FORM 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(MARK ONE)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2004

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 1-6462

 

TERADYNE, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

MASSACHUSETTS   04-2272148
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification Number)
321 HARRISON AVENUE,
BOSTON, MASSACHUSETTS
  02118
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (617) 482-2700

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


 

Name of Each Exchange on Which Registered


Common Stock, par value $0.125 per share

Common Stock Purchase Rights

 

New York Stock Exchange

New York Stock Exchange

 

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 (or for such shorter period that the registrant was required to file such reports), 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 the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12(b-2).

Yes  x    No  ¨

 

The aggregate market value of the voting stock held by nonaffiliates of the registrant as of July 4, 2004 was $4.1 billion based upon the composite closing price of the registrant’s Common Stock on the New York Stock Exchange on that date.

 

The number of shares outstanding of the registrant’s only class of Common Stock as of February 28, 2005 was 195,625,134 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s proxy statement in connection with its 2005 annual meeting of shareholders are incorporated by reference into Part III.

 



TERADYNE, INC.

 

FORM 10-K

 

PART I

 

Item 1: Business

 

Teradyne, Inc. is a leading supplier of automatic test equipment and a leading provider of high performance interconnection systems.

 

Teradyne® automatic test equipment products include systems that:

 

    test semiconductors (“Semiconductor Test Systems”);
    test and inspect circuit-boards (“Assembly Test Systems”);
    diagnose, program and test automotive electronics systems (“Diagnostic Solutions”); and
    test voice and broadband access networks (“Broadband Test Systems”).

 

Teradyne interconnection systems products and services (“Connection Systems”) include:

 

    high bandwidth backplane assemblies; and
    high density connectors.

 

Broadband Test Systems and Diagnostic Solutions have been combined into “Other Test Systems” for purposes of Teradyne’s segment reporting. For financial information concerning Teradyne’s reportable segments and geographical data, see “Note T: Operating Segment and Geographic Information” in Notes to Consolidated Financial Statements.

 

Statements in this Annual Report on Form 10-K which are not historical facts, so called “forward looking statements,” are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. Investors are cautioned that all forward looking statements involve risks and uncertainties, including those detailed in Teradyne’s filings with the Securities and Exchange Commission. See also “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors That May Affect Future Results” and “Note D: Risks and Uncertainties” in Notes to Consolidated Financial Statements.

 

Products

 

Semiconductor Test Systems

 

Teradyne produces Semiconductor Test Systems which test a wide variety of “system on a chip” (“SOC”) semiconductor devices during the manufacturing process. These devices contain integrated analog, digital and memory functions which allow an entire system or subsystem to reside on a single device or “chip.” These chips are used in automotive, communications, consumer, computer and electronic game applications, among others. Semiconductor Test Systems are sold to Integrated Device Manufacturers (“IDMs”), Fabless companies and to Foundries and subcontractors (“Subcons”). Subcons provide test and assembly services for the final packaged devices to both Fabless companies and IDMs. Fabless companies perform the design of integrated circuits without manufacturing capabilities, and use Foundries for wafer manufacturing and Subcons for test and assembly. These customers obtain the overall benefit of comprehensively testing advanced performance devices while reducing their total costs associated with testing by using Teradyne’s Semiconductor Test Systems to:

 

    measure and improve product performance;
    improve and control product quality;
    reduce time to market; and
    increase production yields.

 

The systems work in both wafer probe test and final package test applications.

 

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SOC devices span a huge range of functionality, from very simple low-cost devices such as operational amplifiers or voltage regulators to complex digital signal processors and microprocessors. Teradyne offers a suite of test solutions to cover this range in the most economical way for each segment. The main test equipment products are described below:

 

The J750 test system is designed to address the highest volume semiconductor devices. Devices such as microcontrollers are at the heart of almost every consumer electronics product, from small appliances to automotive engine controllers. These devices are produced in enormous quantities. The lowest cost of test at very high production throughput rates is essential to meeting the economic requirements in these markets. Teradyne’s J750 test systems combine compact packaging, high throughput and ease of production test. These benefits are possible due to the high level of integration in the design. A single circuit board in the J750 test system provides up to 64 digital input/output channels. This innovative approach eliminated the traditional “mainframe,” creating a “tester in the test head,” or “zero footprint design.” This approach allows the test system to be placed directly on top of a wafer prober, without the need for any floor space for the tester itself. The J750 has been met with success in the marketplace, and has an installed base of over 1,900 systems. The J750 platform technology also has been used to create Teradyne’s IP750 Image Sensor test system. The IP750 is focused on testing image sensor devices used in digital cameras and other imaging products.

 

The Catalyst and Catalyst-Tiger test systems are designed to test a broad range of higher performance SOC devices. The Catalyst is designed to test devices requiring data rates up to 400 Mega bits per second (“bps”) with a broad range of analog performance. Over 1,400 Catalyst systems are in use today at IDMs and Subcons testing integrated circuits for DVD players, wireless cellular phones, networking appliances, telecommunications systems, computer peripherals, and many other applications.

 

The “Tiger” version of Catalyst provides similar analog capability, but extends the digital performance up to 3.2 Giga bps on up to 1,264 input/output channels. This extended digital performance enables complete functional testing of the world’s most demanding SOC and high-speed logic integrated circuits used in computer graphics, personal computer chip set, microprocessor, and networking applications. Over 100 Tiger systems are installed at IDMs and Subcons around the world.

 

Teradyne’s most recently introduced test system, the FLEX test system, is the beginning of the next generation of high throughput general purpose SOC test systems, and has been expanded with the addition of the MicroFLEX test system. The FLEX architecture combines the integration and parallelism of the J750 with the synchronization and instrument flexibility of the Catalyst. FLEX employs a unique “SOC tester per pin” concept bringing a higher degree of parallelism to mixed signal and SOC testing. By testing more functions and more devices at the same time (“in parallel”) FLEX increases the production efficiency of SOC device testing. The core of FLEX design employs a “universal slot” concept, which provides the user the flexibility to install any instrument into any of the tester “slots.” FLEX is similar to the J750 in that the instrumentation tends to be implemented on self contained circuit boards that plug into the test head. This modular design and the universal slot architecture adds a level of adaptability and flexibility to production testing which is new to the industry. FLEX currently tests a range of devices in the consumer electronics area, including automotive, higher performance microcontrollers, power control, and wireless applications. FLEX will be expanded to cover the complete non-memory device spectrum as high performance analog and digital instrumentation is added to the platform. The system is also designed with an open-architecture, which allows customers and third party companies to add test capability to the system. The MicroFLEX is a smaller footprint version of the FLEX, fully compatible, and supporting half as many instruments in a smaller cabinet. Like the J750, the MicroFLEX can be positioned directly on top of a wafer prober, providing “zero footprint” testing at wafer probe.

 

Connection Systems

 

Connection Systems is a leader in high-performance connection systems, designing and manufacturing backplane systems, printed circuit boards and the industry’s leading high-speed, high-density connectors.

 

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Connection Systems helps Original Equipment Manufacturers (“OEMs”) solve system design challenges with integrated interconnect solutions for application in the networking, communications, storage, computer server, and military/aerospace markets. Connection Systems’ technology can be found in such products as Internet routers, computer servers, mass data storage systems, telecommunication switches, radar systems and other defense applications.

 

Leading connector technology, advanced printed circuit board fabrication capabilities and decades of backplane assembly expertise gives Connection Systems unique knowledge and experience with the entire signal transmission path. Teradyne believes this experience enables Connection Systems to differentiate itself in the market by providing integrated solutions for backplane systems. Connection Systems’ engineers are involved early in their customers’ product design process to help them get to market quickly with the optimum solution for price and performance. Engineering support, manufacturing and program management is available worldwide at Connection Systems’ locations in Asia, Europe and North America to support both new product introductions and full-scale volume production.

 

Connection Systems’ products and services include a broad range of high-speed, high-density connectors covering multiple applications within a single system. A suite of backplane connectors, including the industry-leading VHDM-HSD and VHDM® and the recently introducted GbX® connectors are utilized for traditional right-angle interface of printed circuit boards with high bandwidth requirements. For parallel connection of printed circuit boards, Connection Systems offers NeXLev®, VHDM Stacker, and HDM® Stacker connectors. These products allow designers to relocate high pin count devices onto mezzanine cards to simplify board routing and optimize system cost and performance. In 2003, Connection Systems introduced the industry’s first modular optical interconnect, the HD-Optyx connector. In addition, Connection Systems works with customers to develop custom products for specific applications.

 

Connection Systems’ printed circuit board capabilities are among the industry’s most advanced, employing innovative solutions, such as improving routing to remove layers, or back drilling and blind or buried vias to produce enhanced signal quality and/or lower cost. Connection Systems was the first printed circuit board facility to be qualified to the military specification MIL-PRF-310321A/2 and has delivered boards for mission critical defense applications since 1982.

 

Assembly Test Systems

 

The functionality of nearly every electronic product is generated by one or more printed circuit boards (PCBs), each of which contain complex components. Cell phones and laptop computers contain single-board assemblies, while more complex Internet switches and military avionics systems usually comprise multi-board assemblies. As more and more functionality is packed into these systems, the manufacturing and assembly processes become more complex. This intensifies the need for fast, accurate and reliable test and inspection systems. Teradyne’s PCB assembly test equipment is commonly used in the production process to maintain high yields, ensure product quality, diagnose faults and reduce manufacturing cost. The company’s functional test equipment is used to verify proper operation of both single- and multi-board assemblies at the end of the manufacturing cycle, and later in the maintenance and repair cycle. The Teradyne assembly test product range includes the following:

 

In-Circuit Test Systems

 

In-circuit test systems examine the assembled and soldered printed circuit board for proper construction under both power-off and power-on conditions. Defective components and solder joints are identified quickly and precisely. Fast, low-cost fault identification and accurate diagnostic capabilities are valued features of Teradyne’s in-circuit testers, which cause them to be used by global electronics manufacturers. Teradyne’s in-circuit products support a full range of PCB test applications, including high-volume production, selective or sample test, prototype testing and final or system test. Accordingly, Teradyne offers a variety of features and

 

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options with its TestStation and Spectrum 8000-series products. The most recent option added to Teradyne’s TestStation family is the SafeTest product. This technology allows users to test the new low-voltage components commonly found on low power PCBs for portable systems and battery operated instrumentation. SafeTest has helped improve the company’s market share of testers sold to manufacturers of consumer and commercial goods.

 

Imaging Inspection Systems

 

As circuit boards grow more complex, achieving the electrical contact that traditional in-circuit testers require is more difficult, time-consuming and expensive. The “loss of (electrical and visual) access” and the move to lead-free manufacturing are contributing to the demand for advanced x-ray imaging inspection systems. Teradyne’s automated x-ray inspection (AXI) systems are used to examine PCBs for manufacturing defects. Solder integrity problems are the most common; however these new systems can automatically detect improper component placement and orientation, electrical opens and shorts and a host of other board quality issues. Teradyne’s XStation products are the most widely used test platforms among major automotive manufacturers worldwide.

 

Military/Aerospace Test Systems & Instrumentation

 

Teradyne’s expertise in the functional test and diagnosis of complex PCBs is valuable to the more demanding military and commercial aerospace markets. Teradyne’s test solutions include a wide range of systems, instruments, and software products that military and aerospace companies use for production test and the military services use to perform critical maintenance and repair duties.

 

The pace of military and aerospace technological advances has increased dramatically in recent years, resulting in board assemblies of greater complexity, speed and accuracy. New programs, such as the F-35 Joint Strike Fighter, as well as widespread retrofit and upgrade programs are continuing to fuel the demand for high performance test systems. Teradyne is a leading provider of test instrumentation and systems with performance that is uniquely suited to the demands of military / aerospace electronics manufacturers and repair depots worldwide.

 

Successful penetration in this market is illustrated by Teradyne’s sales into major Department of Defense programs, including the F-35 Joint Strike Fighter, B-1 Bomber and C-17 Transport.

 

Diagnostic Solutions

 

Diagnostic Solutions provides electronic test and diagnostic systems to the automotive OEM’s and their major subcontractors. The systems are used throughout the vehicle’s lifecycle from design through manufacture to after sale service and consist of highly integrated software and hardware components. As the number and complexity of electronic systems and embedded software proliferate in vehicles, the ability to manufacture and service those vehicles becomes increasingly dependent on electronic diagnostic equipment. Diagnostic Solutions’ products fall into two categories:

 

OEM Service Diagnostics

 

OEM dealer service technicians use Diagnostic Solutions’ systems to find faults in vehicles in use by their customers, and to reduce OEM warranty costs. Historically, the focus has been on fixing faults in the service bay, but is growing to include constant monitoring of the vehicle to predict and prevent failure.

 

Vehicle Configuration and Test Solutions (“VCATS”)

 

Diagnostic Solution’s VCATS products are used on automotive and major automotive subassembly production lines. Diagnostic Solution’s VCATS connects to the vehicle to test and program (or “configure”) the electronic

 

5


systems on vehicles. These vehicle electronic systems include engine control modules and subsystems such as braking, navigation and air conditioning. Diagnostic Solutions is also able to link to an OEM’s manufacturing control system in order to provide statistical quality reports to operators and management. In addition, Diagnostic Solutions also provides VCATS solutions to subcontractors to the OEMs.

 

Both VCATS and OEM Service Diagnostics products utilize Diagnostic Solutions’ “GRADE-X” authoring software enabling the manufacturing and service phases of vehicle development. Diagnostics for electronic modules and systems used on Diagnostic Solutions’ customers’ vehicles can be developed and written using the GRADE-X authoring software. The actual diagnosis of a customer’s vehicle occurs in the OEM dealer’s service bay utilizing a runtime portion of the software to facilitate the service and repair of the vehicle.

 

Broadband Test Systems

 

Broadband Test provides test systems for voice and digital subscriber line (“DSL”) telephone networks. Teradyne’s Celerity® DSL test system is equipped on approximately 60 million subscriber lines to qualify DSL services provided by major telephone companies.

 

Teradyne products within the Broadband Test Systems market include:

 

4TEL Voice Service Test System

 

Testing more than 130 million access lines worldwide for many of the world’s largest telecommunications companies, Teradyne’s 4TEL voice service assurance system is designed to automate customer care and field repair processes to reduce network maintenance and operating costs. 4TEL accurately identifies and isolates faults in the central office exchange, the copper cable to the consumer’s premise, and the premise itself.

 

Celerity DSL Test System

 

Telephone companies need to know which telephone lines between the central office and the consumer are qualified for broadband DSL service before committing service to consumers. Teradyne’s patented Celerity system uses accurate insertion loss, length and load coil detection, to qualify millions of lines in hours for DSL service. This information is then used to support DSL point-of-sale and marketing efforts. Celerity finds more DSL-ready lines in the network that can be sold to residential and small business customers. It also helps reduce the cost of provisioning DSL through automation of the loop qualification process and reduction of field dispatches.

 

Celerity also provides on-demand testing for in-service DSL lines to support quick fault isolation and efficient field repair dispatches. The Celerity system enables a repair technician or call center receptionist to determine the cause of a DSL-related problem by identifying both the type of problem on the line and the dispatch location of the fault. This capability reduces operating costs and decreases DSL maintenance costs.

 

Summary of Net Revenue by Reportable Segment

 

Teradyne’s four reportable segments accounted for the following percentages of consolidated net revenue for each of last three years:

 

       2004

    2003

    2002

 

Semiconductor Test Systems

     64 %   55 %   46 %

Connection Systems

     21     26     32  

Assembly Test Systems

     9     11     14  

Other Test Systems

     6     8     8  
      

 

 

Total

     100 %   100 %   100 %

 

6


Investor Information

 

Teradyne, a Massachusetts corporation incorporated on September 23, 1960, is subject to the informational requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). Therefore, Teradyne files periodic reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street, NW, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

 

You can access financial and other information, including charters for Teradyne’s Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee and Teradyne’s Corporate Governance Guidelines and Standards of Business Conduct (“Ethics Policy”), by clicking the Investors link on Teradyne’s website at www.teradyne.com. Teradyne makes available, free of charge, copies of its SEC filings, including its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act through Teradyne’s website as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC.

 

Sales and Distribution

 

Prices for Teradyne’s systems can reach $3 million or more. In 2004, 2003, and 2002 no single customer accounted for more than 10% of Teradyne’s consolidated net revenue. In each of the years 2004, 2003, and 2002, Teradyne’s three largest customers in aggregate accounted for 18%, 21%, and 23% of consolidated net revenue, respectively.

 

Direct sales to United States government agencies accounted for less than 2% of consolidated net revenue in 2004, 2003 and 2002. Approximately 23%, 12%, and 10% of Assembly Test Systems revenue in 2004, 2003 and 2002, respectively, was to United States government agencies and 24%, 28% and 15% of Assembly Test Systems revenue in 2004, 2003 and 2002, respectively, was to customers who are government contractors.

 

Teradyne has sales and service offices located throughout North America, Asia, and Europe, as Teradyne’s customers outside the United States are located primarily in these geographic areas. Teradyne sells in these areas predominantly through a direct sales force. Although Teradyne conducts some manufacturing activities outside the U.S. as detailed in Item 2—Properties, Teradyne’s manufacturing activities are primarily conducted in the United States.

 

Sales to customers outside the United States accounted for 70% of consolidated net revenue in 2004, 63% in 2003, and 54% in 2002. Sales to customers located in Singapore were 13%, 11%, and 8% of consolidated net revenue in 2004, 2003, and 2002, respectively. Sales to customers located in Taiwan were 15%, 9%, and 9% of consolidated net revenue in 2004, 2003 and 2002, respectively. Sales are attributed to geographic areas based on the location of the customer site.

 

Teradyne is subject to the inherent risks involved in international trade, such as:

 

    unexpected changes in legal and regulatory requirements and in policy changes affecting international markets;
    changes in tariffs and exchange rates;
    social, political and economic instability, acts of terrorism and international conflicts;
    difficulties in accounts receivable collection;
    cultural differences in the conduct of business;
    difficulties in staffing and managing international operations;
    potentially adverse tax consequences; and
    compliance with customs regulations.

 

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Teradyne attempts to reduce the effects of currency fluctuations by hedging those currency exposures associated with certain assets and liabilities denominated in non-functional currencies and by conducting the majority of its international transactions in U.S. dollars or dollar equivalents. See also “Item 7A. Quantitative and Qualitative Disclosures About Market Risks” and “Note F: Financial Instruments” in Notes to Consolidated Financial Statements.

 

Competition

 

Teradyne faces significant competition throughout the world in each of its reportable segments. These competitors include, among others, Advantest Corporation, Agilent Technologies, Inc., Credence Systems Corporation, and LTX Corporation. Some of Teradyne’s competitors have substantially greater financial and other resources to pursue engineering, manufacturing, marketing and distribution of their products. Teradyne also faces competition from internal suppliers at several of its customers. Some of Teradyne’s competitors have introduced or announced new products with certain performance characteristics which may be considered equal or superior to those Teradyne currently offers. Teradyne expects its competitors to continue to improve the performance of their current products and to introduce new products or new technologies that provide improved cost of ownership and performance characteristics. New product introductions by competitors could cause a decline in revenues or loss of market acceptance of Teradyne’s products. Moreover, increased competitive pressure could lead to intensified price-based competition, which could materially adversely affect Teradyne’s business, financial condition and results of operations.

 

Backlog

 

At December 31, 2004 and 2003, Teradyne’s backlog of unfilled orders in each of its four reportable segments was as follows:

 

     2004

   2003

     (in millions)

Semiconductor Test Systems

   $ 224.1    $ 333.7

Connection Systems

     80.5      75.6

Assembly Test Systems

     63.8      56.1

Other Test Systems

     38.8      40.7
    

  

     $ 407.2    $ 506.1

 

Of the backlog at December 31, 2004, approximately 96% of the Semiconductor Test Systems backlog, 100% of the Connection Systems backlog, 100% of Assembly Test Systems backlog, and 93% of the Other Test Systems backlog is expected to be delivered in 2005. Generally, Teradyne’s backlog policy requires delivery of products and services within twelve months.

 

Customers may delay delivery of products or cancel orders suddenly and without significant notice, subject to possible cancellation penalties. Due to possible customer changes in delivery schedules and cancellation of orders, Teradyne’s backlog at any particular date is not necessarily indicative of the actual sales for any succeeding period. Delays in delivery schedules and/or cancellations of backlog during any particular period could have a material adverse effect on Teradyne’s business, financial condition, and results of operations.

 

Raw Materials

 

Teradyne’s products contain electronic and mechanical components that are provided by a wide range of suppliers. Certain of these components are standard products, while others are manufactured to Teradyne’s specifications. Teradyne can experience occasional delays in obtaining timely delivery of certain items. While the majority of Teradyne’s components are available from multiple suppliers, certain items are obtained from sole sources. Teradyne could experience a temporary adverse impact if any of its sole source suppliers ceased to deliver products. Any prolonged inability to obtain adequate supplies, or any other circumstances that would require Teradyne to seek alternative sources of supply could have a material adverse effect on its business, financial condition, and results of operations.

 

8


Patents and Licenses

 

Teradyne’s development of its products, both hardware and software, is based in significant part on proprietary information and technology. Teradyne protects its rights in proprietary information and technology through various methods, such as:

 

    patents and patent applications;
    copyrights;
    trademarks;
    trade secrets;
    business practices;
    software license agreements, non-disclosure agreements, and other contracts; and
    employee agreements.

