filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Overview
We are a leading global supplier of automation equipment for test and industrial applications. We design, develop, manufacture and sell automatic test systems used to test semiconductors, wireless products, data storage and complex electronics systems in the consumer electronics, wireless, automotive, industrial, computing, communications, and aerospace and defense industries. Our industrial automation products include collaborative robotic arms, autonomous mobile robots and advanced robotic control software used by global manufacturing and light industrial customers to improve quality, increase manufacturing and material handling efficiency and decrease manufacturing costs. Our automatic test equipment and industrial automation products and services include:
| • | semiconductor test (“Semiconductor Test”) systems; |
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| • | defense/aerospace (“Defense/Aerospace”) test instrumentation and systems, storage test (“Storage Test”) systems, and circuit-board test and inspection (“Production Board Test”) systems (collectively these products represent “System Test”); |
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| • | industrial automation (“Industrial Automation”) products; and |
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| • | wireless test (“Wireless Test”) systems. |
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We have a customer base which includes integrated device manufacturers (“IDMs”), outsourced semiconductor assembly and test providers (“OSATs”), original equipment manufacturers (“OEMs”), 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, and distributors that sell collaborative robots, autonomous mobile robots and wireless test systems. The sales of our products and services are dependent, to a large degree, on these 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 because our customers often delay or accelerate purchases in reaction to changes in their businesses and to demand fluctuations in the semiconductor, electronics and industrial automation industries. Historically, these demand fluctuations have resulted in significant variations in our results of operations.
The market for our test products is concentrated with a limited number of significant customers accounting for a substantial portion of the purchases of test equipment. A few customers drive significant demand for our test products both through direct sales and sales to the customers’ supply partners. We expect that sales of our test products will continue to be concentrated with a limited number of significant customers for the foreseeable future.
In 2019, revenue in our test businesses exceeded our plan as a result of Semiconductor Test demand in China, early 5G test investments and strength in our System Test businesses. The revenue growth of our Industrial Automation businesses was below our plan. In 2020, we expect continued strong momentum in our test businesses and improvement in the growth of our Industrial Automation businesses.
On February 26, 2018, we acquired Energid Technologies Corporation (“Energid”) for a total purchase price of approximately $27.6 million. Energid’s technology enables and simplifies the programming of complex robotic motions used in a wide variety of end markets, ranging from heavy industry to healthcare, utilizing both traditional robots and collaborative robots. Energid is included in our Industrial Automation segment.
On April 25, 2018, we acquired Mobile Industrial Robots ApS (“MiR”), a Danish limited liability company. MiR is a leading maker of collaborative autonomous mobile robots (“AMRs”) for industrial applications. The total purchase price was approximately $197.8 million, which included cash paid of approximately $145.2 million and $52.6 million in fair value of contingent consideration payable upon achievement of certain thresholds and targets for revenue and earnings before interest and taxes through 2020. Contingent consideration for 2018 was $30.8 million and was paid in March 2019. Contingent consideration for 2019 was $9.1 million and is expected to be paid in March 2020. The remaining maximum contingent consideration that could be paid is $63.2 million. MiR is included in our Industrial Automation segment.
Based on our December 31, 2019 goodwill impairment test, the MiR reporting unit’s estimated fair value exceeded its carrying value by 14%. The MiR goodwill amount is $123.6 million as of December 31, 2019. Key assumptions in the goodwill valuation model are forecasted revenues, discount rate and earnings before interest and taxes. A change in any of these key assumptions could result in the reporting unit being impaired in a future period.
On January 30, 2019, we acquired all of the issued and outstanding shares of Lemsys SA (“Lemsys”) for a total purchase price of approximately $9.1 million. Lemsys strengthens our position in the electrification trends of vehicles, solar, wind, and industrial applications. Lemsys is included in our Semiconductor Test segment.
On June 3, 2019, we invested $15.0 million in RealWear, Inc. (“RealWear”). RealWear, a private company, develops and sells advanced wearable technology including industrial, hands-free, head-mounted augmented reality devices that make the workplace safer and more productive. On February 28, 2020, RealWear’s debt holder demanded repayment of its $25.0 million loan to RealWear. As a result, in the fourth quarter of 2019, we recorded an impairment charge of $15.0 million to reduce our investment in RealWear to zero as of December 31, 2019.
On November 13, 2019, we acquired 100% of the membership interests of AutoGuide, LLC (“AutoGuide”), a maker of high payload AMRs, an emerging and fast growing segment of the global forklift market. The total purchase price was approximately $81.7 million, which included cash paid of approximately $57.8 million and $24.0 million in fair value of contingent consideration payable upon achievement of certain performance targets, extending potentially through 2022. The maximum contingent consideration that could be paid is $106.9 million. AutoGuide’s AMRs are used for material transport of payloads up to 4,500 kg in manufacturing, warehouse and logistics applications. These products complement MiR’s lower payload products. AutoGuide is included in our Industrial Automation segment, which is a key component of our growth strategy.
