TERADYNE, INC (TER) FY 2021 MD&A

Results of Operations

Information pertaining to fiscal year 2019 results of operations, including a

year-to-year

comparison against fiscal year 2020, was included in our Annual Report on Form
10-K
for the year ended December 31, 2020 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Position and Results of Operations,” which was filed with the SEC on February 22, 2021. This information is incorporated by reference herein.

The following table sets forth the percentage of total net revenues included in our consolidated statements of operations:

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Revenues

Revenues for our reportable segments were as follows:

The increase in Semiconductor Test revenues of $382.7 million, or 16.9%, was primarily due to greater tester sales driven by testing high performance compute processors and industrial and automotive devices, partially offset by lower tester sales for mobile application processors. The rise in System Test revenues of $58.0 million, or 14.2%, was driven primarily by elevated sales in Storage Test for system level test demand, and greater sales in Production Board Test. The increase in Industrial Automation revenues of $96.2 million, or 34.4%, was driven by demand for collaborative robotic arms and collaborative autonomous mobile robots. The rise in Wireless Test revenues of $43.9 million, or 25.4%, was primarily due to an increase in WiFi tester sales and higher demand in ultra-wide band wireless test.

Our reportable segments accounted for the following percentages of consolidated revenues:

Revenues by country as a percentage of total revenues were as follows (1):

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The breakout of product and service revenues was as follows:

Our product revenues increased $505.7 million, or 18.8%, primarily due to greater tester sales in Semiconductor Test driven by testing high performance compute processors and industrial and automotive devices, partially offset by lower tester sales for mobile application processors, the rise in System Test revenues primarily due to elevated sales in Storage Test for system level test demand, and greater sales in Production Board Test, increase in Industrial Automation revenues driven by demand for collaborative robotic arms and collaborative autonomous mobile robots, the rise in Wireless Test revenues due to an increase in WiFi tester sales and higher demand in ultra-wide band wireless test.

In 2021 and 2020, revenues from Taiwan Semiconductor Manufacturing Company Ltd., a customer of our Semiconductor Test segment, accounted for 12% and 15%, respectively, of our consolidated revenues. In 2021 and 2020, our five largest direct customers in aggregate accounted for 33% and 36% of our consolidated revenues, respectively.

We estimate consolidated revenues driven by one OEM customer, combining direct sales to that customer with sales to the customer’s OSATs, accounted for approximately 19% and 25% of our consolidated revenues in 2021 and 2020, respectively.

Gross Profit

Gross profit as a percent of total revenues increased by 2.4 points, primarily due to product mix of higher margin products in Semiconductor Test, increase in service margins and operating leverage due to higher revenues.

The breakout of product and service gross profit was as follows:

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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 revenues information is obtained from the sales and marketing groups and incorporates factors such as backlog and future consolidated revenues. 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 within the forecasted demand window, is written down to estimated net realizable value.

During the year ended December 31, 2021, we recorded an inventory provision of $15.5 million included in cost of revenues, primarily due to downward revisions to previously forecasted demand levels for certain products. Of the $15.5 million of total excess and obsolete provisions, $6.7 million was related to Semiconductor Test, $6.4 million was related to Industrial Automation, $1.8 million was related to Wireless Test, and $0.6 million was related to System Test.

During the year ended December 31, 2020, we recorded an inventory provision of $17.5 million included in cost of revenues, primarily due to downward revisions to previously forecasted demand levels for certain products. Of the $17.5 million of total excess and obsolete provisions, $11.0 million was related to Semiconductor Test, $4.8 million was related to Wireless Test, $0.9 million was related to System Test, and $0.8 million was related to Industrial Automation.

During the years ended December 31, 2021 and 2020, we scrapped $10.9 million and $7.7 million of inventory, respectively, and sold $2.5 million and $2.3 million of previously written-down or
written-off
inventory, respectively. As of December 31, 2021, we had inventory related reserves for amounts which had been written-down or
written-off
totaling $114.1 million. We have no
pre-determined
timeline to scrap the remaining inventory.

Selling and Administrative

Selling and administrative expenses were as follows:

The increase of $82.8 million in selling and administrative expenses was primarily due to higher variable compensation and greater selling and administrative spending across all segments.

Engineering and Development

Engineering and development expenses were as follows:

The increase of $52.6 million in engineering and development expenses was primarily due to higher spending in Semiconductor Test, System Test and Industrial Automation segments and higher variable compensation.

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Restructuring and Other

During the year ended December 31, 2021, we recorded $1.5 million of severance charges primarily in Industrial Automation, $0.5 million of acquisition related compensation and expenses and $14.5 million for other expenses, offset by a $7.2 million gain for the decrease in the fair value of the AutoGuide contingent consideration liability.