 

However, these protections might not be effective in all circumstances. Competitors might independently develop similar technology or exploit Teradyne’s proprietary technology and/or information in countries where Teradyne lacks enforceable intellectual property rights (“IP”) or enforcement of such rights through the legal system provides an insufficient deterrent. Also, IP protections can be invalidated through legal processes. While Teradyne does not believe that any single piece of intellectual property or proprietary rights is essential to its business, if a significant portion of Teradyne’s intellectual property or proprietary rights is invalidated or ineffective, Teradyne’s business could be materially adversely affected.

 

Employees

 

As of December 31, 2004, Teradyne employed approximately 6,200 people. Since the inception of Teradyne’s business, there have been no work stoppages or other labor disturbances. Teradyne has no collective bargaining contracts.

 

Engineering and Development Activities

 

The highly technical nature of Teradyne’s products requires a large and continuing engineering and development effort. Engineering and development expenditures were $262.0 million in 2004, $254.6 million in 2003 and $293.9 million in 2002. These expenditures amounted to approximately 15% of consolidated net revenue in 2004, 19% in 2003 and 24% in 2002.

 

Environmental Affairs

 

Teradyne is subject to various federal, state, and local government laws and regulations relating to the protection of employee health and safety and the environment. Teradyne accrues for all known environmental liabilities when it becomes probable that Teradyne will incur cleanup costs and those costs can reasonably be estimated. The amounts accrued do not cover sites that are in the preliminary stages of investigation. Estimated environmental costs are not expected to materially affect the financial position or results of Teradyne’s operations in future periods. However, estimates of future costs are subject to change due to protracted cleanup periods and changing environmental remediation laws and regulations.

 

In 2001, Teradyne was designated as a “potentially responsible party” (“PRP”) at a clean-up site in Los Angeles, California. This claim arises out of Teradyne’s acquisition of Perception Laminates, Inc. in August 2000. Prior to that date, Perception Laminates had itself acquired certain assets of Alco Industries, Inc. under an asset purchase agreement dated July 30, 1992. Neither Teradyne nor Perception Laminates have ever conducted any operations at the Los Angeles site. Teradyne has asked the State of California to drop the PRP designation, but California has not yet agreed to do so. Management does not believe that the outcome of this matter will have a material adverse effect on Teradyne’s financial position or results of operations but there can be no assurance that any such outcome would not have a material adverse effect on Teradyne’s financial position or results of operations.

 

CEO Certification

 

An annual CEO Certification was submitted by our CEO to the New York Stock Exchange on June 18, 2004 in accordance with the NYSE’s listing standards.

 

9


EXECUTIVE OFFICERS OF THE COMPANY

 

The following table sets forth the names of all executive officers of Teradyne and certain other information relating to their positions held with Teradyne and other business experience. Executive officers of Teradyne do not have a specific term of office but rather serve at the discretion of the Board of Directors.

 

Executive Officer


   Age

  

Position


  

Business Experience For The Past 5 Years


George W. Chamillard

   66    Chairman of the Board    Chairman of the Board since 2000; Chief Executive Officer of Teradyne from 1997 to 2004; Director of Teradyne since 1996; President of Teradyne from 1997 to 2003; President and Chief Operating Officer of Teradyne from 1996 to 1997; Executive Vice President of Teradyne from 1994 to 1996.

Michael A. Bradley

   56    President and Chief Executive Officer    Chief Executive Officer since 2004; President of Teradyne since 2003; President of Semiconductor Test Systems from 2001 to 2003; Chief Financial Officer of Teradyne from 1999 to 2001; Vice President of Teradyne from 1992 to 2001.

Gregory R. Beecher

   47    Vice President, Chief Financial Officer and Treasurer    Vice President and Chief Financial Officer of Teradyne since 2001 and Treasurer of Teradyne since 2003; Partner at PricewaterhouseCoopers LLP from 1993 to 2001.

Eileen Casal

   46    Vice President, General Counsel and Secretary    Vice President, General Counsel and Secretary of Teradyne since 2003; Vice President, General Counsel and Corporate Secretary of GSI Lumonics Inc. from 2001 until 2003; Vice President, General Counsel and Corporate Secretary of Adero, Inc. from 2000 until 2001; Vice President, General Counsel and Assistant Clerk of Teradyne, from 1999 to 2000; from 1986 until 1999, Ms. Casal held a number of legal positions at Stratus Computer, Inc. including Vice President, General Counsel and Clerk.

John M. Casey

   56    Senior Vice President    Senior Vice President of Teradyne since 2004; President of Assembly Test Systems from 2002 to 2004; Vice President of Teradyne since 1990.

Jeffrey R. Hotchkiss

   57    President of Assembly Test Systems    President of Assembly Test Systems since 2004; Director, Chief Executive Officer and President of Empirix Corporation from 2000 to 2004; Chief Financial Officer of Teradyne from 1997 to 1999; Vice President of Teradyne from 1990 to 1999.

 

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Executive Officer


   Age

  

Position


  

Business Experience For The Past 5 Years


Mark E. Jagiela

   44    President of Semiconductor Test Systems    President of Semiconductor Test Systems since 2003; Vice President of Teradyne since 2001; General Manager of Teradyne’s VLSI Test Division from 2000 to 2001; VLSI Test Division Engineering Manager from 1999 to 2000; Japan Division General Manager from 1991 to 1999.

G. Richard MacDonald

   56    Controller    Controller of Teradyne since 2001; Controller of Teradyne’s Industrial Consumer Division from 1989 to 2001.

Edward Rogas, Jr.

   64    Senior Vice President    Senior Vice President of Teradyne since 2000; Vice President of Teradyne from 1984 to 1999.

Richard E. Schneider

   47    President of Connection Systems    President of Connection Systems since 2001; Vice President of Teradyne from 1998 to 2001; Connections Systems manager from 1998 to 2001.

 

 

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Item 2: Properties

 

The following table provides certain information as to Teradyne’s principal general offices and manufacturing facilities.

 

Location


  

Operating Segment


   Major
Activity+


   Approximate
Square Feet of
Floor Space


 

Properties Owned:

                

Nashua, New Hampshire

   Connection Systems    2-3-4-5    524,000  

Boston, Massachusetts

   Semiconductor Test & Corporate Offices    1-2-3-4-5    492,000  

North Reading, Massachusetts

   Semiconductor Test & Assembly Test    2-3-4-5    472,000  

North Reading, Massachusetts

   Unoccupied         226,000 (a)

North Reading, Massachusetts

   Unoccupied         242,000 (b)

Agoura Hills, California

   Semiconductor Test    3-5    240,000  

Agoura Hills, California

   Semiconductor Test    6    120,000  

San Jose, California

   Semiconductor Test & Connection Systems    2-3-5    120,000  

Kumamoto, Japan

   Semiconductor Test    2-3-4-5    66,000  

Deerfield, Illinois

   Broadband Test    2-3-4-5    63,000  
              

Subtotal of Owned Properties

   2,565,000  

Properties Leased:

                

Westford, Massachusetts

   Unoccupied         230,000 (d,f)

Woburn, Massachusetts

   Semiconductor Test    2-6    205,000  

Mexicali, Mexico

   Connection Systems    2-5    112,000  

Walnut Creek, California

   Unoccupied         98,000 (d,e)

Shanghai, China

   Connection Systems, Assembly Test, and Semiconductor Test    2-5-6    87,000  

Stockport, England

   Diagnostic Solutions    2-3-4-5-6    75,000  

Agoura Hills, California

   Semiconductor Test    6    59,000  

Stoughton, Massachusetts

   Unoccupied         55,000 (c)

Nashua, New Hampshire

   Connection Systems    6    55,000  

Plano, Texas

   Unoccupied         50,000 (c)

Winston-Salem, North Carolina

   Connection Systems    2-5-6    49,000  

Dublin, Ireland

   Connection Systems    2-5    46,000  

Fremont, California

   Unoccupied         46,000 (c)

Bracknell, England

   Semiconductor Test, Broadband Test, and Assembly Test    3-4-5    44,000  

Tai Yuan, Taiwan

   Semiconductor Test and Assembly Test    5    43,000  
              

Subtotal of Leased Properties

   1,254,000  
              

Total Square Feet of Floor Space

   3,819,000  
              

 

+ Major activities have been separated into the following categories: 1. Corporate Administration, 2. Manufacturing, 3. Research and Development, 4. Marketing, 5. Sales and Administration, and 6. Storage and Distribution

 

(a) This space is unoccupied.

 

(b) This space is currently being leased to two companies.

 

(c) This space is currently being subleased.

 

(d) This space is unoccupied and is currently being marketed for sublease.

 

(e) A termination agreement, effective May 2005, has been signed for 60,000 square feet.

 

(f) A sublease for 100,000 square feet was signed during 2004. The building remains unoccupied as the tenant will not move in until September of 2005.

 

12


Item 3: Legal Proceedings

 

After the August 2000 acquisition of Herco Technology Corp. and Perception Laminates, Inc. the former owners of those companies filed a complaint on September 5, 2001 against Teradyne and two of its executive officers. The case is now pending in Federal District Court in San Diego, California. Teradyne filed a motion to dismiss the complaint in its entirety on behalf of Teradyne and the two individual defendants. The court granted the motion in part, and the only remaining claims were that the sale of our common stock to the former owners violated certain California securities statutes and common law and that we had breached certain contractual obligations in the agreements relating to the acquisitions. Our subsequent motion for partial summary judgment with respect to the breach of contract claims was granted on November 7, 2002. On December 9, 2002, the plaintiffs filed a motion asking the court to reconsider its summary judgment ruling or, alternatively, for certification under Rule 54(b) which would grant the plaintiffs leave to appeal both the Court’s ruling regarding dismissal of claims and its ruling granting summary judgment to the Ninth Circuit Court of Appeals. We opposed these motions. On April 22, 2003, the Court denied the plaintiffs’ motion from reconsideration and the plaintiffs’ request for certification under Rule 54(b). The only claim remaining before the District Court from the original complaint related to an allegation of fraud in connection with the setting of the transaction price. We have answered and denied all liability. On December 27, 2004, Plaintiffs voluntarily stipulated to the dismissal with prejudice of its remaining claims in the trial court, without having received any payment or other consideration from Teradyne. On February 2, 2005, the plaintiffs filed a notice of appeal from the court’s prior orders dismissing certain of the plaintiffs’ claims and granting partial summary judgment against them and denying the plaintiffs’ motion for reconsideration.

 

In 2001, we were designated as a “potentially responsible party” (“PRP”) at a clean-up site in Los Angeles, California. This claim arises out of Teradyne’s acquisition of Perception Laminates, Inc. in August 2000. Prior to that date, Perception Laminates had itself acquired certain assets of Alco Industries Inc. under an asset purchase agreement dated July 30, 1992. Neither Teradyne nor Perception Laminates have ever conducted any operations at the Los Angeles site. We have asked the State of California to drop the PRP designation, but California has not yet agreed to do so.

 

In August of 2003, Hampshire Equity Partners II, LP (“HEP”) informed Teradyne of a potential claim that was subsequently contained in the complaint that HEP filed on April 30, 2004 against Teradyne and Teradyne’s Connection Systems segment (“TCS”) in the United States District Court of the Southern District of New York, relating to its February 21, 2001 investment of $55 million in Connector Service Corporation aka AMAX Plating, Inc. (“CSC”), which was a supplier to TCS at the time. During the due diligence that HEP conducted prior to making that investment, an agent of HEP spoke with TCS, among other CSC customers, concerning CSC. On or about September 24, 2003, CSC filed for bankruptcy protection as discussed above. HEP has now brought suit against Teradyne and TCS asserting fraud and negligence based claims, and a claim for intentional interference with economic opportunity, relating to statements that a TCS representative made to HEP’s agent prior to HEP’s February 2001 investment in CSC. HEP seeks to hold Teradyne and TCS responsible for its decision to invest in CSC and for the losses that it suffered upon the bankruptcy of CSC. HEP is now seeking damages for an unstated amount of not less than $55 million. On June 17, 2004, Teradyne and TCS filed a motion to dismiss HEP’s complaint in its entirety. On August 9, 2004, HEP filed its opposition to the motion to dismiss and Teradyne filed its reply brief on September 22, 2004. Teradyne’s motion to dismiss remains pending.

 

We believe that we have meritorious defenses against the above unsettled claims and intend to vigorously contest them. While it is not possible to predict or determine the outcomes of the unsettled claims or to provide possible ranges of losses that may arise, we believe the losses associated with all of these actions will not have a material adverse effect on our consolidated financial position or liquidity, but could possibly be material to our consolidated results of operations of any one period.

 

In addition, we are subject to legal proceedings, claims and investigations that arise in the ordinary course of business such as, but not limited to, patent, employment, commercial and environmental matters. Although there can be no assurance, there are no such matters pending that we expect to be material with respect to our business, financial position or results of operations.

 

13


Item 4: Submission of Matters to a Vote of Security Holders.

 

None.

 

PART II

 

Item 5: Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

The following table shows the market range for Teradyne’s Common Stock based on reported sale prices on the New York Stock Exchange.

 

    

Period


   High

   Low

2003

  

First Quarter

   $ 16.25    $ 8.75
    

Second Quarter

     19.22      11.00
    

Third Quarter

     22.55      14.89
    

Fourth Quarter

     26.31      18.22

2004

  

First Quarter

   $ 30.70    $ 20.47
    

Second Quarter

     25.81      19.60
    

Third Quarter

     20.99      12.53
    

Fourth Quarter

     18.97      13.10

 

The number of record holders of Teradyne’s Common Stock at February 28, 2005 was 2,997.

 

Teradyne has never paid cash dividends because it has been Teradyne’s policy to use earnings to finance expansion and growth. Payment of future cash dividends will rest within the discretion of the Board of Directors and will depend, among other things, upon Teradyne’s earnings, capital requirements and financial condition. Teradyne presently expects to retain all of its earnings for use in the business.

 

See “Equity Compensation Plans” in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for information on equity compensation plans.

 

14


Item 6: Selected Financial Data

 

    Years Ended December 31,*

 
    2004

  2003

    2002

    2001

    2000

 
    (dollars in thousands, except per share amounts)  

Consolidated Statement of Operations Data:

                                     

Net revenues

  $ 1,791,880   $ 1,352,867     $ 1,222,236     $ 1,440,581     $ 3,043,946  
   

 


 


 


 


Income (loss) before cumulative effect of change in accounting principle

    165,237     (193,993 )     (718,469 )     (202,215 )     517,754  

Cumulative effect of change in accounting principle

    —       —         —         —         (64,138 )
   

 


 


 


 


Net income (loss)

    165,237     (193,993 )     (718,469 )     (202,215 )     453,616  
   

 


 


 


 


Income (loss) before cumulative effect of change in accounting principle per common share—basic

    0.85     (1.03 )     (3.93 )     (1.15 )     2.99  

Cumulative effect of change in accounting principle per common share—basic

    —       —         —         —         (0.37 )
   

 


 


 


 


Net income (loss) per common share—basic

    0.85     (1.03 )     (3.93 )     (1.15 )     2.62  
   

 


 


 


 


Income (loss) before cumulative effect of change in accounting principle per common share—diluted

    0.84     (1.03 )     (3.93 )     (1.15 )     2.86  

Cumulative effect of change in accounting principle per common share—diluted

    —       —         —         —         (0.35 )
   

 


 


 


 


Net income (loss) per common share—diluted

    0.84     (1.03 )     (3.93 )     (1.15 )     2.51  
   

 


 


 


 


Consolidated Balance Sheet Data:

                                     

Total assets

    1,922,562     1,785,362       1,900,150       2,542,391       2,355,868  
   

 


 


 


 


Long-term obligations

    398,932     407,658       450,561       451,682       8,352  
   

 


 


 


 


 

*Note: In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”). SAB 101 summarizes certain of the Staff’s views in applying generally accepted accounting principles to revenue recognition in financial statements. During the fourth quarter of 2000, Teradyne implemented the SEC’s SAB 101 guidelines, retroactive to the beginning of the year. This was reported as a cumulative effect of a change in accounting principle as of January 1, 2000. The cumulative effect of the change in accounting principle on prior years resulted in a charge to income of $64.1 million (net of income taxes of $27.5 million) or $0.35 per diluted share which has been included in income for the fiscal year ended December 31, 2000. For the fiscal year ended December 31, 2000, Teradyne recognized $126.1 million in revenue that is included in the cumulative effect adjustment as of January 1, 2000.

 

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to the historical information contained in this document, the discussion in this Annual Report on Form 10-K contains forward-looking statements, made pursuant to Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties, such as statements of Teradyne’s plans, expectations and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as being applicable to all related forward-looking statements whenever they appear in this Annual Report on Form 10-K. Teradyne’s actual results could differ

 

15


materially from the results contemplated by these and any other forward-looking statements. Factors that could contribute to such differences include those discussed below as well as those cautionary statements and other factors set forth in “Certain Factors That May Affect Future Results” and elsewhere herein.

 

Critical Accounting Policies and Estimates

 

Teradyne has identified the policies discussed below as critical to understanding its business and its results of operations. The impact and any associated risks related to these policies on its business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect its reported and expected financial results.

 

Preparation of Financial Statements and Use of Estimates

 

The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent liabilities. On an on-going basis, management evaluates its estimates, including those related to inventories, investments, goodwill, intangible and other long-lived assets, bad debts, income taxes, pensions, warranties, contingencies, and litigation. Management bases its estimates on historical experience and on appropriate and customary assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue Recognition

 

In accordance with the guidance provided by the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, “Revenue Recognition,” Teradyne recognizes revenue when there is persuasive evidence of an arrangement, title and risk of loss have passed, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to Teradyne’s customers upon shipment. In circumstances where either title or risk of loss pass upon destination, acceptance or cash payment, Teradyne defers revenue recognition until such events occur.

 

For equipment that includes hardware and software that is incidental to the product, revenue is recognized upon shipment provided that customer acceptance criteria can be demonstrated prior to shipment. Certain contracts require Teradyne to perform tests of the product to ensure that performance meets the published product specifications or customer requested specifications, which are generally conducted prior to shipment. Where the criteria cannot be demonstrated prior to shipment, or in the case of new products, revenue is deferred until customer acceptance has been received. For multiple element arrangements, Teradyne defers the greater of the fair value of any undelivered elements of the contract or the portion of the sales price which is not payable until the undelivered elements are delivered. For a delivered item to be considered a separate unit, the delivered item must have value to the customer on a standalone basis, there must be objective and reliable evidence of fair value of the undelivered items in the arrangement and the delivery or performance of the undelivered item must be considered probable and substantially in the control of Teradyne. Teradyne also defers the portion of the sales price that is not due until acceptance, which represents deferred profit. Fair value is the price charged when the element is sold separately. Teradyne’s post-shipment obligations include installation, training services, one-year standard warranties, and extended warranties. Installation does not alter the product capabilities, does not require specialized skills or tools and can be performed by the customers or other vendors. Installation is typically provided within five to fifteen days of product shipment and is completed within one to two days thereafter. Training services are optional and do not affect the customer’s ability to use the product. Teradyne defers revenue for the fair value of installation and training. Extended warranties constitute warranty obligations beyond one year and Teradyne defers revenue in accordance with FASB Technical Bulletin 90-1. Teradyne’s products are generally subject to warranty and related costs are provided for in cost of revenue when product revenue is recognized. Teradyne classifies shipping and handling costs in cost of revenue. Service revenue is recognized over the contractual period or as the services are performed.

 

16


Connection Systems revenue is generally recognized upon shipment according to the shipping terms of the arrangement as there is no installation required and there are no contractual acceptance requirements.

 

Teradyne does not provide its customers with contractual rights of return for any of its products.

 

For transactions involving the sale of software which is not incidental to the product, revenue is recognized in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 97-2 (“SOP 97-2”), “Software Revenue Recognition,” as amended by SOP No. 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Teradyne recognizes revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. In instances where an arrangement contains multiple elements, revenue is deferred related to the undelivered elements to the extent that vendor-specific objective evidence of fair value (“VSOE”) exists for such elements. In instances where VSOE does not exist for one or more of the undelivered elements of an arrangement, all revenue related to the arrangement is deferred until all elements have been delivered. VSOE is the price charged when the element is sold separately. Revenue for the separate elements is only recognized where the functionality of the undelivered element is not essential to the delivered element.

 

For certain contracts eligible for contract accounting under SOP No. 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” revenue is recognized using the percentage-of-completion accounting method based upon the percentage of incurred costs to estimated total costs. These arrangements require significant production, modification or customization. In all cases, changes to total estimated costs and anticipated losses, if any, are recognized in the period in which they are determined. With respect to contract change orders, claims or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. Such amounts are only included in the contract value when they can be reliably estimated and realization is reasonably assured, generally upon receipt of a customer approved change order.

 

Inventories

 

Inventories, which include materials, labor, and manufacturing overhead, are stated at the lower of cost (first-in, first-out basis) or net realizable value. On a quarterly basis, Teradyne uses consistent methodologies to evaluate all inventory for net realizable value. Teradyne records a provision for excess and obsolete inventory when such a writedown is identified through the quarterly review process. The inventory valuation is based upon assumptions about future demand, product mix and possible alternative uses.

 

Stock Option and Stock Purchase Plans

 

Teradyne accounts for its director and employee stock option and employee stock purchase plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations. Teradyne’s employee stock purchase plan is a non-compensatory plan. Teradyne’s stock option plans are accounted for using the intrinsic value method under the provisions of APB 25. Accordingly, there have been no charges for employee or director stock options or employee stock purchase plans. Proceeds from the exercise of stock options and the issuance of stock under the employee stock purchase plan are credited to common stock at par value and the excess is credited to additional paid-in capital.