We believe our recent acquisitions and investments have enhanced our opportunities for growth. We intend to continue to invest in our business, grow market share in our markets and further expand our addressable markets while tightly managing our costs.
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.
Revenue from Contracts with Customers
In accordance with ASC 606, “
Revenue from Contracts with Customers” (“ASC 606”)
, we recognize revenues, when or as control is transferred to a customer. Our determination of revenue is dependent upon a five step process outlined below.
| • | We account for a contract with a customer when there is written approval, the contract is committed, the rights of the parties, including payment terms, are identified, the contract has commercial substance and consideration is probable of collection. |
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| • | We periodically enter into contracts with customers in which a customer may purchase a combination of goods and services, such as products with extended warranty obligations. We determine performance obligations by assessing whether the products or services are distinct from the other elements of the contract. In order to be distinct, the product or service must perform either on its own or with readily available resources and must be separate within the context of the contract. |
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| • | We consider the amount stated on the face of the purchase order to be the transaction price. We do not have variable consideration which could impact the stated purchase price agreed to by us and the customer. |
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| • | Transaction price is allocated to each individual performance obligation based on the standalone selling price of that performance obligation. We use standalone transactions when available to value each performance obligation. If standalone transactions are not available, we will estimate the standalone selling price through market assessments or cost plus a reasonable margin analysis. Any discounts from standalone selling price are spread proportionally to each performance obligation. |
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| • | In order to determine the appropriate timing for revenue recognition, we first determine if the transaction meets any of three criteria for over time recognition. If the transaction meets the criteria for over time recognition, we recognize revenue as the good or service is delivered. We use input variables such as hours or months utilized or costs incurred to determine the amount of revenue to recognize in a given period. Input variables are used as they best align consumption with benefit to the customer. For transactions that do not meet the criteria for over time recognition, we will recognize revenue at a point in time based on an assessment of the five criteria for transfer of control. We have concluded that revenue should be recognized when shipped or delivered based on contractual terms. Typically, acceptance of our products and services is a formality as we deliver similar systems, instruments and robots to standard specifications. In cases where acceptance is not deemed a formality, we will defer revenue recognition until customer acceptance. |
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Translation of
Non-U.S.
Currencies
The functional currency for all
non-U.S.
subsidiaries is the U.S. dollar, except for Universal Robots, MiR and Lemsys for which the local currency is its functional currency. All foreign currency denominated monetary assets and liabilities are remeasured on a monthly basis into the functional currency using exchange rates in effect at the end of the period. All foreign currency denominated
non-monetary
assets and liabilities are remeasured into the functional currency using historical exchange rates. Net foreign exchange gains and losses resulting from remeasurement are included in other (income) expense, net. For Universal Robots, MiR and Lemsys, assets and liabilities are translated into U.S. dollars using exchange rates in effect at the end of the period. Revenues and expense amounts are translated using an average of exchange rates in effect during the period. Translation adjustments are recorded within accumulated other comprehensive income (loss) on the balance sheet.
Retirement and Postretirement Plans
We 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. 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.
In March 2017, the Financial Accounting Standards Board (“FASB”) issued ASU
2017-07,
“Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
.” We retrospectively adopted the new accounting guidance on presentation of net periodic pension costs and net periodic postretirement benefit costs in the first quarter of 2018. This guidance requires the service cost component of net benefit costs to be reported in the same line item in the consolidated statement of operations as other employee compensation costs. The
non-service
components of net benefit costs such as interest cost, expected return on assets, amortization of prior service cost, and actuarial gains or losses, are required to be reported separately outside of income or loss from operations. Following the adoption of this guidance, we continue to record the service cost component in the same line item as other employee compensation costs and the
non-service
components of net benefit costs such as interest cost, expected return on assets, amortization of prior service cost, and actuarial gains or losses are reported within other (income) expense, net. In 2017, the retrospective adoption of this standard decreased income from operations by $5.0 million, due to the reclass of net actuarial pension gains and increased
non-operating
(income) expense by the same amount with no impact to net income (loss).
Inventories
Inventories are stated at the lower of cost using a standard costing system which approximates cost based on a
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.