During the year ended December 31, 2020, we recorded a $19.7 million gain for the decrease in the fair value of the AutoGuide contingent consideration liability, and a $3.5 million gain for the decrease in the fair value of the MiR contingent consideration liability, partially offset by a $4.0 million contract termination settlement charge, $2.5 million of acquisition related compensation and expenses, $2.3 million of severance charges primarily in Industrial Automation, and $1.2 million of other expenses.

Interest and Other

Interest income decreased by $3.4 million primarily due to lower interest rates and a lower marketable securities balance in 2021 compared to 2020. Interest expense decreased by $6.4 million primarily due to lower convertible debt interest expense due to early conversions in 2021. Other (income) expense, net increased by $15.4 million primarily due to $28.8 million of losses on convertible debt conversions in 2021, partially offset by the change in pension actuarial gains/losses, from a $10.3 million loss in 2020 to a $2.2 million gain in 2021.

Income (Loss) Before Income Taxes

The increase in income before income taxes in Semiconductor Test was primarily due to greater tester sales driven by testing high performance compute processors and industrial and automotive devices, partially offset by lower tester sales for mobile application processors. The decrease in loss before income taxes in Industrial Automation was primarily due to demand for collaborative robotic arms and collaborative autonomous mobile robots and lower intangible assets amortization expense. The increase in income before income taxes in System Test was driven primarily by elevated sales in Storage Test for system level test demand, and greater sales in

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Production Board Test. The increase in income before income taxes in Wireless Test was primarily due to an increase in WiFi tester sales and higher demand in ultra-wide band wireless test. The loss before income taxes in Corporate and Other was primarily due to losses on convertible debt conversions in 2021.

Income Taxes

Income tax expense for 2021and 2020, totaled $146.4 million and $116.9 million, respectively. The effective tax rate for 2021 and 2020 was 12.6% and 13.0%, respectively.

The decrease in the effective tax rate from 2020 to 2021 is primarily attributable to a decrease in the expense from U.S. global
low-taxed
income partially offset by a decrease in the benefit from foreign tax credits and a shift in the geographic distribution of income, which increased the income subject to taxation in higher tax rate jurisdictions relative to lower tax rate jurisdictions.

We qualify for a tax holiday in Singapore by fulfilling the requirements of an agreement with the Singapore Economic Development Board under which certain headcount and spending requirements must be met. The tax savings attributable to the Singapore tax holiday for the years ended December 31, 2021and 2020 were $33.3 million or $0.18 per diluted share and $29.9 million or $0.16 per diluted share, respectively. In November 2020, we entered into an agreement with the Singapore Economic Development Board which extended our Singapore tax holiday under substantially similar terms to the agreement which expired on December 31, 2020. The new tax holiday is scheduled to expire on December 31, 2025.

Capital Resources and Material Cash Requirements

Our cash, cash equivalents and marketable securities balance decreased by $54 million in 2021 to $1,500 million. Cash decreased due to stock repurchases in the amount of $600 million, payments of convertible debt principal in the amount of $343 million, quarterly cash dividend payments in the amount of $66 million offset by cash generated by our global operations.

Operating activities during 2021 provided cash of $1,098.4 million. Changes in operating assets and liabilities used cash of $98.8 million. This was due to a $227.1 million increase in operating assets and a $128.4 million increase in operating liabilities.

The increase in operating assets was due to a $175.8 million increase in prepayments and other assets due to prepayments to our contract manufacturers, a $57.8 million increase in accounts receivable due to greater sales, partially offset by a $6.5 million decrease in inventories.

The increase in operating liabilities was due to a $63.5 million increase in other accrued liabilities, a $35.1 million increase in accrued employee compensation, a $22.9 million increase in accounts payable, and a $9.9 million increase in deferred revenue and customer advance payments, partially offset by a $5.6 million decrease in income taxes, and $5.4 million of retirement plan contributions.

Investing activities during 2021 provided cash of $120.4 million, due to $660.1 million and $266.5 million in proceeds from maturities and sales of marketable securities, respectively, partially offset by $661.8 million used for purchases of marketable securities, $132.5 million used for purchases of property, plant and equipment, and $12.0 million used for an investment in MachineMetrics, Inc. (“MachineMetrics”).

Financing activities during 2021 used cash of $1,008.6 million, due to $600.0 million used for the repurchase of 4.8 million shares of common stock at an average price of $125.74 per share, $343.0 million used for the payments of convertible debt principal, $66.0 million used for dividend payments, and $32.3 million used for payments related to net settlement of employee stock compensation awards, partially offset by $32.7 million from the issuance of common stock under employee stock purchase and stock option plans.

