistency, the provisions of this Agreement and the Severance Agreement shall apply cumulatively and not exclusively. 4. Nondisclosure and Assignment of Rights in Company Data. "Company Data" is hereby defined to mean for purposes of this Agreement, programs, improvements, records, ideas, files, drawings, documents, customer lists, investment opportunities, sales and marketing techniques and devices, formulae, specifications, research, studies, investigations, processes, data, and information disclosed to or known by Employee as a consequence, whether directly or indirectly, of his/her employment by the Company which is not generally known in the industry in which the Company is or may become engaged and which involves special techniques or know-how in connection with the industry in which the Company is or may become engaged, and, without limiting the generality of the foregoing, anything not within the public domain and public knowledge, whether or not patentable or copyrightable. The parties hereto acknowledge that in the course of his/her employment, Employee will himself/herself, or with others, have access to, use, come in contact with, obtain, make, evolve or conceive Company Data. As further consideration for the Company's 3 entering into this Agreement, Employee hereby sells, assigns and transfers to the Company all right, title, and interest he/she has or at any time may have to Company Data, and to any and all other Company Data at any time used in the business of the Company in which Employee may have a right, title, or interest, and such Company Data shall be the sole and exclusive property of the Company. 5. Assignment. The rights and obligations of Employee hereunder shall not be assignable and any attempted assignment shall be void. The rights and obligations of the Company hereunder may be assigned as a part of any transaction which includes the transfer of all or substantially all of the assets of the Company, whether such transfer is made pursuant to a sale of assets or stock, or a merger, reorganization, or otherwise. 6. No Obligation to Mitigate Damages. Employee shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by Employee as a result of employment by another employer or by retirement benefits after the Date of Termination, or otherwise. 7. Successor to the Company. The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement satisfactory to Employee, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 7 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 4 8. Heirs of Employee. This Agreement shall inure to the benefit of and be enforceable by Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Employee should die while any amounts are still payable to him/her hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Employee's devisees, legatee, or other designee or, if there be no such designee, to Employee's estate. 9. Arbitration. Any dispute, controversy or claim arising under or in connection with this Agreement, or the breach hereof, shall be settled exclusively by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. Judgment upon the award rendered by Arbitrator(s) may be entered in any court having jurisdiction thereof. Any arbitration held pursuant to this Section 9 shall take place in San Francisco, California. 10. Notice. (a) General. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: If to the Company: Watkins-Johnson Company 3333 Hillview Avenue Palo Alto, California 94304 Attention: President and Chief Executive Officer of the Company If to Employee: __________________ __________________ __________________ 5 or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of address shall be effective only upon receipt. (b) Notice of Termination. Any purported termination of employment shall be communicated by a written Notice of Termination to Employee in accordance with paragraph (a) of this Section 10, and shall state the specific termination provisions in this Agreement relied upon, and set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment. 11. Nonwaiver, Complete Agreement, Governing Law. No provisions of this Agreement may be modified, waived or discharged unless in writing signed by both parties. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 12. Legal Fees and Expenses. The Company shall pay all reasonable legal fees and expenses which Employee may incur as a result of the Company's contesting the validity, enforceability or Employee's good faith interpretation of, or good faith determinations under, this Agreement; provided, however, that the Company shall not pay any legal fees and expenses incurred by Employee in contesting the termination of Employee's employment for Cause if, as a result of such contest, it is determined that Employee was in fact terminated for Cause. 6 13. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 14. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 15. Certain Defined Terms. Capitalized terms used herein without definition shall have the meanings given to such terms in the Severance Agreement. 