” Upon adoption of ASU
2016-09,
“Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,”
in the first quarter of 2017, we made an accounting policy election to continue accounting for forfeitures by applying an estimated forfeiture rate and recognizing compensation costs only for those stock-based compensation awards expected to vest. In accordance with ASU
2016-09,
starting in the first quarter of 2017, excess tax benefits or tax deficiencies are recognized as a discrete tax benefit or discrete tax expense to the current income tax provision in our consolidated statements of operations and are reported as cash flows from operating activities. On January 1, 2017, a cumulative effect adjustment of $39.1 million for any prior year excess tax benefits or tax deficiencies not previously recorded was recorded as an increase to retained earnings and deferred tax assets. All cash payments made to taxing authorities on the employees’ behalf for withheld shares are presented as financing activities on the statement of cash flows. In 2019, 2018 and 2017, we recognized a discrete tax benefit of $4.9 million, $7.6 million and $6.3 million, respectively, related to net excess tax benefit.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The measurement of deferred tax assets is reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be realized. We performed the required assessment of positive and negative evidence regarding the realization of the net deferred tax assets in accordance with ASC 740, “
Accounting for Income Taxes.
” This assessment included the evaluation of scheduled
reversals of deferred tax liabilities, estimates of projected future taxable income and
tax-planning
strategies. Although realization is not assured, based on our assessment, we concluded that it is more likely than not that such assets, net of the existing valuation allowance, will be realized.
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; |
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| • | The financial condition and near-term prospects of the issuer; and |
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| • | 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. |
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Investment in Other Companies
We account for investments in other companies at cost and evaluate for impairment or an indication of changes in fair value resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer on a quarterly basis.
Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU
2016-01,
“
Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.
” We adopted the new accounting guidance in the first quarter of 2018 using the modified retrospective approach. This guidance requires that changes in fair value of equity marketable securities be accounted for directly in earnings. Previously, the changes in fair value of equity marketable securities were recorded in accumulated other comprehensive income on the balance sheet. We continue to record realized gains in interest income and realized losses in interest expense. The adoption of this new accounting guidance increased the January 1, 2018 retained earnings balance by $3.1 million and decreased the accumulated other comprehensive income balance by the same amount.
Goodwill, Intangible and Long-Lived Assets
We assess goodwill for impairment at least annually in the fourth quarter, as of December 31, 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 of goodwill, an impairment charge is recorded in an amount equal to that excess.
No goodwill impairment was identified in 2019, 2018 and 2017.
Based on our December 31, 2019 goodwill impairment test, the MiR reporting unit’s estimated fair value exceeded its carrying value by 14%. The MiR goodwill amount is $123.6 million as of December 31, 2019. Key assumptions in the goodwill valuation model are forecasted revenues, discount rate and earnings before interest and taxes. A change in any of these key assumptions could result in the reporting unit being impaired in a future period.
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.
Business Combination
We recognize the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The fair value of identifiable intangible assets is based on detailed cash flow valuations that use information and assumptions provided by management. We estimate the fair value of contingent consideration at the time of the acquisition using all pertinent information known to us at the time to assess the probability of payment of contingent amounts or through the use of a Monte Carlo simulation model. We allocate any excess purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed to goodwill. The assumptions used in the valuations for our acquisitions may differ materially from actual results depending on performance of the acquired businesses and other factors. While we believe the assumptions used were appropriate, different assumptions in the valuation of assets acquired and liabilities assumed could have a material impact on the timing and extent of impact on our statements of operations. Goodwill is assigned to reporting units as of the date of the related acquisition.
Results of Operations
Information pertaining to fiscal year 2017 results of operations, including a
year-to-year
comparison against fiscal year 2018, was included in our Annual Report on Form
10-K
for the year ended December 31, 2018 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Position and Results of Operations,” which was filed with the SEC on March 1, 2019. 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:
| Years Ended December 31, | ||||||||
| 2019 | 2018 | |||||||
| Percentage of revenues: | ||||||||
| Revenues: | ||||||||
| Products | 82.3 | % | 82.3 | % | ||||
| Services | 17.7 | 17.7 | ||||||
| Total revenues | 100.0 | 100.0 | ||||||
| Cost of revenues: | ||||||||
| Cost of products | 34.1 | 34.6 | ||||||
| Cost of services | 7.5 | 7.3 | ||||||
| Total cost of revenues (exclusive of acquired intangible assets amortization shown separately below) | 41.6 | 41.9 | ||||||
| Gross profit | 58.4 | 58.1 | ||||||
| Operating expenses: | ||||||||
| Selling and administrative | 19.0 | 18.6 | ||||||
| Engineering and development | 14.1 | 14.4 | ||||||
| Acquired intangible assets amortization | 1.7 | 1.9 | ||||||
| Restructuring and other | (0.6 | ) | 0.7 | |||||
| Total operating expenses | 34.3 | 35.5 | ||||||
| Income from operations | 24.1 | 22.6 | ||||||
| Non-operating (income) expenses: | ||||||||
| Interest income | (1.1 | ) | (1.3 | ) | ||||
| Interest expense | 1.0 | 1.5 | ||||||
| Other (income) expense, net | 1.3 | 0.1 | ||||||
| Income before income taxes | 22.9 | 22.3 | ||||||
| Income tax provision | 2.5 | 0.8 | ||||||
| Net income | 20.4 | % | 21.5 | % | ||||
Revenues
Revenues for our reportable segments were as follows:
| 2019 | 2018 | 2018-2019 Dollar Change | ||||||||||
| (in millions) | ||||||||||||
| Semiconductor Test | $ | 1,552.6 | $ | 1,492.4 | $ | 60.2 | ||||||
| Industrial Automation | 298.1 | 261.5 | 36.6 | |||||||||
| System Test | 287.5 | 216.1 | 71.4 | |||||||||
| Wireless Test | 157.3 | 132.0 | 25.3 | |||||||||
| Corporate and Other | (0.5 | ) | (1.2 | ) | 0.7 | |||||||
| $ | 2,295.0 | $ | 2,100.8 | $ | 194.2 | |||||||
The increase in Semiconductor Test revenues of $60.2 million, or 4%, from 2018 to 2019 was driven primarily by an increase in semiconductor tester sales for 5G infrastructure and image sensors and higher service revenue, partially offset by a decrease in sales in the automotive and analog test segments.
