ITEM 1. BUSINESS (a) General Development of Business
The company's structure during 1994 was unchanged from the previous year. Since Watkins-Johnson realigned its business between 1991 and 1993, it has operated in three principal business segments: semiconductor equipment, electronic products and environmental services.
At the end of 1994, the environmental services unit was divested. Including that divestiture, there were no material reclassifications, mergers or consolidations of the company or its subsidiaries during the year. There were no acquisitions or dispositions of materials amounts of assets other than in the ordinary course of business during 1994.
(b) Financial Information about Industry Segments
The company operated within three industry segments--semiconductor equipment, electronics, and environmental services. The environmental services segment was divested at the end of 1994. Financial information about 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
Semiconductor Equipment
The Semiconductor Equipment Group manufactures chemical-vapor-deposition (CVD) equipment. The company's atmospheric-pressure CVD equipment is used by semiconductor manufacturers worldwide in the production of memory devices (DRAMs) and microprocessors.
Historically, the company's CVD systems have been used primarily for the deposition of interlevel-dielectric films--the initial dielectric layer on a semiconductor wafer. The company's current principal products, the TEOS999 and WJ-1000 Systems, deposit both interlevel-dielectric (ILD) and intermetal-dielectric (IMD) layers of film on sub-half-micron geometries. The addition of an IMD capability to WJ's historic concentration on the ILD process potentially doubles the market size for WJ's CVD equipment.
Changing wafer-processing requirements, involving the addition of multiple layers of both ILD and IMD to advanced integrated circuits, are also increasing the market for WJ systems. The WJ-1000 System, designed for high-throughput CVD onto the 200-mm (8-inch) wafers currently entering production in major fabrication facilities in the U.S. and overseas, has been well accepted by the market.
A variant of Watkins-Johnson's semiconductor-production tool is used for manufacturing flat-panel displays for personal-communication, computing and entertainment products.
Sales by the segment were 43% of consolidated sales in 1994, 29% in 1993 and 22% in 1992. The company is changing its mode of selling semiconductor equipment. In place of a network of manufacturers' representatives and distributors, WJ is establishing direct sales and service offices worldwide.
Customers of the Semiconductor Equipment Group are numerous. A majority of the segment's sales is to manufacturers of semiconductor integrated circuits. Marubeni Hytech, the company's Japanese distributor, is a significant customer of the segment. There are several domestic and international competitors and competition is intense. In meeting the competition, emphasis is placed on selling quality products having both reliability and performance and a strong customer- support network.
The Semiconductor Equipment Group's business depends upon the capital expenditures of semiconductor manufacturers, and the current and anticipated market demand for integrated circuits. It is recognized that the semiconductor equipment business is cyclical and can change rapidly. Uncertainty increases significantly when projecting demand for semiconductor equipment products more than 6 months in the future.
Electronics
The Electronics Group manufactures turnkey systems, integrated subsystems and signal-processing components for a broad range of communications and defense-electronics applications. The group is serving new customers with wireless-communication requirements, in addition to supplying sophisticated electronic products for defense-intelligence, missile-guidance and space-communications missions.
Recent non-defense contracts include transceivers for cellular base stations, receivers for locating emergency 911 callers and high-dynamic-range mixers for the Japanese manufacturer of "personal handi-phone" base stations.
Watkins-Johnson receivers, antennas and signal-analysis equipment are used by both commercial and military governmental agencies to perform range-monitoring, frequency-measurement, signal-localization and interference-analysis functions, often in complex, high-signal-density environments.
The company is a subcontractor for certain key missile programs, such as the Advanced Medium-Range Air-to-Air Missile (AMRAAM), the High-speed Anti-Radiation Missile (HARM) and the Standard Missile Block 4 which continue to represent a substantial portion of the group's core defense-electronics business.
Electronics Group products are marketed through direct selling efforts and distributor networks. Sales by the electronics segment were 57% of consolidated sales in 1994, 71% in 1993 and 78% in 1992. A majority of the segment sales is made to government agencies and to customers, such as Hughes Aircraft Company, engaged in defense contracting. The principal end user for such sales is the U.S. Department of Defense. Sales contracts with the government are customarily subject to terms and conditions which provide for renegotiation of profits or termination of the contract at the election of the government. The right to terminate for convenience has not had any significant effect on the company's financial position or results of operations.
