UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended April 2, 2006
OR
For the transition period from to
Commission File No. 1-6462
TERADYNE, INC.
(Exact name of registrant as specified in its charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
617-482-2700
(Registrant’s Telephone Number, Including Area Code)
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 the filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The number of shares outstanding of the registrant’s only class of Common Stock as of April 28, 2006 was 198,219,502 shares.
INDEX
Condensed Consolidated Balance Sheets as of April 2, 2006 and December 31, 2005
Condensed Consolidated Statements of Operations for the Three Months Ended April 2, 2006 and April 3, 2005
Condensed Consolidated Statements of Cash Flows for the Three Months Ended April 2, 2006 and April 3, 2005
Notes to Condensed Consolidated Financial Statements
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Controls and Procedures
Legal Proceedings
Risk Factors
Exhibits
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CONDENSED CONSOLIDATED BALANCE SHEETS
April 2,
2006
December 31,
2005
Current assets:
Cash and cash equivalents
Marketable securities
Accounts receivable, net of allowance for doubtful accounts of $4,887 and $4,926 on April 2, 2006 and December 31, 2005, respectively
Inventories:
Parts
Assemblies in process
Prepayments and other current assets
Total current assets
Property, plant, and equipment, at cost
Less: accumulated depreciation
Net property, plant, and equipment
Goodwill
Other assets
Total assets
Current liabilities:
Notes payable—banks
Current portion of long-term debt
Accounts payable
Accrued employees’ compensation and withholdings
Deferred revenue and customer advances
Other accrued liabilities
Income taxes payable
Total current liabilities
Pension liability
Long-term other accrued liabilities
Other long-term debt
Total liabilities
Commitments and contingencies (Note J)
Common stock, $0.125 par value, 1,000,000 shares authorized, 198,158 shares and 197,011 shares issued and outstanding at April 2, 2006 and December 31, 2005, respectively
Additional paid-in capital
Deferred compensation
Accumulated other comprehensive loss
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
The accompanying notes, together with the Notes to Consolidated Financial Statements included in Teradyne’s Annual Report on Form 10-K for the year ended December 31, 2005 are an integral part of the condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
April 3,
(in thousands,
except per share data)
Net revenues:
Products
Services
Net revenues
Cost of revenues:
Cost of products
Cost of services
Gross profit
Operating expenses:
Engineering and development
Selling and administrative
Restructuring and other charges, net
Operating expenses
Income (loss) from operations
Interest income
Interest expense
Income (loss) from continuing operations before income taxes
Provision for income taxes
Income (loss) from continuing operations
Income from discontinued operations (net of income tax provision of $0 and $462, respectively)
Net income (loss)
Net income (loss) from continuing operations per common share:
Basic
Diluted
Net income (loss) per common share:
Shares used in net income (loss) per common share—basic
Shares used in net income (loss) per common share—diluted
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Income from discontinued operations
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used for) operating activities:
Depreciation
Stock-based compensation
Amortization
Provision for inventory
Impairment of long-lived assets
Gain on sale of product lines
Gain on sale of land and building
Other non-cash items, net
Changes in operating assets and liabilities:
Accounts receivable
Inventories
Accounts payable, deferred revenue and accrued expenses
Accrued income taxes
Net cash provided by (used for) continuing operations
Net cash provided by discontinued operations
Net cash provided (used for) by operating activities
Cash flows from investing activities:
Investments in property, plant and equipment
Proceeds from sale of product lines
Purchases of available-for-sale marketable securities
Proceeds from sale and maturities of available-for-sale marketable securities
Net cash (used for) provided by continuing operations
Net cash used for discontinued operations
Net cash (used for) provided by investing activities
Cash flows from financing activities:
Payments of long term debt and notes payable
Issuance of common stock under employee stock option and stock purchase plans
Net cash used by financing activities
Decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. The Company
Teradyne, Inc. is a leading supplier of automatic test equipment.
Teradyne’s automatic test equipment products include:
Broadband Test Systems and Diagnostic Solutions have been combined into “Other Test Systems” for purposes of Teradyne’s segment reporting.
Statements in this Quarterly Report on Form 10-Q 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 United States Securities and Exchange Commission (the “SEC”). See also “Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors That May Affect Future Results.”