7 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. WATKINS-JOHNSON COMPANY By _____________________ Title: _____________________ (Employee) 8 EX-10.23 7 AMENDED AND RESTATED SEVERANCE AGREEMENT Exhibit 10.23 AMENDED AND RESTATED SEVERANCE AGREEMENT ---------------------------------------- THIS AMENDED AND RESTATED SEVERANCE AGREEMENT (the "Agreement"), originally dated September 28, 1998, and amended and restated in its entirety effective as of January 25, 1999, is entered into by and between Watkins-Johnson Company, a California corporation (the "Company"), and ________________ ("Employee"). The Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of members of the Company's management, including Employee, to their assigned duties without distraction in potentially disturbing circumstances arising from the possibility of a Change in Control (as defined herein) of the Company. This Agreement sets forth the severance compensation which the Company agrees to pay to Employee if Employee's employment with the Company terminates under one of the circumstances described herein. 1. Term. (a) This Agreement shall terminate, except for any unpaid obligation of the Company, upon the earliest of (i) three years from the date hereof if a Change in Control has not occurred within such three-year period; (ii) the termination of Employee's employment based on death, Disability (as defined in Section 2(c)) or Cause (as defined in Section 2(d)) or by Employee other than for Good Reason (as defined in Section 2(e)); or (iii) three years from the date of a Change in Control. (b) Nothing in this Agreement shall confer upon Employee any right to continue in the employ of the Company prior to or following a Change in Control or shall in any way limit the rights of the Company, which are hereby expressly reserved, to discharge Employee at any time prior to or following the date of a Change in Control for any reason whatsoever, with or without Cause. 2. Certain Definitions. (a) Change in Control. A Change in Control shall be deemed to have occurred if (i) there shall be consummated (x) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation, (y) any other consolidation or merger to which the Company is a party, regardless of whether shares of the Company's Common Stock would be converted into cash, securities or other property, other than 2 a merger of the Company in which the holders of the Company's Common Stock immediately prior to the merger have the same proportionate ownership of common stock (or the equivalent fully voting securities) of the surviving corporation or other entity immediately after the merger, or (z) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company, or (ii) the Company consummates (in one or a series of transactions) the disposition of substantially all of its business operations, or (iii) any "person" (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, shall become the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of 30% or more of the Company's outstanding Common Stock, or (iv) during any period of two consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors of the Company shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. 3 (b) Triggering Event. A "Triggering Event" shall be deemed to have occurred if either (i) (A) a Change in Control occurs while Employee is still employed by the Company or any of its subsidiaries and (B) Employee's employment is thereafter terminated (x) by the Company other than for death, Disability or Cause, (y) by Employee for Good Reason or (z) by Employee pursuant to the last paragraph of Section 3, or (ii) a Change in Control occurs after the date on which Employee's employment with the Company or any of its subsidiaries was terminated (A) by the Company other than for death, Disability or Cause or (B) by Employee for Good Reason, and such termination is effected by the Company (or the actions or decisions giving rise to Employee's termination for Good Reason are taken or made by the Company) in anticipation of a Change in Control (any such termination, action or decision effected, taken or made within 90 days prior to the date of any such Change in Control shall be conclusively deemed to be in anticipation of a Change in Control). (c) Disability. If, as a result of Employee's incapacity due to physical or mental illness, Employee shall have been absent from duties with the Company on a full-time basis for six consecutive months and within 30 days after written Notice of 4 Termination (as required by Section 9(b)) is thereafter given by the Company, Employee shall not have returned to the full-time performance of Employee's duties, the Company may terminate this Agreement for "Disability." (d) Cause. For purposes of this Agreement only, the Company shall have "Cause" to terminate Employee's employment hereunder only on the basis of fraud, misappropriation, embezzlement or willful engagement by Employee in misconduct which is demonstrably and materially injurious to the Company and its subsidiaries taken as a whole. An act, or omission of Employee shall not be considered "willful" unless done, or omitted to be done, by Employee without good faith and a reasonable belief that the act or omission was in the best interests of the Company and its subsidiaries. Employee may not be terminated for Cause unless and until there shall have been delivered to Employee a copy of a resolution duly adopted by affirmative vote of not less than three-quarters of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for that purpose (after reasonable notice to Employee and an opportunity for Employee, together with Employee's counsel, to be heard before the