<PAGE>


                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                    FORM 10-K

[x]        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES EXCHANGE ACT OF 1934

            For the Fiscal Year Ended December 31, 1997

                                OR

[  ]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES EXCHANGE ACT OF 1934
      For the Transition Period from __________ to __________

                    Commission File No. 0-25502

                 INFORMATION STORAGE DEVICES, INC.
      (Exact name of registrant as specified in its charter)

              California                        77-0197173
             (State or other jurisdiction       (IRS Employer
              incorporation or organization)    Identification No.)
             2045  Hamilton  Avenue,  San Jose,  CA 95125
         (Address of principal executive offices, including zip code)
     Registrant's telephone number, including area code: (408) 369-2400
                          --------------

 Securities registered pursuant to Section 12(b) of the Act: None

    Securities registered pursuant to Section 12(g) of the Act:
                     Common Stock no par value

      Indicate by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X NO ____

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X ]

      The aggregate  market value of voting stock held by  nonaffiliates  of the
Registrant,  was  approximately  $72,585,252  (based upon the closing  price for
shares of the  Registrant's  Common  Stock as  reported  by the Nasdaq  National
Market on  February  28,  1998).  Shares of Common  Stock held by each  officer,
director  and  holder of 5% or more of the  outstanding  Common  Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate  status is not  necessarily  a conclusive  determination  for other
purposes.

      On February 28, 1998,  approximately  9,842,068 shares of Common Stock, no
par value, were outstanding.



<PAGE>


                                                          1997 10-K
                 Information Storage Devices, Inc.

                               INDEX

              INFORMATION STORAGE DEVICES, INC. (ISD)
<TABLE>
<CAPTION>
<S>        <C>                                              <C>

   PART I                                                      Page No.
                                                               --------

   Item 1.  BUSINESS...............................................1
   Item 2.  PROPERTIES............................................10
   Item 3.  LEGAL PROCEEDINGS.....................................10
   Item 4.  SUBMISSION OF MATTERS TO A VOTE
            OF SECURITY-HOLDERS...................................10
   Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT..................10

   PART II

   Item 5.  MARKET FOR REGISTRANT'S COMMON
            EQUITY AND RELATED STOCKHOLDER MATTERS................12
   Item 6.  SELECTED FINANCIAL DATA...............................12
   Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
            CONDITION AND RESULTS OF OPERATIONS...................13
   Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
            ABOUT MARKET RISK.....................................18
   Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........19
   Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
            ON ACCOUNTING AND FINANCIAL DISCLOSURE................34

   PART III

   Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
            REGISTRANT............................................34
   Item 11. EXECUTIVE COMPENSATION................................36
   Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
            OWNERS AND MANAGEMENT.................................38
   Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........40

   PART IV

   Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
            REPORTS ON FORM 8-K...................................40
</TABLE>


<PAGE>

  This Report contains forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Securities Act") and Section
21E of the  Securities  Exchange Act of 1934,  as amended (the  "Exchange  Act")
regarding  the  Company  and  its  business,  financial  condition,  results  of
operations and  prospects.  Words such as "expects,"  "anticipates,"  "intends,"
"plans,"  "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking  statements,  but are not
the exclusive  means of identifying  forward-looking  statements in this Report.
Additionally,  statements  concerning  future  matters  such  as  the  features,
benefits and  advantages of the Company's  products,  international  sales,  the
development of new products, enhancements or technologies,  migration to smaller
geometries,  foundry  relationships  and risks,  business and sales  strategies,
matters relating to proprietary rights,  litigation,  competition and facilities
needs  and  other  statements  regarding  matters  that are not  historical  are
forward-looking statements.

  Although  forward-looking  statements  in this  Report  reflect the good faith
judgment of the Company's management, such statements can only be based on facts
and  factors  currently  known  by the  Company.  Consequently,  forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ  materially  from the results and outcomes  discussed in
the forward-looking  statements.  Factors that could cause or contribute to such
differences in results and outcomes  include without  limitation those discussed
in Item 7 of this  Report  under the  heading  "Other  Factors  That May  Affect
Operating Results," as well as those discussed elsewhere in this Report. Readers
are urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Report.  The Company  undertakes no obligation
to revise or update any forward-looking statements in order to reflect any event
or circumstance that may arise after the date of this Report.  Readers are urged
to review and consider carefully the various  disclosures made by the Company in
this  Report,  which  attempts  to advise  interested  parties  of the risks and
factors that may affect the Company's business,  financial condition and results
of operations.






<PAGE>


Item 1.      BUSINESS

The Company

   ISD designs,  develops,  and markets  semiconductor  voice solutions based on
analog and digital  technologies  and mixed  signal  expertise.  ISD's  patented
ChipCorder(R)  and  CompactSPEECH(R)   technologies  enable  solid  state  voice
recording  and  playback  applications  in  the  communications,  consumer,  and
industrial markets.  ChipCorder  products deliver single chip solutions,  simple
integration,  exceptional  sound quality,  low power  consumption,  battery-less
voice storage,  and low cost.  CompactSPEECH  products  deliver powerful digital
speech  processing,  advanced  telecommunication  capabilities,  long  recording
times, cost effective high voice quality,  multi-language speech synthesis,  and
battery-less  voice  storage.  The Company was  incorporated  in  California  in
December 1987.  Volume production  shipments  commenced in 1992 and net revenues
grew every year until  1996.  In 1997,  net  revenues  grew by 16% over 1996 net
revenues.

Markets, Applications and Customers

   ISD's mission is to provide products to the communications  marketplace using
its  proprietary  multi-level  storage and related  technologies.  The  wireless
communication and telecommunication  markets continue to be a key focus for ISD.
While these industries form a large part of the Company's current business,  ISD
also provides products to the consumer and industrial  markets.  In 1997, 79% of
net revenues was derived from the  communications  market,  and the consumer and
the industrial markets accounted for 12% and 9% of net revenues, respectively.

   Sales to the Company's top ten customers accounted for 76% of net revenues in
1997 compared to 85% in 1996,  and 66% in 1995.  The top five  customers in 1997
were  Marubun  (the  Company's  Japanese  distributor),   Motorola,  Matsushita,
Philips, and NuHorizons (the Company's United States distributor), accounting 
for 19%, 17%, 13%, 11%, and 7% of net revenues, respectively.

Communications Market

  The Company has broadened its marketing efforts in the  communications  market
by introducing the ISD33000  ChipCorder  series,  the industry's first family of
3-volt,  single-chip  record and playback  products  optimized for communication
devices including cellular and portable phones. Earlier versions of ISD's record
and  playback  chips are still  being used in cellular  phones (as an  answering
machine  function  or as a voice  memo pad) and many other  products,  including
pagers and traffic  information  systems.  The ISD33000  Series is optimized for
both analog and digital cellular phones -- including Global System Mobile (GSM),
Personal  Communication  Service  (PCS),  Personal  Handy  Phone  System  (PHS),
Japanese  Digital  Cellular  (JDC),  and  cordless  phones  that  rely on 3-volt
technologies to minimize power consumption. In addition to cellular and portable
phones,  the ISD33000 has also been designed into pocket recorders and telephone
answering  machines.  Along with  offering true 3-volt  operation,  the ISD33000
product family offers longer recording durations than previous ISD products:  up
to four minutes.  The ISD33000 series is the first ChipCorder  series to support
serial protocols,  including  Motorola's  Serial Peripheral  Interface (SPI) and
National Semiconductor Corporation's Microwire.

   The  largest   single   application   for  the  Company's   products  in  the
communications   market  is   currently   the  cellular   phone.   A  number  of
manufacturers,  including Benefon,  Casio,  Ericsson,  JVC,  Motorola,  Pioneer,
Sagem, Sanyo, Sharp, Sony, Toshiba and Matsushita (Panasonic), have incorporated
ChipCorder products in their communications  products. The Company is developing
single-chip solutions with considerably longer durations that would address both
customers'  outgoing  and  incoming  message  requirements  and  accelerate  the
migration to all integrated  circuit-based  TADs (i.e. those that eliminate tape
mechanisms).  Motorola  has designed the  Company's  products  into its MicroTAC
Elite and StarTAC cellular phones to record incoming messages and/or voice memos
directly  into the  phone.  Other  representative  applications  for  ChipCorder
products in the communications  market include mobile radios, caller ID devices,
telephone announcement systems, personal handy phones and voice pagers.

  The second largest application for the Company's products in the communication
market is the digital telephone answering machine.

<PAGE>

  The  acquisition  of the  CompactSPEECH  product  line in April  1997  brought
advanced,   digital  speech  processing   technology  and  high  quality  speech
compression  algorithms to ISD's product portfolio.  CompactSPEECH products have
also  expanded  ISD's  record  and  playback  durations  to up to one hour.  The
addition of the  CompactSPEECH  product  line has  expanded  ISD's large base of
customers to include several new ones such as Philips, Siemens, and VTech.

Consumer Market

   The Company's  marketing  efforts for its first  generation,  short  duration
products were directed toward the consumer market. The Company believes that the
high voice  quality,  ease of use,  non-volatility  and low cost of its products
combined  with the short  design-in  cycle  typical of the consumer  market have
allowed the Company's  customers to bring their  products to market  rapidly and
economically. The Company's customers in the consumer market typically integrate
a voice  recording and playback  function to create a new product  concept or to
differentiate  an existing  product with additional  features or  functionality.
Prior to the  introduction of ChipCorder  products,  voice functions were almost
all accomplished by read only memory ("ROM") devices,  which typically have very
low  speech  quality  and can be used only to play back  pre-recorded  messages.
Representative  applications  for  ChipCorder  products in the  consumer  market
include interactive books for children, keepsakes,  novelties, pocket recorders,
cameras,  recordable  greeting cards,  recordable  photograph  frames,  toys and
games.

  During 1997, ISD introduced the ISD1500  series,  a family of low-cost  single
chip record and play solutions for the price  sensitive  consumer  market.  This
product family  delivers high quality single  message  functionality  with added
features such as sound warping and user selectable duration.

Industrial Market

   Industrial  applications  for the  Company's  products  are largely  oriented
toward voice prompting (i.e.,  providing a voice interface  between the user and
the  product)  and  include  applications  for  alerting,   educating,  guiding,
informing,  prompting and warning. Prior to ChipCorder  technology,  this market
opportunity  had not been well  developed  because of the complexity of existing
voice solutions,  poor voice quality and the high minimum purchase  requirements
imposed by  manufacturers  of ROM-based  single-chip  solutions.  The  Company's
products  offer  OEM  customers  in  the   industrial   market  the  ability  to
differentiate  their  products by  providing  improved  functionality  and voice
interface.  ChipCorder  products have the advantages of being easy to record and
re-record and of maintaining the recording in the event of power loss or battery
replacement.   The  industrial  market  is  characterized  by  low  to  moderate
production volumes.  Representative  applications for ChipCorder products in the
industrial market include  announcement/annunciator  systems,  building security
systems, instrumentation, alarms and point of sale displays.

Products

ChipCorder Products

   The  Company  currently  offers  seven  product  families  incorporating  its
ChipCorder technology.  These products are available in die or packaged form and
range in retail  list  price from less than  $1.00 to  approximately  $11.00 per
unit.

   The  Company's   original  product  family,  the  ISD1000A  series,  was  the
industry's first  single-chip  recording and playback  device.  This product won
numerous  trade  awards,  including  the 1991  Electronic  Design News  Magazine
"Innovation  of the  Year"  award and the  Electronic  Products  Magazine  "1991
Product of the Year" award.  The ISD33000  series  offers  substantially  longer
voice  recording  and playback  durations.  This product  family has enabled the
development   of  a  wide   variety   of  product   applications,   particularly
communications and industrial applications.

  Most of the  Company's  ChipCorder  products  include an  on-chip  oscillator,
microphone preamplifier,  automatic gain control, antialiasing filter, smoothing
filter and  speaker  amplifier.  A complete  record and  playback  system can be
configured  with the addition of a microphone,  a speaker,  a power source and a
few  resistors  and  capacitors.   The  Company's  products  are  microprocessor
compatible, and provide users with complex messaging and addressing capability.

<PAGE>


CompactSPEECH Products

  The CompactSPEECH product series provides high quality speech processing, long
recording  times,  caller  ID,  full  duplex  speaker  phone  functionality  and
multi-language  speech  synthesis.  CompactSPEECH  products  were  the  first to
provide a digital telephone answering solution with non-volatile memory support.
CompactSPEECH  products are  available in various  packaging  options and retail
between $4.00 and $7.00, depending on volume and packaging options.

Marketing, Sales and Distribution

   The Company markets and  distributes its products  through a direct sales and
marketing  organization  and a worldwide  network of sales  representatives  and
distributors.   Major  OEM  accounts  are  served   directly  by  the  Company's
salespeople  and  support  staff,  which  includes  applications  engineers  and
customer service personnel.  The Company manages its direct sales force from its
headquarters in San Jose, California, and has offices located in France, Israel,
New York and Texas.

   In North America, the Company has 19 sales representatives.  In addition, the
Company  has a  non-exclusive  distributor  that  sells the  Company's  products
directly to many customers throughout North America and a non-exclusive Canadian
distributor.  Neither of these  distributors is subject to any minimum  purchase
requirements  and can cease  promotion  of the  Company's  products at any time.
Select ISD products are also sold through Radio Shack and Digi-Key Corporation.

   Internationally, the Company has 29 distributors located in Australia, China,
Hong Kong, Israel,  Japan,  Korea, South Africa,  Taiwan,  Singapore,  and every
major country in Europe. The Company also has sales  representatives in England,
France,  Germany,  and Italy.  The Company relies on its  distributors for local
product promotion and customer support, including identification and development
of  customers,  applications  support,  and  media  promotion,  such  as  public
relations  and  advertising  activities.   The  Company's  agreements  with  its
international distributors and representatives are renewable on an annual basis,
but can be terminated or discontinued at will.

   Export sales (sales outside North America) constituted approximately 65%, 65%
and 79% of the Company's net revenues for 1995, 1996 and 1997, respectively. Due
to its  reliance  on  export  sales,  the  Company  is  subject  to the risks of
conducting business internationally, including foreign government regulation and
general geopolitical risks such as political and economic instability, potential
hostilities and changes in diplomatic and trade relationships.  In addition, the
laws of certain foreign countries in which the Company's  products are or may be
sold,  including  various  countries  in Asia,  may not  protect  the  Company's
intellectual  property  rights to the same  extent as do the laws of the  United
States and thus make the  possibility  of piracy of the Company's  products more
likely.  Sales  of the  Company's  products  may  also be  materially  adversely
affected by factors such as  unexpected  changes in, or  imposition  of, U.S. or
foreign regulatory  requirements,  tariffs,  import and export  restrictions and
other barriers and restrictions,  longer payment cycles,  greater  difficulty in
accounts  receivable  collection,  potentially  adverse  tax  consequences,  the
burdens of complying with a variety of foreign laws and other factors beyond the
Company's  control.  Because the Company's foreign sales are denominated in U.S.
dollars,  the Company's products become less price competitive in countries with
currencies declining in value against the dollar. There can be no assurance that
these factors will not have a material adverse effect on the Company's business,
financial  condition  or results  of  operations  in the  future or require  the
Company to modify its current business practices.

    A limited number of customers  historically  has accounted for a substantial
portion of the  Company's  net revenues.  In 1995,  1996 and 1997,  sales to the
Company's top ten customers,  including  those  discussed  below,  accounted for
approximately  66%, 85% and 76%,  respectively,  of the  Company's net revenues.
Sales to Marubun, the Company's Japanese distributor, and Motorola accounted for
16% and 13%,  respectively,  of the Company's net revenues in 1995,  23% and 29%
respectively in 1996, and 19% and 17%  respectively in 1997. Sales to Matsushita
and Philips accounted for 13% and 11% of net revenues, respectively, in 1997.

<PAGE>

The Company  expects that sales of its products to a limited number of customers
will  continue  to account for a  substantial  portion of its  revenues  for the
foreseeable  future. The Company has also experienced changes in the composition
of its customer base from year to year and expects this pattern to continue. The
loss of, or significant reduction in purchases by, current major customers, such
as Motorola,  would have a material  adverse  effect on the Company's  business,
financial  condition  and  results.  The  Company's  customers  typically do not
contract for minimum  purchase  quantities.  There can be no assurance  that the
Company  will be able to  continue  to  obtain  the  orders  from new  customers
necessary  to offset  losses of or  reductions  in  purchases  by the  Company's
current major customers.

   The Company's sales are also subject to seasonal factors,  such as the demand
for cellular phones and other products that incorporate the Company's  products,
which is generally strongest in the third and fourth quarters of each year.

Customer Applications Engineering and Technical Support

   To promote  acceptance of the  ChipCorder  and  CompactSPEECH  products,  the
Company  provides   applications   engineering  and  technical  support  to  its
customers.  The Company has implemented an extensive  support effort that begins
with its sales force, and extends through the  manufacturing and delivery of its
products.  The Company offers  product design  assistance to help customers with
limited  electronics  expertise  create  innovative  new  products.  The Company
has  applications  engineering staff located at its headquarters in San Jose,  
California,  and at its office in Austin,  Texas. In addition to publishing  
application  documentation  and other customer support documents,  the Company's
applications  engineering staff works with customers  directly to facilitate the
design-in of the Company's  products.  The Company's independent sales 
representatives  supplement the applications and technical   support  functions 
by providing such services  directly to customers.  The  Company   works 
closely  with  the   independent   sales   representative organizations  to 
enhance  their ability to provide  applications  and technical support directly.

   Although   development   systems  are  not  required   with   ChipCorder   or
CompactSPEECH    devices,    ISD   offers   several    evaluation    tools   and
development/programming systems. These tools allow users to record and play back
messages,  create,  edit and mass  program ISD  devices  with  accurate  message
location,  and develop or test the products' application  environment by using a
PC as the host system to interact with the product.

Technology

   The Company's  technology  differentiation lies in its patented technique for
storing  multilevel  signals  which  is used  in the  design  of all  ChipCorder
products.  In conventional digital data storage,  each memory cell stores one of
two  "bits"  of  information,  either  a "1" or a "0," or,  in terms of  voltage
levels,  either an "on" or an  "off."  Using the  Company's  multilevel  storage
technology,  each ChipCorder  memory cell can store one of more than 250 voltage
levels,  approximately  the  equivalent  of eight bits of  storage,  without any
conversion to digital  data.  Thus,  for a given quality of voice  reproduction,
ChipCorder products require one-eighth the silicon storage space of conventional
digital  storage  techniques  and typically  provide a cost  advantage over such
digital storage technologies in delivering high-quality voice solutions. Because
the  Company's  ChipCorder  technology  enables the direct  storage of voice and
audio  signals  without  analog-to-digital  conversion,  the amount of  external
circuitry  required  can  also  be  reduced.  ChipCorder  products  need  only a
microphone,  a speaker,  power  source and a few  resistors  and  capacitors  to
implement a complete  solid-state,  tapeless,  record/playback  function.  Since
ChipCorder products use nonvolatile memory, they do not require continuous power
or battery backup to preserve the recorded message.  Overall power  consumption,
therefore,  is  reduced,  making  the  Company's  products  ideal for  handheld,
portable, battery-powered applications.

   The  Company   achieves   multilevel   storage  of  analog  signals   through
architectural,  algorithmic and circuit design  techniques  without the need for
special  manufacturing  processes.  The ISD1000 series product is designed using
CMOS EEPROM processes,  with 128,000 storage cells. The Company's technology can
migrate and scale within industry production technology and standards,  and thus
can take advantage of improvements in digital memory processing. Each generation
of new products, from the original ISD1000 series, through the ISD33000 series,

<PAGE>

to the new products under development today,  benefits from cell area reductions
driven by memory  technology  advances  thereby  giving the Company  significant
advantages in density as its products migrate to smaller production  geometries.
The Company  selects its wafer  foundries  according to its  assessment of their
ability  to  make  continually  improving  process  densities  available  to the
Company.

   The Company's  technology is compatible with floating gate processes that use
Fowler-Nordheim  tunneling for both erasing and programming the storage cell, as
used in most digital EEPROM and some "flash" processes. No special process steps
or cell structures are required.  The Company's  technology is transferable from
one wafer  source to another  allowing  the Company to provide  alternate  wafer
sources and position the Company to negotiate for more  attractive  wafer or die
pricing, wafer volume and future technology improvements.

Manufacturing

   Foundries.  The Company  subcontracts  with independent  silicon foundries to
fabricate the wafers for all of its products.  This approach enables the Company
to  concentrate  its  resources on the design and test areas,  where the Company
believes it has the greatest competitive advantage, and eliminates the high cost
of owning and operating a semiconductor wafer fabrication or packaging facility.

   All of the Company's products are manufactured by four independent foundries.
The Company has supply arrangements with each of its current foundries,  and the
Company and its foundries agree on production schedules based on purchase orders
and forecasts for the next six to twelve months.  The Company's primary supplier
is Samsung  Electronics  Co., Ltd.  ("Samsung") in Korea,  which supplied wafers
comprising  about 78% of the Company's 1997 net revenues.  Approximately  20% of
the  Company's  1997 net  revenues  were  supplied  by wafers  produced at Tower
Semiconductor  ("Tower") in Israel.  Rohm  Semiconductor  Co., Ltd.  ("Rohm") in
Japan  accounted  for about 1% of 1997 net revenues as did Sanyo  Electric  Co.,
Ltd.  ("Sanyo") in Japan. In January 1995, Atmel Corporation  ("Atmel") notified
the  Company  and Samsung of certain  claims and  demanded  that the Company and
Samsung  either  negotiate  licenses  with  Atmel  or  cease  manufacturing  the
Company's  products at Samsung,  and, in June 1995, Atmel filed suit against the
Company. See Item 3: Legal Proceedings.

   The  Company is  dependent  on these  foundries  to allocate to the Company a
portion of their foundry  capacity  sufficient to meet the Company's  needs,  to
produce products of acceptable quality and with acceptable  manufacturing yields
and to deliver  products to the Company on time.  On  occasion,  the Company has
experienced  difficulties  in each of these areas,  and the Company is likely to
experience such  difficulties in the future. In order to obtain this capacity or
other  capacity,  the Company may be obligated to pay  nonrecurring  engineering
fees or make certain other payments to any one of its foundries. The Company has
qualified wafer fabrication facilities at Samsung,  Tower, and Rohm. The Company
has qualified another foundry supplier,  Winbond Electronics  Corporation and is
in the process of finalizing  the design for the first product.  However,  there
can be no  assurances  that the  Company  will  continue  to receive its desired
requirements of product at these  foundries.  The loss of Samsung or Tower, as a
supplier, the inability of the Company or Samsung to obtain a license from Atmel
should that prove to be  necessary,  the inability of the Company to maintain or
expand  foundry  capacity  from its current  suppliers or to qualify other wafer
manufacturers  so the  Company  can  obtain  additional  foundry  capacity,  any
inability to obtain timely and adequate deliveries from the Company's current or
future  suppliers or any other  circumstance  that would  require the Company to
seek alternative sources of supply could constrain, interrupt or delay shipments
of the Company's  products and have a material  adverse  effect on the Company's
business, financial condition and results of operations.

