UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-K/A

[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 incorporation             (I.R.S. Employer
            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 ].


Aggregate market value of the voting stock held         As of September 24, 1999
  by non-affiliates of the registrant:                      $170,616,287
Number of shares outstanding: common stock,               6,627,000 shares
  no par value


                       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

<PAGE>

                                     Part I

Item 1.      Business

             The  statements  in this Form 10-K/A  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" in Part I, Item 7,  "Management's  Discussion and Analysis
             of Financial Condition and Results of Operations",  and other risks
             described in this Form 10-K/A. 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.  In October 1997, the
             company   divested  its  Government   Electronics   operations  and
             accounted for it as a discontinued operation. Since the divestiture
             of  Government  Electronics,  the  company has been  operating  and
             reporting   its  financial   results  in  two  business   segments:
             Semiconductor Equipment and Wireless Communications.

             Subsequent Events Affecting this Form 10-K/A--On March 1, 1999, the
             company  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 July 6, 1999,  Watkins-Johnson  completed the sale of
             its  Semiconductor  Equipment Group as reported on a Form 8-K filed
             on July 21,  1999.  See  other  subsequent  events  occurred  after
             December  31,  1998  in  Note  12  to  the  consolidated  financial
             statements.

             This  Form  10-K/A  is  being  filed  to  restate  information  and
             financial  data  about  the  company's  continuing  operations  and
             reflect the divestiture of the  Semiconductor  Equipment Group as a
             discontinued  operation in this report. In addition,  the company's
             remaining  business,  Wireless  Communications,  is being separated
             into two reportable business segments:  Wireless Products Group and
             Telecommunications   Group.  The  Wireless   Products  Group  (WPG)
             designs, manufactures and services radio frequency (RF) components,
             subassemblies,  repeaters and related  equipment with  applications
             for   commercial   wire-line   and   wireless    telecommunications
             infrastructure networks. The Telecommunications Group (TG) designs,
             manufactures  and services  equipment  and related  processes  with
             applications in government  intelligence,  signal  surveillance and
             military communications.

             WPG and TG became significant relative to the continuing operations
             after the divestiture of semiconductor  equipment  business.  Going
             forward,  each Group is  expected to focus on its  respective  core
             products and markets. Each Group's progress and performance will be
             reviewed separately based on its respective  strategic and tactical
             plans.

             Except for the sale of real  property  discussed  in Note 10 to the
             consolidated  financial  statements and write down of  discontinued
             products  and  related  restructuring  discussed  in Note 11 to the
             consolidated   financial   statements,   there  were  no   material
             acquisitions  or  dispositions  of assets  during 1998. No material
             reclassifications,  mergers or consolidations of the company or its
             subsidiaries occurred during 1998.

                                     Page 2

<PAGE>


Item 1.      Business (continued)

     (b)     Financial Information about Industry Segments

             The company's continuing  operations are in two business segments -
             WPG  and TG.  Financial  information  covering  these  segments  is
             included  in  Note  8  to  the  consolidated  financial  statements
             contained in Part II, Item 8 of this Form 10-K/A.

     (c)     Narrative Description of Business

             Watkins-Johnson   Company   is   a   high-technology    corporation
             specializing in wireless and telecommunications products.

             Wireless Products Group (WPG)

             WPG,  which began  operations  in 1996,  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 WPG's more than 20 year  history  with  gallium-arsenide  (GaAs)
             technology.  WPG produces  highly reliable  proprietary  chips that
             perform  signal-processing  functions in subassemblies  and systems
             for PCS, GSM, cellular, and personal phone equipment.

             WPG  is  penetrating  the  growing  market  for  RF  components  by
             expanding   its   gallium   arsenide   (GaAs)    integrated-circuit
             fabrication  capability  and  actively  marketing   WJ-manufactured
             devices   to  the   wireless   industry.   Historically,   WPG  has
             manufactured  GaAs devices only for its own use. The WJ AH1 and RH1
             GaAs  amplifier  chips are getting good  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 and consolidation of the GaAs and thin film
             processing  and design  organization  to the Milpitas,  California,
             facility was on schedule and completed in the first half of 1999.

             In addition to follow-on orders for PCS converter  assemblies,  WPG
             received  several  large  orders in 1998 from Lucent  Technologies,
             Inc. for a wireless-local-loop  assembly. WPG had previously signed
             a contract  with  Lucent  for the  design of 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 WPG, with
             approximately 52% of that segment's sales in 1998.

             WPG has a second wireless-local-loop program, which is smaller than
             the Lucent  program.  In addition to the  subscriber  unit,  WPG is
             making  assemblies  that go in the  transmitter.  WPG has a  5-year
             manufacturing exclusive on this program.

             Other  WPG  products  include  high-dynamic  range  converters  and
             terminals  which are  produced in high volume for PCS  base-station
             and   wireless-local-loop   applications  and   point-to-multipoint
             applications.  Other high volume oscillator  assemblies are used in
             OC-192 fiber-optic communications networks.

                                     Page 3

<PAGE>


Item 1.      Business (continued)

             Sales of WPG were  $63,568,000  or 55% of  consolidated  continuing
             operations  sales  in  1998,   $31,174,000  or  30%  in  1997,  and
             $12,633,000  or 16% in 1996,  respectively.  Company  direct  sales
             personnel and  distributors  perform  marketing  and sales.  Direct
             company  sales  and  service   personnel   handle  major  accounts.
             Components, subassemblies, receivers and transceivers are primarily
             sold  to  firms  which  manufacture  infrastructure  equipment  for
             various  wireline  and  wireless  communication  carriers.   Lucent
             Technologies,   Inc.,   Bartleys  R.F.   Systems  Inc.,  (a  Lucent
             subcontractor),  and Nortel Networks Ltd. are significant customers
             of this business segment.  Approximately 16% of the segment's sales
             in 1998 are to international customers.

             Domestic and international competition from a number of firms, some
             of which are much larger than the company, is intense.  The company
             seeks  to  win  competitions  by  excellent  service  and  superior
             technical performance.  WPG's major customer,  Lucent Technologies,
             Inc.,  recognized  the  excellence  of the  company's  products and
             services by naming  Watkins-Johnson  Company its  "Supplier  of the
             Year" for 1997 and 1998.

             Additional information regarding this business segment along with a
             discussion  of  risks  and  uncertainties  that may  affect  future
             results is included in Part I, Item 7, of this Form 10-K/A.

             Telecommunications Group (TG)

             TG  designs,   manufactures  and  services  equipment  and  related
             processes  with  applications  in government  intelligence,  signal
             surveillance and military communications.  TG offers a selection of
             products  with  wide-bandwidth  capabilities  that the customer may
             adjust using company software for specific applications.

             This business segment draws upon its 40 years working with U.S. and
             selected international  security agencies for its business.  Nearly
             all of  the  group's  products  are  the  result  of the  company's
             internal research and development  program.  The group is beginning
             efforts to allow  customization  of the product  line for  specific
             purposes desired by its agency customers.

             During 1998,  TG  discontinued  its Base2  base-station  product 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 Form 10-K/A.

             Sales of TG were  $51,651,000  or 45% of  consolidated  sales  from
             continuing operations sales in 1998, $73,643,000 or 70% in 1997 and
             $64,050,000  or 84% in 1996,  respectively.  Company  direct  sales
             personnel and  distributors  perform  marketing  and sales.  Direct
             company  sales  and  service   personnel   handle  major  accounts.
             Communications-intelligence   receivers  and  tuners  are  sold  to
             security agencies of the U.S. and other governments.  Various prime
             contractors, such as Lockheed-Martin,  Raytheon Electronic Systems,
             and the United States Government are major customers. Approximately
             23% of the segment's sales in 1998 are to international customers.

                                     Page 4

<PAGE>


Item 1.      Business (continued)

             Although  TG  sells  its  products  on  a  world-wide   basis,  its
             predominant  market is in the United States.  TG faces domestic and
             international  competition from a number of companies, some of whom
             are much larger than TG.  Competition is intense and TG is often at
             a disadvantage  for some foreign sales because of local  government
             policies  and the fact that its products  are only  exported  under
             strict U.S. government control.

             Additional  information  regarding  TG along with a  discussion  of
             risks and that may effect  future  results is  included  in Part I,
             Item 7, of this Form 10-K/A.