Board), finding Employee was guilty of the conduct set forth in the first sentence of this Section, and specifying the particulars thereof in detail. Notwithstanding the foregoing, Employee shall have the right to contest such termination for Cause (for purposes of this Agreement) by arbitration in accordance with the provisions of Section 8. (e) Good Reason. After a Change in Control, Employee may terminate employment for Good Reason at any time during the term of this Agreement. For purposes of this Agreement, "Good Reason" shall mean any of the following (without Employee's express written consent): 5 (i) the assignment to Employee by the Company of duties inconsistent with, or a substantial alteration in the nature or status of, Employee's responsibilities immediately prior to a Change in Control other than any such alteration primarily attributable to the fact that the Company's securities are no longer publicly traded; (ii) a reduction by the Company in Employee's base salary in effect on the date of a Change in Control or as the same may be increased from time to time during the term of this Agreement; (iii) failure by the Company to continue in effect without substantial change any compensation, incentive, welfare or benefit plan or arrangement, as well as any plan or arrangement whereby Employee may acquire securities of the Company, in which Employee is participating at the time of a Change in Control (or any other plans providing Employee with substantially similar benefits, hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect Employee's participation in or materially reduce Employee's benefits under any such Benefit Plan or deprive Employee of any material fringe benefit enjoyed by Employee at the time of a Change in Control; unless an equitable substitute arrangement (embodied in an ongoing substitute or alternative Benefit Plan) has been made for the benefit of Employee with respect to the Benefit Plan in question. For purposes of the foregoing, Benefit Plans shall include, but not be limited to, the Company's Employee Stock Ownership Plan, Employees' Profit Sharing and Investment Plan, Deferred Compensation (401K) Plan, 1991 Stock Option and Incentive Plan, Top Management Incentive Bonus Plan, and/or any other plan or arrangement to receive and exercise stock options or stock appreciation rights, incentive, bonus or other award plans, group 6 life insurance plans, medical, dental, accident and disability plans; (iv) a relocation of the Company's principal executive offices to a location outside the San Francisco-Oakland-San Jose Bay Area, or Employee's relocation to any place other than the principal executive offices of the Company, except for required travel by Employee on Company business to an extent substantially consistent with Employee's business travel obligations at the time of a Change in Control; (v) any material breach by the Company of any provision of this Agreement; (vi) any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company as required in Section 6; (vii) any purported termination of Employee's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 9(b) below. For purposes of this Agreement, no such purported termination shall be effective. 7 (f) Date of Termination. "Date of Termination" shall mean (i) for Disability, 30 days after Notice of Termination is given to Employee (provided Employee has not returned to the performance of Employee's duties on a full-time basis during such 30-day period), or (ii) if Employee's employment is terminated for any other reason, the date on which notice is given by the Company or Employee, as the case may be. 3. Severance Compensation upon Termination of Employment in Connection with a Change in Control. No compensation shall be payable under this Agreement unless and until a Triggering Event has occurred. Upon the occurrence of a Triggering Event, the Company shall: (a) pay to Employee as severance pay in a lump sum, in cash, on the fifth day following the Date of Termination, an amount equal to 299.999% of Employee's "Base Compensation" (as defined below); provided, however, that if the lump sum severance payment under this Section 3, either alone or together with other payments (or the value of benefits) which Employee has the right to receive from the Company in connection with a Change in Control, would not be deductible (in whole or in part) by the Company as a result of such lump sum payment constituting a "parachute payment" (as defined in Section 280G of the Internal 8 Revenue Code of 1986, as amended (collectively the "Code")), such lump sum severance payment (or, at Employee's election, such other payments and/or benefits, or a combination of such other payments and/or benefits and such lump sum severance payment) shall be reduced to the largest amount as will result in no portion of the lump sum severance payment under this Section 3 not being fully deductible by the Company as a result of Section 280G of the Code. The determination of the amount of any such required reduction pursuant to the foregoing provision, or the valuation of any non-cash benefits for purposes of such determination, shall be made exclusively by the firm that was acting as the Company's auditors prior to the Change in Control (whose fees and expenses shall be borne by the Company), and such determination shall be conclusive and