The electronics segment has numerous competitors which include both large, diversified corporations and smaller specialty firms. In addition to pressures from competing companies, Watkins-Johnson's defense-electronics business is influenced by political activity and national budgetary policy. In recent years, Department of Defense budget cutbacks have required the company to reduce its work force and restructure its organization to address changing business opportunities. Ongoing reductions in U.S. defense spending could limit future demand for the company's products.
Due to the various industries in which the company and its competitors operate, a competitive ranking cannot be reasonably established. However, WJ's Electronics Group is a leading supplier in several of its product markets. In meeting its competition, the company offers quality products featuring both reliability and performance at competitive prices.
Other Business Items
Raw materials for the production of semiconductor equipment and electronic products are acquired from a broad range of suppliers. Because suppliers are numerous, dependence on any one supplier is kept to a minimum. On occasion, however, the failure of a supplier to deliver key parts can jeopardize the on-time shipment of WJ products. Business operations are not believed to be seasonal. Except for negotiated advance or progress payments from customers on long-term contracts in the defense-electronics business, there are no 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, 1994 was $235,942,000 compared to $221,437,000 at December 31, 1993. The percentage of backlog attributable to the semiconductor equipment and electronics segments were 39% and 61%, respectively, in 1994, compared to 22% and 78% in 1993. Approximately 92% of all backlog at year-end 1994 is shippable within 12 months, compared to 86% at year-end 1993.
Company-sponsored research and development expense was $34,436,000 in 1994, $27,163,000 in 1993, and $27,210,000 in 1992. Customer-sponsored research and development was estimated to be approximately $24,000,000 in 1994, $18,000,000 in 1993, and $25,000,000 in 1992, and was performed by the Electronics Group.
The company's employment at December 31, 1994 was 2,220. None of the company's employees is covered by a collective-bargaining agreement. The company's relationship with its employees is generally good.
Environmental issues are discussed in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.
(d) Financial Information about Foreign and Domestic Operations and Export Sales.
Assets and sales from foreign operations are less than ten percent of consolidated totals. Export sales and sales from foreign operations accounted for 45% of the company's sales in 1994, 33% in 1993, and 25% in 1992. The inherent risks of foreign business are similar to domestic business, with the additional risks of foreign government instability and export license cancellation. A major portion of foreign product orders in the electronics segment requires export licensing by the Department of State prior to shipment. For international shipments for both electronics and semiconductor equipment segments, the company purchases forward exchange contracts and/or 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.
ITEM 2. PROPERTIES
Watkins-Johnson Company and subsidiaries conduct their main operations at plants in Palo Alto and Scotts Valley, California and Gaithersburg, Maryland. Additional operations are conducted in Windsor, England. The plant in San Jose, California, has been closed and is offered for sale. The company plans to close its 50,000 square foot facility in Columbia (Savage), Maryland, in the first quarter of 1995 and will return it to the lessor.
At December 31, 1994, there were approximately 530,000 square feet of plant space in California, 225,000 square feet in Maryland, and 15,000 square feet in England. Approximately 95% of the company's plant space is occupied for the company's operations. The company is pursuing opportunities to realize the market value of its properties while ensuring efficient use of available space.
The electronics segment utilizes substantially all of the Palo Alto and Gaithersburg facilities. The Scotts Valley plant houses the semiconductor-equipment segment.
The Palo Alto facility and sales office locations are leased. Information on long-term obligations is in Note 3 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Information required under this item is contained in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.
ITEM 4.
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
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.
*In January 1995, Mr. Gilbert resigned as Executive Vice President of the company.
PART II
ITEM 5.
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, 1994 there were approximately 4,600 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
1994 QUARTERS 1ST 2ND 3RD 4TH - --------------------------------------- ----- ----- ----- ----- Dividends Declared Per Share (in cents) 12 12 12 12 Stock Price (NYSE--in dollars) .........High 28-3/4 35-5/8 36-5/8 36 Low 19-5/8 24-7/8 26-1/8 28-1/2
1993 QUARTERS 1ST 2ND 3RD 4TH - --------------------------------------- ------- ------- ------- ------- Dividends Declared Per Share (in cents) 12 12 12 12 Stock Price (NYSE--in dollars) .........High 15-1/2 18-1/2 24-1/2 26-1/4 Low 12 12-3/4 17-1/4 19-3/8
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition:
The company's financial condition remains healthy. During 1994 cash and equivalents decreased $11 million from $45 to $34 million. Although cash flow from operations was positive, the decline in cash was attributable to higher capital expenditures, repayment of a long-term mortgage, dividends, and cash used for stock repurchases exceeding stock issuances. The company expects its operations to generate sufficient funds to meet next year's cash requirements. In addition, the company has the ability to augment any unplanned cash needs with readily available external financing.
