ITEM 1. BUSINESS
Except for the historical information contained herein, matters discussed in the Annual Report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the factors set forth in this report. Although the Company believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, there can be no assurance that such expectations will be achieved.
Dallas Semiconductor Corporation (the "Company" or "Dallas Semiconductor") designs, manufactures and markets electronic chips and chip- based subsystems. Founded in 1984, the Company uses customer problems as an entry point to develop products with widespread applications. The Company is committed to new product development as a means to attempt to increase future revenues and diversify its markets, product offerings and customers.
The Company uses its advanced technologies to gain a competitive edge over the traditional approaches to semiconductors. Combining lithium energy cells with low-power CMOS chips can power them for the useful life of the equipment. Direct laser writing can enhance chip capabilities with higher levels of precision and/or unique identities. Special packaging gives improved functionality to silicon chips.
In its thirteen-year history, Dallas Semiconductor has developed 267 proprietary base products with over 1,000 variations shipped to more than 10,000 customers worldwide. A direct sales force and distribution network sell to original equipment manufacturers (OEMs) of personal computers and workstations, scientific and medical equipment, industrial controls, automatic identification, telecommunications, consumer electronics and other markets.
The Company organizes its products into product categories sharing common technologies, markets or applications as shown below. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report for the 1996 growth rates and relative size of the Company's main product categories.
Computer Timekeeping System Extension Commercial Timekeeping Automatic Information Telecommunications Nonvolatile SRAMs Microcontrollers Others
PRODUCT DEVELOPMENT
The Company developed 21 new proprietary base products during the 1996 fiscal year. The Company's research and development expenditures for fiscal 1996 were $35 million, compared to expenditures in 1995 and 1994 of $28.6 million and $22.7 million, respectively. Dallas Semiconductor intends to continue to commit substantial resources to the development of new products. There can be no assurance, however, that such products, if developed, will gain market acceptance.
PRODUCTS
A description of the Company's product categories is as follows.
COMPUTER TIMEKEEPING. The year 2000 compliant family of clocks introduced in 1995 includes Nonvolatile SRAM densities from 214 bytes to 8K bytes with a pin compatible upgrade path. The devices offer hardware solutions that correctly address year 2000 problems in personal computers and embedded systems. These new clocks offer "wakeup" and "kickstart" features in compliance with PC-95 specifications for soft power on and soft power down by controlling the system power supply. Systems utilizing the power control features can be put into an energy-conserving powered down state and be powered up by the wakeup alarm on a preset date and time by depressing a key on a keypad or from a modem ring detect signal.
- 2 - COMMERCIAL TIMEKEEPING. Accurate clock-calendar information is required in the ever evolving communications, consumer, industrial and medical markets (CCIM). A comprehensive line-up of CCIM timekeepers from the Company, including more than 40 base products in both chip and module packaging are in production to meet this need. Serial Timekeepers provide advanced features including clock-calendar display, talk-time, re-dial timing and power management for digital cellular phones. Phantom and Watchdog modules are used in data communications network routers, hubs and bridges to monitor communications traffic and store the exhaustive amounts of network configuration data. Bytewide Watchdog Timekeepers are also required in industrial control and medical equipment with extended functions including Nonvolatile SRAM and A/D conversion.
TELECOMMUNICATIONS. An emerging and rapidly growing market exists for high capacity voice, data and video transmission. High capacity digital links in North America and Europe/Asia are known as T1/E1 networks. A set of highly integrated chips developed by Dallas Semiconductor addresses the requirements of these protocols and provides one of the most cost-effective solutions available in the industry while minimizing board space and power requirements. Transmission line terminators, such as the SCSI (small computer system interface) Terminator, quiet transmission lines between computers and peripherals, such as disk drives, permitting high speed, high integrity data transmissions.
MICROCONTROLLERS. A microcontroller typically combines a central processing unit, data memory, program memory and input-output devices on a single chip in order to control a wide variety of electronic systems. Dallas Semiconductor offers two product families of microcontroller devices, both based on the popular 8051 instruction set. The first, the secure microcontroller family, is based on the concept of using battery-backed non- volatile SRAM to hold program and data information. Unlike rigid ROM (read only memory) or EPROM (electrically programmable ROM) based microcontrollers, all of Dallas Semiconductor's secure microcontrollers are designed for change. By using high-performance, read/write SRAM memory, software is easily modified and remains nonvolatile for more than 10 years. This memory is initially loaded via a serial port and can be dynamically allocated to fit program and data storage requirements of a particular task. Unique security features of this family allow users to "lock" their software into the processor thereby protecting it from unauthorized access and protecting valuable intellectual property. The second product family of microcontrollers is based on a completely redesigned 8051 core that executes the same instruction set up to three times faster with no hardware changes. With this improved execution efficiency and because these devices were designed to be pin-for-pin compatible, they offer users the unique ability to add features and improve performance of their system without a complete redesign.