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Operating activities during 2020 provided cash of $868.9 million. Changes in operating assets and liabilities used cash of $69.4 million. This was due to a $202.3 million increase in operating assets and a $132.9 million increase in operating liabilities.

The increase in operating assets was due to a $129.5 million increase in accounts receivable due to increased sales, an $8.4 million increase in inventories, and a $64.4 million increase in prepayments and other assets.

The increase in operating liabilities was due to a $54.7 million increase in accrued employee compensation, a $40.0 million increase in deferred revenue and customer advance payments, a $25.2 million increase in income taxes, a $12.8 million increase in other accrued liabilities, and a $5.7 million increase in accounts payable, partially offset by $5.4 million of retirement plan contributions.

Investing activities during 2020 used cash of $569.8 million, due to $900.2 million used for purchases of marketable securities, and $185.0 million used for purchases of property, plant and equipment, partially offset by $480.0 million and $35.0 million in proceeds from maturities and sales of marketable securities, respectively, and proceeds from life insurance of $0.5 million related to the cash surrender value from the cancellation of Teradyne owned life insurance policy.

Financing activities during 2020 used cash of $158.3 million, due to $88.5 million used for the repurchase of 1.5 million shares of common stock at an average price of $58.33 per share, $66.5 million used for dividend payments, $23.0 million used for payments related to net settlement of employee stock compensation awards, and $8.9 million used for payment related to MiR acquisition contingent consideration, partially offset by $28.5 million from the issuance of common stock under employee stock purchase and stock option plans.

In January 2021, May 2021, August 2021 and November 2021, our Board of Directors declared a quarterly cash dividend of $0.10 per share. Total dividend payments in 2021 were $66.0 million.

In January 2020, May 2020, August 2020 and November 2020, our Board of Directors declared a quarterly cash dividend of $0.10 per share. Total dividend payments in 2020 were $66.5 million.

In January 2020, our Board of Directors cancelled the January 2018 stock repurchase program and approved a new stock repurchase program for up to $1.0 billion in common stock. On April 1, 2020, we suspended the share repurchase program. In 2020, we repurchased 1.5 million shares of common stock for $88.5 million at an average price per share of $58.33.

In January 2021, our Board of Directors approved a new repurchase program for up to $2.0 billion of common stock. Unless terminated by resolution of our Board of Directors, the repurchase program will expire when we have repurchased all shares authorized for repurchase under the share repurchase program. In 2021, we repurchased 4.8 million shares of common stock for $600.0 million at an average price of $125.74 per share. We intend to repurchase a minimum of $750.0 million in 2022.

While we declared a quarterly cash dividend and authorized a share repurchase program, we may reduce or eliminate the cash dividend or share repurchase program in the future. Future cash dividends and stock repurchases are subject to the discretion of our Board of Directors, which will consider, among other things, our earnings, capital requirements and financial condition.

On May 1, 2020, we entered into a credit agreement providing a three-year, senior secured revolving credit facility of $400 million. On December 10, 2021, the credit agreement was amended to extend the senior secured revolving credit facility to December 10, 2026. As of February 23, 2022, we have not borrowed any funds under the credit facility.

We expect operations to continue to be the primary source of cash to operate the business and meet material cash commitments, including any payments of convertible debt principal, our stock repurchase program, our

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quarterly dividends, our office lease obligations, contractual obligations related to inventory purchases and the construction of new facilities. We believe our cash, cash equivalents and marketable securities balance will be sufficient to pay our quarterly dividend and meet our working capital and expenditure needs for at least the next twelve months. Inflation has not had a significant long-term impact on earnings. At this time, the
COVID-19
pandemic has not had an impact on our liquidity, but there is no assurance that continued impacts resulting from the pandemic will not have an adverse effect in the future.

At December 31, 2021, our future contractual obligations were related to debt, leases, retirement plan liabilities, deferred tax benefits, and purchase obligations. See Note J. “Debt”, Note I. “Leases”, Note P. “Retirement Plans”, and Note S. “Income Taxes” of Notes to Consolidated Financial Statements in this Annual Report for information about those obligations, which Notes are incorporated by reference into this section. Our purchase obligations were approximately $884.3 million, with $839.2 million expected to be paid within 12 months.

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 plans’ 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.

For the year ended December 31, 2021, 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 $1.8 million. Pension expense is calculated based upon a number of actuarial assumptions. Discount rate and expected return on assets are two assumptions which are important elements of pension plan expense and asset/liability measurement. We evaluate our discount rate and expected rate of return on assets assumptions 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 manager and pension consultants, including their forecast of asset class return expectations. We believe that 2.4% was an appropriate rate of return on assets to use for 2021. The December 31, 2021 asset allocation for our U.S. Plan was 94% invested in fixed income securities, 5% invested in equity securities, and 1% invested in other securities. Our investment manager regularly reviews the actual asset allocation and periodically rebalances the portfolio to ensure alignment with our target allocations.