The increase in Industrial Automation revenues of $36.6 million, or 14%, from 2018 to 2019 was primarily due to higher demand for collaborative robots. The MiR acquisition was completed in April 2018.
The increase in System Test revenues of $71.4 million, or 33%, from 2018 to 2019 was primarily due to higher sales in Storage Test of 3.5” hard disk drive testers, higher sales in Defense/Aerospace test instrumentation and systems, and higher sales in Production Board Test from higher 5G demand.
The increase in Wireless Test revenues of $25.3 million, or 19%, from 2018 to 2019 was primarily due to higher demand for millimeter wave and cellular test products driven by new wireless standards and 5G, partially offset by lower sales in connectivity test products and services.
Our reportable segments accounted for the following percentages of consolidated revenues:
| 2019 | 2018 | |||||||
| Semiconductor Test | 68 | % | 71 | % | ||||
| Industrial Automation | 13 | 12 | ||||||
| System Test | 13 | 10 | ||||||
| Wireless Test | 7 | 6 | ||||||
| 100 | % | 100 | % | |||||
Revenues by country as a percentage of total revenues were as follows (1):
| 2019 | 2018 | |||||||
| China | 22 | % | 17 | % | ||||
| Taiwan | 21 | 25 | ||||||
| United States | 15 | 13 | ||||||
| Korea | 10 | 8 | ||||||
| Europe | 10 | 11 | ||||||
| Japan | 8 | 8 | ||||||
| Thailand | 4 | 3 | ||||||
| Singapore | 4 | 5 | ||||||
| Malaysia | 3 | 6 | ||||||
| Philippines | 2 | 4 | ||||||
| Rest of the World | 2 | 2 | ||||||
| 100 | % | 100 | % | |||||
| (1) | Revenues attributable to a country are based on the location of the customer site. |
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The breakout of product and service revenues was as follows:
| 2019 | 2018 | 2018-2019 Dollar Change | ||||||||||
| (in millions) | ||||||||||||
| Products revenues | $ | 1,887.7 | $ | 1,729.6 | $ | 158.1 | ||||||
| Services revenues | 407.3 | 371.2 | 36.1 | |||||||||
| $ | 2,295.0 | $ | 2,100.8 | $ | 194.2 | |||||||
Our product revenues increased $158.1 million, or 9%, in 2019 from 2018 primarily due to higher sales in Semiconductor Test of testers for 5G infrastructure and image sensors, higher sales in Storage Test of 3.5” hard disk drive testers, and higher demand in Industrial Automation, partially offset by a decrease in sales in Semiconductor Test automotive and analog test segments. Service revenues increased $36.1 million or 10%.
In 2019 and 2018, no single direct customer accounted for more than 10% of our consolidated revenues. In 2019 and 2018, our five largest direct customers in aggregate accounted for 27% and 27% of our consolidated revenues, respectively.
We estimate consolidated revenues driven by Huawei Technologies Co. Ltd. (“Huawei”), combining direct sales to that customer with sales to the customer’s OSATs, accounted for approximately 11% and 4% of our consolidated revenues in 2019 and 2018, respectively. We estimate consolidated revenues driven by another OEM customer, combining direct sales to that customer with sales to the customer’s OSATs, accounted for approximately 10% and 13% of our consolidated revenues in 2019 and 2018, respectively.
