Overview

Linear Technology Corporation is a manufacturer of high performance linear integrated circuits. The Company generates revenue exclusively from the sale of analog integrated circuits. The Company targets the high performance segment of the analog integrated circuit market. The Company was founded in 1981 and became a public company in 1986. Linear Technology products include high performance amplifiers, comparators, voltage references, monolithic filters, linear regulators, DC-DC converters, battery chargers, data converters, communications interface circuits, RF signal conditioning circuits, µModule products, and many other analog functions. Applications for Linear Technology's high performance circuits include telecommunications, cellular telephones, networking products such as optical switches, notebook and desktop computers, computer peripherals, video/multimedia, industrial instrumentation, security monitoring devices, high-end consumer products such as digital cameras and global positioning systems, complex medical devices, automotive electronics, factory automation, process control, military, space and harsh environment systems.

Fiscal year 2009 was a challenging year for the Company in which the Company achieved record quarterly revenue of $310.4 million in the first quarter of fiscal year 2009 and then the subsequent three quarters had substantial year-over-year revenue declines. Although fourth quarter revenues were down on a year-over-year basis, the Company ended its fiscal year on a positive note with fourth quarter revenue growing 4% over the third quarter. The Company continues to experience the impact of the U.S. credit crisis and the global recession. Despite significant decreases in quarterly year-over-year revenues, the Company continues to be highly profitable, as fiscal 2009 operating margins were 42.5% of sales. To maintain strong operating margins, the Company has cut variable costs aggressively where possible in reaction to revenue declines. The Company has significantly reduced costs through weekly plant closures, forced vacation, variable compensation reductions, modest employee terminations and otherwise limiting discretionary spending.

Factors that impacted fiscal year 2009 included:
• Revenue decreased by $206.7 million or 18% from fiscal year 2008.
• Operating expenses were reduced by lower labor costs as employees were required to take approximately 5.5 weeks of time-off during the year and a temporary 10% reduction in salaries beginning the middle of the fourth quarter.
• The Company reported approximately $3.9 million in restructuring expenses for employee severance costs related to reductions in workforce of approximately 230 employees.
• The Company purchased and retired $294.4 million face value of its 3.125% Convertible Senior Notes, which resulted in a gain of approximately $24.3 million.
• The Company's annual effective tax rate of 23.0% was positively impacted by various discrete tax benefits primarily related to the Company's domestic manufacturing deduction and the reinstatement of the federal R&D credit.

Critical Accounting Policies

The Company's financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require it to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The Company regularly evaluates these estimates, including those related to stock-based compensation, inventory valuation, revenue recognition and income taxes. These estimates are based on historical experience and on assumptions that are believed by management to be reasonable under the circumstances. Actual results may differ from these estimates, which may impact the carrying values of assets and liabilities.

The Company believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company's consolidated financial statements.

Revenue Recognition

The Company recognizes revenues when the earnings process is complete, when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection is reasonably assured. During fiscal years 2009 and 2008, the Company recognized approximately 16% of net revenues from domestic distributors that are recognized under agreements which provide for certain sales price rebates and limited product return privileges. Given the uncertainties associated with the levels of pricing rebates, the ultimate sales price on domestic distributor sales transactions is not fixed or determinable until domestic distributors sell the merchandise to the end-user. At the time of shipment to domestic distributors, the Company records a trade receivable and deferred revenue at the distributor purchasing price since there is a legally enforceable obligation from the distributor to pay for the products delivered. The Company relieves inventory as title has passed to the distributor and recognizes deferred cost of sales in the same amount. "Deferred income on shipments to distributors" represents the difference between deferred revenue and deferred cost of sales and is recognized as a current liability until such time as the distributor confirms a final sale to its end customer. At June 28, 2009, the Company had approximately $34.7 million of deferred revenue and $6.2 million of deferred cost of sales recognized as $28.5 million of "Deferred income on shipment to distributors." At June 29, 2008, the Company had approximately $46.2 million of deferred revenue and $8.4 million of deferred cost of sales recognized as $37.8 million of "Deferred income on shipment to distributors." The Company believes that its deferred costs of revenues have limited risk of material impairment, as the Company offers stock rotation privileges to distributors (up to 3% to 5% of quarterly purchases) which enable distributors to rotate slow moving inventory. In addition, stock rotated inventory that is returned to the Company is generally resalable. The Company reviews distributor ending on-hand inventory balances, as well as orders placed on the Company to ensure that distributors are not overstocking parts and are ordering to forecasted demand. To the extent the Company had a significant reduction in distributor price or grant significant price rebates, there could be a material impact on the ultimate revenue and gross profit recognized. The price rebates that have been remitted back to distributors have ranged from $1.5 million to $3.1 million per quarter.