B. Accounting Policies
Basis of Presentation
The condensed consolidated interim financial statements include the accounts of Teradyne and its subsidiaries. All significant intercompany balances and transactions have been eliminated. These financial statements reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair statement of such interim financial statements. Certain prior years’ amounts were reclassified to conform to the current year presentation. The year-end condensed consolidated balance sheet data were derived from audited financial statements, but do not include all disclosures required by generally accepted accounting principles.
The accompanying financial information should be read in conjunction with the consolidated financial statements and notes thereto contained in Teradyne’s Annual Report on Form 10-K, filed with the SEC on March 14, 2006 for the year ended December 31, 2005.
Preparation of Financial Statements
The preparation of consolidated financial statements requires management to make estimates and judgments that affect the amounts reported in the financial statements. Actual results may differ significantly from these estimates.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Product Warranty
Teradyne generally provides a one year warranty on its products commencing upon installation or shipment. A provision is recorded upon revenue recognition to cost of revenues for the estimated warranty expense based on historical experience. Related costs are charged to the warranty accrual as incurred. The balance below is included in other accrued liabilities (in thousands).
Balance at beginning of period
Accruals for warranties issued during the period
Settlements made during the period
Balance at end of period
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 (in thousands).
Deferral of new extended warranty revenue
Recognition of extended warranty deferred revenue
Employee Stock Option Plans and Employee Stock Purchase Plan
Effective January 1, 2006, Teradyne adopted the fair value recognition provision of Financial Accounting Standards No. 123 (revised 2004) “Share Based Payment” (“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock based compensation expense for the first quarter of fiscal 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, and is calculated based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 “Accounting for Stock Based Compensation” (“SFAS 123”). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with SFAS 123R. As required by SFAS 123R, Teradyne has made an estimate of expected forfeitures and is recognizing compensation costs only for those stock-based compensation awards expected to vest. The cumulative effect of the initial adoption of SFAS 123R was not material.
Prior to the adoption of SFAS 123R, Teradyne accounted for its equity incentive plans and employee stock purchase plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations (“APB 25”). In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. Teradyne has applied provisions of SAB 107 in its adoption of SFAS 123R.
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The pro-forma table below reflects the effect of recording stock-based compensation for the three months ended April 3, 2005, had Teradyne applied the fair value recognition provisions of SFAS 123:
Net loss from continuing operations as reported
Add: Stock-based compensation included in net loss from continuing operations
Deduct: Total stock-based employee compensation expense determined under fair value method (no tax effects included )
Pro forma loss from continuing operations
Net loss from continuing operations per common share—basic as reported
Net loss from continuing operations per common share—diluted as reported
Net loss from continuing operations per common share—basic pro forma
Net loss from continuing operations per common share—diluted pro forma
Net loss as reported
Add: Stock-based compensation included in net loss
Pro forma net loss
Net loss per common share—basic as reported
Net loss per common share—diluted as reported
Net loss per common share—basic pro forma
Net loss per common share—diluted pro forma
Teradyne implemented the expense recognition provisions of SFAS 123R effective January 1, 2006. Under the modified prospective transition method as permitted under SFAS 123R, results for prior periods have not been restated. The effect of recording stock-based compensation for the three months ended April 2, 2006 was as follows:
For the ThreeMonths Ended
April 2, 2006
Cost of sales
Research and development
Income tax benefit
Total stock-based compensation expense after income taxes
The impact on both basic and diluted earnings per share for the three months ended April 2, 2006 was $0.03 per share.