 

Teradyne makes pro forma footnote disclosures as though the fair value method was followed under Statement of Financial Accounting Standard No. 123, “Accounting For Stock-Based Compensation” (“FAS 123”), as amended by SFAS No. 148, “Accounting for Stock Based Compensation – Transition and Disclosure.” See “Note B: Accounting Policies,” in the Notes to Consolidated Financial Statements for pro forma stock option and stock purchase plan information.

 

In December 2004, the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment” (“SFAS 123R”). In interim or annual periods beginning after June 15, 2005, SFAS 123R would eliminate the ability to

 

17


account for equity-based compensation using the intrinsic value-based method under APB 25. SFAS 123R requires companies’ to calculate equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant. Under SFAS 123R, equity-based compensation is required to be recognized in companies’ financial statements. Teradyne expects to adopt SFAS 123R in the third quarter of 2005, as required. For the years ended December 31, 2004, 2003 and 2002, had SFAS 123R been effective, Teradyne would have recognized additional non-cash equity-based compensation expense of $91.8 million, $85.1 million, and $110.3 million, respectively, applying the provisions of SFAS 123.

 

Income Taxes

 

On a quarterly basis, Teradyne evaluates the realizability of its deferred tax assets and assesses the need for a valuation allowance. As a result of its review undertaken at December 31, 2002, Teradyne concluded under applicable accounting criteria that it was more likely than not that its deferred tax assets would not be realized and established a valuation allowance. Due to the continued uncertainty of realization, Teradyne maintained its valuation allowance at December 31, 2003 and 2004. Teradyne does not expect to significantly reduce its valuation allowance until sufficient positive evidence, including sustained profitability, exists that realization is more likely than not.

 

Goodwill, Intangible and Long-Lived Assets

 

Teradyne assesses the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors Teradyne considers important in the determination of an impairment include significant underperformance relative to historical or projected future operating results, significant changes in the manner of Teradyne’s use of the acquired asset and significant negative industry or economic trends. When Teradyne determines that the carrying value of intangibles and long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, Teradyne measures any impairment based on a projected discounted cash flow method using a discount rate commensurate with the associated risks. Teradyne assesses goodwill for impairment at least annually in the fourth quarter, on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. If the book value of a reporting unit exceeds its fair value, the implied fair value of goodwill is compared with the carrying amount of goodwill. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recorded in an amount equal to that excess.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The volatility of the industries that Teradyne serves can cause certain of its customers to experience shortages of cash flows, which can impact their ability to make required payments. Teradyne maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Estimated allowances for doubtful accounts are reviewed periodically taking into account the customer’s current payment history, the customer’s current financial statements and other information regarding the customer’s credit worthiness. If the financial condition of Teradyne’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Account balances are charged off against the allowance when it is probable the receivable will not be recovered.

 

18


SELECTED RELATIONSHIPS WITHIN THE CONSOLIDATED

STATEMENTS OF OPERATIONS

 

     Year Ended December 31,

 
     2004

    2003

    2002

 

Percentage of net revenue:

                  

Net Revenue:

                  

Products

   86.8 %   82.5 %   81.2 %

Service

   13.2     17.5     18.8  
    

 

 

Total net revenue

   100.0     100.0     100.0  

Cost of Revenues:

                  

Cost of products

   50.4     59.0     67.9  

Cost of service

   9.2     11.5     13.1  
    

 

 

Total cost of revenue

   59.6     70.5     81.0  

Gross Profit

   40.4     29.5     19.0  

Operating Expenses:

                  

Engineering and development

   14.6     18.8     24.0  

Selling and administrative

   15.0     18.4     23.8  

Restructuring and other charges

   0.3     5.3     10.2  

Goodwill impairment

   —       —       6.5  

Gain on the sale of a business

   —       —       —    
    

 

 

     29.9     42.5     64.5  

Net interest and other (expense) income

   —       (0.7 )   (0.4 )
    

 

 

Income (loss) before income taxes

   10.5     (13.7 )   (45.9 )

Provision for income taxes

   1.3     0.6     12.9  
    

 

 

Net income (loss)

   9.2 %   (14.3 )%   (58.8 )%
    

 

 

 

Results of Operations:

 

Bookings

 

Teradyne’s net orders for its four reportable segments for 2004, 2003 and 2002 are as follows:

 

     2004

   2003

   2002

   2003-2004
Percent
Change


    2002-2003
Percent
Change


 
     (in millions except percent change)  

Semiconductor Test Systems

   $ 1,036.4    $ 837.9    $ 480.5    24 %   74 %

Connection Systems

     384.8      317.7      149.8    21     112  

Assembly Test Systems

     162.1      156.6      167.8    4     (7 )

Other Test Systems

     107.6      105.9      107.2    2     (1 )
    

  

  

  

 

     $ 1,690.9    $ 1,418.1    $ 905.3    19 %   57 %

 

From 2003 to 2004, Semiconductor Test Systems bookings increased due to growth in the overall system-on-a-chip (“SOC”) tester market (excluding memory testers). Semiconductor Test Systems bookings within the SOC market showed a continuation of the growth in Asian markets from 2003 into 2004, mainly related to Subcons in Taiwan and Singapore. Over 2004, Teradyne saw a rise in bookings driven primarily by semiconductor testing needs in the wireless, broadband, consumer electronics, and mass storage/datacom markets, which are serviced by the J750, Catalyst and FLEX products, and whose chips are sold mainly by European and U.S. semiconductor companies. Many of these chips are fabricated and tested by Foundries and

 

19


Subcons in many parts of Asia, but concentrated in Taiwan and Singapore. The economic downturn which prevailed in past years has pushed companies to lower fixed costs. As a result, an increasing trend by chip makers has been to outsource non-core competency testing needs to Subcons in low cost regions. As total Semiconductor Test Systems bookings have grown, the bookings from Subcons have continued to make up a large percentage of total orders. Bookings from Subcons increased 45% to $443 million in 2004 from $307 million in 2003, and made up 43% of bookings in 2004 compared to 37% in 2003. Semiconductor Test Systems backlog increased from 2002 to 2003 primarily due to increased orders from Subcons and Foundries located in the Asian markets.

 

The growth in Connection Systems orders from 2003 to 2004 was a result of continued spending for wireless network deployments in the United States and Europe as well as an increase in network spending for both the enterprise and service provider markets. The computer/server market was also strong. Bookings were up appreciably for Connection Systems’ VHDM-HSD backplane interconnect product lines as well as the NeXLev family of high-speed, high-density mezzanine connectors. Similar to 2003, the growth in orders was partially offset by a decline in orders due to the decision to exit a portion of Connection Systems’ lower margin EMS product line. The increase in Connection Systems bookings from 2002 to 2003 was due in part to a decrease in cancellations in 2003, as well as an increase in demand in the telecommunications market, driven by wireless network deployments, which increased for both U.S. and European telecommunications equipment providers in the latter part of the fourth quarter of 2003 compared to the first half of 2003.

 

Orders in the Assembly Test Systems segment increased from 2003 to 2004, primarily driven by increases in the mil/aero business and increased sales of in-circuit products. The growth in these areas was offset by a decline in orders resulting from the sale of the manufacturing software and the manual x-ray and rework product lines in 2003. The net decrease in Assembly Test Systems orders from 2002 to 2003 is due primarily to the sale of the manufacturing software and the manual x-ray and rework product lines. This decrease was offset by a 25% increase in orders by government agencies and contractors in the Mil/Aero business, which had a twofold increase in orders from the first half to the second half of 2003.

 

Teradyne’s cancellations for its four reportable segments for the last three years are as follows:

 

     2004

   2003

   2002

     (in millions)

Semiconductor Test Systems

   $ 10.5    $ 6.9    $ 52.5

Connection Systems

     —        16.0      104.3

Assembly Test Systems

     0.2      2.5      2.2

Other Test Systems

     —        —        —  
    

  

  

     $ 10.7    $ 25.4    $ 159.0

 

Semiconductor Test Systems experienced $10.5 million of cancellations and backlog adjustments in 2004. Approximately 50% of this amount was related to cancellations, while the remainder was a backlog adjustment related to management’s estimate of what may be canceled in future periods.

 

The Connection Systems cancellations in 2003 were from major customers in the telecommunications and networking infrastructure industries, due principally to product program cancellations.

 

20


Teradyne’s net bookings by region as a percentage of total net bookings are as follows:

 

     2004

    2003

    2002

 

United States

   32 %   35 %   44 %

South East Asia

   19     18     13  

Europe

   17     17     18  

Taiwan

   15     10     6  

Singapore

   11     11     8  

Japan

   5     8     9  

Rest of the World

   1     1     2  
    

 

 

     100 %   100 %   100 %

 

For the past three years, Teradyne’s backlog of unfilled orders for its four reportable segments is as follows:

 

     2004

   2003

   2002

     (in millions)

Semiconductor Test Systems

   $ 224.1    $ 333.7    $ 240.0

Connection Systems

     80.5      75.6      104.2

Assembly Test Systems

     63.8      56.1      53.4

Other Test Systems

     38.8      40.7      43.3
    

  

  

     $ 407.2    $ 506.1    $ 440.9

 

Customers may delay delivery of products or cancel orders suddenly and without significant notice, subject to possible cancellation penalties. In 2004, 2003, and 2002 there were no significant cancellation penalties received. Due to possible customer changes in delivery schedules and cancellation of orders, Teradyne’s backlog at any particular date is not necessarily indicative of the actual sales for any succeeding period. Delays in delivery schedules and/or cancellations of backlog during any particular period could have a material adverse effect on Teradyne’s business, financial condition, and results of operations.

 

Revenue

 

Teradyne’s net revenue for its four reportable segments for 2004, 2003 and 2002 is as follows:

 

     2004

   2003

   2002

   2003-2004
Percent
Change


    2002-2003
Percent
Change


 
     (in millions except percent change)  

Semiconductor Test Systems

   $ 1,146.3    $ 735.4    $ 557.5    56 %   32 %

Connection Systems

     381.7      357.2      397.0    7     (10 )

Assembly Test Systems

     155.2      151.6      170.8    2     (11 )

Other Test Systems

     108.7      108.7      96.9    —       12  
    

  

  

  

 

     $ 1,791.9    $ 1,352.9    $ 1,222.2    32 %   11 %

 

The increase in Semiconductor Test Systems sales from 2003 to 2004 is attributable to growth in the overall SOC test market, and a share gain by Semiconductor Test Systems in that market. The worldwide market for semiconductor test equipment (excluding memory testers) grew by approximately 34% in 2004. Semiconductor Test System’s share in that market grew from 2003 to 2004. Much of the increased sales for Semiconductor Test Systems came from Subcon customers for use in their Asian facilities, primarily in Singapore and Taiwan. The revenue derived from Subcons was driven by higher demand from their mixed signal SOC customers, led by sales of Catalyst and FLEX systems. As is described in the Bookings section, Semiconductor Test Systems has seen growth in revenue from 2003 to 2004 due to increased need for testing in the wireless, broadband, and to a lesser extent, mass storage/datacom sectors. Sales of the J750 product were also relatively strong in 2004, serving the microcontroller and high volume logic customer segments. Similar to the increase in sales from 2003 to 2004, the increase from 2002 to 2003 was attributable to increased demand from Subcons located in the Asian markets, particularly, Singapore, Taiwan, and Malaysia.

 

21


Connection Systems sales in 2004 increased to $381.7 million led by stronger customer demand for Connection Systems’ high-speed, high-density interconnect products, which more than offset the decrease in sales associated with the exiting of the lower margin EMS business in 2003. Connection Systems sales declined from 2002 to 2003 primarily as a result of the decision to exit the lower margin EMS business. The segment saw downward pricing pressure throughout the past three years.

 

The increase in Assembly Test Systems sales from 2003 to 2004 was due to increases in both the commercial and mil/aero businesses. Commercial business growth was due to increased sales of in circuit test products, while the increase in mil/aero sales was generated by a number of large projects which were undertaken in 2004. These increases were offset, in part, by decreases from the sale of the manual x-ray, rework and AOI product lines in 2003. From 2002 through 2003, the commercial business saw decreases in revenue, particularly due to the sale of product lines referenced above, while mil/aero revenue increased slightly year over year .

 

Teradyne’s four reportable segments accounted for the following percentages of consolidated net revenue for each of the last three years:

 

     2004

    2003

    2002

 

Semiconductor Test Systems

   64 %   55 %   46 %

Connection Systems

   21     26     32  

Assembly Test Systems

   9     11     14  

Other Test Systems

   6     8     8  
    

 

 

     100 %   100 %   100 %

 

Teradyne’s net revenue by region as a percentage of total revenue is as follows:

 

     2004

    2003

    2002

 

United States

   30 %   37 %   46 %

Europe

   15     17     18  

South East Asia

   20     17     11  

Singapore

   13     11     8  

Taiwan

   15     9     9  

Japan

   5     8     6  

Rest of the World

   2     1     2  
    

 

 

     100 %   100 %   100 %

 

Teradyne’s product and service revenue breakout for the past three years is as follows:

 

     2004

   2003

   2002

   2003-2004
Percent
Change


    2002-2003
Percent
Change


 
     (in millions except percent change)  

Product Revenue

   $ 1,554.8    $ 1,115.9    $ 992.1    39 %   12 %

Service Revenue

     237.1      237.0      230.1    —       3  
    

  

  

  

 

     $ 1,791.9    $ 1,352.9    $ 1,222.2    32 %   11 %

 

Service revenue is derived from the servicing of Teradyne’s installed base of products and includes maintenance contracts, repairs, extended warranties, parts sales and applications support.

 

In the past three years, no single customer accounted for more than 10% of consolidated net revenue. In 2004, 2003, and 2002, Teradyne’s three largest customers in the aggregate accounted for 18%, 21% and 23% of consolidated net revenue, respectively.

 

22


Gross Margin

 

     2004

    2003

    2002

    2003-2004
Point
Change


   2002-2003
Point
Change


     (dollars in millions)           

Gross Margin

   $ 723.9     $ 398.9     $ 232.7           

Percent of Total Revenue

     40.4 %     29.5 %     19.0 %   10.9    10.5

 

The gross margin improvement from 2003 to 2004 was the result of several factors. An improvement of 9 points is credited to an increase in sales volumes and a shift in the mix of revenues, with higher Semiconductor Test Systems content which has higher incremental margins. The remainder is attributable to lower material costs and a reduction in fixed manufacturing costs, including depreciation and facility costs resulting from past restructuring actions.

 

Teradyne’s gross margin improvement from 2002 to 2003 was impacted by a variety of factors, including an improvement of 4.9 points related to reduced manufacturing costs and increased volume levels, and an improvement of 2.5 points related to an increase in volume and a shift in product mix. Inventory provisions decreased from $39.0 million in 2002 to $16.6 million in 2003, which contributed a 2.0 point gross margin improvement.

 

The breakout of product and service gross margin is as follows:

 

     2004

    2003

    2002

    2003-2004
Point
Change


    2002-2003
Point
Change


     (dollars in millions)            

Product Gross Margin

   $ 651.4     $ 317.1     $ 163.0            

Percent of Product Revenue

     41.9 %     28.4 %     16.4 %   13.5     12.0
     2004

    2003

    2002

    2003-2004
Point
Change


    2002-2003
Point
Change


     (dollars in millions)            

Service Gross Margin

   $ 72.5     $ 81.8     $ 69.7            

Percent of Service Revenue

     30.6 %     34.5 %     30.3 %   (3.9 )   4.2

 

Teradyne assesses the carrying value of its inventory on a quarterly basis by estimating future demand and comparing that demand against on-hand and on-order inventory positions. Forecasted revenue information is obtained from the sales and marketing groups and incorporates factors such as backlog and future revenue demand. This quarterly process identifies obsolete and excess inventory. Obsolete inventory, which represents items for which there is no demand, is fully reserved. Excess inventory, which represents inventory items that are not expected to be consumed, is written-down to estimated net realizable value. These write-offs and write-downs consist of raw materials and components. Sales of previously reserved inventory items result in recovery of the related inventory provision which is recorded in cost of revenues.

 

During the year ended December 31, 2004, Teradyne recorded excess and obsolete provisions in cost of revenues of $3.5 million and $7.8 million, respectively. Of the $11.3 million of total excess and obsolete provisions recorded, $6.2 million related to Semiconductor Test Systems, $3.0 million related to Assembly Test Systems, $1.6 million related to Connection Systems and $0.5 million related to Other Test Systems.

 

During the year ended December 31, 2003, Teradyne recorded excess and obsolete provisions in cost of revenues of $7.4 million and $9.2 million, respectively. Of the $16.6 million of total excess and obsolete provisions recorded, $9.3 million related to Assembly Test Systems which included $3.6 million relating to the discontinuance of manufacturing, distributing and primary support of the AOI product line and $5.2 million related to Semiconductor Test Systems SOC parts and components.

 

23


During the year ended December 31, 2002, Teradyne recorded excess and obsolete provisions in cost of revenues of $28.1 million and $10.9 million, respectively. Of the $39.0 million of total excess and obsolete provisions recorded, $27.9 million related to Semiconductor Test Systems, including $20.7 million of memory test inventory related to Probe-One and J996 product line discontinuances. The Probe-One and J996 inventory had been fully written-off as of December 31, 2003. There is no material exposure remaining for the Probe-One or J996 products.

 

During the years ended December 31, 2004 and 2003, Teradyne sold inventory that was previously reserved for which had a gross margin impact of $2.2 million and $5.3 million, respectively.

 

Teradyne scrapped $44.8 million, $30.3 million, and $22.8 million of inventory which had been previously written-down or written-off during the years ended December 31, 2004, 2003 and 2002, respectively. Teradyne has no set timeline for scrapping the remaining inventory.

 

As of December 31, 2004 and 2003, Teradyne had inventory reserves for amounts which have been written-down or written-off of $153.9 million and $191.1 million, respectively. Of the reserves at December 31, 2004, $10.5 million, $12.6 million, $3.6 million, and $127.2 million relate to inventory provisions recorded in 2004, 2003, 2002, and prior to 2002, respectively. Of the reserves at December 31, 2003, $16.6 million, $20.2 million, and $154.3 million related to inventory provisions recorded in 2003, 2002 and prior to 2002, respectively.

 

Engineering and Development

 

     2004

    2003

    2002

    2003-2004
Change


   2002-2003
Change


 
     (dollars in millions)  

Engineering and Development

   $ 262.0     $ 254.6     $ 293.9     $ 7.4    $ (39.3 )

Percent of Total Revenue

     14.6 %     18.8 %     24.0 %               

 

During 2004, Teradyne maintained its commitment to sustained levels of investment in research through continued engineering and development spending. More than two-thirds of Teradyne’s total engineering and development expenses are incurred by the Semiconductor Test Systems segment, where a new test platform requires up to three years for development and costs between $150-$250 million. During 2002 and 2003, Semiconductor Test Systems reduced the number of platforms under major development, which increased the resources for continued engineering on selective platforms. The consolidation of multiple product divisions within Semiconductor Test Systems into one group has enabled more leverage and reuse for application specific integrated circuits development and instrumentation.

 

The increase of $7 million in engineering and development spending from 2003 to 2004 consists of the following amounts:

 

    $7 million increase due to variable employee compensation;
    $6 million increase in prototype material for engineering development projects;
    $4 million increase in outsourced project engineering; and
    $1 million increase in travel and training costs;

 

These increases were offset in part by the following:

 

    $6 million decrease in salaries and fringe benefits due to a decrease in headcount, offset by salary increases effective July 1, 2004; and

 

24


    $5 million decrease in depreciation and facility costs as a result of facility closures and lower capital spending, including a decrease of $2 million in accelerated depreciation related to asset writedowns and facility closures in 2003.

 

The reduction in engineering and development expenses from 2002 to 2003 resulted primarily from the exiting of product lines within Semiconductor Test Systems and Assembly Test Systems. The elimination of memory test within the Semiconductor Test Systems segment resulted in a reduction of $5 million in engineering expenses from 2002 to 2003. In addition, Semiconductor Test Systems consolidated engineering facilities, outsourced certain software engineering development to a low-cost region and limited the amount of engineering work done by outside consultants in an effort to reduce costs. As a result of the sale in Assembly Test Systems of its manufacturing software product line and manual x-ray inspection and rework product line as well as the discontinuance of the automated optical inspection products, engineering expenses from 2002 to 2003 decreased by approximately $15 million.

 

The decrease from 2002 to 2003 in engineering and development spending resulting from the discontinuance of product lines and actions taken to reduce costs consists of the following amounts:

 

    $16 million as a result of a workforce reduction, partially offset by a $10 million increase from the elimination of company-wide paycuts and the granting of previously frozen salary increases in the third quarter of 2002;
    $13 million from a reduction in outsourced contract engineering;
    $4 million from a decrease in depreciation as a result of the recent writedown of assets, as well as the trend to rent or lease, rather than purchase, development tools; and
    $3 million from reduced office and facility costs.

