ANALOG DEVICES INC 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This information should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020 (fiscal 2020). This Quarterly Report on Form 10-Q, including the following discussion, contains forward-looking statements regarding future events and our future results that are subject to the safe harbor created under the Private Securities Litigation Reform Act of 1995 and other safe harbors under the Securities Act of 1933 and the Securities Exchange Act of 1934. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “could” and “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections regarding our future financial performance; the proposed acquisition of Maxim Integrated Products, Inc.; our anticipated growth and trends in our businesses; our future liquidity, capital needs and capital expenditures; the impact of the COVID-19 pandemic on our business, financial condition and results of operations; our future market position and expected competitive changes in the marketplace for our products; our ability to pay dividends or repurchase stock; our ability to service our outstanding debt; our expected tax rate; the effect of changes in or the application of new or revised tax laws; expected cost savings; the effect of new accounting pronouncements; our ability to successfully integrate acquired businesses and technologies; and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified in Part II, Item 1A. “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements, including to reflect events or circumstances occurring after the date of the filing of this report, except to the extent required by law. Impact of COVID-19 on our Business The pandemic caused by the novel strain of the coronavirus (COVID-19) and the numerous measures implemented by government authorities in response, have impacted and likely will continue to impact our workforce and operations, the operations of our customers and those of our respective vendors and suppliers. We have significant operations worldwide, including in the United States, the Philippines, Ireland, Singapore, Malaysia, China and India. Each of these countries has been affected by the pandemic and taken measures to try to contain it, resulting in disruptions at some of our manufacturing operations and facilities. Since the beginning of the third quarter of fiscal 2020, our manufacturing operations and supply chain generally stabilized at normal levels, but that could change in the future given that the COVID-19 situation remains dynamic. The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, modifying employee work locations and cancelling physical participation in meetings, events and conferences) and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and shareholders. While we are confident that our strategy and long-term contingency planning have positioned us well to weather the current uncertainty, we cannot at this time fully quantify or forecast the impact of COVID-19 on our business. The full extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations will depend on future developments, which are highly uncertain such as the continued duration and severity of the pandemic, the actions to contain the virus or treat its impact, or how quickly and to what extent normal economic and operating conditions can resume. Proposed Acquisition of Maxim Integrated Products, Inc. On July 12, 2020, we entered into a definitive agreement (the Merger Agreement) to acquire Maxim Integrated Products, Inc. (Maxim), an independent manufacturer of innovative analog and mixed-signal products and technologies. Under the terms of the Merger Agreement, Maxim stockholders will receive, for each outstanding share of Maxim common stock, 0.630 of a share of our common stock at the closing. The estimated merger consideration is approximately $25.0 billion based on the closing price of our common stock on May 14, 2021. The value of the merger consideration will fluctuate based upon changes in the price of our common stock and the number of shares of Maxim common stock, restricted stock awards and restricted stock unit awards outstanding on the closing date. 18 The transaction is subject to customary closing conditions, including receipt of certain remaining non-U.S. regulatory approvals. To date, required regulatory approvals have been obtained in all jurisdictions with the exception of China. The Merger Agreement includes termination rights for us and Maxim. We may be required to pay Maxim a regulatory termination fee of $830.0 million in cash if the Merger Agreement is terminated in certain circumstances involving the failure to obtain required regulatory approvals. On October 8, 2020, the required shareholder approvals relating to the Merger Agreement were obtained from both our shareholders and Maxim's shareholders. See Note 13, Acquisitions , in the Notes to the Condensed Consolidated Financial Statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information. Results of Operations Overview (all tabular amounts in thousands except per share amounts and percentages) Three Months Ended May 1, 