Current Operations:
The semiconductor-equipment business remained strong during 1994 as semiconductor manufacturers continued to expand their plant capacity. The Semiconductor Equipment Group increased its production capacity to keep pace with demand. To better serve its international
customers, in 1994 the group established subsidiary operations in Japan, Singapore and Taiwan in addition to South Korea, which was established in 1993. Preparations are underway to open an office in Europe in early 1995. Although the company remains cautious about the uncertainty and cyclical nature of the semiconductor-equipment business, it is encouraged by the group's record backlog at the end of 1994 and good order prospects in the first half of 1995.
In contrast to the burgeoning semiconductor-equipment market, the persistent weakness in the defense market prompted the Electronics Group to further streamline its operations and reduce costs. During 1994, the group consolidated its two Northern California operations into the company's Palo Alto, California Plant. The group is also planning to consolidate its East Coast operations into the Gaithersburg, Maryland Plant in early 1995. The company believes these actions should help to improve its competitiveness in the shrinking defense electronics market.
Furthermore, the company divested its Environmental business at the end of the year. The divestiture did not have a significant impact on the company's results of operation and financial position. The divestiture should allow the company to focus its resources on high-growth areas such as the already robust semiconductor-equipment segment and the telecommunications market within the electronics segment.
Results of Operations:
1994 Compared to 1993: Sales in the semiconductor-equipment segment surged 78% and more than offset the 6% decline in the electronics segment resulting in an overall company increase of 18%. The favorable shift towards more profitable semiconductor-equipment products helped to improve the company's gross margin to above 40% despite consolidation costs incurred in the Electronics Group. Selling and administrative expenses grew faster than revenues because of commissions on higher international semiconductor-equipment sales. As previously discussed, to improve customer service and better control international expenses, the company established certain foreign operations. The offices will operate in parallel with the current distributors during a transition period. Research and development expenditures were expectedly higher than last year due to the company's efforts in advancing high-density plasma technology and development of the next generation of products for both business segments. The effective tax rate declined from 31% to 30% primarily due to higher R&D credit. As a result of the above factors, net income from continuing operations rose 78%.
1993 Compared to 1992: Semiconductor Equipment Group sales jumped 46% while Electronics Group sales were flat. Margins improved significantly in the Semiconductor Equipment Group due to the higher volume and operational efficiencies. This more than offset the slight decline in profit margins experienced in the Electronics Group. As a result, the combined gross margin improved from 35% in 1992 to 36% in 1993. Selling and administrative expenses were higher as expected due to the increase in volume and expenses associated with the profitability of the company. In a percentage-of-sales comparison, selling and administrative expenses were favorable relative to 1992 but may increase in 1994 due to anticipated higher commissions and expenses associated with certain international sales. Research and development expenses decreased for the first three quarters of 1993 as activities eased from the intense levels experienced in 1992. In the fourth quarter 1993, the Semiconductor Equipment Group began to reemphasize research and development activities to focus on the next generation of products to meet the time-to-market window. The higher level of research and development expenses incurred in the fourth quarter is expected to continue for at least the first half of 1994. All other nonoperating income and expenses were within expectations. Due to the combined effect of the above factors, 1993 net income more than doubled the 1992 income before the cumulative effect of an accounting change.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
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.
Cash Equivalents--Cash equivalents consist principally of commercial paper acquired with remaining maturity periods of 90 days or less and are stated at cost plus accrued interest which approximates market value. The company's investment guidelines limit holdings in commercial paper to $1,000,000 per issuer.
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. Leases which at inception assure the lessor full recovery of the fair market value of the property over the lease term are capitalized. Provision for depreciation and amortization is primarily based on the sum-of-the-years'-digits and straight-line methods.
