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TERADYNE, INC - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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, as amended. 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. Readers are cautioned not to place undue reliance on these forward-looking statements which reflect management's analysis only as of the date hereof. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements, except as may be required by law. 19 -------------------------------------------------------------------------------- Table of Contents Overview We are a leading global supplier of automatic test equipment. We design, develop, manufacture and sell automatic test systems and solutions used to test semiconductors, wireless products, hard disk drives and circuit boards in the consumer electronics, wireless, automotive, industrial, computing, communications and aerospace and defense industries. Our automatic test equipment products and services include: • semiconductor test ("Semiconductor Test") systems; • wireless test ("Wireless Test") systems; and • military/aerospace ("Mil/Aero") test instrumentation and systems, storage test ("Storage Test") systems, circuit-board test and inspection ("Commercial Board Test") systems, collectively these products represent "Systems Test Group". We have a broad customer base which includes integrated device manufacturers ("IDMs"), outsourced semiconductor assembly and test providers ("OSATs"), wafer foundries, fabless companies that design, but contract with others for the manufacture of integrated circuits ("ICs"), developers of wireless devices and consumer electronics, manufacturers of circuit boards, automotive suppliers, wireless product manufacturers, storage device manufacturers, aerospace and military contractors. In 2011, we acquired LitePoint Corporation ("LitePoint") to expand our product portfolio of test equipment in the wireless test sector. LitePoint designs, develops, and supports advanced wireless test solutions for the development and manufacturing of wireless devices, including smart phones, tablets, notebooks/laptops, personal computer peripherals, and other Wi-Fi and cellular enabled devices. LitePoint is our Wireless Test segment. The sales of our products and services are dependent, to a large degree, on customers who are subject to cyclical trends in the demand for their products. These cyclical periods have had, and will continue to have, a significant effect on our business since our customers often delay or accelerate purchases in reaction to changes in their businesses and to demand fluctuations in the semiconductor industry. Historically, these demand fluctuations have resulted in significant variations in our results of operations. This was particularly relevant beginning in the fourth quarter of fiscal year 2008 where we saw a significant decrease in revenues in our Semiconductor Test business which was impacted by the deteriorating global economy, which negatively impacted the entire semiconductor industry. The sharp swings in the semiconductor industry in recent years have generally affected the semiconductor test equipment and services industry more significantly than the overall capital equipment sector. We believe our acquisitions of LitePoint, Eagle Test and Nextest, and our entry into the high speed memory and storage test markets have enhanced our opportunities for growth. We will continue to invest in our business to expand further our addressable markets while tightly managing our costs. On March 21, 2011, we completed the sale of our Diagnostic Solutions business unit, which was included in the Systems Test Group segment, to SPX Corporation for $40.2 million in cash. We sold this business as its growth potential as a stand-alone business was significantly less than if it was part of a larger automotive supplier. The financial information for Diagnostic Solutions has been reclassified to discontinued operations. Critical Accounting Policies and Estimates We have identified the policies discussed below as critical to understanding our business and our results of operations and financial condition. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. 20 -------------------------------------------------------------------------------- Table of Contents 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, deferred tax assets, 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 We recognize revenues 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 our customers upon shipment or at delivery destination point. In circumstances where either title or risk of loss pass upon destination, acceptance or cash payment, we defer revenue recognition until such events occur. Our equipment has non-software and software components that function together to deliver the equipment's essential functionality. Revenue is recognized upon shipment or at delivery destination point, provided that customer acceptance criteria can be demonstrated prior to shipment. Certain contracts require us 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, revenue is deferred until customer acceptance has been received. We also defer the portion of the sales price that is not due until acceptance, which represents deferred profit. For multiple element arrangements, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, a hierarchy is used to determine the selling price for allocating revenue to deliverables as follows: (i) vendor-specific objective evidence of selling price ("VSOE"), (ii) third-party evidence of selling price ("TPE"), and (iii) best estimate of the selling price ("BESP"). For a delivered item to be considered a separate unit, the delivered item must have value to the customer on a standalone basis and the delivery or performance of the undelivered item must be considered probable and substantially in our control. Our 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 days of product shipment and is completed within one to two days thereafter. Training services are optional and do not affect the customers' ability to use the product. We defer revenue for the selling price of installation and training. Extended warranties constitute warranty obligations beyond one year and we defer revenue in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 605-20, "Separately Priced Extended Warranty and Product Maintenance Contracts" and ASC 605-25, "Revenue Recognition Multiple-Element Arrangements." Service revenue is recognized over the contractual period or as services are performed. Our products are generally subject to warranty and the related costs of the warranty are provided for in cost of revenues when product revenue is recognized. We classify shipping and handling costs