2021 May 2, 2020 $ Change % Change Revenue $ 1,661,407 $ 1,317,060 $ 344,347 26 % Gross margin % 68.4 % 64.3 % Net income $ 422,905 $ 267,696 $ 155,209 58 % Net income as a % of revenue 25.5 % 20.3 % Diluted EPS $ 1.14 $ 0.72 $ 0.42 58 % Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change Revenue $ 3,219,865 $ 2,620,625 $ 599,240 23 % Gross margin % 67.8 % 64.7 % Net income $ 811,424 $ 471,570 $ 339,854 72 % Net income as a % of revenue 25.2 % 18.0 % Diluted EPS $ 2.18 $ 1.27 $ 0.91 72 % Revenue Trends by End Market The following table summarizes revenue by end market. The categorization of revenue by end market is determined using a variety of data points including the technical characteristics of the product, the “sold to” customer information, the “ship to” customer information and the end customer product or application into which our product will be incorporated. As data systems for capturing and tracking this data and our methodology evolves and improves, the categorization of products by end market can vary over time. When this occurs, we reclassify revenue by end market for prior periods. Such reclassifications typically do not materially change the sizing of, or the underlying trends of results within, each end market. 19 Three Months Ended May 1, 2021 May 2, 2020 Revenue % of Revenue* Y/Y% Revenue % of Revenue* Industrial $ 972,177 59 % 36 % $ 716,364 54 % Communications 276,960 17 % — % 276,575 21 % Automotive 257,586 16 % 42 % 181,211 14 % Consumer 154,684 9 % 8 % 142,910 11 % Total revenue $ 1,661,407 100 % 26 % $ 1,317,060 100 % Six Months Ended May 1, 2021 May 2, 2020 Revenue % of Revenue* Y/Y% Revenue % of Revenue* Industrial $ 1,828,140 57 % 30 % $ 1,405,224 54 % Communications 557,786 17 % 8 % 517,872 20 % Automotive 503,501 16 % 30 % 386,618 15 % Consumer 330,438 10 % 6 % 310,911 12 % Total revenue $ 3,219,865 100 % 23 % $ 2,620,625 100 % * The sum of the individual percentages may not equal the total due to rounding. Revenue increased in the three- and six-month periods ended May 1, 2021, as compared to the same periods of the prior fiscal year, primarily as a result of higher broad-based demand for our products sold into the Industrial and Automotive end markets, and to a lesser extent, sold into the Consumer end market. Revenue in the Communications end market was relatively flat in the three-month period ended May 1, 2021 and increased in the six-month period ended May 1, 2021 due to the timing of infrastructure deployment cycles and the ramp up of these cycles in certain regions. Revenue by Sales Channel The following table summarizes revenue by sales channel. We sell our products globally through a direct sales force, third party distributors, independent sales representatives and via our website. Distributors are customers that buy products with the intention of reselling them. Direct customers are non-distributor customers and consist primarily of original equipment manufacturers (OEMs). Other customers include the U.S. government, government prime contractors and certain commercial customers for which revenue is recorded over time. Three Months Ended May 1, 2021 May 2, 2020 Revenue % of Revenue* Revenue % of Revenue* Channel Distributors $ 1,092,928 66 % $ 750,388 57 % Direct customers 546,555 33 % 546,051 41 % Other 21,924 1 % 20,621 2 % Total revenue $ 1,661,407 100 % $ 1,317,060 100 % Six Months Ended May 1, 2021 May 2, 2020 Revenue % of Revenue* Revenue % of Revenue* Channel Distributors $ 2,039,314 63 % $ 1,497,949 57 % Direct customers 1,136,011 35 % 1,077,382 41 % Other 44,540 1 % 45,294 2 % Total revenue $ 3,219,865 100 % $ 2,620,625 100 % * The sum of the individual percentages may not equal the total due to rounding. 20 The percentage of total revenue sold via each channel can fluctuate from time to time based on end customer demand. In the three- and six-month periods ended May 1, 2021, higher demand within our Industrial end market resulted in increased revenue through our distributor channel. Gross Margin Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change May 1, 2021 May 2, 2020 $ Change % Change Gross margin $ 1,136,637 $ 846,674 $ 289,963 34 % 2,182,008 1,694,816 $ 487,192 29 % Gross margin % 68.4 % 64.3 % 67.8% 64.7 % Gross margin percentage increased by 410 and 310 basis points in the three- and six-month periods ended May 1, 2021, respectively, as compared to the same periods of the prior fiscal year, primarily as a result of higher utilization of our factories due to increased customer demand. Research and Development (R&D) Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change May 1, 2021 May 2, 2020 $ Change % Change R&D expenses $ 302,238 $ 252,413 $ 49,825 20 % $ 590,388 $ 509,486 $ 80,902 16 % R&D expenses as a % of revenue 18 % 19 % 18 % 19 % R&D expenses increased in the three- and six-month periods ended May 1, 2021, as compared to the same periods of the prior fiscal year, primarily as a result of higher R&D employee-related variable compensation expense and salary and benefit expenses. In the six-month period ended May 1, 2021, those increases were partially offset by lower discretionary spending. R&D