 

Selling and Administrative

 

     2004

    2003

    2002

    2003-2004
Change


   2002-2003
Change


 
     (dollars in millions)  

Selling and Administrative

   $ 268.6     $ 249.5     $ 290.4     $ 19.1    $ (40.9 )

Percent of Total Revenue

     15.0 %     18.4 %     23.8 %               

 

The increase in spending of $19 million from 2003 to 2004 was principally due to the following approximate amounts:

 

    $16 million increase due to variable employee compensation;
    $7 million from an increase in consulting expenses; and
    $3 million increase in travel and training costs;

 

These increases were offset in part by the following:

 

    $5 million in lower depreciation costs due to asset writedowns and capital spending cutbacks; and
    $2 million decrease in rental and lease payments due to increased sublease income and facilities consolidation.

 

The decrease in spending from 2002 to 2003 was principally due to the following approximate amounts:

 

    $18 million as a result of a workforce reduction, partially offset by a $3 million increase from the elimination of company-wide paycuts and the granting of previously frozen salary increases;
    $12 million in reduced utility costs from the consolidation of facilities, lower promotional spending and travel cutbacks;
    $7 million from a decrease in consulting spending and legal fees; and
    $4 million in lower depreciation due to the writedown of assets.

 

25


Restructuring and Other Charges

 

The tables below represent activity related to restructuring charges for the years ended December 31, 2004, 2003, and 2002. The accrual for severance and benefits is reflected in accrued employees’ compensation and withholdings. The accrual for lease payments on vacated facilities is reflected in other accrued liabilities and other long-term accrued liabilities and is expected to be paid out over the lease terms, the latest of which expires in 2012. Teradyne expects to pay out approximately $7.0 million against the lease accruals over the next twelve months. Teradyne’s future lease commitments are net of expected sublease income of $13 million as of December 31, 2004. Teradyne has subleased approximately 52% of its unoccupied space as of December 31, 2004 and is actively attempting to sublease the remaining space.

 

The table below summarizes the liability and activity for the year ended December 31, 2004 relating to restructuring and other charges (in thousands):

 

     Long-Lived
Asset
Impairment


    Severance
and
Benefits


    Facility
Related


    Other
Charges


    Total

 

Balance at December 31, 2003

   $ —       $ 7,766     $ 29,222     $ 1,273     $ 38,261  

2004 provision (reversal)

     810       2,864       3,188       (1,503 )     5,359  

Cash payments

     —         (7,570 )     (11,182 )     1,259       (17,493 )

Asset write-downs

     (810 )     —         —         —         (810 )
    


 


 


 


 


Balance at December 31, 2004

   $ —       $ 3,060     $ 21,228     $ 1,029     $ 25,317  
    


 


 


 


 


 

During the year ended December 31, 2004, Teradyne recorded the following activity related to restructuring and other charges:

 

    $1.4 million reversal due to revised estimates related to long-lived asset impairment charges that had previously been recorded where the impaired assets sold for more than their respective carrying amounts, and $2.2 million of charges for certain long-lived assets that were impaired as the estimated value of such assets was less than the carrying amount. The Assembly Test Systems segment recorded $1.1 million of this charge and $0.9 million was recorded in the Connection Systems segment. The remainder of the charge was recorded across other reportable segments.
    $5.0 million charge taken for severance and related benefits. This charge is offset by a $2.1 million reversal of estimates on future benefits for severed employees. There were approximately 184 employees terminated in the year ended December 31, 2004 across Teradyne.
    $3.2 million charge for revised estimates of losses due to changes in the assumed amount and timing of sublease income on facilities that have been exited prior to the end of the lease term. The Connection Systems, Assembly Test and Semiconductor Test segments recorded $2.0 million, $1.0 million and $0.2 million, respectively.
    $1.5 million net reversal of other charges consisting of $1.4 million of amounts realized under agreements related to product lines that were sold, and $0.1 million of revisions of estimates of liabilities incurred during restructuring activities, both of which occurred in prior reporting periods in the Assembly Test and Other Test Systems segments.

 

The restructuring actions taken in 2004 are expected to generate cost savings of approximately $13.8 million million annually across all areas of operations.

 

During 2004, Teradyne recorded a gain on the sale of a business of $0.9 million. This amount related to an earn-out provision from a divestiture in the Connection Systems segment in 1999, and has been classified as a gain on the sale of business in the statement of operations for the year ended December 31, 2004.

 

26


The table below summarizes the liability and activity for the year ended December 31, 2003 relating to restructuring and other charges:

 

     Long-Lived
Asset
Impairment


    Severance
and
Benefits


    Loss on
Sale of
Product
Lines


    Facility
Related


    Other
Charges


   Total

 
     (in thousands)  

Balance at December 31, 2002

   $ —       $ 8,242     $ —       $ 25,240     $ —      $ 33,482  

2003 provision

     29,403       21,367       6,891       12,350       1,273      71,284  

Cash payments

     —         (21,843 )     —         (8,368 )     —        (30,211 )

Asset writedowns

     (29,403 )     —         (6,891 )     —         —        (36,294 )
    


 


 


 


 

  


Balance at December 31, 2003

   $ —         $ 7,766     $ —       $ 29,222     $ 1,273    $ 38,261  
    


 


 


 


 

  


 

During the year ended December 31, 2003, Teradyne recorded the following activity related to restructuring and other charges:

 

    $29.4 million charge, primarily for certain long-lived assets held for sale that were impaired as the estimated fair value was less than the carrying value of the assets, including $11.2 million for the sale and leaseback of certain manufacturing assets, and $7.8 million for a reduction in the fair value of properties held for sale in the Connection Systems segment. The charge for the Semiconductor Test Systems segment of $3.5 million related primarily to a reduction in the fair value of properties held for sale, and $6.9 million related to the impairment of manufacturing assets held for sale in the Assembly Test Systems segment.
    $21.4 million charge for severance and related benefits. There were approximately 890 employees terminated in 2003 across Teradyne.
    $8.1 million charge for the loss on sale of product lines, of which $6.9 million has been recorded in restructuring and other charges and $1.2 million has been recorded in cost of sales. The product lines sold were in the Assembly Test Systems segment and the Other Systems segment. In the first quarter of 2003, the Assembly Test Systems segment sold its manufacturing software product line and manual x-ray inspection and rework product line for total cash proceeds of $2.1 million. These transactions resulted in a loss of $6.7 million for the year ended December 31, 2003 of which $6.2 million has been recorded in restructuring and other charges, and $0.5 million has been recorded in cost of sales. In the year ended December 31, 2003, the Other Test Systems Segment recorded a charge of $1.4 million to write down its net assets relating to the sale of the Autodiagnosis automotive after market product line of which $0.7 million has been recorded in restructuring and other charges and $0.7 million has been recorded in cost of sales.
    $12.4 million charge consisting primarily of revised estimates of losses due to changes in the assumed amount and timing of sublease income on facilities that have been exited prior to the end of the lease term. The Connection Systems segment recorded $3.2 million of this charge and $8.7 million was recorded in the Assembly Test Systems segment. The remainder of the charge was recorded across other operating segments.
    $1.3 million charge primarily for contractual penalties associated with resizing the Connections Systems segment.

 

The restructuring actions taken in 2003 were expected to generate cost savings of approximately $86.3 million annually across all areas of operations.

 

27


The table below summarizes activity for the year ended December 31, 2002 relating to restructuring and other charges:

 

     Long-Lived
Asset
Impairment


    Facility
Related


    Severance
and
Benefits


    Total

 
     (in thousands)  

Balance at December 31, 2001

   $ —       $ 1,676       8,471     $ 10,147  

2002 provision

     76,994       25,751       22,495       125,240  

Cash payments

     —         (2,187 )     (22,724 )     (24,911 )

Asset writedowns

     (76,994 )     —         —         (76,994 )
    


 


 


 


Balance at December 31, 2002

   $ —       $ 25,240     $ 8,242     $ 33,482  
    


 


 


 


 

During the year ended December 31, 2002, Teradyne recorded the following activity related to restructuring and other charges:

 

    $77.0 million charge primarily for certain long-lived assets held for sale that were impaired as the estimated fair value was less than the carrying value of these assets. The charges included machinery and equipment, facilities held for sale and intangible assets. All of the machinery and equipment and facilities have been sold or disposed of as of December 31, 2004.
    $25.8 million charge related to future lease commitments for vacated manufacturing and administrative space which have been exited prior to the end of the lease term.
    $22.5 million charge for severance and related benefits. There were approximately 1,010 employees terminated across Teradyne during the year ended December 31, 2002.

 

For further details on Teradyne’s restructuring and other charges during 2004, 2003 and 2002 see “Note L: Restructuring and Other Charges,” in the Notes to Consolidated Financial Statements.

 

In January 2005, Teradyne committed to a restructuring plan (“the Plan”) as part of an ongoing effort to lower expenses. Pursuant to the Plan, Teradyne believes that it will incur costs for severance and related employee benefits, impairment charges and remaining lease obligations related to a vacated facility, and other charges. The total charges expected to be incurred under the Plan are $11.0 million. The actions taken in accordance with the Plan are expected to generate cost savings of approximately $18.4 million annually, primarily in the Connection Systems and Assembly Test segments. Through March 11, 2005, Teradyne has incurred charges of approximately $8.2 million, related to severance and related employee benefits, remaining lease obligations and related asset impairments, and other charges.

 

Goodwill Impairment

 

Unless conditions dictate otherwise, Teradyne’s annual impairment test is performed in the fourth quarter of each fiscal year. Teradyne tested the Assembly Test Systems and Connection Systems reporting units, for impairment during its annual test and concluded that there was no impairment of goodwill in either reporting unit as of December 31, 2004 and 2003.

 

During the quarter ended September 28, 2003, Teradyne decreased its forecasted revenue, bookings and profit for the fiscal years 2004 through 2006 from the previous quarter’s forecast for the Assembly Test Systems segment and reduced its workforce by 112 employees to appropriately size the segment given the revised business outlook. As a result, Teradyne performed an interim impairment test for the goodwill related to the Assembly Test Systems segment as of September 28, 2003. Teradyne concluded that the carrying value of the assets and liabilities associated with the Assembly Test Systems segment did not exceed its fair value and thus no impairment charge was recorded. The fair value of the segment was estimated using the expected present value of future cash flows.

 

28


During the quarter ended September 29, 2002, as a result of contraction in the Assembly Test Systems market to its lowest level in a decade as evidenced by various market reports available to Teradyne, Teradyne decreased its forecasted revenue, bookings and profit for fiscal years 2003 through 2005 from the previous quarter’s forecast for the Assembly Test Systems segment and reduced its workforce by 94 employees to appropriately size the segment given the revised business outlook. As a result, Teradyne performed an interim impairment test for the goodwill related to the Assembly Test Systems segment as of September 29, 2002. Teradyne concluded that the carrying value of the assets and liabilities associated with the Assembly Test Systems segment exceeded its fair value and recognized a $78.5 million goodwill impairment charge recorded in Goodwill impairment in the consolidated Statements of Operations. The impairment charge was measured by comparing the implied fair value of the goodwill associated with the Assembly Test Systems segment to its carrying value. The fair value of the segment was estimated using the expected present value of future cash flows.

 

Interest Income and Expense

 

     2004

    2003

    2002

    2003-2004
Change


   2002-2003
Change


 
     (in millions)  

Interest income

   $ 15.4     $ 14.0     $ 17.0     $ 1.4    $ (3.0 )

Interest expense

   $ (18.8 )   $ (20.9 )   $ (21.8 )   $ 2.1    $ 0.9  

 

The increase in interest income from 2003 to 2004 was due primarily to an increase in interest rates in the latter half of 2004 and increased cash balances throughout 2004. The decrease in interest income from 2002 to 2003 was attributable to lower cash balances and lower interest rates.

 

The decrease in interest expense from 2003 to 2004 and from 2002 to 2003 was primarily attributable to the prepayment of Teradyne’s California mortgage of $42.3 million in the third quarter of 2003 which reduced interest expense for the fourth quarter of 2003 and all of 2004, as well as the repurchase of $8.5 million of Teradyne’s 3.75% Convertible Notes in the third quarter of 2004.

 

Other Income and Expense, Net

 

Other income and expense, net for the years ended December 31, 2004, 2003, and 2002 includes the following:

 

Income/(expense)


   2004

    2003

    2002

 
     (in thousands)  

Gain on sale of investment (1)

   $ 2,584     $ 2,800     $ —    

Collection of loan (2)

     585       —         7,144  

Other than temporary impairment of common stock investment

     (267 )     —         (3,115 )

Fair value adjustment on warrants

     (366 )     138       (2,051 )

Mortgage prepayment penalty (3)

     —         (3,220 )     —    

Other than temporary impairment of investment

     —         (2,592 )     —    

Writedown of investment in an engineering service provider

     —         —         (2,288 )
    


 


 


Total

   $ 2,536     $ (2,874 )   $ (310 )
    


 


 


 

(1) Gain on sale of an investment in common stock.

 

(2) The loan had previously been valued at zero due to its uncertainty of collection.

 

(3) Penalties related to prepayment of a $42.3 million mortgage loan collateralized against certain California real estate properties, which was to mature on January 1, 2007.

 

29


Income (loss) before Income Taxes

 

     2004

    2003

    2002

    2003-2004
Change


    2002-2003
Change


 
     (in millions)  

Semiconductor Test Systems

   $ 199.4     $ (60.1 )   $ (266.1 )   $ 259.5     $ 206.0  

Connection Systems

     25.2       (36.0 )     (79.6 )     61.2       43.6  

Assembly Test Systems

     —         (72.8 )     (200.4 )     72.8       127.6  

Other Test Systems

     6.8       2.5       1.2       4.3       1.3  

Corporate

     (43.5 )     (19.8 )     (16.0 )     (23.7 )     (3.8 )
    


 


 


 


 


Total

   $ 187.9     $ (186.2 )   $ (560.9 )   $ 374.1     $ 374.7  
    


 


 


 


 


 

The change to an income position from a loss position from 2003 to 2004 was mainly attributable to increased sales in the Semiconductor, Connector and Assembly Test Systems segments, as well as continued cost reductions throughout the company.

 

The decrease in the loss before income taxes from 2002 to 2003 in Semiconductor Test Systems, Connection Systems, and Assembly Test Systems was primarily due to cost reduction actions in the respective segments and market conditions during the year. Other Test Systems income before income taxes increased primarily due to increased revenues from 2002 to 2003.

 

Income Taxes

 

For the years ended December 31, 2004 and 2003, tax expense relates primarily to a tax provision for foreign taxes. Tax expense for 2004 also included an IRS settlement related to the closing out of tax years 1999 through 2001. During 2004, Teradyne utilized previously reserved net operating losses to reduce taxable income and lower the effective tax rate. Teradyne did not record an income tax benefit against the loss incurred in 2003. Until sufficient positive evidence exists, including an appropriate level of profitability, Teradyne will not record tax benefits on operating losses in future results of operations. Due to the continued uncertainty of realization, Teradyne maintained its valuation allowance against its deferred tax assets at December 31, 2004 and 2003. Teradyne does not expect to significantly reduce its valuation allowance until sufficient positive evidence, including sustained profitability, exists that realization is more likely than not. The effective tax rates for the years ended December 31, 2004 and 2003 were 12.1% and 4.2%, respectively.

 

For the year ended December 31, 2002, Teradyne recorded a tax provision of $157.5 million resulting in a tax rate of 28%. The tax rate of 28% is primarily due to the recording of a provision for income taxes to establish a valuation allowance against net deferred tax assets. In the fourth quarter of 2002, Teradyne recorded a tax provision to establish a valuation allowance against its net deferred tax assets. The valuation allowance was determined in accordance with the provisions of SFAS No. 109 which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. The evidence that Teradyne reviewed during the fourth quarter of 2002 included actual revenues and net loss for the fiscal year 2002 compared to earlier Teradyne forecasts, the inability to get to break-even during 2002 despite implementing several restructuring programs, and a reduction in revenues and an increase in the loss forecasted for the fiscal year 2003. As a result of its review undertaken at December 31, 2002, Teradyne concluded under applicable accounting criteria that it was more likely than not that its deferred tax assets would not be realized.

 

30


Contractual Obligations

 

The following table reflects Teradyne’s contractual obligations as of December 31, 2004:

 

     Purchase
Obligations


   Non-cancelable
Lease
Commitments*


   Interest
on
Debt**


   Convertible
Senior Notes


   Pension
Funding†


   Notes
Payable


   Other
Debt


   Total

     (in thousands)

2005

   $ 146,518    $ 27,681    $ 14,877    $ —      $ 30,000    $ 4,826    $ 321    $ 224,223

2006

            16,862      14,871      391,500                    321      423,554

2007

            14,235      184                           321      14,740

2008

            6,527      179                           321      7,027

2009

            5,759      173                           321      6,253

Beyond 2009

            12,817      525                           6,148      19,490
    

  

  

  

  

  

  

  

Total

   $ 146,518    $ 83,881    $ 30,809    $ 391,500    $ 30,000    $ 4,826    $ 7,753    $ 695,287
    

  

  

  

  

  

  

  

 

* Minimum payments have not been reduced by minimum sublease income of $9.6 million due in the future under non-cancelable subleases.
** Includes interest on convertible notes.
Pension funding requirements are not known beyond 2005.

 

Liquidity and Capital Resources

 

Teradyne’s cash, cash equivalents and marketable securities balance increased $105.2 million in 2004 from 2003, to $691.2 million. Teradyne’s cash, cash equivalents and marketable securities balance decreased $44.9 million in 2003 from 2002, to $586.0 million and increased $45.1 million in 2002 from 2001, to $541.1 million. Cash activity for 2004, 2003 and 2002 was as follows (in millions):

 

     2004

    2003

    2002

    2003-2004
Change


    2002-2003
Change


 

Cash provided by (used for) operating activities:

                                        

Cash provided by (used for) net income (loss), adjusted for non cash items:

   $ 299.7     $ 15.3     $ (207.4 )   $ 284.4     $ 222.7  

Change in operating assets and liabilities, net of product lines and businesses sold and acquired

     (44.9 )     18.9       203.1       (63.8 )     (184.2 )
    


 


 


 


 


Total cash provided by (used for) operating activities

     254.8       34.2       (4.3 )     220.6       38.5  

Cash used for investing activities

     (292.9 )     (114.4 )     (102.2 )     (178.5 )     (12.2 )

Cash provided by financing activities

     18.8       57.1       40.4       (38.3 )     16.7  
    


 


 


 


 


Total

   $ (19.3 )   $ (23.1 )   $ (66.1 )   $ 3.8     $ 43.0  
    


 


 


 


 


 

Changes in operating assets and liabilities, net of product lines and businesses sold and acquired used cash of $44.9 million in 2004 as inventory balances increased $16.0 million across each of Teradyne’s segments, although primarily in the Semiconductor Test Systems segment, and accounts payable, deferred revenue and accruals decreased by $42.3 million, which includes a contribution to Teradyne’s U.S. Qualified Pension Plan of approximately $35.6 million. The inventory, accounts payable, deferred revenue and accrual balances were partially offset by a decrease of $6.0 million in the accounts receivable balances primarily due to an decrease in days sales outstanding, based on annualized fourth quarter net revenues, from 59 days in 2003 to 54 days in 2004. Changes in operating assets and liabilities provided cash of $18.9 million in 2003 primarily due to a decrease in inventory balances of $56.3 million across all segments. Changes in operating assets and liabilities provided cash of $203.1 million in 2002 primarily due to a decrease in inventory balances across all segments and the receipt of a tax refund in March of 2002.

 

31


Investing activities consist of purchases, sales and maturities of marketable securities, proceeds from the sale of businesses, proceeds from asset disposals, proceeds from the sale of product lines, cash paid for assets and purchases of capital assets. Capital expenditures increased by $84.1 million in 2004 compared to 2003. Additions of internally constructed systems for use in marketing and engineering activities in the Semiconductor Test Systems segment accounted for approximately $69.2 million of the increase in capital expenditures due to the recent introduction of the FLEX platform. The remainder of the increase was attributable to purchases of manufacturing and engineering equipment across Teradyne to support the increase in revenues in 2004 and continued investment in research and development. Capital expenditures were $165.2 million in 2004, $81.2 million in 2003, and $76.4 million in 2002.

 

Financing activities include sales of Teradyne’s common stock, as well as repayments of debt. During 2004 and 2003, repayments of long-term debt used cash of $11.5 million and $43.4 million, respectively as Teradyne repurchased a portion of its outstanding 3.75% Convertible Senior Notes in the third quarter of 2004, and prepaid its mortgage on its California properties in the third quarter of 2003. During 2004, 2003 and 2002, issuances of common stock under stock option and stock purchase plans generated $30.3 million, $100.5 million, and $41.2 million, respectively.

 

On October 24, 2001, Teradyne issued $400 million principal amount of 3.75% Convertible Senior Notes due 2006 (the “Notes”) in a private placement and received net proceeds of $389 million. The Notes are convertible at the option of the holders at a rate which is equivalent to a conversion price of approximately $26.00 per share, which is equal to a conversion rate of approximately 38.4615 shares of common stock per $1,000 principal amount of Notes. Teradyne began making annual interest payments of $15 million, paid semi-annually, on the Notes commencing on April 15, 2002. The Notes are senior unsecured obligations of Teradyne that rank equally with Teradyne’s existing and future unsecured and unsubordinated indebtedness. In the event of a change in control by which Teradyne merges with or sells substantially all of its assets to a third party, the holders of the Notes may be able to require Teradyne to redeem some or all of the Notes either in discounted Teradyne common stock or in cash. On February 8, 2002, the Securities and Exchange Commission declared effective a Registration Statement on Form S-3 covering both the Notes and the shares of common stock into which they can be converted.