Inventory Valuation

The Company values inventories at the lower of cost or market. The Company records charges to write-down inventories for unsalable, excess or obsolete raw materials, work-in-process and finished goods. Newly introduced parts are generally not valued until success in the market place has been determined by a consistent pattern of sales and backlog among other factors. The Company arrives at the estimate for newly released parts by analyzing sales and customer backlog against ending inventory on hand. The Company reviews the assumptions on a quarterly basis and makes decisions with regard to inventory valuation based on the current business climate. In addition to write-downs based on newly introduced parts, judgmental assessments are calculated for the remaining inventory based on salability, obsolescence, historical experience and current business conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required that could adversely affect operating results. If actual market conditions are more favorable, the Company may have higher gross margins when products are sold. Sales to date of such products have not had a significant impact on gross margin.

Stock-Based Compensation

The Company uses the Black-Scholes valuation model to determine the fair value of its stock options at the date of grant. The stock options fair value is then amortized 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 option term, stock price volatility, dividend yields and risk free interest rates that determine the stock options fair value. Higher volatility and longer expected lives result in a proportional increase to stock-based compensation determined at the date of grant. The expected dividend rate and expected risk-free rate do not have as significant an effect on the calculation of fair value. As a result, if factors change and the Company's estimates of volatility and expected life were to increase or decrease, the Company's stock-based compensation expense could be materially different in the future. In addition, if deferred taxes based on the Black-Scholes valuation are greater than or less than the gain on the sale of the associated stock option, the Company's income tax expense could increase or decrease.

Income Taxes

The Company must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, tax benefits and deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes to these estimates may result in an increase or decrease to the tax provision in a subsequent period.

The calculation of the Company's tax liabilities involves uncertainties in the application of complex tax regulations. In the first quarter of fiscal year 2008, the Company adopted Financial Accounting Standards Board ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of SFAS No. 109 ("FIN 48"), and related guidance. As a result of the implementation of FIN 48, the Company recognizes liabilities for uncertain tax positions based on the two-step process prescribed in the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires the Company to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as the Company has to determine the probability of various possible outcomes. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision. Refer to Note 10 of Notes to Consolidated Financial Statements of this Annual Report on Form 10-K for a discussion of current tax matters.

The table below presents the income statement items as a percentage of revenues and provides the percentage change of such items compared to the prior fiscal year amount.

                                        Fiscal Year Ended           Percentage Change
                                  June 28,   June 29,   July 1,   2009 Over   2008 Over
                                   20091      20081      20071      2008        2007

Revenues                           100.0%     100.0%    100.0%      (18%)        9%
Cost of sales                       24.6       22.7       22.3         (11)         11
Gross profit                        75.4       77.3       77.7         (20)         8
Expenses:
Research & development              19.2       16.8       17.0         (6)          7
Selling, general & administrative   13.3       12.1       12.3        (10)          7
Restructuring                        0.4          -         -          -           -
                                    32.9       28.9       29.3         (6)          7
Operating income                    42.5       48.4       48.4         (28)         8
Interest expense                    (5.4)      (4.9)     (1.1)        (10)         378
Interest income                      2.4        2.6        5.3        (24)        (48)
Gain on early retirement of
convertible senior notes             2.5          -         -          -           -
Income before income taxes         42.0%      46.0%      52.6%         (25)        (5)
Effective tax rates                23.0%      28.3%      27.8%