Gross Profit
| 2019 | 2018 | 2018-2019 Dollar / Point Change | ||||||||||
| (dollars in millions) | ||||||||||||
| Gross profit | $ | 1,339.8 | $ | 1,220.4 | $ | 119.4 | ||||||
| Percent of total revenues | 58.4 | % | 58.1 | % | 0.3 |
Gross profit as a percent of total revenues increased from 2018 to 2019 by 0.3 points, primarily due to favorable product mix in Semiconductor Test and Storage Test.
The breakout of product and service gross profit was as follows:
| 2019 | 2018 | 2018-2019 Dollar / Point Change | ||||||||||
| (dollars in millions) | ||||||||||||
| Product gross profit | $ | 1,105.6 | $ | 1,002.5 | $ | 103.1 | ||||||
| Percent of product revenues | 58.6 | % | 58.0 | % | 0.6 | |||||||
| Service gross profit | $ | 234.2 | $ | 217.9 | $ | 16.3 | ||||||
| Percent of service revenues | 57.5 | % | 58.7 | % | (1.2 | ) |
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 during the next twelve quarters for our Semiconductor Test, Industrial Automation and System Test segments and next four quarters for our Wireless Test segment, is written-down to estimated net realizable value.
During the year ended December 31, 2019, we recorded an inventory provision of $15.2 million included in cost of revenues, primarily due to downward revisions to previously forecasted demand levels for certain products. Of the $15.2 million of total excess and obsolete provisions, $8.7 million was related to Semiconductor Test, $4.0 million was related to Wireless Test, $2.0 million was related to System Test, and $0.5 million was related to Industrial Automation.
During the year ended December 31, 2018, we recorded an inventory provision of $11.2 million included in cost of revenues, primarily due to downward revisions to previously forecasted demand levels for certain products. Of the $11.2 million of total excess and obsolete provisions, $6.8 million was related to Semiconductor Test, $2.5 million was related to Wireless Test, $1.2 million was related to System Test, and $0.7 million was related to Industrial Automation.
During the years ended December 31, 2019 and 2018, we scrapped $9.2 million and $7.0 million of inventory, respectively, and sold $3.2 million and $6.7 million of previously written-down or
written-off
inventory, respectively. As of December 31, 2019, we had inventory related reserves for amounts which had been written-down or
written-off
totaling $103.6 million. We have no
pre-determined
timeline to scrap the remaining inventory.
Selling and Administrative
Selling and administrative expenses were as follows:
| 2019 | 2018 | 2018-2019 Change | ||||||||||
| (dollars in millions) | ||||||||||||
| Selling and administrative | $ | 437.1 | $ | 390.7 | $ | 46.4 | ||||||
| Percent of total revenues | 19.0 | % | 18.6 | % |
The increase of $46.4 million in selling and administrative expenses from 2018 to 2019 was due primarily to higher spending in Industrial Automation from higher sales and marketing spending in Universal Robots and MiR, which was acquired on April 25, 2018, higher sales and marketing spending in Semiconductor Test and higher variable compensation.
Engineering and Development
Engineering and development expenses were as follows:
| 2019 | 2018 | 2018-2019 Change | ||||||||||
| (dollars in millions) | ||||||||||||
| Engineering and development | $ | 322.8 | $ | 301.5 | $ | 21.3 | ||||||
| Percent of total revenues | 14.1 | % | 14.4 | % |
The increase of $21.3 million in engineering and development expenses from 2018 to 2019 was due primarily to higher spending in Industrial Automation and Wireless Test and higher variable compensation.
Restructuring and Other
During the year ended December 31, 2019, we recorded a gain of $22.2 million from the decrease in the fair value of the MiR contingent consideration liability, partially offset by a $3.0 million increase in the fair value of the AutoGuide contingent consideration, $2.9 million of severance charges related to headcount reductions primarily in Semiconductor Test and Industrial Automation, and $2.5 million for acquisition related expenses and compensation.
During the year ended December 31, 2018, we recorded an expense of $17.7 million for the increase in the fair value of the MiR contingent consideration liability, $8.7 million of severance charges related to headcount reductions primarily in Semiconductor Test, and $4.5 million for acquisition related expenses and compensation, partially offset by a gain of $16.7 million from the decrease in the fair value of the Universal Robots contingent consideration liability.
The remaining accrual for severance of $0.5 million is reflected in the accrued employees’ compensation and withholdings on the balance sheet and is expected to be paid by October 2020.
Interest and Other
| 2019 | 2018 | 2018-2019 Change | ||||||||||
| (in millions) | ||||||||||||
| Interest income | $ | (24.8 | ) | $ | (26.7 | ) | $ | 1.9 | ||||
| Interest expense | 23.1 | 31.3 | (8.2 | ) | ||||||||
| Other (income) expense, net | 29.5 | 1.4 | 28.1 |
Interest income decreased by $1.9 million from 2018 to 2019 due primarily to lower cash and marketable securities balances in 2019. Interest expense decreased by $8.2 million from 2018 to 2019 due primarily to unrealized losses on equity marketable securities recognized in 2018. Other (income) expense, net increased by $28.1 million from 2018 to 2019 due primarily to a $15.0 million charge for the impairment of the investment in RealWear and an $11.5 million change in pension actuarial (gains) losses from a $3.3 million gain in 2018 to an $8.2 million loss in 2019.