 

On or after October 18, 2004, Teradyne may redeem the Notes in whole or in part at the prices set forth below. The redemption price, expressed as a percentage of principal amount, is as follows for the designated periods:

 

Period


   Redemption
Price


 

Beginning on October 18, 2004 and ending on October 14, 2005

   101.50 %

Beginning on October 15, 2005 and ending on October 14, 2006

   100.75 %

 

and thereafter equal to 100% of the principal amount. The Board of Directors of Teradyne has authorized management to repurchase up to $100 million of the outstanding Notes in open market purchases at negotiated prices below 101.50. In the third quarter of 2004 and the first quarter of 2005, Teradyne repurchased $8.5 million and $20.0 million of the Notes, respectively. The decision to repurchase a portion of the Notes was based on the fair market value of the notes being below the redemption price during the period. Currently, management intends to repurchase the Notes on the open market through negotiated transactions when management believes that such price is beneficial to Teradyne. There are a number of factors that will affect the timing of when and the amount of the Notes that management may elect to repurchase, including the price of the available Notes, Teradyne’s stock price, Teradyne’s available cash and marketable securities, prevailing interest rates, and Teradyne’s anticipated liquidity needs.

 

32


If, at some point in the future, Teradyne’s stock price is greater than the conversion price of approximately $26.00 per share, management may elect to convert a portion of the Notes into equity, to avoid the continuation of interest payments and to conserve capital. However, there can be no assurance that even if Teradyne’s stock price is above the conversion price upon the notice of redemption that the Notes will convert into equity as Teradyne’s stock price may drop between the redemption notification date and the actual redemption date. If this were to occur, Teradyne would be forced to redeem the portion of the Notes called into cash. There are a number of factors that will affect the timing and amount that management may elect to redeem including Teradyne’s stock price, Teradyne’s available cash and marketable securities and Teradyne’s anticipated liquidity needs.

 

Teradyne believes its cash, cash equivalents and marketable securities balance of $691.2 million will be sufficient to meet working capital and expenditure needs for at least the next twelve months. Teradyne plans to contribute approximately $30.0 million in 2005 to Teradyne’s U.S. Qualified Pension Plan which is currently under-funded. Inflation has not had a significant long-term impact on earnings.

 

Retirement Plans

 

Teradyne’s pension expense, which includes the U.S. Qualified Pension Plan, certain Qualified Plans for non-U.S. subsidiaries and a Supplemental Executive Defined Benefit plan, was approximately $11.8 million for the year ended December 31, 2004, which was 0.73% of Teradyne’s cost of revenue and operating expenses. The largest portion of Teradyne’s 2004 pension expense was $5.7 million for its U.S. Qualified Pension Plan, which is calculated based upon a number of actuarial assumptions, including an expected return on plan assets for Teradyne’s U.S. Qualified Pension Plan assets of 8%. In developing the expected return on plan assets assumption, Teradyne evaluated input from its investment manager and pension consultants, including their review of asset class return expectations. Teradyne also considered its historical 15-year compounded return of 8.41% for the period ending December 31, 2003, which has been in excess of the broad equity and bond benchmark indices. Based on these historical returns, Teradyne believes that 8% was an appropriate rate to use for fiscal 2004. Teradyne will continue to evaluate its expected return on plan assets at least annually, and will adjust these returns as necessary.

 

The current asset allocation for Teradyne’s U.S. Qualified Pension Plan is 48.1% invested in equity securities and 51.9% invested in fixed income securities, which is in accordance with the plan’s asset allocation requirements. Teradyne’s actual asset allocation as of December 31, 2004 was virtually identical to its asset allocation model. Teradyne’s investment manager regularly reviews Teradyne’s actual asset allocation and periodically rebalances the portfolio to ensure alignment with Teradyne’s targeted allocations.

 

Teradyne bases its determination of pension expense or income on a market-related valuation of assets, which reduces year-to-year volatility. This market-related valuation recognizes investment gains or losses over a five-year period from the year in which they occur. Investment gains or losses for this purpose are the difference between the expected return calculated using the market-related value of assets and the actual return on assets. Since the market-related value of assets recognizes gains or losses over a five-year period, the future value of assets will be impacted as previously deferred gains or losses are recognized. As of December 31, 2004 in the U.S. Qualified Pension Plan Teradyne had cumulative losses of approximately $6.2 million, which remain to be recognized in the calculation of the market-related value of assets. The discount rate that Teradyne utilized for determining future pension obligations for the U.S. Qualified Pension Plan is based on the Citigroup Pension Liability Index (formerly Salomon Brothers Pension Liability Index), which was at 5.68% at December 31, 2004, down from 6.00% at December 31, 2003. As a result, Teradyne selected 5.75% for its December 31, 2004 discount rate, which was down from 6% as of December 31, 2003. Each year Teradyne considers the Citigroup Pension Liability Index, along with other indices including the Moody’s AA rated corporate bond yield and the Citigroup 10+ Year AAA/AA rate. Teradyne estimates that its pension expense for the U.S. Qualified Pension Plan will be approximately $5.7 million, $5.1 million and $4.7 million in fiscal 2005, 2006, and 2007, respectively. The pension expense estimates are based on a 5.75% discount rate. Future actual pension expense will depend on future investment performance, changes in future discount rates and various other factors related to the employee population participating in Teradyne’s pension plans.

 

33


Teradyne performed a sensitivity analysis, which expresses the estimated U.S. Qualified Pension Plan pension expense that would have resulted for the year ended December 31, 2004, if Teradyne changed either the discount rate or the expected return on plan assets.

 

     Discount Rate

Return on Plan Assets


   5%

   6%

   7%

     (in millions)

7%

   $ 10.8    $ 7.3    $ 4.0

8%

     9.3      5.7      2.4

9%

     7.7      4.2      0.9

 

Teradyne’s funding policy is to make contributions to the plans in accordance with local laws and to the extent that such contributions are tax deductible. The assets of these plans consist primarily of equity and fixed income securities. The value of Teradyne’s U.S. Qualified Pension Plan assets has increased from $121.6 million at December 31, 2003 to $165.9 million at December 31, 2004. The investment performance returns and Teradyne contributions have decreased the deficit of Teradyne’s U.S. Qualified Pension Plan, net of benefit obligations, from $70.9 million at December 31, 2003 to $37.9 million at December 31, 2004. During 2004, Teradyne contributed $35.6 million to the U.S. Qualified Pension Plan. Teradyne plans to contribute approximately $30.0 million in 2005 to this plan.

 

Equity Compensation Plans

 

In addition to Teradyne’s 1996 Employee Stock Purchase Plan discussed in “Note P: Stock Based Compensation,” Teradyne maintains three equity compensation plans under which its equity securities are authorized for issuance to Teradyne’s employees, directors and/or consultants:

 

1) 1991 Employee Stock Option Plan;

 

2) 1997 Employee Stock Option Plan; and

 

3) 1996 Non-Employee Director Stock Option Plan.

 

The purpose of these plans is to promote the interests of Teradyne by attracting and retaining the services of qualified and talented persons to serve as employees, directors and/or consultants of Teradyne. Except for the 1997 Employee Stock Option Plan, each of the foregoing plans was approved by Teradyne’s shareholders.

 

The following table presents information about these plans as of December 31, 2004:

 

    
  
  

Plan category


  

Number of securities

to be issued upon

exercise of

outstanding options,

warrants and rights


  

Weighted-average

exercise price of

outstanding options,

warrants and rights


  

Number of securities remaining

available for future issuance

under stock option compensation

plans (excluding securities

reflected in column(1))


     (shares in thousands)

Stock option plans approved by shareholders

   5,427    $ 22.73    2,856

Stock option plans not approved by shareholders(1)

   25,329      22.23    16,777
    
  

  

Total

   30,756    $ 22.31    19,633
    
  

  

 

34


(1) In connection with the acquisition of GenRad, Inc. in October 2001 (the “Acquisition”), Teradyne assumed the outstanding options granted under the GenRad, Inc. 1991 Equity Incentive Plan, the GenRad, Inc. 1991 Directors’ Stock Option Plan and the GenRad, Inc. 1997 Non-Qualified Employee Stock Option Plan (collectively, the “GenRad Plans”). Upon the consummation of the Acquisition, these options became exercisable for shares of Teradyne common stock based on an exchange ratio of 0.1733 shares of Teradyne common stock for each share of GenRad common stock. No additional options will be granted pursuant to the GenRad Plans. As of December 31, 2004, there were outstanding options exercisable for an aggregate of 260 shares of Teradyne common stock pursuant to the GenRad Plans, with a weighted average exercise price of $71.09 per share.

 

1991 Employee Stock Option Plan (the “1991 Plan”)

 

Under the 1991 Plan, Teradyne is authorized to issue options which qualify as incentive stock options under the Internal Revenue Code of 1986, as amended (“ISOs”) and non-qualified stock options (“NQOs”), up to a maximum of 30,000,000 shares of Teradyne common stock. ISOs may be granted only to employees of Teradyne and its subsidiaries and NQOs may be granted to employees, consultants and directors who are also employees of Teradyne. ISOs must be granted at an exercise price of at least 100% of fair market value of the common stock on the date of grant, and in the case of an employee owning more than 10% of the outstanding voting stock of Teradyne, the price per share must be at least 110% of the fair market value on the date of grant. No more than 200,000 NQOs may be granted at an exercise price less than fair market value. All other NQOs must be granted at an exercise price of at least 100% of fair market value on the date of grant. No employee may be granted options to purchase, in the aggregate, more than 300,000 shares of common stock under the 1991 Plan during any fiscal year. Teradyne’s Compensation Committee administers the 1991 Plan and specifies at the time of grant of an option whether such option will be an ISO or NQO, the number of shares subject to the option, its exercise price and other pertinent terms, including vesting provisions. Generally, the term of each option may be for a period not exceeding ten years from the date of grant. Under certain circumstances, if an employee retires from Teradyne, such employee’s option may expire prior to expiration of its stated term if such employee is engaged by a competitor of Teradyne. The 1991 Plan is a shareholder approved fixed accounting plan which expires in 2011.

 

The 1997 Employee Stock Option Plan (the “1997 Plan”)

 

Under the 1997 Plan, Teradyne is authorized to issue ISOs to employees of Teradyne and its subsidiaries, and NQOs, stock awards and authorizations to purchase Teradyne common stock to employees, consultants or directors (provided that no options may be granted to non-employee directors) up to a maximum of 53,000,000 shares. ISOs must be granted at an exercise price of at least 100% of fair market value of the common stock on the date of grant and in the case of an employee owning more than 10% of the outstanding voting stock of Teradyne, the price per share must be at least 110% of the fair market value on the date of grant. No more than 400,000 NQOs may be granted at an exercise price less than fair market value. All other NQOs must be granted at an exercise price of at least 100% of fair market value on the date of grant. No employee may be granted an option to acquire more than 4,000,000 shares of common stock under the 1997 Plan during any fiscal year. Teradyne’s Compensation Committee administers the 1997 Plan and specifies at the time of grant of an award, the pertinent terms of such award, including, if such award is an option, whether such option will be an ISO or NQO, the number of shares subject to the award, its exercise price and vesting provisions. Generally, the term of each award may be for a period not exceeding ten years from the date of grant. Under certain circumstances, if an employee retires from Teradyne, such employee’s award may expire prior to expiration of its stated term if such employee is engaged by a competitor of Teradyne. The 1997 Plan is a fixed accounting plan which expires in 2007.

 

Options granted prior to September 2001 under the 1991 and 1997 Plans vest in equal installments over four years and have a maximum term of five years. Beginning in September 2001, options granted under the 1991 and 1997 Plans vest in equal installments over four years and have a maximum term of seven years. In addition, Teradyne made a one-time grant to all employees under the 1991 and 1997 Plans that vests over two years and has a term of seven years.

 

35


1996 Non-Employee Director Stock Option Plan (the “1996 Plan”)

 

Each non-employee director of Teradyne is entitled to participate in the 1996 Plan. Under the 1996 Plan, Teradyne is authorized to issue options to purchase up to a maximum of 1,600,000 shares of common stock. The 1996 Plan currently provides for the automatic grant (i) on the date of election, of an option to purchase 25,000 shares of Teradyne common stock to each non-employee director who becomes a member of the Board of Directors on or after January 1, 2004 (“Initial Grant”), (ii) on the first Monday in February in each year, beginning in 2004 and continuing throughout the Plan, of an option to purchase 15,000 shares of Teradyne common stock to each existing non-employee Director (“Annual Grant”); and (iii) on the first Monday in February in each year, beginning in 2005 and continuing throughout the Plan, of an option to purchase 30,000 shares of Teradyne common stock to the non-employee Chairman of the Board of Directors (“Chair”) in lieu of the Annual Grant (“Annual Chair Grant”). The 1996 Plan was amended on January 24, 2005 to increase the automatic grant to a non-employee Chair from 15,000 to 30,000 shares of Teradyne common stock. Options granted under the 1996 Plan must be NQOs, shall be granted at 100% of the fair market value of the common stock on the date of grant. Options granted under the 1996 Plan prior to January 2002 expire five years following the date of grant and options granted thereafter expire seven years following the date of grant. Options granted under the 1996 Plan prior to February 5, 2001 become exercisable at the rate of 25% per year and options granted on or after February 5, 2001 are immediately exercisable. Teradyne’s Compensation Committee administers the 1996 Plan. Generally, if an optionee ceases to be a director of Teradyne other than by reason of death, no further installments of his or her options become exercisable and the options terminate after three months. However, under certain circumstances, unless a board member becomes a director of a competitor of Teradyne, if the board member goes into government service or retires from the Board of Directors, such option may be exercised within its original terms. The 1996 Plan is a shareholder approved fixed accounting plan which expires in 2006.

 

Recently Issued Accounting Pronouncements

 

In March 2004, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“EITF 03-1”), but, in September 2004, delayed the recognition and measurement provisions of EITF 03-1. For reporting periods beginning after June 15, 2004, only the disclosure requirements for available-for-sale securities and cost method investments are required.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123R (revised 2004), “Share-Based Payment” (“SFAS 123R”). In interim or annual periods beginning after June 15, 2005, SFAS 123R would eliminate the ability to account for equity-based compensation using the intrinsic value-based method under APB 25. SFAS 123R requires companies’ to calculate equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant.

 

Under SFAS 123R, public companies are allowed to select from three alternative transition methods: the Modified Prospective Application, which allows for the adoption of SFAS 123R without restatement of prior interim periods in the year of adoption; the Modified Prospective Application with restatement of prior interim periods in the year of adoption; and the Modified Retrospective Application which allows companies to restate prior financial statements. Teradyne expects to adopt SFAS 123R beginning in the third quarter of 2005, as required, using the Modified Prospective method, and will not restate prior periods for the adoption of SFAS 123R .

 

Currently, Teradyne discloses pro forma net income (loss) and related pro forma net income (loss) per share in accordance with SFAS 123 and SFAS 148. Under SFAS 123R, equity-based compensation expense is required to be recognized in companies’ financial statements. For the years ended December 31, 2004, 2003 and 2002, had SFAS 123R been effective, Teradyne would have recognized additional non-cash equity-based compensation expense of $91.8 million, $85.1 million, and $110.3 million, respectively, applying the provisions of SFAS 123. Teradyne is considering accelerating the vesting of certain outstanding unvested “out of the money” stock options awarded to employees, officers and other eligible participants under Teradyne’s various stock option plans. In addition, Teradyne is considering the use of other equity compensation vehicles including the use of restricted stock.

 

36


In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 modifies the accounting for abnormal inventory costs, and the manner in which companies allocate fixed overhead expenses to inventory. SFAS 151 is effective for inventory costs incurred during annual periods beginning after June 15, 2005. Teradyne does not expect SFAS 151 to have a material impact on its financial position and results of operations.

 

Certain Factors That May Affect Future Results

 

From time to time, information we provide, statements made by our employees or information included in our filings with the Securities and Exchange Commission (including this Form 10-K) contain statements that are not purely historical, but are forward looking statements, made under Section 21E of the Securities Exchange Act of 1934, which involve risks and uncertainties. In particular, forward looking statements made herein include projections, plans and objectives for our business, financial condition, operating results, future operations, or future economic performance, statements relating to the sufficiency of capital to meet working capital requirements, capital expenditures, expectations as to customer orders and demand for our products and statements relating to backlog, bookings and cancellations, gross margins and pricing considerations. These statements are neither promises nor guarantees but involve risks and uncertainties, both known and unknown, which could cause our actual future results to differ materially from those stated in any forward looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. These factors, and others, are discussed from time to time in our filings with the Securities and Exchange Commission.

 

Our Business Is Impacted by Worldwide Economic Cycles, Which Are Difficult to Predict.

 

Capital equipment providers in the electronics and semiconductor industries, such as Teradyne, have, in the past, been negatively impacted by sudden slowdowns in the global economies, and resulting reductions in customer capital investments. Future slowdowns in global economies and reductions in customer capital investments, which may adversely impact our business, are difficult to predict.

 

Acts of War, Terrorists Attacks and the Threat of Domestic and International Terrorist Attacks May Adversely Impact Our Business.

 

Acts of war and terrorists attacks may cause damage or disruption to our employees, facilities, customers, suppliers and distributors which could have a material adverse effect on our business, results of operation or financial condition. As we sell and manufacture products both in the United States and internationally, the threat of future terrorist attacks could lead to changes in security and operations at those locations which could increase our operating costs and which may adversely affect our business. Such conflicts may also cause damage or disruption to transportation and communication systems. All of these conditions make it difficult for us, and our customers, to accurately forecast and plan future business activities and could have a material adverse effect on our business, financial condition and results of operations.

 

Our Business is Dependent on the Current and Anticipated Market for Electronics, Which Historically Have Been Highly Cyclical.

 

Our business and results of operations depend in significant part upon capital expenditures of manufacturers of semiconductors and other electronics, which in turn depend upon the current and anticipated market demand for those products. The market demand for electronics is impacted by economic slowdowns and the effects of hostile acts. Historically, the electronics and semiconductor industry has been highly cyclical with recurring periods of over-supply, which often have had a severe negative effect on demand for test equipment, including systems we manufacture and market. We believe that the markets for newer generations of electronic products such as those that we manufacture and market will also be subject to similar fluctuations. We are dependent on the timing of orders from our customers and the deferral or cancellation of previous customer orders could have an adverse effect on our results of operations. We cannot assure that the level of revenues or new orders for a calendar quarter will be sustained in subsequent quarters. In addition, any factor adversely affecting the electronics industry or particular segments within the electronics industry may adversely affect our business, financial condition and operating results.

 

37


We Have Taken Measures to Address the Slowdown in the Market for Our Products Which Could Have Long-term Negative Effects on Our Business.

 

During 2001, 2002, 2003, and 2004, we took measures to address slowdowns in the market for our products. In particular, we reduced our workforce, closed and/or sold facilities, discontinued certain product lines, implemented material cost reduction programs and reduced planned capital expenditures and expense budgets. Each measure we took to address such slowdowns could have long-term negative effects on our business by reducing our pool of technical talent, decreasing or slowing improvements in our products, increasing our debt, and making it more difficult to respond to customers or competitors, as the market and customer orders turn around.

 

We May Not Be Able to Adequately Address a Rapid Increase in Customer Demand.

 

Because we took measures in recent years to scale back operations and reduce expenses in response to decreased customer demand for products and services, we may not be able to satisfy a rapid increase in customer demand. Our ability to meet rapid increases in customer demand is also, to a certain extent, dependant upon the ability of our suppliers and contractors to meet increased product or delivery requirements, over which we have little or no control.

 

Our Business May Be Adversely Impacted by Acquisitions Which May Affect Our Ability to Manage and Maintain Our Business.

 

Since our inception, we have acquired a number of businesses. In the future, we may undertake additional acquisitions of businesses that complement our existing operations. Such past or future acquisitions could involve a number of risks, including:

 

    the diversion of the attention of management and other key personnel;
    the costs associated with and/or the inability to effectively integrate an acquired business into our culture, product and service delivery methodology and other standards, controls, procedures and policies;
    the inability to retain the management, key personnel and other employees of an acquired business;
    the inability to retain the customers of an acquired business;
    the possibility that our reputation will be adversely affected by customer satisfaction problems of an acquired business;
    potential known or unknown liabilities associated with an acquired business, including but not limited to regulatory, environmental and tax liabilities;
    significant underperformance of the acquired business relative to our expectations;
    the amortization of acquired identifiable intangibles, which may adversely affect our reported results of operations; and
    litigation which has or which may arise in the future in connection with such acquisitions.

 

For example, in connection with the August 2000 acquisition of each of Herco Technology Corp., a California company, and Perception Laminates, Inc., a California company, a complaint was filed on or about September 5, 2001 and is now pending in Federal District Court, San Diego, California, by the former owners of those companies naming as defendants Teradyne and two of our executive officers. This case is further described in “Part I, Item 3: Legal Proceedings” in this Form 10-K.

 

Additionally, in 2001, we were designated as a “potentially responsible party” (“PRP”) at a clean-up site in Los Angeles, California. This claim arises out of our acquisition of Perception Laminates, Inc. in August 2000. Prior to that date, Perception Laminates had itself acquired certain assets of Alco Industries Inc. under an asset purchase agreement dated July 30, 1992. This matter is further described in “Part I, Item 3: Legal Proceedings” in this Form 10-K.

 

38


We Currently Are and in the Future May Be Subject to Litigation that Could Have an Adverse Effect on Our Business.