   The  Company's  reliance  on third party  manufacturers  involves a number of
risks,  including but not limited to reduced  control over  delivery  schedules,
quality  assurance  and  costs.  In  addition,  as a  result  of  the  Company's
dependence  on foreign  subcontractors,  the  Company is subject to the risks of
conducting business internationally, including foreign government regulation and
general  geopolitical  risks,  such  as  political  and  economic   instability,
potential hostilities, changes in diplomatic and trade relationships, unexpected
changes in, or imposition of, U.S. or foreign regulatory requirements,  tariffs,
import and export restrictions and other barriers and restrictions,  potentially
adverse tax  consequences,  the burdens of  complying  with a variety of foreign
laws and other factors beyond the Company's  control.  The Company's  agreements
with its offshore wafer fabrication and assembly  facilities provide for pricing
and payment in U.S. dollars.

<PAGE>

   ChipCorder  and  CompactSPEECH   products  are  designed  using  the  process
specifications  of the Company's  foundries.  Currently,  the foundries use CMOS
process  technology  with 1.2  micron and 0.8 micron  feature  sizes.  To reduce
manufacturing  costs,  the  Company  continuously   evaluates  the  benefits  of
migrating particular products to smaller geometry process technologies. In 1997,
wafers  produced  on a 0.8  micron  process  accounted  for  almost  half of the
Company's  net  revenues.  Migration to smaller  geometries  is essential if the
Company is to remain cost competitive, and operating results could be materially
adversely   affected  if  these   transitions  are   substantially   delayed  or
inefficiently   implemented.   The  Company  has  experienced  delays  in  these
migrations, and there can be no assurance that further delays will not occur.

  Manufacturing  Yields.  The  fabrication  of  integrated  circuits is a highly
complex and precise process, requiring production in a highly controlled,  clean
environment.  As  a  result,  semiconductor  companies  often  have  experienced
problems in achieving an  acceptable  wafer  manufacturing  yield,  which is the
number of good die (semiconductor  products) that results from each manufactured
wafer as a proportion of the total  potential die on the wafer. As is typical in
the  semiconductor  industry,  the  Company  purchases  its  products  from  its
suppliers on either a wafer or die basis. Because the capacity for production of
wafers is limited,  low yields  decrease the total number of products  available
for delivery to the  Company.  Semiconductor  manufacturing  yield is a function
both of design  technology,  which is  developed  by the  Company,  and  process
technology, which is typically proprietary to the foundry. The design is created
from the design rules  depicting  the process  technology.  Since low yields may
result from either design or process technology failures, yield problems may not
be effectively determined or improved until an actual product exists that can be
analyzed and tested to recognize process sensitivities in relation to the design
rules that are used. As a result,  yield  problems may not be  identified  until
well into the production  process and require  cooperation by and  communication
between the Company and the foundry for resolution.  The Company is particularly
susceptible  to  yield  problems  because  it is not in  direct  control  of the
independent  offshore  foundries that manufacture its products,  which increases
the effort and time required to identify,  communicate and resolve manufacturing
yield problems. In addition, as the Company qualifies additional foundries,  the
Company must design its products  using the process  technology and design rules
of each of these foundries.

  In the past, the Company has experienced  yield problems on its ISD1400 series
as it was  converted to the 1.2 micron  process and on its ISD2500  series as it
was  converted  to the 0.8 micron  process.  The  ISD33000  experienced  a yield
problem  in the third and  fourth  quarters  of 1997.  The  current  levels  are
variable and the Company  continues  to take actions to improve the yields.  The
inability of the Company to achieve improved yields could prevent revenue growth
and margin  improvement from existing  capacity.  There can be no assurance that
the Company's foundries will achieve or maintain acceptable manufacturing yields
in the future or that sudden declines in yields will not again occur. Failure to
improve, or fluctuations in,  manufacturing  yields,  particularly at times when
the Company is experiencing  severe pricing  pressures from its customers or its
competitors,  would have a material  adverse  effect on the Company's  business,
financial condition and results of operations.

   Testing  and  Assembly.  Wafers  that have been  tested and  accepted  by the
Company are cut into die and either sold in that form or assembled into packages
by  subcontractors  located  in either  Korea or the  Philippines.  The  Company
qualifies and monitors assembly contractors using procedures similar in scope to
those used for wafer  procurement.  For products  sold in die form,  the Company
also  employs  several  "die  preparation"  subcontractors  that are  located in
Taiwan, the Philippines,  China, and Thailand. The Company's die preparation and
assembly subcontractors provide fixed cost per-unit pricing, as is common in the
semiconductor industry.

   Because the Company's  products are manufactured and assembled by independent
subcontractors,  the Company is subject to the risks of shortages, and increases
in the  cost,  of raw  materials  used in the  manufacture  or  assembly  of the
Company's  products.  Shortages of raw materials or disruptions in the provision
of  services  by  the  Company's  manufacturing  or  assembly  houses  or  other
circumstances  that would  require  the Company to seek  alternative  sources of
supply or assembly could lead to constraints,  interruptions or delays in timely
delivery of the Company's products. Such constraints, interruptions or delays or
any other problem  resulting from the risks  described above might result in the
loss of customers,  limitations or reductions in the Company's revenues or other
material  adverse  effects on the Company's  business,  financial  condition and
results of operations.

<PAGE>

  Quality  Assurance.  The  communications  industry  demands  high  quality and
reliability.  The Company seeks to build product  reliability  into each circuit
from the  beginning  stages  of  design,  through  specific  design  and  layout
reliability  guidelines.  Also,  to  maximize  quality,  reliability  and  yield
relationships,  the Company  participates in quality and reliability  monitoring
through  each  aspect  of the  production  cycle  by  reviewing  electrical  and
inspection data from its wafer foundry and assembly subcontractors.  The Company
monitors wafer foundry  production for consistent  overall quality,  reliability
and yield levels.  As part of its total quality program,  the Company  completed
its ISO 9001  certification in October of 1996 and the 1997  surveillance  audit
with no deviations.  All of the Company's wafer  foundries and package  assembly
facilities are also ISO 9000 certified.

Research and Development

   The markets for the Company's  products are characterized by rapidly changing
technology and evolving industry standards. The Company's operating results will
depend  to a  significant  extent  on  its  ability  to  introduce  commercially
attractive and competitively priced new products on a timely basis and to reduce
production  costs of existing  products.  The Company  believes  that  continued
significant  expenditures  for research and development  will be required in the
future as the Company  develops more products  with  improved  features.  During
1997, the Company introduced the short duration ISD1500, an innovative, low cost
circuit topology  manufactured at Rohm  Semiconductor in Japan; and demonstrated
the  eight  minute  record  and  playback  capability  utilizing  a  flash-based
technology built at Winbond Electronics  Corporation in Taiwan. In addition,  in
April 1997,  the Company  established  a design  center in Israel to support the
CompactSPEECH  product  line.  This design  center is also  responsible  for the
enhancement  of the existing  products as well as  development  of the Company's
next generation of digital signal processing ("DSP") products.

   There can be no assurance that these products will be successfully  developed
or will achieve  market  acceptance.  The failure of any of these products to be
introduced  successfully or to achieve market  acceptance  could have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.  The success of new product  introductions  is  dependent on several
factors,  including  recognition of market  requirements,  product cost,  timely
completion or acquisition and  introduction of new product  designs,  quality of
new  products  and  achievement  of  acceptable  manufacturing  yields  from the
Company's subcontractor  manufacturers.  Because of the design complexity of its
products,  the Company has  experienced  delays from time to time in  completing
development and introduction of new products, and there can be no assurance that
the Company will not encounter such delays in the development  and  introduction
of future products. There can be no assurance that the Company will successfully
identify new product opportunities and develop or acquire and bring new products
to market in a timely manner,  that the Company's  products will be selected for
design  into  the  products  of its  targeted  customers  or  that  products  or
technologies  developed  by others  will not render the  Company's  products  or
technologies  obsolete  or  noncompetitive.  The  failure of the  Company's  new
product  development  efforts or market acceptance of such products would have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

   Research and development  expenses in 1995, 1996 and 1997 were  approximately
$6.6  million,  $11.8  million  and $15.1  million,  respectively.  Fiscal  1997
research and development  expenses includes $4.0 million of in-process  research
and development related to the Company's CompactSPEECH product line acquisition.
As of December 31, 1997,  the Company had 48  full-time  and contract  employees
engaged in research and development.

Backlog

   As of December 31,  1997,  the  Company's  total  backlog was $13.8  million,
compared to $6.8 million as of December 31, 1996. The Company's backlog consists
of customers' purchase orders that have been booked, acknowledged by the Company
and scheduled for shipment within six months.

  The  Company's   business  and,  to  a  large  extent,   that  of  the  entire
semiconductor  industry,  is  characterized  by  short-term  order and  shipment
schedules.  Since orders  constituting the Company's current backlog are subject
to  changes  in  delivery  schedules  or to  cancellation  at the  option of the
purchaser without significant penalty,  backlog is not necessarily an indication
of future revenue.  In addition,  there can be no assurance that current backlog
will necessarily lead to revenues in any future period. Cancellations of pending
purchase orders or termination or reduction of purchase orders in progress could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

<PAGE>

Patents and Licenses

   The  Company  relies on a  combination  of  patents,  mask  work  protection,
trademarks,  copyright  and trade secret laws,  confidentiality  procedures  and
licensing  arrangements to protect its intellectual property rights. The Company
seeks the issuance of patents to protect  inventions and technology that support
the Company's multilevel storage technology and various  architectural,  circuit
design and other  techniques.  The  Company  currently  has 19  patents  granted
(including  one  patent  that was  acquired),  22 patents  pending  and 2 patent
applications  in preparation  in the United States,  and intends to seek further
United  States  patents on its  technology.  The Company's  already  issued U.S.
patents  expire  between  July 2008 and May 2016.  The terms of the issued  U.S.
patents and any U.S.  patent  issued in the future are subject to the  Company's
making required  annuity  payments to the U.S. Patent and Trademark Office three
years and six  months,  seven  years and six  months,  and eleven  years and six
months after the  respective  issue dates of the  patents.  The Company has also
filed applications for 91 patents in Europe, Japan and elsewhere; has one patent
granted in each of Europe,  Singapore,  and Korea;  and intends to seek  further
foreign  patents.  Maintenance  of the foreign  applications  and  patents  also
depends upon the timely  payment of annuities in accordance  with the applicable
foreign   requirements.   The  Company   has  four   United   States  mask  work
registrations,  three in the approval  process and plans to apply for additional
such registrations as necessary. There can be no assurance that any patents held
by the Company will not be challenged and  invalidated,  that patents will issue
from any of the Company's  pending  applications or that any claims allowed from
existing or pending patents will be of sufficient scope or strength or be issued
in all countries where the Company's  products can be sold to provide meaningful
protection  or any  commercial  advantage  to the  Company.  Competitors  of the
Company also may be able to design  around the Company's  patents.  In addition,
parties might have or obtain patents or other exclusive  proprietary rights that
would  potentially  limit the number of  possible  customers  for the  Company's
products  for  certain  applications.  Any  such  limitations  in the  Company's
potential  markets  could  have a  material  adverse  effect  on  the  Company's
business,  financial condition and results of operations.  Finally,  the laws of
certain  foreign  countries  in  which  the  Company's  products  are  or may be
developed,  manufactured or sold,  including  various countries in Asia, may not
protect the Company's  intellectual property rights to the same extent as do the
laws of the  United  States  and thus  make the  possibility  of  piracy  of the
Company's products more likely.

   The Company owns five trademarks  registered in the United States;  has seven
additional  United  States  applications   pending;   and  has  eight  trademark
applications  pending in Israel.  The  Company  attempts  to protect its circuit
designs,  software,  trade secrets,  and other proprietary  information  through
copyright  protection,  agreements  with  customers and  suppliers,  proprietary
agreements  with employees and other security  measures.  While no  intellectual
property right of the Company has been  invalidated  or declared  unenforceable,
there can be no assurance that such rights will be upheld in the future.

   The  semiconductor  industry  is  characterized  by vigorous  protection  and
pursuit of  intellectual  property  rights or positions,  which have resulted in
significant and often protracted and expensive litigation. The only intellectual
property  litigation   currently  pending  against  the  Company  is  the  Atmel
litigation  described in "Legal Proceedings" below.  However, the Company or its
foundries may from time to time be notified of additional  claims that it may be
infringing  patents or other  intellectual  property rights owned by other third
parties.  If it is necessary or desirable,  the Company may seek licenses  under
such patents or intellectual property rights. However, there can be no assurance
that licenses will be offered or that the terms of any offered  licenses will be
acceptable  to the  Company.  The failure to obtain a license from a third party
for technology used by the Company could cause the Company to incur  substantial
liabilities and to suspend the manufacture or shipment of products or the use by
the Company's foundries of processes requiring the technology.  Furthermore, the
Company may initiate claims or litigation against third parties for infringement
of  the  Company's  proprietary  rights  or to  establish  the  validity  of the
Company's  proprietary  rights.  Litigation,  either as plaintiff or  defendant,
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel,  whether or not such litigation is
determined  in favor of the  Company.  In the event of an adverse  result in any
such litigation, the Company could be required to pay substantial damages, cease
the  manufacture,  use  and  sale of  infringing  products,  expend  significant
resources to develop or acquire non-infringing  technology,  discontinue the use
of certain processes or obtain licenses to the infringing technology.  There can
be no assurance  that the Company  would be successful  in such  development  or
acquisition or that such licenses would be available under reasonable terms, and
any such development,  acquisition or license could require  expenditures by the
Company of substantial time and other resources.

<PAGE>

Competition

   The  markets  in  which  the  Company  competes  are  characterized  by rapid
technological change, declining average selling prices and product obsolescence.
Although the Company  believes that it currently faces no direct  competition in
direct analog storage, a variety of digital approaches, including DSP and ADPCM,
compete with certain of the Company's products for certain  applications.  These
digital   approaches   include   products   from   Oki   Semiconductor,   United
Microelectronics Corporation, Toshiba Semiconductor, NEC Technologies, Inc., DSP
Group, Inc. and Winbond Electronics Corporation. Many of the Company's customers
may be purchasing products from both the Company and the Company's  competitors.
The  Company  expects  competition  to  increase  in the  future  from  existing
competitors  and from other  companies that may enter the Company's  existing or
future  markets  with  similar  or  substitute   voice  recording  and  playback
solutions,  such as voice  mail  services,  that may be less  costly or  provide
additional features.  The Company's  competitors include many large domestic and
international  companies that have substantially  greater financial,  technical,
marketing  and  other  resources,  broader  product  lines and  longer  standing
relationships  with customers than the Company,  as well as emerging  companies.
The Company believes that the principal  competitive  factors are product price,
quality,  performance and  availability.  The Company  believes that it competes
favorably with respect to these factors in the Company's  targeted markets.  The
Company  believes that its competitive  strengths  include the cost advantage of
its single-chip solution and the features and benefits of ChipCorder devices.

   The Company believes that its ability to compete successfully in its targeted
markets depends on a number of factors,  which include success in developing new
products, adequate foundry capacity and sources of raw materials,  efficiency of
production,  timing of new product  introductions by the Company,  its customers
and its  competitors,  the rate at which  the  Company's  customers  design  the
Company's  products into their products,  the number and nature of the Company's
competitors in a given market,  assertion of  intellectual  property  rights and
general market and economic  conditions.  Although the Company  believes that it
competes favorably on the basis of product cost and performance, there can be no
assurance that the Company will be able to compete successfully in the future.

Employees

   As of December 31, 1997,  the Company had 173  full-time,  1 part-time and 18
contract/temporary employees. This included 79 employees in manufacturing, 33 in
finance and  administration,  32 in sales and marketing,  and 48 in research and
development.  The Company's  employees are not  represented by a labor union and
are not covered by any collective  bargaining  agreement.  The Company has never
experienced a work stoppage and believes its employee relations are good.

   The  Company's  success  depends to a  significant  degree upon the continued
contributions  of members of its senior  management  and other key  research and
development,  sales,  marketing and operations personnel.  The Company does have
employment  agreements  with certain  executive  officers  and key  personnel as
described  in Item 13.  However,  the loss of any of such  persons  could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.  The Company believes that its future success will depend
in large part upon its ability to attract and retain highly skilled  managerial,
engineering,  sales and marketing  personnel.  Competition for such personnel is
intense,  and there can be no assurance  that the Company will be  successful in
attracting  and retaining  such  personnel.  The loss of any key  employee,  the
failure of any key  employee  to perform in his or her  current  position or the
Company's  inability to attract and retain new qualified  employees could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

<PAGE>

Item 2.    PROPERTIES

   The Company's  principal  facilities  consist of approximately  40,000 square
feet of space  located in  adjacent  buildings  in a business  park in San Jose,
California.  This  space is leased  pursuant  to an  agreement  that  expires in
December 1999. The Company also maintains  domestic sales offices in Mendon, New
York and Austin,  Texas. The Company leases  approximately  3,500 square feet of
space in an office  building in Herzelia,  Israel for its Israeli design center.
The Company  believes  that its current  space will be adequate for at least the
next 12 months.

Item 3.    LEGAL PROCEEDINGS

   In January 1995, Atmel notified the Company and Samsung of certain claims and
demanded that the Company and Samsung  either  negotiate  licenses with Atmel or
cease  manufacturing the Company's products at Samsung.  The Company received an
opinion from its patent counsel,  Blakely,  Sokoloff,  Taylor & Zafman, that the
Company does not violate any of the patents  identified in Atmel's notice to the
Company,  and the Company  believes  the patent  claims are without  merit.  The
Company  also  believes  that the other  claims in the  notice  from  Atmel were
without merit,  and its general  counsel,  on January 14, 1995,  after reviewing
with appropriate  senior and knowledgeable  personnel at the Company the factual
information  surrounding the other claims,  provided a written response to Atmel
that these claims were without  merit.  Atmel filed a complaint on June 15, 1995
in the United  States  District  Court for the Northern  District of  California
which  alleges  causes of action  against the  Company for patent  infringement,
trade secret  misappropriation,  breach of written contract,  breach of contract
implied-in-fact, unjust enrichment and declaratory relief. Atmel, in addition to
damages and  injunctive  relief,  is seeking a  declaration  from the Court that
Atmel is a co-owner  of the  Company's  ChipCorder  products.  All the causes of
action  alleged in the  complaint  appear to be based on the same  circumstances
alleged in the January  1995 Atmel  notice.  The Company  believes the causes of
action in the complaint to be without merit and has had its general counsel file
an answer denying any wrongful  conduct and asserting  counterclaims  for damage
caused the Company by Atmel's termination of the fabrication arrangement between
the  parties.  The Court has  bifurcated  the issues  related to  liability  and
damages,  and the  parties  are in the  process of  conducting  final  discovery
relating to the  liability  issues.  On February  27,  1998,  the Court issued a
decision regarding the patent claims. The Company believes that this decision is
at least in part  favorable to the  Company.  While the Company does not believe
the  ultimate  resolution  of this  matter  will have a  material  impact on its
business or financial  position,  it may have a material  adverse  impact on the
results of operations in the period in which it is resolved.

Item 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

  Not Applicable.

Item 4A.   EXECUTIVE OFFICERS OF THE REGISTRANT

  The  following  table  lists  certain  information   regarding  the  Company's
executive officers as of December 31, 1997.
<TABLE>
<CAPTION>
<S>                   <C>  <C>            <C>

Name                   Age                  Position
----                   ---                  --------

David L. Angel          56   Chairman of the Board and Chief Executive Officer
Eric J. Ochiltree       50   Director, President and Chief Operating Officer
Karin L. Bootsma        33   Vice President, Marketing
James Brennan           55   Vice President, Technology and Advanced Development
Michael Geilhufe        54   Vice President, Business Development
P. Ross Hayden          53   Vice President, Sales
Carl R. Palmer          46   Vice President, Engineering
Felix J. Rosengarten    63   Vice President, Finance and Administration and Chief Financial
                             Officer, Assistant Secretary of the Board
Alfred R. Woodhull      58   Vice President, Manufacturing
-----------
</TABLE>
<PAGE>

  Mr. Angel has served as Chairman  of the  Board,  Chief Executive  Officer and
a director of the Company since November 1996. Mr. Angel served as President,
Chief Executive Officer and a director of the Company since he joined the
Company in February 1991.  From  January  1989 to  January  1991,  he was Group
Vice President of the Semiconductor Group of Dataquest, Inc., a market research
company. He holds a B.Sc. degree from Marietta College.

  Mr.   Ochiltree   joined  the  Company  as  President  and  Chief
Operating  Officer in November  1996.  From August 1995 to November
1996, he was Vice President,  Products Group, of Exar  Corporation,
a  semiconductor  company.  From  August  1991 to August  1995,  he
served  as Vice  President  of Analog  Devices,  Inc.  and  General
Manager of Analog's  Santa Clara site.  He holds a B.S.E.E.  degree
from  Georgia  Institute  of  Technology,  an M.S.E.E.  degree from
Arizona   State   University,   and  an  M.B.A.   degree  from  the
University of Santa Clara.

  Ms.  Bootsma  joined  the  Company  in  April  1993 as  Marketing
Manager.   She  became  Director  of  Marketing  in  January  1994,
Managing  Director  of  Marketing  in  November  1996,  and she was
appointed  Vice  President of  Marketing  in March 1997.  From July
1990  to  April  1993,  she was a  Product  Marketing  Manager  for
Cirrus Logic.  She holds a B.S.M.E.  degree from the  University of
the  Pacific  and an M.B.A.  degree  from the  University  of Santa
Clara.

  Mr.  Brennan  joined  the  Company  in  June  1995  as  principal
engineer  and  was  appointed   Vice   President,   Technology  and
Advanced  Development  in March  1996.  From  1989  until he joined
the  Company Mr.  Brennan  held a similar  position  at Intel.  Mr.
Brennan  has  a  B.S.E.E.   degree  from  Duke  University  and  an
M.S.E.E. degree from the University of Houston.

  Mr.  Geilhufe  co-founded  the Company in December  1987.  He has
served  as Vice  President,  Business  Development  since  February
1997 and Vice President,  Quality and Reliability  from May 1993 to
February  1997.  From  June  1989 to May  1993,  he  served as Vice
President,  Manufacturing  of the Company.  Mr. Geilhufe was also a
director of the Company from  December  1987 to May 1990.  He holds
a B.S.E.E.  degree from the  University  of California at Berkeley,
an M.S.E.E.  degree from California  State University at Long Beach
and an M.B.A. degree from the University of Santa Clara.

  Mr.  Hayden  joined the Company in  December  1993 as Director of
North  American  Sales.  He became  Director of World Wide Sales in
August 1996 and was appointed  Vice  President of Sales in February
1997.  From  April  1993  to  December  1993,  he was  Director  of
World  Wide  Sales  for  Austek   Microsystems,   a   semiconductor
company.   He  holds  B.S.E.E.   and  M.S.E.E.   degrees  from  the
University of Louisville.