             Other Business Items

             Raw materials for the production of wireless and telecommunications
             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  impact  the timely  shipment  of  company  products.
             Business   operations   are  not  believed  by   management  to  be
             significantly seasonal.

             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 in
             either of the company's business segments.

             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  backlog at December 31, 1998 was $67.0  million  compared to
             $60.3  million at December  31,  1997.  The  percentage  of backlog
             attributable to WPG and TG is 65.5% and 34.5% respectively in 1998;
             and 44.4% and 55.6% in 1997.  Substantially  all of the  backlog at
             the end of 1998 and 1997  were  shippable  within  12  months.  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  $21.9
             million in 1998,  $22.9 million in 1997, and $14.0 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 mostly by
             TG.

             The company's employment for continuing  operations at December 31,
             1998 was 554.  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 report on
             Form 10-K/A.

                                     Page 5

<PAGE>



Item 1.      Business (continued)

     (d)     Financial  Information  about Foreign and Domestic  Operations  and
             Export Sales.

             Combined export sales and sales from foreign  operations  accounted
             for 19% of the company's  total sales in 1998,  11% in 1997 and 10%
             in 1996.  Assets of foreign  operations  were not  significant  and
             accounted for less than 5% of  consolidated  assets at December 31,
             1998,  1997 and 1996.  The inherent  risks of foreign  business are
             similar to domestic business,  with the additional risks of foreign
             government instability,  currency fluctuations,  and export license
             cancellation.  A small portion of products to foreign  customers in
             both business  segments  require export licensing by the Department
             of State prior to shipment.  International shipments denominated in
             a foreign  currency  are not  material.  Nevertheless,  the company
             maintains a policy to purchase  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 Form 10-K/A.

Item 2.      Properties

             The company conducts its main operations at plants in Palo Alto and
             Milpitas, California and Gaithersburg, Maryland.

             In 1998, approximately 15 acres of undeveloped land adjacent to the
             company's San Jose,  California,  facility was sold.  The remainder
             property  including a 190,000  square foot building in San Jose was
             vacated  in 1998 and held for  sale and is  therefore  included  in
             "Other Assets"  (long-term)  in the December 31, 1998  Consolidated
             Balance Sheet. The company expects to sell this property in 1999.

             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.

             Excluding the San Jose facility,  there were approximately  262,000
             square feet of plant space in California and 175,000 square feet in
             Maryland available for the company's continuing operations.  Of the
             262,000  square  feet of plant space in  California,  approximately
             133,000 square feet in Palo Alto was occupied by Stellex  Microwave
             Systems,  Inc. (SMS) on a sublease  expiring on October 31, 2000 as
             part of the stock  purchase  agreement  included  in Part II,  Item
             14(a)3,  by reference as Exhibit 10.11.  The space is leased to SMS
             at  a  price  which  includes  utilities,   maintenance  and  other
             services,  and  may be  canceled  by  SMS  with  6  months  notice.
             Excluding the San Jose facility and the sublease  discussed  above,
             approximately  85% of the company's  available plant space is being
             utilized by the company's continuing operations.

             WPG utilizes  the Palo Alto and  Milpitas,  California  plant space
             while TG utilizes the Gaithersburg, Maryland plant.

             The Palo Alto and Milpitas,  California facilities are leased while
             the Gaithersburg, Maryland property is owned by the company with no
             outstanding mortgage or debt.  Information on long-term obligations
             is discussed  in Note 3 to the  consolidated  financial  statements
             contained in Part II, Item 8 of this Form 10-K/A.

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 Form 10-K/A.

                                     Page 6

<PAGE>


<TABLE>
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 as of December 31, 1998

<CAPTION>
                                                                             Officer    Business Experience
Name                                Age     Office Held                      Since      Last Five Years
----------------------------------- ------- -------------------------------- ---------- ------------------------------------

<S>                                 <C>     <C>                              <C>        <C>
Dr. Dean A. Watkins (1)             76      Chairman of the Board            1957       Chairman of the Board
Dr. H. Richard Johnson (1)          72      Vice Chairman of the Board       1957       Vice Chairman of the Board
Dr. W. Keith Kennedy, Jr. (2)       55      President and Chief Executive    1977       President and Chief Executive
                                                Officer                                     Officer
Scott G. Buchanan                   47      Vice President, Chief            1989       Vice President, Chief Financial
                                                Financial Officer and                       Officer and Treasurer; Prior
                                                Treasurer                                   to 1998, Vice President and
                                                                                            Chief Financial Officer
Dr. Patrick J. Brady                53      Vice President                   1996       (3) President, Semiconductor
                                                                                            Equipment Group; Prior to
                                                                                            1996, Vice President of
                                                                                            Engineering, Semiconductor
                                                                                            Equipment Group
Malcolm J. Caraballo                43      Vice President                   1996       President, Wireless Products
                                                                                            Group; Prior to 1997,
                                                                                            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

<FN>
(1) Dr.  Watkins and Dr.  Johnson have been  directors of the company  since its
    incorporation in 1957.
(2) Dr. Kennedy has been a director of the company since August 1987.
(3) Semiconductor  Equipment  Group is reported as a  discontinued  operation in
    this  Form  10-K/A.  See Part I,  Item  1(a)  and  Notes 8, 10 and 12 to the
    consolidated  financial  statements contained in Part II, Item 8 of the Form
    10-K/A.
</FN>
</TABLE>

None of the above  officers is related to any other  officer at  Watkins-Johnson
Company.

                                     Page 7

<PAGE>


                                                      Part II

<TABLE>
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

<CAPTION>
1998 Quarters                                                    1st          2nd        3rd          4th
--------------------------------------- ------------------------ ------------ ---------- ------------ -----------

<S>                                                  <C>         <C>          <C>        <C>          <C>
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
</TABLE>


<TABLE>
Item 6.      Selected Financial Data

<CAPTION>
(Dollars in thousands,
except per share amounts)                 1998           1997          1996          1995            1994
-------------------------------------------------------------------------------------------------------------------

<S>                                   <C>           <C>           <C>            <C>            <C>
OPERATING RESULTS*

Sales                                 $   115,219   $   104,817   $    76,683    $    62,123    $    65,794
Net income (loss) from
    continuing operations                   5,080         5,036        (6,335)        (3,184)         3,969
Basic net income (loss) per share
    from continuing operations               0.66          0.61         (0.77)         (0.40)          0.53
Diluted net income (loss) per share
    from continuing operations               0.65          0.59         (0.77)         (0.40)          0.49
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           7,857,000     8,509,000     8,265,000      7,938,000      8,153,000

FINANCIAL POSITION*

Working capital**                     $    83,565   $   128,381   $    41,576    $    41,124    $    36,273
Total assets                              202,380       300,942       233,139        232,246        192,428
Long-term obligations                       8,611        10,534        13,124         16,088         16,574
Shareowners' equity                       133,679       220,987       195,005        191,253        149,626
Shareowners' equity per share         $     20.42   $     26.75   $     23.41    $     23.54    $     19.75
Number of shareowners                       8,500         6,500         5,400          4,900          4,600

<FN>
*Restated  to  reflect  the  Semiconductor  Equipment  Group  as a  discontinued
operation as a result of the sale of this segment in July 1999.

**Working capital does not include "Net assets of discontinued operations".  See
Note 8 to the consolidated financial statements for divested businesses.
</FN>
</TABLE>

                                     Page 8

<PAGE>


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  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 from
             discontinued   operations,   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  included  in Part  II,  Item 8 of this  Form
             10-K/A, 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 and  discontinued  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 more than  sufficient  to fund the  acquisition  of
             capital assets totaling $7.0 million in 1997.

             In 1996, cash and equivalents  decreased $18.9 million,  from $34.6
             million to $15.7  million.  Net cash used by continuing  operations
             was $19.4 million.

             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 $45.3 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 healthy 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.

             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.  At the end
             of  1998,   there  were  no   material   commitments   for  capital
             expenditures.