Income (Loss) Before Income Taxes
| 2019 | 2018 | 2018-2019 Change | ||||||||||
| (in millions) | ||||||||||||
| Semiconductor Test | $ | 417.0 | $ | 397.6 | $ | 19.4 | ||||||
| System Test | 93.5 | 48.9 | 44.6 | |||||||||
| Wireless Test | 35.6 | 29.1 | 6.5 | |||||||||
| Industrial Automation | (5.9 | ) | 7.7 | (13.6 | ) | |||||||
| Corporate and Other (1) | (14.4 | ) | (15.4 | ) | 1.0 | |||||||
| $ | 525.8 | $ | 467.8 | $ | 58.0 | |||||||
| (1) | Included in Corporate and Other are the following: contingent consideration adjustments, investment impairment, pension and postretirement plans actuarial (gains) and losses, interest (income) and expense, net foreign exchange (gains) and losses, intercompany eliminations and acquisition related charges. |
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The increase in income before income taxes in Semiconductor Test from 2018 to 2019 was driven primarily by an increase in semiconductor tester sales for 5G infrastructure and image sensors, partially offset by a decrease in sales in the automotive and analog test segments. The increase in income before income taxes in System Test from 2018 to 2019 was primarily due to higher sales in Storage Test of 3.5” hard disk drive testers, higher sales in Defense/Aerospace test instrumentation and systems, and higher sales in Production Board Test
from higher 5G demand. The increase in income before income taxes in Wireless Test from 2018 to 2019 was primarily due to higher demand for millimeter wave and cellular test products driven by new wireless standards and 5G partially offset by lower sales in connectivity test products and services. The decrease in income before income taxes in Industrial Automation from 2018 to 2019 was due primarily to higher sales and marketing, and engineering spending.
Income Taxes
Income tax expense for 2019, 2018 and 2017 totaled $58.3 million, $16.0 million and $266.7 million, respectively. The effective tax rate for 2019, 2018 and 2017 was 11.1%, 3.4% and 50.9%, respectively.
The increase in the effective tax rate from 2018 to 2019 is primarily attributable to increases in expense associated with U.S. global intangible
low-taxed
income and U.S. transition tax on the mandatory deemed repatriation of foreign earnings. These increases in expense were partially offset by increased benefit from the U.S. foreign derived intangible income deduction, foreign tax credits and a net reduction in reserves for uncertain tax positions.
We recorded $186.0 million of additional income tax expense in the fourth quarter of 2017 which represented our best estimate of the impact of the Tax Reform Act in accordance with our understanding of the Tax Reform Act and available guidance as of that date. The $186.0 million was primarily composed of expense of $161.0 million related to the
one-time
transition tax on the mandatory deemed repatriation of foreign earnings, $33.6 million of expense related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, and benefit of $10.3 million associated with the impact of correlative adjustments on uncertain tax positions. In accordance with the requirements of SEC Staff Accounting Bulletin (“SAB”) No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act”, in the fourth quarter of 2018, we completed our analysis of the effect of the Tax Reform Act based on the application of the guidance available as of December 31, 2018 and recorded $49.5 million of net income tax benefit. The net benefit consisted of $51.7 million of benefit resulting from a reduction in the estimate of the
one-time
transition tax on the mandatory deemed repatriation of foreign earnings and an expense of $2.2 million associated with the impact of correlative adjustments on uncertain tax positions.
The change in the effective tax rate from 2017 to 2018 was also impacted by a shift in the geographic distribution of income which increased income subject to taxation in the U.S. relative to lower tax rate jurisdictions, the benefit of the U.S. foreign derived intangible income deduction and increases in discrete benefit from
non-taxable
foreign exchange gains and losses.
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, 2019, 2018 and 2017 were $15.1 million or $0.08 per diluted share, $11.9 million or $0.06 per diluted share and $24.8 million or $0.12 per diluted share, respectively. The tax holiday is scheduled to expire on December 31, 2020.