  Mr. Palmer  joined the Company in November  1995 as Director,  IC
Design  Center,  and was appointed Vice  President,  Engineering in
March  1996.  From 1983 until he joined  the  Company,  Mr.  Palmer
held  various   engineering   management   positions  at  SuperFlow
Corporation,   a  manufacturer   of  computer   automated   engine,
vehicle,  and emissions test equipment,  the most recent being Vice
President,  Engineering.  He holds  B.S.E.E.  and M.S.E.E.  degrees
from  University  of Florida and an M.B.A.  from the  University of
Colorado.

  Mr.  Rosengarten  joined the Company as Acting Vice  President of
Finance and  Administration  in March 1991. He was appointed  Chief
Financial  Officer of the Company in May 1991 and was elected  Vice
President,  Finance and  Administration and Chief Financial Officer
in  July  1991.  From  May  1989  to  December  1990,  he was  Vice
President  and  General  Manager  of the West Coast  operations  of
Drytek, Inc., a semiconductor  processing  equipment  manufacturer.
Mr.  Rosengarten has a B.S. Chem.E.  degree from Cornell University
and an M.B.A. degree from Villanova University.

  Mr. Woodhull has served as Vice President,  Manufacturing  since he joined the
Company in April 1994.  From November 1989 to April 1994, he was Vice President,
Operations, of Avasem, a semiconductor company, and of Avasem/ICS after Avasem's
acquisition  by  Integrated  Circuit  Systems,  Inc.  He was  also  founder  and
President of Advanced World Products,  a company providing  duplication services
and equipment  repair,  from October 1989 to December 1992. From January 1987 to
November 1989, Mr.  Woodhull was Vice President and General  Manager of National
Computer  Consulting,  Inc., a distributor of computer  supplies.  Mr.  Woodhull
completed undergraduate studies through Lafayette College.

<PAGE>


                              PART II

Item 5.    MARKET  FOR  REGISTRANT'S   COMMON  EQUITY  AND  RELATED
           SHAREHOLDER MATTERS.

  The Company's  common stock (Nasdaq symbol  "ISDI") began trading  publicly on
the Nasdaq National Market on February 9, 1995. Prior to that date, there was no
public market for the Company's  common stock.  The following table presents for
the period  indicated the intraday high and low sale prices for the common stock
as reported by the Nasdaq National Market.

  As of December 31, 1997, there were  approximately  2,140 beneficial owners of
the  Company's  common  stock.  The Company has not paid cash  dividends  on its
common stock and presently  intends to follow a policy of retaining any earnings
for reinvestment in its business. <TABLE> <CAPTION> <S> <C> <C>

1997                                           High            Low
------------------------------------------------------------------

First Quarter                                  $ 9.125      $6.313
Second Quarter                                 $ 7.500      $6.125
Third Quarter                                  $12.875      $6.750
Fourth Quarter                                 $11.375      $4.813

</TABLE>

<TABLE>
<CAPTION>
<S>                                          <C>           <C>


1996                                           High            Low
------------------------------------------------------------------

First Quarter                                  $12.875      $7.500
Second Quarter                                 $12.375      $8.000
Third Quarter                                  $ 9.875      $6.375
Fourth Quarter                                 $ 7.625      $5.875

</TABLE>


Item 6.    SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
<S>                                                      <C>        <C>        <C>        <C>      <C>

Years Ended December 31,                                1993       1994        1995      1996      1997
(Amounts in thousands, except per share amounts)

Statement of Operations Data:
Net revenues                                         $22,485    $38,805    $ 55,467   $41,339   $47,950
Net income (loss)                                         21      4,021       5,812   (8,971)  (13,528)
Net income (loss) per share:
     Basic                                              0.00       3.51        0.70    (0.92)    (1.40)
     Diluted                                            0.00       0.67        0.64    (0.92)    (1.40)
Shares used in per share computation:
     Basic                                             5,300      1,145       8,303     9,788     9,652
     Diluted                                           5,300      6,045       9,084     9,788     9,652
Balance Sheet Data:
Cash, cash equivalents and short-term investments    $ 5,789    $ 7,605    $ 75,094   $55,544   $39,808
Working capital                                        6,789      9,735      79,279    65,102    44,354
Total assets                                          13,691     22,268     105,430    78,865    71,037
Long-term liabilities                                    388      1,775       2,958     1,986       994
Total shareholders' equity                             8,094     12,220      87,453    70,301    58,005

</TABLE>


QUARTERLY RESULTS OF OPERATIONS

  The following  table sets forth unaudited  quarterly  statements of operations
for each of the Company's  last eight  quarters.  These  statements  reflect all
adjustments,  consisting only of normal recurring adjustments,  that are, in the
opinion of  management,  necessary  for a fair  presentation  of the  results of
operations for such interim  periods,  when read in conjunction with the audited
financial  statements of the Company and notes thereto.  These quarterly results
are not necessarily indicative of future results of operations.

<PAGE>



<TABLE>
<CAPTION> 
<S>                                   <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
                                                                       Quarters Ended
(Amounts in thousands,                 -----------------------------------------------------------------------------
except  per share  amounts)            Mar 30,   Jun 28,   Sep 28,   Dec 31,   Mar 29,   Jun 28,    Sep27,   Dec 31,
                                         1996      1996      1996      1996      1997      1997      1997      1997
                                         ----      ----      ----      ----      ----      ----      ----      ----

Net revenues......................    $12,335   $11,183   $ 8,153   $ 9,668   $ 8,342   $11,387   $13,813   $14,408
Gross margin......................      2,907     4,029      (66)     2,195     2,689     4,153     4,965     3,205
Income (loss) from operations.....    (3,822)     (258)   (5,348)   (3,499)   (6,033)   (1,415)   (1,252)   (7,153)
Net income (loss).................    (1,977)       191   (5,743)   (1,442)   (5,399)     (910)     (701)   (6,518)
Net income (loss) per share:
     Basic:.......................    $(0.19)   $  0.02   $(0.60)   $(0.15)   $(0.56)   $(0.09)   $(0.07)   $(0.67)
     Diluted:.....................     (0.19)      0.02    (0.60)    (0.15)    (0.56)    (0.09)    (0.07)    (0.67)
Shares used in per share computation:
     Basic:......................      10,235     9,702     9,661     9,552     9,615     9,609     9,654     9,743
     Diluted:....................      10,235     9,886     9,661     9,552     9,615     9,609     9,654     9,743

</TABLE>


Item 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATION.

  This Management's  Discussion and Analysis of Financial  Condition and Results
of Operations  contains  forward-looking  statements  that reflect the Company's
current  views with respect to future  matters such as gross  margins,  spending
levels, international operations, gross profit and capital needs. Actual results
may  differ   materially  from  the  results  and  outcomes   discussed  in  the
forward-looking  statements.  Factors  that could  cause or  contribute  to such
differences in results and outcomes  include without  limitation those discussed
below as well as those discussed elsewhere in this Report.

RESULTS OF OPERATIONS

Net Revenues

  The  Company  had net  revenues  of $47.9  million in 1997  compared  to $41.3
million for 1996,  an increase of 16%. Net revenues in 1996  decreased  25% from
$55.5  million for 1995.  The  increase in net  revenues  for 1997  reflects the
acceptance of the Company's products into the growing  communications market and
additional  net  revenues  as  a  result  of  the  CompactSPEECH   product  line
acquisition  in  March  1997.  The  decrease  in net  revenue  in 1996  reflects
unexpected softness in the consumer market for the Company's products throughout
1996 compared to the strong  demand  experienced  in the consumer  market during
1995.  Net  revenues in the  communications  market grew to about $38 million in
1997 compared to about $30 million in 1996 and $28 million in 1995. Net revenues
in the consumer  market  accounted  for about $6 million of net revenues in 1997
compared to about $9 million in 1996 and $25 million in 1995.  The growth in net
revenues for 1997 encompasses increased shipment volume of ChipCorder product as
well as the advent of the CompactSPEECH  product line shipments.  In 1997, as in
1996,  product  volume  continued to increase in the  communications  market but
decreased  significantly in the consumer market.  In 1995, net revenue reflected
increased  volume  of  ChipCorder  products  sold in both the  consumer  and the
communication markets.

  Sales by market segment for 1997 were 79% communications,  12% consumer and 9%
industrial  compared to 72%  communications,  21% consumer and 7% industrial for
1996 and 50%  communications,  45%  consumer  and 5%  industrial  for 1995.  The
Company's  communications customers in 1997 continued representing such products
as telephone  answering  machines,  cellular  phones,  personal handy phones and
pagers.  Products for consumer customers in 1997 consisted primarily of personal
memory recorders, cameras, photo frames, books, educational toys and novelties.

  Sales to the Company's top ten customers  accounted for 76% of net revenues in
1997  compared to 85% in 1996 and 66% in 1995.  The top five  customers  in 1997
were  Marubun  (the  Company's  Japanese  distributor),   Motorola,  Matsushita,
Philips,  and NuHorizons (the Company's United States  distributor),  accounting
for 19%,  17%,  13%,  11%,  and 7% of net  revenues,  respectively.  The Company
expects  that  sales of its  products  to a  limited  number of  customers  will
continue  to  account  for  a  substantial  portion  of  its  revenues  for  the
foreseeable future. The Company has also experienced changes in the composition

<PAGE>

of its customer base from year to year and expects this pattern to continue. The
loss of, or significant reduction in purchases by, current major customers, such
as Motorola,  would have a material  adverse  effect on the Company's  business,
financial condition and results of operations. The Company's customers typically
do not contract for minimum purchase quantities.  There can be no assurance that
the Company  will be able to  continue  to obtain the orders from new  customers
necessary to offset any losses of or  reductions  in purchases by the  Company's
current major customers.

  Export sales for 1997 were 79% of the Company's  net revenues  compared to 65%
in 1996 and  1995.  Geographically,  sales  to  Europe  increased  to 37% of the
Company's  net revenues in 1997 from 11% in 1996 and 7% in 1995;  sales to South
East Asia were 23% of the Company's net revenues in 1997 compared to 22% in 1996
and 35% in 1995. Japan accounted for 19% of total net revenues in 1997 down from
31% a year  earlier  and 27% in  1995.  North  American  sales  were  21% of the
Company's  net revenues in 1997,  35% in 1996,  and 35% in 1995.  The Company is
subject to the risk of conducting  business  internationally,  including foreign
government  regulation  and general  geopolitical  risks,  such as political and
economic  instability,  potential  hostilities,  changes in diplomatic and trade
relationships,  unexpected  changes  in,  or  imposition  of,  U.S.  or  foreign
regulatory  requirements,  tariffs,  import  and export  restrictions  and other
barriers and restrictions,  potentially adverse tax consequences, the burdens of
complying  with a variety of foreign laws and other factors beyond the Company's
control.  As is common in the semiconductor  industry,  certain of the Company's
sales are made to  distributors  under  agreements  allowing  certain  rights of
return and price protection on unsold products.  Accordingly, the Company defers
recognition of such sales until the distributor sells the product.

Gross Margin

  Gross  margin  increased  to 31% in 1997  compared to 22% in 1996 but remained
less than the 39%  achieved  in 1995.  The  increase  in 1997 was  caused by the
higher margins generated from the ISD33000 and the CompactSPEECH  products, both
of which are  manufactured in the smaller  geometry 0.8 micron  process.  In the
fourth quarter of 1997, one of the Company's  international  customers went into
receivership  and  inventory,  specific to this  customer,  was written  off. In
addition,  competitive  and market  pressures on selling  prices for some of the
Company's  older  product  lines  required  inventory  reserves  that  were also
recorded on the fourth quarter of 1997. The higher gross margin realized in 1995
came as a result of reduced  manufacturing  costs,  yield  improvements  and the
conversion  to smaller (1.2 micron from 1.5 micron)  geometry  processes for the
majority of products  shipped  during 1995.  The Company  expects to continue to
experience declines in its average selling prices,  which could adversely affect
gross margins, particularly if higher yields and reduced costs are not achieved.
Additionally,  the Company expects that it could experience  variations in gross
margins as a result of shifts in product and customer mix.

Research and Development

   Research and  development  (R&D) expenses  increased to $15.1 million in 1997
compared to $11.8 million in 1996 and $6.6 million in 1995. R&D  expenditures as
a percent of net revenues were 31.5% in 1997 compared to 28.6% in 1996 and 11.8%
in 1995.  This  increase  in R&D  expenses  both in  absolute  dollars  and as a
percentage of total revenues relates to continued  investment in the development
of new products and to costs  associated with bringing up new  technologies  and
new foundries; specifically this includes $4 million of R & D expense associated
with the acquisition of the  CompactSPEECH  product line,  explained  below. The
Company  expects  research  and  development  expenses  to  increase in absolute
dollars.

  On March 28, 1997, the Company  acquired the  CompactSPEECH  speech  processor
line from National Semiconductor for a total purchase price of $5.1 million. The
acquisition was accounted for using the purchase method of accounting. A portion
of the purchase price was allocated to assets  acquired based on their estimated
fair  value,  approximately  $0.1  million.  In  addition,  $4.0  million of the
purchase  price was allocated to in-process  research and  development  projects
that had not reached  technological  feasibility and had no probable alternative
future  uses,  which the Company  expensed at the date of the  acquisition  as a
one-time  non-recurring  charge.  The  remainder  of the  purchase  price,  $1.0
million,  was  allocated to goodwill and will be amortized  over five years on a
straight-line basis. See Note 3 of Notes to the Financial Statements.

<PAGE>

  The in-process research and development projects for the CompactSPEECH product
line relate  primarily to  developing  significant  enhancements  to the current
product  offering as well as introducing  advanced new products.  The incomplete
projects include caller I.D. Type II, the integration of all telephone answering
functions,  and the ability to interface with additional flash memory. Given the
uniqueness of the tasks and the technologies  involved,  alternative future uses
for these projects,  apart from the objectives and economies of the projects for
which they are intended, do not exist.

  The Company  believes  that the efforts to complete  the  acquired  in-process
research and development projects will consist of internally staffed engineering
costs  over  the  next  one  to two  years.  These  costs  are  estimated  to be
approximately  $3.0 million to complete the research and development.  There can
be no  assurance  that the Company will  succeed in making  commercially  viable
products from the CompactSPEECH product line.

   There can be no assurance that new products will be successfully developed or
will achieve  market  acceptance.  The success of new product  introductions  is
dependent on several  factors,  including  recognition  of market  requirements,
product cost,  timely  completion or acquisition and introduction of new product
designs,  quality of new products and  achievement  of acceptable  manufacturing
yields from the  Company's  subcontractor  manufacturers.  Because of the design
complexity of its products, the Company has experienced delays from time to time
in completing  development and introduction of new products, and there can be no
assurance that the Company will not encounter such delays in the development and
introduction  of future  products.  The  failure of the  Company's  new  product
development  efforts or market acceptance of such products would have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.

Selling, General and Administrative

  Selling,  general,  and  administrative  expenses (SG&A)  increased in 1997 to
$15.7 million from $10.2 million in 1996 and $8.7 million in 1995. SG&A expenses
as a percent of net revenues grew to 32.8% in 1997 compared to 24.6% in 1996 and
15.6% in 1995.  The growth in SG&A  expenses  in 1997 came from the  addition of
staff  in  marketing  and  sales  as well as  increased  marketing  investments,
including the cost of advertising,  participation in trade shows, several direct
mailers, and additional sales collateral. Further, S G & A expenses increased as
a result of  approximately  $2.9  million in  one-time  charges  recorded in the
fourth quarter of 1997. These one-time charges relate to a $1.4 million addition
to  bad  debt  reserves  as a  result  of  an  international  customer  entering
receivership  in the  fourth  quarter of 1997.  Additional  costs have also been
incurred related to the new information system implementation. Certain long term
investments were written down, also, in the fourth quarter of 1997, resulting in
a $0.8 million charge.  The growth in SG&A expenses in 1996 came from additional
legal,  accounting and insurance  expense incurred in the first year as a public
company, legal expenses incurred in connection with the Atmel litigation matter,
and increased commission expense corresponding to increased revenue. The Company
anticipates that SG&A expenses will continue to increase in total expenses.

Other Income (Expense)

  Net  interest  and other  income was $2.3  million  for 1997  compared to $2.4
million for 1996 and $1.8 million in 1995. The interest  income in 1997 and 1996
relates to investment  earnings on funds raised from the initial public offering
in February 1995 and the follow-on offering in September 1995.

Provision for Income Taxes

  As a result  of the  Company's  net loss in 1997 and the full  utilization  of
carryback  losses in 1996,  the  Company  recorded no  provision  or benefit for
income  taxes.  In 1996,  the Company  recorded a tax  benefit of $1.5  million,
reflecting the carryback of 1996 losses to prior years. The Company's  effective
tax rate was 29% for 1995 and reflects the  utilization of federal and state net
operating loss ("NOL") and tax credit carryforwards.

  At  December  31,  1997,  the Company had  established  a valuation  allowance
against  its  total  gross  deferred  tax  asset of  $8,863,000.  The  valuation
allowance was established due to the Company's limited history of profitability,
limitations on the utilization of NOL carryforwards, which are restricted in use
under  the  Internal  Revenue  Code of 1986  (see  Note 8 of Notes to  Financial
Statements) and  uncertainties  regarding future operations due to the increased
competition within the Company's industry.

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

  In February  1995,  the Company  received  net proceeds of  approximately  $23
million in its initial  public  offering  and, in  September  1995,  the Company
received net proceeds of approximately  $44 million in a follow-on public common
stock  offering.  The Company has a line of credit with a commercial  bank under
which the  Company may borrow up to $15 million  based on eligible  assets;  the
term of the credit line runs through June 30,  1998.  At December 31, 1997,  the
Company had no borrowings  outstanding under this line of credit, but the credit
line is being  used to  guarantee  certain  letters of credit  generated  by the
Company.  The line of credit  does not  restrict  the  Company  from paying cash
dividends on its capital stock and the only financial  covenant is to maintain a
minimum of pledged  investments  of $17.7  million  in the  Company's  Liquidity
Management  account with the bank.  The Company is currently in compliance  with
this financial covenant under the line of credit agreement.

  The Company's operating activities used net cash of $6.3 million in 1997; used
net cash of $11.2 million in 1996; and provided $4.6 million 1995. Net cash used
for  operations  in 1997 and 1996 was  primarily the result of the Company's net
loss for both years.  In 1995 the cash provided by operations  was primarily the
result of the  Company's net income in 1995.  Cash used by investing  activities
was $5.4 million in 1997  compared to $14.2  million  provided in 1996 and $51.2
million used in 1995.  From 1995 through 1997,  investing  activities  consisted
principally of the purchase and maturity of investments. Cash used for financing
activities  was  $0.2  million  in 1997 and  $10.3  million  in 1996.  Financing
activities in 1996 primarily  consisted of the repurchase of common stock.  Cash
provided by financing  activities was $68.3 million in 1995, primarily resulting
from the sale of common and preferred stock.

  At December 31, 1997, the Company had cash, cash  equivalents,  and short-term
investments of $39.8 million and working  capital of $44.4 million.  The Company
believes its existing cash, cash equivalents, and short-term investments and its
available  line of credit and current  equipment  lease  lines will  satisfy the
Company's projected working capital and capital expenditure  requirements for at
least the next 12 months.  From time to time, the Company has evaluated and will
continue to evaluate possible business acquisitions.

OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

  This section on "Other  Factors That May Affect  Operating  Results"  includes
forward-looking statements that reflect the Company's current views with respect
to future  matters  such as  factors  that can affect  the  Company's  operating
results, foundry capacity, litigation, manufacturing yields, the markets for the
Company's  products and protection of intellectual  property.  This section also
contains  cautionary  statements  that  identify  important  factors,  including
certain risks and uncertainties,  that could cause actual results or outcomes to
differ materially from those in the  forward-looking  statements in this section
and elsewhere in this Report.

  All of the Company's products are manufactured by four independent  foundries.
The  Company's  primary  supplier  is Samsung in Korea,  which  supplied  wafers
comprising  about 78% of the Company's 1997 net revenues.  Approximately  20% of
the  Company's  1997 net revenues  was  supplied by wafers  produced at Tower in
Israel.  Rohm in Japan  accounted for about 1% of 1997 net revenues as did Sanyo
in Japan.  The Company  depends on these  foundries to allocate to the Company a
portion of their foundry  capacity  sufficient to meet the Company's  needs,  to
produce products of acceptable quality with acceptable  manufacturing yields and
to deliver  products  to the  Company on time.  On  occasion,  the  Company  has
experienced  difficulties  in each of these areas,  and the Company is likely to
experience such  difficulties in the future.  There can be no assurance that the
Company will  receive its desired  allocation  of product at these  foundries or
that additional  needed foundry capacity will be qualified.  The loss of Samsung
or Tower as a  supplier,  the  inability  of the  Company or Samsung to obtain a
license from Atmel should that become necessary, the inability of the Company to
maintain or expand  foundry  capacity  from its current  suppliers or to qualify
other wafer manufacturers so the Company can obtain additional foundry capacity,
any  inability  to obtain  timely and  adequate  deliveries  from the  Company's
current or future  suppliers or any other  circumstance  that would  require the
Company to seek  alternative  sources of supply  could  constrain,  interrupt or
delay shipments of the Company's  products and have a material adverse effect on
the Company's  business and results of  operations.  The  Company's  reliance on
third party manufacturers also involves a number of additional risks,  including
but not limited to reduced control over delivery  schedules,  quality  assurance
and costs.

<PAGE>

  The semiconductor industry is characterized by vigorous protection and pursuit
of intellectual property rights or positions, which have resulted in significant
and often protracted and expensive  litigation.  On June 15, 1995, Atmel filed a
complaint  in the United  States  District  Court for the  Northern  District of
California  which  alleges  causes of action  against  the  Company  for  patent
infringement, trade secret misappropriation,  breach of written contract, breach
of contract implied-in-fact, unjust enrichment and declaratory relief. Atmel, in
addition to damages and  injunctive  relief,  is seeking a declaration  from the
Court that Atmel is a co-owner of the Company's ChipCorder products. The Company
believes the causes of action in the  complaint to be without  merit and has had
its general  counsel file an answer  denying any wrongful  conduct and asserting
counterclaims  for damage  caused the  Company  by  Atmel's  termination  of the
fabrication arrangement between the parties. The Court has bifurcated the issues
related  to  liability  and  damages,  and the  parties  are in the  process  of
conducting  final discovery  relating to the liability  issues.  On February 27,
1998,  the Court issued a decision  construing  the patent  claims.  The Company
believes that this decision is at least in part favorable to the Company.  While
the Company does not believe the ultimate  resolution of this matter will have a
material  impact on its business or financial  position,  it may have a material
adverse  impact  on the  results  of  operations  in the  period  in which it is
resolved. See Item 3.