                                     Page 9

<PAGE>


Item 7.      Management's  Discussion  and Analysis of Financial  Condition  and
             Results of Operations (continued)

             The company  believes that its year-ending cash and equivalents and
             short-term  investments  are 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 $115.2  million and net
             income  from  continuing  operations  of $5.1  million or $0.65 per
             share.  The net loss  including  discontinued  operations was $49.2
             million,  or $6.26 loss per share.  This loss includes $6.1 million
             of pre-tax charges for the write down of discontinued  products and
             related  restructuring.  Also  included in 1998  results is a $15.0
             million  pre-tax gain on the sale of undeveloped  land, see Note 10
             to the consolidated  financial statements included in Part II, Item
             8 of this Form 10-K/A.

             In 1997,  sales were $104.8 million and net income from  continuing
             operations  was $5.0  million  or $0.59 per  share.  The net income
             including  discontinued  operations  was $32.9 million or $3.87 per
             share.  The 1997 net income  was  comprised  of a net  income  from
             continuing  operations of $5.0 million,  or $0.59 income per share,
             and a gain and net loss related to discontinued operations of $27.9
             million, or $3.28 per share.  Backlog on December 31, 1998 stood at
             $67.0 million, compared to the 1997 backlog of $60.3 million.

             During the third  quarter of 1998,  TG  discontinued  its Base2(TM)
             base-station  product line after reassessing key customer needs and
             market conditions.  Inventory, demo equipment, and customized fixed
             assets  associated  with this product line were written down in the
             restructuring. The company recorded charges of $6.1 million related
             to the write down of nonproductive equipment, discontinued products
             and  exit  costs  as  more  fully  described  in  Note  11  to  the
             consolidated  financial  statements  included in Part II, Item 8 of
             this Form 10-K/A.

             Looking   forward,   the  company   believes  the  realignment  and
             refocusing of TG set the stage for future growth and  profitability
             for that business segment. Operations and business outlook for each
             of the  company's  business  segments are  discussed in more detail
             below.

             Wireless Products Group (WPG)

             WPG sales for 1998 totaled $63.6 million which was more than double
             the prior year's $31.2 million. WPG is entering 1999 with a backlog
             totaling  $43.9  million  compared to $26.8 million on December 31,
             1997.

             WPG had a very  encouraging  year in  1998.  WPG  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.

             The  company  accelerated  WPG's  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 in the first half of 1999.

                                    Page 10

<PAGE>


Item 7.      Management's  Discussion  and Analysis of Financial  Condition  and
             Results of Operations (continued)

             WPG 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,  WPG is in an excellent position to participate in this
             growth.

             Looking  forward,  it is too early to tell what WPG's shipment rate
             will be in 1999.  However,  the  company  expects  WPG to  continue
             growing  although  no  assurance  can be given.  If the  economy in
             general stays strong, the company expects WPG to be profitable next
             year.  WPG  intends  to focus  on the  following  opportunities  to
             continue its growth: gallium-arsenide (GaAs) semiconductor devices,
             repeaters, and advanced RF technology.

             Telecommunications Group (TG)

             TG sales for 1998 totaled $51.7 million which was 30% less than the
             prior year's $73.6  million.  TG's backlog on December 31, 1998 was
             $23.1 million compared to $33.6 million on December 31, 1997.

             TG's financial  results were adversely  affected by the decision to
             discontinue marketing its wideband digital Base2 product. Adding to
             TG's difficulty was a delay of a major  government  order which was
             expected to start work by year-end.  The company is following  this
             program closely and is hopeful TG will be able to receive the order
             during 1999.

             The communications  surveillance  receiver  requirements and orders
             are expected to remain at a fairly steady level. Going forward,  TG
             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.  TG intends to  emphasize  programs  with
             strong  follow-on  potential,  especially  those which  enhance the
             segment's   overall  product   strength  for  additional   business
             opportunities.

             1998 Compared to 1997

             Sales for WPG  increased  from $31.2 million to $63.6  million,  or
             104% in 1998.  Despite a softer  overall base station  market,  WPG
             sustained strong growth as a high-volume  manufacturer of custom RF
             subsystems   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.

             Sales for TG decreased from $73.6 million to $51.7 million,  or 30%
             in 1998. Reasons for the decrease were a slowdown in new orders for
             certain catalog  products,  delay of a major government  order, and
             the effects of discontinuing its wideband digital Base2 product.

                                     Page 11

<PAGE>



Item 7.      Management's  Discussion  and Analysis of Financial  Condition  and
             Results of Operations (continued)

             Gross  margin for WPG  increased  from 18% to 31%,  reflecting  the
             benefits   resulting   from  higher   volume  sales  and  increased
             production efficiencies.

             Gross margin for TG decreased from 46% of sales to 20%. The reasons
             for the drop in gross margin were  attributable  to the lower sales
             volume,  a $3.4 million  inventory  write down  associated with the
             discontinued  Base2 product  line,  and $6.7 million of charges for
             slow-moving  inventory and loss contracts related to the continuing
             operations.

             WPG's selling and  administrative  expenses  decreased  from 11% of
             sales to 9% of sales  as the  group  benefited  from  higher  sales
             volume.  Actual  expenses  increased  from  $3.5  million  to  $5.8
             million.

             Excluding  restructuring charges of $2.7 million in 1998 associated
             with the discontinued Base2 product,  TG selling and administrative
             expenses  increased from 19% of sales to 27% of sales mostly due to
             the lower sales  volume while actual  expenses  decreased  slightly
             from $13.9 million to $13.8 million.

             WPG research and development expenses were $14.1 million in 1998 or
             22% of sales,  compared to $10.2  million in 1997, or 33% of sales.
             Research and development activities were intense as WPG was focused
             to bring certain key products to market.

             TG research and development expenses decreased from 17% of sales to
             15% as TG halted its  spending  on the Base2  product in  September
             1998. Actual expenses decreased from $12.7 million to $7.7 million.

             Pre-tax  operating loss in 1998,  before other income and a gain on
             the sale of  undeveloped  land,  was $13.7 million  compared with a
             loss from continuing  operations of $1.0 million for 1997. Interest
             and other income (net of other expenses)  increased to $6.3 million
             due primarily to interest  income  earned on the increased  average
             cash balance and short-term  investments.  Included in other income
             for 1998 is $1.2 million of rental income from  subleasing  part of
             the Palo Alto facility;  see Note 3 to the  consolidated  financial
             statements included in Part II, Item 8 of this Form 10-K/A. Also in
             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 (see Note 10 in the consolidated financial statements).

             The 1998  effective tax rate for income taxes was 32.5% compared to
             35.0% in 1997,  mostly due to higher export sales benefit earned in
             1998.

             As a result  of the  above  factors,  net  income  from  continuing
             operations  was $5.1  million in 1998  compared to $5.0  million in
             1997,  or $0.65 per  diluted  share  compared  to $0.59 per diluted
             share, respectively.

             1997 Compared to 1996

             WPG sales  increased from $12.6 million to $31.2 million,  or 148%,
             in 1997 as its  radio-frequency  assemblies  for  cellular  and PCS
             systems  gained  customer  acceptance.  WPG's gross  margin in 1997
             increased  to 18% of sales  from 3% in 1996 as it began to  achieve
             higher production levels over the small volume produced in 1996.

                                    Page 12

<PAGE>


Item 7.      Management's  Discussion  and Analysis of Financial  Condition  and
             Results of Operations (continued)

             TG sales  increased  from $64.1 million in 1996 to $73.6 million in
             1997,  or 15%,  as TG  shipped at a higher  unit  volume of matured
             products for U.S. government agencies. Gross margin for TG improved
             from 35% of sales to 46%.

             WPG selling and administrative expenses decreased from 33% of sales
             to 11% of sales.  Actual  expenses  decreased  from $4.1 million to
             $3.5 million. WPG group expects that such expenses, as a percentage
             of sales, should continue to decline as volume improves.

             TG selling and  administrative  expenses  increased  slightly  from
             $13.2  million  in  1996  to  $13.9  million,  but  decreased  as a
             percentage of sales from 21% to 19% due to the higher sales volume.

             WPG research and development  expenses  increased from $6.6 million
             to $10.2 million. WGP's product development activities were intense
             as the new business  segment was focused to introduce  new products
             to market.

             TG research and development  expenses  increased from $7.4 million,
             or 12% of sales in 1996 to $12.7 million,  or 17% of sales in 1997,
             mostly due to an increase in spending of $3.9  million on the Base2
             program.