in cost of revenue. We generally do not provide our customers with contractual rights of return for any of our products. Retirement and Postretirement Plans Effective January 1, 2012, we changed the method of recognizing actuarial gains and losses for our defined benefit pension plans and postretirement benefit plan and calculating the expected return on plan assets for our 21-------------------------------------------------------------------------------- Table of Contents defined benefit pension plans. Historically, we recognized net actuarial gains and losses in accumulated other comprehensive income within shareholders' equity on our consolidated balance sheets on an annual basis and amortized them into operating results over the average remaining years of service of the plan participants, to the extent such gains and losses were outside of a range ("corridor"). We elected to immediately recognize net actuarial gains and losses and the change in the fair value of the plan assets in our operating results in the year in which they occur or upon any interim remeasurement of the plans. In addition, we used to calculate the expected return on plan assets using a calculated market-related value of plan assets. Effective January 1, 2012, we elected to calculate the expected return on plan assets using the fair value of the plan assets. We believe that this new method is preferable as it eliminates the delay in recognizing gains and losses in our operating results and it will improve the transparency by faster recognition of the effects of economic and interest rate trends on plan obligations and investments. These actuarial gains and losses are generally measured annually as of December 31 and, accordingly, will be recorded during the fourth quarter of each year or upon any interim remeasurement of the plans. In accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 250, Accounting Changes and Error Corrections, all prior periods presented in this Annual Report on Form 10-K have been adjusted to apply the new accounting method retrospectively. Inventories Inventories are stated at the lower of cost (first-in, first-out basis) or net realizable value. On a quarterly basis, we use consistent methodologies to evaluate all inventories for net realizable value. We record a provision for both excess and obsolete inventory when such write-downs or write-offs are identified through the quarterly review process. The inventory valuation is based upon assumptions about future demand, product mix, and possible alternative uses. Equity Incentive and Stock Purchase Plans Stock-based compensation expense is based on the grant-date fair value estimated in accordance with the provisions of ASC 718 "Compensation-Stock Compensation". As required by ASC 718, we have made an estimate of expected forfeitures and are recognizing compensation costs only for those stock-based compensation awards expected to vest. Income Taxes On a quarterly basis, we evaluate the realizability of our deferred tax assets by jurisdiction and assess the need for a valuation allowance. We consider the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. As a result of this review, undertaken at December 31, 2002, we concluded under applicable accounting criteria that it was more likely than not that our deferred tax assets would not be realized and established a valuation allowance in several jurisdictions, most notably the United States. At December 31, 2011, we reassessed this judgment and concluded that it is more likely than not that a substantial majority of our deferred tax assets will be realized through consideration of both the positive and negative evidence. The evidence consisted primarily of our three year U.S. historical cumulative profitability, projected future taxable income, forecasted utilization of the deferred tax assets and the fourth quarter of 2011 acquisition of LitePoint offset by the volatility of the industries we operate in, primarily the semiconductor industry. As such, we reduced the valuation allowance by $190.2 million, which was recorded as a tax benefit in the year ended December 31, 2011. At December 31, 2012 and 2011, we maintained a valuation allowance for certain deferred tax assets of $55.4 million and $51.1 million, respectively, primarily related to excess stock compensation deductions associated with pre-2006 activity, state net operating losses and state tax credit carryforwards, due to uncertainty regarding their realization. Adjustments could be required in the future if we estimate that the amount of deferred tax assets to be realized is more or less than the net amount we have recorded. 22 -------------------------------------------------------------------------------- Table of Contents On January 2, 2013, the American Taxpayer Relief Act of 2012 was enacted which retrospectively reinstated the research and development tax credit for 2012 and extended it through December 31, 2013. As a result, in the first quarter of 2013, we expect to record a discrete benefit related to 2012 of approximately $7.0 million. Investments We account for our investments in debt and equity securities in accordance with the provisions of ASC 320-10, "Investments-Debt and Equity Securities." On a quarterly basis, we review our investments to identify and evaluate those that have an indication of a potential other-than-temporary impairment. Factors considered in determining whether a loss is other-than-temporary include: • The length of time and the extent to which the market value has been less than cost; • The financial condition and near-term prospects of the issuer; and • The intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value. Goodwill, Intangible and Long-Lived Assets We assess the impairment of intangible and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important in the determination of an impairment include significant underperformance relative to historical or projected future operating results, significant changes in the manner that we use the acquired asset and significant negative industry or economic trends. When we determine 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, we measure any impairment based on a projected discounted cash flow method using a discount rate commensurate with the associated risks. We assess 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. No goodwill impairment was identified in 2012 or 2011. 