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Valuation Assumptions
There were no options granted in the three months ended April 2, 2006. The weighted-average grant date fair value for options granted during the three months ended April 3, 2005 was $7.70 per option. The fair value of options at the date of grant was estimated using the Black-Scholes option-pricing model with the following assumptions:
Expected life (years)
Interest rate
Volatility
Dividend yield
The weighted-average fair value of employee stock purchase rights granted in the first three months of 2006 and 2005, was $3.93 and $4.06 respectively. The fair value of the employees’ purchase rights was estimated using the Black-Scholes option-pricing model with the following assumptions:
Stock Compensation Plans
Under its stock compensation plans, Teradyne grants options to purchase its common stock at 100% of the fair market value on the date of grant as well as restricted stock units. Options granted to employees prior to September 2001 vest in equal installments over four years and have a maximum term of five years. Beginning in September 2001, options granted to employees vest in equal installments over four years and have a maximum term of seven years. Options granted to non-employee directors on or after February 5, 2001 are immediately vested, fully exercisable and have a maximum term of either five or seven years. Restricted stock unit awards to employees vest over a two year period, with 50% vesting on each of the first and the second anniversaries of the grant date. Restricted stock unit awards that have been made to directors will vest after a one year period, with 100% of the award vesting on the first anniversary of the grant date. Restricted stock unit awards that have been made to executive officers, including the CEO, will vest over two years, with 50% of the award subject to time-based vesting and 50% of the award subject to performance-based vesting. The performance criteria for performance-based grants will be assessed on the first anniversary of the grant date and, in turn, determine the number of performance-based restricted stock units available for vesting over the two-year vesting period; portions of the performance-based grants not available for vesting will be forfeited. Restricted stock units do not have common stock voting rights, and the shares underlying the restricted stock units are not considered issued and outstanding. Teradyne expenses the cost of the restricted stock unit awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restrictions lapse.
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Restricted Stock Unit and Stock Option Activity:
Restricted stock unit activity and weighted-average grant date fair value information for the three months ended April 2, 2006 follows:
Number ofShares
(in thousands)
Non-vested January 1, 2006
Awards Granted
Awards Forfeited
Non-vested at April 2, 2006
As of April 2, 2006, there was $25.5 million unrecognized stock-based compensation expense related to non-vested restricted stock units. That cost is expected to be recognized over the weighted-average period of 1.23 years. As of April 2, 2006, there were no vested restricted stock units.
Stock option activity, average option exercise price, weighted-average remaining contractual term and aggregate intrinsic value information for the three months ended April 2, 2006 follows:
Aggregate IntrinsicValue
Outstanding January 1, 2006
Options granted
Options exercised
Options forfeited
Options canceled
Outstanding at April 2, 2006
Vested and expected to vest at April 2, 2006
Exercisable at April 2, 2006
As of April 2, 2006, there was $7.1 million unrecognized compensation expense related to non-vested options. Total instrinsic value of options excercised for the three months ended April 2, 2006 was $1.9 million.
Shares available:
Available for grant at January 1, 2006
Option grants
Restricted stock unit grant
Option forfeitures
Option cancellations
Restricted stock unit forfeitures
Available for grant at April 2, 2006
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Significant option groups outstanding at April 2, 2006 and related weighted-average price and remaining contractual life information follows:
Range Of Exercise Prices
Weighted-
Average Remaining
Contractual Life
(Years)
Weighted-Average
Exercise Price
$ 9.42 - $17.40
$17.48 - $20.27
$21.65 - $21.68
$21.91 - $27.40
$27.66 - $166.98
Total
Other Comprehensive Income (Loss)
Comprehensive income (loss) includes net income (loss), minimum pension liability adjustments, unrealized gains and losses on foreign exchange contracts, unrealized gains and losses on certain investments in debt and equity securities and cumulative translation adjustments. The components of comprehensive income (loss) are as follows (in thousands):
Foreign currency translation adjustments
Change in unrealized gain (loss) on foreign exchange contracts
Change in unrealized loss on marketable securities, net of applicable tax of $0
Additional minimum pension liability
Comprehensive income (loss)
C. Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R. In annual periods beginning after June 15, 2005, SFAS 123R eliminates the ability to account for equity-based compensation using the intrinsic value-based method under APB 25. SFAS 123R requires companies to record in their Statements of Operations equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of the grant. Teradyne adopted SFAS 123R beginning in the first quarter of 2006, as required, using the modified prospective method, and did not restate prior periods.
In November 2004, the FASB issued SFAS 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 implemented SFAS 151 beginning in the first quarter of 2006 and it did not have a material impact on its financial position or results of operations.