  The  fabrication  of  integrated  circuits  is a highly  complex  and  precise
process,  requiring production in a highly controlled,  clean environment.  As a
result,  the Company has experienced  problems in achieving an acceptable  wafer
manufacturing  yield  (the  number  of  good  die per  wafer).  The  Company  is
particularly  susceptible to yield problems  because it is not in direct control
of the  independent  offshore  foundries that  manufacture  its products,  which
increases  the effort and time  required to  identify,  communicate  and resolve
manufacturing   yield  problems.   In  addition,   in  order  to  reduce  future
manufacturing costs and remain competitive, the Company is continually designing
smaller die sizes with smaller geometry  processes to increase the number of die
produced on each wafer.  Problems  with  future  transitions  of this type could
cause disruptions in the manufacturing flow and reduce manufacturing yields. The
inability of the Company to achieve improved yields could prevent revenue growth
from  existing  capacity  and could delay margin  improvements.  There can be no
assurance  that the  Company's  foundries  will  achieve or maintain  acceptable
manufacturing  yields in the future or that  sudden  declines in yields will not
again occur.  Failures to improve,  or fluctuations  in,  manufacturing  yields,
particularly at times when the Company is experiencing  severe pricing pressures
from its customers or its  competitors,  would have a material adverse effect on
the Company's business and results of operations.

  The Company's success depends to a significant  extent upon the development of
new  applications  for  voice  recording  and  playback  in the  communications,
consumer  and  industrial  markets.  In  addition,  product  life  cycles in the
communication  and consumer markets are typically short. As a result,  customers
must design the Company's products into their products as each new generation is
developed.  Furthermore,  the Company  expects  that it may sell many of its new
products,   including  products  with  longer  recording   durations  now  under
development,  to customers  that are  developing  new product  applications  and
markets. Accordingly, the success of the Company will depend upon the success of
its  customers in  developing  such  applications  and markets.  There can be no
assurance  that new  applications  or markets  will  develop as  expected by the
Company or that prospective  customers  developing products for any such markets
will  design  the  Company's  products  into  their  products  and  successfully
introduce such products.  The failure of new  applications or markets to develop
or the failure of new markets to be receptive to the  Company's  products  could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

  The willingness of prospective customers to design the Company's products into
their products  depends to a significant  extent upon the ability of the Company
to price its products at a level that is cost effective for such customers.  The
markets  for most of the  potential  applications  for the  Company's  products,
particularly   the  consumer   market,   are   characterized  by  intense  price
competition.  As the markets for the Company's  products develop and competition
increases,  the Company  anticipates  that its average  selling  prices on these
products will continue to decline, particularly as product technology matures

<PAGE>

and if per  order  unit  volumes  for such  products  increase.  These and other
downward  pressures on the  Company's  average  selling  prices will require the
Company to seek sales in emerging  markets where average  selling  prices may be
higher and to produce its  products at lower cost if it is to avoid  significant
degradation  in its gross  margins.  To the  extent  that the  Company  fails to
facilitate its  customers'  opening of new markets,  experiences  yield or other
production  problems or  shortages  in supply that  increase  its  manufacturing
costs,  or fails to reduce  its  manufacturing  costs,  it would have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.

The  Company  relies  on  a  combination  of  patents,   mask  work  protection,
trademarks,  copyright  and trade secret laws,  confidentiality  procedures  and
licensing arrangements to protect its intellectual property rights. There can be
no assurance  that any patents held by the Company  will not be  challenged  and
invalidated,  that  patents  will  issue  from  any  of  the  Company's  pending
applications or that any claims allowed from existing or pending patents will be
of  sufficient  scope or  strength  or be  issued  in all  countries  where  the
Company's  products  can  be  sold  to  provide  meaningful  protection  or  any
commercial advantage to the Company. Competitors of the Company also may be able
to design  around the  Company's  patents.  In addition,  parties  might have or
obtain  patents or other  exclusive  proprietary  rights that would  potentially
limit the number of possible  customers for the  Company's  products for certain
applications. Any such limitations in the Company's potential markets could have
a material  adverse effect on the Company's  business and results of operations.
Finally,  the laws of certain foreign countries in which the Company's  products
are or may be developed,  manufactured or sold,  including  various countries in
Asia,  may not protect the Company's  intellectual  property  rights to the same
extent as do the laws of the  United  States  and thus make the  possibility  of
piracy of the Company's products more likely.

  Potential  Fluctuations in Operating Results.  The Company's operating results
are subject to quarterly  and annual  fluctuations  due to a variety of factors,
including  availability of foundry  capacity and raw materials,  fluctuations in
manufacturing yields,  competitive pricing pressures,  the timing of significant
orders,  changes in shipment  schedules,  changes in the mix of  products  sold,
changes in the mix of  customers,  availability  and cost of  products  from the
Company's suppliers,  the timing of new product  announcements and introductions
by the Company and its  competitors,  the cyclical  nature of the  semiconductor
industry and certain markets  addressed by the Company's  products,  the gain or
loss of  significant  customers,  increased  research and  development  expenses
associated with new product introductions or enhancements,  market acceptance of
new or enhanced  versions of the  Company's  products,  changes in the  channels
through which the Company's  products are distributed,  and economic  conditions
generally  or in various  geographic  areas.  These  factors  are  difficult  to
forecast,  and  these or other  factors  can  materially  affect  the  Company's
quarterly or annual operating results. The Company's operating results will also
fluctuate  as a result of  seasonal  factors.  Demand for cell  phones and other
products that incorporate the Company's  products  generally is strongest in the
third and fourth  quarters of each year.  In  addition,  the Company  expects to
continue  to increase  its  operating  expenses  for  personnel  and new product
development.  If the  Company  does not  achieve  increased  levels of  revenues
commensurate  with these increased levels of operating  expenses,  the Company's
operating results will be materially adversely affected.

  For a discussion of other factors that may affect future operating  results,
see Item 1:  Business;  Marketing,  Sales  and Distribution;     Manufacturing;
Research    and    Development; Competition; and Employees.

  All of the above factors are difficult to forecast, and these or other factors
can materially affect the Company's  quarterly or annual operating  results.  No
assurance  can be given that the  Company  will be able to  achieve or  maintain
profitability  on a quarterly or annual  basis in the future.  Due to all of the
foregoing  factors,  it is possible  that in some future  quarter the  Company's
operating  results will be below the  expectations  of stock market analysts and
investors.  In such event,  the price of the Company's Common Stock would likely
be materially adversely affected.

Item 7A:  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK

  Not Applicable.

<PAGE>


  Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

                                                  BALANCE SHEETS
                                         (In thousands, except share amounts)


                                                ASSETS

<TABLE>
<CAPTION>
<S>                                                                     <C>            <C>
                                                                              December 31,
                                                                          --------------------
                                                                           1997          1996
                                                                           ----          ----

  Current assets:
    Cash and cash equivalents........................................    $10,102       $21,927
    Short-term investments...........................................     29,706        33,617
    Accounts receivable, net of allowance for doubtful
     accounts of $1,870 and $600, respectively.......................      6,577         3,203
    Inventories......................................................      7,742        10,059
    Prepaid expenses and other current assets........................      2,265         2,874
                                                                        --------      --------
            Total current assets.....................................     56,392        71,680
                                                                        --------      --------
  Property and equipment, at cost:
    Furniture, fixtures and leasehold improvements...................      1,107           796
    Equipment........................................................     14,287        11,063
                                                                        --------      --------
                                                                          15,394        11,859
    Less -- Accumulated depreciation.................................    (9,077)       (6,024)
                                                                        --------      --------
            Net property and equipment...............................      6,317         5,835
                                                                        --------      --------
  Other assets, net..................................................      2,146         1,200
  Long-term investments..............................................      6,182           150
                                                                        ========      ========
                                                                         $71,037       $78,865
                                                                        ========      ========


                                  LIABILITIES AND SHAREHOLDERS' EQUITY


  Current liabilities:
    Current portion of capitalized lease obligations.................     $1,591        $1,270
    Accounts payable.................................................      6,683         3,153
    Accrued liabilities..............................................      2,548           856
    Deferred revenue.................................................      1,216         1,299
                                                                        --------      --------
            Total current liabilities................................     12,038         6,578
                                                                        --------      --------
  Long-term liabilities:
    Capitalized lease obligations, net of current portion............        817         1,814
    Other long-term liabilities......................................        177           172
                                                                        --------      --------
            Total long-term liabilities..............................        994         1,986
                                                                        --------      --------
  Commitments and contingencies (Note 5)
  Shareholders' equity:
    Common stock, no par value-
       Authorized -- 22,000,000 shares
       Outstanding -- 9,771,526 and 9,564,875 shares respectively....     79,429        78,261
    Deferred compensation............................................      (254)         (332)
    Accumulated deficit..............................................   (21,186)       (7,658)
    Unrealized gain on investments...................................         16            30
                                                                        --------      --------
            Total shareholders' equity...............................     58,005        70,301
                                                                        --------      --------
                                                                         $71,037       $78,865
                                                                        ========      ========
</TABLE>



          The accompanying notes are an integral part of these balance sheets.



<PAGE>


                                              STATEMENTS OF OPERATIONS
                                       (In thousands, except per share amounts)
<TABLE>
<CAPTION>
<S>                                                                    <C>        <C>        <C>


                                                                             Years Ended December 31,
                                                                             ------------------------
                                                                            1997       1996       1995
                                                                            ----       ----       ----

  Net revenues....................................................       $47,950    $41,339    $55,467
  Cost of revenues................................................        32,939     32,274     33,836
                                                                       ---------   --------    -------
  Gross margin....................................................        15,011      9,065     21,631
                                                                       ---------   --------    -------
  Operating expenses:
    Research and development......................................        11,118     11,817      6,550
    In-process research and development (1).......................         4,000         --         --
    Sales, general and administrative.............................        15,748     10,175      8,668
                                                                       ---------   --------    -------
            Total operating expenses..............................        30,866     21,992     15,218
                                                                       ---------   --------    -------
  Income (loss) from operations...................................      (15,855)   (12,927)      6,413
                                                                       ---------   --------    -------
  Other income (expense):
    Interest expense..............................................         (341)      (473)      (536)
    Interest income...............................................         2,661      2,901      2,340
    Other, net....................................................             7       (14)        (2)
                                                                       ---------   --------    -------
            Total other income (expense), net.....................         2,327      2,414      1,802
                                                                       ---------   --------    -------
  Income (loss) before provision (benefit) for income taxes.......      (13,528)   (10,513)      8,215
 Provision (benefit) for income taxes.............................            --    (1,542)      2,403
                                                                       ---------   --------    -------
  Net income (loss)...............................................     ($13,528)    ($8,971)    $5,812
                                                                       =========   =========   =======
  Net income (loss) per share
   Basic..........................................................       $(1.40)     $(0.92)     $0.70
                                                                       =========   =========   =======
   Diluted........................................................       $(1.40)     $(0.92)     $0.64
                                                                       =========   =========   =======
  Shares used in computing per share amounts
   Basic..........................................................         9,652       9,788     8,303
                                                                       =========   =========   =======
   Diluted........................................................         9,652       9,788     9,084
                                                                       =========   =========   =======
</TABLE>

(1) - In-process  research and  development is as a result of the Compact Speech
      Acquisition.

                The accompanying notes are an integral part of these statements.



<PAGE>

<TABLE>
<CAPTION>
<S>                                  <C>           <C>      <C>           <C>     <C>        <C>        <C>           <C>

                                                              STATEMENTS OF SHAREHOLDERS' EQUITY
                                                             (In thousands, except share amounts)

                                           Convertible                             Deferred   Retained   Unrealized        Total
                                          Preferred Stock       Common Stock       Compen-    Earnings   Gain on       Shareholders'
                                        Shares       Amount   Shares       Amount   sation    (Deficit)  Investments       Equity
                                        ------       ------   ------       ------   ------    ---------  -----------       ------

Balance, December 31, 1994..........    13,773,826   16,354   1,237,837       525    (160)      (4,499)          --           12,220
  Preferred stock converted to
   common stock at a 3 to 1
   conversion rate upon
   initial public offering..........  (13,773,826) (16,354)   4,591,240    16,354       --           --          --               --
  Common stock issued for cash
   upon initial public offering
   and exercise of underwriters'
   over-allotment option, net
   of issuance costs................            --       --   1,725,944    23,086       --           --          --           23,086
  Common stock issued for cash
   upon exercise of stock warrants..            --       --     249,169       591       --           --          --              591
  Common stock issued under the
   employee stock purchase plan.....            --       --       5,895       108       --           --          --              108
  Common stock issued upon
   secondary public offering and
   exercise of underwriters' over-
   allotment option, net of
   issuance costs...................            --       --   2,407,781    45,190       --           --          --           45,190
  Sale of common stock pursuant to
   stock option exercises for cash..            --       --     206,604       402       --           --          --              402
  Amortization of deferred
   compensation related to
   stock option grants..............            --       --          --        --       44           --          --               44
  Net income........................            --       --          --        --       --        5,812          --            5,812
                                          --------    -----  ----------    ------    -----      -------       -----         --------
Balance, December 31, 1995..........            --       --  10,424,470    86,256    (116)        1,313          --           87,453
  Common stock issued under the
   employee stock purchase plan.....            --       --      43,212       369       --           --          --              369
  Common stock repurchased..........            --       -- (1,077,000)   (9,711)       --           --          --          (9,711)
  Sale of common stock pursuant to
   stock option exercises for cash..            --       --     174,193       144       --           --          --              144
  Deferred compensation related to
   stock option grants..............            --       --          --       452    (452)           --          --               --
  Amortization of deferred
   compensation related to
   stock option grants..............            --       --          --        --      236           --          --              236
  Tax benefit related to exercise
   of stock options.................            --       --          --       751       --           --          --              751
  Adjustment for unrealized holding
   gains on available-for-sale
   securities.......................            --       --          --        --       --           --          30               30
  Net loss..........................            --       --          --        --       --      (8,971)          --          (8,971)
                                          --------    -----   ---------    ------    -----      -------       -----         --------
Balance, December 31, 1996..........            --       --   9,564,875    78,261    (332)      (7,658)          30           70,301
  Common stock issued under the
   employee stock purchase plan.....            --       --      55,288       373       --           --          --              373
  Sale of common stock pursuant to
   stock option exercises for cash..            --       --     151,363       695       --           --          --              695
   Amortization of deferred
   compensation related to
   stock option grants..............            --       --          --        --       78           --          --               78
  Issuance of common stock
   warrants at fair value...........            --       --          --       100       --           --          --              100
  Adjustment for unrealized holding
   gains on available-for-sale
   securities.......................            --       --          --        --       --           --        (14)             (14)
  Net loss..........................            --       --          --        --       --     (13,528)          --         (13,528)
                                          ========    =====   =========   =======   ======    =========       =====        =========
Balance, December 31, 1997..........            --     $ --   9,771,526   $79,429   $(254)    $(21,186)        $ 16          $58,005
                                          ========    =====   =========   =======   ======    =========       =====        =========
</TABLE>


                The accompanying notes are an integral part of these statements.


<PAGE>


                                             STATEMENTS OF CASH FLOWS
                                                 (In thousands)

<TABLE>
<CAPTION>
<S>                                                    <C>              <C>                <C>

                                                                   Years Ended December 31,
                                                             ---------------------------------------
                                                             1997              1996             1995
                                                             ----              ----             ----

Cash flows from operating activities:
  Net income (loss)..................................   $ (13,528          $(8,971)          $ 5,812
  Adjustments to reconcile net income (loss)
   to net cash provided by (used for)
   operating activities --
   Depreciation and amortization.....................       3,403             2,537            1,971
   Amortization of investment discount...............          --                39            (600)
   Compensation costs related to stock and
    stock option grants..............................          79               235               44
   In-process research and development...............       4,000                --               --
   Provision for allowance for doubtful accounts.....       1,270               325              210
   Changes in assets and liabilities --
    Accounts receivable..............................     (4,644)             4,026          (2,053)
    Inventories......................................       2,316             (249)          (6,042)
    Prepaid expenses and other assets................         751           (1,079)          (1,521)
    Accounts payable.................................       3,530           (6,630)            4,732
    Accrued liabilities..............................       1,692             (705)              410
    Deferred revenue.................................        (83)             (535)            1,289
    Other long-term liabilities......................           5             (156)              307
                                                       ----------         ---------        ---------
       Net cash provided by (used for) operating
        activities...................................     (1,209)          (11,163)            4,559
                                                       ----------         ---------        ---------
Cash flows from investing activities:
  Purchase of property and equipment.................     (2,885)           (2,479)          (1,296)
  Patent costs ......................................       (338)             (174)             (95)
  Purchase of CompactSPEECH..........................     (5,100)                --               --
  Purchase of short and long term investments........    (55,033)          (71,233)         (75,749)
  Proceeds from maturities and sale of investments...      52,898            88,099           25,924
                                                       ----------         ---------        ---------
       Net cash provided by (used for) investing
        activities...................................    (10,458)            14,213         (51,216)
                                                       ----------         ---------        ---------
Cash flows from financing activities:
  Proceeds from sale of common stock, net of
   issuance costs....................................       1,168               514           69,377
  Repurchase of common stock.........................          --           (9,712)               --
  Payments on capitalized lease obligations..........     (1,326)           (1,127)          (1,123)
                                                       ----------         ---------        ---------
       Net cash provided by (used for) financing
        activities...................................       (158)          (10,325)           68,254
                                                       ----------         ---------        ---------
Net increase in cash and cash equivalents............    (11,825)           (7,275)           21,597
Cash and cash equivalents at beginning of year.......      21,927            29,202            7,605
                                                       ==========         =========        =========
Cash and cash equivalents at end of year.............     $10,102           $21,927          $29,202
                                                       ==========         =========        =========
Supplemental cash flow information:
  Cash paid for interest.............................        $341              $472             $536
                                                        =========         =========       ==========
  Cash paid for income taxes.........................      $   --           $    --           $3,203
                                                        =========         =========       ==========
  Property and equipment acquired under capital
   leases............................................        $650              $491           $2,314
                                                       ==========         =========        =========
</TABLE>


                The accompanying notes are an integral part of these statements.


<PAGE>


                   NOTES TO FINANCIAL STATEMENTS


1    ORGANIZATION AND OPERATIONS:

   ISD designs,  develops,  and markets  semiconductor  voice solutions based on
analog and digital  technologies  and mixed  signal  expertise.  ISD's  patented
ChipCorder(R)  and  CompactSPEECH(R)   technologies  enable  solid  state  voice
recording  and  playback  applications  in  the  communications,  consumer,  and
industrial  markets.  The  Company's  markets  are  primarily  in Europe,  North
America,  Japan,  and South East Asia.  The Company  directs its  marketing  and
product development efforts toward products for the communications, consumer and
industrial markets.  The Company distributes its products through a direct sales
and marketing  organization and a worldwide network of sales representatives and
distributors.

2     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

  Use of Estimates

  The preparation of financial  statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

   Cash and Cash Equivalents

   The Company considers all highly liquid investments with original  maturities
of three months or less to be cash  equivalents.  Such investments  consisted of
municipal bonds, commercial paper, bankers' acceptance notes and certificates of
deposit.

   Short-term and Long-term Investments

At December 31, 1997, approximately  $26,253,000 of the Company's investments in
debt  securities  were  classified as  available-for-sale,  and had  contractual
maturities  ranging from one month to two years from the date of purchase by the
Company.  Available  for sale debt  Securities  are  carried  at fair value with
unrealized  holding  gains  and  losses  reported  as a  separate  component  of
shareholders'  equity. Debt securities are classified as  held-to-maturity  when
the  Company  has the  positive  intent and  ability to hold the  securities  to
maturity.  As of December 31, 1997,  approximately  $16,241,000 of the Company's
investments  were classified as  held-to-maturity  and were carried at amortized
cost. Contractual maturities range from one month to two years from December 31,
1997. For all of the Company's  investments,  the fair value of the  investments
approximated  amortized cost and, as such,  unrealized  holding gains and losses
were insignificant.  The fair value of the Company's  investments was determined
based on quoted market prices at the reporting date for those  instruments.  The
carrying  value of the Company's  investments by major security type at December
31, 1997 and December 31, 1996, was as follows (in thousands):
<TABLE>
<CAPTION>
<S>                                                         <C>         <C>


                                                                  December 31,
                                                                  ------------
   Available-for-Sale Securities:                                1997       1996
   ------------------------------                                ----       ----
   Government bonds.....................................      $ 7,508    $ 9,012
   Certificates of deposit..............................        5,502      4,511
   Commercial paper.....................................        9,541      9,378
   Bankers' acceptance notes............................           --        992
   Corporate debt securities............................        3,702      3,792
                                                             --------    -------
        Total available-for-sale securities.............      26,253      27,685
                                                             --------    -------
   Held-to-Maturity Securities:
   ----------------------------
   Commercial paper.....................................        8,175     22,473
   Corporate debt securities............................        1,050         --
   Municipal debt securities............................        7,016      2,355
                                                             --------    -------
        Total held-to-maturity securities...............       16,241     24,828
                                                             --------    -------
   Total investments in debt securities.................      $42,494    $52,513
                                                             ========    =======
</TABLE>

<PAGE>

  Approximately  $6,606,000  and  $18,896,000  of the total  investment  in debt
securities is included in cash equivalents on the accompanying balance sheets as
of December 31, 1997 and 1996,  respectively;  the  remainder is  classified  as
either short-term or long-term investments.

   Inventories

   Inventories  consist of material,  labor and  manufacturing  overhead and are
stated  at the  lower  of  cost  (first-in,  first-out  basis)  or  market.  The
components of inventory are as follows (in thousands):

<TABLE>
<CAPTION>
<S>                              <C>       <C>

                                      December 31,
                                      ------------
                                     1997      1996
                                     ----      ----
   Work-in-process...........      $4,280   $ 6,157
   Finished goods............       3,462     3,902
                                   ------    ------
                                   $7,742   $10,059
</TABLE>

  Inventories  contained  products in excess of the Company's  current estimated
requirements  and were fully  reserved  at December  31,  1997 and 1996.  Due to
competitive  pressures,  it is possible that these estimates could change in the
near term.

   Property and Equipment

   Depreciation  is provided on property and equipment  using the  straight-line
method over the  estimated  useful lives of the assets of three (3) to seven (7)
years.  Leasehold  improvements  are  amortized  over  the  useful  lives of the
improvements  or lease term,  whichever  is shorter.  Betterments,  renewals and
extraordinary  repairs that extend the life of the asset are capitalized;  other
repairs and  maintenance  are expensed.  The cost and  accumulated  depreciation
applicable to assets  retired are removed from the accounts and the gain or loss
on disposition recognized in income.

   Patent Costs

   Legal costs  incurred in connection  with filing the Company's  patent claims
are recorded as patent costs. Upon receiving a determination  that the Company's
claims have been approved or denied, these costs are either amortized over their
estimated useful lives or expensed.

   Revenue Recognition

   Revenues from product sales are generally  recognized at the time of shipment
to the customer,  with provisions for estimated returns and allowances.  Returns
and allowances have not been significant to date. Certain of the Company's sales
are made to distributors under agreements  allowing certain rights of return and
price  protection  on  unsold  merchandise.   Accordingly,  the  Company  defers
recognition of such sales until the merchandise is sold by the distributor.  The
deferral of such sales is included in deferred  revenue.  Amounts  billed to the
distributor upon shipment by the Company are included in accounts receivable.