23-------------------------------------------------------------------------------- Table of Contents SELECTED RELATIONSHIPS WITHIN THE CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2012 2011 2010 Percentage of net revenues: Net revenues: Products 83.5 % 81.2 % 85.0 % Services 16.5 18.8 15.0 Total net revenues 100.0 100.0 100.0 Cost of revenues: Cost of products 38.8 40.5 37.7 Cost of services 7.7 9.7 7.6 Total cost of revenues 46.5 50.2 45.2 Gross profit 53.5 49.8 54.8 Operating expenses: Engineering and development 15.2 13.8 12.3 Selling and administrative 17.0 16.5 14.4 Acquired intangible assets amortization 4.4 2.8 1.9 Restructuring and other (0.5 ) 0.5 (0.2 ) Total operating expenses 36.1 33.6 28.3 Income from operations 17.3 16.2 26.5 Interest income 0.2 0.5 0.4 Interest expense and other (1.5 ) (1.7 ) (1.6 ) Income from continuing operations before income taxes 16.1 15.0 25.3 Provision (benefit) for income taxes 3.0 (9.1 ) 1.1 Income from continuing operations 13.1 24.1 24.2 Income from discontinued operations before income taxes - 0.1 0.3 (Benefit) provision for income taxes - 0.0 0.0 Income from discontinued operations - 0.1 0.3 Gain on disposal of discontinued operations (net of tax) - 1.7 - Net income 13.1 % 25.9 % 24.6 % Results of Operations Book to Bill Ratio Book to bill ratio is calculated as net bookings divided by net sales. Book to bill ratio by reportable segment was as follows: Three months ended December 31, 2012 2011 2010 Semiconductor Test 1.0 1.2 1.1 Wireless Test 1.1 0.7 - Systems Test Group 1.6 1.9 1.0 Total Company 1.1 1.3 1.1 24 -------------------------------------------------------------------------------- Table of Contents Revenues Net revenues for our three reportable segments were as follows: 2011-2012 2010-2011 Dollar Dollar 2012 2011 2010 Change Change (in millions) Semiconductor Test $ 1,127.7 $ 1,106.2 $ 1,413.3 $ 21.5 $ (307.1 ) Wireless Test 286.4 28.4 - 258.0 28.4 Systems Test Group 242.7 294.5 152.9 (51.8 ) 141.6 $ 1,656.8 $ 1,429.1 $ 1,566.2 $ 227.7 $ (137.1 ) The increase in Semiconductor Test revenues of $21.5 million or approximately 2% from 2011 to 2012 was primarily due to an increase in system-on-a-chip ("SOC") test products for mobility applications, partially offset by a decrease in memory system sales. Semiconductor Test revenues decreased $307.1 million or approximately 22% from 2010 to 2011, due to a decrease in SOC product sales. Semiconductor Test product demand can fluctuate significantly from year to year based upon semiconductor device unit growth and installed base utilization. The 2011 decrease was due to lower volume from reduced demand. The decrease in Systems Test Group revenues of $51.8 million or approximately 18% from 2011 to 2012 was primarily due to a decrease in sales due to lower volume in both Storage Test systems and Commercial Board Test systems, partially offset by an increase in Mil/Aero systems and instruments. The increase in Systems Test Group revenues of $141.6 million or approximately 93% from 2010 to 2011 was primarily due to an increase in sales of Storage Test systems, which was driven by new customers and new product applications. The acquisition of LitePoint, which was completed in October of 2011, added $286.4 million and $28.4 million of revenues in 2012 and 2011, respectively. LitePoint is our Wireless Test segment. Our three reportable segments accounted for the following percentages of consolidated net revenues for each of the last three years: 2012 2011 2010 Semiconductor Test 68 % 77 % 90 % Wireless Test 17 2 - Systems Test Group 15 21 10 100 % 100 % 100 % Net revenues by region as a percentage of total revenues were as follows: 2012 2011 2010 China 21 % 13 % 9 % Taiwan 18 12 18 United States 14 16 15 Korea 14 10 8 Japan 6 10 5 Philippines 6 9 12 Europe 5 7 6 Singapore 5 6 9 Thailand 5 6 4 Malaysia 4 10 13 Rest of the World 2 1 1 100 % 100 % 100 % 25 -------------------------------------------------------------------------------- Table of Contents The breakout of product and service revenues for the past three years was as follows: 2011-2012 2010-2011 Dollar Dollar 2012 2011 2010 Change Change (in millions) Product Revenues $ 1,383.6 $ 1,160.2 $ 1,331.0 $ 223.4 $ (170.8 ) Service Revenues 273.2 268.9 235.2 4.3 33.7 $ 1,656.8 $ 1,429.1 $ 1,566.2 $ 227.7 $ (137.1 ) Our product revenues increased $223.4 million or 19% in 2012 from 2011 primarily due to $282.4 million of product revenues from the addition of LitePoint, an increase in SOC Semiconductor Test products for mobility applications and an increase in Mil/Aero systems and instruments. The increase was partially offset by a decrease in sales in our memory test and Storage Test systems. Service revenues, which are derived from the servicing of our installed base of products and includes maintenance contracts, repairs, extended warranties, parts sales, and applications support, increased $4.3 million or 2% due to higher volume. Our product revenues decreased $170.8 million or 13% in 2011 from 2010 primarily due to lower sales of SOC Semiconductor Test products. Semiconductor Test product sales demand can fluctuate significantly from year to year based upon semiconductor device unit growth and installed base utilization. The 2011 decrease was due to lower volume from reduced demand. The decrease was partially offset by an increase in sales of Storage Test systems, which was driven by new customers and new product applications. The LitePoint acquisition which was completed in October of 2011 added $27.8 million of product revenue in 2011. Service revenues, which are derived from the servicing of our installed base of products and includes maintenance contracts, repairs, extended warranties, parts sales, and applications support, increased $33.7 million or 14% due to higher volume. In 2012, revenues from one customer accounted for 10% of our consolidated net revenues. In 2011 and 2010, no single customer accounted for 10% or more of our consolidated net revenues. In each of the years 2012, 2011 and 2010, our three largest customers in aggregate accounted for 29%, 19% and 21% of our consolidated net revenues, respectively. Gross Profit 2011-2012 2010-2011 Dollar / Dollar / Point Point 2012 2011 2010 Change Change (dollars in millions) Gross Profit $ 886.0 $ 711.8 $ 857.6 $ 174.2 $ (145.8 ) Percent of Total Revenues 53.5 % 49.8 % 54.8 % 3.7 (5.0 ) Gross profit as a percentage of revenues increased from 2011 to 2012 by 3.7 percentage points. This increase was a result of an increase of 4.6 points primarily due to the addition of LitePoint, partially offset by a decrease of 1.2 points due to higher inventory provisions. Gross profit as a percentage of revenues decreased from 2010 to 2011 by 5.0 percentage points. This decrease was the result of a decrease of 2.9 points related to product mix primarily from higher Storage Test system sales, a decrease of 0.9 points for a charge to adjust LitePoint acquired inventory to fair value, a decrease of 0.5 points due to lower volume, and a decrease of 0.3 points due to higher inventory provisions. 