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D. Goodwill and Intangible Assets
Amortizable intangible assets consist of the following and are included in other assets on the balance sheet (in thousands):
Completed technology
Service and software maintenance contracts and customer relationships
Trade names and trademarks
Total intangible assets
Aggregate amortization expense was $0.9 million for both the three months ended April 2, 2006 and April 3, 2005. Estimated amortization expense for each of the five succeeding fiscal years is as follows (in thousands):
Year
2006 (remainder)
2007
2008
2009
2010
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E. Net Income (Loss) per Common Share
The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share amounts):
Net income (loss) from continuing operations
Shares used in income (loss) per common share—basic
Effect of dilutive securities:
Employee and director stock options
Restricted stock units
Employee stock purchase rights
Dilutive potential common shares
Net income (loss) per common share—basic
Continued operations
Discontinued operations
Net income (loss) per common share—diluted
The computation of diluted net income per common share for the three months ended April 2, 2006, excludes the effect of the potential exercise of options to purchase approximately 17.0 million shares because the effect would have been anti-dilutive. The computation of diluted net income per common share for the three months ended April 3, 2005 excludes the effect of the potential exercise of options to purchase 30.3 million shares, because the option price was greater than the average market price of the common shares and the effect would have been anti-dilutive. Diluted income (loss) per common share for the three months ended April 2, 2006 and April 3, 2005 also excludes 11.3 million and 14.3 million shares, respectively, related to Teradyne’s convertible notes outstanding because the effect would have been anti-dilutive.
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F. Restructuring and Other Charges
The tables below represent activity related to restructuring charges in the three months ended April 2, 2006. 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 $4.4 million against the lease accruals over the next twelve months. Teradyne’s future lease commitments are net of expected sublease income of $13.2 million as of April 2, 2006.
2006 Activities
Facility
Related
Balance at December 31, 2005
Charges
Cash payments
Asset writedowns
Balance at April 2, 2006
During the three months ended April 2, 2006, Teradyne recorded in connection with the 2006 restructuring activities, $1.1 million of facility related charges for the exit of a Semiconductor Test facility in Newbury Park, CA.
2005 Activities
During the three months ended April 2, 2006, Teradyne recorded the following activities related to the 2005 restructuring activities:
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Pre-2005 Activities
Credits
Cash (payments) receipts
During the three months ended April 2, 2006, Teradyne recorded the following activities related to pre-2005 restructuring activities:
G. Debt
During the three months ended April 2, 2006, Teradyne repurchased $15 million of the 3.75% Convertible Senior Notes due 2006, resulting in a remaining outstanding amount of $285 million. No gain or loss was recorded related to this transaction for the three months ended April 2, 2006.
H. Retirement Plans
Teradyne has defined benefit pension plans covering a majority of domestic employees and employees of certain non-U.S. subsidiaries. Benefits under these plans are based on employees’ years of service and compensation. 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 the plans consist primarily of equity and fixed income securities. In addition, Teradyne has an unfunded supplemental executive defined benefit plan in the United States to provide retirement benefits in excess of levels allowed by the Employment Retirement Income Security Act and the Internal Revenue Code, as well as unfunded foreign plans.
Components of net periodic pension cost for the three months ended April 2, 2006 and April 3, 2005, respectively, are as follows (in thousands):
Net Periodic Benefit Cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of unrecognized:
Net transition obligation
Prior service cost
Net loss
Total expense
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Contributions
Teradyne contributed $20 million to its U.S. Qualified Pension Plan in the three months ended April 2, 2006. There are no additional contributions planned for the remainder of fiscal 2006.
Postretirement Benefit Plans
In addition to receiving pension benefits, Teradyne’s U.S. employees who meet specific retirement eligibility requirements as of their termination dates may participate in Teradyne’s Welfare Plan, which includes death benefits, and medical and dental benefits up to age 65. Death benefits provide a fixed sum to retirees’ survivors and are available to all retirees.
Substantially all of Teradyne’s current U.S. employees could become eligible for these benefits, and the existing benefit obligation relates primarily to those employees.
Components of net periodic postretirement cost are as follows (in thousands):
I. Segment Information
Teradyne has three reportable segments and four operating segments with Diagnostic Solutions and Broadband Test Systems combined as Other Test Systems. The three reportable segments are the design, manufacturing and marketing of Semiconductor Test Systems, Assembly Test Systems, and Other Test Systems. These reportable segments were determined based upon the nature of the products and services offered.