   Warranty Costs

   Anticipated  costs  related to product  warranties  are charged to expense as
sales are  recognized.  The Company  has not  experienced  significant  warranty
claims to date.

  Concentrations of Risk

   Financial  instruments that potentially subject the Company to concentrations
of credit risk consist  principally of cash  investments and trade  receivables.
The Company has cash investment policies that limit cash investments to low risk
investments.  With respect to trade  receivables,  the Company  performs ongoing
credit evaluations of its customers' financial condition and requires letters of
credit  whenever  deemed  necessary.  Additionally,  the Company  establishes an
allowance for doubtful  accounts based upon factors  surrounding the credit risk
of specific customers,  historical trends and other information.  As of December
31, 1997, ten customers  accounted for  approximately 71% of the Company's trade
receivables.

<PAGE>

   Of the Company's net revenues  approximately  78% are supplied by wafers from
one  foundry  and 20% from  another.  Although  there  are a  limited  number of
foundries  available that could manufacture the Company's  products,  management
believes  that other  suppliers  can  provide  similar  integrated  circuits  on
comparable  terms.  A  change  in  suppliers,  however,  could  cause a delay in
manufacturing and a possible loss of sales, which would affect operating results
adversely.

Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
<S>                               <C>       <C>

                                      December 31,
                                      ------------
                                     1997      1996
                                     ----      ----
System Implementation Costs.....      812        --
Other...........................    1,736       856
                                   ------    ------
                                    2,548       856
                                   ======    ======
</TABLE>

  Net Income (Loss) Per Share

   Effective December 31, 1997, the Company retroactively adopted the provisions
of Statement of Financial  Accounting  Standards  No. 128 (SFAS),  "Earnings per
Share". SFAS 128 requires companies to compute net income (loss) per share under
two different methods,  basic and diluted; and to present per share data for all
periods for which an income  statement is  presented.  Basic  earnings per share
were computed by dividing net income or net loss by the weighted  average number
of common  shares  outstanding  during the period.  Diluted  earnings  per share
reflect the  potential  dilution  that could occur if the income were divided by
the weighted  average number of common and potential  common shares  outstanding
during the period.  Diluted  earnings  per share were  computed by dividing  net
income by the weighted  average  number of common  shares and  potential  common
shares from  outstanding  stock  options for the year ended  December  31, 1995.
Potential  common  shares were  calculated  using the treasury  stock method and
represent incremental shares issuable upon exercise of the Company's outstanding
options.  For the years ended  December 31, 1996 and 1997,  the diluted loss per
share  calculation  excludes  effects  for  outstanding  stock  options  as such
inclusion would be anti-dilutive. The following table provides reconciliation of
the numerators and denominators  used in calculating  basic and diluted earnings
per share for the prior three years.


 (In thousands, except per share data)
<TABLE>
<CAPTION>
<S>                                                        <C>           <C>            <C>
                                                                 For the Year Ended December 31,
                                                                 -------------------------------
                                                                 1997          1996         1995
                                                                 ----          ----         ----
Net income (loss)........................................   $(13,528)      $(8,971)      $ 5,812
Basic Earnings Per Share
 Income (loss) available to common shareholders..........   $(13,528)      $(8,971)      $ 5,812
 Weighted average common shares outstanding..............       9,652         9,788        8,303
Basic earnings (loss) per share..........................   $  (1.40)      $ (0.92)      $  0.70
                                                            =========      ========      =======

Diluted Earnings Per Share
 Income (loss) available to common shareholders..........   $(13,528)      $(8,971)      $ 5,812
 Weighted average common shares outstanding..............       9,652         9,788        8,303
 Common stock option grants (unless anti-dilutive).......          --            --          733
 Weighted average warrants outstanding...................          --            --           48
                                                            ---------      --------      -------
Total weighted average common shares and equivalents.....       9,652         9,788        9,084
Diluted earnings (loss) per share........................   $  (1.40)      $ (0.92)      $  0.64
                                                            =========      ========      =======
</TABLE>

<PAGE>

  Options to purchase a weighted  average of  approximately  2.4 million and 1.7
million  shares of common stock were  outstanding at December 31, 1997 and 1996,
respectively,  but were not included in the computation of diluted  earnings per
share as a result of their anti-dilutive  effect on the loss available to common
shareholders.

3.    ACQUISITION:

  On March 28, 1997, the Company  acquired the  CompactSPEECH  speech  processor
product  line from  National  Semiconductor  for a cash  purchase  price of $5.1
million.  The  acquisition  was  accounted  for  under  the  purchase  method of
accounting.  A portion of the purchase  price was  allocated to assets  acquired
based on their estimated fair value.  In addition,  $4.0 million of the purchase
price was allocated to in-process research and development projects that had not
reached  technological  feasibility and had no probable alternative future uses,
which  the  Company  expensed  at the  date  of the  acquisition  as a  one-time
non-recurring  charge.  The remainder of the purchase price,  $1.0 million,  was
allocated to goodwill and will be amortized  over five years on a  straight-line
basis.  Comparative pro forma information has not been presented, as the results
of operations  for  CompactSPEECH  are not material to the  Company's  financial
statements.

4.    LINE OF CREDIT:

   In June 1997, the Company  entered into a revolving line of credit  agreement
with a bank  under  which it can  borrow  up to  $15,000,000  based on  eligible
investments. The line of credit is secured by substantially all of the Company's
assets,  bears  interest  at LIBOR plus 1.25% (7.2% at  December  31,  1997) and
expires on June 30,  1998.  At  December  31,  1997,  there  were no  borrowings
outstanding  under  the line of  credit  and the  Company's  borrowing  base was
approximately $17,700,000. The line of credit does not restrict the Company from
paying cash dividends on its capital stock and the only financial covenant is to
maintain a minimum  of pledged  investments  of $17.7  million in the  Company's
Liquidity Management account with the bank.

5.    CAPITALIZED LEASE OBLIGATIONS:

   The Company leases certain equipment under capital lease agreements. The cost
of equipment under capital leases included in property and equipment at December
31, 1997 and  December 31, 1996 was  approximately  $7,408,000  and  $6,758,000,
respectively.  Accumulated  amortization  of leased  equipment at such dates was
approximately  $5,358,000  and  $3,955,000,  respectively.  Future minimum lease
payments  together with the present  value of the  payments,  as of December 31,
1997, are as follows (in thousands):

<TABLE>
<CAPTION>
<S>  <C>                                                          <C>

   Years Ending December 31,
   -------------------------

      1998.....................................................      1,763
      1999.....................................................        657
      2000.....................................................        209
                                                                   -------
   Total minimum lease payments................................      2,629
   Less -- Amount representing interest (9.4% - 14.6%).........      (221)
                                                                   -------
   Present value of minimum lease payments.....................      2,408
   Less -- Current portion.....................................    (1,591)
                                                                   -------
   Long-term portion...........................................       $817
                                                                   =======
</TABLE>


6.    COMMITMENTS AND CONTINGENCIES:

  Operating Leases

   The Company's  principal  facilities  consist of approximately  40,000 square
feet of space  located in  adjacent  buildings  in a business  park in San Jose,
California.  This  space is leased  pursuant  to an  agreement  that  expires in
December 1999. The Company also maintains  domestic sales offices in Mendon, New
York and Austin,  Texas. The Company leases  approximately  3,500 square feet of
space in an office  building in Herzelia,  Israel for its Israeli design center.
The leases for facilities and certain equipment are operating leases that expire
at various dates through  2000.  Future  minimum  annual rental  payments  under
operating leases are as follows (in thousands):

<PAGE>
<TABLE>
<CAPTION>
<S> <C>                                                          <C>

    Year Ending December 31,
    ------------------------
      1998.....................................................      1,354
      1999.....................................................      1,296
      2000.....................................................        121
      2001.....................................................          3
                                                                    ------
                                                                    $2,774
                                                                    ======
</TABLE>

   During the years ended December 31, 1997, 1996 and 1995, rent expense totaled
approximately $1,627,000 $1,380,000, and $807,000, respectively.

   Litigation

   In January 1995, Atmel Corporation ("Atmel") notified the Company and Samsung
Electronics  Co.,  Ltd.  ("Samsung")  of certain  claims and  demanded  that the
Company and Samsung either negotiate licenses with Atmel or cease  manufacturing
the  Company's  products at Samsung.  The Company  received an opinion  from its
patent counsel,  Blakely,  Sokoloff,  Taylor & Zafman, that the Company does not
violate any of the patents identified in Atmel's notice to the Company,  and the
Company  believes the patent claims are without merit. The Company also believes
that the other  claims in the  notice  from  Atmel are  without  merit,  and its
general counsel,  on January 14, 1995,  after reviewing with appropriate  senior
and knowledgeable  personnel at the Company the factual information  surrounding
the other  claims,  provided a written  response to Atmel that these claims were
without  merit.  Atmel,  filed a complaint on June 15, 1995 in the United States
District Court for the Northern  District of California  which alleges causes of
action   against   the   Company   for   patent   infringement,   trade   secret
misappropriation,    breach   of   written   contract,    breach   of   contract
implied-in-fact, unjust enrichment and declaratory relief. Atmel, in addition to
damages and  injunctive  relief,  is seeking a  declaration  from the Court that
Atmel is a co-owner  of the  Company's  ChipCorder  products.  All the causes of
action  alleged in the  complaint  appear to be based on the same  circumstances
alleged in the January  1995 Atmel  notice.  The Company  believes the causes of
action in the complaint to be without merit and has had its general counsel file
an answer denying any wrongful  conduct and asserting  counterclaims  for damage
caused the Company by Atmel's termination of the fabrication arrangement between
the  parties.  The Court has  bifurcated  the issues  related to  liability  and
damages,  and the  parties  are in the  process of  conducting  final  discovery
relating to the  liability  issues.  On February  27,  1998,  the Court issued a
decision  regarding the paten claims. The Company believes that this decision is
at least in part  favorable to the  Company.  While the Company does not believe
the  ultimate  resolution  of this  matter  will have a  material  impact on its
business or financial  position,  it may have a material  adverse  impact on the
results of operations in the period in which it is resolved.

7.    EQUITY:

  In January 1996, the Company's Board of Directors  approved a stock repurchase
plan of up to one million  shares of common shares.  In addition,  in July 1996,
the Board of Directors approved a stock repurchase plan of an additional 100,000
shares of common  stock.  As of December  31,  1997 the Company had  repurchased
1,077,000 shares at an average price of $9.02 per share.

   Shares Reserved for Future Issuance

   As of December 31, 1997, the Company had reserved  shares of its common stock
for the following purposes:
<TABLE>
<CAPTION>
<S>  <C>                                        <C>

     1987 Stock Option Plan....................     144,387
     1994 Employee Stock Purchase Plan.........      65,605
     1994 Equity Incentive Plan................   2,743,184
     1994 Directors Stock Option Plan..........     120,000
     Nonqualified stock options................      42,500
     Warrants issued...........................      25,000
                                                  ---------
                                                  3,140,676
                                                  =========
</TABLE>

<PAGE>

   Employee Stock Purchase Plan

   In September 1994, the Company approved the Employee Stock Purchase Plan. The
plan  reserved  up to  170,000  shares  of  common  stock  for sale to  eligible
employees  at 85% of the  lesser of the fair  market  value of the shares on the
first  day of the  offering  period  or the  last  day of the  offering  period.
Offerings  under this plan  commence on February 1 and August 1 of each year and
end on July 31 and January 31,  respectively.  As of December 31, 1997,  104,395
shares have been issued  under this plan.  The  weighted  average  fair value of
shares sold in 1997 was $6.74.

  Stock Option Plans

   In December 1987,  the Company  adopted the 1987 Stock Option Plan (the "1987
Plan").  The 1987 Plan was  terminated  as to new  issuances  in February  1995.
Options  granted  under the 1987 Plan have a term of five  years and vest over a
vesting  schedule  determined by the Board of Directors,  generally  four years.
Options to purchase 144,387 shares were outstanding  under this plan at December
31, 1997.

   In September  1994, the Company  adopted the 1994 Equity  Incentive Plan (the
"1994 Plan"),  which became effective upon the closing of the Company's  initial
public  offering in February  1995 and serves as the successor to the 1987 Plan.
The Company has reserved  2,750,000  shares for issuance  under the terms of the
1994 Plan, and may grant stock options,  stock bonuses or issue restricted stock
to employees, officers, directors and consultants.  Nonqualified options granted
under this plan have a term of ten years and must be issued at a price  equal to
at least 85% of the fair market value of the Company's  common stock at the date
of grant. Incentive stock options granted under this plan may be granted only to
employees of the Company, may have a term of up to ten years, and must be issued
at a price equal to the fair market value of the  Company's  common stock at the
date of  grant.  Restricted  stock  may be  awarded  to  eligible  personnel  as
determined by the Board of Directors,  and must be issued at a price equal to at
least 85% of the fair market value of the shares  granted.  Stock bonuses may be
awarded for services rendered to the Company under such terms as are established
by the Board of Directors.

   In September 1994, the Company approved the 1994 Directors Stock Option Plan.
The  Company  reserved  120,000  shares  of its  common  stock for  issuance  to
directors under this plan.  This plan was amended  effective March 21, 1996, the
"Amendment  Effective Date", as per the annual shareholder  meeting.  Any option
grant,  granted  prior to  January 1,  1996,  will fully vest as to  twenty-five
percent  (25%) of the  shares at the end of each full year  following  the grant
date,  so long as the optionee  continuously  remains a director of the Company.
Any option grant,  granted  following the Amendment  Effective  Date,  will vest
ratably at the end of each of the  twelve  months  following  the grant date and
will be fully vested on the first  anniversary of the grant date, so long as the
optionee  continuously  remains a director of the Company  until each such first
anniversary.  Any option grant made during 1996 prior to the Amendment Effective
Date became fully vested on December 31, 1996.

   During 1996, holders of options to purchase 1,368,639 shares of the Company's
common  stock at  exercise  prices of $7.50 to $15.00  per share  were given the
opportunity  to exchange  previously  granted stock options for new common stock
options  exercisable  at $6.875 per share,  the fair market  value of the common
stock on the date of the  exchange.  Options to purchase  1,123,621  shares were
exchanged.

  Also included in the options granted during 1996 were options granted in March
1996 to purchase 113,146 shares under the 1994 Plan that were granted below fair
market  value.  The Company  recorded  deferred  compensation  of  approximately
$452,000  for the  difference  between the option price and fair market value of
common  stock on the date of  grant.  The  Company  is  expensing  the  deferred
compensation over the related vesting periods.

The  Company  accounts  for the above plans under  Accounting  Principles  Board
Opinion  No. 25,  under  which no  compensation  cost has been  recognized.  Had
compensation  cost for these plans been determined  consistent with Statement of
Financial  Accounting  Standards  (SFAS) No. 123,  "Accounting  for  Stock-Based
Compensation",  the  Company's net income (loss) and net income (loss) per share
would have been reduced to the following pro forma amounts:

<PAGE>

<TABLE>
<CAPTION>
<S>                                       <C>          <C>         <C>
                                                 Years Ended December 31,
                                                 ------------------------
                                                 1997        1996      1995
                                                 ----        ----      ----
   Net Income (loss):
     As reported                            $ (13,528)  $ (8,971)   $ 5,812
     Pro forma                                (16,742)   (12,558)     4,939
   Net Income (loss) per share:
     As reported                            $   (1.40)  $  (0.92)   $  0.64
     Pro forma                              $   (1.73)  $  (1.28)   $  0.54
</TABLE>


  Because the SFAS No. 123 method of accounting  has not been applied to options
granted prior to January 1, 1995, the resulting pro forma  compensation cost may
not be representative of that to be expected in future years.

  A summary of the  Company's  option plans at December 31, 1997,  1996 and 1995
and changes during the years then ended is presented below:

<TABLE>
<CAPTION>
<S>                                     <C>          <C>         <C>           <C>           <C>         <C>

                                                   1997                      1996                     1995
                                                   ----                      ----                     ----
                                                        Weighted                  Weightd                  Weighted
                                                        Average                   Average                  Average
                                                        Exercise                  Exercise                 Exercise
                                             Shares     Price          Shares     Price         Shares     Price
                                             ------     -----          ------     -----          ------     -----
Outstanding at beginning of year          2,051,945    $ 6.74       1,406,133    $ 8.98         634,897    $ 1.56
  Granted                                 1,037,879      6.82       2,465,998      7.51       1,450,519     12.78
  Exercised                               (151,363)      4.60       (174,193)      1.00       (207,199)      1.84
  Forfeited                               (190,713)      6.77     (1,645,993)     10.06       (472,084)     15.18
                                          ---------               -----------                 ---------
Outstanding at end of year                2,747,748    $ 6.92       2,051,945    $ 6.74       1,406,133    $ 8.98
                                          =========               ===========                 =========
Exercisable at end of year                  806,819                   391,542                   329,601
Weighted  average fair value
 of options granted                           $3.21                     $3.27                     $4.13
Options available for grant                 367,928                   399,489                   219,494
</TABLE>


<TABLE>
<CAPTION>
<S>                   <C>             <C>               <C>                <C>        <C>
                                                  December 31, 1997
                 ---------------------------------------------------------------------------------
                           Options Outstanding                      Options Exercisable
                 ---------------------------------------------------------------------------------
                                       Wtd. Avg.         Wtd. Avg.                     Wtd. Avg.
                                        exercise        years left                      exercise
Exercise Prices           Number           price       to exercise           Number        price
--------------------------------------------------------------------------------------------------
$  .45 - $ 6.19          406,312          $ 4.68               6.7          175,349       $ 2.94
  6.63 -   6.63          714,909            6.63              10.0               --         0.00
  6.81 -   6.81          148,068            6.81               9.0           28,389         6.81
  6.88 -   6.88          960,478            6.88               8.5          332,897         6.88
  7.06 -  25.25          517,981            9.19               7.0          270,184         9.43
                       ---------                                            -------
$  .45 - $25.25        2,747,748          $ 6.92               8.3          806,819       $ 6.87
                       =========                                            =======
</TABLE>

  The fair value of each option  grant is  estimated  on the date of grant using
the  Black-Scholes  options  pricing model with the  following  weighted-average
assumptions  used for grants in 1997,  1996, and 1995,  respectively:  risk-free
interest  rates of  5.66%,  5.57% and  6.45%;  expected  dividend  yields of 0%;
expected lives of 1.5 years; expected volatility of 58%, 82%, and 47%.

  Warrants

   Holders of warrants to purchase a total of 328,981 shares of preferred  stock
exercised  such warrants in February 1995 on a net issuance basis for a total of
236,730 shares of preferred  stock,  which  converted to 78,910 shares of common
stock upon the  closing of the  Company's  initial  public  offering in February
1995. Additionally,  holders of warrants to purchase 368,874 shares of preferred
stock (122,956  shares of common stock as converted) and 47,303 shares of common
stock  exercised  such  warrants for cash prior to the closing of the  Company's
initial  public  offering in February 1995. Net proceeds to the Company for such
exercises were approximately $591,000.

<PAGE>

  A warrant to purchase 25,000 shares of the Company's  common stock was granted
on December 3, 1997 as part of the Company's investment in another entity; these
shares vest over a two year period and can be exercised over a four year period.
The fair value of this warrant was $100,000 and the amount has been  recorded as
part of the cost of the Company's investment in the other entity.

  Shareholder Rights Plan

  During December 1995, the Company  adopted a Shareholder  Rights Plan, and the
Plan became effective in March of 1996 following the filing of the Plan with the
Securities and Exchange  Commission.  The Shareholder  Rights Plan provides that
there shall be  declared a dividend of one  preferred  share  purchase  right (a
"Right") for each outstanding share of common stock.  Under certain  conditions,
each Right may be exercised to purchase one one-hundredth of a share of Series A
Preferred Stock at an exercise price of $75. The Rights will be exercisable if a
person or group has acquired  beneficial  ownership of 15% or more of the common
stock or has  announced  a tender  offer or exchange  offer that if  consummated
would result in such a person or group  owning 15% or more of the common  stock.
The Company generally will be entitled to redeem the Rights at $.01 per Right at
any time prior to the earlier of (i) the tenth day following public announcement
that a 15% stock position has been acquired and (ii) the expiration  date of the
Rights on December 28, 2005.

  If any person or group becomes a beneficial owner of 15% or more of the common
stock (except  pursuant to a tender or exchange  offer for all shares at a price
determined  as fair  by a  majority  of the  outside  members  of the  Board  of
Directors),  each Right not owned by such 15% stockholder will enable its holder
to purchase  such number of shares of common  stock as is equal to the  exercise
price of the Right divided by one-half of the current market price of the common
stock on the date of the  occurrence of the event.  In addition,  if the Company
engages in a merger or other business  combination  with another person or group
in which it is not the surviving  corporation  or in  connection  with which its
common stock is changed or  converted,  or if the Company sells or transfers 50%
or more of its assets or earning  power to another  person,  each Right that has
not previously been exercised will entitle its holder to purchase such number of
shares of common stock of such other person as is equal to the exercise price of
the Right  divided by one-half of the current  market price of such common stock
on the date of the occurrence of the event.

