The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to the historical information contained in this document, the discussion in this Annual Report on Form 10-K contains forward-looking statements, made pursuant to Section 21E of the Exchange Act, that involve risks and uncertainties, such as statements of our plans, expectations and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as being applicable to all related forward-looking statements whenever they appear in this Annual Report on Form 10-K. Our actual results could differ materially from the results contemplated by these and any other forward-looking statements. Factors that could contribute to such differences include those discussed below as well as those cautionary statements and other factors set forth in "Item 1A: Risk Factors" and elsewhere herein.

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.

The preparation of consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent liabilities. On an on-going basis, management evaluates its estimates, including those related to inventories, investments, goodwill, intangible and other long-lived assets, bad debts, income taxes, pensions, warranties, contingencies, and litigation. Management bases its estimates on historical experience and on appropriate and customary assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

Revenue Recognition

We recognize revenue when there is persuasive evidence of an arrangement, title and risk of loss have passed, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to our customers upon shipment or at delivery destination point. In circumstances where either title or risk of loss pass upon destination, acceptance or cash payment, we defer revenue recognition until such events occur.

Our equipment includes embedded software which is considered incidental to the product. Revenue is recognized upon shipment or at delivery destination point, provided that customer acceptance criteria can be demonstrated prior to shipment. Certain contracts require us to perform tests of the product to ensure that performance meets the published product specifications or customer requested specifications, which are generally conducted prior to shipment. Where the criteria cannot be demonstrated prior to shipment, revenue is deferred until customer acceptance has been received.

For multiple element arrangements we defer the fair value of any undelivered elements of the contract. We also defer the portion of the sales price that is not due until acceptance, which represents deferred profit. For a delivered item to be considered a separate unit, the delivered item must have value to the customer on a standalone basis, there must be objective and reliable evidence of fair value of the undelivered items in the arrangement and the delivery or performance of the undelivered item must be considered probable and substantially in our control. Fair value is the price charged when the element is sold separately. Our post-shipment obligations include installation, training services, one-year standard warranties, and extended warranties. Installation does not alter the product capabilities, does not require specialized skills or tools and can be performed by the customers or other vendors. Installation is typically provided within five to fifteen days of product shipment and is completed within one to two days thereafter. Training services are optional and do not affect the customer's ability to use the product. We defer revenue for the fair value of installation and training. Extended warranties constitute warranty obligations beyond one year and we defer revenue in accordance with Financial Accounting Standards Board ("FASB") Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts.

Our products are generally subject to warranty and related costs of the warranty are provided for in cost of revenue when product revenue is recognized. We classify shipping and handling costs in cost of revenue. Service revenue is recognized over the contractual period or as the services are performed.

We generally do not provide our customers with contractual rights of return for any of our products.

For transactions involving the sale of software which is not incidental to the product, revenue is recognized in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition," as amended by SOP No. 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." We recognize revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. In instances where an arrangement contains multiple elements, revenue is deferred related to the undelivered elements to the extent that vendor-specific objective evidence of fair value ("VSOE") exists for such elements. In instances where VSOE does not exist for one or more of the undelivered elements of an arrangement, all revenue related to the arrangement is deferred until all elements have been delivered. VSOE is

For certain contracts eligible for contract accounting under SOP No. 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," revenue is recognized using the percentage-of-completion accounting method based upon the percentage of incurred costs to estimated total costs. These arrangements require significant production, modification or customization. In all cases, changes to total estimated costs and anticipated losses, if any, are recognized in the period in which they are determined. With respect to contract change orders, claims or similar items, judgment must be used in estimating related amounts and assessing the potential for realization. Such amounts are only included in the contract value when they can be reliably estimated and realization is reasonably assured, generally upon receipt of a customer approved change order.

Inventories

Inventories, which include materials, labor, and manufacturing overhead, are stated at the lower of cost (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

Effective January 1, 2006, we adopted the fair value recognition provision of Financial Accounting Standards No. 123 (revised 2004) "Share Based Payment" ("SFAS 123R"), using the modified prospective transition method and therefore have not restated results for prior periods. Under this transition method, stock based compensation expense for the first quarter of fiscal 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, and is calculated based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 "Accounting for Stock Based Compensation" ("SFAS 123"). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provision of SFAS 123R. As required by SFAS 123R, we have made an estimate of expected forfeitures and are recognizing compensation costs only for those stock-based compensation awards expected to vest. The cumulative effect of the initial adoption of SFAS 123R was not material.

Prior to the adoption of SFAS 123R, we recognized stock-based compensation expense in accordance with Accounting Principles Board ("APB") Opinion No. 25 ("APB 25"). In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107") regarding the SEC's interpretation of SFAS 123R and the valuation of share-based payments for public companies. We have applied provisions of SAB 107 in our adoption of SFAS 123R.