Teradyne evaluates performance based on several factors, of which the primary financial measure is business segment income before taxes. The accounting policies of the business segments are the same as those described in Note B: “Accounting Policies” in Teradyne’s Annual Report on Form 10-K for the year ended December 31, 2005. Variable compensation, which was previously recorded at Corporate, has been allocated to each reportable segment. Prior periods have been reclassified to conform to this presentation. Segment information for the three months ended April 2, 2006 and April 3, 2005 is as follows (in thousands):
Three months ended April 2, 2006:
Net revenue
Income before taxes (1)(2)
Three months ended April 3, 2005:
(Loss) income before taxes (1)(2)
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Included in the Semiconductor Test Systems segment are charges for the following (in thousands):
Cost of revenues—inventory
Restructuring charges
Included in the Assembly Test Systems segment are charges for the following (in thousands):
Restructuring (reversals) charges
Included in the Other Test Systems segment are charges for the following (in thousands):
Restructuring reversals
Included in the Corporate and Eliminations segment are charges for the following (in thousands):
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J. Commitments and Contingencies
On September 5, 2001, after Teradyne’s August 2000 acquisition of Herco Technology Corp. and Perception Laminates, Inc., the former owners of those companies filed a complaint against Teradyne and two of its then executive officers in the Federal District Court in San Diego, California, asserting securities fraud and breach of contract related to the acquisition. Pursuant to motions filed by Teradyne and by the plaintiffs, the District Court dismissed certain of the plaintiff’s claims, granted partial summary judgment against them with respect to their breach of contract claim and denied their motion for reconsideration. The only claim that remained before the District Court from the original complaint related to an allegation of fraud in connection with the setting of the transaction price. On December 27, 2004, the plaintiffs voluntarily stipulated to the dismissal with prejudice of their remaining claim in the District Court, without having received any payment or other consideration from Teradyne. On February 2, 2005, the plaintiffs filed a notice of appeal from the District Court’s prior orders. The appeal is now pending before the U.S. Court of Appeals for the Ninth Circuit.
In 2001, Teradyne was designated as a “potentially responsible party” (“PRP”) at a clean-up site in Los Angeles, California. This claim arose out of Teradyne’s acquisition of Perception Laminates in August 2000. Prior to that date, Perception Laminates had itself acquired certain assets of Alco Industries Inc. under an asset purchase agreement dated October 20, 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.
Teradyne believes that it has 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, Teradyne believes the losses associated with all of these actions will not have a material adverse effect on its consolidated financial position or liquidity, but could possibly be material to its consolidated results of operations of any one period.
In addition, Teradyne is 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 Teradyne expects to be material with respect to its business, financial position or results of operations.
K. Discontinued Operations
In November, 2005, Teradyne sold its Connection Systems segment to Amphenol Corporation for $390.0 million in cash, subject to a post-closing net asset value adjustment. As a result of the post-closing adjustment process, the final purchase price was $384.7 million. This resulted in a net gain on disposal after tax of $137.0 million. Teradyne sold this operating segment to focus on its core test businesses. Connection Systems had net revenues for the quarter ended April 3, 2005 of $95.2 million. Net income of the discontinued operations was $2.9 million for the quarter ended April 3, 2005.
L. Subsequent Event
In April 2006, Teradyne closed on the sale of three of its buildings, one located in Boston, MA and two located in Nashua, NH, for net proceeds of approximately $36.4 million.
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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies and Estimates
We have identified the policies which are critical to understanding our business and our results of operations. Management believes that other than the adoption of Financial Accounting Standards No. 123 (revised 2004) “Share Based Payment” (“SFAS 123R”), there have been no significant changes during the three months ended April 2, 2006 to the items disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Stock-Based Compensation Expense
Effective January 1, 2006, we adopted the fair value recognition provision of SFAS 123R, using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock based compensation expense for the first quarter of fiscal 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, and is calculated based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 “Accounting for Stock Based Compensation” (“SFAS 123”). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provision of SFAS 123R. As required by SFAS 123R, Teradyne has made an estimate of expected forfeitures and is recognizing compensation costs only for those stock-based compensation awards expected to vest. The cumulative effect of the initial adoption of SFAS 123R was not material.