8.    INCOME TAXES:

   The components of the provision (benefit) for income taxes are as follows (in
thousands):

<TABLE>
<CAPTION>
<S>                                                        <C>         <C>          <C>
                                                             Years Ended December 31,
                                                             ------------------------
                                                                1997        1996       1995
                                                                ----        ----       ----
   Current payable (benefit):
     Federal...............................................  $    --    $(2,314)     $3,029
     State.................................................       --       (185)        331
                                                             -------    --------    -------
             Total current.................................       --     (2,499)      3,360
   Deferred (benefit):
     Federal...............................................       --         752      (629)
     State.................................................       --         205      (328)
                                                             -------    --------    -------
             Total deferred................................       --         957      (957)
             Total provision (benefit) for income taxes....  $    --    $(1,542)     $2,403
                                                             =======    ========    =======
</TABLE>


   The provision (benefit) for income taxes differs from the amounts which would
result by applying the  applicable  statutory  Federal income tax rate to income
(loss) before income taxes as follows (in thousands):

<PAGE>

<TABLE>
<CAPTION>
<S>                                                            <C>          <C>           <C>
                                                                        Years Ended December 31,
                                                                        ------------------------
                                                                     1997          1996         1995
                                                                     ----          ----         ----

   Provision (benefit) computed at Federal statutory rate.....  $ (4,735)     $ (3,680)      $ 2,875
   State income taxes, net of Federal tax benefit.............      (825)         (636)          497
   In-process research and development write-off..............      1,644            --           --
   Nondeductible expenses.....................................         47            36            2
   Tax credits................................................         --            --        (274)
   Change in valuation allowance..............................      4,707         3,565      (1,205)
   Other......................................................      (838)         (827)          508
                                                                ---------     ---------      -------
             Total provision, (benefit) for income taxes......         --     $ (1,542)       $2,403
             Effective tax rate...............................         --         (15%)          29%
                                                                =========     =========      =======
</TABLE>

   Components  of  the  net  deferred  income  tax  asset  are  as  follows  (in
thousands):

<TABLE>
<CAPTION>
<S>                                                                   <C>           <C>

                                                                            As of December 31,
                                                                            ------------------
                                                                            1997          1996
                                                                            ----          ----

   Federal net operating loss carryforwards...................          $  4,712      $    833
   State net operating loss carryforwards.....................                94           234
   Tax credit carryforwards...................................             1,720         1,322
   Cumulative temporary differences:
     Deferred revenue.........................................               271           225
     Patent costs.............................................             (148)         (141)
     Depreciation expense.....................................             (434)         (403)
     Research and development costs...........................             1,545            --
     Reserve for doubtful accounts and returns................               266           204
     Inventory reserves.......................................               856         1,543
     Accrued vacation.........................................               174           142
     Other temporary differences..............................             (193)           197
                                                                        --------      --------
   Total deferred income tax asset............................             8,863         4,156
   Valuation allowance........................................           (8,863)       (4,156)
   Net deferred income tax asset..............................          $     --      $     --
                                                                        ========      ========
</TABLE>


   The Company's net operating loss ("NOL") and tax credit  carryforwards expire
at various dates through  2012.  In  accordance  with certain  provisions of the
Internal Revenue Code, as amended,  a change in ownership of greater than 50% of
a company  within a three year  period  results in an annual  limitation  on the
Company's ability to utilize its NOL carryforwards from tax periods prior to the
ownership  change.  Such a change in  ownership  occurred  with  respect  to the
Company in July 1991 and February 1995.  Accordingly,  at December 31, 1997,
federal NOL  carryforwards  of  approximately $1.6 million of the $13.5 million
NOL is restricted to annual amounts of  approximately  $150,000,  which
accumulate to the extent not used and are subject to the expiration of these
carryforwards.

  At  December  31,  1997,  the Company had  established  a valuation  allowance
against the gross deferred tax asset of $8,863,000.  The valuation allowance was
established due to the Company's limited history of  profitability,  limitations
on the utilization of NOL  carryforwards,  which are restricted in use under the
Internal Revenue Code of 1986 and uncertainties  regarding future operations due
to the increased competition within the Company's industry.

9.    EXPORT SALES AND SIGNIFICANT CUSTOMERS:

   The Company operates in the communications,  consumer,  and industrial market
segments.  The Company  markets its products in the United States and in foreign
countries  through its sales personnel,  independent sales  representatives  and
distributors. The Company's geographic sales as a percent of net revenues are as
follows:

<TABLE>
<CAPTION>
<S>                                    <C>        <C>      <C>

                                         Years Ended December 31,
                                         ------------------------
                                         1997      1996      1995
                                         ----      ----      ----
   United States.....................     21%       35%       35%
   Export:
     Asia............................     42        54        58
     Europe..........................     37        11         7
                                         100%      100%      100%
                                         ----      ----      ----
</TABLE>

<PAGE>

   Sales to major customers as a percentage of net revenues are as follows:

<TABLE>
<CAPTION>
<S>                                     <C>       <C>       <C>

                                         Years Ended December 31,
                                         ------------------------
                                         1997      1996      1995
                                         ----      ----      ----
   Sanyo.............................      1%        8%       10%
   Motorola..........................     17%       29%       13%
   Marubun...........................     19%       23%       16%
   Matsushita........................     13%       --        --
   Philips...........................     11%       --        --
</TABLE>


<PAGE>

                 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Information Storage Devices, Inc.:

  We have  audited  the  accompanying  balance  sheets  of  Information  Storage
Devices,  Inc. (a California  corporation) as of December 31, 1997 and 1996, and
the related  statements of operations,  shareholders'  equity and cash flows for
each of the three years in the period ended December 31, 1997.  These  financial
statements  and the  schedule  referred to below are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements 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 financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the 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 financial statements referred to above present fairly, in
all material respects,  the financial  position of Information  Storage Devices,
Inc. as of December 31, 1997 and 1996, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.

  Our  audits  were made for the  purpose  of  forming  an  opinion on the basic
financial  statements  taken as a whole. The schedule listed under Item 14(a) is
presented  for  purposes  of  complying   with  the   Securities   and  Exchange
Commission's  rules  and is not part of the  basic  financial  statements.  This
schedule has been subjected to the auditing  procedures applied in our audits of
the  basic  financial  statements  and,  in our  opinion,  fairly  states in all
material  respects  the  financial  data  required  to be set forth  therein  in
relation to the basic financial statements taken as a whole.

                      /S/ Arthur Andersen LLP


San Jose, California
January 19, 1998


<PAGE>


Item 9.   CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON ACCOUNTING AND
           FINANCIAL DISCLOSURE.

  Not applicable.

                             PART III

Item 10.     DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

  The information  required by this item with respect to the executive  officers
of the Company is incorporated by reference from "Item 4A: Executive Officers of
the Registrant" in Part I of this report.

  The  Company's  Bylaws  currently  provide that the number of directors of the
Company  shall be from four (4) to seven (7),  the actual  number to be fixed by
resolution of the Board. The current number of authorized directors is six (6).

<TABLE>
<CAPTION>
<S>                    <C>    <C>                                                     <C>

 Name of Director       Age              Principal Occupation                           Director Since
 ----------------       ---              --------------------                           --------------

David L. Angel           56    Chairman of the Board of the Company; Chief Executive           1991
                               Officer of the Company

Frederick B. Bamber      55    Managing Director of Applied Technology Investors, Inc.,        1990
                               and a General Partner of Technologies for Information &
                               Publishing, L.P. (1) (2)

Eugene J. Flath          60    General Partner of AVI Management Partners (1) (2)              1988

Alan V. King             63    Chairman of the Board and Chief Executive Officer of            1997
                               Volterra Semiconductor Corporation, Chairman of the
                               Board of Arithmos, Inc., and a Director of Smartflex
                               Systems (2)

Eric J. Ochiltree        50    President and Chief Operating Officer of the Company            1997

Frederick L. Zieber      56    President, Pathfinder Research, Incorporated (2)                1995
</TABLE>

-----------
(1)  Member of Audit Committee
(2)  Member of Compensation Committee

  Mr.  Angel has served as Chairman of the Board,  Chief  Executive
Officer and a director  of the Company  since  November  1996.  Mr.
Angel served as President,  Chief Executive  Officer and a director
of the  Company  since he joined  the  Company  in  February  1991.
From January 1989 to January 1991,  he was Group Vice  President of
the  Semiconductor  Group of  Dataquest,  Inc.,  a market  research
company. He holds a B.Sc. degree from Marietta College.

  Mr.  Bamber has served as a director of the Company  since March 1990.  He has
been Managing Director of Applied Technology Investors,  Inc., a venture capital
firm, since January 1983 and a general partner of Technologies for Information &
Publishing,  L.P., a venture  capital firm and  shareholder of the Company since
June 1990. Since 1988, Mr. Bamber has also a been director of Interleaf, Inc., a
publishing  software company. He holds a B.A. degree from Yale University and an
M.B.A.  degree  from  the  Wharton  School  of  Business  of the  University  of
Pennsylvania.

  Mr. Flath has served as a director of the Company  since  October
1988  and as  Chairman  of the  Board  from  January  1993  through
November  1996.  He has been a general  partner  of AVI  Management
Partners,  a  venture  capital  firm and an  affiliate  of  various
Company  shareholders,  since  February  1988.  Mr.  Flath  holds a
B.S.E.E.  degree from the  University  of Wisconsin and an M.S.E.E.
degree from the University of New Hampshire.

<PAGE>

  Mr. King was  appointed  a director  of the Company in May 1997.  Mr. King has
been Chairman of the Board,  President,  and Chief Executive Officer of Volterra
Semiconductor  Corporation,  a semiconductor  company,  since September 1996. He
also has served as  Chairman of the Board of  Arithmos,  Inc.,  a  semiconductor
company,  since  February  1995;  has been a director of  Smartflex  Systems,  a
turnkey contract assembler company,  since October 1993; and has been a Director
of Elantec Semiconductor,  Inc., an analog semiconductor company, since December
1997.  From  September  1991 to November  1994, he served as President and Chief
Executive  Officer of Silicon Systems,  Inc. From September 1986 to August 1991,
he was President and Chief Executive Officer of Precision Monolithics, Inc. Mr.
King holds a B.S. Ceramic E.
degree from the University of Washington.

  Mr.   Ochiltree   joined  the  Company  as  President  and  Chief
Operating  Officer in November  1996.  From August 1995 to November
1996, he was Vice President,  Products Group, of Exar  Corporation,
a  semiconductor  company.  From  August  1991 to August  1995,  he
served  as Vice  President  of Analog  Devices,  Inc.  and  General
Manager of Analog's  Santa Clara site.  He holds a B.S.E.E.  degree
from  Georgia  Institute  of  Technology,  an M.S.E.E.  degree from
Arizona   State   University,   and  an  M.B.A.   degree  from  the
University of Santa Clara.

  Mr.  Zieber  was  appointed  a  director  of the  Company in July
1995. He has been President of Pathfinder  Research,  Incorporated,
a  semiconductor  industry  consulting  firm he founded,  since May
1991.  Mr.  Zieber was employed by Dataquest,  Inc. from  September
1974  until   January  1991,   most  recently  as  Executive   Vice
President.  He holds  B.S.E.E.  and M.B.A.  degrees  from  Stanford
University.

Section 16(a) Beneficial Ownership Reporting Compliance

  Section 16 of the Exchange Act, as amended,  requires the Company's  directors
and  officers,  and persons who own more than 10% of a  registered  class of the
Company's equity securities, to file initial reports of ownership and reports of
changes in ownership with the Securities and Exchange  Commission.  Such persons
are required by SEC regulation to furnish the Company with copies of all Section
16(a)  forms they file.  Based  solely on its review of the copies of such forms
furnished to the Company and written representations from the executive officers
and directors of the Company,  the Company believes that all filings required to
be made by the Company's  officers,  directors and 10% shareholders  during 1997
were made in a timely manner.


<PAGE>


Item 11.     EXECUTIVE COMPENSATION

  The following table sets forth all compensation  awarded to, earned by or paid
for services  rendered to the Company in all capacities by, the Company's  Chief
Executive Officer and the Company's four other most highly compensated executive
officers who were serving as  executive  officers at the end of 1997  (together,
the "Named Officers") during 1997, 1996, and 1995.
<TABLE>
<CAPTION>
<S>                                            <C>       <C>      <C>              <C>                  <C>  

                                                                   Summary Compensation Table

                                                                     Annual Compensation
                                                            --------------------------------------
                                                                                                           All Other
   Name and Principal Position                   Year       Salary      Bonus      Options Granted        Compensation
   ---------------------------                   ----       ------      -----      ---------------        ------------

David L. Angel..............................     1997     $249,000    $     0           20,837                 $ 0
   Chairman and Chief Executive Officer          1996      175,000          0          282,000 (1)          22,245 (2)
                                                 1995      175,000     30,000           82,000                   0

Eric J. Ochiltree...........................     1997      215,000     10,000           21,875                   0
 President and Chief Operating Officer           1996       24,460          0          150,000                   0

Carl R. Palmer..............................     1997      155,000          0           17,188              28,774 (3)
 Vice President, Engineering                     1996      125,000     20,000           87,500 (4)          23,576 (5)
                                                 1995       15,019          0           25,000                   0

Felix J. Rosengarten........................     1997      155,000          0           13,688               8,942 (2)
 Vice President, Finance and Administration,     1996      130,000          0          111,500 (6)           8,525 (2)
 and Chief Financial Officer                     1995      130,000     30,000           31,000                   0

James Brennan...............................     1997      155,000          0           27,500                 217 (7)
 Vice President, Advanced Technology             1996      140,000          0           28,750                   0
                                                 1995       74,683     20,000           25,000                   0
</TABLE>


(1) Mr. Angel  received  100,000  shares as new option  grants in 1996.  Options
    granted in 1996 also include  grants of options to purchase  182,000  shares
    associated with the repricing of previously granted options.

(2) Represents payment for vacation accrued in excess of 20 days.

(3) Represents  compensation  for  relocation of $8,300 and accrued  vacation of
    $20,474.

(4) Mr. Palmer  received  32,500  shares as new option  grants in 1996.  Options
    granted in 1996 also  include  grants of options to purchase  55,000  shares
    associated with the repricing of previously granted options.

(5) Represents payment for relocation.

(6) Mr. Rosengarten received 40,500 shares as new option grants in 1996. Options
    granted in 1996 also  include  grants of options to purchase  70,000  shares
    associated with the repricing of previously granted options.

(7) Represents  awards  received  in  connection  with the  filing of new patent
    applications.


<PAGE>


     The following table shows, as to each of the Named Officers,  option grants
during  the  last  year and the  potential  realizable  value of those  options,
assuming 5% and 10% appreciation, at the end of their term:

                                                           Option Grants in 1997
<TABLE>
<CAPTION>
<S>                      <C>              <C>                 <C>              <C>            <C>

                                 Individual Grants
                          ---------------------------------                                    Potential Realizable Value
Potential Realizable      Number of        % of Total                                          at Assumed Annual Rates
                          Securities       Options                                             of Stock Price Appreciation
                          Underlying       Granted to                                          for Option Term
                          Options          Employees in         Exercise        Expiration     -----------------------------
     Name                 Granted (1)      Current Year (2)     Price           Date(3)          5% (4)           10% (4)
--------------------      -----------      ----------------     --------        ----------     ----------         ----------

David L. Angel               20,837              2.0%            $6.625          1/1/08        $  86,816           $ 220,008
Eric J. Ochiltree            21,875              2.1%             6.625          1/1/08           91,140             230,968
Carl R. Palmer               17,188              1.7%             6.625          1/1/08           71,612             181,480
Felix J. Rosengarten         13,688              1.3%             6.625          1/1/08           57,030             144,525
James Brennan                27,500              2.6%             6.625          1/1/08          114,576             290,360

</TABLE>

--------

(1)Options  granted under the Company's  1994 Stock Option Plan typically have a
   10-year term, vest over a four-year period of employment and have an exercise
   price equal to market value on the date of grant.

(2)Options to purchase an aggregate  of 1,007,879  shares of Common Stock of the
   Company were granted to employees during the year ended December 31, 1997.

(3)Options may terminate before their expiration dates if the optionee's  status
   as an employee or consultant is terminated, upon the optionee's death or upon
   an acquisition of the Company.

(4)Potential realizable value is based on an assumption that the market price of
   the stock appreciates at the stated rate, compounded annually,  from the date
   of  grant  until  the end of the  ten-year  option  term.  These  values  are
   calculated  based on requirements  promulgated by the Securities and Exchange
   Commission  and do not reflect the  Company's  estimate of future stock price
   appreciation.

The following  table sets forth certain  information  concerning the exercise of
options by each of the Named  Officers  during  1997,  including  the  aggregate
amount of gain on the date of  exercise.  In  addition,  the table  includes the
number of shares covered by both exercisable and unexercisable  stock options as
of December 31, 1997.  Also reported are values of  "in-the-money"  options that
represent the difference  between the respective  exercise prices of outstanding
stock  options and the fair market  value of the  Company's  Common  Stock as of
December  31,  1997 ($  6.031  per  share),  based on the  closing  price of the
Company's  stock  on  December  31,  1997.  The  Company  does not  grant  stock
appreciation rights.


<TABLE>
<CAPTION>
<S>                     <C>                 <C>               <C>          <C>             <C>             <C>

                                             Aggregated Option Exercises in 1997 and Year-End Option Values

                                                               Number of Securities           Value of Unexercised
                                                               Underlying Unexercised         In-the-Money Options
                                                               Options at Year-End (#)            at Year-End
                                                               -----------------------         --------------------
                          Shares Acquired        Value
    Name                  on Exercise (#)     Realized (1)   Exercisable    Unexercisable    Exercisable    Unexercisable
    ----                  ----------------    ------------   -----------    -------------    -----------    -------------
David L. Angel                       0          $      0       93,333           145,962       $198,003            $     0
Eric J. Ochiltree                8,000           (2,000)       32,625           131,250          1,011              3,391
Carl R. Palmer                       0                 0       17,188            57,500              0                  0
Felix J. Rosengarten            14,101            91,656       29,688            63,000         40,733                  0
James Brennan                        0                 0       23,021            58,229              0                  0

</TABLE>

--------------
 (1) "Value  Realized"  represents the fair market value of the shares of Common
   Stock  underlying  the options on the date of  exercise  based on the closing
   price of the  Company's  stock on the date of  exercise,  less the  aggregate
   exercise price of the options.


<PAGE>


Director Compensation

  Directors of the Company do not receive any compensation for their services as
such but are reimbursed for their reasonable  expenses in attending  meetings of
the  Board of  Directors.  The  Board of  Directors  adopted,  and  shareholders
approved  adoption  of, the 1994  Directors  Stock  Option Plan (the  "Directors
Plan") in September 1994 which became effective on February 16, 1995.

  Under the Directors Plan, each non-employee  director initially elected to the
Board of Directors on or after  February  16, 1995 is  automatically  granted an
option to purchase 7,500 shares of Common Stock  ("Initial  Option") on the date
such director first joins the Board. In addition,  each non-employee director is
granted a succeeding  option  ("Succeeding  Option") to purchase 7,500 shares of
Common Stock on January 1 of each year that vest at the rate of one-twelfth  per
month, for as long as the non-employee  director continuously remains a director
of the  Company.  The  maximum  number of shares  issuable  to any  non-employee
director under the Directors Plan is 30,000. The exercise price for such options
is the fair market  value of the Common  Stock on the date of grant.  A total of
120,000  shares of Common  Stock is reserved for  issuance  under the  Directors
Plan,  67,500 of which were  subject to  outstanding  options as of December 31,
1997.

Compensation Committee Interlocks and Insider Participation

  During 1997, the Compensation Committee of the Board of Directors consisted of
Frederick B. Bamber, Eugene J. Flath and Frederick L. Zieber. In addition,  Alan
V. King became a member of the  Compensation  Committee when he joined the Board
of Directors in May 1997. All of the members of the  Compensation  Committee are
independent outside directors. There is no interlocking relationship between the
Board or  Compensation  Committee  and the board of  directors  or  compensation
committee of any other company.

Item 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The following table sets forth certain information known to the Company, as of
December 31, 1997, with respect to beneficial  ownership of the Company's Common
Stock by (i) each shareholder known by the Company to be the beneficial owner of
more than 5% of the Company's Common Stock,  (ii) each present  director,  (iii)
each Named Officer and (iv) all executive officers and directors as a group.

<TABLE>
<CAPTION>
<S>                                                                                    <C>                  <C>

                                                                                              Shares Beneficially
                                                                                                    Owned (1)
                                                                                           -------------------------
            Name of Beneficial Owner                                                       Number            Percent
            ------------------------                                                       ------            -------
Pioneering Management Corp.(2)...........................................                 976,000             9.99%
Kaufmann Fund Inc.(3)....................................................                 700,000             7.16%
Frederick B. Bamber
     Technologies for Information & Publishing, L.P.(4)..................                 568,114             5.81%
Dimensional Fund Advisors Inc.(5)........................................                 503,500             5.15%
David L. Angel(6)........................................................                 218,957             2.24%
Eugene J. Flath(7).......................................................                 113,381             1.16%
Felix J. Rosengarten(8)..................................................                 104,120             1.07%
Eric J. Ochiltree(9).....................................................                  47,397               *
Frederick L. Zieber(10)..................................................                  26,843               *
James Brennan(11)........................................................                  28,250               *
Carl R. Palmer(12).......................................................                  22,585               *
Alan V. King (13)........................................................                   5,625               *
All executive officers and directors as a group (13 persons)(14).........               1,352,690            13.84%

</TABLE>

----------------
 * less than 1%

<PAGE>


(1) Beneficial   ownership  is  determined  in  accordance  with  rules  of  the
    Securities and Exchange Commission that deem shares to be beneficially owned
    by any person who has or shares voting or  investment  power with respect to
    such shares.  Unless  otherwise  indicated,  the persons named in this table
    have sole voting and sole investment  power with respect to all shares shown
    as beneficially owned,  subject to community property laws where applicable.
    Shares of Common Stock subject to options that are currently  exercisable or
    exercisable within 60 days of December 31, 1997 are deemed to be outstanding
    and to be  beneficially  owned by the person  holding  such  options for the
    purpose of  computing  the  percentage  ownership of such person but are not
    treated as outstanding for the purpose of computing the percentage ownership
    of any other person.

(2) The share  ownership  is as  reported  on  schedule  13G/A as amended  dated
    January 21, 1998.  The address for Pioneering  Management  Corporation is 60
    State Street, Boston, Massachusetts 02109.

(3) The share  ownership is as reported on schedule 13G as amended dated January
    29,  1998.  The  address for  Kaufmann  Fund  Incorporated  is 140 East 45th
    Street, 43rd Floor, Suite 2624, New York, New York 10017.

(4) Mr. Bamber, a director of the Company, is a managing general partner of such
    partnership.  The other managing  general  partners of the  partnership  are
    David A. Boucher and Thomas H. Grant.  The managing  general  partners share
    voting and  investment  power over the shares held by the  partnership.  The
    address for Messrs.  Bamber,  Boucher and Grant and the  partnership  is One
    Cranberry Hill, Lexington,  Massachusetts 02173. Also includes 20,468 shares
    subject to options exercisable within 60 days of December 31, 1997.

(5) The share ownership is as reported on schedule 13G as amended dated February
    10, 1998. The address for  Dimensional  Fund Advisors  Incorporated  is 1299
    Ocean Avenue, 11th Floor, Santa Monica, California 90401.

(6) Includes  100,916  shares subject to options  exercisable  within 60 days of
    December  31,  1997.  Mr.  Angel is Chairman of the Board,  Chief  Executive
    Officer and a director of the Company.

(7) Includes  61,874  shares  subject to options  exercisable  within 60 days of
    December 31, 1997.  Mr. Flath is a director of the Company.  The address for
    Mr. Flath is 1010 El Camino, Suite 300, Menlo Park, California 94025.

(8) Includes  32,687  shares  subject to options  exercisable  within 60 days of
    December  31,  1997.  Mr.   Rosengarten  is  Vice  President,   Finance  and
    Administration, and Chief Financial Officer of the Company.

(9) Includes  38,876  shares  subject to options  exercisable  within 60 days of
    December 31, 1997. Mr. Ochiltree is President and Chief Operating Officer of
    the Company.

(10)Includes  19,843  shares  subject to options  exercisable  within 60 days of
    December 31, 1997. Mr. Zieber is a director of the Company.  The address for
    Mr. Zieber is 1620 Old Oakland Road, D-207, San Jose, California 95131.

(11)These shares are subject to options exercisable within 60 days of December
    31, 1997.  Mr. Brennan is Vice President, Technology and Advanced
    Development, of the Company.

(12)These shares are subject to options exercisable within 60 days of December
    31, 1997.  Mr. Palmer is Vice President, Engineering, of the Company.