1The results for fiscal years 2009, 2008 and 2007 were impacted by the Company's $3.0 billion Accelerated Stock Repurchase ("ASR") transaction during the fourth quarter of fiscal year 2007. The ASR transaction was funded by $1.3 billion of the Company's own cash and $1.7 billion of convertible debt. As a result, the Company's fiscal years 2009, 2008 and to a lesser extent fiscal year 2007 results all have lower interest income and higher interest expense. Consequently, income before income taxes as a percentage of revenues was lower than past results. On an earning per share ("EPS") basis, these decreases were offset since shares used in the calculation of diluted EPS decreased by 83.3 million or by approximately 27% due to the ASR.

Revenues for the fiscal year ended June 28, 2009 were $968.5 million, a decrease of $206.7 million or 18% from revenues of $1,175.2 million for fiscal year 2008. The decrease in revenue was primarily due to lower domestic and international sales as a result of the global recession. The recession impacted all of the Company's end-markets, particularly the Company's automotive and cell phone end-markets. The average selling price ("ASP") for fiscal year 2009 decreased slightly to $1.51 per unit compared to $1.56 per unit in fiscal year 2008. Geographically, international revenues were $679.2 million or 70% of revenues for the twelve months ended June 28, 2009, a decrease of $149.1 million as compared to international revenues of $828.3 million or 70% of revenues for the same period in the previous fiscal year. Internationally, sales to Rest of the World ("ROW"), which is primarily Asia excluding Japan, represented $390.3 million or 40% of revenues, while sales to Europe and Japan were $166.9 million or 17% of revenues and $122.0 million or 13% of revenues, respectively. Domestic revenues were $289.3 million or 30% of revenues for the twelve months ended June 28, 2009, a decrease of $57.5 million from domestic revenues of $346.8 million or 30% of revenues in the same period in fiscal year 2008.

Revenues for the fiscal year ended June 29, 2008 were $1,175.2 million, an increase of $92.1 million or 9% over revenues of $1,083.1 million for fiscal year 2007. The increase in revenue was primarily due to the Company selling more units into the industrial, communication, automotive, military and computer end-markets while the high-end consumer end-market decreased slightly. The ASP for fiscal year 2008 decreased slightly to $1.56 per unit compared to $1.60 per unit in fiscal year 2007. Geographically, international revenues were $828.3 million or 70% of revenues for the twelve months ended June 29, 2008, an increase of $90.2 million as compared to international revenues of $738.1 million or 68% of revenues for the same period in the previous fiscal year. The increase in international revenues as a percentage of revenues is primarily due to certain domestic OEM customers migrating their manufacturing to international subcontractors. Internationally, sales to ROW represented $461.5 million or 39% of revenues, while sales to Europe and Japan were $212.7 million or 18% of revenues and $154.1 million or 13% of revenues, respectively. Domestic revenues were $346.8 million or 30% of revenues for the twelve months ended June 29, 2008, an increase of $1.8 million over domestic revenues of $345.0 million or 32% of revenues in the same period in fiscal year 2007.

Gross profit for the fiscal year ended June 29, 2008 was $908.1 million, an increase of $66.6 million or 8% over gross profit of $841.6 million in fiscal year 2007. Gross profit as a percentage of revenues was 77.3% of revenues in fiscal year 2008 as compared to 77.7% of revenues in fiscal year 2007. The decrease in gross profit as a percentage of revenues in fiscal year 2008 was primarily due to increases in profit sharing, a decrease in ASP and an increase in raw material costs such as gold. These increases were partially offset by lower stock-based compensation of $3.6 million and improved factory efficiency on higher sales volumes.