SYSTEM EXTENSION. This product family provides complete solutions to common problems facing many systems designers. Nearly all of the products include both analog and digital circuitry on the same chip. Direct-to-Digital Temperature Sensors help manage the growing thermal problems facing designers as the inevitable march to put more power into shrinking form factors continues. Digital Potentiometers permit a digital microprocessor to easily control an analog parameter such as volume or display screen brightness. CPU Supervisors monitor the power supply voltages in a system and issue a warning to the system should any fall below a critical value.
AUTOMATIC INFORMATION. The Company has developed a family of Automatic Information chips that can be attached to an object, or carried by a person, which identifies the user and holds relevant information. Unlike barcodes, users do not need to refer to a remote database to decipher the code -- the information is available in the device itself. These read/write data carriers can also be updated via computer while affixed to an object. Automatic Information chips can facilitate automation by tracking a work piece as it travels along an assembly line; they can also be used to identify people for access to secure areas. Using Dallas Semiconductor's l-Wire(TM) technology, a memory chip can be read or written with the touch of a probe. iButton(TM) devices are packaged in a stainless steel MicroCan(TM) 16mm in diameter.
- 3 - The Automatic Information family also includes Software Authorization products that provide security for intellectual property (e.g., software and data). In an information age, an increasing demand exists to provide security for intellectual property and data. Publishers of premium-priced personal computer software who have strong motivations to protect their products from unauthorized use is one example of this demand. Devices in this product family can also be used to control access to buildings and equipment. Cryptographic iButton(TM) is a new product that enables a standard PC to send secure communications across networks, such as the Internet, to facilitate electronic commerce or to send private e-mail messages.
NONVOLATILE RAMS. Static RAMs (SRAMs), which were first introduced over 20 years ago, are used for high speed storage and retrieval of data. SRAMs have always had the undesirable characteristic of data loss when power is disrupted. Dallas Semiconductor has combined its circuitry and understanding of ultra low power CMOS SRAMs with improvements in long life lithium power sources to develop a family of Nonvolatile SRAM products. Nonvolatile SRAMs integrate a lithium power source and intelligent control circuitry to retain data even in the absence of system power. The control circuit, by monitoring the level of system voltage available to the memory at all times, switches to the lithium power source when necessary, and also protects the memory contents against inadvertent changes during system power fluctuations. A lithium power source provides backup power for more than 10 years in the absence of system power. Recent additions to the product line have increased memory capacity, added features to the basic architecture, and offered a solution for surface mount systems.
OTHER. A description of some of the more significant categories described as "Other" include the following.
OTHER: INTEGRATED BATTERY BACKUP. Nearly all electronic systems operate under the control of one or more microprocessors (uP). The instructions for these uPs or the data they use are subject to loss or corruption in the event of a power outage. Power outages can be inadvertent or intentional, but in either case an orderly transition to an alternate source of power is critical to retain instructions or data held in random access memory (RAM). The Nonvolatile Controller monitors the main power supply to the RAM in a system. In the event of a power failure it switches the RAM over to an alternate source of power and prevents any data loss or corruption. The Smart Battery operates as a miniature uninterruptible power supply (UPS) by not only detecting a main power supply failure, but providing the switchover circuitry and an embedded alternate power source.
OTHER: INTELLIGENT SOCKETS. Often, after a system's design is complete, the manufacturer may desire to enhance functionality because of increased competition from newer products. Dallas Semiconductor has incorporated active electronics in sockets which can be soldered into a system board and add capabilities without requiring substantive changes in the existing system. For example, many systems manufacturers desire the capability to make SRAMs (static random access memory) in existing systems nonvolatile. In this instance, they can replace the SRAM's socket in a system currently in use with a SmartSocket in the same place, and plug the memory circuit into the SmartSocket. A lithium battery and control circuit within the SmartSocket now allow the SRAM to retain data in the event of a loss of system power. Another example is a requirement in many existing systems to monitor and record time of day. The SmartWatch replaces standard SRAM sockets in existing systems and adds the ability to keep time of day to hundredths of a second while also making connected memory circuits nonvolatile.
OTHER: SILICON TIMED CIRCUITS. Electronic systems require exact timing to control the transmission of data between their component parts. Timing requirements vary across systems. Historically, systems designers have not been able to use semiconductors as timing references because of their lack of precision; they consequently achieved the required accuracy by using, in combination or separately, quartz crystals and hybrid passive components, known as delay lines. Dallas Semiconductor's all-silicon delay lines offer single chip reliability, economy and significantly greater precision due to their laser-defined specifications. Direct laser writing provides precise accuracy and, because the products are
- 4 - defined in the final stage of manufacturing, a broad product mix is available without losing the economic benefits of standard integrated circuit production. Customers are provided maximum flexibility, as well as the option of purchasing tailor-made products at the approximate cost of standard, off-the-shelf solutions. These all-silicon products can be designed into new systems, as well as retrofitted into existing systems which otherwise utilize hybrid approaches.