(13)These shares are subject to options  exercisable  within 60 days of December
    31, 1997. Mr. King is a director of the Company. The address for Mr. King is
    2730 San Tomas Expressway, Suite 210, Santa Clara, California 95051.

(14)Includes  the shares  subject to options  stated to be included in footnotes
    (4) and (6) through (13) and 234,243  additional  shares  subject to options
    exercisable within 60 days of December 31, 1997.

<PAGE>

Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  Since  January  1,  1997,  there  have  been  no  transactions  or  series  of
transactions  involving  more than  $60,000  between the Company and any current
executive officer,  director,  5% beneficial owner of the Company's Common Stock
or any member of the  immediate  family of any of the  foregoing in which one or
more of the foregoing individuals or entities had a material interest, except as
indicated in Item 11.


                              PART IV

Item 14.  EXHIBITS,  FINANCIAL  STATEMENT  SCHEDULES AND REPORTS ON FORM 8-K.

(a)   1.  Financial Statements.

  The  following   financial   statements  and  Report  of  Independent   Public
Accountants are included in Item 8 of this report.

       Balance Sheets at December 31, 1997 and 1996
       Statements of Operations for the  years  ended  December  31,  1997,
         1996, and 1995
       Statements of Stockholders' Equity for the years ended December 31, 1997,
         1996, and 1995
       Statements of Cash Flows for the years ended December 31, 1997, 1996, and
         1995
       Notes to Financial Statements
       Report of Independent Public Accountants

      2.  Financial Statement Schedules.

  The  following  financial  statement  schedule is filed as part of this Annual
Report on Form 10-K.

<TABLE>
<CAPTION>
<S>    <C>                                                    <C>
                                                                  Page(s) in
                                                               Annual Report on
             Description                                          Form 10-K
             -----------                                          ---------
        Schedule II - Valuation and Qualifying Accounts......        F-1
</TABLE>

  All other  schedules  are  omitted  because  they are not  applicable,  or not
required,  or because the  required  information  is  included in the  financial
statements or notes thereto.

      3.   Exhibits -

<TABLE>
<CAPTION>
<S>     <C>           <C>
                         INDEX TO EXHIBITS

         Exhibit
         Number                Exhibit Title
         -------               -------------
           3.01 -- Registrant's Articles of Incorporation, as amended to date(1)
           3.03 -- Registrant's Bylaws, as amended to date(2)
           3.04         -- Certificate of Determination  specifying the terms of
                        the  Series  A  Participating  Preferred  Stock  of  the
                        Registrant  as filed with the  California  Secretary  of
                        State on December 28, 1995(3)
           4.01    --  Form of Specimen Certificate for Registrant's Common Stock(2)
           4.02 -- Amended and Restated Registration Rights Agreement,  dated as
           of  July 8,  1991,  as  amended(1)  4.03 --  Rights  Agreement  dated
           December 28, 1995, between the Registrant and the First National
                       Bank of Boston, as Rights Agent, and related documents(3)
          10.01    --  Registrant's 1987 Stock Option Plan, as amended, and related documents(4)*
          10.02    --  Registrant's 1994 Equity Incentive Plan, as amended, and related documents(5)*
          10.03    --  Registrant's 1994 Directors Stock Option Plan and related documents(6)*
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
<S>     <C>           <C>

          10.04 --  Registrant's  1994 Employee  Stock Purchase Plan and related
          documents,  as amended(5)* 10.05 -- Form of Indemnification  Agreement
          entered into with each of Registrant's directors and
                        executive officers(2)*
          10.08         -- Lease  Agreement  between  Registrant  and  Greylands
                        Business Park,  Phase I dated August 24, 1994,  together
                        with Addendum dated July 25, 1995(1)
          10.09         --  Wafer  Foundry  Agreement  between   Registrant  and
                        Samsung  Electronics  Co., Ltd., dated December 26, 1992
                        as amended(1)** together with Amendment to Wafer Foundry
                        Agreement  Process and Storage Cell  Technology  License
                        dated December 26, 1995(7)
          10.21    --  Acceptance, Letter of Credit, Loan and Security Agreements between Registrant and Union
                        Bank dated June 30, 1997 (includes related Summary Schedules)
          10.22         --   Agreement   for  Contract   Manufacturing   between
                        Registrant  and Rohm  Electronics,  a  Division  of Rohm
                        Corporation, dated as of November 27, 1995(7)**
          10.23         -- Form of Employment  Agreement  dated January 19, 1996
                        between  Registrant  and all of the Company's  executive
                        officers and certain key employees(6)*
          10.24    --  Form of Amended and Restated Employment Agreement dated May 14, 1996 between Registrant
                        and certain of the Company's executive officers(4)*
          10.25    --  Form of Amended and Restated Employment Agreement dated November 19, 1996 between
                        Registrant and certain of the Company's executive officers(8)*
          10.26    --  International Distributorship Agreement between Registrant and Marubun Corporation
                        effective as of April 12, 1994(9)
          23.01    --  Consent of Arthur Andersen LLP, Independent Public Accountants
          27.01    --  Financial Data Schedule

</TABLE>

      ----------

      *    Management contract or compensatory plan or arrangement.

      **  Confidential treatment has been granted for portions of this document.
          Such  portions  have been omitted from this filing and have been filed
          separately with the Securities and Exchange Commission.

      (1) Incorporated by reference to the exhibit of the same number filed with
          Registrant's Form S-1 Registration Statement (File No. 33-94852).

      (2) Incorporated by reference to the exhibit of the same number filed with
          Registrant's Form S-1 Registration Statement (File No. 33-86458).

      (3) Incorporated by reference to the exhibit of the same number filed with
          Registrant's Form 8-K filed on or about January 5, 1996.

      (4) Incorporated by reference to the exhibit of the same number filed with
          Registrant's  Quarterly Report on Form 10-Q for the quarter ended June
          30, 1996.

      (5) Incorporated by reference to the exhibit of the same number filed with
          Registrant's  Quarterly  Report  on Form  10-Q for the  quarter  ended
          September 27, 1997.

      (6) Incorporated by reference to the exhibit of the same number filed with
          Registrant's Quarterly Report on Form 10-Q for the quarter ended March
          31, 1996.

      (7) Incorporated by reference to the exhibit of the same number filed with
          Registrant's  Annual  Report on Form 10-K for the year ended  December
          31, 1995.

      (8) Incorporated by reference to the exhibit of the same number filed with
          Registrant's  Annual  Report on Form 10-K for the year ended  December
          31, 1996.

      (9) Incorporated by reference to the exhibit of the same number filed with
          Registrant's  Quarterly Report on Form 10-Q for the quarter ended June
          28, 1997.


<PAGE>


(b)  Reports on Form 8-K.  The  Company  filed no reports on Form 8-K during the
     fourth quarter of the fiscal year ended December 31, 1996.

(c) The exhibits required by this Item are listed under Item 14 (a) 3 above.

(d) The financial  statement schedule required by this Item is listed under Item
    14 (a) 2 above.




<PAGE>


                                   SIGNATURES



  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                     INFORMATION STORAGE DEVICES, INC.

                       By:   /S/DAVID L. ANGEL
                             ----------------------
                             David L. Angel
                             Chairman of the
                             Board and Chief
                             Executive Officer

                       Date: March 25, 1998



  Pursuant to the  requirements  of the  Securities  Exchange Act of 1934,  this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities an on the dates indicated.

<TABLE>
<CAPTION>
<S>                        <C>                                            <C>

Signature                   Title                                           Date
---------                   -----                                           ----

/S/ DAVID L. ANGEL          Chairman of the Board, Chief Executive          March 25, 1998
                            Officer and Director
----------------------      (Principle Executive Officer)
David L. Angel


/S/ FELIX J. ROSENGARTEN    Vice President, Finance and Administration,     March 25, 1998
                            and Chief Financial Officer
----------------------      (Principal Financial Officer and
Felix J. Rosengarten        Principal Accounting Officer)


/S/  FREDERICK B. BAMBER    Director                                        March 25, 1998

----------------------
Frederick B. Bamber


/S/ EUGENE J. FLATH         Director                                        March 25, 1998

----------------------
Eugene J. Flath


/S/ ALAN V. KING            Director                                        March 25, 1998

----------------------
 Alan V. King


/S/ ERIC J. OCHILTREE       Director                                        March 25, 1998

----------------------
 Eric J. Ochiltree


/S/ FREDERICK L. ZIEBER     Director                                        March 25, 1998

----------------------
Frederick L. Zieber

</TABLE>


<PAGE>


<TABLE>
<CAPTION>
<S>                                          <C>                          <C>                    <C>                <C>

                                                                                                                     Schedule II




                        INFORMATION STORAGE DEVICES, INC.

                        VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)


                                                                            Additions
                                                 Balance at               Charged to Costs                            Balance at
Description                                      Beginning of Year         and Expenses            Deductions         End of Year
-----------                                      -----------------        ----------------         ----------         -----------

Year ended December 31, 1995
     Allowance for doubtful accounts........          $  76                   $   210                  $ (11)            $   275

Year ended December 31, 1996
     Allowance for doubtful accounts........          $ 275                   $   325                  $   --            $   600

Year ended December 31, 1997
     Allowance for doubtful accounts........          $ 600                   $ 1,270                  $   --            $ 1,870

</TABLE>




<PAGE>



CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

  As independent public  accountants,  we hereby consent to the incorporation of
our report  included (or  incorporated  by reference) in this Form 10-K into the
Company's previously filed Registration  Statements No. 33-90824,  No. 333-08037
and No. 333-43065, on Form S-8.

                                     ARTHUR ANDERSEN LLP

San Jose, California
March  25 , 1998

<PAGE>



                               COMMERCIAL PROMISSORY NOTE
                                      (BASE RATE)

<TABLE>
<CAPTION>
<S>                                    <C>                 <C>


Borrower Name:
INFORMATION STORAGE DEVICES, INC.,
a California corporation

Borrower Address:                       Office:                   Loan Number:
2045 Hamilton Avenue                    Sunnyvale                 0005-00-0000
San Jose, CA 95125:

                                        Maturity Date:            Amount:
                                        June 30,1998              $15,000,000.00


Sunnyvale, California                   $15,000,000.00       Date: July 24, 1997
---------------------                   --------------       -------------------
</TABLE>

FOR VALUE RECEIVED, on June 30, 1998, the undersigned ("Debtor") promises to pay
to the order of UNION BANK OF CALIFORNIA, N.A. ("Bank"), as indicated below, the
principal sum of FIFTEEN MILLION AND NO/100 DOLLARS ($15,000,000.00), or so much
thereof as is Disbursed, together.with interest on the balance of such principal
from time to time  outstanding,  at the per annum rate or rates and at the times
set forth below.

1.  INTEREST  PAYMENTS.  Debtor shall pay interest on the last day of each month
(commencing  August 31,  1997).  Should  interest not be paid when due, it shall
become  part  of the  principal  and  bear  interest  as  herein  provided.  All
computations of interest under this note shall be made on the basis of a year of
360 days, for actual days elapsed.

    a. BASE INTEREST RATE. At Debtor's option,  amounts outstanding hereunder in
    increments of at least  $10,000  shall bear interest at a rate,  based on an
    index selected by Debtor, which is 1.25% per annum in excess of Bank's LIBOR
    Rate for the Interest Period selected by Debtor.

    Any Base  Interest  Rate may not be changed,  altered or otherwise  modified
    until the expiration of the Interest Period selected by Debtor. The exercise
    of interest  rate options by Debtor shall be as recorded in Bank's  records,
    which records  shall be prima facie  evidence of the amount  borrowed  under
    either  interest  option and the  interest  rate;  provided,  however,  that
    failure of Bank to make any such notation in its records shall not discharge
    Debtor  from its  obligations  to repay in full with  interest  all  amounts
    borrowed.  In no event shall any Interest  Period extend beyond the maturity
    date of this note.

    To  exercise  this  option,  Debtor may,  from time to time with  respect to
    principal outstanding on which a Base Interest Rate is not accruing,  and on
    the expiration of any Interest Period with respect to principal  outstanding
    on which a Base Interest Rate has been accruing,  select an index offered by
    Bank for a Base Interest Rate Loan and an Interest  Period by telephoning an
    authorized  lending officer of Bank located at the banking office identified
    below prior to 10:00 a.m.  Pacific  time,  on any  Business Day and advising
    that officer of the selected index,  the Interest Period and the Origination
    Date selected (which  Origination  Date, for a Base Interest Rate Loan based
    on the LIBOR Rate,  shall follow the date of such  selection by no more than
    two (2) Business Days).

<PAGE>

    Bank will  mail a written  confirmation  of the  terms of the  selection  to
    Debtor  promptly  after  the  selection  is  made.   Failure  to  send  such
    confirmation  shall not affect Bank's rights to collect interest at the rate
    selected. If, on the date of the selection, the index is unavailable for any
    reason,  the  selection  shall be void.  Bank reserves the right to fund the
    principal  from any source of funds  notwithstanding  any Base Interest Rate
    selected by Debtor.

b. VARIABLE  INTEREST RATE.  All principal  outstanding  hereunder  which is not
bearing interest at a Base Interest Rate shall bear interest at a rate per annum
at the  Reference  Rate,  which rate shall vary as and when the  Reference  Rate
changes.

At any time prior to the  maturity of this note,  subject to the  provisions  of
paragraph 4, below, of this note,  Debtor may borrow,  repay and reborrow hereon
so long as the total  outstanding  at any one time does not exceed the principal
amount of this note.  Debtor shall pay all amounts due under this note in lawful
money of the United States at Bank's Sunnyvale  Office,  or such other office as
may be designated by Bank, from time to time.

2. LATE PAYMENTS. If any payment required by the terms of this note shall remain
unpaid ten days after same is due, at the option of Bank, Debtor shall pay a fee
of $100 to Bank.

3. INTEREST RATE FOLLOWING  DEFAULT.  In the event of default,  at the option of
Bank,  and, to the extent  permitted  by law,  interest  shall be payable on the
outstanding  principal under this note at a per annum rate equal to five percent
(5%)  in  excess  of the  interest  rate  specified  in  paragraph  1.b,  above,
calculated  from the date of default  until all amounts  payable under this note
are paid in full.

 4.    PREPAYMENT.

a. Amounts  outstanding  under this note bearing interest at a rate based on the
Reference Rate may be prepaid in whole or in part at any time,  without  penalty
or  premium.  Amounts  outstanding  under this note  bearing  interest at a Base
Interest  Rate  may only be  prepaid,  in  whole  or in part  provided  Bank has
received  not less  than  five (5)  Business  Days  prior  written  notice of an
intention to make such prepayment and Debtor pays a prepayment fee to Bank in an
amount equal to the present value of the product of: (i) the difference (but not
less than zero) between (a) the Base  Interest Rate  applicable to the principal
amount  which  Debtor  intends  to prepay,  and (b) the return  which Bank could
obtain if it used the amount of such  prepayment of principal to purchase at bid
price regularly quoted  securities issued by the United States having a maturity
date most closely  coinciding with the relevant Base Rate Maturity Date and such
securities  were held by Bank until the relevant Base Rate Maturity Date ("Yield
Rate");  (ii) a fraction,  the  numerator  of which is the number of days in the
period  between the date of prepayment  and the relevant Base Rate Maturity Date
and the  denominator  of which is 360; and (iii) the amount of the  principal so
prepaid (except in the event that principal  payments are required and have been
made as scheduled  under the terms of the Base Interest Rate Loan being prepaid,
then an amount  equal to the lesser of (A) the amount  prepaid or (B) 50% of the
sum of (1) the amount  prepaid and (2) the amount of principal  scheduled  under
the terms of the Base Interest Rate Loan being prepaid to be  outstanding at the
relevant Base Rate Maturity  Date).  Present value under this note is determined
by  discounting  the above  product to present value using the Yield Rate as the
annual discount factor.

<PAGE>

b.In no event shall Bank be  obligated  to make any payment or refund to Debtor,
nor shall Debtor be entitled to any setoff or other claim against  Bank,  should
the return which Bank could obtain under the above prepayment formula exceed the
interest  that Bank would have  received  if no  prepayment  had  occurred.  All
prepayments shall include payment of accrued interest on the principal amount so
prepaid  and shall be  applied  to payment of  interest  before  application  to
principal.  A  determination  by Bank as to the prepayment  fee amount,  if any,
shall be conclusive.

c. Such  prepayment  fee, if any, shall also be payable if prepayment  occurs as
the result of the  acceleration of the principal of this note by Bank because of
any default hereunder. If, following such acceleration,  all or any portion of a
Base  Interest  Rate  Loan  is  satisfied,  whether  through  sale  of  property
encumbered by any security agreement or other agreement securing this note, at a
foreclosure  sale held  thereunder  or through the tender of payment at any time
following such  acceleration,  but prior to such a foreclosure  sale,  then such
satisfaction  shall be deemed an evasion of the prepayment  conditions set forth
above, and Bank shall,  automatically  and without notice or demand, be entitled
to receive,  concurrently  with such  satisfaction  the prepayment fee set forth
above,  and the amount of such  prepayment  fee shall be added to the principal.
DEBTOR  HEREBY  ACKNOWLEDGES  AND  AGREES  THAT BANK  WOULD NOT MAKE THE LOAN TO
DEBTOR EVIDENCED BY THIS NOTE WITHOUT DEBTOR'S AGREEMENT, AS SET FORTH ABOVE, TO
PAY BANK A  PREPAYMENT  FEE UPON THE  SATISFACTION  OF ALL OR ANY PORTION OF THE
PRINCIPAL BEARING INTEREST AT A BASE INTEREST RATE FOLLOWING THE ACCELERATION OF
THE MATURITY DATE HEREOF BY REASON OF A DEFAULT. DEBTOR HAS CAUSED THOSE PERSONS
SIGNING THIS NOTE ON ITS BEHALF TO SEPARATELY INITIAL THE AGREEMENT CONTAINED IN
THIS PARAGRAPH BY PLACING THEIR INITIALS BELOW:

INITIALS:

5. DEFAULT AND ACCELERATION OF TIME FOR PAYMENT.  Default shall include, but not
be  limited  to,  any of the  following  (a) the  failure  of Debtor to make any
payment required under this note when due; (b) any breach,  misrepresentation or
other default by Debtor,  any guarantor,  co-maker,  endorser,  or any person or
entity  other  than  Debtor  providing   security  for  this  note  (hereinafter
individually and  collectively  referred to as the "Obligor") under any security
agreement,  guaranty or other  agreement  between Bank and any Obligor;  (c) the
insolvency  of any Obligor or the failure of any Obligor  generally  to pay such
Obligor's debts as such debts become due; (d) the commencement as to any Obligor
of  any  voluntary  or  involuntary   proceeding  under  any  laws  relating  to
bankruptcy, insolvency,  reorganization,  arrangement, debt adjustment or debtor
relief;  (e) the  assignment  by any Obligor  for the benefit of such  Obligor's
creditors;  (f) the  appointment,  or  commencement  of any  proceeding  for the
appointment  of a receiver,  trustee,  custodian or similar  official for all or
substantially  all  of any  Obligor's  property;  (9)  the  commencement  of any
proceeding  for  the  dissolution  or  liquidation  of  any  Obligor;   (h)  the
termination  of  existence or death of any Obligor;  (i) the  revocation  of any
guaranty or subordination  agreement given in connection with this note; (j) the
failure of any Obligor to comply with any order, judgment,  injunction,  decree,
writ or  demand  of any  court or other  public  authority;  (k) the  filing  or
recording against any Obligor, or the property of any

<PAGE>

Obligor,  of any notice of levy, notice to withhold,  or other legal process for
taxes other than  property  taxes;  (1) the  default by any  Obligor  personally
liable for amounts owed hereunder on any obligation  concerning the borrowing of
money; (m) the issuance against any Obligor,  or the property of any Obligor, of
any  writ  of  attachment,  execution,  or  other  judicial  lien;  or  (n)  the
deterioration  of the  financial  condition of any Obligor which results in Bank
deeming  itself,  in good  faith,  insecure.  Upon  the  occurrence  of any such
default,  Bank, in its discretion,  may cease to advance funds hereunder and may
declare all obligations  under this note  immediately due and payable;  however,
upon the  occurrence  of an event of default  under d, e, f, or g, all principal
and interest shall automatically become immediately due and payable.

6. ADDITIONAL AGREEMENTS OF DEBTOR. If any amounts owing under this note are not
paid  when  due,  Debtor  promises  to pay all  costs  and  expenses,  including
reasonable attorneys' fees, incurred by Bank in the collection or enforcement of
this note. Debtor and any endorsers of this note, for the maximum period of time
and the full extent permitted by law, (a) waive diligence,  presentment, demand,
notice of nonpayment,  protest, notice of protest, and notice of every kind; (b)
waive the right to assert the defense of any statute of  limitations to any debt
or obligation hereunder;  and (c) consent to renewals and extensions of time for
the payment of any  amounts due under this note.  If this note is signed by more
than one party,  the term  "Debtor"  includes  each of the  undersigned  and any
successors  in  interest  thereof;  all of whose  liability  shall be joint  and
several.  Any married person who signs this note agrees that recourse may be had
against the separate property of that person for any obligations hereunder.  The
receipt of any check or other item of payment by Bank, at its option,  shall not
be  considered a payment on account until such check or other item of payment is
honored when presented for payment at the drawee bank. Bank may delay the credit
of such payment based upon Bank's schedule of funds  availability,  and interest
under this note shall accrue until the funds are deemed collected. In any action
brought  under or arising out of this note,  Debtor and any  Obligor,  including
their  successors  and  assigns,  hereby  consent  to  the  jurisdiction  of any
competent  court within the State of California,  as provided in any alternative
dispute  resolution  agreement  executed between Debtor and Bank, and consent to
service of process by any means  authorized by said state's law. The term "Bank"
includes,  without  limitation,  any  holder of this  note.  This note  shall be
construed  in  accordance  with  and  governed  by  the  laws  of the  State  of
California.  This note hereby  incorporates any alternative  dispute  resolution
agreement previously, concurrently or hereafter executed between Debtor and Bank

7.  DEFINITIONS.  As used herein,  the  following  terms shall have the meanings
respectively set forth below: "Base Interest Rate" shall mean a rate of interest
based  on  the  LIBOR  Rate.  "Base  Interest  Rate  Loan"  shall  mean  amounts
outstanding  under this note that bear interest at a Base Interest  Rate.  "Base
Rate Maturity Date" shall mean the last day of the Interest  Period with respect
to principal  outstanding under a Base Interest Rate Loan.  "Business Day" shall
mean a day which is not a Saturday or Sunday on which Bank is open for  business
in the state  identified in paragraph 6, above, and with the respect to the rate
of interest based on the LIBOR Rate, on which dealings in U.S.  dollar  deposits
outside of the United States may be carried on by Bank.  "Interest Period" shall
mean  any  calendar  period  of one,  three,  six,  nine or  twelve  months.  In
determining  an  Interest  Period,  a month  means a period  that  starts on one
Business  Day in a  month  and  ends  on and  includes  the  day  preceding  the
numerically corresponding day in the next month. For any month in which there is
no such numerically  corresponding day, then as to that month, such day shall be
deemed to be the last  calendar  day of such month.  Any  Interest  Period which
would  otherwise  end on a  non-Business  Day shall  end on the next  succeeding
Business  Day  unless  that is the first  day of a month,  in which  event  such
Interest Period shall end on the next preceding Business Day. "LIBOR Rate" shall

<PAGE>

mean a per annum rate of interest (rounded upward, if necessary,  to the nearest
1/100 of 1%) at which dollar  deposits,  in immediately  available  funds and in
lawful  money of the United  States  would be  offered  to Bank,  outside of the
United States, for a term coinciding with the Interest Period selected by Debtor
and for an amount equal to the amount of principal  covered by Debtor's interest
rate  selection,  plus  Bank's  costs,  including  the cost,  if any of  reserve
requirements.  "Origination Date" shall mean the Business Day on which funds are
made available to Debtor relating to Debtor's selection of a Base Interest Rate.
"Reference  Rate" shall mean the rate announced by Bank from time to time at its
corporate  headquarters  as its Reference  Rate.  The Reference Rate is an index
rate  determined  by Bank  from  time to time  as a  means  of  pricing  certain
extensions  of credit  and is  neither  directly  tied to any  external  rate of
interest or index nor necessarily the lowest rate of interest charged by Bank at
any given time.