Contractual Obligations
The following table reflects our contractual obligations as of December 31, 2019:
| Payments Due by Period | ||||||||||||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | Other | |||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||
| Convertible debt | $ | 460,000 | $ | — | $ | — | $ | 460,000 | $ | — | $ | — | ||||||||||||
| Purchase obligations | 415,582 | $ | 412,948 | 2,634 | — | — | — | |||||||||||||||||
| Retirement plans contributions | 139,451 | 5,069 | 10,464 | 10,336 | 113,582 | — | ||||||||||||||||||
| Transition tax payable (1) | 88,157 | 5,515 | 15,741 | 22,628 | 44,273 | — | ||||||||||||||||||
| Operating lease obligations | 72,505 | 21,933 | 30,582 | 11,602 | 8,388 | — | ||||||||||||||||||
| Interest on long term debt | 23,000 | 5,750 | 11,500 | 5,750 | — | — | ||||||||||||||||||
| Fair value of contingent consideration | 39,705 | 9,106 | 30,599 | — | — | — | ||||||||||||||||||
| Other long-term liabilities reflected on the balance sheet under GAAP (2) | 79,579 | — | 39,156 | 6,348 | 470 | 33,605 | ||||||||||||||||||
| Total | $ | 1,317,979 | $ | 460,321 | $ | 140,676 | $ | 516,664 | $ | 166,713 | $ | 33,605 | ||||||||||||
| (1) | Represents the transition tax liability associated with our accumulated foreign earnings as a result of enactment of the Tax Reform Act on December 22, 2017. |
|---|
| (2) | Included in other long-term liabilities are liabilities for customer advances, extended warranty, uncertain tax positions, deferred tax liabilities 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 decreased by $189 million from 2018 to 2019 to $1,016 million.
Operating activities during 2019 provided cash of $578.8 million. Changes in operating assets and liabilities used cash of $51.7 million due to a $121.6 million increase in operating assets and a $69.9 million increase in operating liabilities.
The increase in operating assets was due to a $70.4 million increase in accounts receivable due to increased sales, a $27.4 million increase in inventories, and a $23.8 million increase in prepayments and other assets.
The increase in operating liabilities was due to a $39.3 million increase in deferred revenue and customer advance payments, a $24.8 million increase in accounts payable, a $15.3 million increase in accrued employee compensation and a $9.2 million increase in other accrued liabilities, partially offset by a $13.6 million decrease in income taxes, and $5.1 million of retirement plan contributions.
Investing activities during 2019 used cash of $156.7 million, due to $662.7 million used for purchases of marketable securities, $134.6 million used for purchases of property, plant and equipment, $57.8 million, net of cash acquired, used for the acquisition of AutoGuide, $15.0 million used for an investment in RealWear, and $7.0 million, net of cash acquired, used for the acquisition of Lemsys, partially offset by $611.9 million and $105.6 million in proceeds from maturities and sales of marketable securities, respectively, and proceeds from life insurance of $2.9 million related to the cash surrender value from the cancellation of Teradyne owned life insurance policies.
Financing activities during 2019 used cash of $574.3 million, due to $500.0 million used for the repurchase of 10.9 million shares of common stock at an average price of $45.89 per share, $61.3 million used for dividend
payments, $27.6 million used for payments related to MiR and Universal Robots acquisition contingent consideration and $14.7 million used for payments related to net settlement of employee stock compensation awards, partially offset by $29.3 million from the issuance of common stock under employee stock purchase and stock option plans.
Operating activities during 2018 provided cash of $476.9 million. Changes in operating assets and liabilities used cash of $163.5 million. This was due to a $105.8 million increase in operating assets and a $57.7 million decrease in operating liabilities.
The increase in operating assets was due to a $58.4 million increase in prepayments and other assets due primarily to payments to our contract manufacturers, a $29.5 million increase in inventories, and a $17.9 million increase in accounts receivable due to higher sales in the fourth quarter of 2018.
The decrease in operating liabilities was due to a $80.4 million decrease in income taxes, primarily related to a decrease in our transitional tax liability associated with our accumulated foreign earnings under the U.S. Tax Reform Act, a $5.5 million decrease in other accrued liabilities and $4.3 million of retirement plans contributions, partially offset by a $13.4 million increase in customer advance payments and deferred revenue, a $12.9 million increase in accounts payable, and a $6.3 million increase in accrued employee compensation due primarily to variable compensation.
Investing activities during 2018 provided cash of $923.0 million, due to $1,270.4 million and $846.1 million in proceeds from maturities and sales of marketable securities, respectively, proceeds from a government subsidy of $7.9 million for property, plant and equipment, and proceeds from life insurance of $1.1 million related to the cash surrender value from the cancellation of a Teradyne owned life insurance policy, partially offset by $918.7 million used for purchase of marketable securities, $169.5 million used for the acquisitions of MiR and Energid, and $114.4 million used for purchases of property, plant and equipment.