expenses as a percentage of revenue will fluctuate from year-to-year depending on the amount of revenue and the success of new product development efforts, which we view as critical to our future growth. We expect to continue the development of innovative technologies and processes for new products. We believe that a continued commitment to R&D is essential to maintain product leadership with our existing products as well as to provide innovative new product offerings. Therefore, we expect to continue to make significant R&D investments in the future. Selling, Marketing, General and Administrative (SMG&A) Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change May 1, 2021 May 2, 2020 $ Change % Change SMG&A expenses $ 206,612 $ 141,775 $ 64,837 46 % $ 391,887 $ 341,055 $ 50,832 15 % SMG&A expenses as a % of revenue 12 % 11 % 12 % 13 % SMG&A expenses increased in the three-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, primarily as a result of higher variable compensation expense, $23.0 million in acquisition-related transaction costs in connection with the proposed acquisition of Maxim and higher salary and benefit expenses. SMG&A expenses increased in the six-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, primarily as a result of higher variable compensation expense, $38.2 million in acquisition-related transaction costs in connection with the proposed acquisition of Maxim and higher salary and benefit expenses, partially offset by a $40.0 million charitable contribution to the Analog Devices Foundation made in the first quarter of fiscal 2020. 21 Operating Income Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change May 1, 2021 May 2, 2020 $ Change % Change Operating income $ 519,690 $ 344,020 $ 175,670 51 % $ 983,550 $ 617,448 $ 366,102 59 % Operating income as a % of revenue 31.3 % 26.1 % 30.5 % 23.6 % The year-over-year increase in operating income in the three-month period ended May 1, 2021 was primarily the result of an increase in revenue of $344.3 million, which drove an increase in gross margin of $290.0 million, partially offset by increases of $64.8 million in SMG&A expenses and $49.8 million in R&D expenses, as described above under the headings Revenue Trends by End Market, Gross Margin, Selling, Marketing, General and Administrative (SMG&A) and Research and Development (R&D). The year-over-year increase in operating income in the six-month period ended May 1, 2021 was primarily the result of an increase in revenue of $599.2 million, which drove an increase in gross margin of $487.2 million, and a decrease in special charges of $11.7 million, partially offset by an $80.9 million increase in R&D expenses and a $50.8 million increase in SMG&A expenses, as described above under the headings Revenue Trends by End Market, Gross Margin, Research and Development (R&D) and Selling, Marketing, General and Administrative (SMG&A). Nonoperating Expense (Income) Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change May 1, 2021 May 2, 2020 $ Change Total nonoperating expense (income) $ 43,705 $ 48,959 $ (5,254) $ 70,947 $ 96,170 $ (25,223) The year-over-year decrease in nonoperating expense in the three-month period ended May 1, 2021 was primarily the result of a decrease in interest expense related to our debt obligations. The year-over-year decrease in nonoperating expense in the six-month period ended May 1, 2021 was primarily the result of a $16.2 million gain recorded in other investments in the first quarter of fiscal 2021 and a decrease in interest expense related to our debt obligations. Provision for Income Taxes Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change May 1, 2021 May 2, 2020 $ Change Provision for income taxes $ 53,080 $ 27,365 $ 25,715 $ 101,179 $ 49,708 $ 51,471 Effective income tax rate 11.2 % 9.3 % 11.1 % 9.5 % The effective tax rates for the three- and six-month periods ended May 1, 2021 and May 2, 2020 were below the U.S. statutory tax rate of 21% due to lower statutory tax rates applicable to our operations in the foreign jurisdictions in which we earn income. Our pretax income for the three- and six-month periods ended May 1, 2021 and May 2, 2020 was primarily generated in Ireland at a tax rate of 12.5%. See Note 11, Income Taxes , in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion. Net Income Three Months Ended Six Months Ended May 1, 2021 May 2, 2020 $ Change % Change May 1, 2021 May 2, 2020 $ Change % Change Net Income $ 422,905 $ 267,696 $ 155,209 58 % $ 811,424 $ 471,570 $ 339,854 72 % Net Income as a % of revenue 25.5 % 20.3 % 25.2 % 18.0 % Diluted EPS $ 1.14 $ 0.72 $ 2.18 $ 1.27 Net income increased in the three-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, as a result of a $175.7 million increase in operating income and a $5.3 million decrease in nonoperating expense, partially offset by a $25.7 million increase in provision for income taxes. 