26-------------------------------------------------------------------------------- Table of Contents The breakout of product and service gross profit was as follows: 2011-2012 2010-2011 Dollar / Dollar / Point Point 2012 2011 2010 Change Change (dollars in millions)Product Gross Profit $ 740.7 $ 581.2 $ 741.1 $ 159.5 $ (159.9 ) Percent of Product Revenues 53.5 % 50.1 % 55.7 % 3.4 (5.6 ) Service Gross Profit $ 145.3 $ 130.6 $ 116.5 $ 14.7 $ 14.1 Percent of Service Revenues 53.2 % 48.6 % 49.5 % 4.6 (0.9 ) We assess the carrying value of our 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 during the next four quarters, is written-down to estimated net realizable value. During the year ended December 31, 2012, we recorded an inventory provision of $26.8 million included in cost of revenues, due to the following factors: - A decline in demand compared to previously forecasted demand levels for prior generation Nextest Magnum testers resulted in an inventory provision of $12.0 million in Semiconductor Test. - A $5.3 million inventory write-down as a result of product transition related to the Flex Test Platform in Semiconductor Test. - A $3.9 million inventory write-down as a result of product transition in Wireless Test. - The remainder of the charge of $5.6 million primarily reflects downward revisions to previously forecasted demand levels, of which $4.3 million was in Systems Test Group, $0.2 million in Wireless Test and $1.1 million in Semiconductor Test. During the year ended December 31, 2011, we recorded an inventory provision of $11.6 million included in cost of revenues, due to the downward revisions to previously forecasted demand levels. Of the $11.6 million of total excess and obsolete provisions recorded in 2011, $10.4 million was related to Semiconductor Test primarily due to product transition, $1.1 million was in Systems Test Group, and $0.1 million was in Wireless Test. During the year ended December 31, 2010, we recorded an inventory provision of $6.0 million included in cost of revenues, due to the downward revisions to previously forecasted demand levels. Of the $6.0 million of total excess and obsolete provisions recorded in 2010, $4.5 million was related to Semiconductor Test and $1.5 million was in Systems Test Group. During the years ended December 31, 2012, 2011 and 2010, we scrapped $9.6 million, $9.2 million and $4.7 million of inventory, respectively, and sold $4.3 million, $8.1 million and $8.3 million of previously written-down or written-off inventory, respectively. As of December 31, 2012, we had inventory related reserves for amounts which had been written-down or written-off totaling $141.8 million. We have no pre-determined timeline to scrap the remaining inventory. Engineering and Development Engineering and development expenses were as follows: 2011-2012 2010-2011 2012 2011 2010 Change Change (dollars in millions) Engineering and Development $ 251.4 $ 197.8 $ 191.9 $ 53.6 $ 5.9 Percent of Total Revenues 15.2 % 13.8 % 12.3 % 27 -------------------------------------------------------------------------------- Table of Contents The increase of $53.6 million in engineering and development expenses from 2011 to 2012 was due primarily to additional costs of $37.1 million related to LitePoint and increased spending in Semiconductor Test. The increase of $5.9 million in engineering and development expenses from 2010 to 2011 was due primarily to additional costs of $6.0 million related to LitePoint. Selling and Administrative Selling and administrative expenses were as follows: 2011-2012 2010-2011 2012 2011 2010 Change Change (dollars in millions) Selling and Administrative $ 281.5 $ 235.3 $ 225.3 $ 46.2 $ 10.0 Percent of Total Revenues 17.0 % 16.5 % 14.4 % The increase of $46.2 million in selling and administrative expenses from 2011 to 2012 was due primarily to additional costs of $49.7 million related to LitePoint. The increase of $10.0 million in selling and administrative expenses from 2010 to 2011 was due primarily to additional costs of $9.7 million related to LitePoint. Acquired Intangible Assets Amortization Acquired intangible assets amortization expense was as follows: 2011-2012 2010-2011 2012 2011 2010 Change Change (dollars in millions) Acquired Intangible Assets Amortization $ 73.5 $ 40.5 $ 29.3 $ 33.0 $ 11.2 Percent of Total Revenues 4.4 % 2.8 % 1.9 % Acquired intangible assets amortization expense increased from 2011 to 2012 and from 2010 to 2011, due to the LitePoint acquisition. Restructuring and Other Other During the year ended December 31, 2012, due to a decrease in specified new product revenue through the December 31, 2012 earn-out period end date, we recorded an $8.8 million fair value adjustment to decrease the LitePoint acquisition contingent consideration. The $68.5 million decrease in the contingent consideration liability from December 31, 2011 is due to $59.7 million in payments and the $8.8 million fair value decrease. During the year ended December 31, 2011, we recorded $5.8 million of other charges of which $4.6 million related to LitePoint acquisition costs and $1.2 million related to non-U.S. pension settlements. During the year ended December 31, 2010, we had $3.0 million of gains related to non-U.S. pension settlements. Restructuring In response to a downturn in the industry in 2008 and 2009, we initiated restructuring activities across our Semiconductor Test and Systems Test Group segments to reduce costs, principally through headcount reductions and facility consolidations. The remaining accrual for severance and benefits of $0.2 million is reflected in the 28 -------------------------------------------------------------------------------- Table of Contents accrued employees' compensation and withholdings on the balance sheet and is expected to be paid by June 2013. The remaining accrual for lease payments on vacated facilities of $1.1 million is reflected in the other accrued liabilities and is expected to be paid over the next twelve months. As of December 31, 2012, we have subleased approximately 37% of our unoccupied space. During the year ended December 31, 2012, we recorded the following restructuring activities: Severance and Benefits: - $0.5 million of charges related to headcount reductions of 7 people in Systems Test Group. - $0.3 million of charges related to headcount reductions of 10 people in Semiconductor Test. - $0.2 million of charges related to headcount reductions of 2 people in Wireless Test. During the year ended December 31, 2011, we recorded the following restructuring activities: Severance and Benefits: - $1.2 million of charges related to headcount reductions of 7 people in Semiconductor Test. Facilities and Exit Charges: - $(0.5) million credit related to changes in the estimated exit costs related to the