MANUFACTURING
In March 1987 the Company began production at its advanced wafer fabrication facility, in which it is currently producing high performance CMOS integrated circuits with sub-micron geometries. This facility processes six- inch wafers and utilizes an automated modular process technology that provides substantial flexibility in the manufacturing process and significantly reduces the number of persons required for operation. Physical expansion of this facility was completed in 1989 and an additional wafer fabrication facility module was completed in 1994. Additional equipment is installed from time-to- time to support higher production volumes or advanced processing needs. The Company's wafer fabrication facility increased its wafer production by approximately 45% in 1995 and by approximately 28% in 1996. During fiscal 1996 all of the wafers used by the Company were processed at its own facility.
After silicon wafers have been fabricated, the Company utilizes overseas assembly contractors to cut the wafers into individual chips and assemble them into integrated circuit packaging. The Company performs module assembly operations and final testing for substantially all of the Company's products in Dallas, Texas.
PRODUCT COMPONENTS
During fiscal 1996 the Company was able to obtain an adequate supply of static memory circuits from multiple suppliers. These circuits are used in a number of the Company's products. The Company anticipates that, at least for the short term, an adequate supply of these memory circuits will be available; however, given the historically unpredictable and undependable supply of these components, shortages may recur causing future sales of some Company products to be delayed or lost. If such shortages occur, future sales and earnings from products using these circuits, primarily Nonvolatile RAMs, could be adversely affected. Additionally, any significant fluctuations in the purchase price for these components could impact the Company's gross margins. The Company continues to seek alternative sources for these components, including internal production of static memory circuits for use in its own products, primarily the Nonvolatile RAMs.
SALES
Sales are made to distributors and to OEMs. During fiscal 1996 no OEM customer accounted for more than 3.1% of the Company's net sales, and the Company's top 25 OEM customers accounted for 24.2% of net sales. The Company sells its products directly to OEMs through its own sales force, sales representative firms, and domestic and foreign distributors. During fiscal 1996 sales to domestic distributors represented approximately 31% of the Company's net sales, with the Company's largest domestic distributor, Avnet, accounting for a total of approximately 10.7% of net sales.
The Company sells its products in a number of foreign countries, including a number of countries in Europe and the Far East. Export sales accounted for 45% of net sales in fiscal 1996. Export sales were 18% and 27% in Europe and the Far East, respectively, in fiscal 1996. The Company's export sales are billed in United States dollars and, therefore, the Company's results of operations are not subject to currency exchange adjustments. Although export sales are subject to government export regulations, the Company has not experienced any significant difficulties to date because of these regulations.
The Company recognizes revenues from sales to distributors at the time of shipment to the distributor. As is common in the semiconductor industry, the Company grants price protection to distributors. Under this policy, distributors are granted credits for the difference between the price they were originally charged for products in inventory at the time of a price reduction and the reduced price which the Company subsequently charges distributors. From time to time, distributors are also granted credits on an individual basis for Company-approved price reductions to specific customers made to meet
- 5 - competition. The Company also grants distributors limited rights to return products. The Company maintains reserves against which these credits and returns are charged.
BACKLOG
The Company's backlog, although useful for scheduling production, does not represent actual sales and should not be used as a measure of future revenues. Backlog orders are generally subject to cancellation without penalty at the option of the purchaser and to changes in delivery schedules and do not reflect adjustments made for price decreases passed on to distributors or credits for returned products. As of December 29, 1996, the Company's backlog was approximately $72.1 million, as compared to approximately $59.5 million at December 31, 1995. The Company includes in its backlog all released purchase orders shippable within the next 12 months.
THE SEMICONDUCTOR INDUSTRY AND COMPETITION
The semiconductor industry is characterized by rapid technological change, intense competition from domestic and foreign competitors, cyclical market patterns, price erosion, occasional shortages of materials, variations in manufacturing yields and efficiencies and significant expenditures for capital equipment and product development. The industry has from time to time experienced severely depressed business conditions as well as short term softness and imbalances. While the Company's strategy is designed to reduce its exposure to these factors, fluctuations in operating results could occur due to one or more of these factors. The available supply of certain memory circuits used in a number of the Company's products has historically been unpredictable and undependable. Shortages in the supply of these circuits could limit the Company's future sales and earnings growth, and significant price fluctuations in the purchase price for these circuits could impact the Company's gross margins. See "Item 1. Business - Product Components."
The Company faces competition from major domestic and international integrated circuit manufacturers, many of which have substantially greater manufacturing, financial, distributing and marketing resources than the Company, as well as from emerging companies attempting to obtain a share of the existing market. The Company competes principally on the basis of the quality, technical innovation, functionality and timeliness of introduction of its products, the adaptability of such products to specific applications, and price. The Company believes that the early recognition of market opportunities and its willingness to invest substantial time and capital in product development, coupled with product complexity and diversity, constitute an important competitive advantage. The Company's ability to compete successfully in the rapidly evolving semiconductor industry depends on numerous factors, some of which are within the Company's control and others of which are predominately outside of the Company's control. These factors include general economic conditions, changes in conditions affecting OEMs, competition, alternative technologies, the Company's success in developing new products and process technologies, market acceptance of new products, distributor and sales representative performances, the ability of the Company to continue diversifying its product line, manufacturing performance, subcontractor performance, availability and price fluctuations of components and other raw materials, and other factors. Any of these uncertainties could cause a severe near-term impact on the Company's order growth, net sales growth or results of operations.