             Pre-tax  operating  loss in 1997,  before  other  income,  was $1.0
             million  compared  with a loss from  continuing  operations of $8.5
             million for 1996. Interest and other income (net of other expenses)
             increased to $1.1 million due  primarily to interest  income earned
             on  higher  funds  available  for  investments.   Interest  expense
             decreased  due to a  credit  line of $10.0  million  drawn in 1996.
             Included  in other  income for 1997 is a real  estate  gain of $7.6
             million on the  exchange of the  subleasehold  interest at the Palo
             Alto facility; see Note 10 to the consolidated financial statements
             included in Part II, Item 8 of this Form 10-K/A.

             As a result  of the  above  factors,  net  income  from  continuing
             operations  was $5.0 million in 1997 compared to a net loss of $6.3
             million in 1996, or $0.59 net income per diluted share  compared to
             $0.77 net loss per diluted share, respectively.

                                    Page 13

<PAGE>


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 Form 10-K/A 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,  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, risks of foreign business
             discussed in Part I, Item 1(d) above,  risks  related to "Year 2000
             Compatibility"  as discussed  below, the risk that the company will
             not be able to  complete  its  strategy  for the sale of the entire
             company, 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  and  telecommunications  industries  are  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   and
             telecommunications  companies,  some of which are much  larger than
             the  company,  is  intense.  The effect of these and 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 14

<PAGE>


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  operations  run  all  financial  and  manufacturing
             business  applications  on an Oracle  database with the  associated
             Oracle application modules.  Oracle's stated solution to Y2K is its
             version  10.7  of the  application  software  which  the  company's
             operations are using. There is 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 WPG and TG, respectively. The company believes the Y2K
             situation is an issue for only certain non-core  products.  Each of
             the two business  segments is developing a  communication  plan and
             recommended  solutions  to  distribute  to  customers  who  may  be
             affected by  mid-1999.  The  segments  have also  addressed  non-IT
             issues with respect to their  respective  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 was less than $100,000
             for the  years  1997 and 1998  and is  expected  to be the same for
             1999.

                                    Page 15

<PAGE>


Item 7.      Management's  Discussion  and Analysis of Financial  Condition  and
             Results of Operations (continued)

             Single European Currency Conversion

             The company has addressed 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 of the Euro,  based on  current
             available  information  management  does not believe  that 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.

<TABLE>
             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.

<CAPTION>
                                                            Expected Maturity
                                                                 Amounts               Weighted Average
             Expected Maturity Dates                          (in thousands)            Interest Rate
             ---------------------------------------      -----------------------    ---------------------
<S>                  <C>                                                 <C>                 <C>
                 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
                                                                         =======
</TABLE>

                                    Page 16

<PAGE>


Item 7A.     Quantitative  and  Qualitative   Disclosures   About  Market  Risks
             (continued)

             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  specific  transactions  denominated  in  a  foreign
             currency.  Gains and losses on the  forward  contracts  are largely
             offset by the underlying  transactions' 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.

             Additional  information  regarding  market  risks are  disclosed in
             Notes 1, 2 and 3 to the consolidated  financial statements included
             in Part II, Item 8 of this Form 10-K/A.

                                    Page 17

<PAGE>


<TABLE>
Item 8.      Financial Statements and Supplementary Data

                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                       CONSOLIDATED STATEMENTS OF OPERATIONS

<CAPTION>
                                                                                             Year Ended December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)                            1998             1997              1996
                                                                            ---------------------------------------
                                                                                (As Restated - Note 12)
-------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>              <C>               <C>
Sales                                                                   $115,219         $104,817          $ 76,683
-------------------------------------------------------------------------------------------------------------------

Costs and expenses:
    Cost of goods sold                                                    81,320           65,558            53,942
    Cost of goods sold-write down of
        discontinued products                                              3,399
    Selling and administrative                                            19,636           17,352            17,267
    Restructuring charges                                                  2,700
    Research and development                                              21,861           22,861            13,985
-------------------------------------------------------------------------------------------------------------------
                                                                         128,916          105,771            85,194
-------------------------------------------------------------------------------------------------------------------

Loss from operations                                                     (13,697)            (954)           (8,511)

Other income (expense):
    Interest income                                                        5,681            2,198               789
    Interest expense                                                        (601)            (795)           (1,574)
    Other income (expense)--net                                            1,170             (289)             (509)
    Gain on real property (Note 10)                                       14,973            7,609
-------------------------------------------------------------------------------------------------------------------

Income (loss) from continuing operations before
    income taxes                                                           7,526            7,769            (9,805)
Income tax benefits (expense)                                             (2,446)          (2,733)            3,470
-------------------------------------------------------------------------------------------------------------------

Net income (loss) from continuing operations                               5,080            5,036            (6,335)
Discontinued operations (Note 8):
    Income (loss) from discontinued operations, net of taxes             (54,288)          (1,788)            9,369
    Gain on disposition, net of taxes                                                      29,677
-------------------------------------------------------------------------------------------------------------------
Net income (loss)                                                     $  (49,208)      $   32,925        $    3,034
===================================================================================================================

Basic per share amounts:
    Income (loss) from continuing operations                          $     0.66       $     0.61        $    (0.77)
    Income (loss) from discontinued operations                             (7.02)           (0.22)             1.13
    Gain on disposition of discontinued operations                                           3.60
-------------------------------------------------------------------------------------------------------------------
Net income (loss)                                                     $    (6.36)      $     3.99        $     0.36
===================================================================================================================
Basic average common shares                                            7,737,000        8,258,000         8,265,000

Diluted per share amounts:
    Income (loss) from continuing operations                          $     0.65       $     0.59        $    (0.77)
    Income (loss) from discontinued operations                             (6.91)           (0.21)             1.13
    Gain on disposition of discontinued operations                                           3.49
-------------------------------------------------------------------------------------------------------------------
Net income (loss)                                                     $    (6.26)      $     3.87        $     0.36
===================================================================================================================
Diluted average common shares                                          7,857,000        8,509,000         8,265,000

<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>
                                    Page 18

<PAGE>


<TABLE>
                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                  CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

<CAPTION>
                                                                                             Year Ended December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)                                                      1998             1997              1996
                                                                            ---------------------------------------
                                                                                (As Restated - Note 12)
-------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>               <C>               <C>
Net income (loss)                                                    $   (49,208)      $   32,925        $    3,034
-------------------------------------------------------------------------------------------------------------------

Other comprehensive income, net of tax:

    Unrealized holding gains on securities-net
        of taxes of $97                                                      152
-------------------------------------------------------------------------------------------------------------------
    Other comprehensive income                                               152
-------------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss)                                           $  (49,056)      $   32,925        $    3,034
===================================================================================================================

<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>

                                    Page 19

<PAGE>
<TABLE>
                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                            CONSOLIDATED BALANCE SHEETS
<CAPTION>
                                                                                                        December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)                                    1998                       1997
                                                                                    -------------------------------
                                                                                       (As Restated - Note 12)
-------------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>                       <C>
ASSETS

CURRENT ASSETS:
      Cash and equivalents                                                     $  19,271                 $  134,462
      Short-term investments                                                      45,353
      Receivables (net of allowance for doubtful accounts
           of $1,433 in 1998 and $1,291 in 1997)                                  19,588                     22,796
      Inventories:
           Finished goods                                                            875                      1,180
           Work in process                                                         3,167                      5,978
           Raw materials and parts                                                 5,664                      5,333
      Deferred income taxes                                                       32,288                     24,830
      Income taxes receivable                                                     13,570
      Net current assets of discontinued operations                                7,453                     25,226
      Other                                                                        3,879                      3,223
-------------------------------------------------------------------------------------------------------------------
      Total current assets                                                       151,108                    223,028
-------------------------------------------------------------------------------------------------------------------

PROPERTY, PLANT AND EQUIPMENT:
      Land                                                                         2,591                      3,080
      Buildings and improvements                                                   7,523                      6,394
      Plant facilities, leased                                                    11,184                     11,012
      Machinery and equipment                                                     47,122                     46,280
-------------------------------------------------------------------------------------------------------------------
                                                                                  68,420                     66,766
      Accumulated depreciation and amortization                                  (44,829)                   (42,302)
-------------------------------------------------------------------------------------------------------------------
      Property, plant and equipment--net                                          23,591                     24,464
-------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
      Net noncurrent assets of discontinued operations                            16,965                     49,894
      Other                                                                       10,716                      3,556
===================================================================================================================
                                                                              $  202,380                 $  300,942
===================================================================================================================
LIABILITIES AND SHAREOWNERS' EQUITY