Westford, MA and Poway, CA facilities in Systems Test Group, and the North Reading, Massachusetts facility in Semiconductor Test and Systems Test Group. During the year ended December 31, 2010, we recorded the following restructuring activities: Severance and Benefits: - $1.2 million of severance charges related to headcount reductions of approximately 17 people in Systems Test Group. - $0.9 million of severance charges related to headcount reductions of approximately 4 people in Semiconductor Test. Facilities and Exit Charges: - $(2.7) million credit related to the early exit of previously impaired leased facilities in Westford, Massachusetts, in Systems Test Group. Interest and Other 2011-2012 2010-2011 2012 2011 2010 Change Change (in millions) Interest Income $ 4.1 $ 6.6 $ 5.9 $ (2.5 ) $ 0.7 Interest Expense and Other $ (25.5 ) $ (23.7 ) $ (24.5 ) $ (1.8 ) $ 0.8 Interest income decreased by $2.5 million, from $6.6 million in 2011 to $4.1 million in 2012, due to a decrease in marketable securities used to fund the LitePoint acquisition in 2011. Interest income increased by $0.7 million, from $5.9 million in 2010 to $6.6 million in 2011, due primarily to higher cash and marketable securities balances in 2011. Interest expense and other increased by $1.8 million, from $23.7 million in 2011 to $25.5 million in 2012, due primarily to higher interest expense from increased convertible debt discount amortization. 29-------------------------------------------------------------------------------- Table of Contents Interest expense and other decreased by $0.8 million, from $24.5 million in 2010 to $23.7 million in 2011, due primarily to a loss on the exercise of the auction rate securities related UBS Put recorded in 2010, partially offset by higher convertible debt discount amortization in 2011. Income (Loss) from Continuing Operations before Income Taxes 2011-2012 2010-2011 2012 2011 2010 Change Change (in millions) Semiconductor Test $ 186.0 $ 212.2 $ 415.0 $ (26.2 ) $ (202.8 ) Wireless Test 83.1 (20.6 ) - 103.7 (20.6 ) Systems Test Group 34.2 51.8 (8.9 ) (17.6 ) 60.7 Corporate (37.3 ) (29.0 ) (9.8 ) (8.3 ) (19.2 ) $ 266.0 $ 214.4 $ 396.3 $ 51.6 $ (181.9 ) The increase in income from continuing operations before income taxes from 2011 to 2012 was primarily due to higher revenue in 2012 compared to 2011, a $14.5 million decrease in restructuring and other costs, partially offset by a $33.0 million increase in intangible assets amortization. The decrease in income from continuing operations before income taxes from 2010 to 2011 was primarily due to lower revenue in 2011 compared to 2010, an $11.2 million increase in intangible assets amortization, a $12.2 million charge to adjust LitePoint acquired inventory to fair value and a $10.5 million increase in restructuring and other costs. Income Taxes The income tax expense from continuing operations for 2012 totaled $48.9 million, primarily attributable to a U.S. federal tax provision and foreign taxes. The income tax benefit from continuing operations for 2011 totaled $129.5 million, primarily attributable to the reduction of our deferred income tax valuation allowance. We considered the weight of both the positive and negative evidence as of December 31, 2011 and concluded that a substantial majority of the deferred tax assets will be realized. The income tax expense from continuing operations of $16.7 million for 2010 was related primarily to tax provisions for foreign taxes. Contractual Obligations The following table reflects our contractual obligations as of December 31, 2012: Payments Due by Period Less than 1-3 3-5 More than Total 1 year years years 5 years Other (in thousands) Long-Term Debt Obligations (1) $ 193,491 $ 2,328 $ 191,163 $ - $ - $ - Interest on Debt 12,897 8,590 4,307 - - - Contingent Consideration 388 388 - - - - Operating Lease Obligations 54,915 14,174 21,794 11,510 7,437 - Purchase Obligations 209,962 206,952 3,010 - - -Retirement Plan Contributions 54,627 5,169 10,499 10,678 28,281 - Other Long-Term Liabilities Reflected on the Balance Sheet under GAAP (2) 87,730 - 16,227 - - 71,503 Total $ 614,010 $ 237,601 $ 247,000 $ 22,188 $ 35,718 $ 71,503 30 -------------------------------------------------------------------------------- Table of Contents (1) Long-Term Debt Obligations include current maturities. (2) Included in Other Long-Term Liabilities are liabilities for customer advances, extended warranty, uncertain tax positions and other obligations. For certain long-term obligations, we are unable to provide a reasonably reliable estimate of the timing of future payments relating to these obligations and therefore we included these amounts in the column marked "Other". Liquidity and Capital Resources Our cash, cash equivalents and marketable securities balance increased $251.7 million from 2011 to 2012, to $1.0 billion. Cash activity for 2012, 2011 and 2010 was as follows: 2011-2012 2010-2011 2012 2011 2010 Change Change (in millions) Cash provided by operating activities: Income from continuing operations, adjusted for non cash items $ 444.9 $ 372.6 $ 508.6 $ 72.3 $ (136.0 ) Change in operating assets and liabilities, net of businesses sold and acquired (40.4 ) (94.0 ) 52.7 53.6 (146.7 ) Cash (used for) provided by discontinued operations - (4.8 ) 5.0 4.8 (9.8 ) Total cash provided by operating activities $ 404.5 $ 273.8 $ 566.3 $ 130.7 $ (292.5 ) Cash used for investing activities from continuing operations (603.9 ) (120.5 ) (627.7 ) (483.4 ) 507.2 Cash provided by investing activities from discontinued operations - 39.0 - (39.0 ) 39.0 Total cash used for investing activities $ (603.9 ) $ (81.5 ) $ (627.7 ) $ (522.4 ) $ 546.2 Total cash (used for) provided by financing activities $ (35.4 ) $ (16.3 ) $ 42.4 $ (19.1 ) $ (58.7 ) Total (decrease) increase of cash and cash equivalents $ (234.8 ) $ 176.0 $ (19.0 ) $ (410.8 ) $ 195.0 In 2012, changes in operating assets and liabilities, net of businesses sold and acquired, used cash of $40.4 million. This was due to an $8.0 million increase in operating assets and a $32.4 million decrease in operating liabilities. The increase in operating assets was due to a $24.1 million increase in accounts receivable and a $1.5 million increase in prepayments due primarily to supplier prepayments, partially offset by a $17.6 million decrease in inventories. The decrease in operating liabilities was due to a $15.7 million decrease in accrued employee compensation due primarily to employee stock awards payroll taxes and variable compensation payments, a $14.6 million decrease in customer advance payments and deferred revenue, a $11.5 million decrease in accounts payable due to lower fourth quarter sales volume, a $5.6 million decrease in other accrued liabilities, and $4.8 million