Research and development ("R&D") expense for the fiscal year ended June 28, 2009 was $185.8 million, a decrease of $11.2 million or 6% from R&D expense of $197.1 million in fiscal year 2008. The decrease in R&D expenses was primarily due to a $7.1 million decrease in employee profit sharing. In addition, compensation costs decreased $3.9 million as employees were required to take approximately 5.5 weeks of vacation or time-off without pay during the fiscal year and due to the reductions in workforce that occurred during the second and fourth quarters of fiscal year 2009. The decrease in R&D expense was also due to a $2.2 million decrease in other R&D expenses such as software and equipment maintenance fees. Partially offsetting these decreases to R&D expenses was a $2.0 million increase in stock-based compensation.

R&D expense for the fiscal year ended June 29, 2008 was $197.1 million, an increase of $13.5 million or 7% over R&D expense of $183.6 million in fiscal year 2007. The increase in R&D was due to an $11.4 million increase in compensation costs related to new employees, primarily circuit designers and support engineers, and annual salary increases. The increase in R&D expense was also due to higher costs related to profit sharing, which increased $5.0 million. In addition, the Company had a $1.7 million increase in other R&D related expenses such as legal costs, mask costs and small tool charges. Offsetting these increases was a $4.6 million decrease in stock-based compensation.

Selling general and administrative ("SG&A") expense for the fiscal year ended June 28, 2009 was $128.8 million, a decrease of $13.6 million or 10% from SG&A expense of $142.4 million in fiscal year 2008. The decrease in SG&A expenses was primarily due to a $5.2 million decrease in employee profit sharing. In addition, compensation costs decreased $2.2 million as employees were required to take approximately 5.5 weeks of vacation or time-off without pay during the fiscal year and due to reductions in workforce that occurred during the second and fourth quarters of fiscal year 2009. Other SG&A expenses such as legal cost decreased $5.1 million as well as advertising costs which decreased $2.1 million. Partially offsetting these decreases was a $1.6 million increase in stock-based compensation.

SG&A expense for the fiscal year ended June 29, 2008 was $142.4 million, an increase of $8.7 million or 7% over SG&A expense of $133.7 million in fiscal year 2007. The increase in SG&A was due to a $7.5 million increase in compensation costs related to new employees, primarily field sales engineers and annual salary increases. In addition to compensation costs the Company had a $3.7 million increase in profit sharing, a $1.3 million increase in legal expenses and a $0.7 million increase in other SG&A costs. Offsetting these increases was a $4.5 million decrease in stock-based compensation.

During the second and fourth quarters of fiscal year 2009, the Company responded to lower sales levels and the uncertain business climate by reducing its workforce by approximately 100 employees and 130 employees, respectively, or about 5% of its workforce in total. The $3.9 million restructuring charge represents severance costs incurred in connection with these workforce reductions and the majority of these severance amounts were paid during the fiscal year. In addition to these reduction activities, the Company's workforce was reduced by approximately 120 employees related to attrition. The Company incurred no restructuring expenses in fiscal years 2008 and 2007.

Interest expense for the fiscal year ended June 28, 2009 was $52.3 million, a decrease of $5.5 million from interest expense of $57.8 million in fiscal year 2008. The decrease in interest expense was primarily due to the purchase and retirement of $294.4 million face value of the Company's 3.125% Convertible Senior Notes during fiscal year 2009. Interest expense for fiscal year 2009 is primarily comprised of convertible debt interest, amortization of the convertible debt discount and amortization of issuance costs.

Interest expense for the fiscal year ended June 29, 2008 was $57.8 million, an increase of $45.7 million over interest expense of $12.1 million in fiscal year 2007. The increase in interest expense was due to the Company's issuance of $1.7 billion Convertible Senior Notes during the fourth quarter of fiscal year 2007 bearing interest at 3.0% and 3.125%. Interest expense for fiscal year 2008 is primarily comprised of convertible debt interest, amortization of the convertible debt discount and amortization of issuance costs.