Revenue Recognition--Revenue on fixed-price contracts other than long-term contracts is recorded upon shipment or completion of tasks as specified in the contract. 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. Gains or losses, which result from the process of remeasuring foreign currency financial statements and transactions into U.S. dollars, are included in net income and are not material in any year presented.
Income Taxes--In 1992, the company adopted Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes" (SFAS 109); previously the company had accounted for taxes under SFAS 96 (see Note 5). Under SFAS 109, the consolidated statements of income 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. State and local income taxes are included in selling and administrative expenses.
Per Share Information--Beginning in 1993, net income per share is computed using the weighted average number of common and common equivalent shares (dilutive stock options) outstanding during the year. The difference between fully diluted earnings per share and primary earnings per share is not significant. Prior to 1993, the computation excluded outstanding stock options as their dilutive effect was not material.
Reclassification--Certain amounts for 1993 and 1992 have been reclassified to conform to the 1994 presentation.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. RECEIVABLES
Receivables consist of the following (in thousands):
1994 1993 ---------- --------- U.S. Government long-term contracts: Billed ....................................$ 2,613 $ 2,936 Unbilled .................................. 9,516 4,896 Commercial long-term contracts: Billed .................................... 9,663 3,818 Unbilled .................................. 723 11,917 ---------- --------- Total long-term contract receivables ..... 22,515 23,567 Other trade receivables ................... 57,912 50,404 ---------- --------- Total receivables less allowance of $1,015 in 1994 and $999 in 1993 ..................$80,427 $ 73,971 ========== =========
Unbilled receivables represent revenue recognized for long-term contracts not yet billable based on the terms of the contract. These amounts are billable upon shipment of the product, achievement of milestones, or completion of the contract. Unbilled receivables are expected to be billed and collected within one year. Receivables representing retainage not collectible within one year are not material. There are no significant billed or unbilled receivables subject to future negotiation.
Government contracts have provisions for audit, price redetermination and other profit and cost limitations. Contracts may be terminated without prior notice at the Government's convenience. In the event of such termination, the company may be compensated for work performed, a reasonable allowance for profit, and commitments at the time of termination. The right to terminate for convenience has not had any significant effect on the company's financial position or results of operations.
3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT
Long-term obligations, excluding amounts due within one year, consist of (in thousands):
1994 1993 ---------- --------- Mortgage ..................$ 0 $ 4,238 Deferred compensation .... 6,330 4,034 Environmental remediation 8,430 10,257 Long-term leases .......... 7,823 7,934 ---------- --------- Total .....................$22,583 $ 26,463 ========== =========
The current portion of long-term obligations is included in current liabilities. The expected maturity amounts are as follows: 1995, $2,947,000; 1996, $2,072,000; 1997, $1,955,000; 1998, $1,948,000; 1999, $1,942,000.
Mortgage--Primarily consisted of a mortgage bearing 8 3/4 % interest secured by the San Jose, California plant. During 1994, the mortgage was paid while the property was offered for sale. Based on the borrowing rates available to the company for loans with similar terms, the carrying value of the mortgage at December 31, 1993 approximated fair value.
Deferred Compensation--The company has deferred compensation plans covering selected members of management and key technical employees. The purpose is to reward and encourage talented employees to remain with the company.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Environmental Remediation--As discussed in Note 6, the company is obligated to remediate groundwater contamination at the Scotts Valley and Palo Alto facilities. The portion expected to be paid within one year is included in current liabilities.
Leases--Certain long-term leases for plant facilities are treated as capital leases for financial statement purposes. The leases expire during the years 2014 to 2029, and renewal options do not provide for lease extensions beyond the year 2029. The company also has noncancellable operating leases for plant facilities and equipment expiring through 1998. The leases may be renewed for various periods after the initial term. Payment obligations under these capitalized and operating leases as of December 31, 1994 are as follows (in thousands):
CAPITAL OPERATING LEASES LEASES ---------- ----------- 1995 ...........................$ 848 $1,176 1996 ........................... 848 357 1997 ........................... 848 319 1998 ........................... 848 115 1999 ........................... 848 0 Remaining years ................ 15,720 0 ---------- ----------- Total .......................... 19,960 $1,967 =========== Imputed interest ............... (12,026) ---------- Present value of lease payments (current portion, $111) ........$ 7,934 ==========
Rent expense included in continuing operations for property and equipment relating to operating leases is as follows (in thousands):
1994 1993 1992 --------- --------- -------- Real property $ 774 $ 822 $ 866 Equipment ..... 626 865 830 --------- --------- -------- Total .........$ 1,400 $ 1,687 $ 1,696 ========= ========= ========
Lines of Credit--The company has arranged with certain banks to provide unsecured revolving lines of credit totaling $23,500,000. These agreements are generally renegotiated on an annual basis. No material compensating balances are required or maintained. Borrowings under these facilities generally bear interest at prime rate, which ranged from 6 to 8 1/2 percent in 1994. The lines of credit were substantially unused during the year. The amount of outstanding letters of credit and other guarantees, which may reduce the company's available lines, totaled $4,701,000 at December 31, 1994.
