F. Financial Instruments and Derivatives

Financial Instruments

Teradyne uses the market and income approach to value its financial instruments and there was no change in valuation techniques used by Teradyne during the three and nine months ended September 30, 2012 and October 2, 2011. As defined in ASC 820-10, “Fair Value Measurements and Disclosures”, fair value is the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820-10 requires that assets and liabilities are carried at fair value and are classified in one of the following three categories:

Level 1: Quoted prices in active markets for identical assets as of the reporting date.

Level 2: Inputs other than Level 1, that are observable either directly or indirectly as of the reporting date. For example, a common approach for valuing fixed income securities is the use of matrix pricing. Matrix pricing is a mathematical technique used to value securities by relying on the securities’ relationship to other benchmark quoted prices.

Level 3: Unobservable inputs that are not supported by market data. Unobservable inputs are developed based on the best information available, which might include Teradyne’s own data.

Most of Teradyne’s fixed income securities are classified as Level 2, with the exception of U.S. Treasury securities and investments in equity and debt mutual funds, which are classified as Level 1, and contingent consideration, which is classified as Level 3. As of September 30, 2012, the majority of Level 2 securities were priced by third party pricing vendors. These pricing vendors utilize the most recent observable market information in pricing these securities or, if specific prices are not available, use other observable inputs like market transactions involving identical or comparable securities.

During the nine months ended September 30, 2012 and October 2, 2011, there were no transfers in or out of Level 1, Level 2 or Level 3 financial instruments.

The following table sets forth by fair value hierarchy Teradyne’s financial assets and liabilities that were measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011.


	September 30, 2012
	Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Assets
Cash	$	194,724	$	—	$	—	$	194,724
Cash equivalents		275,546		15,422		—		290,968
Available for sale securities:
U.S. Treasury securities		268,020		—		—		268,020
U.S. government agency securities		—		146,655		—		146,655
Corporate debt securities		—		47,490		—		47,490
Commercial paper		—		44,476		—		44,476
Equity and debt mutual funds		9,552		—		—		9,552
Certificates of deposit and time deposits		—		6,660		—		6,660
Non-U.S. government securities		278		—		—		278

Total	$	748,120	$	260,703	$	—	$	1,008,823

Liabilities
Contingent consideration	$	—	$	—	$	16,513	$	16,513
Derivatives		—		106		—		106

Total	$	—	$	106	$	16,513	$	16,619

Reported as follows:


	(Level 1)		(Level 2)		(Level 3)		Total
	(in thousands)
Assets
Cash and cash equivalents	$	470,270	$	15,422	$	—	$	485,692
Marketable securities		198,289		146,561		—		344,850
Long-term marketable securities		79,561		98,720		—		178,281

	$	748,120	$	260,703	$	—	$	1,008,823

Liabilities
Contingent consideration	$	—	$	—	$	16,513	$	16,513
Other accrued liabilities		—		106		—		106

	$	—	$	106	$	16,513	$	16,619


	December 31, 2011
	Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Assets
Cash	$	161,243	$	—	$	—	$	161,243
Cash equivalents		396,329		16,164		—		412,493
Available for sale securities:
U.S. government agency securities		—		83,197		—		83,197
Corporate debt securities		—		44,829		—		44,829
Commercial paper		—		22,075		—		22,075
U.S. Treasury securities		14,180		—		—		14,180
Equity and debt mutual funds		8,237		—		—		8,237
Certificates of deposit and time deposits		—		8,117		—		8,117
Non-U.S. government securities		274		—		—		274

Total	$	580,263	$	174,382	$	—	$	754,645

Liabilities
Contingent consideration	$	—	$	—	$	68,892	$	68,892
Derivatives		—		314		—		314

Total	$	—	$	314	$	68,892	$	69,206

Reported as follows:


	(Level 1)		(Level 2)		(Level 3)		Total
	(in thousands)
Assets
Cash and cash equivalents	$	557,572	$	16,164	$	—	$	573,736
Marketable securities		9,044		87,458		—		96,502
Long-term marketable securities		13,647		70,760		—		84,407