CURRENT LIABILITIES:
      Accounts payable                                                        $    9,685                 $    5,540
      Accrued expenses                                                            26,237                     17,501
      Advances on contracts                                                        1,663                      1,867
      Provision for losses on contracts                                            5,774                      2,475
      Payroll and profit sharing                                                   7,343                     10,439
      Income taxes                                                                 9,388                     31,599
-------------------------------------------------------------------------------------------------------------------
      Total current liabilities                                                   60,090                     69,421
-------------------------------------------------------------------------------------------------------------------
LONG-TERM OBLIGATIONS                                                              8,611                     10,534
-------------------------------------------------------------------------------------------------------------------
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                                         152
-------------------------------------------------------------------------------------------------------------------
      Total shareowners' equity                                                  133,679                    220,987
-------------------------------------------------------------------------------------------------------------------
                                                                              $  202,380                   $300,942
===================================================================================================================
<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>
                                    Page 20

<PAGE>


<TABLE>
                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                  CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY

<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                                                             Other            Total
                                                                                           Compre-           Share-
(Dollars in thousands,                             Common Stock           Retained        hensive-          owners'
except per share amounts)                      Shares      Dollars        Earnings          Income           Equity

-------------------------------------------------------------------------------------------------------------------
<S>                                         <C>           <C>          <C>                  <C>          <C>
(As Restated - Note 12)
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
-------------------------------------------------------------------------------------------------------------------
(As Restated - Note 12)
Balance, December 31, 1996                  8,329,248       38,998         156,007                          195,005
    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)
-------------------------------------------------------------------------------------------------------------------
(As Restated - Note 12)
Balance, December 31, 1997                  8,261,036       40,631         180,356                          220,987
    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)
    Unrealized holding gains on
        securities-net of taxes of $97                                                         152              152
-------------------------------------------------------------------------------------------------------------------
(As Restated - Note 12)
Balance, December 31, 1998                  6,547,687     $ 34,454       $  99,073          $  152        $ 133,679
===================================================================================================================

<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>

                                    Page 21

<PAGE>


<TABLE>
                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                       CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>
                                                                                             Year Ended December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)                                                      1998             1997              1996
                                                                            ---------------------------------------
                                                                                (As Restated - Note 12)
-------------------------------------------------------------------------------------------------------------------

<S>                                                                    <C>              <C>               <C>
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                                   4,118            2,968             2,352
           Gain on disposal of property, plant and equipment             (13,545)          (6,732)                0
           Deferred income taxes                                          (8,597)         (10,785)           (2,980)
           Results of discontinued operations and
               (gain) loss on disposal                                    54,288          (27,889)           (9,369)
           Restructuring write-downs - non-cash portion                    5,651
           Net changes in:
               Receivables                                                 3,207            2,895           (16,271)
               Inventories                                                  (613)          (3,334)            3,187
               Other assets                                              (20,346)          (1,792)            3,353
               Accruals and payables                                     (14,986)          40,363            (3,208)
               Advances on contracts                                        (204)             435               555
               Provision for losses on contracts                           3,299            3,411                43
               Environmental remediation                                    (176)             (26)             (126)
-------------------------------------------------------------------------------------------------------------------
      Net cash provided (used) by continuing operating activities        (37,112)          32,439           (19,430)
           Net cash provided (used) by discontinued operations            (3,585)          16,229             3,218
-------------------------------------------------------------------------------------------------------------------
      Net cash provided (used) by operating activities                   (40,697)          48,668           (16,212)
-------------------------------------------------------------------------------------------------------------------

INVESTING ACTIVITIES:

      Additions of property, plant and equipment                          (7,337)          (7,025)           (3,394)
      Purchase of short-term investments                                (101,046)
      Proceeds from sale of short-term investments                        55,943
      Proceeds from sale of discontinued operations                                        77,884
      Proceeds on real estate sales and assets retirements                16,334            8,538               157
-------------------------------------------------------------------------------------------------------------------
      Net cash provided (used) by investing activities                   (36,106)          79,397            (3,237)
-------------------------------------------------------------------------------------------------------------------

FINANCING ACTIVITIES:

      Payments on long-term borrowings                                      (136)          (2,362)             (123)
      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)
-------------------------------------------------------------------------------------------------------------------
      Net cash provided (used) by financing activities                   (38,388)          (9,305)              595
-------------------------------------------------------------------------------------------------------------------

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
===================================================================================================================

<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>

                                    Page 22

<PAGE>


<TABLE>
                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                 CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

<CAPTION>
                                                                                             Year Ended December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)                                                      1998             1997              1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                                    <C>              <C>               <C>
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
-------------------------------------------------------------------------------------------------------------------

<FN>
                 See notes to consolidated financial statements.
</FN>
</TABLE>

                                    Page 23

<PAGE>


                    WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation--The consolidated financial statements include those
of the company and its subsidiaries  after elimination of intercompany  balances
and transactions.  The company disposed of its Government Electronics segment in
1997  and  Semiconductor  Equipment  segment  in  July  1999.  The  consolidated
financial  statements reflect such disposition and result of operations of these
businesses  as   discontinued   operations.   For   additional   information  on
discontinued  operations,  see  Note  8 and  12 to  the  consolidated  financial
statements.

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  maturity  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  company's  continuing  operations  have  no
foreign operations subject to foreign currency translation.

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.

                                    Page 24

<PAGE>


1.       SIGNIFICANT ACCOUNTING POLICIES (continued)

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." In June 1999,
the FASB issued SFAS 137,  "Accounting  for Derivative  Instruments  and Hedging
Activities  - Deferral  of the  Effective  Date of SFAS 133."  These  Statements
require  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,  2001.  The company  enters into forward  exchange  contracts to hedge sales
transactions and firm commitments denominated in foreign currencies.  Management
does not expect these  Statements to have a significant  impact on the company's
financial condition or results of operations.

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.

                                    Page 25

<PAGE>


2.       FINANCIAL INSTRUMENTS AND SHORT-TERM INVESTMENTS (continued)

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-sale  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
================================================================================

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
------------------------------------------------------------------------------
 Deferred compensation                               $   291         $   1,913
 Environmental remediation                             3,254             3,431
 Long-term leases                                      5,066             5,190
==============================================================================
 Total                                                $8,611           $10,534
==============================================================================

The current portion of long-term obligations is included in current liabilities.
The expected maturity amounts are as follows:  1999,  $311,000;  2000, $441,000;
2001, $378,000; 2002, $407,000; 2003, $438,000; thereafter, $6,948,000.

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 Palo Alto, California,  facility. 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 2002.  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           $564
      2000                                                  635            503
      2001                                                  635            416
      2002                                                  635              2
      2003                                                  635
      Remaining years                                     6,822
--------------------------------------------------------------------------------
Total                                                     9,997         $1,485
                                                                    ===========
Imputed interest                                         (4,795)
====================================================================
Present value of lease payments
      (including current portion of $136)              $  5,202
====================================================================

                                    Page 26

<PAGE>


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.  Included in other
income for 1998 is approximately $1.2 million of income after expenses from this
rental agreement. 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                   $   514            $   126         $   164
Equipment                           192                593             417
================================================================================
Total                           $   706            $   719         $   581
================================================================================


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  company's  Board  of  Directors
increased the company's 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 company's  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 (the 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 27

<PAGE>

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.  As
included in the tables below, options on 21,000 shares were granted at $26.50 in
1998,  options on 21,000  shares  were  granted at $26.88 in 1997 and options on
21,000 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  outstanding  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 28

<PAGE>


4.       SHAREOWNERS' EQUITY (continued)

<TABLE>
The following table summarizes  information concerning currently outstanding and
exercisable options at December 31, 1998:

<CAPTION>
                                         Options Outstanding                            Options Exercisable
                        -------------------------------------------------------    ----------------------------------
                                                   Weighted
                                              Average Years           Weighted                              Weighted
              Range of          Number         of Remaining            Average              Number           Average
       Exercise Prices     Outstanding     Contractual Life     Exercise Price         Exercisable    Exercise Price