22 Net income increased in the six-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, as a result of a $366.1 million increase in operating income and a $25.2 million decrease in nonoperating expense, partially offset by a $51.5 million increase in provision for income taxes. Liquidity and Capital Resources At May 1, 2021, our principal source of liquidity was $1,305.2 million of cash and cash equivalents, of which approximately $498.4 million was held in the United States and the balance of our cash and cash equivalents was held outside the United States in various foreign subsidiaries. We manage our worldwide cash requirements by, among other things, reviewing available funds held by our foreign subsidiaries and the cost effectiveness by which those funds can be accessed in the United States. We do not expect current regulatory restrictions or taxes on repatriation to have a material adverse effect on our overall liquidity, financial condition or the results of operations. Our cash and cash equivalents consist of highly liquid investments with maturities of three months or less, including money market funds. We maintain these balances with high credit quality counterparties, continually monitor the amount of credit exposure to any one issuer and diversify our investments in order to minimize our credit risk. We believe that our existing sources of liquidity and cash expected to be generated from future operations, together with existing and anticipated available long-term financing, will be sufficient to fund operations, capital expenditures, research and development efforts, transaction costs associated with our proposed merger with Maxim and dividend payments (if any) in the immediate future and for at least the next twelve months. Six Months Ended May 1, 2021 May 2, 2020 Net cash provided by operating activities $ 1,164,303 $ 778,689 Net cash provided by operations as a % of revenue 36 % 30 % Net cash used for investing activities $ (135,768) $ (116,284) Net cash used for financing activities $ (783,408) $ (525,282) The following changes contributed to the net change in cash and cash equivalents in the six-month period ended May 1, 2021 as compared to the same period in fiscal 2020. Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in operating assets and liabilities. The increase in cash provided by operating activities during the six-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, was primarily the result of higher net income adjusted for non-cash items and changes in working capital. Investing Activities Investing cash flows generally consist of capital expenditures and cash used for acquisitions. The increase in cash used for investing activities during the six-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, was primarily the result of cash payments for an asset acquisition and an increase in cash used for capital expenditures, partially offset by proceeds from other investments. Financing Activities Financing cash flows generally consist of payments of dividends to stockholders, repurchases of common stock, issuance and repayment of debt and proceeds from the sale of shares of common stock pursuant to employee equity incentive plans. The increase in cash used for financing activities during the six-month period ended May 1, 2021, as compared to the same period of the prior fiscal year, was primarily the result of increases in common stock repurchases and dividend payments to shareholders. The comparable period of fiscal 2020 also included proceeds from our bond issuance as well as debt repayments, which did not repeat in fiscal 2021. 23 Working Capital May 1, 2021 October 31, 2020 $ Change % Change Accounts receivable $ 814,135 $ 737,536 $ 76,599 10 % Days sales outstanding* 45 45 Inventory $ 641,202 $ 608,260 $ 32,942 5 % Days cost of sales in inventory* 109 116 * We use the average of the current quarter and prior quarter ending accounts receivable and ending inventory balances in our calculation of days sales outstanding and days cost of sales in inventory, respectively. The increase in accounts receivable in dollars was primarily the result of variations in the timing of collections and billings and increased revenue levels. Inventory increased, primarily as a result of our efforts to balance manufacturing production, demand and inventory levels. Our inventory levels are impacted by our need to support forecasted sales demand and variations between those forecasts and actual demand. Current liabilities increased to approximately $2,776.8 million at May 1, 2021 from approximately $1,365.0 million at the end of fiscal 2020. The increase was primarily due to increases in the current portion of our debt, accounts payable and accrued liabilities, partially offset by a decrease in income taxes payable. Debt As of May 1, 2021, our debt obligations consisted of the following: Principal Amount Outstanding 3-Year term loan, due March 2022 $ 925,000 2.50% Senior unsecured notes, due December 2021 400,000 2.875% Senior unsecured notes, due June 2023 500,000 3.125% Senior unsecured notes, due December 2023 550,000 2.95% Senior unsecured notes, due April 2025 400,000 3.90% Senior unsecured notes, due December 2025 850,000 3.50% Senior unsecured notes, due December 2026 900,000 4.50% Senior unsecured notes, due December 2036 250,000 5.30% Senior unsecured notes, due December 2045 