Prior to the adoption of SFAS 123R, we recognized stock-based compensation expense in accordance with Accounting Principles Board (“APB”) Opinion No. 25 (“APB 25”). In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. We have applied provisions of SAB 107 in our adoption of SFAS 123R. See Note B to the Consolidated Financial Statements for a further discussion on stock-based compensation.
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SELECTED RELATIONSHIPS WITHIN THE CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
Percentage of net revenues:
Income (loss) from discontinued operations(net of income tax provision of $0 and $462 respectively)
Provision for income taxes as a percentage of income (loss) from continuing operations before income taxes
Results of Operations
Discontinued Operations
In November, 2005, we sold our Connection Systems segment to Amphenol Corporation for $390.0 million in cash, subject to a post-closing net asset value adjustment. As a result of the post-closing adjustment process, the final purchase price was $384.7 million. This resulted in a net gain on disposal after tax of $137.0 million. We sold this operating segment to increase our focus on our core businesses. We have reclassified the results of Connection Systems as discontinued operations for all periods presented in the consolidated financial statements.
Connection Systems had net revenues for the quarter ended April 3, 2005 of $95.2 million. Net income of the discontinued operations was $2.9 million for the quarter ended April 3, 2005.
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Unless indicated otherwise, the discussion and amounts provided in this “Results of Operations” section and elsewhere in this Form 10-Q relate to continuing operations only.
First Quarter 2006 Compared to First Quarter 2005
Bookings
Net bookings for our three reportable segments were as follows (in millions, except percent change):
Semiconductor Test Systems
Assembly Test Systems
Other Test Systems
The growth in Semiconductor Test Systems orders was primarily due to the capacity increase in the system-on-a-chip (“SOC”) market in the first quarter of 2006. Over half of the product bookings were for FLEX systems, which have moved strongly into mainstream production. Our J750 product contributed to increased bookings due to growth in the microcontroller, image and digital wafer test applications.
The decrease in orders for Assembly Test Systems products is attributed to our military/aerospace (“mil/aero”) business, offset by an increase in commercial products and services. The decrease in mil/aero was primarily driven by the timing of program awards.
The decrease in Other Test Systems’ orders resulted from decreases at both Diagnostic Systems and Broadband Test Systems. Other Test Systems’ bookings are program related and have significant fluctuations from period to period.
Cancellations and backlog adjustments for our three reportable segments were as follows (in millions):
Customers may delay delivery of products or cancel orders suddenly and without significant notice, subject to possible cancellation penalties. In the first quarter of 2006 and 2005, there were no significant cancellation penalties received. Due to possible changes in delivery schedules and cancellations of orders, our 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 our business, financial condition and results of operations.
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Net bookings by region as a percentage of total net bookings were as follows:
United States
South East Asia
Singapore
Taiwan
Europe
Japan
Korea
Backlog of unfilled orders for our three reportable segments was as follows (in millions):
Revenue
Net revenues for our three reportable segments were as follows (in millions, except percent changes):
The increase in Semiconductor Test Systems revenue was due to capacity expansion in the SOC market. The demand was strong for FLEX test systems in the wireless, automotive, gaming, datacom and consumer portable markets. Additional growth came from J750 and Catalyst test systems with the J750 particularly strong in the consumer device test applications.
The increase in Assembly Test System sales was primarily due to an increase in commercial products and services, offset by a decrease in mil/aero. The increase in commercial business was driven by market share gains.
The increase in Other Test System sales resulted from an increase in Diagnostic Systems, offset by a slight decrease in Broadband Test Systems.
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Our sales by region as a percentage of total net sales were as follows:
Rest of the World
Gross Margin
Our gross profit was as follows (dollars in millions):
Gross Profit
Percent of Total Revenue
The increase in gross margin from the first quarter of 2005 to 2006 was primarily the result of higher volume in Semiconductor Test Systems, which accounted for 8 points of the increase. A shift in mix within Semiconductor Test Systems contributed 5 points, primarily due to more product content, as products have higher margins than service, as well as improved service margins from the first quarter of 2005 to 2006. These increases were offset in part by 2 points resulting from the writedown of $8 million of non-FLEX inventory in Semiconductor Test Systems in the first quarter of 2006, and 1 point from increased variable employee compensation and other higher variable costs.