We recognize net actuarial gains and losses and the change in the fair value of plan assets in our operating results in the year in which they occur or upon any interim remeasurement of the plans. We calculate the expected return on plan assets using the fair value of the plan assets. Actuarial gains and losses are generally measured annually as of December 31 and, accordingly, recorded during the fourth quarter of each year or upon any interim remeasurement of the plans.

The discount rate that we utilized for determining future pension obligations for the U.S. Plan is based on the FTSE Pension Index adjusted for the U.S. Plan’s expected cash flows and was 2.65% at December 31, 2021, up from 2.3% at December 31, 2020. We estimate that in 2022 we will recognize approximately $1.8 million of pension expense for the U.S. Plan. The U.S. Plan pension expense estimate for 2022 is based on a 2.65% discount rate and a 2.0% 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.

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As of December 31, 2021, our pension plans had no unrecognized pension prior service cost.

The assets of the U.S. Plan consist substantially of fixed income securities. U.S. Plan assets have decreased from $158.9 million at December 31, 2020 to $149.6 million at December 31, 2021, while the U.S. Plan’s liability decreased from $141.4 million at December 31, 2020 to $134.5 million at December 31, 2021. In 2021, the decrease in plan assets and plan liability was due to an increase in interest rates. In 2020, the accrued pension obligations for approximately 115 retiree participants were transferred to an insurance company and resulted in a $24.4 million reduction in the pension benefit obligation and pension assets. We recorded $2.2 million of pension actuarial loss and a settlement loss of $0.5 million related to the retiree group annuity transaction.

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 2021, we made contributions of $3.3 million to the U.S. supplemental executive defined benefit pension plan, and $1.0 million to certain qualified plans for
non-U.S.
subsidiaries. In 2022, we expect to contribute approximately $3.3 million to the U.S. supplemental executive defined benefit pension plan. Contributions to be made in 2022 to certain qualified plans for
non-U.S.
subsidiaries are based on local statutory requirements and are estimated at approximately $1.0 million.

Equity Compensation Plans

In addition to our 1996 Employee Stock Purchase Plan discussed in Note Q: “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 21, 2013, 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 32.0 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 30.4 million shares issuable thereunder. At our annual meeting of stockholders held May 12, 2015, our stockholders approved an amendment to the 2006 Equity Plan to extend its term until May 12, 2025. At our annual meeting of stockholders held May 7, 2021, our stockholders approved an amendment to our 1996 Employee Stock Purchase Plan to increase the number of shares issuable thereunder by 3.0 million, for an aggregate of 33.4 million shares issuable thereunder.

The following table presents information about these plans as of December 31, 2021 (share numbers in thousands):

The purpose of the 2006 Equity Plan is to motivate employees, officers and directors by providing equity ownership and compensation opportunities in Teradyne. The aggregate number of shares available under the 2006 Equity Plan as of December 31, 2021 was 5,711,709 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

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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.

As of December 31, 2021, total unrecognized compensation expense related to
non-vested
restricted stock units and options was $50.6 million and is expected to be recognized over a weighted average period of 2.4 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 Global Semiconductor Equipment & Materials GR USD Industry Group. The comparison assumes $100.00 was invested on December 31, 2016 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any. Historic stock price performance is not necessarily indicative of future price performance.

Recently Issued Accounting Pronouncements

In August 2020, the FASB issued ASU
2020-06
– “Debt—Debt with Conversion and Other Options and Derivatives and Hedging—Contracts in Entity’s Own Equity,” which simplifies the accounting for convertible debt instruments by reducing the number of accounting models and the number of embedded conversion features that could be recognized separately from the primary contract. This ASU requires a convertible debt instrument to be accounted for as a single liability measured at its amortized cost, as long as no other features require bifurcation and recognition as derivatives. This ASU requires an entity to use the
if-converted
method in the diluted earnings per share calculation for convertible instruments. This ASU permits the use of either the modified retrospective or fully retrospective method of transition.

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On November 4, 2021, we made an irrevocable election under the indenture to require the principal portion of the remaining Notes to be settled in cash. Upon adoption of ASU
2020-06
only the amounts settled in excess of the principal will be considered in diluted earnings per share under the
if-converted
method. We have adopted the standard effective January 1, 2022 using the modified retrospective method of transition. As a result of adoption, we expect to record an entry to increase current debt, debt, and retained earnings by $1.5 million, $6.5 million, and $92.8 million, respectively. Mezzanine equity and additional
paid-in
capital are expected to be reduced by $100.8 million combined. The adoption of ASU
2020-06
will have an immaterial impact on our results of operations, statement of cash flows, and earnings per share (“EPS”).