of retirement plans contributions, partially offset by a $19.8 million increase in accrued income taxes. Investing activities during 2012 used cash of $603.9 million, due to $751.1 million used for purchases of marketable securities and $119.1 million used for purchases of property, plant and equipment, partially offset by proceeds from sales and maturities of marketable securities that provided cash of $95.2 million and $171.1 million, respectively. Financing activities during 2012 used cash of $35.4 million, $18.5 million was from the issuance of common stock under stock option and stock purchase plans, and $8.4 million from the tax benefit related to stock 31-------------------------------------------------------------------------------- Table of Contents options and restricted stock units, partially offset by $59.7 million of cash used for payments related to LitePoint acquisition contingent consideration and $2.5 million of cash used for payments on long-term debt related to the Japan loan. In 2011, changes in operating assets and liabilities, net of businesses sold and acquired, used cash of $94.0 million. This was due to a $43.2 million decrease in operating assets and a $137.2 million decrease in operating liabilities. The decrease in operating assets was due to a $66.4 million decrease in accounts receivable resulting from increased collections, partially offset by a $22.6 million increase in prepayments due primarily to supplier prepayments and a $0.6 million increase in inventories. The decrease in operating liabilities was due to a $62.6 million decrease in customer advance payments due to shipments of systems prepaid by customers, a $28.3 million decrease in accrued employee compensation due primarily to employee stock awards payroll taxes and variable compensation payments, a $19.9 million decrease in accounts payable due to decreased sales volume, $11.9 million of retirement plans contributions, an $8.7 million decrease in accrued income taxes, and a $5.8 million decrease in deferred revenue. Investing activities during 2011 used cash of $120.5 million. In October 2011, we completed the acquisition of LitePoint for an initial cash purchase price, net of cash acquired, of $537.5 million. Capital expenditures were $86.1 million. Proceeds from sales and maturities of marketable securities that provided cash of $676.4 million and $518.5 million, respectively, partially offset by $691.8 million used for purchase of marketable securities. The net proceeds were used to acquire LitePoint. Financing activities during 2011 used cash of $16.3 million, due to the repurchase of 2.6 million shares of common stock for $31.2 million at an average price of $11.84 per share and $2.5 million for payments on long-term debt related to the Japan loan, partially offset by $17.4 million from the issuance of common stock under stock option and stock purchase plans. In 2010, changes in operating assets and liabilities, net of businesses sold and acquired, provided cash of $52.7 million. This was due to a $38.2 million increase in operating assets and a $90.9 million increase in operating liabilities. The increase in operating assets was due to an increase in accounts receivable of $50.4 million due to higher sales volume, partially offset by a $3.7 million decrease in inventories, and a decrease in other current assets of $8.5 million. The increase in operating liabilities was due to a $57.7 million increase in customer advance payments due primarily to an advanced payment received from one of our Semiconductor Test customers, a $44.5 million increase in accrued employee compensation due to higher variable compensation and employee stock awards payroll taxes, a $15.0 million increase in accounts payable, a $15.0 million increase in deferred revenue, an $8.5 million increase in accrued income taxes, and a $2.7 million increase in other accrued liabilities, partially offset by $52.5 million of retirement plans contributions. Investing activities during 2010 used cash of $627.7 million, due to $870.8 million used for purchases of marketable securities and $76.0 million used for purchases of property, plant and equipment, partially offset by proceeds from sales and maturities of marketable securities that provided cash of $181.2 million and $136.8 million, respectively, and proceeds from life insurance that provided cash of $1.1 million. Financing activities during 2010 provided cash of $42.4 million due to $44.7 million from the issuance of common stock under stock option and stock purchase plans which was partially offset by $2.3 million of cash used for payments on long-term debt related to the Japan loan. On April 6, 2009, we completed a registered public offering of $190.0 million aggregate principal amount convertible senior notes ("Notes") and settled the related convertible bond hedge and warrant transaction and received approximately $163.0 million as a result of these financing transactions. The Notes bear interest at a rate 32 -------------------------------------------------------------------------------- Table of Contents of 4.50% per annum, payable semi- annually in arrears on March 15 and September 15 of each year. The first interest payment was on September 15, 2009. The Notes will mature on March 15, 2014, unless earlier repurchased by us or converted. The Notes may be converted, under certain circumstances and during certain periods, at an initial conversion rate of approximately 182.65 shares of our common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $5.48. The convertible note hedge and warrant transaction will generally have the effect of increasing the conversion price of the Notes to approximately $7.67 per share of our common stock, representing a 75% conversion premium based upon the closing price of our common stock on March 31, 2009. We may not redeem the Notes prior to their maturity. Holders of the Notes may require us to purchase in cash all or a portion of their Notes at a price equal to 100% of the principal amount, plus accrued and unpaid interest, upon the occurrence of certain fundamental changes involving the Company. We believe our cash, cash equivalents and marketable securities balance will be sufficient to meet working capital and expenditure needs for at least the next twelve months. The amount of cash, cash equivalents and marketable securities in the U.S. and our operations in the U.S. provide sufficient liquidity to fund our business activities in the U.S. We have approximately $300 million of cash outside the U.S. that if repatriated would incur additional taxes. Inflation has not had a significant long-term impact on earnings. Retirement Plans ASC 715-20, "Compensation - Retirement Benefits - Defined Benefit Plans" requires an employer