 

From time to time, we may be subject to litigation or other administrative and governmental proceedings that could require significant management time and resources and cause us to incur expenses and, in the event of an adverse decision, pay damages in an amount that could have a material adverse effect on our financial position or results of operations.

 

For example, on April 30, 2004, Hampshire Equity Partners II, L.P. (“HEP”), filed a complaint against Teradyne and Teradyne Connection Systems segment (“TCS”) asserting fraud and negligence based claims, and a claim for intentional interference with economic opportunity. In the complaint, HEP alleges that it relied upon statements made by a representative of TCS to a HEP agent during its due diligence prior to investing $55 million in Connector Services Corporation, aka AMAX Plating, Inc (“CSC”). HEP seeks to hold Teradyne and TCS responsible for its decision to invest in CSC and for the losses it has suffered upon the bankruptcy of CSC. HEP seeks damages in an unstated amount exceeding $55 million. The case is currently pending in the U.S. District Court of the Southern District of New York. We believe we have meritorious defenses to the claims and will defend ourselves vigorously. Management does not believe that the outcomes of these claims will have a material adverse effect on our financial position or results of operations but there can be no assurance that any such claims would not have a material adverse effect on our financial position or results of operations. This case is further described in “Part I, Item 3: Legal Proceedings” in this Form 10-K.

 

Our Business May be Adversely Impacted by Divestitures of Lines of Business Which May Affect Our Ability to Manage and Maintain Our Business.

 

Since our inception, we have divested certain lines of business. In the future, we may undertake additional such divestitures. Such past or future divestitures could involve a number of risks, including:

 

    the diversion of the attention of management and other key personnel;
    disruptions and other effects caused by the divestiture of a line of business on our culture, product and service delivery methodology and other standards, controls, procedures and policies;
    customer satisfaction problems caused by the loss of a divested line of business;
    restructuring, inventory and other charges which may affect our results of operations; and
    the decreased diversification of our product lines caused by the divestiture of a line of business which may make our operating results subject to increased market fluctuations.

 

If We Are Unable to Protect Our Intellectual Property, We May Lose a Valuable Asset or May Incur Costly Litigation to Protect Our Rights.

 

Our products incorporate technology that we protect in several ways, including patents, copyrights, trade secrets and by contract (“IP”). However, even with these protections, our IP may still be challenged, invalidated or subject to other infringement actions. While we believe that our IP has value in the aggregate, no single element of our IP is in itself essential. If a significant portion of our IP is invalidated or ineffective, our business could be materially adversely affected. In addition, we receive notifications from time to time that we may be in violation of patents held by others. An assertion of patent infringement against us, if successful, could have a material adverse effect on our ability to sell our products, or require a significant use of management resources and necessitate a lengthy and expensive defense which could adversely affect our operating results.

 

If We Fail to Develop New Technologies to Adapt to Our Customers’ Needs and if Our Customers Fail to Accept Our New Products, Our Revenues Will Be Adversely Affected.

 

We believe that our technological position depends primarily on the technical competence and creative ability of our engineers. In a rapidly evolving market, such as ours, the development of new technologies,

 

39


commercialization of those technologies into products and market acceptance and customer demand for those products are critical to our success. Successful product development and introduction depends upon a number of factors, including:

 

    new product selection;
    ability to meet customer requirements;
    development of competitive products by competitors;
    timely and efficient completion of product design;
    timely and efficient implementation of manufacturing; and
    assembly processes and product performance at customer locations.

 

We Are Subject to Intense Competition.

 

We face significant competition throughout the world in each of our reportable segments. Some of our competitors have substantial financial and other resources to pursue engineering, manufacturing, marketing and distribution of their products. We also face competition from internal suppliers at several of our customers. Some of our competitors have introduced or announced new products with certain performance characteristics which may be considered equal or superior to those we currently offer. We expect our competitors to continue to improve the performance of their current products and to introduce new products or new technologies that provide improved cost of ownership and performance characteristics. New product introductions by competitors could cause a decline in revenues or loss of market acceptance of our products. Moreover, increased competitive pressure could lead to intensified price based competition, which could materially adversely affect our business, financial condition and results of operations.

 

We Are Subject to Risks of Operating Internationally.

 

A significant portion of our total revenue is derived from customers outside the United States. Our international sales and operations are subject to significant risks and difficulties, including:

 

    unexpected changes in legal and regulatory requirements and in policy changes affecting international markets;
    changes in tariffs and exchange rates;
    social, political and economic instability, acts of terrorism and international conflicts;
    difficulties in accounts receivable collection;
    cultural differences in the conduct of business;
    difficulties in staffing and managing international operations;
    potentially adverse tax consequences; and
    compliance with customs regulations.

 

In addition, an increasingly large portion of our products are sourced or manufactured in foreign locations, including China, and a large portion of the devices our products test are fabricated and tested by foundries and subcontractors in Taiwan, Singapore, China and other parts of Asia. As a result, we are subject to a number of economic and other risks, particularly during times of political or financial instability in these regions. Disruption of manufacturing or supply sources in these international locations could materially adversely impact our ability to fill customer orders and potentially result in lost business.

 

Our Business May Suffer if We Are Unable to Attract and Retain Key Employees.

 

Competition for employees with skills we require is intense in the high technology industry. Our success will depend on our ability to attract and retain key technical employees. The loss of one or more key or other employees, our inability to attract additional qualified employees, or the delay in hiring key personnel could each have a material adverse effect on our business, results of operations or financial condition.

 

40


If Our Suppliers do not Meet Product or Delivery Requirements, We Could Have Reduced Revenues and Earnings.

 

Certain components, including semiconductor chips, may be in short supply from time to time because of high industry demand or the inability of some vendors to consistently meet our quality or delivery requirements. Approximately 30% of material purchases require some custom work where having multiple suppliers would be cost prohibitive. If any of our suppliers were to cancel contracts or commitments or fail to meet the quality or delivery requirements needed to satisfy customer orders for our products, we could lose time-sensitive customer orders and have significantly decreased quarterly revenues and earnings, which would have a material adverse effect on our business, results of operations and financial condition. In addition, we rely on contract manufacturers for certain subsystems used in our products, and our ability to meet customer orders for those products depends upon the timeliness and quality of the work performed by these subcontractors, over whom we do not exercise any control.

 

We are also dependent on the financial strength of our suppliers and may be subject to litigation arising from our relationships with suppliers and others. There can be no assurance that the loss of suppliers either as a result of bankruptcy or otherwise will not have a material adverse effect on our business, results of operations or financial condition.

 

We May Incur Significant Liabilities if We Fail to Comply With Environmental Regulations.

 

We are subject to both domestic and international environmental regulations and statutory strict liability relating to the use, storage, discharge, site cleanup and disposal of hazardous chemicals used in our manufacturing processes. If we fail to comply with present and future regulations, or are required to perform site remediation, we could be subject to future liabilities or the suspension of production. Present and future regulations may also:

 

    restrict our ability to expand facilities;
    require us to acquire costly equipment; or
    require us to incur other significant costs and expenses.

 

Pursuant to present regulations and agreements, we are conducting groundwater and subsurface assessment and monitoring and are implementing remediation and corrective action plans for facilities located in California, Massachusetts and New Hampshire which are no longer conducting manufacturing operations. As of December 31, 2004, we have not incurred material costs as result of the monitoring and remediation steps taken at the California, Massachusetts and New Hampshire sites.

 

On January 27, 2003, the European Union adopted the following directives: (i) the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”); and (ii) the Waste Electrical and Electronic Equipment Directive (the “WEEE Directive”). Both the RoHs Directive and the WEEE Directive will alter the type and manner in which electronic equipment is imported, sold and handled in the European Union. Ensuring compliance with the RoHs Directive and the WEEE Directive and integrating compliance activities with our suppliers could result in additional costs and disruption to operations and logistics and thus, could have a negative impact on the business, operations and financial condition. The RoHs Directive and the WEEE Directive will be become effective on July 6, 2006 and August 13, 2005, respectively.

 

We Have Substantially Increased Our Indebtedness.

 

On October 24, 2001, we completed a private placement of $400 million principal amount of 3.75% Convertible Senior Notes (the “Notes”) due October 15, 2006 and received net proceeds of $389 million. As a result, we have incurred approximately $400 million principal amount of additional indebtedness, substantially increasing our ratio of debt to total capitalization. The level of our indebtedness, among other things, could:

 

    make it difficult to make payments on our debt and other obligations;

 

41


    make it difficult to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes;
    require the dedication of a substantial portion of any cash flow from operations to service for indebtedness, thereby reducing the amount of cash flow available for other purposes, including capital expenditures;
    limit our flexibility in planning for, or reacting to changes in our business and the industries in which we compete;
    place us at a possible competitive disadvantage with respect to less leveraged competitors and competitors that have better access to capital resources; and
    make us more vulnerable in the event of a downturn in our business.

 

During the year ended December 31, 2004, and in the first quarter of 2005, Teradyne took steps to reduce its indebtedness, including repurchasing a total of $28.5 million of the Notes on the open market pursuant to the Board of Directors authorization given to management to repurchase up to $100 million of the outstanding Notes in open market purchases at negotiated prices below 101.50. There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the Notes.

 

We May Not Be Able to Satisfy Certain Obligations in the Event of a Change in Control.

 

The indenture governing the Notes contains provisions that apply to a change in control of Teradyne. If a “change in control” occurs, the holders of the Notes have the right to require us to repurchase all of the Notes not previously called for redemption. The price that we are required to pay is 100% of the principal amount of the Notes to be repurchased, together with interest accrued but unpaid to, but excluding, the repurchase date. At our option and subject to the satisfaction of certain conditions, instead of paying the repurchase price in cash, we may pay the repurchase price in common stock valued at 95% of the average of the closing prices of common stock for the five trading days immediately preceding and including the third trading day prior to the repurchase date. If we are required to repurchase the Notes, there is no guarantee that we will have enough funds to pay such amounts.

 

As a result, a change in control could have a material adverse effect on our business, results of operations or financial condition.

 

We May Not Be Able to Pay Our Debt and Other Obligations.

 

If our cash flow is inadequate to meet our obligations, we could face substantial liquidity problems. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments on the Notes or certain of our other obligations, we would be in default under the terms thereof, which would permit the holders of those obligations to accelerate their maturity and also could cause defaults under future indebtedness we may incur. Any such default could have a material adverse effect on our business, prospects, financial position and operating results. In addition, we cannot assure that we would be able to repay amounts due in respect of the Notes if those obligations were to be accelerated following the occurrence of any other event of default as defined in the instruments creating those obligations. Moreover, we cannot assure that we will have sufficient funds or will be able to arrange for financing to pay the principal amount due on the Notes at maturity.

 

We May Need Additional Financing, Which Could Be Difficult to Obtain.

 

We expect that our existing cash and marketable securities and cash generated from operations will be sufficient to meet our cash requirements to fund operations and expected capital expenditures for the next twelve months. However, we have a finite amount of cash and in the event we may need to raise additional funds, due to losses or other reasons, we cannot be certain that we will be able to obtain such additional financing on favorable terms, if at all. Further, if we issue additional equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. Future financings may place restrictions on how we operate our business. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services, take advantage of future opportunities, grow our business or respond to competitive pressures, which could seriously harm our business.

 

42


We Will Be Required to Account for Options Under Our Employee Stock Plans as a Compensation Expense, Which Will Adversely Affect Our Operating Results

 

There has been an increasing public debate about the proper accounting treatment for employee stock options. We currently disclose pro forma compensation expense quarterly and annually by calculating the grants’ fair value and disclosing the impact on net income (loss) and net income (loss) per share in a footnote to the consolidated financial statements. SFAS 123R or any other future laws and regulations requiring us to record the fair value of all stock options as compensation expense in our consolidated statement of operations will adversely affect operating results. Note B: “Accounting Policies,” of the consolidated financial statements reflects the impact that such a change in accounting treatment would have had on net income (loss) and net income (loss) per share if it had been in effect during the year ended December 31, 2004. Included in Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are additional stock-based compensation disclosures.

 

Provisions of Our Charter and By-Laws and Massachusetts Law Make a Takeover of Teradyne More Difficult.

 

Our basic corporate documents, our stockholder rights plan and Massachusetts law contain provisions that could discourage, delay or prevent a change in control, even if a change in control might be regarded as beneficial to some or all of our stockholders.

 

Our Operating Results Are Likely to Fluctuate Significantly.

 

Our annual operating results are affected by a wide variety of factors that could materially adversely affect revenues and profitability.

 

The following factors set out below are expected to impact future operations:

 

    competitive pressures on selling prices;
    our ability to introduce and the market acceptance of new products planned for 2005 and beyond;
    changes in product revenue mix resulting from changes in customer demand;
    the level of orders received which can be shipped in a quarter resulting from the tendency of customers to wait until late in a quarter to commit to purchase due to capital expenditure approvals and constraints occurring at the end of a quarter, or the hope of obtaining more favorable pricing from a competitor seeking the business;
    engineering and development investments relating to new product introductions in 2005 and beyond, and the expansion of manufacturing and engineering operations in Asia;
    the ability of our suppliers and subcontractors to meet product quality or delivery requirements needed to satisfy customer orders for our products, especially if product demand increases rapidly;
    provisions for excess and obsolete inventory relating to the lack of demand for and the discontinuance of products; and
    impairment charges for certain long-lived assets.

 

In particular, due to the introduction of a number of new, complex test systems in 2003 and 2004 and the planned introduction of other systems in 2005 and beyond, there can be no assurance that we will not experience delays in shipment of our products or that our products will achieve customer acceptance.

 

As a result of the foregoing and other factors, we have and may continue to experience material fluctuations in future operating results on a quarterly or annual basis which could materially and adversely affect our business, financial condition, operating results and stock price.

 

43


We have Significant Guarantees and Indemnification Obligations

 

From time to time we make guarantees to customers regarding the performance of our products, guarantee certain indebtedness obligations of our subsidiary companies and have agreed to provide indemnification to our officers, directors, employees and agents, to the extent permitted by law, arising from certain events or occurrences while the officer, director, employee or agent, is or was serving at our request in such capacity. If we become liable under any of these obligations, it could materially and adversely affect our business, financial condition and operating results. For additional information regarding “Guarantees and Indemnification Obligations” see Part I, Note J: “Commitments and Contingencies” in this Form 10-K. In addition to the guarantee and indemnification obligations set forth in this 10-K, Teradyne occasionally guarantees the performance obligations and responsibilities of its subsidiary and affiliate companies.

 

Item 7a: Quantitative and Qualitative Disclosures About Market Risks

 

Concentration of Credit Risk

 

Financial instruments which potentially subject Teradyne to concentrations of credit risk consist principally of cash investments, forward currency contracts and accounts receivable. Teradyne maintains cash investments primarily in U.S. Treasury and government agency securities and corporate debt securities, rated AA or higher, which have minimal credit risk. Teradyne places forward currency contracts with high credit-quality financial institutions in order to minimize credit risk exposure. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of geographically dispersed customers. Teradyne performs ongoing credit evaluations of its customers’ financial condition and does not require collateral to secure accounts receivable.

 

Exchange Rate Risk Management

 

Teradyne regularly enters into foreign currency forward contracts to hedge the value of our net monetary assets in European and Japanese currencies. These foreign currency forward contracts have maturities of less than one year. These contracts are used to reduce Teradyne’s risk associated with exchange rate movements, as gains and losses on these contracts are intended to offset exchange losses and gains on underlying exposures. In addition, we periodically hedge anticipated cash flow transactions with foreign currency forward contracts. The gains and losses on these contracts are deferred and recognized in the same period as the hedged transaction is recognized in income. Teradyne does not engage in currency speculation.

 

We performed a sensitivity analysis assuming a hypothetical 10% fluctuation in foreign exchange rates to the hedging contracts and the underlying exposures described above. As of December 31, 2004 and 2003, the analysis indicated that these hypothetical market movements would not have a material effect on our consolidated financial position, results of operations or cash flows.

 

Interest Rate Risk Management

 

Teradyne is exposed to potential loss due to changes in interest rates. The principal interest rate exposure is to changes in domestic interest rates. Investments with interest rate risk include short and long-term marketable securities. Debt with interest rate risk includes the fixed rate convertible debt and mortgages.

 

In order to estimate the potential loss due to interest rate risk, a 10% fluctuation in interest rates was assumed. Since the Notes were “out-of- the-money” at year-end, they were treated as a fixed rate debt security and the analysis assumes that the entire principal amount is repaid in full at maturity and the exercise of the embedded equity option is ignored. Market risk for the short and long-term marketable securities was estimated as the potential change in the fair value resulting from a hypothetical change in interest rates for securities contained in the investment portfolio. On these bases, the potential change in fair value from changes in interest rates is $0.9 million and $2.3 million as of December 31, 2004 and 2003, respectively.

 

44


Item 8: Financial Statements and Supplementary Data

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Teradyne, Inc.:

 

We have completed an integrated audit of Teradyne, Inc.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statement schedule

 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Teradyne, Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting

 

45


includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

PRICEWATERHOUSECOOPERS LLP

 

Boston, Massachusetts

March 15, 2005

 

46


TERADYNE, INC.

 

CONSOLIDATED BALANCE SHEETS

 

December 31, 2004 and 2003

 

     2004

    2003

 
     (in thousands, except
per share information)
 
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 209,147     $ 228,444  

Marketable securities

     75,431       60,974  

Accounts receivable, less allowance for doubtful accounts of $5,737 and $5,968 in 2004 and 2003, respectively

     223,491       229,532  

Inventories

                

Parts

     140,094       109,538  

Assemblies in process

     122,902       105,396  
    


 


       262,996       214,934  

Prepayments and other current assets

     34,761       35,393  
    


 


Total current assets

     805,826       769,277  

Property, plant and equipment:

                

Land

     48,112       50,503  

Buildings and improvements

     320,918       328,468  

Machinery and equipment

     948,840       894,924  

Construction in progress

     31,627       31,359  
    


 


Total

     1,349,497       1,305,254  
    


 


Less: Accumulated depreciation

     (802,422 )     (760,885 )
    


 


Net property, plant and equipment

     547,075       544,369  

Marketable securities

     406,615       296,618  

Goodwill

     116,176       118,203  

Intangible and other assets

     46,870       56,895  
    


 


Total assets

     1,922,562     $ 1,785,362  
    


 


LIABILITIES                 

Current liabilities:

                

Notes payable—banks

   $ 4,826     $ 7,272  

Current portion of long-term debt

     321       310  

Accounts payable

     62,006       74,097  

Accrued employees’ compensation and withholdings

     106,298       91,244  

Deferred revenue and customer advances

     30,399       25,391  

Other accrued liabilities

     60,970       75,125  

Accrued income taxes

     11,738       7,376  
    


 


Total current liabilities

     276,558       280,815  

Pension liability

     69,187       93,878  

Long-term other accrued liabilities

     44,321       53,441  

Convertible senior notes

     391,500       400,000  

Other long-term debt

     7,432       7,658  
    


 


Total liabilities

     788,998       835,792  
    


 


Commitments and contingencies (Note J)

                
SHAREHOLDERS’ EQUITY                 

Common stock, $0.125 par value, 1,000,000 shares authorized, 194,253 and 218,628 shares issued at December 31, 2004 and 2003, respectively and 194,253 and 191,973 shares outstanding at December 31, 2004 and 2003, respectively

     24,282       27,329  

Additional paid-in capital

     768,875       1,294,661  

Treasury stock, at cost, 26,655 shares at December 31, 2003

     —         (557,057 )

Accumulated other comprehensive loss

     (61,313 )     (51,846 )

Retained earnings

     401,720       236,483  
    


 


Total shareholders’ equity

     1,133,564       949,570  
    


 


Total liabilities and shareholders’ equity

   $ 1,922,562     $ 1,785,362  
    


 


 

The accompanying notes are an integral part of the consolidated financial statements.

 

47


TERADYNE, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Years Ended December 31,

 
     2004

    2003

    2002

 
     (in thousands,
except per share amounts)
 

Net revenue:

                        

Products

   $ 1,554,847     $ 1,115,888     $ 992,127  

Services

     237,033       236,979       230,109  
    


 


 


Total net revenue

     1,791,880       1,352,867       1,222,236  

Cost of revenues:

                        

Cost of products

     903,496       798,748       829,172  

Cost of services

     164,511       155,220       160,395  
    


 


 


Gross profit

     723,873       398,899       232,669  

Operating expenses:

                        

Engineering and development

     262,000       254,600       293,922  

Selling and administrative

     268,576       249,464       290,376  

Restructuring and other charges

     5,359       71,284       125,240  

Goodwill impairment

     —         —         78,936  

Gain on sale of a business

     (865 )     —         —    
    


 


 


       535,070       575,348       788,474  
    


 


 


Income (loss) from operations

     188,803       (176,449 )     (555,805 )

Interest income

     15,387       14,013       16,953  

Interest expense

     (18,752 )     (20,883 )     (21,783 )

Other income and expense, net

     2,536       (2,874 )     (310 )
    


 


 


Income (loss) before income taxes

     187,974       (186,193 )     (560,945 )

Provision for income taxes

     22,737       7,800       157,524  
    


 


 


Net income (loss)

   $ 165,237     $ (193,993 )   $ (718,469 )
    


 


 


Net income (loss) per common share—basic

   $ 0.85     $ (1.03 )   $ (3.93 )
    


 


 


Shares used in net income (loss) per common share—basic

     194,048       187,845       182,861  
    


 


 


Net income (loss) per common share—diluted

     0.84       (1.03 )     (3.93 )
    


 


 


Shares used in net income (loss) per common share—diluted

     197,432       187,845       182,861  
    


 


 


 

The accompanying notes are an integral part of the consolidated financial statements.