PATENTS AND INTELLECTUAL PROPERTIES
Dallas Semiconductor has to date acquired or been granted 181 U.S. patents and two foreign patents. The expiration dates of the Company's patents range from 1998 to 2014. None of the patents individually is considered material to the Company's business. The Company has a number of patent applications pending, although no assurance can be given that patents will ever be issued from such applications or that any patents, if issued, will be determined to be valid. The Company has also registered a number of its trademarks, as well as the mask works for certain products, and has sought copyright protection for its software and product literature. No assurance can be given, however, that such protection will give the Company any material competitive advantage in the semiconductor industry, due to the possibility of rapid technological obsolescence of such patented products, trademarks, copyrights and
- 6 - registered mask works, and the inherent limitations of the protection afforded under such laws.
The Company has been notified that it may be infringing certain patents held by others. These notices are in various stages of evaluation. In the event infringement is claimed and the Company believes that a license is necessary or desirable, a license may be sought. The Company believes that if sought, a license could be obtained on commercially reasonable terms, although no assurance can be given in this regard.
ENVIRONMENTAL REGULATION
The Company is subject to a variety of local, state and federal governmental regulations in connection with emissions, the discharge of certain chemicals during its manufacturing process and the handling and disposal of various substances used in manufacturing. Failure to comply with present or future regulations could result in the suspension or cessation of the Company's operations. In addition, such regulations could in the future restrict the Company's ability to expand at its present location or could require the Company to acquire significant equipment or incur other substantial expenses.
EMPLOYEES
At December 29, 1996 the Company had 1,348 employees. The Company believes that its future success is dependent upon its ability to employ and retain qualified technical and management personnel, particularly the highly skilled design engineers involved in the development of new products. The competition for such personnel is intense. During fiscal 1996, the Company continued its practice of utilizing contract labor supplied by temporary agencies, primarily in the manufacturing area. At December 29, 1996, the Company was utilizing the services of 438 such temporary agency employees.
ITEM 2.

ITEM 2. PROPERTIES
The Company's headquarters are located in Dallas, Texas. As of December 29, 1996 the Company owned approximately 35 acres of land that includes approximately 550,000 square feet of building space. The Company's property provides space for administrative and engineering personnel, as well as wafer fabrication, test and surface mount production areas, warehousing, distribution facilities and assembly operations. In 1996, the Company purchased an additional four acres that include an additional 83,000 square feet of building space. A portion of this space is currently subject to certain existing leases. All indebtedness previously secured by the Company's land and buildings has been repaid.
The Company currently leases small office facilities for its sales staff in Irvine, California, Sunnyvale, California, Chelmsford, Massachusetts, Marlton, New Jersey, Duluth, Georgia, Hoffman Estates, Illinois, and Dallas, Texas, under short term leases. The Company's subsidiary, Dallas Semiconductor Corporation Limited, leases an office facility in Birmingham, England. The Company's subsidiary, Dallas Semiconductor Corporation (Taiwan), leases an office facility in Taipei, Taiwan. The Company's foreign sales corporation operates out of Bridgetown, Barbados, W.I.
ITEM 3.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
- 7 - EXECUTIVE OFFICERS OF THE REGISTRANT
The following information as of March 3, 1997, is provided with respect to each executive officer of the registrant pursuant to General Instruction G of Form 10-K.
Mr. Prothro has been Chairman of the Board since February 1984 and served as acting President of the Company from February 1984 to November 1985. Mr. Prothro was named Chief Executive Officer of the Company in January 1989 and President of the Company in October 1989. Since August 1983, Mr. Prothro has been a general partner of Southwest Enterprise Associates, L.P., a venture capital fund. Previously, he served as Chief Executive Officer of Mostek Corporation, a semiconductor manufacturer, during 1981-82, and as its President and Chief Operating Officer from 1977 to 1981.
Dr. Mai joined the Company as Vice President - Engineering in February 1984. He served in such capacity until he became Vice President - Manufacturing in November 1985 and as Vice President - Wafer Fabrication and Technology Development from June 1988 until January 1993. Dr. Mai was named Senior Vice President in January 1993. Previously he was employed in various capacities by Mostek Corporation for over 13 years including the position of Vice President of Process Research and Development beginning in 1980.
Mr. Bolan joined the Company as Director of Marketing in June 1984. He served in that capacity until his election as Vice President - Marketing and Product Development in November 1985. He was employed as an analyst for Southwest Enterprise Associates, L.P. from November 1983 to June 1984. Prior thereto he was employed by Mostek Corporation from November 1978 to October 1983 in various capacities in technical planning, product planning and marketing.