On May 26, 2005, our Board of Directors approved the accelerated vesting of certain outstanding, unvested "out of the money" stock options awarded to employees, officers and other eligible participants under our various stock option plans in effect at that time. The stock options that were accelerated had exercise prices that were in excess of $13.26, the closing price of our common stock on the New York Stock Exchange on May 26, 2005 and ranged in exercise price from $13.73 to $41.37 per share. As a result of the vesting acceleration, options to purchase approximately 7.6 million shares became exercisable immediately and we reduced the compensation expense we otherwise would have been required to record under SFAS 123R by approximately $48.6 million in the aggregate on a pre-tax basis over fiscal years 2006, 2007 and 2008.

Income Taxes

On a quarterly basis, we evaluate the realizability of our deferred tax assets by jurisdiction and assess the need for a valuation allowance. As a result of this review, undertaken at December 31, 2002, we concluded under

Investments

We account for our investments in debt and equity securities in accordance with the provisions of Statement of Financial Accounting Standards No 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115") and FASB Staff Position Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." 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;

• The financial condition and near-term prospects of the issuer; and

• 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.

We have determined that we do not intend to hold certain marketable securities for a period of time sufficient to allow for recovery in market value and recognized an other-than-temporary impairment loss in the amount of $11.0 million, in the year ended December 31, 2008, primarily related to mortgage and asset backed debt securities.

Effective January 1, 2008, we adopted Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS No. 157") for financial assets and liabilities. As defined in SFAS No. 157, 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. We use the market and income approach techniques to value our financial instruments. SFAS No. 157 requires that assets and liabilities carried at fair value be classified and disclosed 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, and therefore is considered a Level 2 input.

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.

As a result of our November 14, 2008 acquisition of Eagle Test, we acquired $26.5 million of auction rate securities (ARS) at fair value ($30.0 million par value). In addition, we acquired (1) the right ("UBS Put") to sell our ARS back to UBS at par plus interest, at our sole discretion, during a two-year period beginning on June 30, 2010, and (2) received an option to borrow up to 75% of the fair value of the ARS at no cost.

Beginning in February 2008 and continuing through December 31, 2008, the securities in our acquired ARS portfolio have experienced failed auctions, resulting in inability to sell these securities. Consequently, as set forth in the trust indentures, the coupon rate resets to a contractual rate which may not equal the current market rate. A failed auction results in a lack of liquidity in the securities but does not necessarily represent a deterioration of the credit quality of the issuer. All of our ARS, are AAA, AA or A rated by one or more of the major credit rating

Because the UBS Put is expected to allow us to sell our ARS securities at par within a relatively short time horizon and provides UBS with the ability to require us to sell the securities to them at any time between acceptance of the UBS Put through July 2012, we do not anticipate holding these investments to the earlier of maturity or redemption by the issuer. We intend to exercise the UBS Put and require UBS to repurchase our ARS at par at the earliest possible time, June 2010. As a result, as of the Eagle Test acquisition date (November 14, 2008), we classified the ARS as trading securities under SFAS No. 115. During the fourth quarter of 2008, we recorded a loss of $0.5 million in interest expense and other, net in our consolidated statement of operations for the decrease in the ARS fair value from November 14, 2008 to December 31, 2008. Future changes in fair value of the ARS will be recorded in operating results.

In determining the fair value of our ARS and other investments we utilize the provisions of SFAS No. 157. In determining the value of our ARS as of December 31, 2008 we utilized a discounted cash flow valuation model with the major inputs to such model based on our estimates of the assumptions that market participants would use in valuing these instruments. Specifically, we used the following key inputs to our valuation model:

• Term - we estimated a five-year expected life of the instruments, based on our expectations of the most likely time in which it would take for the instruments to be called by the issuer or liquidity to be restored to the market place.

• Probability of Default - we determined the probability of default using market credit spreads.

• Discount Rate - we determined the discount rate based on estimated yields of similar publicly traded instruments (e.g., similar collateral, terms, credit quality, etc.).

• Liquidity Risk Premium - given the recent instability in the financial markets and the low demand for auction rate securities, it is unclear as to when these securities will become liquid again. Without the auction process functioning again, it would be extremely difficult to estimate the expected holding period for these instruments. As a result, we included a 500 to 600 basis point premium to the discount rate to reflect the illiquidity of these bonds.

Based on these key inputs, we estimated the fair value of our ARS portfolio was $26.0 million as of December 31, 2008 representing a $0.5 million decrease in fair value since November 14, 2008. Our ARS securities and the related put option were the only investments as of December 31, 2008 in which we utilized Level 3 valuation techniques under SFAS No. 157.

On November 14, 2008, we recognized the UBS Put as an asset measured at a fair value of $2.7 million. At December 31, 2008, the fair value of the UBS Put was $3.3 million. We recorded a $0.6 million gain in interest income during the fourth quarter of 2008 for the increase in the fair value of the UBS Put since November 14, 2008. In determining the fair value of the UBS Put as of December 31, 2008, we assumed we would redeem the auction rate securities at par at the earliest possible time, June 30, 2010. We utilized a discounted cash flow model to determine the fair value of the UBS Put using the following assumptions
(1) a time period of 1.5 years, representing the period from December 31, 2008 to the earliest date we can expect to be able to redeem the UBS Put (June 30, 2010) and (2) a discount rate of 3.79%, which included a spread based on the credit default swap of UBS in order to account for the credit risk of UBS.