binding. The term "Base Compensation" shall mean an average of the annual cash compensation paid to Employee by the Company and any of its subsidiaries in the form of salary or bonuses (including any amount that is the subject of an elective deferral by Employee) during the five taxable years (or such lesser period as Employee was employed by the Company or any of its subsidiaries) immediately preceding the Change in Control which was includable in gross income (or would have been so included but for any such 9 elective deferral) by Employee for federal income tax reporting purposes; and (b) arrange to provide Employee, for a six-month period (or such shorter period as Employee may elect), with disability, accident, group life, medical and dental insurance, all of which shall be prepaid, substantially similar to those insurance benefits which Employee is receiving immediately prior to the Notice of Termination. Benefits otherwise receivable by Employee pursuant to this Section 3(b) shall be reduced to the extent comparable benefits are actually received by Employee during such six-month period following termination (or such shorter period elected by Employee), and any such benefits actually received by Employee shall be reported by Employee to the Company. Notwithstanding any other provision of this Agreement, if a Change in Control occurs while Employee is still an employee of the Company, Employee may, after 90 days and within 120 days of the Change in Control and upon written notice given in accordance with Section 9(b), terminate employment without Good Reason, and shall thereupon be entitled to one-half (1/2) of the compensation described in this Section 3. 10 4. No Obligation to Mitigate Damages. Employee shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by Employee as a result of employment by another employer or by retirement benefits after the Date of Termination, or otherwise, except to the extent provided in Section 3 above. 5. No Effect on Other Contractual Rights. The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish Employee's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, employment agreement or other contract, plan or arrangement, except that the provisions of this Agreement and any payment provided for hereunder, shall be in lieu of payments otherwise due to Employee under any of the Company's severance pay policies on account of Employee's termination of employment upon (or in anticipation of, as set forth in Section 2(b)) the occurrence of a Change in Control. 6. Successor to the Company. The Company shall require any successor or assign (whether direct or indirect, by purchase, 11 merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement satisfactory to Employee, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 6 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 7. Heirs of Employee. This Agreement shall inure to the benefit of and be enforceable by Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Employee should die while any amounts are still payable to Employee hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Employee's devisee, legatee, or other designee or, if there be no such designee, to Employee's estate. 12 8. Arbitration. Any dispute, controversy or claim arising under or in connection with this Agreement, or the breach hereof, shall be settled exclusively by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. Judgment upon the award rendered by Arbitrator(s) may be entered in any court having jurisdiction thereof. Any arbitration held pursuant to this Section 8 shall take place in San Francisco, California. 9. Notice. (a) General. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: If to the Company: Watkins-Johnson Company 3333 Hillview Avenue Palo Alto, California 94304-1223 Attention: President of the Company If to Employee: _______________________ _______________________ _______________________ 13 or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. (b) Notice of Termination. Any purported termination of employment shall be communicated by a written Notice of Termination to Employee in accordance with paragraph (a) of this Section 9, and shall state the specific termination provisions in this Agreement relied upon, and set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment. 10. Nonwaiver, Complete Agreement, Governing Law. No provisions of this Agreement may be modified, waived or discharged unless in writing signed by both parties. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by 14 and construed in accordance with the laws of the State of California. 11. Legal Fees and Expenses. The Company shall pay all reasonable legal fees and expenses which Employee may incur as a result of the Company's contesting the validity, enforceability or Employee's good faith interpretation of, or good faith determinations under, this Agreement; provided, however, that the Company shall not pay any legal fees and expenses incurred by Employee in contesting the termination of Employee's employment for Cause if, as a result of such contest, it is determined that Employee was in fact terminated for Cause. 12. Confidentiality. Employee shall retain in confidence any and all confidential information known to Employee concerning the Company and its business so long as such information is not otherwise publicly disclosed. 13. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 14. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an 15 original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. WATKINS-JOHNSON COMPANY, a California corporation By ____________________________ Title: _____________________ _______________________________ Employee 16 EX-10.24 8 AMENDED AND RESTATED SEVERANCE AGREEMENT Exhibit 10.24 AMENDED AND RESTATED SEVERANCE AGREEMENT THIS AMENDED AND RESTATED SEVERANCE AGREEMENT (the "Agreement"), originally dated September 28, 1998, and amended and restated in its entirety effective as of January 25, 1999, is entered into by and between Watkins-Johnson Company, a California corporation (the "Company"), and Scott Buchanan ("Employee"). The Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of Employee to his assigned duties without distraction in potentially disturbing circumstances arising from the possibility of a Change in Control (as defined in Section 2(a)) of the Company. This Agreement sets forth the severance compensation which the Company agrees to pay to Employee if Employee's employment with the Company terminates under one of the circumstances described herein. 1. Term. (a) This Agreement shall terminate, except for any unpaid obligation of the Company, upon the earliest of (i) three years from the date hereof if a Change in Control has not occurred within such three-year period; (ii) the termination of Employee's employment by the Company based on death, Disability (as defined in Section 2(c)) or Cause (as defined in Section 2(d)) or by Employee other than for Good Reason (as defined in Section 2(e); or (iii) three years from the date of a Change in Control. (b) Nothing in this Agreement shall confer upon Employee any right to continue in the employ of the Company prior to or following a Change in Control or shall in any way limit the rights of the Company, which are hereby expressly reserved, to discharge Employee at any time prior to or following the date of a Change in Control for any reason whatsoever, with or without Cause. 2. Certain Definitions. (a) Change in Control. A "Change in Control" shall be deemed to have occurred if (i) there shall be consummated (x) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation, (y) any other consolidation or merger to which the Company is a party, regardless of whether shares of the Company's Common Stock would 2 be converted into cash, securities or other property, other than a merger of the Company in which the holders of the Company's Common Stock immediately prior to the merger have the same proportionate ownership of common stock (or the equivalent fully voting securities) of the surviving corporation or other entity immediately after the merger, or (z) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company, or (ii) the Company consummates (in one or a series of transactions) the disposition of substantially all of its operating businesses, or (iii) any "person" (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, shall become the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of 30% or more of the Company's outstanding Common Stock, or (iv) during any period of two consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors of the Company shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. (b) Triggering Event. A "Triggering Event" shall be deemed to have occurred if either (i) a Change in Control occurs while Employee is still an employee of the Company or any of its subsidiaries or (ii) a Change in Control occurs after the date on which Employee's employment with the Company or any of its subsidiaries was terminated (x) by the Company other than for death, Disability or Cause or (y) by Employee for Good Reason, and such termination is effected by the Company (or the actions or decisions giving rise to Employee's termination for Good Reason are taken 3 or made by the Company) in anticipation of a Change in Control (any such termination, action or decision effected, taken or made within 90 days prior to the date of any such Change in Control shall be conclusively deemed to be in anticipation of a Change in Control). (c) Disability. If, as a result of Employee's incapacity due to physical or mental illness, Employee shall have been absent from duties with the Company on a full-time basis for six consecutive months and within 30 days after written Notice of Termination (as required by Section 9(b)) is thereafter given by the Company, Employee shall not have returned to the full-time 4 performance of Employee's duties, the Company may terminate this Agreement for "Disability." (d) Cause. For purposes of this Agreement only, the Company shall have "Cause" to terminate Employee's employment hereunder only on the basis of fraud, misappropriation, embezzlement or willful engagement by Employee in misconduct which is demonstrably and materially injurious to the Company and its subsidiaries taken as a whole. An act, or omission of Employee shall not be considered "willful" unless done, or omitted to be done, by Employee without good faith and a reasonable belief that the act or omission was in the best interests of the Company and its subsidiaries. Employee may not be terminated for Cause unless and until there shall have been delivered to Employee a copy of a resolution duly adopted by affirmative vote of not less than