 

48


TERADYNE, INC.

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

Years Ended December 31, 2004, 2003 and 2002

 

    Shares

    Common
Stock Par
Value


    Additional
Paid-in
Capital


    Treasury
Stock


    Accumulated
Other
Comprehensive
Loss


    Retained
Earnings


    Total
Shareholders’
Equity


    Comprehensive
Income (Loss)


 
    Issued

    Reacquired

               
    (in thousands)  

Balance, December 31, 2001

  207,774     26,655     $ 25,972     $ 1,154,266     $ (557,057 )   $ (7,742 )   $ 1,148,945     $ 1,764,384          

Issuance of stock to employees under benefit plans

  2,077             259       40,980                               41,239          

Comprehensive loss:

                                                                   

Net loss

                                                (718,469 )     (718,469 )   $ (718,469 )

Foreign currency translation adjustment

                                        (104 )             (104 )     (104 )

Reclassification adjustment for loss on marketable securities included in net loss net of applicable tax of $0

                                        942               942       942  

Unrealized gains on investments, net of applicable tax of $0

                                        829               829       829  

Additional minimum pension liability, net of applicable tax of $0

                                        (60,348 )             (60,348 )     (60,348 )
                                                               


Total comprehensive loss

                                                              $ (777,150 )
   

 

 


 


 


 


 


 


 


Balance, December 31, 2002

  209,851     26,655     $ 26,231     $ 1,195,246     $ (557,057 )   $ (66,423 )   $ 430,476     $ 1,028,473          

Issuance of stock to employees under benefit plans

  8,777             1,098       99,415                               100,513          

Comprehensive loss:

                                                                   

Net loss

                                                (193,993 )     (193,993 )   $ (193,993 )

Foreign currency translation adjustment

                                        663               663       663  

Reclassification adjustment for gain on marketable securities included in net loss net of applicable tax of $0

                                        (1,776 )             (1,776 )     (1,776 )

Unrealized gains on investments, net of applicable tax of $0

                                        2,340               2,340       2,340  

Additional minimum pension liability, net of applicable tax of $0

                                        13,350               13,350       13,350  
                                                               


Total comprehensive loss

                                                              $ (179,416 )
   

 

 


 


 


 


 


 


 


Balance, December 31, 2003

  218,628     26,655     $ 27,329     $ 1,294,661     $ (557,057 )   $ (51,846 )   $ 236,483     $ 949,570          

Issuance of stock to employees under benefit plans

  2,316             289       29,962                               30,251          

Return of escrowed shares

        36                       (2,027 )                     (2,027 )        

Conversion of treasury stock to unissued shares

  (26,691 )   (26,691 )     (3,336 )     (555,748 )     559,084                       —            

Comprehensive income:

                                                                   

Net income

                                                165,237       165,237     $ 165,237  

Foreign currency translation adjustment

                                        813               813       813  

Reclassification adjustment for gain on marketable securities included in net income net of applicable tax of $0

                                        (2,404 )             (2,404 )     (2,404 )

Unrealized loss on cash flow hedge

                                        (275 )             (275 )     (275 )

Unrealized losses on investments, net of applicable tax of $0

                                        (5,339 )             (5,339 )     (5,339 )

Additional minimum pension liability, net of applicable tax of $0

                                        (2,262 )             (2,262 )     (2,262 )
                                                               


Total comprehensive income

                                                              $ 155,770  
   

 

 


 


 


 


 


 


 


Balance, December 31, 2004

  194,253     —       $ 24,282     $ 768,875     $ —       $ (61,313 )   $ 401,720     $ 1,133,564          
   

 

 


 


 


 


 


 


       

 

The accompanying notes are an integral part of the consolidated financial statements.

 

49


TERADYNE, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years Ended December 31,

 
     2004

    2003

    2002

 
     (in thousands)  

Cash flows from operating activities:

                        

Net income (loss)

   $ 165,237     $ (193,993 )   $ (718,469 )

Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:

                        

Depreciation

     118,579       147,289       151,811  

Amortization

     5,729       5,199       7,878  

Gain on sale of business

     (865 )     —         —    

Impairment of long-lived assets

     810       29,403       76,994  

Impairment of goodwill

     —         —         78,936  

(Gain) loss on sale of product lines

     (1,362 )     8,048       —    

Provision for doubtful accounts

     —         1,091       1,073  

Provision for inventory reserves

     11,335       16,569       39,021  

Deferred income tax (credit) provision

     (612 )     (2,013 )     145,326  

Other non-cash items, net

     879       3,693       10,094  

Changes in operating assets and liabilities, net of businesses and product lines sold and acquired:

                        

Accounts receivable

     6,041       (58,348 )     (6,281 )

Inventories

     (16,040 )     56,298       93,690  

Other assets

     2,992       (884 )     91,359  

Accounts payable, deferred revenue and accruals

     (42,257 )     24,025       16,025  

Accrued income taxes

     4,362       (2,211 )     8,295  
    


 


 


Net cash provided by (used for) operating activities

     254,828       34,166       (4,248 )
    


 


 


Cash flows from investing activities:

                        

Investments in property, plant and equipment

     (165,245 )     (81,185 )     (76,359 )

Proceeds from sale of business

     865       —         —    

Proceeds from asset disposals

     —         34,521       —    

Proceeds from sale of product lines

     1,259       2,114       —    

Purchases of held-to-maturity marketable securities

     —         —         (139,716 )

Maturities of held-to-maturity marketable securities

     —         29,905       139,697  

Purchases of available-for-sale marketable securities

     (367,037 )     (290,409 )     (255,161 )

Proceeds from sales and maturities of available-for-sale marketable securities

     237,249       190,689       237,741  

Cash paid for acquisition of assets

     —         —         (8,392 )
    


 


 


Net cash used by investing activities

     (292,909 )     (114,365 )     (102,190 )
    


 


 


Cash flows from financing activities:

                        

Payments of long-term debt and notes payable

     (11,467 )     (43,391 )     (871 )

Issuance of common stock under stock option and stock purchase plans

     30,251       100,513       41,239  
    


 


 


Net cash provided by financing activities

     18,784       57,122       40,368  
    


 


 


Decrease in cash and cash equivalents

     (19,297 )     (23,077 )     (66,070 )

Cash and cash equivalents at beginning of year

     228,444       251,521       317,591  
    


 


 


Cash and cash equivalents at end of year

   $ 209,147     $ 228,444     $ 251,521  
    


 


 


Supplementary disclosure of cash flow information:

                        

Cash paid (received) during the year for:

                        

Interest

   $ 16,658     $ 18,703     $ 18,963  

Income taxes paid (received)

   $ 13,963     $ 7,124     $ (88,823 )

 

The accompanying notes are an integral part of the consolidated financial statements.

 

50


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

A. THE COMPANY

 

Teradyne, Inc. is a leading supplier of automatic test equipment and a leading provider of high performance interconnection systems.

 

Teradyne’s automatic test equipment products include systems that:

 

    test semiconductors (“Semiconductor Test Systems”);
    test and inspect circuit-boards (“Assembly Test Systems”);
    diagnose, program and test automotive electronics systems (“Diagnostic Solutions”); and
    test voice and broadband access networks (“Broadband Test Systems”).

 

Teradyne’s interconnection systems products and services (“Connection Systems”) include:

 

    high bandwidth backplane assemblies; and
    high density connectors

 

Broadband Test Systems and Diagnostic Solutions have been combined into “Other Test Systems” for purposes of Teradyne’s segment reporting.

 

B. ACCOUNTING POLICIES

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Teradyne and its wholly-owned subsidiaries. All significant intercompany balances and transactions are eliminated. Certain prior years’ amounts were reclassified to conform to the current year presentation.

 

Preparation of Financial Statements and Use of Estimates

 

The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, management evaluates its estimates, including those related to inventories, investments, goodwill, intangible and other long-lived assets, bad debts, income taxes, pensions, warranties, contingencies and litigation. Management bases its estimates on historical experience and on appropriate and customary assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

 

Revenue Recognition

 

In accordance with the guidance provided by the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, “Revenue Recognition,” Teradyne recognizes revenue when there is persuasive evidence of an arrangement, title and risk of loss have passed, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to Teradyne’s customers upon shipment. In circumstances where either title or risk of loss pass upon destination, acceptance or cash payment, Teradyne defers revenue recognition until such events occur.

 

For equipment that includes hardware and software that is incidental to the product, revenue is recognized upon shipment provided that customer acceptance criteria can be demonstrated prior to shipment. Certain

 

51


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

contracts require Teradyne to perform tests of the product to ensure that performance meets the published product specifications or customer requested specifications, which are generally conducted prior to shipment. Where the criteria cannot be demonstrated prior to shipment, or in the case of new products, revenue is deferred until customer acceptance has been received. For multiple element arrangements, Teradyne defers the greater of the fair value of any undelivered elements of the contract or the portion of the sales price which is not payable until the undelivered elements are delivered. For a delivered item to be considered a separate unit, the delivered item must have value to the customer on a standalone basis, there must be objective and reliable evidence of fair value of the undelivered items in the arrangement and the delivery or performance of the undelivered item must be considered probable and substantially in the control of Teradyne. Teradyne also defers the portion of the sales price that is not due until acceptance, which represents deferred profit. Fair value is the price charged when the element is sold separately. Teradyne’s post-shipment obligations include installation, training services, one-year standard warranties, and extended warranties. Installation does not alter the product capabilities, does not require specialized skills or tools and can be performed by the customers or other vendors. Installation is typically provided within five to fifteen days of product shipment and is completed within one to two days thereafter. Training services are optional and do not affect the customer’s ability to use the product. Teradyne defers revenue for the fair value of installation and training. Extended warranties constitute warranty obligations beyond one year and Teradyne defers revenue in accordance with FASB Technical Bulletin 90-1. Teradyne’s products are generally subject to warranty and related costs are provided for in cost of revenue when product revenue is recognized. Teradyne classifies shipping and handling costs in cost of revenue. Service revenue is recognized over the contractual period or as the services are performed.

 

Connection Systems revenue is generally recognized upon shipment according to the shipping terms of the arrangement as there is no installation required and there are no contractual acceptance requirements.

 

Teradyne does not provide its customers with contractual rights of return for any of its products.

 

For transactions involving the sale of software which is not incidental to the product, revenue is recognized in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 97-2 (“SOP 97-2”), “Software Revenue Recognition,” as amended by SOP No. 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Teradyne recognizes revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. In instances where an arrangement contains multiple elements, revenue is deferred related to the undelivered elements to the extent that vendor-specific objective evidence of fair value (“VSOE”) exists for such elements. In instances where VSOE does not exist for one or more of the undelivered elements of an arrangement, all revenue related to the arrangement is deferred until all elements have been delivered. VSOE is the price charged when the element is sold separately. Revenue for the separate elements is only recognized where the functionality of the undelivered element is not essential to the delivered element.

 

For certain contracts eligible for contract accounting under SOP No. 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” revenue is recognized using the percentage-of- completion accounting method based upon the percentage of incurred costs to estimated total costs. These arrangements require significant production, modification or customization. In all cases, changes to total estimated costs and anticipated losses, if any, are recognized in the period in which they are determined. With respect to contract change orders, claims or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. Such amounts are only included in the contract value when they can be reliably estimated and realization is reasonably assured, generally upon receipt of a customer approved change order. As of December 31, 2004 and 2003, Teradyne had $13.3 million and $5.4 million in unbilled amounts on long-term contracts included in accounts receivable, respectively. These amounts will be billed on a milestone basis in accordance with contractual terms.

 

52


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

Inventories

 

Inventories, which include materials, labor, and manufacturing overhead, are stated at the lower of cost (first-in, first-out basis) or net realizable value. On a quarterly basis, Teradyne uses consistent methodologies to evaluate all inventory for net realizable value. Teradyne records a provision for excess and obsolete inventory when such a writedown is identified through the quarterly review process. The inventory valuation is based upon assumptions about future demand, product mix and possible alternative uses.

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost and depreciated over the estimated useful lives of the assets. Leasehold improvements and major renewals are capitalized and included in property, plant and equipment accounts while expenditures for maintenance and repairs and minor renewals are charged to expense. When assets are retired, the assets and related allowances for depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in operations.

 

Teradyne provides for depreciation of its assets principally on the straight line method with the cost of the assets being charged to expense over their useful lives as follows:

 

Buildings

   40 years

Building improvements

   5 to 10 years

Leasehold improvements

   3 to 10 years

Furniture and fixtures

   10 years

Test systems manufactured internally

   6 years

Machinery and equipment

   3 to 5 years

Software

   3 to 5 years

 

Test systems manufactured internally are used by Teradyne for manufacturing and support of its customers. Teradyne depreciates the test systems manufactured internally over a six-year life to cost of revenues. Teradyne often sells internally manufactured test equipment to customers. Upon the sale of the internally manufactured test system, the net book value of the system is transferred to inventory and expensed as cost of revenues. The net book value of internally manufactured test systems sold in the years ended December 31, 2004, 2003 and 2002 was $43.4 million, $15.1 million and $1.7 million, respectively.

 

Goodwill, Intangible and Long-Lived Assets

 

Teradyne accounts for its goodwill and intangible assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” Intangible assets are amortized over their estimated useful economic life using the straight-line method and are carried at cost less accumulated amortization. Goodwill is assessed for impairment at least annually in the fourth quarter, on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. If the book value of a reporting unit exceeds its fair value, the implied fair value of goodwill is compared with the carrying amount of goodwill. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recorded in an amount equal to that excess.

 

53


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

In accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” Teradyne reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the estimated undiscounted cash flows to the recorded value of the asset. If an impairment is indicated, the asset is written down to its estimated fair value based on a discounted cash flow analysis. The cash flow estimates used to determine the impairment, if any, contain management’s best estimates using appropriate assumptions and projections at that time.

 

Engineering and Development Costs

 

Teradyne’s products are highly technical in nature and require a large and continuing engineering and development effort. Software development costs incurred prior to the establishment of technological feasibility are charged to expense. Software development costs incurred subsequent to the establishment of technological feasibility are capitalized until the product is available for release to customers. To date, the period between achieving technological feasibility and general availability of the product has been short and software development costs eligible for capitalization have not been material. Engineering and development costs are expensed as incurred.

 

Advertising Costs

 

Teradyne expenses all advertising costs as incurred. Advertising costs were $3.7 million, $3.3 million and $6.5 million in 2004, 2003 and 2002, respectively.

 

Product Warranty

 

Teradyne generally provides a one-year warranty on its products commencing upon installation. A provision is recorded to cost of revenues for estimated warranty expense based upon historical experience. Related costs are charged to the warranty accrual as incurred. The balance below is included in other accrued liabilities.

 

 

     Balance

 
     (in thousands)  

Balance at December 31, 2002

   $ 9,087  

Accruals for warranties issued during the period

     17,550  

Settlements made during the period

     (15,201 )
    


Balance at December 31, 2003

   $ 11,436  

Accruals for warranties issued during the period

     16,923  

Settlements made during the period

     (15,284 )
    


Balance at December 31, 2004

   $ 13,075  
    


 

 

54


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

When Teradyne receives revenue for extended warranties beyond one year it is deferred and recognized on a straight-line basis over the contract period. Related costs are expensed as incurred. The balance below is included in other accrued liabilities.

 

     Balance

 
     (in thousands)  

Balance at December 31, 2002

   $ 2,134  

Deferral of new extended warranty revenue

     1,223  

Recognition of extended warranty deferred revenue

     (1,707 )
    


Balance at December 31, 2003

   $ 1,650  

Deferral of new extended warranty revenue

     3,793  

Recognition of extended warranty deferred revenue

     (1,353 )
    


Balance at December 31, 2004

   $ 4,090  
    


 

Employee Stock Option Plans and Employee Stock Purchase Plan

 

Teradyne accounts for its director and employee stock option and employee stock purchase plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations. Teradyne’s employee stock purchase plan is a non-compensatory plan. Teradyne’s stock option plans are accounted for using the intrinsic value method under the provisions of APB 25. Accordingly, here has been no expense for employee or director stock options or employee stock purchase plans. Proceeds from the exercise of stock options and the issuance of the employee stock purchase plan under Teradyne’s stock plans are credited to common stock at par value and the excess is credited to additional paid-in capital.

 

Teradyne makes pro forma footnote disclosures as though the fair value method was followed under Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting For Stock-Based Compensation” (“SFAS 123”), as amended by SFAS No. 148, “Accounting for Stock Based Compensation—Transition and Disclosure.” Had compensation for Teradyne’s stock based compensation plans been accounted for at fair value the amounts reported in the Statement of Operations for the years 2004, 2003 and 2002 would have been:

 

     2004

    2003

    2002

 
     (in millions, except per
share amounts)
 

Net income (loss) as reported

   $ 165.2     $ (194.0 )   $ (718.5 )

Deduct: Total stock-based employee compensation expense determined under fair value method (no tax effects included )

     (91.8 )     (85.1 )     (110.3 )
    


 


 


Pro forma net income (loss)

   $ 73.4     $ (279.1 )   $ (828.8 )

Net income (loss) per common share—basic as reported

   $ 0.85     $ (1.03 )   $ (3.93 )

Net income (loss) per common share—diluted as reported

   $ 0.84     $ (1.03 )   $ (3.93 )

Net income (loss) per common share—basic pro forma

   $ 0.38     $ (1.49 )   $ (4.53 )

Net income (loss) per common share—diluted pro forma

   $ 0.37     $ (1.49 )   $ (4.53 )

 

The weighted average grant fair value for options granted during 2004, 2003 and 2002 was $14.30, $6.47 and $9.58 per option, respectively. The fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

     2004

    2003

    2002

 

Expected life (years)

   4.5     4.4     4.3  

Interest rate

   3.1 %   2.5 %   3.4 %

Volatility

   65.5 %   68.2 %   67.1 %

Dividend yield

   0.0 %   0.0 %   0.0 %

 

55


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

The weighted-average fair value of employee stock purchase rights granted in 2004, 2003 and 2002 was $5.52, $6.07 and $5.29, respectively. The fair value of the employees’ purchase rights was estimated using the Black-Scholes option-pricing model with the following assumptions for 2004, 2003 and 2002, respectively:

 

     2004

    2003

    2002

 

Expected life (years)

   1.0     1.0     1.0  

Interest rate

   1.3 %   1.3 %   1.3 %

Volatility

   43.0 %   48.0 %   63.9 %

Dividend yield

   0.0 %   0.0 %   0.0 %

 

Investments in Other Companies

 

Teradyne holds minority interests in public and private companies having operations or technology in areas within its strategic focus. These investments are included in other long-term assets and include investments accounted for at cost and under the equity method of accounting. Under the equity method of accounting, which generally applies to investments that represent a 20 to 50 percent ownership of the equity securities of the investees, Teradyne’s proportionate share of the earnings or losses of the investees is included in other income and expense. Teradyne records an impairment charge when it believes an investment has experienced a decline in value that is other-than-temporary. At December 31, 2004 and 2003, these investments were zero and $4.6 million, respectively.

 

Income Taxes

 

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. U.S. income taxes are not provided for on the earnings of non-U.S. subsidiaries which are expected to be reinvested indefinitely in operations outside the U.S.

 

Translation of Non-U.S. Currencies

 

Assets and liabilities of non-U.S. subsidiaries except for Diagnostic Solutions, which are denominated in currencies other than the U.S. dollar, are remeasured into U.S. dollars at rates of exchange in effect at the end of the fiscal year except nonmonetary assets and liabilities which are remeasured using historical exchange rates. The functional currency for non-U.S. subsidiaries is the U.S. dollar except for Diagnostic Solutions. Diagnostic Solutions local currency is its functional currency. Revenue and expense amounts are remeasured using an average of exchange rates in effect during the year, except those amounts related to nonmonetary assets and liabilities, which are remeasured at historical exchange rates. Net realized gains and losses resulting from currency remeasurement are included in operations and were immaterial for years ended December 31, 2004, 2003 and 2002.

 

Net Income (Loss) per Common Share

 

Basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is

 

56


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

B. ACCOUNTING POLICIES—(Continued)

 

calculated by dividing net income (loss) by the sum of the weighted average number of common shares plus common stock equivalents, if applicable.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The volatility of the industries that Teradyne serves can cause certain of its customers to experience shortages of cash flows, which can impact their ability to make required payments. Teradyne maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Estimated allowances for doubtful accounts are reviewed periodically taking into account the customer’s current payment history, the customer’s current financial statements and other information regarding the customer’s credit worthiness. If the financial condition of Teradyne’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Account balances are charged off against the allowance when it is probable the receivable will not be recovered.

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) includes net income (loss), minimum pension liability adjustments, unrealized gains and losses on certain investments in debt, equity and derivative securities and cumulative translation adjustments.

 

C. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In March 2004, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“EITF 03-1”), but, in September 2004, delayed the recognition and measurement provisions of EITF 03-1. For reporting periods beginning after June 15, 2004, only the disclosure requirements for available-for-sale securities and cost method investments are required.

 

In December 2004, the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment” (“SFAS 123R”). In interim or annual periods beginning after June 15, 2005, SFAS 123R would eliminate the ability to account for equity-based compensation using the intrinsic value-based method under APB 25. SFAS 123R requires companies’ to calculate equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant.