with defined benefit plans or other postretirement benefit plans to recognize an asset or a liability on its balance sheet for the overfunded or underfunded status of the plans as defined by ASC 715-20. The pension asset or liability represents the difference between the fair value of the pension plan's assets and the projected benefit obligation as of December 31. For other postretirement benefit plans, the liability is the difference between the fair value of the plan's assets and the accumulated postretirement benefit obligation as of December 31. Our pension expense, which includes the U.S. Qualified Pension Plan ("U.S. Plan"), certain qualified plans for non-U.S. subsidiaries, and a U.S. Supplemental Executive Defined Benefit Plan, was approximately $26.0 million for the year ended December 31, 2012. The largest portion of our 2012 pension expense was $9.0 million for our U.S. Plan. Pension expense is calculated based upon a number of actuarial assumptions, a significant input to the actuarial models that measure pension benefit obligations. Discount rate and expected return on assets are two assumptions which are important elements of pension plan expense and asset/liability measurement. We evaluate these critical assumptions at least annually on a plan and country specific basis. We evaluate other assumptions related to demographic factors, such as retirement age, mortality and turnover periodically, and update them to reflect our experience and expectations for the future. In developing the expected return on U.S. Plan assets assumption, we evaluated input from our investment managers and pension consultants, including their review of asset class return expectations. Based on this review, we believe that 5.0% was an appropriate rate to use for 2012. We will continue to evaluate the expected return on plan assets at least annually, and will adjust the rate as necessary. The December 31, 2012 asset allocation for our U.S. Plan is 86% invested in fixed income securities, 13% invested in equity securities, and 1% invested in other securities. Our investment managers regularly review the actual asset allocation and periodically rebalance the portfolio to ensure alignment with our targeted allocations. Effective January 1, 2012, we have elected to immediately recognize net actuarial gains and losses and the change in the fair value of plans assets in our operating results in the year in which they occur or upon any interim remeasurement of the plans. In addition, we used to calculate the expected return on plan assets using a calculated market-related value of plan assets. Effective January 1, 2012, we elected to calculate the expected return on plan assets using the fair value of the plan assets. The discount rate that we utilized for determining future pension obligations for the U.S. Plan is based on the Citigroup Pension Index adjusted for the U.S. Plan's expected cash flows and was 3.6% at December 31, 33-------------------------------------------------------------------------------- Table of Contents 2012, down from 4.2% at December 31, 2011. We estimate that in 2013 we will recognize approximately $2.1 million of pension income for the U.S. Plan. The U.S. Plan related pension income estimate for 2013 is based on a 3.6% discount rate and 5.0% return on assets. Future pension expense or income will depend on future investment performance, changes in future discount rates and various other factors related to the employee population participating in our pension plans. As of December 31, 2012, we had an unrecognized pension prior service cost of $0.7 million. We performed a sensitivity analysis, which expresses the potential U.S. Plan (income) expense for the year ending December 31, 2013, which would result from changes to either the discount rate or the expected return on plan assets. The below estimates exclude the impact of any potential actuarial gains or losses. It is difficult to reliably forecast or predict whether there will be any actuarial gains or losses in 2013 as they are primarily driven by events and circumstances beyond our control, such as changes in interest rates and the performance of the financial markets. Discount Rate Return on Plan Assets 3.1% 3.6% 4.1% (in millions) 4.5% $ (1.5 ) $ (0.7 ) $ (0.1 ) 5.0% (2.9 ) (2.1 ) (1.4 ) 5.5% (4.2 ) (3.5 ) (2.8 ) The assets of the U.S. Plan consist primarily of fixed income and equity securities. U.S. Plan assets have decreased from $319.1 million at December 31, 2011 to $278.9 million at December 31, 2012. The decrease was due primarily to $52.0 million of payments made to certain former U.S. employees which were offered an option to receive their vested pension benefit as a one-time, lump sum payment. Approximately 2,000 former employees elected to receive a one-time, lump sum payment. Our funding policy is to make contributions to our pension plans in accordance with local laws and to the extent that such contributions are tax deductible. During 2012, we made contributions of $1.7 million to the U.S. supplemental executive defined benefit pension plan and $1.6 million to certain qualified plans for non-U.S. subsidiaries. We expect to contribute approximately $1.8 million to the U.S. supplemental executive defined benefit pension plan in 2013. Contributions that will be made in 2013 to certain qualified plans for non-U.S. subsidiaries are based on local statutory requirements and will be approximately $2.0 million. We do not expect to make any contributions to the U.S. Plan in 2013. Equity Compensation Plans In addition to our 1996 Employee Stock Purchase Plan discussed in Note P: "Stock Based Compensation" in Notes to Consolidated Financial Statements, we have a 2006 Equity and Cash Compensation Incentive Plan (the "2006 Equity Plan") under which equity securities are authorized for issuance. The 2006 Equity Plan was initially approved by stockholders on May 25, 2006. At our annual meeting of stockholders held May 28, 2009, our stockholders approved an amendment to the 2006 Equity Plan to increase the number of shares issuable thereunder by 10.0 million, for an aggregate of 22.0 million shares issuable thereunder, and our stockholders also approved an amendment to our 1996 Employee Stock Purchase Plan to increase the number of shares issuable thereunder by 5.0 million, for an aggregate of 25.4 million shares issuable thereunder. 