Mr. Scherpenberg was a Product Manager for the Company from May 1984 to March 1989 and Director of Sales from March 1989 to July 1989. He served as Vice President - Sales from July 1989 to July 1990, and became Vice President - Computer Products in July 1990. Prior to his employment with the Company, Mr. Scherpenberg was employed by Mostek Corporation for approximately five years in various capacities, including Field Applications Engineer and Strategic Marketing and Applications Engineer.
Mr. Hale joined the Company in 1987 and has been Vice President of Finance since 1992. Mr. Hale's prior positions with the Company include Controller, Treasurer and Accounting Manager. Previously, he spent five years as an auditor with the Dallas office of Ernst & Young LLP, where his primary client base included Texas Instruments and other electronics manufacturers. He is a CPA in the State of Texas and has received an MBA degree from Southern Methodist University.
- 8 - PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Dallas Semiconductor's common stock is traded on the New York Stock Exchange under the symbol DS. At December 29, 1996, there were approximately 637 holders of record of the Company's common stock. Set forth below are the high, low and quarter-end closing prices for the Company's common stock as reported by The Wall Street Journal during each quarterly period of the 1995 and 1996 fiscal years:
In January 1995, the Board of Directors authorized the initiation of a quarterly dividend program. Total dividends paid in 1996 were $0.12 per share or $3,176,000. On January 23, 1997 the Board of Directors increased its annual cash dividend on the Company's common stock from $0.12 to $0.14 per share. The board also declared a quarterly cash dividend of $0.035 on each outstanding share of its common stock, payable on March 3, 1997 to holders of record on February 14, 1997.
- 9 - ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED SELECTED FINANCIAL DATA (Dollars in thousands, except per share amounts)
- 10 - ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table contains certain amounts, and the amounts as a percentage of net sales, reflected in the Company's consolidated statements of operations for the 1996, 1995, and 1994 fiscal years.
1996 Results of Operations Compared with 1995
Net sales in 1996 were $288.4 million, up 24% compared with $233.3 million in 1995. Net sales increases resulted from higher unit sales of new and/or existing products in several product categories as shown in the table below.
Export sales accounted for 45% and 39% of total net sales in 1996 and 1995, respectively. Export sales were 18% and 27% in Europe and the Far East, respectively. During 1996, the Company continued its policy of generally not selling or licensing manufacturing or marketing rights to its products or the underlying proprietary technologies.
Cost of sales were $157.1 and $117.6 million in 1996 and 1995, respectively. Gross margins declined to 45.5% in 1996 from 49.6% in 1995. The decline in gross margins resulted principally from pricing pressures that were not offset by cost reductions.
Research and development ("R&D") expenses were $35.0 million and $28.6 million or 12.1% and 12.3% of net sales in 1996 and 1995, respectively. Higher R&D expenses resulted primarily from increased salaries and benefits. Increased R&D spending reflects the Company's commitment to new product development as a means to increase future revenues and to further diversify the Company's product offerings. The Company introduced 21 new base products in 1996 compared with 31 new base product introductions in 1995. Product introduction occurs when sample quantities of product are shipped to one or more customers. The cumulative number of base products introduced by the Company totaled 267 at fiscal year end 1996.
Selling, general and administrative ("SG&A") expenses increased to $42.2 million from $35.5 million or 14.6% and 15.2% of net sales in 1996 and 1995, respectively. The increase consisted primarily of increased sales commissions to support higher net sales and increased personnel costs.
- 11 - Operating income in 1996 was $54.1 million, up 5% from $51.6 million in 1995. Operating income as a percentage of net sales (operating margin) decreased to 18.8% in 1996 from 22.1% in 1995. The decrease resulted primarily from the gross margin decline of 4.1%.
Net interest income was $3.0 and $3.4 million in 1996 and 1995, respectively. Net interest income declined primarily due to lower average cash balances in 1996. Changes in interest rates will continue to affect net interest income as will any substantial change in the Company's cash and short-term investments or any substantial change in borrowings.
The provision for income taxes was $18.7 million in 1996 and $18.3 million in 1995. The provision for income taxes consisted of estimated federal and state income taxes at statutory rates and a deferred tax benefit of $0.7 million in 1996 and $0.2 million in 1995. The Company's effective tax rate decreased to 32.8% in 1996 from 33.2% in 1995 as a result of the reinstatement and modification of the federal research and development tax credit by the Small Business Jobs Protection Act of 1996, partially offset by changes in anticipated differences between income for financial statement purposes and taxable income for the two periods.
A number of uncertainties exist that may influence the Company's future operating decisions and results, including general economic conditions, changes in conditions affecting original equipment manufacturers, competition, alternative technologies, the Company's success in developing new products and process technologies, market acceptance of the Company's new products, distributor and sales representative performances, the ability of the Company to continue diversifying its product line, manufacturing performance, subcontractor performance, availability and price fluctuations of raw materials, and other factors. Any of these uncertainties could cause a severe near-term impact on the Company's order growth, net sales growth or results of operations.