	$	580,263	$	174,382	$	—	$	754,645

Liabilities
Contingent consideration	$	—	$	—	$	68,892	$	68,892
Other accrued liabilities		—		314		—		314

	$	—	$	314	$	68,892	$	69,206

Contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which represents a Level 3 measurement within the fair value hierarchy. The valuation of contingent consideration uses assumptions and estimates to forecast a range of outcomes. Teradyne assesses these assumptions and estimates on a quarterly basis as additional data impacting the assumptions is obtained. Changes in the fair value of contingent consideration related to updated assumptions and estimates are recognized within the condensed consolidated statements of operations.

The following table provides quantitative information associated with the fair value measurement of Teradyne’s Level 3 financial instrument:

September 30, 2012

Weighted
Average

Liability

Fair Value

Valuation Technique

Unobservable Inputs

(in thousands)

Contingent

consideration

16,513

Income approach—discounted
cash flow

Discount rate for revenue earn-out

3.5

Discount rate for new product earn-out

3.5

The following table represents changes in the fair value of Level 3 contingent consideration:


	Contingent consideration
	(in thousands)
Balance at December 31, 2011	$	68,892
Fair value adjustment		(1,858	)
Payment		(5,824	)

Balance at April 1, 2012		61,210
Fair value adjustment		(6,548	)

Balance at July 1, 2012		54,662
Payment		(38,149	)

Balance at September 30, 2012	$	16,513

On October 24, 2012 Teradyne paid $14.4 million of the contingent consideration.

For the nine months ended September 30, 2012 and October 2, 2011, proceeds from sales of available-for-sale marketable securities were $70.9 million and $627.4 million, respectively. The proceeds from the sales of marketable securities during the nine months ended October 2, 2011 were used to fund Teradyne’s acquisition of LitePoint.

During the three and nine months ended September 30, 2012, Teradyne recorded a net gain of $0.3 million and $0.9 million, respectively, from sales of marketable securities. During the three and nine months ended October 2, 2011, Teradyne recorded a net gain of $2.2 million from sales of marketable securities.

Realized losses from sales of marketable securities are included in interest expense and other. Realized gains from sales of marketable securities are included in interest income.

The carrying amounts and fair values of financial instruments at September 30, 2012 and December 31, 2011 were as follows:


	September 30, 2012				December 31, 2011
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(in thousands)
Cash and cash equivalents	$	485,692	$	485,692	$	573,736	$	573,736
Marketable securities		523,131		523,131		180,909		180,909
Convertible debt(1)		166,268		499,225		156,098		485,925
Japan loan		5,151		5,151		6,431		6,431

(1)	The carrying value represents the bifurcated debt component only, while the fair value is based on quoted market prices for the convertible note which includes the equity conversion feature.

The fair values of cash and cash equivalents, accounts receivable, net and accounts payable approximate the carrying amount due to the short-term maturities of these instruments.

The following tables summarize the composition of available for sale marketable securities at September 30, 2012 and December 31, 2011:


	September 30, 2012
	Available-for-Sale									Fair Market Value of Investments with Unrealized Losses
	Cost		Unrealized Gain		Unrealized (Loss)			Fair Market Value		Fair Market Value of Investments with Unrealized Losses
	(in thousands)
U.S. Treasury securities	$	267,831	$	190	$	(1	)	$	268,020	$	175
U.S. government agency securities		146,418		237		—			146,655		—
Corporate debt securities		44,858		2,689		(57	)		47,490		872
Commercial paper		44,474		6		(4	)		44,476		10,235
Equity and debt mutual funds		8,471		1,084		(3	)		9,552		148
Certificates of deposit and time deposits		6,658		2		—			6,660		—
Non-U.S. government securities		278		—		—			278		—

	$	518,988	$	4,208	$	(65	)	$	523,131	$	11,430

Reported as follows:


	Cost		Unrealized Gain		Unrealized (Loss)			Fair Market Value		Fair Market Value of Investments with Unrealized Losses
	(in thousands)
Marketable securities	$	344,777	$	77	$	(4	)	$	344,850	$	10,235
Long-term marketable securities		174,211		4,131		(61	)		178,281		1,195

	$	518,988	$	4,208	$	(65	)	$	523,131	$	11,430


	December 31, 2011
	Available-for-Sale									Fair Market Value of Investments with Unrealized Losses
	Cost		Unrealized Gain		Unrealized (Loss)			Fair Market Value		Fair Market Value of Investments with Unrealized Losses
	(in thousands)
U.S. government agency securities	$	83,070	$	152	$	(25	)	$	83,197	$	28,510
Corporate debt securities		43,077		1,893		(141	)		44,829		17,033
Commercial paper		22,083		2		(10	)		22,075		9,479
U.S. Treasury securities		14,141		39		—			14,180		—
Equity and debt mutual funds		7,876		477		(116	)		8,237		3,749
Certificates of deposit and time deposits		8,122		—		(5	)		8,117		5,800
Non-U.S. government securities		256		18		—			274		—

	$	178,625	$	2,581	$	(297	)	$	180,909	$	64,571

Reported as follows:


	Cost		Unrealized Gain		Unrealized (Loss)			Fair Market Value		Fair Market Value of Investments with Unrealized Losses
	(in thousands)
Marketable securities	$	96,518	$	24	$	(40	)	$	96,502	$	35,595
Long-term marketable securities		82,107		2,557		(257	)		84,407		28,976

	$	178,625	$	2,581	$	(297	)	$	180,909	$	64,571

As of September 30, 2012, the fair market value of marketable securities with unrealized losses totaled $11.4 million. There were no unrealized losses greater than one year. As of December 31, 2011, the fair market value of marketable securities with unrealized losses totaled $64.6 million. Of this value, $2.4 million had unrealized losses greater than one year and $62.2 million had unrealized losses less than one year.

The contractual maturities of available-for-sale marketable securities as of September 30, 2012 were as follows:


	September 30, 2012
	Cost		Fair Market Value
Due within one year	$	344,777	$	344,850
Due after 1 year through 5 years		155,621		157,028
Due after 5 years through 10 years		2,819		3,025
Due after 10 years		15,771		18,228

Total	$	518,988	$	523,131

Derivatives

Teradyne conducts business in a number of foreign countries, with certain transactions denominated in local currencies. The purpose of Teradyne’s foreign currency management is to minimize the effect of exchange rate fluctuations on certain foreign currency denominated net monetary assets. Teradyne does not use derivative financial instruments for trading or speculative purposes.

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

The notional amount of foreign exchange contracts hedging monetary assets and liabilities denominated in foreign currencies was $84.5 million and $85.4 million at September 30, 2012 and December 31, 2011, respectively.

The following table summarizes the fair value of derivative instruments at September 30, 2012 and December 31, 2011.


	Balance Sheet Location		September 30, 2012		December 31, 2011
			(in thousands)
Derivatives not designated as hedging instruments:
Foreign exchange contracts		Other accrued liabilities	$	106	$	314

			$	106	$	314

The following table summarizes the effect of derivative instruments in the statement of operations recognized during the three and nine months ended September 30, 2012 and October 2, 2011. The table does not reflect the corresponding gains (losses) from the remeasurement of the monetary assets and liabilities denominated in foreign currencies.


	Location of Gains (Losses) Recognized in Statement of Operations		For the Three Months Ended						For the Nine Months Ended
			September 30, 2012			October 2, 2011			September 30, 2012			October 2, 2011
			(in thousands)
Derivatives not designated as hedging instruments:
Foreign exchange contracts		Interest expense and other	$	(1,197	)	$	(1,429	)	$	(677	)	$	(858	)

			$	(1,197	)	$	(1,429	)	$	(677	)	$	(858	)

See Note G “Debt” regarding derivatives related to convertible senior notes.