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 provisions. Forecasted revenue information is obtained from the sales and marketing groups and incorporates factors such as backlog and future product 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.
The provisions for excess and obsolete inventory were $8.3 million and $2.1 million for the three months ended April 2, 2006 and April 3, 2005, respectively. During the three months ended April 2, 2006, we scrapped $7.5 million of inventory. As of April 2, 2006, we have inventory related reserves for amounts which had been written-down or written-off of $159.2 million. We have no pre-determined timeline to scrap the remaining inventory.
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Engineering and Development
Engineering and development expenses were as follows (dollars in millions):
The decrease of $9.2 million in engineering and development spending from the first quarter of 2005 to 2006 was due to the following:
The above reductions were offset in part by a $4.7 million increase in variable employee compensation.
Selling and Administrative
Selling and administrative expenses were as follows (dollars in millions):
The increase of $7.9 million from the first quarter of 2005 to the first quarter of 2006 is primarily the result of:
These increases were offset in part by a $2.9 million reduction in salaries and fringe due to headcount reductions primarily in Semiconductor Test Systems.
Restructuring and Other Charges
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During the three months ended April 2, 2006, Teradyne recorded in connection with the 2006 restructuring activities $1.1 million of facility related charges for the exit of a Semiconductor Test facility in Newbury Park, CA.
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Interest Income and Expense
Interest income increased to $9.5 million for the first quarter of 2006 from $4.4 million in the first quarter of 2005 due to a large increase in cash from the sale of Connection Systems as well as an overall increase in interest rates. Interest expense decreased to $3.4 million in the first quarter of 2006 from $4.4 million in the first quarter of 2005 due primarily to repurchases of Teradyne’s 3.75% Senior Convertible Notes made in 2005 and the first quarter of 2006.
Income Taxes
As a result of incurring significant operating losses from 2001 through 2003, we determined that it was more likely than not that our deferred tax assets may not be realized, and since the fourth quarter of 2002 we established a full valuation allowance for our net deferred tax assets. If we generate sustained future taxable income against which these tax attributes may be applied, some portion or all of the valuation allowance would be reversed. If the valuation allowance were reversed, a portion would be recorded as an increase to additional paid in capital, and the remainder would be recorded as a reduction to income tax expense. The tax provision for the first quarter of 2006 consists of amounts recorded for foreign taxes as well as federal alternative minimum tax and state taxes in the United States. The tax provision for the first quarter of 2005 consists of taxes incurred in foreign locations combined with audit settlements with the Internal Revenue Service and the State of California.
Liquidity and Capital Resources
Our cash, cash equivalents and marketable securities balance increased $38.0 million in the first three months of 2006, to $965.9 million. Cash activity for the first three months of 2006 and 2005 was as follows (in millions):
Cash provided by (used for) operating activities:
Net income (loss) from continuing operations, adjusted for non-cash items
Changes in operating assets and liabilities, net of product lines and businesses sold and acquired
Cash provided by discontinued operations
Total cash provided by (used for) operating activities
Cash (used for) provided by investing activities from continuing operations
Cash used for investing activities from discontinued operations
Total cash (used for) provided by investing activities
Cash used for financing activities from continuing operations
Cash used for financing activities from discontinued operations
Total cash used for financing activities
Changes in operating assets and liabilities used cash of $6.8 million in the first three months of 2006 due primarily to a decrease in accounts payable, deferred revenue and accrued expenses which had a net decrease of $11.8 million due primarily to employee compensation accruals which are paid out at the beginning of the year and a $20 million contribution to Teradyne’s U.S. Qualified Pension Plan in the first quarter. Accounts receivable balances increased $26.8 million, primarily in the Semiconductor Test Systems segment, due to an increase in sales, partially offset by a decrease in days sales outstanding (“DSO”) from 71 days as of April 3, 2005 to 65 days as of April 2, 2006. Inventory decreased $33.4 million in the first three months of 2006 due primarily to
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volume increases in our Semiconductor Test Systems segment. Changes in operating assets and liabilities used cash of $40.7 million in the first three months of 2005, primarily due to a decrease in accounts payable, deferred revenue and accrued expenses.