1995 Results of Operations Compared with 1994
Net sales in 1995 were $233.3 million, up 28.6% compared with $181.4 million in 1994. Net sales increases resulted from higher unit sales of new and/or existing products in several product families.
Export sales accounted for 39% and 38% of total net sales in 1995 and 1994, respectively. Export sales were 17% and 22% in Europe and the Far East, respectively.
Cost of sales were $117.6 and $90.3 million in 1995 and 1994, respectively. Gross margins declined slightly to 49.6% in 1995 from 50.2% in 1994.
R&D expenses were $28.6 million and $22.7 million or 12.3% and 12.5% of net sales in 1995 and 1994, respectively. Higher R&D expenses resulted primarily from increased salaries and benefits. The Company introduced 31 new base products in 1995 compared with 25 new base product introductions in 1994. The cumulative number of base products introduced by the Company totaled 246 at fiscal year end 1995.
SG&A expenses increased to $35.5 million from $26.5 million or 15.2% and 14.6% of net sales in 1995 and 1994, respectively. The increase consisted primarily of increased salaries and benefits, sales commissions, and advertising expenditures to support higher sales volume.
Operating income in 1995 was $51.6 million, up 23.1% from $41.9 million in 1994. Operating income as a percentage of net sales (operating margin) decreased to 22.1% in 1995 from 23.1% in 1994. The decrease resulted from higher selling, general and administrative expenses as a percentage of net sales in 1995.
Net interest income was $3.4 and $3.1 million in 1995 and 1994, respectively. Net interest income increased primarily due to higher average cash balances and decreased interest expense during 1995.
The provision for income taxes was $18.3 million in 1995 and $15.3 million in 1994. The provision for income taxes consisted of estimated federal and state income taxes at statutory rates and a deferred tax benefit of $0.2 million for both 1995 and 1994. The Company's effective tax rate decreased to 33.2% in 1995 from 34.0% in 1994 as a result of changes in anticipated differences between income for financial statement purposes and taxable income for the two periods.
- 12 - Financial Condition
The Company's cash and short-term investments totaled $70.3 million at December 29, 1996, compared with $69.3 million at December 31, 1995. The increase in cash and short-term investments was primarily the result of net cash provided from operations of $63.6 million, offset by investments in property, plant and equipment of $60.5 million. The Company continues to invest in financial instruments having maturities in excess of one year to obtain yields higher than those available in the short-term market.
The current ratio at fiscal year end 1996 decreased slightly to 4.1, compared with 4.3 at fiscal year end 1995. The Company expects to fund its 1997 capital needs primarily with cash flows from operations, supplemented where appropriate with existing cash and short-term investments or external financing.
Gross capital additions to property, plant and equipment in 1996 totaled $60.5 million, compared with $49.3 million in 1995. The 1996 capital additions included $2.8 million in building purchases near its facilities in Dallas. As of December 29, 1996, the Company owned approximately 550,000 square feet of building space and 35 acres of land in Dallas. Capital additions in 1996 included $25.3 million in capital expenditures for wafer fabrication ("fab") equipment and $21.6 million for manufacturing and test equipment.
Capital expenditures in 1997 are anticipated to be $65 million and will be used primarily for fabrication equipment, manufacturing and test equipment, and computer hardware and software.
In August 1994, the Board of Directors authorized the purchase from time-to-time, depending on market conditions, of up to 500,000 shares of its common stock. As of December 29, 1996, 215,900 shares at a cumulative average price of $15.96, totaling $3,446,000, have been purchased pursuant to this stock repurchase plan.
In January 1995 the Board of Directors authorized the initiation of a quarterly dividend program. Total dividends paid in 1996 were $0.12 per share or $3,176,000. On January 23, 1997 the Board of Directors increased its annual cash dividend on the Company's common stock from $0.12 to $0.14 per share. The board also declared a quarterly cash dividend of $0.035 on each outstanding share of its common stock, payable on March 3, 1997 to holders of record on February 14, 1997.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF INCOME (Thousands except per share amounts)
See accompanying notes.
- 13 - PRIVATE CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts)
See accompanying notes.
- 14 - CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands)
See accompanying notes.
- 15 - CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Three years ended December 29, 1996 (Thousands)
See accompanying notes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Dallas Semiconductor Corporation (the "Company") was incorporated in Delaware in February 1984. The Company develops, manufactures and markets high-performance complementary metal oxide silicon (CMOS) integrated circuits and semiconductor-based systems that provide innovative and cost-effective solutions to electronic design problems in a wide range of existing and emerging markets.
Export sales, principally to customers in Europe and the Far East, represented approximately 45%, 39%, and 38% of net sales in 1996, 1995, and 1994 respectively. Sales to domestic distributors comprised approximately 31%, 34%, and 34% of net sales in 1996, 1995, and 1994 respectively. In 1996, 1995 and 1994 one distributor accounted for $30,889,000 or 11%, $26,081,000 or 11%, and $18,641,000 or 10% of net sales, respectively. No other distributor or original equipment manufacturer ("OEM") customer accounted for 10% or more of net sales in the years presented.