We have elected fair value treatment for the UBS Put under SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS No. 159"). The UBS Put is the only instrument of its nature/type that we hold and for which we have elected the fair value option under SFAS No. 159.

We assess the impairment of identifiable intangibles, long-lived assets and goodwill 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. When we determine that the carrying value of intangibles and long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate commensurate with the associated risks. We assess goodwill for impairment at least annually in the fourth quarter, 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, an impairment loss is recorded in an amount equal to that excess.

We determined that the worsening in our demand outlook experienced during the fourth quarter of 2008 was a significant event that indicated that the carrying amount of certain long-lived and intangible asset groups might not be recoverable. We conducted recoverability tests in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). As the undiscounted future cash flows of the long-lived asset groups exceeded their carrying amount, we determined that no impairment of our long-lived assets had occurred at December 31, 2008.

                 SELECTED RELATIONSHIPS WITHIN THE CONSOLIDATED

                            STATEMENTS OF OPERATIONS



                                                                   Year Ended December 31,
                                                                 2008         2007       2006
Percentage of net revenue:
Net Revenue:
Products                                                          75.5 %       78.2 %     82.5 %
Services                                                          24.5         21.8       17.5

Total net revenue                                                100.0        100.0      100.0
Cost of revenues:
Cost of products                                                  40.8         39.0       40.6
Cost of services                                                  14.2         14.4       11.3

Total cost of revenue                                             55.0         53.4       51.9
Gross profit                                                      45.0         46.6       48.1
Operating Expenses:
Engineering and development                                       19.6         18.6       14.9
Selling and administrative                                        22.4         22.5       20.6
Acquired intangible assets amortization                            1.9          0.3        0.3
In-process research and development                                0.1          1.5         -
Restructuring and other, net                                       5.6         (0.1 )     (2.7 )
Goodwill impairment                                               30.1           -          -

Total operating expenses                                          79.7         42.8       33.1
Net interest and other                                            (0.2 )        3.4        2.4

(Loss) income from continuing operations before income taxes     (34.9 )        7.2       17.4
Provision for income taxes                                         1.1          0.7        2.1

(Loss) income from continuing operations                         (36.0 )%       6.5 %     15.3 %

Results of Operations

Discontinued Operations

On August 1, 2007, we completed the sale of the Broadband Test Division to Tollgrade for $11.3 million in cash. Broadband Test Division had revenues for the seven month period ended July 31, 2007 of $11.2 million

In accordance with SFAS 144, we are reporting Broadband Test Division as discontinued operations in the consolidated financial statements for all periods presented throughout this Annual Report on Form 10-K. Unless indicated otherwise, the discussion and amounts provided in this "Results of Operations" section and elsewhere in this Form 10-K relate to continuing operations only.

Bookings

Net bookings for our two reportable segments were as follows:



                                                              2007-2008       2006-2007
                                                               Dollar          Dollar
                            2008       2007        2006        Change          Change
                                                   (in millions)
      Semiconductor Test   $ 768.1   $   899.7   $ 1,012.6   $    (131.6 )   $    (112.9 )
      Systems Test Group     211.5       208.2       270.5           3.3           (62.3 )

                           $ 979.6   $ 1,107.9   $ 1,283.1   $    (128.3 )   $    (175.2 )

The Semiconductor Test business is dependent on the current and anticipated market for test equipment, which historically has been highly cyclical. Semiconductor Test bookings decreased $131.6 million or 15% from 2007 to 2008 due primarily to lower demand across all customer groups. In 2008, Nextest contributed $67.6 million of bookings and Eagle Test contributed $1.0 million of bookings.

The Semiconductor Test bookings decreased $112.9 million or 11% from 2006 to 2007 due to lower demand across a wide range of end markets, applications and geographies, as SOC device units grew at a lower rate in 2007 than in 2006. The lower demand in SOC market was lessened by our increase in SOC market share during 2007, by approximately 2 to 3 points.

Systems Test Group bookings increased $3.3 million or 2% from 2007 to 2008, primarily due to an increase in Mil/Aero board test program related bookings partially offset by decreases in Commercial Board Test and Diagnostic Solutions.

Systems Test Group bookings decreased $62.3 million or 23% from 2006 to 2007, primarily due to decreases across all business units. Diagnostic Solutions orders are program related and have significant fluctuations. There was a large program rollout in 2006 for the Vehicle Measurement Module product line. Mil/Aero bookings are also often program related, and there was also a significant military program that took place in 2006. Commercial Board Test bookings decreased in 2007 due to a contraction in the size of the ICT market.

Order cancellations and backlog adjustments for our two reportable segments for the last three years were as follows:

                                            2008     2007    2006
                                                (in millions)
                      Semiconductor Test   $ 10.3   $ 13.6   $ 3.3
                      Systems Test Group       -       0.3     0.5

                                           $ 10.3   $ 13.9   $ 3.8

Customers may delay delivery of products or cancel orders suddenly and without significant notice, subject to possible cancellation penalties. In 2008, 2007 and 2006, there were no significant cancellation penalties received.

Net bookings by region as a percentage of our total net bookings were as follows:

. . .