Linear Technology (LLTC)

Adoption of SFAS 123R

In fiscal 2006, the Company began accounting for stock-based compensation arrangements in accordance with the provisions of Financial Accounting Standards Board Statement (FASB) No. 123(R) (SFAS 123R), “Share-Based Payment.” Under SFAS 123R, compensation cost is calculated on the date of grant using the fair value of the option as determined using the Black-Scholes valuation model.  The Company amortizes the compensation cost straight-line over the vesting period, which is generally five years.  The Black-Scholes valuation model requires the Company to estimate key assumptions such as expected term, volatility and forfeiture rates to determine the fair value of a stock option. The estimate of these key assumptions is based on historical information and judgment regarding market factors and trends.

Prior to July 4, 2005, the Company accounted for stock options under the recognition and measurement provisions of APB Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by FASB Statement No. 123 (SFAS 123), “Accounting for Stock-Based Compensation.” No stock-based compensation was recognized on employee stock options or ESPP in the Consolidated Income Statement before July 4, 2005.  However, as required by APB 25 the Company recognized stock-based compensation related to restricted stock grants prior to July 4, 2005.  The Company began issuing restricted stock grants to employees during the first quarter of fiscal year 2005. The right to sell the shares generally vests over a period of three to five years based upon continued employment. Upon termination of employment the Company has the right to buy back unvested shares at the exercise price.

Effective for fiscal year 2006 commencing July 4, 2005, the Company adopted the fair value recognition provisions of SFAS 123R using the modified prospective transition method.  Under the modified prospective transition method, prior periods are not restated for the effect of SFAS 123R.  Commencing with the first quarter of fiscal year 2006, compensation cost includes all share-based payments granted prior to, but not yet vested as of July 4, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation for all share-based payments granted subsequent to July 4, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

As a result of adopting SFAS 123R on July 4, 2005, total stock-based compensation resulted in a decrease to income before income taxes for the three and nine months ended April 2, 2006 of $13.2 million and $40.3 million, respectively, and a decrease to net income of $9.2 million and $28.0 million, respectively, after tax.  Total stock-based compensation includes the impact of stock options, restricted stock and the ESPP.  Throughout fiscal 2005 the Company, in accordance with APB 25, recognized the impact of restricted stock in its reported financial results.  Accordingly, the Company’s income before income taxes for the three and nine months ended April 2, 2006, was $7.8 million and $23.4 million lower, respectively, than if the Company had continued to account for share-based compensation under APB 25.   These amounts represent solely the impact of stock options and the ESPP, since restricted stock is accounted for similarly under both APB 25 and SFAS 123R.  

As of April 2, 2006 there was approximately $121.4 million of total unrecognized stock-based compensation cost related to share-based payments granted under the Company’s stock-based compensation plans that will be recognized over a period of approximately five years.  Future grants will add to this total, whereas quarterly amortization and the vesting of the existing grants will reduce this total.

7

The table below outlines the effects of total stock-based compensation for the three and nine months ended April 2, 2006 and April 3, 2005:

*  Stock-based compensation includes the effects of stock options, restricted stock, restricted stock units and the ESPP.

(1) As a result of adopting SFAS 123R, the shares used in calculating diluted earnings per share for the three and nine months ended April 2, 2006, increased 2.0 million and 1.9 million shares, respectively, as compared to the diluted shares calculated under APB 25 due to the change in the diluted shares calculation under the treasury stock method of SFAS 123R.

Prior to the adoption of SFAS 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows.  SFAS 123R requires the cash flows resulting from the tax benefits from tax deductions in excess of deferred tax assets (hypothetical and actual) recorded for stock compensation costs (excess tax benefits) to be classified as financing cash flows. The $19.7 million excess tax benefit classified as a financing cash inflow for the nine months ended April 2, 2006 would have been classified as an operating cash inflow if the Company had not adopted SFAS 123R.

The Company issues new shares of common stock upon exercise of stock options. For the three and nine months ended April 2, 2006, 1.6 million and 3.3 million stock options, respectively, were exercised for a gain (aggregate intrinsic value) of $42.7 and $80.0 million, respectively, determined as of the date of option exercise.