- 16 - 2. SIGNIFICANT ACCOUNTING POLICIES
Fiscal year. The Company operates on a 52- or 53-week fiscal year ending on the Sunday nearest December 31. Fiscal year 1996, a 52-week year, ended December 29, 1996. Fiscal years 1995 and 1994 ended December 31, 1995 and January 1, 1995, respectively.
Principles of consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of estimates from which actual results could vary.
Cash and short-term investments. Since 1995, the Company has classified its cash equivalents and short-term investments as current. Cash and short-term investments consist of municipal bonds and money market funds, U.S. government agency obligations and corporate notes. At December 29, 1996 and December 31, 1995 cash and short-term investments which had a maturity of greater than 90 days when purchased were $69,483,000 and $67,958,000, respectively. Such investments are carried at amounts which approximate their fair market value based on quoted market prices. The Company places its investments only in high credit quality financial instruments, and limits the amount invested in any one institution or in one instrument.
Inventories. Inventories are stated at the lower of standard cost, which approximates actual cost (first-in, first-out), or market.
Depreciation. Depreciation is calculated based on the straight-line method over the estimated useful lives of the related assets, generally forty years for buildings, five to ten years on building improvements and two to five years for computer hardware, software, and machinery and equipment.
Revenue recognition. Sales are recognized upon shipment to distributors and to OEM customers. Sales to domestic distributors are made under distributor agreements which provide the distributor certain price reduction and return and allowance rights. Such sales are reduced for estimated future price reductions and returns.
Research and development. Research and development costs are charged to operations when incurred.
Net income per common share. Net income per common share is computed based upon net income and the weighted average number of shares of common stock and dilutive common equivalent shares outstanding. Common equivalent shares assume the exercise of all dilutive stock options and warrants. The difference between primary and fully diluted net income per common and common equivalent share was not material in any year.
Income taxes. Taxes are reported under Statement of Financial Accounting Standards No. 109 and, accordingly, deferred taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes.
Concentration of credit risk. The Company markets its products for sale to OEMs and distributors primarily in the United States, Europe, and the Far East. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations.
Reclassifications. Certain prior year amounts have been reclassified to conform to the current year presentation.
Stock Options. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" effective for all stock-based compensation awarded after December 15, 1994. As allowed under this standard, the Company has elected not to recognize the effects of stock-based compensation in its financial statements. Pro forma effects on net income and earnings per share are not material for the fiscal years 1996 or 1995.
- 17 - 3. BALANCE SHEET DETAIL
4. STOCKHOLDERS' EQUITY
Stock options. In August 1984, the Company adopted the 1984 Stock Option Plan (the "1984 Plan") under which, as amended, an aggregate of 2,220,919 shares of common stock has been reserved for issuance. In February 1987, the Company adopted the 1987 Stock Option Plan (the "1987 Plan") under which, as amended, an aggregate of 5,389,608 shares of common stock has been reserved for issuance. On April 23, 1996, the 1987 Plan was amended to provide for an annual increase, on and as of January 1st of each calendar year, of 1% of the number of shares of common stock outstanding on December 31st of the preceding year. Under this 1987 Plan provision, 263,555 and 266,053 shares were reserved for issuance on January 1st 1996 and 1997, respectively. These shares are reflected in the option table on the next page. All options have been granted at no less than 100% of the fair market value of the stock at the date of grant. As of December 29, 1996, the 1984 Plan and the 1987 Plan had options outstanding ranging from $0.70 to $6.25 and $2.00 to $22.13, respectively. The options generally are nontransferable and expire no later than ten years (for the 1984 Plan) and eleven years (for the 1987 Plan) from date of grant. Options generally are exercisable upon grant. Shares of common stock issuable and/or exercised under the 1984 Plan and the 1987 Plan vest based upon years of service, generally four years. Upon termination of a participant's employment, the Company reserves the right to repurchase the nonvested portion of the stock held by the employee, at the original option price.
On April 26, 1994, the 1993 Officer and Director Stock Option Plan ("1993 Plan") was approved by the stockholders. The 1993 Plan initially reserved an aggregate of 2,300,000 shares for issuance and provides for an annual increase, on and as of January 1st of each calendar year, of 1% of the number of shares of common stock outstanding on December 31st of the preceding year. Under this 1993 Plan provision, 254,216, 263,555 and 266,053 shares were reserved for issuance on January 1st, 1995, 1996, and 1997, respectively. These shares are reflected in the outstanding options table below in the year authorized. Under the 1993 Plan, as of December 29, 1996, 2,844,000 options were outstanding ranging from $14.75 to $17.88.
- 18 - Total shares reserved for future issuance upon exercise of options are 6,764,512. Additional information with respect to stock options under the 1984, 1987, and 1993 Plans is as follows.