4. SHAREOWNERS' EQUITY
Stock Repurchase Program--During 1994, the Board of Directors increased its common-stock-repurchase authorization from 1,500,000 to 2,500,000 shares. Through December 31, 1994, 1,500,000 shares have been repurchased completing the previous repurchase authorization. The new authorization enables the company to continue to acquire its common stock from time to time when appropriate.
Common Share Purchase Rights--For each share of company common stock outstanding, one Common Share Purchase Right is attached. The Rights expire October 20, 1996, and may be redeemed by the company for $.01 per Right at any time prior to 15 days after an entity acquires 20% or more of the company's common stock. The Rights become exercisable if an entity acquires 20% or more of the company's outstanding common stock, or announces an offer which would result in such entity acquiring
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
30% or more of the company's common stock. When exercisable, the Rights trade separately from the common stock and entitle a holder to buy one share of the company's common stock for $160. If the company is subsequently involved in a merger or other business combination, 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. The Rights also provide for protection against self-dealing transactions by a controlling shareowner.
Stock Option Plans--The Employee Stock Option Plan provides for grants of nonqualifying and incentive stock options to certain key employees and officers. The options are granted at the market price on date of grant and expire at the tenth anniversary date. One-third of the options granted are exercisable in each of the third, fourth and fifth succeeding years. The Plan allows those employees who are subject to the insider trading restrictions certain limited rights to receive cash in the event of a change in control. Shares issued are net of retirement of shares used in payment for options exercised. In addition, the Plan permits 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, 1994.
The Nonemployee Directors Stock Option Plan provides for a fixed schedule of options to be granted through 1998. Options granted are exercisable similarly to the Employee Stock Option Plan. The total number of shares to be issued under this plan may not exceed 200,000 shares. Included in the tables below, 16,320 option shares were granted at $29.00 in 1994 and 17,640 option shares were granted at $12.88 in 1993.
Activity related to stock option plans is as follows:
1994 SHARES PRICE - --------------------------- ----------- ---------------- Granted .................... 577,320 $22.75 to $35.88 Exercised .................. 573,842 $ 9.63 to $28.25 Terminated ................. 28,641 At December 31: Outstanding ................1,844,249 $ 9.63 to $36.75 Exercisable ................ 865,146 $ 9.63 to $36.75 Reserved for future grants 1,108,551
1993 SHARES PRICE - --------------------------- ----------- ---------------- Granted .................... 449,640 $12.38 to $24.50 Exercised .................. 87,945 $13.00 to $21.00 Terminated ................. 154,167 At December 31: Outstanding ................1,869,412 $ 9.63 to $36.75 Exercisable ................1,058,700 $ 9.88 to $36.75 Reserved for future grants 1,657,230
Included in the Consolidated Statements of Shareowners' Equity are tax benefits related to sales under stock option plans of $2,327,000, $123,000 and $9,000 for 1994, 1993 and 1992, respectively.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. INCOME TAXES
In 1992 the company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109) which permits recognition of tax benefits for certain temporary differences that could not be recognized under SFAS 96. Under SFAS 109, 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, SFAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates, whereas SFAS 96 gave no recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. The cumulative effect of this accounting change increased deferred tax assets at January 1, 1992 and first quarter 1992 net income by $5,438,000 or 72 cents per share. The provision for Federal and foreign income taxes on income from continuing operations consists of the following (in thousands):
1994 1993 1992 --------- --------- --------- Current ....$ 9,895 $ 6,625 $ 3,662 Deferred .. (695) (1,075) (1,012) --------- --------- --------- Total ......$ 9,200 $ 5,550 $ 2,650 ========= ========= =========