-------------------------------------------------------------------------------    ----------------------------------
<S>   <C>       <C>            <C>                      <C>             <C>                <C>                <C>
      $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
===============================================================================    ==================================
</TABLE>


<TABLE>
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 $(50.4)  million,  $31.7
million and $1.3 million,  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:

<CAPTION>
                                                                              1998           1997          1996
--------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>            <C>            <C>
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
</TABLE>

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 29

<PAGE>


5.       INCOME TAXES

The provision for income taxes includes  deferred  taxes  reflecting the net tax
effects of temporary  differences  that are reported in one period for financial
accounting purposes and in another period for income tax purposes.  Deferred tax
assets  are  recognized  when  management  believes  realization  of future  tax
benefits of temporary  differences is more likely than not. In estimating future
tax consequences, generally all expected future events are considered other than
enactments of changes in the tax law or rates.  The  components of income (loss)
from  continuing  operations  before  federal,  state and foreign  income  taxes
consists of the following:

(in thousands)                        1998             1997              1996
-----------------------------------------------------------------------------
U.S.                             $   6,379        $  7,769          $  (9,642)
Foreign                              1,147                               (163)
-----------------------------------------------------------------------------
Total                            $   7,526        $   7,769         $  (9,805)
=============================================================================

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.                        $  6,541         $   4,271         $  (2,917)
    State                            340             1,261              (557)
    Foreign                                                             (168)
----------------------------------------------------------------------------
Total current                       6,881            5,532            (3,642)
----------------------------------------------------------------------------
Deferred:
    U.S.                           (2,852)          (1,076)               90
    State                          (1,583)          (1,723)               82
============================================================================
Total                           $   2,446        $   2,733         $  (3,470)
============================================================================

Deferred tax assets (liabilities) are comprised of the following at December 31:

(in thousands)                                1998          1997           1996
-------------------------------------------------------------------------------
Deferred compensation                    $   1,902     $   1,380      $   1,202
Loss accruals                                9,887         5,576            681
Environmental remediation                    1,596         1,576          1,305
Uniform capitalization                          66           296            324
Vacation accrual                               717         1,011            858
NOL and tax credits carried forward         19,925        15,861         12,090
Depreciation and amortization                1,202           747
Other                                          675         1,023            893
-------------------------------------------------------------------------------
      Gross deferred tax assets             35,970        27,470         17,353
-------------------------------------------------------------------------------
Depreciation                                                               (295)
Other                                                                       (58)
-------------------------------------------------------------------------------
      Gross deferred tax liabilities                                       (353)
-------------------------------------------------------------------------------
Net deferred tax asset                   $  35,970     $  27,470      $  17,000
===============================================================================

                                    Page 30

<PAGE>


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                        (3.0)      (1.7)       (1.2)
      Research credit                             (2.7)      (2.6)      (1.1)
      State taxes (benefit) net of federal tax     2.6        2.1       (1.1)
      Other                                         .6        2.2         2.0
-----------------------------------------------------------------------------
Effective tax (benefit) rate                      32.5%      35.0%      (35.4)%
=============================================================================


6.           ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES

In 1991 the company  recorded a $5.2 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 Palo Alto
site and no  additional  provision has been  recorded  since 1991.  Expenditures
charged  against the provision  totaled  $176,000,  $26,000 and $126,000 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.

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 $959,000,  $982,000 and $873,000
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 company's
Board of Directors 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 $208,000,  $330,000
and $324,000,  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 AND DISCONTINUED OPERATIONS

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.

                                    Page 31

<PAGE>

8.           BUSINESS SEGMENT REPORTING AND DISCONTINUED OPERATIONS (continued)

Under SFAS 131,  the  company's  continuing  operations  were  divided  into two
business segments:  Wireless Products Group (WPG) and  Telecommunications  Group
(TG). WPG designs, manufactures  and services radio  frequency (RF)  components,
subassemblies,  repeaters and related equipment with applications for commercial
wire-line and wireless  telecommunications  infrastructure networks. TG designs,
manufactures and services  equipment and related  processes with applications in
government intelligence, signal surveillance and military communications.

As discussed  below,  two divested  segments are being reported as  discontinued
operations.  The  Government  Electronics  segment was  divested in 1997 and the
Semiconductor Equipment Group segment was divested in July 1999.

<TABLE>
Management  evaluates  segment  performance based primarily on segment revenues,
pre-tax operating profit or loss before interest and other  nonoperating  income
and expenses,  and return on assets.  Sales between continuing  segments are not
significant for any year presented.  Continuing  operations by business  segment
are as follows:

<CAPTION>
(in thousands)                                                                         Year Ended December 31, 1998
-------------------------------------------------------------------------------------------------------------------
                                                           Pre-tax          Year-
                                                            Income            End         Capital
                                                Sales       (Loss)         Assets       Additions      Depreciation
-------------------------------------------------------------------------------------------------------------------
<S>                                        <C>            <C>          <C>              <C>               <C>
Wireless Products Group                    $   63,568     $    198     $   27,059       $   5,692         $   1,519
Telecommunications Group                       51,651      (13,895)        22,203           1,632             2,136
Corporate                                                                 153,118              13               463
-------------------------------------------------------------------------------------------------------------------

Loss from operations                                       (13,697)
Other income (expense)--net                                 21,223
-------------------------------------------------------------------------------------------------------------------
Total                                      $  115,219     $  7,526     $  202,380       $   7,337         $   4,118
===================================================================================================================

                                                                                       Year Ended December 31, 1997
-------------------------------------------------------------------------------------------------------------------
Wireless Products Group                    $   31,174     $ (8,080)    $   15,386       $   2,743         $     658
Telecommunications Group                       73,643        7,126         37,423           4,138             1,852
Corporate                                                                 248,133             144               458
-------------------------------------------------------------------------------------------------------------------

Loss from operations                                          (954)
Other income (expense)--net                                  8,723
-------------------------------------------------------------------------------------------------------------------
Total                                      $  104,817     $  7,769     $  300,942       $   7,025         $   2,968
===================================================================================================================

                                                                                       Year Ended December 31, 1996
-------------------------------------------------------------------------------------------------------------------
Wireless Products Group                    $   12,633     $(10,214)    $    8,275       $     473         $     419
Telecommunications Group                       64,050        1,703         41,805           2,681             1,420
Corporate                                                                 183,059             240               513
-------------------------------------------------------------------------------------------------------------------

Loss from operations                                        (8,511)
Other income (expense)--net                                 (1,294)
-------------------------------------------------------------------------------------------------------------------
Total                                      $   76,683     $ (9,805)    $  233,139        $   3,394         $  2,352
===================================================================================================================
</TABLE>

Corporate assets consist primarily of cash, cash equivalents and deferred taxes,
and net assets of the  discontinued  Government  Electronics  and  Semiconductor
Equipment Group segments.

                                    Page 32

<PAGE>


8.       BUSINESS SEGMENT REPORTING AND DISCONTINUED OPERATIONS (continued)

<TABLE>
Sales  to  individual  customers   representing  greater  than  10%  of  company
consolidated sales during at least one of the past three years are as follows:

<CAPTION>
(in thousands)                                                              1998             1997              1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>              <C>                <C>
Wireless Products Group:
        Lucent Technologies, Inc.                                     $   33,000       $   20,000         $  11,000

Telecommunications Group:
        United States Government                                          26,000           36,000            28,000
        Raytheon Electronic Systems                                        6,000            3,000             1,000

Sales to unaffiliated customers by geographic area are as follows:

(in thousands)                                                              1998             1997              1996
-------------------------------------------------------------------------------------------------------------------
United States                                                         $   93,419       $   93,114         $  69,376
Export sales from United States:
      Europe                                                               5,717            3,842               978
      Canada                                                               8,010            1,228                 0
      Singapore                                                            4,518            2,388             1,622
      Other Asia-Pacific countries                                         1,829            2,306             1,003
      Other                                                                1,726            1,939             3,704
-------------------------------------------------------------------------------------------------------------------
Total                                                                 $  115,219       $  104,817         $  76,683
===================================================================================================================
</TABLE>

Intercompany  transfers of products and services between continuing  operations'
geographic regions were not material for the years 1998, 1997 and 1996.