In August 1994, the Board of Directors authorized the purchase, from time-to-time, depending on market conditions, of up to 500,000 shares of its common stock. As of December 29, 1996, 215,900 shares at a cumulative average price of $15.96, totaling $3,446,000 have been purchased pursuant to this stock repurchase program and recorded using the cost method.
5. INCOME TAXES
The provision for income taxes differs from the amount computed by applying the U.S. federal statutory income tax rate to income before income taxes as follows (in thousands).
- 19 - The components of the provision for income taxes are as follows (in thousands).
Current state amounts included in the provision for income taxes include $1,700,000, $1,200,000, and $1,266,000 for the years ended 1996, 1995, and 1994, respectively.
The components of the net deferred tax assets are as follows (in thousands).
================================================================================
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders:
We have audited the accompanying consolidated balance sheets of Dallas Semiconductor Corporation as of December 29, 1996 and December 31, 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three fiscal years in the period ended December 29, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Dallas Semiconductor Corporation as of December 29, 1996 and December 31, 1995, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 29, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP Dallas, Texas January 7, 1997
- 20 - SUPPLEMENTARY FINANCIAL DATA (Unaudited) (Thousands except per share amounts)
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section entitled "Election of Directors" of the Company's definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held April 22, 1997, is incorporated herein by reference. Additional information with respect to executive officers of the Company is found in Part I hereof under the heading "Executive Officers of the Registrant."
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The sections entitled "Director Compensation" and "Executive Compensation" of the Company's definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held April 22, 1997 (other than the subsections entitled "Report of Compensation Committee on Executive Compensation" and "Comparison of Five Year Cumulative Total Return Among the Company, S&P 500 Index and S&P Semiconductor Index"), are incorporated herein by reference.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The sections entitled "Certain Beneficial Owners" and "Election of Directors" of the Company's definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held April 22, 1997, are incorporated herein by reference.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The subsection entitled "Executive Compensation -- Compensation Committee Interlocks and Insider Participation" of the Company's definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held April 22, 1997, is incorporated herein by reference.
- 21 - PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules
The following consolidated financial statement schedule of Dallas Semiconductor Corporation is included on the page set forth below.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted as they are either not required, not applicable or the required information is included in the financial statements or notes thereto.
(b) Reports on Form 8-K None.
(c) Exhibits
Previously Filed* -----------------
- 22 - Previously Filed* -----------------
- - --------- *Incorporated herein by reference. Abbreviations used are as follows: Admit. No. 2 to Form 10 is the Registrant's Amendment No. 2 on Form 8, dated May 9, 1988, to its Registration Statement on Form 10, File No. 0-16170; 7/3/88 10-Q is the Registrant's Quarterly Report on Form 10-Q for the period ended July 3, 1988, File No. 0-16170; 1988 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 1, 1989, File No. 0-16170; 1989 10- K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-10464; 1990 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 30, 1990, File No. 1- 10464; 1991 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1991, File No. 1-10464; 1992 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 3, 1993, File No. 1-10464; 1993 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 2, 1994, File No. 1-10464; 1994 10-K is the Registrant's annual Report on Form 10-K for the fiscal year ended January 1, 1995, File No. 1-10464; 1995 10-K is the Registrant's annual Report on Form 10- K for the fiscal year ended December 31, 1995, File No. 1-10464
+Filed herewith. **Management contract or compensation plan or arrangement required to be filed as an exhibit hereto pursuant to Item 14(c).
- 23 - SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 3, 1997 DALLAS SEMICONDUCTOR CORPORATION
By: /s/C.V. Prothro -------------------------------------- C.V. Prothro, Chairman of the Board of Directors, President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
- 24 - SCHEDULE II
DALLAS SEMICONDUCTOR CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
Years ended January 1, 1995, December 31, 1995 and December 29, 1996
- S1 - EXHIBIT INDEX
- - --------- *Incorporated herein by reference. Abbreviations used are as follows: Admit. No. 2 to Form 10 is the Registrant's Amendment No. 2 on Form 8, dated May 9, 1988, to its Registration Statement on Form 10, File No. 0-16170; 7/3/88 10-Q is the Registrant's Quarterly Report on Form 10-Q for the period ended July 3, 1988, File No. 0-16170; 1988 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 1, 1989, File No. 0-16170; 1989 10- K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-10464; 1990 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 30, 1990, File No. 1- 10464; 1991 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1991, File No. 1-10464; 1992 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 3, 1993, File No. 1-10464; 1993 10-K is the Registrant's Annual Report on Form 10-K for the fiscal year ended January 2, 1994, File No. 1-10464; 1994 10-K is the Registrant's annual Report on Form 10-K for the fiscal year ended January 1, 1995, File No. 1-10464; 1995 10-K is the Registrant's annual Report on Form 10- K for the fiscal year ended December 31, 1995, File No. 1-10464
+Filed herewith. **Management contract or compensation plan or arrangement required to be filed as an exhibit hereto pursuant to Item 14(c).