“Over-all, semiconductor equipment orders are down 69 percent year-over-year and 71 percent from the peak in November 1997. Declines at this level make the 1998 downturn the worst in the history of the modern semiconductor equipment industry.”

Brett Hodess
NationsBanc Montgomery Securities LLC
(writing in Channel, a publication of the trade group SEMI)

A bookings collapse of this magnitude is serious business, and, not surprisingly, the red ink flowed throughout the equipment industry last year — just as it had at Teradyne in the downturns of earlier decades. But this time we were better prepared. Here is how your Company performed during the semiconductor equipment bloodbath of 1998:

• We reported net income of over $100 million.

• We increased total sales to a record $1.489 billion. Our sales of semiconductor test equipment grew by 14 percent, and in that business we outshipped every other supplier in the world.

• Our Connection Systems Division increased its sales by 19 percent, to a record $280 million.

• We gained market share in every one of our major product lines.

• We increased our R&D spending to a record $195 million.

• We invested more than $20 million in a new plant under construction in North Reading, Massachusetts, $11 million in a major expansion of our printed-circuit plant in Nashua, New Hampshire, and another $8.5 million to double the size of our plant in Kumamoto, Japan.

• We aggressively recruited on the college campuses once again, hiring more than 280 recent graduates.

• We repurchased 1.4 million shares of our stock in the open market.

• After making all these investments in our future, we ended the year with about $50 million more in cash and marketable securities than we had a year earlier.

If you are a regular reader of these reports, you will remember that in 1996 we introduced a long list of new products — so many, in fact, that we compared the occasion to a banner season on Broadway, with Catalyst, Marlin, Avalanche, 4TEL II, and other marquee titles opening while we waited hopefully for the reviews. In 1997, the first wave of orders hit, and it was clear that we had a string of solid hits. Then, in 1998, came the challenge of deploying these systems by the hundreds in our customers’ plants. Our field support staffs came through brilliantly, and that is one of the reasons for our outstanding results in the year. Of the $1.5 billion worth of systems we shipped last year, almost half were the very products highlighted in that 1996 Annual Report.

Although sales hit a record level for the year, our bookings fell as the semiconductor industry retrenched, and we responded by bringing down our shipments from quarter to quarter. We did not, however, resort to deep personnel cuts, because we were reasonably sure that bookings would soon recover. Our faith was rewarded by a year-end surge in orders across most of our product lines. In fact, fourth-quarter orders of $371 million were the fourth highest in our history, building our backlog and doing wonders for our self-confidence.

The near-doubling of our sales from 1994 through 1998 placed a great strain on our facilities, and it was not uncommon to find makeshift offices in the stairwells at Agoura Hills and shrinking cubicles at our downtown Boston headquarters. The growth that lies ahead of us cannot be accommodated by more scrambling and squeezing, so we have embarked on a major expansion of our facilities. The largest of the projects is a new plant being built on a 45-acre site in North Reading, Massachusetts. The first two buildings, totaling 273,000 square feet, will be completed in 1999, and the site will accommodate two additional buildings, bringing the total to about a half million square feet.

Our Connection Systems Division, whose sales have also doubled since 1994, has done its own share of squeezing, and new space has been added. In 1998 we invested $11 million to complete a major expansion of the printed-circuit facility that produces the Division’s large, multilayer backplanes, and we brought on line a new plant in Milpitas, California. The Division now has over 600,000 square feet of manufacturing space at its disposal.

We also doubled the size of our plant in Kumamoto, Japan, where we produce testers for the Japanese market, including a highly successful system to test image-sensing semiconductor devices.

In addition to the plant expansions noted above, we invested heavily in the Teradyne systems we need for customer demonstrations and in our own manufacturing operations. Our total investment in property, plant, and equipment during the year totaled $164 million, about $32 million more than we spent in 1997.

And, as mentioned above, we bought back over a million shares of stock and generated a lot of cash.

Where did all the money come from?

In addition to $102 million of net income, we “earned” another $52 million by reducing our working capital, continuing an effort that has engaged our attention for many years, with gratifying results.

Since one of the largest cost items in our industry is the payroll, it is not unusual to see companies responding to business downturns by laying off employees. When it is unavoidable, we will, too. At the margin, we’d rather not, so we have looked for other ways to deal with the issue. The widespread use of temporary employees has given us the flexibility we need to adjust quickly to changing conditions, and last year several of our divisions trimmed payroll principally by reducing the number of “temps.” Thus, although the number of permanent employees increased by about 8 percent from year-end to year-end (or about half the rate of sales growth), our total headcount, including temporary employees, fell.

Among the new employees hired by Teradyne in 1998 were 287 new college graduates, a record yield from our latest college recruiting effort. Throughout our history we have always devoted great energy to the search for the brightest young people we could find. This recruiting effort goes on, year in, year out, no matter what the economic environment, and we are especially proud of the “Class of ’98,” some of whom can be seen on page 13.

In 1998 we gained four new vice presidents: Roger Saylor, a 20-year Teradyne veteran who oversees semiconductor test sales in Southeast Asia; Rick Schneider, an 11-year employee who manages our Connection Systems Division; Joe Wrinn, who has been with Teradyne 23 years and now manages our Assembly Test Division; and Rob Strickland, who recently joined Teradyne to manage our Information Systems program. Roger, Rick, and Joe have solid records of achievement at Teradyne, and Rob brings to the Company a wealth of experience as an information technology professional.

Where electronics technology goes, we go, and today that means just about everywhere. One gets some sense of our changing universe when one looks at our 1998 customer list. It is no surprise, of course, to find the likes of Motorola and Texas Instruments and Siemens on that list. But MONY? Fidelity? Wells Fargo? Travelers? They were all customers in 1998, as were dozens of other companies not usually associated with Teradyne. But today virtually every company in every industry uses the hardware and software tools our high-tech industries provide, and those tools always need testing.

As we near the end of the century, technology is accelerating at a dizzying pace. As technologies converge and collide, chaos is the order of the day. Companies are investing staggering sums in what they hope will be the infrastructure of tomorrow, and every electronics manufacturer is desperately trying to squeeze new products into some market window.

Everywhere, the pursuit of bandwidth has become a crusade, because there are so many gigabits and so little time.

At such times, the search for testing solutions becomes intense: How can we be sure this new wireless chip will work at 900 megahertz? How do we know this Web site won’t crash when 2,000 people try to access it at the same time? How can we guarantee that this modem will work at this speed in this network? How can we assure our telephone subscribers that their lines will handle ADSL or ISDN service? The questions are asked with a high degree of urgency, because everyone wants to be the first on the block with the answer.

We have the answers, or at least enough of them to make life interesting for us and our investors in the years ahead. Given the game we are playing and the cards we hold, our future growth seems as sure a bet as you can find in this uncertain world; the only question is how much, how fast.