Deferred tax assets (liabilities) are comprised of the following at December 31 (in thousands):
1994 1993 1992 ---------- --------- --------- Capitalized leases .............$ 632 $ 675 $ 736 Deferred compensation .......... 3,251 3,357 2,055 Loss accruals .................. 6,295 5,423 5,919 Environmental remediation ..... 3,490 4,034 4,601 Uniform capitalization ......... 1,273 1,055 929 Vacation accrual ............... 1,724 1,744 1,698 Other .......................... 675 454 211 ---------- --------- --------- Gross deferred tax assets ..... 17,340 16,742 16,149 ---------- --------- --------- Depreciation ................... (1,562) (1,413) (1,910) Other .......................... (158) (404) (389) ---------- --------- --------- Gross deferred tax liabilities (1,720) (1,817) (2,299) --------- --------- --------- Net deferred tax asset .........$15,620 $ 14,925 $ 13,850 ========== ========= =========
The differences between the effective income tax rate and the statutory Federal income tax rate are as follows:
1994 1993 1992 ------- ------- ------- Statutory Federal tax rate ...... 35.0% 35.0% 34.0% Foreign sales corporation benefit (5.5) (7.0) (6.3) Research credit .................. (2.3) Foreign subsidiary losses ........ .2 1.7 2.5 Other ............................ 2.4 1.7 1.3 ------- ------- ------- Effective rate ................... 29.8% 31.4% 31.5% ======= ======= =======
Domestic state and local income taxes included in selling and administrative expenses totaled $1,813,000 in 1994, $1,257,000 in 1993, and $640,000 in 1992. Foreign operation amounts represent less than 5% of totals.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Omnibus Budget Reconciliation Act of 1993 (the Act) became effective on August 10, 1993. The provisions of the Act did not have a material effect on the company's deferred taxes or its results of operations.
6. ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES
The company remains in compliance with the remedial action plans being monitored by various regulatory agencies at its Scotts Valley and Palo Alto sites. In 1994 the company reached agreement with the other potential responsible parties regarding allocations of the remediation costs at the Palo Alto site.
In 1991 the company recorded a $15 million charge for estimated remediation actions and cleanup costs. No additional provision has been recorded since 1991. Expenditures of $2,727,000, $1,676,000 and $1,581,000 were incurred for the years 1994, 1993 and 1992, respectively. While the timing and ultimate amount of expenditures of restoring the sites cannot be predicted with certainty, the company 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. Although the environmental provision was not reduced by any potential recoveries from insurers or other responsible parties, the company will continue to vigorously pursue such recoveries. Except for the environmental provision noted above, the company believes the final resolution of these matters should not have a material impact on its results of operations, cash flows, and financial position.
7. EMPLOYEE BENEFIT PLANS
Profit Sharing Investment Plan--The Watkins-Johnson Employees' Profit Sharing Investment Plan conforms to the requirements of ERISA and the Internal Revenue Code as a qualified defined contribution plan. The Plan covers substantially all employees and provides that the company's contribution equal 9% of the net pretax earnings and be funded each year. The amount charged to income was $3,190,000 in 1994, $1,945,000 in 1993, and $906,000 in 1992. During the fourth quarter of 1994, the Board of Directors approved an amendment to the Plan which provides for earnings contributions to be replaced with company matching of employees' 401(k) salary deferrals effective January 1, 1995. Under the revised plan, the company will match up to 3% of eligible employee compensation.
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 contribution depending on the performance and financial condition of the company. The Board approved a contribution equal to 1% of eligible employee compensation for 1994, 1993, and 1992, which resulted in charges to income of $894,000, $887,000, and $900,000, respectively. The ESOP held 204,000 and 185,000 shares of common stock at December 31, 1994 and 1993, respectively. The ESOP is a qualified defined contribution plan under ERISA and the Internal Revenue Code.