 

Under SFAS 123R, public companies are allowed to select from three alternative transition methods: the Modified Prospective Application, which allows for the adoption of SFAS 123R without restatement of prior interim periods in the year of adoption; the Modified Prospective Application with restatement of prior interim periods in the year of adoption; and the Modified Retrospective Application which allows companies to restate prior financial statements. Teradyne expects to adopt SFAS 123R beginning in the third quarter of 2005, as required, using the Modified Prospective method, and will not restate prior periods for the adoption of SFAS 123R.

 

Currently, Teradyne discloses pro forma net income (loss) and related pro forma net income (loss) per share in accordance with SFAS 123 and SFAS 148. Under SFAS 123R, equity-based compensation expense is required to be recognized in companies’ financial statements. For the years ended December 31, 2004, 2003 and 2002, had SFAS 123R been effective, Teradyne would have recognized additional non-cash equity-based compensation expense of $91.8 million, $85.1 million, and $110.3 million, respectively, applying the provisions of SFAS 123R. Teradyne is considering accelerating the vesting of certain outstanding, unvested “out of the money” stock options awarded to employees, officers and other eligible participants under Teradyne’s various stock option plans. In addition, Teradyne is considering the use of other equity compensation vehicles including the use of restricted stock.

 

57


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

C. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS—(Continued)

 

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 modifies the accounting for abnormal inventory costs, and the manner in which companies allocate fixed overhead expenses to inventory. SFAS 151 is effective for inventory costs incurred during annual periods beginning after June 15, 2005. Teradyne does not expect SFAS 151 to have a material impact on its financial position and results of operations.

 

D. RISKS AND UNCERTAINTIES

 

Teradyne’s future results of operations involve a number of risks and uncertainties. These factors include, but are not limited to, the slowdown in economies worldwide, current geopolitical turmoil, the continuing threat of domestic and international terrorist attacks, the current and anticipated market for electronics, risks associated with any measures Teradyne has taken to address the past slowdown in the market, Teradyne’s ability to address a rapid increase in customer demand, failure to adequately protect Teradyne’s intellectual property rights, failure to develop new technologies and customers’ failure to accept new products, risks associated with acquisitions and divestitures, material litigation, competition, including new product introductions from Teradyne’s competitors and competitive pricing pressures, risks of operating internationally, risks associated with an inability to attract and retain key employees, risks associated with Teradyne’s suppliers’ failure to meet Teradyne’s product or delivery requirements, risks associated with, among other things, obligations and potential liabilities under environmental laws and regulations, Teradyne’s debt service obligations with respect to its issuance in 2001 of convertible senior notes, provisions of Teradyne’s charter and by-laws and Massachusetts law that make a takeover of Teradyne more difficult, changes in product revenue mix, the ability of Teradyne’s suppliers and subcontractors to meet product and delivery requirements, the timing and level of customer orders received which can be shipped in a quarter and the timing of investments in engineering and development.

 

E. ACQUISITIONS AND DIVESTITURES

 

On August 9, 2002, Teradyne acquired certain assets of Precision Concepts Inc. (“PCI”), of Winston-Salem, North Carolina through a bankruptcy court sanctioned sale of assets. PCI was a sole source supplier of certain components to Connection Systems. The acquisition is part of the Connection Systems operating segment. The cost of the acquired manufacturing assets and inventory was $8.4 million in cash. There was no ongoing customer revenue stream that was acquired. The operations are used to satisfy internal demand in the Connection Systems segment. Based on the purchase price allocation, the following table summarizes the fair values of the assets acquired on August 9, 2002:

 

     (in thousands)

Consideration:

      

Cash paid

   $ 8,392
    

Total consideration

   $ 8,392
    

Assets acquired:

      

Inventories

   $ 838

Property, plant, & equipment

     7,554
    

Total assets acquired

   $ 8,392
    

 

58


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

F. FINANCIAL INSTRUMENTS

 

Cash Equivalents

 

Teradyne considers all highly liquid investments with original maturities of three months or less at the date of acquisition to be cash equivalents.

 

Marketable Securities

 

Teradyne classifies investments in marketable securities as trading, available-for-sale or held-to-maturity at the time of purchase and periodically re-evaluates such classification. There were no securities classified as trading at December 31, 2004 or 2003. Securities are classified as held-to-maturity when Teradyne has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at cost with corresponding premiums or discounts amortized over the life of the investment to interest income. Securities classified as available-for-sale are reported at fair value. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income. For the years ended December 31, 2004, 2003, and 2002, Teradyne recorded realized gains of $0.7 million, $3.2 million, and $1.1 million, respectively, on the sale of its investments. For the years ended December 31, 2004, 2003, and 2002, Teradyne recorded realized losses of $0.1 million, $0.1 million, and $0.5 million, respectively, on the sale of its investments. Unrealized gains and losses are included in accumulated other comprehensive income (loss). The cost of securities sold is based on the specific identification method.

 

Short-term marketable securities mature in less than one year. Long-term marketable securities have maturities of one to five years. At December 31, 2004 and 2003 these investments are reported as follows:

 

     Available-for-Sale

     Cost

   Unrealized
Gain


   Unrealized
(Loss)


    Fair Market
Value


          (in thousands)      
2004                     

Short-term marketable securities:

                            

U.S. Treasury and government agency securities

   $ 22,218    $ 16    $ (95 )   $ 22,139

Corporate debt securities

     53,369      140      (217 )     53,292
    

  

  


 

     $ 75,587    $ 156    $ (312 )   $ 75,431
    

  

  


 

Long-term marketable securities:

                            

U.S. Treasury and government agency securities

   $ 152,200    $ 401      (1,094 )   $ 151,507

Corporate debt securities

     256,112      986      (1,990 )     255,108
    

  

  


 

     $ 408,312    $ 1,387    $ (3,084 )   $ 406,615
    

  

  


 

     Available-for-Sale

     Cost

   Unrealized
Gain


   Unrealized
(Loss)


    Fair Market
Value


     (in thousands)
2003                     

Short-term marketable securities:

                            

U.S. Treasury and government agency securities

   $ 23,770    $ 178    $ (2 )   $ 23,946

Corporate debt securities

     36,527      504      (3 )     37,028
    

  

  


 

     $ 60,297    $ 682    $ (5 )   $ 60,974
    

  

  


 

Long-term marketable securities:

                            

U.S. Treasury and government agency securities

   $ 153,225    $ 1,392    $ (370 )   $ 154,247

Corporate debt securities

     139,464      3,465      (558 )     142,371
    

  

  


 

     $ 292,689    $ 4,857    $ (928 )   $ 296,618
    

  

  


 

 

59


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

F. FINANCIAL INSTRUMENTS—(Continued)

 

Other

 

As of December 31, 2004, the estimated fair value of Teradyne’s convertible notes was approximately $395.3 million compared to the carrying value of $391.5 million. As of December 31, 2003, the estimated fair value of Teradyne’s convertible notes was approximately $462.0 million compared to the carrying value of $400.0 million. The estimated fair value of the convertible notes is based on the quoted market prices of the convertible notes on December 31, 2004 and 2003.

 

Fair values for Teradyne’s non-convertible debt were determined based on interest rates that are currently available to Teradyne for the issuance of debt with similar terms and remaining maturities for debt issues and approximate carrying values.

 

For all other balance sheet financial instruments, the carrying amount approximates fair value.

 

Derivatives

 

Teradyne adopted SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 137, SFAS 138, and SFAS 149. SFAS 133 requires Teradyne to recognize all derivatives on the balance sheet at fair value. Adoption of SFAS 133 did not have a material impact on Teradyne’s financial position and results of operations.

 

Teradyne conducts business in a number of foreign countries, with certain transactions denominated in local currencies. The purpose of Teradyne’s foreign currency management is to minimize the effect of exchange rate fluctuations on certain foreign denominated net monetary assets and anticipated cash flows. The terms of currency instruments used for hedging purposes are consistent with the timing of the transactions being hedged. Teradyne does not use derivative financial instruments for trading or speculative purposes.

 

To minimize the effect of exchange rate fluctuations associated with the remeasurement of net monetary assets denominated in foreign currencies, Teradyne enters into foreign currency forward contracts. The change in fair value of these derivatives is recorded directly in earnings, and is used to offset the change in fair value of the net monetary assets denominated in foreign currencies.

 

To minimize the effect of exchange rate fluctuations associated with the future cash flows of revenue contracts denominated in a foreign currency, Teradyne enters into foreign currency forward contracts. These foreign currency forward contracts are designated as cash flow hedges and are carried on the Teradyne’s balance sheet at fair value with the effective portion of the contracts’ gains or losses included in accumulated other comprehensive income (loss) and subsequently recognized in earnings in the same period the hedged transaction occurs. These forward contracts generally expire within 24 months.

 

At December 31, 2004 and 2003, Teradyne had the following forward currency contracts to buy and sell non-U.S. currencies for U.S. dollars with the following notional amounts:

 

     December 31, 2004

    December 31, 2003

 
     Buy
Position


    Sell
Position


   Net
Total


    Buy
Position


    Sell
Position


   Net
Total


 
     (in millions)  

Japanese Yen

   $ —       $ 16.5    $ 16.5     $ (0.5 )   $ 8.9    $ 8.4  

British Pound Sterling

     (11.7 )     11.0      (0.7 )     (8.8 )     11.6      2.8  

European Euro

     (1.2 )     17.2      16.0       (9.7 )     4.4      (5.3 )
    


 

  


 


 

  


Total

   $ (12.9 )   $ 44.7    $ 31.8     $ (19.0 )   $ 24.9    $ 5.9  
    


 

  


 


 

  


 

60


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

F. FINANCIAL INSTRUMENTS—(Continued)

 

The fair value of the outstanding contracts at December 31, 2004 and 2003 was not material. Teradyne recorded net realized losses related to foreign currency forward contracts hedging net monetary positions in 2004 of $1.9 million. For 2003 and 2002, Teradyne recorded net realized gains related to forward contracts hedging net monetary positions of $1.7 million and $0.9 million, respectively. Both the contract gains and losses on the items being hedged are included in selling and administrative expenses.

 

During fiscal 2002 and 2003, there were no cash flow designated hedges. During 2004, $0.1 million of losses on cash flow hedges due to ineffectiveness was included in selling and administrative expense.

 

Derivative gains and losses included in accumulated other comprehensive loss are reclassified into earnings when the forecasted transaction occurs. During fiscal 2004, $0.4 million of losses were reclassified to revenue.

 

Of the net derivative losses included in accumulated other comprehensive loss as of December 31, 2004, $0.3 million will be reclassified into earnings within the next twelve months. No cash flow hedges were derecognized or discontinued during fiscal 2004.

 

At December 31, 2003 and 2002, Teradyne held warrants to purchase 0.3 million shares of common stock of LogicVision, Inc., a public technology company, at an exercise price of $4.86 per share. During 2004, the warrants expired. In accordance with SFAS 133, Teradyne recorded a loss of $0.4 million, a gain of $0.1 million and a loss of $2.1 million in other income and expense for the changes in fair value of the warrants for the years ended December 31, 2004, 2003 and 2002 respectively.

 

Concentration of Credit Risk

 

Financial instruments which potentially subject Teradyne to concentrations of credit risk consist principally of marketable securities, forward currency contracts and accounts receivable. Teradyne maintains cash investments primarily in U.S. Treasury and government agency securities and corporate debt securities, rated AA or higher, which have minimal credit risk. Teradyne places forward currency contracts with high credit-quality financial institutions in order to minimize credit risk exposure. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of geographically dispersed customers. Teradyne performs ongoing credit evaluations of its customers’ financial condition but does not require collateral to secure accounts receivable.

 

G. DEBT

 

Long-term debt at December 31, 2004 and 2003 consisted of the following:

 

     2004

   2003

     (in thousands)

Convertible senior notes

   $ 391,500    $ 400,000

Mortgage notes payable

     5,040      5,040

Other long-term debt

     2,713      2,928
    

  

Total

     399,253      407,968

Less current maturities

     321      310
    

  

     $ 398,932    $ 407,658
    

  

 

The total maturities of long-term debt for the succeeding five years and thereafter are: 2005—$0.3 million; 2006—$391.8 million; 2007—$0.3 million; 2008—$0.3 million; 2009—$0.3 million and $6.3 million thereafter.

 

61


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

G. DEBT—(Continued)

 

Convertible Senior Notes

 

In 2001, Teradyne issued $400 million principal amount of 3.75% Convertible Senior Notes due 2006 (the “Notes”) in a private placement and received net proceeds of $389 million. The Notes are convertible at the option of the holders at a rate which is equivalent to a conversion price of approximately $26.00 per share, which is equal to a conversion rate of approximately 38.4615 shares of common stock per $1,000 principal amount of Notes. On or after October 18, 2004, Teradyne may redeem the Notes in whole or in part at the prices set forth below. The redemption price, expressed as a percentage of principal amount, is as follows for the designated periods:

 

Period


   Redemption
Price


 

Beginning on October 18, 2004 and ending on October 14, 2005

   101.50 %

Beginning on October 15, 2005 and ending on October 14, 2006

   100.75 %

 

and thereafter equal to 100% of the principal amount.

 

Teradyne began making annual interest payments of up to $15 million, paid semi-annually, on the Notes on April 15, 2002. The Notes are senior unsecured obligations of Teradyne that rank equally with Teradyne’s existing and future unsecured and unsubordinated indebtedness. If a “change in control” occurs, the holders of the Notes have the right to require Teradyne to repurchase all of the Notes not previously called for redemption. The price Teradyne is required to pay is 100% of the principal amount of the Notes to be repurchased, together with interest accrued but unpaid to, but excluding, the repurchase date. At Teradyne’s option and subject to the satisfaction of certain conditions, instead of paying the repurchase price in cash, it may pay the repurchase price in common stock valued at 95% of the average of the closing prices of common stock for the five trading days immediately preceding and including the third trading day prior to the repurchase date. During 2004, Teradyne repurchased $8.5 million of the outstanding principal amount of the Notes pursuant to the Board of Directors authorization given to management to repurchase up to $100 million of the outstanding Notes in open market purchases at negotiated prices below 101.50. Teradyne incurred no gain or loss during the year ended December 31, 2004 as a result of this transaction. As of December 31, 2004, $391.5 million of the Notes remain outstanding.

 

Mortgage Notes Payable

 

On December 19, 2001, Teradyne obtained a loan of approximately $45 million in the form of a 7.5% mortgage loan maturing on January 1, 2007. This loan was collateralized by certain Teradyne California real estate properties. Teradyne prepaid this mortgage in the third quarter of 2003. Prior to the prepayment, principal payments were made according to a twenty-year amortization schedule through December 2006, with the remaining principal due on January 1, 2007.

 

In 1983, Teradyne obtained a loan of $4.5 million from the Boston Redevelopment Authority in the form of a 3% mortgage loan maturing March 31, 2013. This loan is collateralized by Teradyne’s property in Boston, Massachusetts, which may, at Teradyne’s option, become subordinated to another mortgage up to a maximum of $5.0 million. Interest for the first 4½ years of the loan was capitalized up to a principal amount of $5.0 million. Since September 30, 1987, Teradyne has been making semi-annual interest payments. The outstanding principal balance of this mortgage was $5.0 million as of December 31, 2004.

 

62


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

G. DEBT—(Continued)

 

Notes Payable- Banks

 

The weighted average interest rates on notes payable outstanding in Japan as of December 31, 2004 and 2003 was 1.4% and 1.2%, respectively. The outstanding notes payable balance as of December 31, 2004 and 2003 was $4.8 million and $7.3 million, respectively.

 

H. ACCUMULATED OTHER COMPREHENSIVE LOSS

 

At December 31, 2004 and 2003, the accumulated other comprehensive loss balances were:

 

     2004

    2003

 
     (in thousands)  

Minimum pension liability

   $ (60,548 )   $ (58,286 )

Unrealized (loss)/gain on investments

     (1,871 )     5,872  

Foreign currency translation adjustments

     1,381       568  

Unrealized loss on cash flow hedge

     (275 )     —    
    


 


Total accumulated other comprehensive loss

   $ (61,313 )   $ (51,846 )
    


 


 

I. GOODWILL AND INTANGIBLE ASSETS

 

Intangible Assets

 

Amortizable intangible assets consist of the following:

 

     December 31, 2004

     Gross
Carrying
Amount


   Accumulated
Amortization


   Net
Carrying
Amount


  

Weighted

Average

Useful Life


     (in thousands)

Completed technology

   $ 19,193    $ 8,145    $ 11,048    7.5 years

Service and software maintenance contracts and customer relationships

     8,342      5,440      2,902    5.7 years

Tradenames and trademarks

     3,800      1,504      2,296    8.0 years
    

  

  

    

Total intangible assets

   $ 31,335    $ 15,089    $ 16,246    7.1 years
    

  

  

    
     December 31, 2003

     Gross
Carrying
Amount


  

Accumulated

Amortization


   Net
Carrying
Amount


  

Weighted

Average

Useful Life


     (in thousands)

Completed technology

   $ 19,193    $ 5,577    $ 13,616    7.5 years

Service and software maintenance contracts and customer relationships

     8,342      4,840      3,502    5.7 years

Tradenames and trademarks

     3,800      1,029      2,771    8.0 years
    

  

  

    

Total intangible assets

   $ 31,335    $ 11,446    $ 19,889    7.1 years
    

  

  

    

 

During 2003, Assembly Test Systems sold its manufacturing software product line and manual x-ray inspection and rework product line for total cash proceeds of $2.1 million. These transactions resulted in a loss of $6.2 million which has been recorded in restructuring and other charges. Included in the $6.2 million loss is an intangible asset impairment charge of $3.7 million. Also during 2003, Assembly Test Systems recorded an

 

63


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

I. GOODWILL AND INTANGIBLE ASSETS—(Continued)

 

intangible asset impairment charge of $2.6 million as a result of the discontinuance of manufacturing, distributing and primary support of one of the automated x-ray inspection (“AXI”) products. Both charges were recorded in Restructuring and Other Charges in the consolidated Statement of Operations.

 

During 2002, Teradyne recorded an intangible asset impairment charge of $7.3 million related to the divestiture of two product lines in its Assembly Test Systems segment. The charge was recorded in Restructuring and Other Charges in the consolidated Statement of Operations.

 

Aggregate amortization expense for the years ended December 31, 2004, 2003 and 2002 was $3.6 million, $4.4 million and $7.3 million, respectively. Estimated amortization expense for each of the five succeeding fiscal years is as follows:

 

Year


   Amount

     (in thousands)

2005

   $ 3,643

2006

     3,643

2007

     3,529

2008

     2,962

2009

     2,469

 

Goodwill

 

Teradyne has identified two reporting units with goodwill, Connection Systems and Assembly Test Systems, which are also reportable segments. The changes in the carrying amounts of goodwill during the years ended December 31, 2004 and 2003 are as follows:

 

     Connection
Systems


   Assembly
Test
Systems


   Total

     (in thousands)

Balance at December 31, 2003

   $ 49,056    $ 69,147    $ 118,203

Balance at December 31, 2004

   $ 47,029    $ 69,147    $ 116,176

 

During 2004, goodwill was reduced by $2.0 million in the Connection Systems segment as a result of the return of escrowed shares related to the Herco Technology, Corp. and Perception Laminates, Inc. acquisitions.

 

SFAS 142 required Teradyne to complete a transitional goodwill impairment test within six months from the date of adoption. Following the adoption of SFAS 142, Teradyne completed an initial impairment test, during the first quarter of 2002, based on the comparison of the fair value of the reporting units with their respective carrying value as of January 1, 2002. Teradyne concluded that there was no impairment in either the Assembly Test Systems segment or the Connection Systems segment as of adoption. As of January 1, 2002, Teradyne ceased the amortization of goodwill. SFAS 142 provides that goodwill of a reporting unit be tested for impairment on an annual basis and between annual tests in certain circumstances including a significant adverse change in the business outlook. Teradyne’s annual impairment test is performed in the fourth quarter of each fiscal year. Teradyne tested both the Assembly Test Systems and Connection Systems reporting units for impairment during its annual test and concluded that there was no impairment of goodwill in either reporting unit as of December 31, 2004, 2003 and 2002.

 

During the quarter ended September 29, 2002, as a result of contraction in the Assembly Test Systems market to its lowest level in a decade as evidenced by various market reports available to Teradyne, Teradyne

 

64


TERADYNE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

I. GOODWILL AND INTANGIBLE ASSETS—(Continued)

 

decreased its forecasted revenue, bookings and profit for fiscal years 2003 through 2005 from the previous quarter’s forecast for the Assembly Test Systems segment and reduced its workforce by 94 employees to appropriately size the segment given the revised business outlook. As a result, Teradyne performed an interim impairment test for the goodwill related to the Assembly Test Systems segment as of September 29, 2002. Teradyne concluded that the carrying value of the assets and liabilities associated with the Assembly Test Systems segment exceeded its fair value and recognized a $78.5 million goodwill impairment charge recorded in Goodwill impairment in the consolidated Statements of Operations. The impairment charge was measured by comparing the implied fair value of the goodwill associated with the Assembly Test Systems segment to its carrying value. The fair value of the segment was estimated using the expected present value of future cash flows.

 

J. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

 

Rental expense for the years ended December 31, 2004, 2003 and 2002 was $24.3 million, $26.4 million and $32.4 million, respectively.

 

The following table reflects Teradyne’s non-cancelable operating lease commitments:

 

     Non-cancelable
Lease
Commitments*


     (in thousands)

2005

   $ 27,681

2006

     16,862