The  company's  continuing  operations'  operating  profit  (loss) and  year-end
long-lived assets by geographic area are substantially all located in the United
States.

The company's  Government  Electronics  segment was divested on October 31, 1997
and  resulted  in  a  net  gain  of  $29.7  million.  Operations  of  Government
Electronics included the development, manufacture and sale of advanced microwave
devices and tactical electronic systems and devices for guided-missile  programs
and other government applications.

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 and were not  significant for the
years presented.

                                                      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
==============================================================================

                                    Page 33

<PAGE>



8.       BUSINESS SEGMENT REPORTING AND DISCONTINUED OPERATIONS (continued)

The company's  Semiconductor  Equipment segment was divested on July 6, 1999 and
resulted  in a net  gain  of  $7.3  million.  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.

Summarized below are the net assets of the discontinued  Semiconductor Equipment
business.

                                                         Year Ended December 31
(in thousands)                                            1998          1997
-------------------------------------------------------------------------------
Accounts receivable                                     $12,354         $22,895
Other assets                                             16,087          37,496
Current liabilities                                     (20,988)        (35,165)
-------------------------------------------------------------------------------
Net assets of discontinued operations, current          $ 7,453         $25,226
===============================================================================

Fixed assets, net                                       $39,048         $71,949
Other assets                                              2,006             646
Long-term obligations                                   (20,224)        (18,695)
Environmental remediation                                (3,866)         (4,006)
-------------------------------------------------------------------------------
Net assets of discontinued operations, noncurrent       $16,964         $49,894
===============================================================================


Summarized  below  are  operating  results  of  the  discontinued  Semiconductor
Equipment business.

                                                          Year Ended December 31
(in thousands)                                  1998          1997         1996
--------------------------------------------------------------------------------
Net sales                                     $ 97,000     $186,500    $272,400

Gross profit                                  $ 16,653     $ 55,337    $ 95,822
================================================================================

Loss from operations before income taxes      $(80,534)    $(14,731)   $  7,709
Income taxes (benefit)                         (26,246)      (5,733)      2,695
================================================================================
Net loss from discontinued operations         $(54,288)    $ (8,998)   $  5,014
================================================================================

                                    Page 34

<PAGE>


9.       EARNINGS PER SHARE

<TABLE>
Basic and diluted earnings per share were computed as follows:

<CAPTION>
                                                                                             Year Ended December 31
(in thousands, except per share amounts)                                  1998              1997            1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>              <C>             <C>
Basic per share amounts:
-------------------------------------------------------------------------------------------------------------------
Net income (loss) from continuing operations (numerator)                  $5,080           $5,036          $(6,335)
-------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (denominator)                          7,737            8,258            8,265
-------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per share                                         $ 0.66           $ 0.61          $ (0.77)
===================================================================================================================

-------------------------------------------------------------------------------------------------------------------
Diluted per share amounts:
-------------------------------------------------------------------------------------------------------------------
Net income (loss) from continuing operations (numerator)                  $5,080           $5,036          $(6,335)
-------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding                                        7,737            8,258            8,265
Effect of dilutive stock options                                             120              251
-------------------------------------------------------------------------------------------------------------------
Dilutive shares outstanding (denominator)                                  7,857            8,509            8,265
-------------------------------------------------------------------------------------------------------------------

Diluted net income (loss) per share                                       $ 0.65           $ 0.59          $ (0.77)
===================================================================================================================
</TABLE>

For 1996 the  incremental  shares  from the assumed  exercise  of 272,000  stock
options are not included in computing  the  dilutive per share  amounts  because
continuing  operations  resulted in a loss and such assumed  conversion would be
antidilutive.  Additionally,  weighted  average options  outstanding to purchase
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.  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 35

<PAGE>


11.      DISCONTINUED PRODUCT LINE AND RELATED RESTRUCTURING CHARGES

During the third  quarter of 1998,  the TG segment  discontinued  its  Base2(TM)
base-station  product  line  after  reassessing  key  customer  needs and market
conditions.  Inventory,  demo equipment, and specialized fixed assets associated
with the  discontinued  product  were  written  down in the  restructuring.  The
company  recorded  charges of $6.1 million  related to fixed assets,  inventory,
severance and other exit costs as follows:

                                      Accrued
                                    Severance,
                                 Benefits, and    Write Down of     Write Down
(in thousands)                     Other Costs     Fixed Assets   of Inventory
------------------------------ ----------------  --------------- --------------
Restructuring provision                   $448           $2,252         $3,399
                                                 =============== ==============

Amounts paid                               213
------------------------------ ----------------
Balance at December 31, 1998              $235
============================== ================

The company anticipates substantially all accrued severance and benefits will be
paid within a year.

12.          SUBSEQUENT EVENTS

On March 1, 1999, the company announced that, after a strategic review performed
by its investment banking firm, it would pursue a sale either of the company, in
its entirety or its component businesses.

On March 31,  1999,  the company sold the  high-density  plasma  chemical  vapor
deposition  (HDPCVD)  intellectual  property assets and related  hardware of its
Semiconductor  Equipment  Group. In July 1999, the company sold the remainder of
its Semiconductor  Equipment Group business,  consisting of atmospheric pressure
chemical vapor disposition  products (APCVD),  completing the divestiture of its
Semiconductor  Equipment Group. The transactions  resulted in a net gain of $7.3
million  included in the second quarter of 1999. The  accompanying  consolidated
financial  statements  and  related  notes have been  restated  to  reflect  the
Semiconductor Equipment Group as a discontinued operation.

In  August  1999,  the  company   announced  a  definitive   agreement  to  sell
substantially  all of TG's assets to a unit of Marconi  North  America,  Inc., a
subsidiary of the General  Electric  Company p.l.c. of the United  Kingdom.  The
sale is subject to certain  conditions  in addition to approval by the company's
shareowners and government approvals.

In September  1999,  the company  completed  the sale of its remaining San Jose,
California  facility  including a 190,000 square foot building  resulting in net
proceeds of about $17.0 million.

On October 1, 1999, the company completed the sale of one of its long-term lease
interests in Palo Alto to Stanford University resulting in net proceeds of about
$54.0 million.

On October 26,  1999,  the company  announced  it has entered  into a definitive
merger agreement with FP-WJ  Acquisition  Corp., a new company formed by certain
investment funds managed by Fox Paine & Company, LLC ("FP-WJ").  Under the terms
of the merger  agreement,  the  company's  outstanding  common  shares  would be
converted into the right to receive  $41.125 per share in cash. The  transaction
is subject to certain  conditions  in  addition  to  approval  by the  company's
shareowners  and  government  approvals and the  completion of the sale of TG to
Marconi North America, Inc.

There can be no  assurance  that the sale of TG or the merger with FP-WJ will be
completed nor can there be any  assurance  that company will be able to complete
its strategy for the sale of the entire company.

                                    Page 36

<PAGE>


<TABLE>
13.      QUARTERLY FINANCIAL DATA--UNAUDITED

Unaudited quarterly financial data are as follows:

<CAPTION>
(in thousands, except per share amounts)
---------------------------------------------------------------------------------------------
1998 Quarters                                         1st         2nd         3rd         4th
---------------------------------------------------------------------------------------------
<S>                                              <C>         <C>         <C>         <C>
Sales                                            $ 30,006    $ 26,835    $ 19,069    $ 39,309
Gross profit (loss)                                11,767      10,183      (1,970)     10,520
Net income (loss) from continuing operations       11,546         563      (8,891)      1,862
Net income (loss) from discontinued operations     (1,845)     (6,770)    (45,523)       (150)
Net income (loss)                                   9,701      (6,207)    (54,414)      1,712
Basic net income (loss) per share from
    continuing operations                            1.40        0.07       (1.13)       0.28
Diluted net income (loss) per share from
    continuing operations                            1.37        0.07       (1.13)       0.28
Basic net income (loss) per share                    1.17       (0.75)      (6.93)       0.26
Diluted net income (loss) per share              $   1.15    $  (0.74)   $  (6.93)   $   0.25

---------------------------------------------------------------------------------------------
1997 Quarters                                         1st         2nd         3rd         4th
---------------------------------------------------------------------------------------------
Sales                                            $ 23,054    $ 24,688    $ 28,853    $ 28,222
Gross profit                                        8,280       9,471      11,328      10,180
Net income (loss) from continuing operations         (339)        378       1,553       3,444
Net income (loss) from discontinued operations      2,817       2,704       2,037      (9,346)
Net income                                          2,478       3,082       3,590      23,775
Basic net income (loss) per share from
    continuing operations                           (0.04)       0.05        0.19        0.42
Diluted net income (loss) per share from
    continuing operations                           (0.04)       0.04        0.18        0.41
Basic net income per share                           0.30        0.37        0.44        2.88
Diluted net income per share                     $   0.30    $   0.36    $   0.42    $   2.80
</TABLE>

The first  quarter of 1998  includes a pre-tax  gain on the sale of  undeveloped
land in San Jose totaling about $15.0 million. See Note 10.