three-quarters of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for that purpose (after reasonable notice to Employee and an opportunity for Employee, together with Employee's counsel, to be heard before the Board), finding Employee was guilty of the conduct set forth in the first sentence of this Section, and specifying the particulars thereof in detail. Notwithstanding the foregoing, Employee shall have the right to contest such termination for Cause (for purposes of this Agreement) by arbitration in accordance with the provisions of Section 8. (e) Good Reason. For purposes of this Agreement, "Good Reason" shall mean any of the following (without Employee's express written consent): (i) the assignment to Employee by the Company of duties inconsistent with, or a substantial alteration in the nature or status of, Employee's responsibilities immediately prior to a 5 Change in Control other than any such alteration primarily attributable to the fact that the Company's securities are no longer publicly traded; (ii) a reduction by the Company in Employee's base salary in effect on the date of a Change in Control or as the same may be increased from time to time during the term of this Agreement; (iii) failure by the Company to continue in effect without substantial change any compensation, incentive, welfare or benefit plan or arrangement, as well as any plan or arrangement whereby Employee may acquire securities of the Company, in which Employee is participating at the time of a Change in Control (or any other plans providing Employee with substantially similar benefits, hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company which would adversely affect Employee's participation in or materially reduce Employee's benefits under any such Benefit Plan or deprive Employee of any material fringe benefit enjoyed by Employee at the time of a Change in Control; unless an equitable substitute arrangement (embodied in an ongoing substitute or alternative Benefit Plan) has been made for the benefit of Employee with respect to the Benefit Plan in question. For purposes of the foregoing, Benefit Plans shall include, but not be limited to, the Company's Employee Stock Ownership Plan, Employees' Profit Sharing and Investment Plan, Deferred Compensation (401K) Plan, 1991 Stock Option and Incentive Plan, Top Management Incentive Bonus Plan, and/or any other plan or arrangement to receive and exercise stock options or stock appreciation rights, incentive, bonus or other award plans, group life insurance plans, medical, dental, accident and disability plans; (iv) a relocation of the Company's principal executive offices to a location outside the San Francisco-Oakland-San Jose Bay Area, or Employee's relocation to any place 6 other than the principal executive offices of the Company, except for required travel by Employee on Company business to an extent substantially consistent with Employee's business travel obligations at the time of a Change in Control; (v) any material breach by the Company of any provision of this Agreement; (vi) any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company as required in Section 6; (vii) any purported termination of Employee's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 9(b) below. For purposes of this Agreement, no such purported termination shall be effective. (f) Date of Termination. "Date of Termination" shall mean (i) for Disability, 30 days after Notice of Termination is given to Employee (provided Employee has not returned to the performance of Employee's duties on a full-time basis during such 30-day period), or (ii) if Employee's employment is terminated for any other reason, the date on which notice is given by the Company or Employee, as the case may be. 7 3. Severance Compensation upon Termination of Employment in Connection with a Change in Control. No compensation shall be payable under this Agreement unless and until a Triggering Event has occurred. Upon the occurrence of a Triggering Event, the provisions of this Agreement shall be binding on and shall inure to the benefit of the surviving or resulting corporation, or (in the case of a Change in Control of the kind referred to in Section 2(a)(i)(y)) the corporation to which the applicable assets of the Company have been transferred; provided, however, that (a) Employee may treat the occurrence of a Triggering Event as a material breach of this Agreement and may terminate this Agreement upon written notice given (in accordance with Section 9(b)) within 120 days of the occurrence of a Change in Control, unless Employee's employment has theretofore been terminated for death, Disability or Cause, and (b) Employee may terminate this Agreement for Good Reason at any time prior to the second anniversary of a Change in Control and during the remainder of the term of this Agreement as specified in Section 1(a). Upon such termination by Employee under this Section 3, or upon the termination of Employee's employment by the Company without Cause at any time prior to the second anniversary of a Change in Control, the Company shall: 8 (i) pay to Employee as severance pay in a lump sum, in cash, on the fifth day following the Date of Termination, an amount equal to the aggregate of (x) 299.999% of Employee's "Base Compensation" (as defined below), plus (y) an amount equal to (A) the amount previously determined