Investing activities consist of purchases of capital assets, as well as the purchase, sale and maturity of marketable securities. Capital expenditures decreased by $12.2 million in the first three months of 2006 compared to the first three months of 2005 across all operating segments, primarily related to decreased spending on internally manufactured test systems.
Financing activities represent the sale of our common stock and payments on our convertible senior notes and other debt. The decrease of $5.1 million from the first three months of 2005 to the first three months of 2006 is due primarily to a decrease in stock option exercises.
We believe our cash, cash equivalents and marketable securities balance of $965.9 million will be sufficient to meet working capital and expenditure needs for at least the next twelve months. Inflation has not had a significant long-term impact on earnings.
Subsequent Event
In April 2006, we closed on the sale of three of our buildings, one located in Boston, MA and two located in Nashua, NH, for net proceeds of approximately $36.4 million.
Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R. In annual periods beginning after January 15, 2005, SFAS 123R eliminates the ability to account for equity-based compensation using the intrinsic value-based method under APB 25. SFAS 123R requires companies to record in their Statements of Operations equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant. We adopted SFAS 123R beginning in the first quarter of 2006, as required, using the Modified Prospective method, and did not restate prior periods.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No.43, Chapter 4” (“SFAS”). 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. We implemented SFAS 151 beginning in the first quarter of 2006 and it did not have a material impact on our financial position or 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 United States Securities and Exchange Commission (the “SEC”) (including this Form 10-Q) contain statements that are not purely historical, but are forward looking statements, made under Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), 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, including future lease payments and commitments and contributions to our pension plan, 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 following:
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These factors, and others, are discussed from time to time in our filings with the SEC, including our Annual Report on Form 10-K filed with the SEC on March 14, 2006 for the year ended December 31, 2005.
Item 3: Quantitative and Qualitative Disclosures about Market Risk
For “Quantitative and Qualitative Disclosures about Market Risk” affecting Teradyne, see Item 7a. “Quantitative and Qualitative Disclosures About Market Risks,” in our Annual Report on Form 10-K filed with the SEC on March 14, 2006. There were no material changes in our exposure to market risk from those set forth in our Annual Report for the fiscal year ended December 31, 2005.
Item 4: Controls and Procedures.
As of the end of the period covered by this report, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) promulgated under the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in ensuring that material information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, including ensuring that such material information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
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During the period covered by this report, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
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PART II. OTHER INFORMATION
Item 1: Legal Proceedings
On September 5, 2001, after our August 2000 acquisition of Herco Technology Corp. and Perception Laminates, Inc., the former owners of those companies filed a complaint against Teradyne and two of our then executive officers in the Federal District Court in San Diego, California, asserting securities fraud and breach of contract related to the acquisition. Pursuant to motions filed by Teradyne and by the plaintiffs, the District Court dismissed certain of the plaintiffs’ claims, granted partial summary judgment against them with respect to their breach of contract claim and denied their motion for reconsideration. The only claim that remained before the District Court from the original complaint related to an allegation of fraud in connection with the setting of the transaction price. On December 27, 2004, the plaintiffs voluntarily stipulated to the dismissal with prejudice of their remaining claim in the District Court, without having received any payment or other consideration from Teradyne. On February 2, 2005, the plaintiffs filed a notice of appeal from the District Court’s prior orders. The appeal is now pending before the U.S. Court of Appeals for the Ninth Circuit.
In 2001, we were designated as a “potentially responsible party” (“PRP”) at a clean-up site in Los Angeles, California. This claim arose out of our acquisition of Perception Laminates in August 2000. Prior to that date, Perception Laminates had itself acquired certain assets of Alco Industries Inc. under an asset purchase agreement dated October 20, 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.
We believe that it has meritorious defenses against the above unsettled claims and intends 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, Teradyne believes the losses associated with all of these actions will not have a material adverse effect on its consolidated financial position or liquidity, but could possibly be material to its 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 Teradyne expects to be material with respect to its business, financial position or results of operations.
Item 1A: Risk Factors
In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A: Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
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Item 6: Exhibits
Description
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Registrant
Gregory R. Beecher
Vice President andChief Financial Officer(Duly Authorized Officerand Principal Financial Officer)
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