8. BUSINESS SEGMENT REPORTING
The company had operated in three industry segments. Operations in the Electronics segment include the design, development, manufacture and sale of advanced electronic systems and devices for military, space, and commercial applications. Operations in the Semiconductor Equipment segment involve the development, production, sales and service of chemical-vapor-deposition equipment used in the manufacture of semiconductor products and flat-panel displays. The Environmental Services operations provide technical consulting services ranging from the exploration, development and utilization of groundwater resources to the detection and remediation of contaminated sites. This business was divested at the end of 1994 and is reported as a discontinued business in the financial statements.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The U.S. Government and Hughes Aircraft Company are significant customers for the Electronics segment. Sales to U.S. Government agencies and Hughes Aircraft Company totaled $57,000,000 and $35,000,000 in 1994; $60,000,000 and $41,000,000 in 1993; $62,000,000 and $28,000,000 in 1992, respectively. Marubeni Hytech, the company's Japanese distributor, is a significant customer for the Semiconductor Equipment Group. Sales to Marubeni Hytech totaled $39,000,000 in 1994; $16,000,000 in 1993; and $7,000,000 in 1992.
Continuing operations by business segment are as follows (in thousands):
Corporate assets consist primarily of cash and equivalents. Also included, are assets of discontinued operations which are not material for any year represented.
WATKINS-JOHNSON COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Summarized below are operating results and assets of the discontinued Environmental Services business. Intersegment sales were transferred based on negotiated prices (in thousands).
YEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 --------- --------- ---------- Sales ..........................$ 4,911 $ 5,536 $ 10,490 Intersegment sales ............. (1,294) (1,380) (1,575) --------- --------- ---------- Net sales ...................... 3,617 4,156 8,915 --------- --------- ---------- Loss before income taxes ...... (690) (869) (1,241) Income tax benefit ............. 200 300 400 Loss on disposition net of $100 income tax benefit ............ (200) --------- --------- ---------- Net loss .......................$ (690) $ (569) $ (841) ========= ========= ========== DECEMBER 31 ---------------------------- 1994 1993 1992 --------- --------- -------- Assets .........................$ 2,281 $ 3,923 $ 5,633 ========= ========= ========
Sales from continuing operations by geographic area are as follows (in thousands):
1994 1993 1992 ----------- ----------- ----------- United States ...............$183,963 $ 188,919 $ 190,696 Export sales: Europe ...................... 26,534 20,830 12,266 Far East .................... 98,924 44,970 26,548 Other ....................... 12,385 15,652 11,311 European foreign operations 10,800 11,763 14,664 ----------- ----------- ----------- Total .......................$332,606 $ 282,134 $ 255,485 =========== =========== ===========
Foreign operations' sales and identifiable assets are less than ten percent of consolidated totals.
9. QUARTERLY FINANCIAL DATA--UNAUDITED
Unaudited quarterly financial data are as follows (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31 --------------------------------------- 1994 QUARTERS 1ST 2ND 3RD 4TH - -------------------- --------- --------- --------- --------- Sales ...............$80,526 $87,365 $83,174 $81,541 Gross profit ........ 29,476 37,585 34,776 35,211 Net income .......... 3,624 5,934 5,386 6,017 Net income per share $ .45 $ .73 $ .61 $ .77
1993 QUARTERS 1ST 2ND 3RD 4TH - -------------------- --------- --------- --------- --------- Sales ...............$65,443 $66,963 $71,804 $77,924 Gross profit ........ 21,821 22,762 25,352 30,642 Net income .......... 1,370 2,652 3,512 4,062 Net income per share $ .18 $ .33 $ .42 $ .52
Included in net income and net income per share are results from discontinued operations which do not have a material impact on any individual quarter.
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. Perhaps 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
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, 1994 and 1993, and the related consolidated statements of operations, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.
In 1992, the company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," as described in Note 5 to the consolidated financial statements.
February 3, 1995
Deloitte & Touche LLP San Francisco, California
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
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.
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.
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.
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.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
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) No 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.
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 1, 1995 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.
INDEPENDENT AUDITORS' REPORT
Watkins-Johnson Company:
We have audited the consolidated financial statements of Watkins-Johnson Company and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 3, 1995, which report includes an explanatory paragraph as to an accounting change in 1992 to adopt Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," such consolidated financial statements and report are included in Item 8 of this annual report on Form 10-K. Our audits also included the consolidated financial statement schedule of Watkins-Johnson Company and subsidiaries, listed in Item 14. This consolidated financial statement schedule is the responsibility of the company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement taken as a whole, present fairly in all material respects the information set forth therein.
February 3, 1995
Deloitte & Touche LLP San Francisco, California
SCHEDULE II WATKINS-JOHNSON COMPANY AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
EXHIBIT INDEX