The third quarter of 1998 includes  pre-tax  charges for a discontinued  product
line and related restructuring totaling $6.1 million. See Note 11.

The fourth quarter of 1997 includes a pre-tax gain of $7.6 million related to an
exchange of subleasehold interest in its Palo Alto, California facility.

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 37

<PAGE>


                              REPORT OF MANAGEMENT

The   consolidated   financial   statements  of   Watkins-Johnson   Company  and
subsidiaries  were  prepared  by  management,  which is  responsible  for  their
integrity and  objectivity.  The  statements  were  prepared in conformity  with
generally accepted accounting  principles and, as such, include amounts that are
based on the best judgments of management.

The system of internal controls of the company is designed to provide reasonable
assurance  that assets are  safeguarded  and that  transactions  are executed in
accordance with management's  authorization and are reported properly.  The most
important  safeguard for shareowners is the company's emphasis in the selection,
training and  development of professional  accounting  managers to implement and
oversee the proper  application  of its internal  controls and the  reporting of
management's  stewardship  of corporate  assets and  maintenance  of accounts in
conformity with generally accepted accounting principles.

Deloitte & Touche LLP, independent auditors, are retained to provide an audit of
the consolidated financial statements. 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 38

<PAGE>


INDEPENDENT AUDITORS' REPORT

The Shareowners and Board of Directors
    of Watkins-Johnson Company:

We have audited the accompanying  consolidated balance sheets of Watkins-Johnson
Company  and  subsidiaries  as of December  31,  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.

As discussed in Note 12, the accompanying consolidated financial statements have
been restated to reflect the  Semiconductor  Equipment segment as a discontinued
operation as a result of the sale of this segment in July 1999.

Deloitte & Touche LLP
San Jose, California
February 5, 1999
(October 29, 1999 as to Note 12)

                                    Page 39

<PAGE>


Item 9.      Changes in and  Disagreements  with  Accountants  on Accounting and
             Financial Disclosure

             Not applicable.

                                    Part III

Item 10.     Directors and Executive Officers of the Registrant

             The  information  required by this item  concerning  the  company's
             directors is shown under the caption "Election of Directors" in the
             company's  definitive proxy statement filed with the Securities and
             Exchange Commission (Commission) pursuant to Regulation 14A.

             The  information  relating to the company's  executive  officers is
             presented  in  Part  I  of  this  Form  10-K/A  under  the  caption
             "Executive Officers of the Registrant".

Item 11.     Executive Compensation

             See this caption in the definitive  proxy  statement 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  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            18

             Consolidated Statements of Comprehensive Income
             For the Years Ended December 31, 1998, 1997 and 1996            19

             Consolidated Balance Sheets
             December 31, 1998 and 1997                                      20

             Consolidated Statements of Shareowners' Equity
             For the Years Ended December 31, 1998, 1997 and 1996            21

             Consolidated Statements of Cash Flows
             For the Years Ended December 31, 1998, 1997 and 1996         22-23

             Notes to Consolidated Financial Statements                   24-37

             Report of Management                                            38

             Independent Auditors' Report                                    39

                                    Page 40

<PAGE>


     2.      Financial Statement Schedules                                 Page

             Independent Auditors' Report                                    44

             II     Valuation and Qualifying Accounts and Reserves
                    For the Years Ended December 31, 1998, 1997 and 1996     45

             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 consolidated financial statements or
             in the notes thereto.

     3.      Exhibits

             A list of the  exhibits  required  to be filed as part of this Form
             10-K/A  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 Commission 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 share  purchase  rights issued under the Rights
             Agreement.  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 41

<PAGE>



                                   SIGNATURES

            Pursuant  to  the  requirements  of  Section  13  or  15(d)  of  the
Securities  Exchange  Act of 1934,  the  registrant  has duly caused this annual
report to be signed on its behalf by the undersigned, thereunto duly authorized.

                                                WATKINS-JOHNSON COMPANY
                                        ----------------------------------------
                                                     (Registrant)

Date:  October 29, 1999                 By       /s/  Dean A. Watkins
      -------------------                        -------------------------------
                                                      Dean A. Watkins
                                                      Chairman of the Board

<TABLE>
            Pursuant to the requirements of the Securities Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.

<CAPTION>
                Signature                                          Title                        Date
                ---------                                          -----                        ----
Principal Executive Officer:

<S>                                                      <C>                            <C>
  /s/       W. Keith Kennedy, Jr.                              President and             October 29, 1999
  ----------------------------------                      Chief Executive Officer       -------------------
            W. Keith Kennedy, Jr.

Principal Financial and Accounting Officer:

  /s/         Scott G. Buchanan                          Executive Vice President,       October 29, 1999
  ----------------------------------                      Chief Financial Officer       -------------------
              Scott G. Buchanan                              and Treasurer
</TABLE>

                                    Page 42

<PAGE>


<TABLE>
<CAPTION>
                Signature                                          Title                        Date
                ---------                                          -----                        ----

<S>                                                              <C>                      <C>
  /s/        H. Richard Johnson                                  Director                  October 29, 1999
----------------------------------------                                                  -----------------
             H. Richard Johnson

  /s/         John J. Hartmann                                   Director                  October 29, 1999
----------------------------------------                                                  -----------------
              John J. Hartmann

  /s/        Raymond F. O'Brien                                  Director                  October 29, 1999
----------------------------------------                                                  -----------------
             Raymond F. O'Brien

  /s/         William R. Graham                                  Director                  October 29, 1999
----------------------------------------                                                  -----------------
              William R. Graham

  /s/         Robert L. Prestel                                  Director                  October 29, 1999
----------------------------------------                                                  -----------------
              Robert L. Prestel

  /s/         Gary M. Cusumano                                   Director                  October 29, 1999
----------------------------------------                                                  -----------------
              Gary M. Cusumano
</TABLE>

                                    Page 43

<PAGE>


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  (October  29, 1999 as to Note 12);  such  consolidated
financial  statements and report are included elsewhere in this annual report on
Form 10-K/A.  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
(October 29, 1999 as to Note 12 of the
Consolidated Financial Statements)

                                    Page 44

<PAGE>


<TABLE>
                                                                                                        Schedule II

                                     WATKINS-JOHNSON COMPANY AND SUBSIDIARIES

                                  VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                               FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996

<CAPTION>
                                                   Balance at       Charged to                            Balance at
                                                    Beginning        Costs and                                End of
Description                                        of Period*        Expenses*      Deductions(1)*           Period*
-----------                                        ----------        ---------      --------------        ----------
<S>                                                <C>                <C>                 <C>             <C>
1998
Allowance for doubtful accounts                    $1,291,169         $180,072            $ 38,399        $1,432,842

1997
Allowance for doubtful accounts                       550,321          740,848                   0         1,291,169

1996
Allowance for doubtful accounts                       454,871           95,450                   0           550,321

<FN>
*As  restated to reflect the  Semiconductor  Equipment  Group as a  discontinued
operation as a result of the sale of this  segment in July 1999.  See Note 12 to
the consolidated financial statements.

(1) With respect to the allowance for doubtful  accounts,  deductions  represent
write-off of uncollectible accounts receivables.
</FN>
</TABLE>

                                    Page 45

<PAGE>


                                  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  Watkins-Johnson  Company
                           and  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 46

<PAGE>


             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).

               10.11     * 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 47

<PAGE>


             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  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 48