by the Board as Employee's target bonus for the calendar year in which Notice of Termination is given by Employee or the Company, as the case may be, multiplied by (B) a fraction, the numerator of which shall be the number of days that have elapsed during such calendar year, through and including the date on which such Notice of Termination is given, and the denominator of which shall be 365; provided, however, that if the lump sum severance payment under this Section 3, either alone or together with other payments (or the value of other benefits) which Employee has the right to receive from the Company in connection with a Change in Control, would not be deductible (in whole or in part) by the Company as a result of such lump sum payment constituting a "parachute payment" (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (collectively the "Code")), such lump sum severance payment (or, at Employee's election, such other payments and/or benefits, or a combination of such other payments and/or benefits and such lump sum severance payment) shall be 9 reduced to the largest amount as will result in no portion of the lump sum severance payment under this Section 3 not being fully deductible by the Company as a result of Section 280G of the Code. The determination of the amount of any such required reduction pursuant to the foregoing provision, and the valuation of any non-cash benefits for purposes of such determination, shall be made exclusively by the firm that was acting as the Company's auditors prior to the Change in Control (whose fees and expenses shall be borne by the Company), and such determination shall be conclusive and binding. The term "Base Compensation" shall mean an average of the annual cash compensation paid to Employee by the Company and any of its subsidiaries in the form of salary or bonuses (including any amount that is subject of an elective deferral by Employee) during the five taxable years immediately preceding the Change in Control which was includable in gross income (or would have been so included but for any such elective deferral) by Employee for federal income tax reporting purposes; and (ii) arrange to provide Employee, for a thirty-six month period (or such shorter period as Employee may elect), with disability, accident, group life, medical and dental insurance, all of which shall be prepaid, substantially similar to those 10 insurance benefits which Employee is receiving immediately prior to a termination by Employee under this Section 3. Benefits otherwise receivable by Employee pursuant to this Section 3 shall be reduced to the extent comparable benefits are actually received by Employee during such thirty-six month period (or such shorter period elected by Employee), and any such benefits actually received by Employee shall be reported by Employee to the Company. 4. No Obligation to Mitigate Damages. Employee shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by Employee as a result of employment by another employer or by retirement benefits after the Date of Termination, or otherwise, except to the extent provided in Section 3 above. 5. No Effect on Other Contractual Rights. The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish Employee's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, employment agreement or other contract, plan or arrangement, 11 except that the provisions of this Agreement and any payment provided for hereunder, shall be in lieu of payments otherwise due to Employee under any of the Company's severance pay policies on account of Employee's termination of employment upon (or in anticipation of, as set forth in Section 2(b)) the occurrence of a Change in Control. 6. Successor to the Company. The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement satisfactory to Employee, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 6 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 7. Heirs of Employee. This Agreement shall inure to the benefit of and be enforceable by Employee's personal and legal 12 representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Employee should die while any amounts are still payable to Employee hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Employee's devisee, legatee, or other designee or, if there be no such designee, to Employee's estate. 8. Arbitration. Any dispute, controversy or claim arising under or in connection with this Agreement, or the breach hereof, shall be settled exclusively by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect. Judgment upon the award rendered by Arbitrator(s) may be entered in any court having jurisdiction thereof. Any arbitration held pursuant to this Section 8 shall take place in San Francisco, California. 9. Notice. (a) General. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: 13 If to the Company: Watkins-Johnson Company 3333 Hillview Avenue Palo Alto, California 94304-1223 Attention: President of the Company If to Employee: Scott Buchanan 5144 Independence Drive Pleasanton, California 94566 or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. (b) Notice of Termination. Any purported termination of employment shall be communicated by a written Notice of Termination to Employee in accordance with paragraph (a) of this Section 9, and shall state the specific termination provisions in this Agreement relied upon, and set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment. 10. Nonwaiver, Complete Agreement, Governing Law. No provisions of this Agreement may be modified, waived or discharged unless in writing signed by both parties. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this agreement shall be deemed a waiver of similar or dissimilar 14 provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 11. Legal Fees and Expenses. The Company shall pay all reasonable legal fees and expenses which Employee may incur as a result of the Company's contesting the validity, enforceability or Employee's good faith interpretation of, or good faith determinations under, this Agreement; provided, however, that the Company shall not pay any legal fees and expenses incurred by Employee in contesting the termination of Employee's employment for Cause if, as a result of such contest, it is determined that Employee was in fact terminated for Cause. 12. Confidentiality. Employee shall retain in confidence any and all confidential information known to Employee concerning the Company and its business so long as such information is not otherwise publicly disclosed. 15 13. Validity. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 14. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. WATKINS-JOHNSON COMPANY, a California corporation By /s/ W. Keith Kennedy -------------------- Title: President & CEO --------------- /s/ Scott G. Buchanan --------------------- Scott Buchanan 16 EX-10.25 9 EMPLOYEE RETENTION PROGRAM Exhibit 10.25 Watkins-Johnson Company Employee Retention Program March 1, 1999 As WJ has announced its intention to sell itself either in its entirety or as separate business segments, we want to assure you of the continued importance you each have to WJ, the products we produce, and the customers we support. We hope that the bonus programs described below will ensure that every employee will have an incentive to stay with WJ during these difficult times. To participate in the following programs, or any other severance payments, you will be required to waive any claims against WJ. This waiver will be given to you at the time the entire company or your business unit is sold. Enhanced Profit Sharing Package Currently, every employee of Watkins-Johnson Company shares in a profit sharing bonus that pays a percentage of salary based on either group profit or WJ profit. Realizing that strong profitability is a large factor in creating value, WJ will double and annualize the profit sharing for each employee. This means that when the divestiture transaction for each employees' group closes or when the sale of all of WJ is complete, whichever comes first, using the regular profit sharing formula, WJ will compute the profit sharing percentage at the close of the transaction and then double and extend that percentage for all of 1999. Transfer Bonus We want to further reward those people who choose to stay with WJ until their group's transaction closes or until the sale of the entire company is complete, whichever comes first, and who then accept and begin employment with the company that purchases their group or the entire company. These people will receive a transfer bonus of two weeks base salary to be paid by WJ. The Transfer Bonus will require the confirmation to WJ that you have begun employment with the buyer of your group or the entire company. RIF Protection With the uncertainties of this period, we recognize the concern employees may have about the possible necessity for a reduction in force in selected job areas. To address this concern, in addition to the WJ Enhanced Severance package, any WJ employee not transferred to the new employer and RIF'd by WJ during the balance of 1999 will receive the doubled and annualized Enhanced Profit Sharing Bonus described above. This RIF protection will not be applicable in circumstances in which the transfer bonus would apply. The purpose of this document is to summarize the retention program and is informational only. Formal documents will be distributed at a later date. EX-21 10 SUBSIDIARIES OF WATKINS-JOHNSON COMPANY Exhibit 21 SUBSIDIARIES OF WATKINS-JOHNSON COMPANY Jurisdiction of Subsidiary Incorporation - -------------------------------------------------------------------------------- WJ Semiconductor Equipment Group, Inc. California Watkins-Johnson FSC Guam Watkins-Johnson International California Watkins-Johnson International Japan, K.K. Japan Watkins-Johnson International Korea, Limited Korea Watkins-Johnson International Singapore PTE, Limited Singapore Watkins-Johnson International Taiwan Taiwan Watkins-Johnson Europe, Limited United Kingdom Page 53 EX-23 11 INDEPENDENT AUDITORS' CONSENT Exhibit 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-21142 on Form S-8 of our reports dated February 5, 1999 (March 4, 1999 as to Note 12 of the Consolidated Financial Statements) appearing in this Annual Report on Form 10-K of Watkins-Johnson Company for the year ended December 31, 1998. Deloitte & Touche LLP San Jose, California March 11, 1999 Page 54 EX-27 12 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 19,271 45,353 31,942 0 23,370 172,096 140,224 77,585 245,478 81,078 32,701 0 0 34,454 97,245 245,478 212,200 212,200 161,648 161,648 122,392 0 1,168 (73,008) (23,800) (49,208) 0 0 0 (49,208) (6.36) (6.36)
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