400,000 Total debt $ 5,175,000 The indentures governing our outstanding notes contain covenants that may limit our ability to: incur, create, assume or guarantee any debt for borrowed money secured by a lien upon a principal property; enter into sale and lease-back transactions with respect to a principal property; and consolidate with or merge into, or transfer or lease all or substantially all of our assets to, any other party. As of May 1, 2021, we were in compliance with these covenants. Revolving Credit Facility Our Second Amended and Restated Revolving Credit Agreement, dated as of June 28, 2019, with Bank of America N.A. as administrative agent and other banks identified therein as lenders (Revolving Credit Agreement) provides for a five-year unsecured revolving credit facility in an aggregate principal amount of up to $1.25 billion, expiring on June 28, 2024. We may borrow under this revolving credit facility in the future and use the proceeds for repayment of existing indebtedness, stock repurchases, acquisitions, capital expenditures, working capital and other lawful corporate purposes. The terms of the Revolving Credit Agreement impose restrictions on our ability to undertake certain transactions, to create certain liens on assets and to incur certain subsidiary indebtedness. In addition, the Revolving Credit Agreement contains a consolidated leverage ratio covenant of total consolidated funded debt to consolidated earnings before interest, taxes, depreciation, and amortization (EBITDA) of not greater than 3.5 to 1.0. As of May 1, 2021, we were in compliance with these covenants. 24 Stock Repurchase Program In the aggregate, our Board of Directors has authorized us to repurchase $8.2 billion of our common stock under our common stock repurchase program. Unless terminated earlier by resolution of our Board of Directors, the repurchase program will expire when we have repurchased all shares authorized under the program. As of May 1, 2021, an additional $1.6 billion remains available for repurchase under the current authorized program. The repurchased shares are held as authorized but unissued shares of common stock. We also repurchase shares in settlement of employee tax withholding obligations due upon the vesting of restricted stock units/awards or the exercise of stock options. Future repurchases of common stock will be dependent upon our financial position, results of operations, outlook, liquidity, and other factors we deem relevant. Capital Expenditures Net additions to property, plant and equipment were $126.6 million in the first six months of fiscal 2021 and were funded with a combination of cash on hand and cash generated from operations. We expect capital expenditures for fiscal 2021 to be between 4% and 5% of fiscal 2021 revenue. We expect these capital expenditures will be funded with a combination of cash on hand and cash generated from operations. Dividends On May 18, 2021, our Board of Directors declared a cash dividend of $0.69 per outstanding share of common stock. The dividend will be paid on June 8, 2021 to all shareholders of record at the close of business on May 28, 2021 and is expected to total approximately $254.5 million. We currently expect quarterly dividends to continue in future periods. The payment of any future quarterly dividends, or a future increase in the quarterly dividend amount, will be at the discretion of the Board and will be dependent upon our financial position, results of operations, outlook, liquidity, and other factors deemed relevant by the Board. Contractual Obligations There have not been any material changes during the six-month period ended May 1, 2021 to the amounts presented in the table summarizing our contractual obligations included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020. New Accounting Pronouncements From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board that are adopted by us as of the specified effective date. Unless otherwise discussed, management believes that the impact of recently issued standards will not have a material impact on our future financial condition and results of operations. See Note 12, New Accounting Pronouncements, in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of recently issued and adopted accounting pronouncements, including the dates of adoption and impact on our historical financial condition and results of operations. Critical Accounting Policies and Estimates Except for the accounting policies for credit losses and income taxes that were updated as a result of adopting ASU 2016-13 and ASU 2019-12, respectively, there were no other changes in the six-month period ended May 1, 2021 to the information provided under the heading “Critical Accounting Policies and Estimates” in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended October 31, 2020. 25 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk There were no material changes in the six-month period ended May 1, 2021 to the information provided under Item 7A. “Quantitative and Qualitative Disclosures about Market Risk,” set forth in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020 .