Financing activities during 2018 used cash of $903.4 million, due to $823.5 million used for the repurchase of 21.6 million shares of common stock at an average price of $38.06 per share, $67.3 million used for dividend payments, $20.0 million used for payments related to net settlement of employee stock compensation awards, and $13.6 million used for a payment related to Universal Robots acquisition contingent consideration, partially offset by $21.0 million from the issuance of common stock under employee stock purchase and stock option plans.
In January 2019, May 2019, August 2019 and November 2019, our Board of Directors declared a quarterly cash dividend of $0.09 per share. Total dividend payments in 2019 were $61.3 million.
In January 2018, May 2018, August 2018 and November 2018, our Board of Directors declared a quarterly cash dividend of $0.09 per share. Total dividend payments in 2018 were $67.3 million.
In January 2020, our Board of Directors declared a quarterly cash dividend of $0.10 per share to be paid on March 20, 2020 to shareholders of record as of February 21, 2020. Payment of future cash dividends are subject to the discretion of our Board of Directors and will depend, among other things, upon our earnings, capital requirements and financial condition.
In January 2018, our Board of Directors cancelled the December 2016 stock repurchase program and authorized a new stock repurchase program for up to $1.5 billion of common stock. In 2019, we repurchased 10.9 million shares of common stock for $500.0 million at an average price per share of $45.89. In 2018, we repurchased 21.6 million shares of common stock for $823.5 million at an average price per share of $38.06. The cumulative repurchases as of December 31, 2019 totaled 32.5 million shares of common stock for $1,323.0 million at an average price per share of $40.68.
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 of common stock. We intend to repurchase a minimum of $250.0 million in 2020.
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.
We believe our cash, cash equivalents and marketable securities balance will be sufficient to pay our quarterly dividend, execute our authorized share repurchase program 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.
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.
For the year ended December 31, 2019, 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 $11.6 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 4.25% was an appropriate rate of return on assets to use for 2019. The December 31, 2019 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 plans 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 3.10% at December 31, 2019, down from 4.15% at December 31, 2018. We estimate that in 2020 we will recognize approximately $0.9 million of pension expense for the U.S. Plan. The U.S. Plan pension expense estimate for 2020 is based on a 3.1% discount rate and a 3.0% 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, 2019, 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 increased from $144.3 million at December 31, 2018 to $166.9 million at December 31, 2019 while the U.S. Plan’s liability increased from $127.4 million at December 31, 2018 to $148.5 million at December 31, 2019. In 2019, the increase in plan assets and plan liability was due to a decrease in interest rates. In 2018, the accrued pension obligations for approximately 1,700 retiree participants were transferred to an insurance company and resulted in a $151.3 million reduction in the pension benefit obligation and pension assets. We recorded a settlement loss of $0.3 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 2019, we made contributions of $2.8 million to the U.S. supplemental executive defined benefit pension plan, and $0.9 million to certain qualified plans for
non-U.S.
subsidiaries. In 2020, we expect to contribute approximately $2.8 million to the U.S. supplemental executive defined benefit pension plan. Contributions to be made in 2020 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.
The following table presents information about these plans as of December 31, 2019 (share numbers in thousands):
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column one) | |||||||||
| Equity plans approved by shareholders | 2,542 | (1) | $ | 34.52 | 8,543 | (2) | ||||||
| Equity plans not approved by shareholders (3) | 47 | 2.89 | — | |||||||||
| Total | 2,589 | 29.91 | 8,543 | |||||||||
| (1) | Includes 2,269,426 shares of restricted stock units that are not included in the calculation of the weighted average exercise price. |
|---|
| (2) | Consists of 6,719,918 securities available for issuance under the 2006 Equity Plan and 1,822,724 of securities available for issuance under the Employee Stock Purchase Plan. |
|---|
| (3) | In connection with the 2011 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 were granted under the LitePoint Plan. As of December 31, 2019, there were outstanding options exercisable for an aggregate of |
|---|
| 46,518 shares of our common stock pursuant to the LitePoint Plan, with a weighted average exercise price of $2.89 per share. |
|---|
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, 2019 was 6,719,918 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.
As of December 31, 2019, total unrecognized compensation expense related to
non-vested
restricted stock units and options was $45 million, and is expected to be recognized over a weighted average period of 1.8 years.
Performance Graph
The following graph compares the change in our cumulative total shareholder return in our common stock with (i) the NYSE Composite Index and (ii) the Morningstar Semiconductor Equipment & Materials Industry Group (compiled by Morningstar, Inc.). The comparison assumes $100.00 was invested on December 31, 2014 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
On January 26, 2017, the FASB issued ASU
2017-04,
“Intangibles—Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment.”
The new guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will be the
amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same
one-step
impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. The revised guidance will be applied prospectively, and is effective in 2020. Early adoption is permitted for any impairment tests performed after January 1, 2017. This pronouncement is not expected to have a material impact on our financial position, results of operations and statements of cash flows.
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