Interest income for the fiscal year ended June 29, 2008 was $30.1 million, a decrease of $27.6 million or 48% from interest income of $57.7 million in fiscal year 2007. Interest income decreased due to the Company's lower average cash, cash equivalents and marketable securities balances as the Company used $1.3 billion of its cash to fund a portion of its $3.0 billion accelerated share repurchase ("ASR") transaction during the fourth quarter of fiscal year 2007.

During fiscal year 2009, the Company took advantage of depressed market prices on its outstanding debt and purchased and retired $294.4 million face value of its 3.125% Convertible Senior Notes, resulting in a gain of approximately $24.3 million, net of deferred issuance costs. The Company did not purchase any of its outstanding debt in fiscal years 2008 and 2007.

The Company's effective tax rate was 23.0% in fiscal year 2009 compared to 28.3% in fiscal year 2008. The decrease in the effective tax rate from fiscal year 2008 to fiscal year 2009 is primarily the result of the reinstatement of the federal R&D tax credit legislation during the second quarter of fiscal year 2009 and higher tax benefits for domestic manufacturing. The Company's tax rate also decreased due to quarterly discrete tax benefits related to an agreement with the IRS to effectively settle certain disputed extraterritorial income ("ETI") export benefits claimed during fiscal years 2002 through 2006; prior year tax benefits realized in fiscal year 2009 resulting from the reinstatement of the federal R&D tax credit; and prior year domestic manufacturing tax benefits.

The Company's effective tax rate was 28.3% in fiscal year 2008 compared to 27.8% in fiscal year 2007. The increase in the effective tax rate was primarily due to lower federal R&D tax credits as the related tax benefit expired as of December 31, 2007. In addition, the effective tax rate was higher when compared to fiscal year 2007 due to lower tax-exempt interest income and the expiration of the ETI export tax benefit when compared to fiscal year 2007. Offsetting these increases to the effective tax rate was an increase in foreign earnings in lower tax jurisdictions, higher domestic manufacturing tax benefits and the impact of other quarterly discrete adjustments.

The Company's effective tax rate is lower than the federal statutory rate of 35% as a result of lower tax rates on the earnings of its wholly-owned foreign subsidiaries, principally in Singapore and Malaysia. The Company has a partial tax holiday through July 2015 in Malaysia and a partial tax holiday in Singapore through August 2011. In addition, the Company receives tax benefits primarily from non-taxable interest income, domestic manufacturing and R&D tax credits.

Factors Affecting Future Operating Results

Except for historical information contained herein, the matters set forth in this Annual Report on Form 10-K, including the statements in the following paragraphs, are forward-looking statements that are dependent on certain risks and uncertainties including such factors, among others, as the timing, volume and pricing of new orders received and shipped during the quarter, timely ramp-up of new facilities, the timely introduction of new processes and products; increases in costs associated with utilities, transportation and raw materials; currency fluctuations; the effects of adverse economic and financial conditions in the United States and throughout the world; and other factors described below and in "Item 1A - Risk Factors" section of this Annual Report on Form 10-K.

The Company grew revenues in the fourth quarter of fiscal year 2009 4% over the previous quarter and continued to control its variable expenses where possible to reduce the impact on profits due to lower year-over-year revenues. Because of these cost-saving measures, operating margin was 38% for the fourth quarter, which was an improvement over the 36.4% reported in the prior quarter. Looking ahead to the September quarter, there is continued uncertainty in the marketplace, and customers continue to be cautious with their ordering patterns. Forecasting operating results in the current environment is difficult, particularly since lead times are shorter than usual as customers tend to order only what they urgently need. However, customers have become more consistent in their ordering patterns and recently there have been some improvements in the automotive and industrial end markets. The Company's book to bill ratio was positive in the June quarter. Accordingly, although the summer quarter is . . .