34 -------------------------------------------------------------------------------- Table of Contents The following table presents information about these plans as of December 31, 2012 (share numbers in thousands): Number of securities Number of securities remaining to be issued upon Weighted-average available for future issuance exercise of exercise price of under equity compensation outstanding options, outstanding options, plans (excluding securities Plan category warrants and rights warrants and rights reflected in column one) Equity plans approved by shareholders 5,878 (1) $ 9.77 9,246 (2) Equity plans not approved by shareholders (3,4,5) 2,933 $ 3.06 - Total 8,811 $ 4.64 9,246 (1) Includes 4,970,308 shares of restricted stock units that are not included in the calculation of the weighted average exercise price. (2) Consists of 6,413,195 securities available for issuance under the 2006 Equity Plan and 2,832,538 of securities available for issuance under the Employee Stock Purchase Plan. (3) In connection with the acquisition of Nextest (the "Nextest Acquisition"), we assumed the options and restricted stock units granted under the Nextest Systems Corporation 1998 Equity Incentive Plan, as amended, and the Nextest Systems Corporation 2006 Equity Incentive Plan (collectively, the "Nextest Plans"). Upon the consummation of the Nextest Acquisition, these options and restricted stock units were converted automatically into, respectively, options to purchase and restricted stock units representing, an aggregate of 4,417,594 shares of our common stock. No additional awards will be granted under the Nextest Plans. As of December 31, 2012, there were outstanding options exercisable for an aggregate of 768,382 shares of our common stock pursuant to the Nextest Plans, with a weighted average exercise price of $3.57 per share. (4) In connection with the acquisition of Eagle Test (the "Eagle Acquisition"), we assumed the options granted under the Eagle Test Systems, Inc. 2003 Stock Option and Grant Plan and the Eagle Test Systems, Inc. 2006 Stock Option and Incentive Plan (collectively, the "Eagle Plans"). Upon the consummation of the Eagle Acquisition, these options were converted automatically into options to purchase an aggregate of 3,594,916 shares of our common stock. No additional awards will be granted under the Eagle Plans. As of December 31, 2012, there were outstanding options exercisable for an aggregate of 236,839 shares of our common stock pursuant to the Eagle Plans, with a weighted average exercise price of $3.85 per share. (5) In connection with the acquisition of LitePoint Corporation (the "LitePoint Acquisition"), we assumed the options granted under the LitePoint Corporation 2002 Stock Plan (the "LitePoint Plan"). Upon the consummation of the LitePoint Acquisition, these options were converted automatically into options to purchase an aggregate of 2,828,344 shares of our common stock. No additional awards will be granted under the LitePoint Plan. As of December 31, 2012, there were outstanding options exercisable for an aggregate of 1,927,222 shares of our common stock pursuant to the LitePoint Plan, with a weighted average exercise price of $2.75 per share. The purpose of the 2006 Equity Plan is to motivate employees, officers, directors, consultants and advisors by providing equity ownership and compensation opportunities in Teradyne. The aggregate number of shares available under the 2006 Equity Plan as of December 31, 2012 was 6,413,195 shares of our common stock. The 2006 Equity Plan authorizes the grant of stock-based awards in the form of (1) non-qualified and incentive stock options, (2) stock appreciation rights, (3) restricted stock awards and restricted stock unit awards, (4) phantom stock, and (5) other stock-based awards. Awards may be tied to time-based vesting schedules and/or performance-based vesting measured by reference to performance criteria chosen by the Compensation Committee of the Board of Directors, which administers the 2006 Equity Plan. Awards may be made to any employee, officer, consultant and advisor of Teradyne and our subsidiaries, as well as, to our directors. The maximum number of shares of stock-based awards that may be granted to one participant during any one fiscal year is 2,000,000 shares of common stock. The 2006 Equity Plan will expire on May 24, 2016. 35 -------------------------------------------------------------------------------- Table of Contents As of December 31, 2012, total unrecognized compensation expense related to non-vested awards and options was $52.1 million, and is expected to be recognized over a weighted average period of 2.0 years. Performance Graph The following graph compares the change in our cumulative total shareholder return in our common stock with (i) the Standard & Poor's 500 Index and (ii) the Morningstar Semiconductor Equipment & Materials Index. The comparison assumes $100.00 was invested on December 31, 2007 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any. [[Image Removed: LOGO]] Annual Rate of Return 2008 2009 2010 2011 2012 Teradyne, Inc. -59 % 154 % 31 % -3 % 24 % Morningstar Semiconductor Equipment & Materials Index -56 % 68 % 12 % -11 % 24 % S&P 500 Index -37 % 26 % 15 % 2 % 16 % (1) This graph is not "soliciting material," is not deemed filed with the SEC and is not to be incorporated by reference in any other filing under the Securities Act or the Exchange Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. (2) The stock price performance shown on the graph is not necessarily indicative of future price performance. Information used on the graph was obtained from Zacks Investment Research, Inc., a source believed to be reliable, but we are not responsible for any errors or omissions in such information. Recently Issued Accounting Pronouncements In December 2011, the FASB issued ASU No. 2011-11, "Disclosures about Offsetting Assets and Liabilities." This ASU is intended to enhance the understanding of the effects of netting arrangements on an entity's financial statements, including financial instruments and derivative instruments that are either offset or subject to a master netting arrangement. The scope of this ASU includes derivatives, sale and repurchase agreements, reverse sale and repurchase agreements, and securities borrowing and lending arrangements. In 36 -------------------------------------------------------------------------------- Table of Contents January 2013, the FASB issued ASU No. 2013-01 "Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." This standard provided additional guidance on the scope of ASU 2011-11. The provisions of this ASU are effective for interim and annual periods beginning on or after January 1, 2013. In February 2013, the FASB issued ASU No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." Under this ASU, an entity is required to provide information about the amounts reclassified out of Accumulated Other Comprehensive Income ("AOCI") by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. The provisions of this ASU are effective for interim and annual periods beginning on or after January 1, 2013. |