This note is subject to the terms of that certain Trade Credit Agreement between
Debtor and Bank dated as of July 24, 1997, and any extension,  modifications  or
amendments thereof.

INFORMATION STORAGE DEVICES, INC.



 By:  /S/ Felix Rosengarten

Felix Rosengarten
Chief Financial Officer




<PAGE>

                                                                   AUTHORIZATION

Borrower Name
INFORMATION STORAGE DEVICES, INC.

Borrower Address                             Office Number        Loan Number
2045 HAMILTON AVENUE                             126              0005-00-0000
SAN JOSE, CA 95125
                                             Matunty Date         Amount
                                             June 30, 1998        $15,000,000.00


Union Bank of California, N.A. ("Bank") is hereby authorized and instructed to
disburse the proceeds of that certain Note referenced above in the following
manner:

Deposit the proceeds of our  revolving  note into our account  #1260002364  from
time to time and in such amounts as may be requested verbally or in writing.

Fees itemized below are payable as follows (check one):

__ Charge account number:             N/A                      __ Check enclosed

                            TERMS AND CONDITIONS

1. Bank is  authorized  to charge  account  number  1260002364 in the name(s) of
INFORMATION  STORAGE  DEVICES,  INC.  for  payments of interest  (or  principal/
interest)  when due in connection  with this Note and all renewals or extensions
thereof.

2.  Bank shall disburse  proceeds in the amounts stated above in accordance with
    the  foregoing  authorization  or  when  Bank  receives  verbal  or  written
    authorization  from  Borrower(s) to do so, or any one of the  Borrowers,  if
    there are joint  Borrowers,  but not later than June 30, 1998.  The Bank, at
    its  discretion,  may  elect  to  extend  this  date  without  notice  to or
    acknowledgement  by  the  borrower(s).  This  Authorization  and  the  above
    mentioned Note will remain in full force and effect until the obligations in
    connection with this Note have been fulfilled.

3.  Unless dated by Bank prior to execution,  the Note shall be dated by Bank as
    of the date on which Bank disburses proceeds.

4.  Notwithstanding  anything to the contrary herein, Bank reserves the right to
    decline to advance the  proceeds of the above  described  Note if there is a
    filing as to the  Borrower(s),  or any of them of a voluntary or involuntary
    petition  under the  provisions of the Federal  Bankruptcy  Act or any other
    insolvency  law; the issuance of any attachment,  garnishment,  execution or
    levy of any asset of the  Borrower(s),  or any endorser or  guarantor  which
    results in Bank deeming itself, in good faith insecure.

5.  The  borrower(s)  authorizes  Bank to  release  information  concerning  the
    borrower(s)  financial  condition  to  suppliers,  other  creditors,  credit
    bureaus and other credit reporters;  and also authorizes Bank to obtain such
    information from any third party at any time.


<PAGE>


The  Borrower(s) by their execution of this  Authorization  accept the foregoing
terms, conditions and instructions.

Executed on July 24, 1997



Individual's Name (Type)      Corporation or Partnership (Typed Name)

Individual's Signature        Information Storage Devices, INC.

Individual's Name (Type)      By    /S/ Felix Rosengarten

Individual's Signature        Title:   Felix Rosengarten,Chief Financial Officer

Address





<PAGE>


TRADE CREDIT AGREEMENT

This Trade Credit Agreement  ("Agreement") entered into as of the date set forth
below between the undersigned  ("Borrower")  and Union Bank of California.  N.A.
("Bank"),  with  respect  to each and every  extension  of credit  (collectively
referred to as the "Trade Facility") from Bank to Borrower.  In consideration of
the  Trade  Facility,  Bank  and  Borrower  agree  to the  following  terms  and
conditions:

1. THE TRADE: FACILITY

1.1 The Note. The Trade Facility is evidenced by one or more  promissory  notes,
reimbursement  agreements.  or other  evidence of  indebtedness,  including each
amendment,  extension,  renewal or replacement  thereof,  which are incorporated
herein by this reference.

1.2 The Trade Finance Credit  Facilities.  The Trade Finance  Credit  Facilities
available  to  Borrower   shall  expire  on  June  30,  1998,  and  shall  total
$15,000,000.00 and be evidenced by a note and other evidence of indebtedness and
subject to the following, sublimits:

The Commercial L/C Line in an amount not to exceed $ 14,400,000.00

The Trade Finance Line in an amount not to exceed $ - 0 -

The Clean Advance Line in an amount not to exceed $ 14,400,000.00

The Standby L/C Line in an amount not to exceed $ 600,000.00

and other terms and  conditions  described  below.  Also,  the  combined  amount
outstanding  under the Trade  Finance Line and the Clean  Advance Line shall not
exceed $ 14,400,000.00, at any time.

1.3  The  Commercial  L\C  Line  shall  be  for  commercial  letters  of  credit
("Commercial L/C's") calling for

X sight drafts;                                 X issuance drafts up to 60 days

for the  importation  or  purchase  of  general  merchandise  , each  having  an
expiration  date not more  than 180 days from its date of  issuance,  but in any
event not later than October30,1998.

1.4 The Trade Finance Line (the "Line") shall be for the purpose of

X Creating bankers' acceptances under usance Commercial L/Cs;

Each  drawing  under the Line  shall,  be due and payable not later than N/A (_)
days  following,  as the case  may be.  (a) the  release  of  documents  by Bank
(including  any issuance  period),  or (b) the date of shipment on open account,
under the applicable transaction. All advances under the Line must be made on or
before  N/A,  199_.  In the event of a renewal  or  extension  of the Line,  the
original  maturities of each advance shall continue unless  otherwise  agreed in
writing between Borrower and Bank.

1.5 The Clean Advance Line shall be for  Borrower's  working  capital  purposes.
Advances must be made on or before June 30,1998. The Clean Advance Line shall be
evidenced  by, and subject to the terms of a note on the  standard  form used by
Bank for commercial loans.

1.6  Clean-up  Period.  Under  the  Clean  Advance  Line,  during  at least  N/A
consecutive  clays in each 12 month  period,  the principal  amount  outstanding
under such line must be zero.

1.7 The Standby Letter of Credit Line shall be for  irrevocable  standby letters
of credit,  each having an expiration date not more than 12 months from its date
of issuance, but in any event not later than June 30 1998.

<PAGE>

1.8  Limitations on the Trade Finance Credit  Facilities.  The aggregate  amount
available to be drawn under each sublimit listed above shall be reduced,  dollar
for dollar,  by the aggregate amount of unpaid principal  obligations  under the
respective  sublimit.  The  aggregate of all unpaid  advances and  reimbursement
obligations shall reduce, dollar for collar, the maximum

*  Wherever , "N/A". appears in a blank in this Agreement, it means the
   Subsection in which it appears is deemed deleted from this Agreement If only
   a portion of a Subsection is to be deleted. it is crossed-out (e.g.,
   crossed-out).

amount available under the Trade Finance Credit Facilities Borrower may reborrow
or obtain new  extensions of credit under h such sublimit  until the  expiration
date of such  facilities.  to the extent  that  Borrower  has paid or  otherwise
satisfied  prior  borrowings or  extensions of credit,  subject to all terms and
conditions in the Loan Documents (defined below).

1.9 Trade Finance Fees.  All fees in  connection  with the Trade Finance  Credit
Facilities  will be in  accordance  with  Bank's  standard  schedule  of fees as
published from time to time or as otherwise agreed to in writing by Borrower and
Bank.

1.10 Other Fee. Borrower shall also pay to Bank a fee of $ N/A

1.11  Collateral.  The payment and  performance  of all  obligations of Borrower
under the Loan  Documents  are and shall be ring the term of the Trade  Facility
secured by a  perfected  security  interest  in such real or  personal  property
collateral as is required by Bank and each security interest shall rank in first
priority unless otherwise specit~ied in v rising by Bank.

1.12 Term Loan. In addition to the Trade Finance Credit Facility, each term loan
  available to Borrower  shall be evidenced a note on the standard  form used by
  Bank for commercial  loans.  Proceeds of each term loan shall be available for
  disbursement from N/A , 199_, through N/A , 199_ only.

1.13 Guaranty.  The payment and performance of all obligations of Borrower under
the  Trade  Facility  are and  shall  be ring  the  term of the  Trade  Facility
guaranteed by:   N/A

1.14  Subordination.  Certain  other  obligations  of Borrower  are and shall be
during  the  term  of  the  Trade  Facility  Coordinated  to  repayment  of  all
obligations  of  Borrower  to  Bank,  pursuant  to  one  or  more  subordination
agreement(s) in, or of Bank executed and delivered by: N/A

2. CONDITIONS TO AVAILABILITY OF THE TRADE FACILITY

re Bank is obligated to extend any credit under this  Agreement,  Bank must have
received (a) every document required by : in connection with the Trade Facility,
each of which must be in form and substance  satisfactory to Bank (together with
Agreement,  referred  to as  the  "Loan  Documents"),  (b)  confirmation  of the
perfection  of its  security  interest  in any  feral  required  by Bank and (c)
payment of any fees required in connection with the Trade Facility.

<PAGE>

3. REPRESENTATIONS AND WARRANTIES

Borrower  represents  and warrants  (and each request for an extension of credit
hereunder  shall be  deemed a  representation  and City made on the date of such
request) that:

3.1 Borrower is an individual or Borrower is duly  organized and existing  under
the laws of the state of its organization and duly qualified to conduct business
in each jurisdiction in which its business is conducted.

3.2 The execution,  delivery and  performance of the Loan Documents  executed by
Borrower are within  Borrower's  power,  have been duly  authorized,  are legal,
valid and binding  obligations  of  Borrower,  and are not in conflict  with the
terms of the after,  bylaw, or other organization papers of Borrower or with any
law,  indenture,  agreement or  undertaking  to which  borrower is a party or by
which Borrower is bound or affected.

3.3 All  financial  statements  and other  financial  information  submitted  by
Borrower to Bank are true and correct in all  material  respects,  and there has
been no material adverse change in Borrower's financial condition since the date
of the latest such financial statements.

3.4 Borrower is properly  licensed  and in good  standing in each state in which
Borrower  is  doing  business,  and  Borrower  s  complied  with  all  laws  and
regulations  affecting  Borrower,  including within limitation,  each applicable
fictitious business name statute.

3.5 There is no event  which is, or with  notice or lapse of time or both  would
be, an Event of Default (as defined in article 5).

3.6 Borrower is not engaged in the business of extending  credit for the purpose
of, and no part of the Trade Facility will be used, directly or indirectly,  for
purchasing or carrying  margin stock within the meaning of Federal Reserve Board
Reg. U.

3.7 Borrower is not aware of any fact, occurrence or circumstance which Borrower
  has not disclosed to Bank in writing which has or could reasonably be expected
  to have, a material  adverse  effect on  Borrower's  ability to pay or perform
  borrower's obligations to Bank.

4.COVENANTS. Borrower agrees, so long as the Trade Facility or any commitment to
make any advance  thereunder is outstanding  and until full and final payment of
all sums outstanding under any Loan Document, that Borrower will:

<PAGE>

4.1 Maintain:

(a) Working, Capital of at least $ N/A current assets over current liabilities);
(As used  herein,  "Working  Capital"  means the excess of current  assets  over
current liabilities);

(b) A ratio of current assets to current liabilities of at least N/A l.00;

(c) A quick;  ratio of cash,  accounts  receivable and marketable  securities to
current liabilities of at least N/A:1.00;

(d) Tangible Net Worth of at least $ N/A (As used herein,  "Tangible  Net Worth"
means net worth increased by  indebtedness of Borrower  subordinated to Bank and
decreased by patents,  licenses,  trademarks,  trade  names,  goodwill and other
similar  intangible  assets,   organizational   expenses  and  monies  due  from
affiliates (including officers, shareholders and directors));

(e) A ratio of total  liabilities  to Tangible Net Worth of not greater than N/A
:1.00  (As used  herein  "Tangible  Net  Worth"  means net  worth  increased  by
indebtedness  of  Borrower  subordinated  to  Bank  and  decreased  by  patents,
licenses, trademarks, trade names, goodwill and other similar intangible assets,
organizational  expenses, and monies due from affiliates  (including,  officers,
shareholders and directors));

(f) A profit after taxes of not less than $ N/A, to be measured as of the end of
each fiscal N/A of Borrower for the N/A period immediately preceding the date of
measurement;

(g) A ratio of Cash Flow to Debt Service of at least N/A :1.00.  Compliance with
this subsection to be measured as of the end of each fiscal N/A of Borrower. (As
used herein,  "Cash Flow" means net profit after taxes,  to which  depreciation,
amortization  and other  non-cash  expenses  are added for the N/A month  period
immediately  preceding the date of  calculation,  and "Debt  Service" means that
portion of long-term liabilities and capital leases coming due within N/A months
after the date of calculation);

(h)  Borrower to maintain a minimum of $17,700,000.00 in pledged  investments in
     its ) Liquidity Management Account.

All accounting  terms used in this Agreement  shall have the  definitions  given
them by generally  accepted  accounting,  principles.  unless otherwise  defined
herein

4.9 Give written notice to Bank within I 5 days after the following,:

(a) Any litigation or arbitration proceeding affecting Borrower where the amount
in controversy is $ 25,000.00 or more:

(b) Any material  dispute  which may exist between  Borrower and any  government
regulatory body or law enforcement body;

(c) Any Event of Default or any event which,  upon notice,  or lapse of time, or
both, would become an Event of Default:

(c) Any other  matter  which has  resulted  or is likely to result in a material
adverse change in Borrower's financial condition or operation; and

(e) Any change in Borrower's name or the location of Borrower's  principal place
of business,  or the location of any collateral for the Trade  Facility,  or the
establishment of any new place of business or the discontinuance of any existing
place of business.

<PAGE>

4.3  Furnish  to Bank an income  statement,  balance  sheet,  and  statement  of
retained earnings with supportive schedules  ("Financial  Statements"),  and any
other  financial  information  requested by Bank,  prepared in  accordance  with
generally accepted  accounting  principles and in a form satisfactory to Bank as
follows:

(a)  Within  45 days  after the close of each  quarter  ,  Borrower's  Financial
Statement as of the close of such period;

(b) Within 120 days after close of each fiscal year, a copy of Borrower's annual
Financial  Statement  prepared by an independent  certified public accountant on
a(n) audited basis.  Any independent  certified  public  accountant who prepares
Borrower's  Financial  Statement  shall be selected by Borrower  and  reasonably
satisfactory to Bank;

(c)  Annually,  upon  request,  a copy  of  each  guarantor's  annual  Financial
Statement;

(d) If a Borrowing Base Addendum is made part of this Agreement, within N/A days
after each  calendar  monthend' in form  required by Bank, a copy of  Borrower's
monthly accounts receivable and accounts payable agings,

 a report of  Borrower's  inventory,  and a certificate  of compliance  with the
bonTowing base described in sail  Borrowing  Base  Addendum,  which  certificate
shall accurately report the collateral in form required by Banli; an

(e) Promptly upon request, any other financial information requested by Bank.

4.4  Furnish  to  Bank,  on  Bank's  request,  a copy  of  Borrower's  and  each
guarantor's  most recently filed federal  income tax unit with all  accompanying
schedules.

4.5 Pay or reimburse  Bank for all costs,  expenses and fees incurred by Bank in
preparing and documenting this Agreement i the Trade Facility and all amendments
and modifications thereof, including but not limited to all filing and recording
s, costs of appraisals,  insurance and attorneys' fees, including the reasonable
estimate of the allocated  costs and expenses  in-house legal counsel and staff.
4.6 Maintain and preserve Borrower's existence, present form of business and all
rights,  privileges and franchises  necessary  desirable in the normal course of
its  business and keep all of Borrower s  properties  in good working  order and
condition.

4.7 Maintain and keep in force  insurance with companies  acceptable to Bank and
in such  amounts  and  types,  including  without  limitation  fire  and  public
liability insurance,  as is usual in the business carried on by Borrower,  or as
Bank  may  reasonably  request.  Stick  insurance  policies  must be in form and
substance satisfactory to Bank.

4.8 Maintain  adequate  books,  accounts  and records and prepare all  financial
statements  required  hereunder in accordance th generally  accepted  accounting
principles and in compliance with the regulations of any governmental regulatory
body  having  jurisdiction  over  Borrower  or  Borrower's  business  and permit
employees or agents of Bank at any reasonable time to inspect  Borrower's assets
and properties,  and to examine or audit Borrower's books,  accounts and records
and make copies and memoranda thereof.

  4.9 At all times comply with or cause to be complied with, all laws, statutes,
rules,  regulations,  orders and directions of any governmental authority having
jurisdiction over Borrower or Borrower's  business,  and all material agreements
to which Borrower is a party.

  4.10 Except as provided in this  Agreement  or in the  ordinary  course of its
business  as  currently  concluded,  not make any  loans or  advances,  become a
guarantor or surety,  pledge its credit or properties  in any manner,  or extend
credit.

<PAGE>

  4.11 Not  purchase the debt or equity of another  person or entity  except for
savings  accounts and  certificates of deposit of Bank,  direct U.S.  Government
obligations  and  commercial  paper issued by  corporations  with top ratings of
Moody's or Standard & Poor's, provided that all such permitted investments shall
mature within one year of purchase.

  4.12 Not create, assume or suffer to exist any mortgage, encumbrance, security
interest,  pledge or lien  ("Lien") on  Borrower's  real or  personal  property,
whether now owned or hereafter  acquired,  or upon the income or profits thereof
except  the  following:  (a) Liens in favor  Bank,  (b) Liens for taxes or other
items not delinquent or contested in good faith and (c) other Liens which do not
exceed in the aggregate $ 25,000,000 at any one time.

4.13 Not sell or discount any account  receivable  or evidence of  indebtedness,
 except to Bank;  not borrow any money or become  contingently  liable for money
 borrowed, except pursuant to agreements made with Bank.

4.14  Neither  liquidate,  dissolve,  enter  into  any  consolidation,   merger,
 partnership or other combination;  nor convey, sell or lease all or the greater
 part of its assets or  business;  nor purchase or lease all or the greater part
 of the assets or business of another.

4.15 Not engage in any business activities or operations substantially different
 from or unrelated to Borrower's present business activities and operations.

4.16 Not, in any single fiscal year of Borrower,  expend or incur obligations of
 more than $ N/A the acquisition of fixed or capital assets.

4.17 Not in any single fiscal year of Borrower,  enter into any lease of real or
 personal  property which would cause Borrower's  aggregate  annual  obligations
 under all such real and personal property leases to exceed $ /A

4.18 If Bank creates bankers' acceptances  ("Acceptances") they shall be created
only under the following terms:

(a) Borrower agrees to pay to Bank the amount of such Acceptance (and the amount
of all charges and expenses that Bank may incur relating to such  Acceptance) no
later than the banking day prior to maturity of the relevant  draft,  or earlier
upon Bank's demand following an Event of Default. (b) Borrower shall also pay to
Bank,  as and when the same would be payable under Bank's  standard  procedures,
any and all standard fees and  commissions  payable with respect to the creation
of bankers'  acceptances,  and shall reimburse Bank, on demand for all of Bank's
out-of-pocket costs and expenses incurred in connection with each Acceptance and
not otherwise  covered by such standard fees or  commissions.  All such standard
fees and commissions shall be computed and paid at Bank's prevailing rates. Bank
shall  have no  obligation  to repay  all or any  portion  of  Banks  acceptance
commission (or any other amount paid by Borrower with respect to an Acceptance).

(c) If any Acceptance created is, for any reason,  subsequently determined to be
ineligible  for discount with Federal  Reserve  Banks,  or if there shall be any
change in law or  regulation  with  respect to the  creation or  discounting  of
Acceptances or the maintaining of reserves with respect thereto, Borrower shall,
upon Bank's demand,  pay to Bank additional amounts sufficient to indemnify Bank
against any additional costs incurred by Bank in connection with such ineligible
Acceptance or such change in law or  regulation.  Bank's  certificate  as to any
such  additional  amounts.  submitted to Borrower,  shall he  conclusive  absent
manifest error.

<PAGE>

(d) Borrower  represents  and agrees that the creation by Bank of each  eligible
Acceptance  for Borrower will he deemed an additional  representation  that each
Acceptance  created for Borrower shall (i) arise solely out of transactions  for
the current sale and distribution on usual credit terms of imported, exported or
domestically  shipped  goods,  and (ii) have a face  amount not in excess of the
amount  invoiced to Borrower  in  connection  with such  transaction  and,  with
respect to the creation of each eligible  Acceptance,  otherwise comply with all
applicable  rules and  regulations  of the  Federal  Reserve  System  governing,
bankers'  acceptances  and meet the  requirements  for  eligibility for discount
with' Federal  Reserve  Banks.  Borrower  shall  maintain and. at Bank's request
shall provide to Bank or its designee such evidence,  certificates and documents
sufficient to establish that Bank's creation of such Acceptance is in compliance
with all applicable laws, regulations and administrative  orders., 4.19 Borrower
will  promptly,  upon demand by Bank,  take such further  action and execute all
such  additional  documents and instruments in connection with this Agreement as
Bank in its reasonable  discretion deems necessary and promptly supply Bank with
such other  information  concerning its affairs as Bank may request from time to
time.

5. EVENTS OF DEFAULT

The  occurrence  of any of the  following  events  ("Events of  Default")  shall
terminate  any  obligation  on the part of Bank to make or  continue  the  Trade
Facility and automatically,  unless otherwise provided under the Loan Documents,
shall make all sums of interest and  principal and any other amounts owing under
the Trade  Facility  immediately  due and  payable,  without  notice of default,
presentment or demand for payment,  protest or notice of nonpayment or dishonor,
or any other notices or demands:

5.1 Borrower  shall default in the due and punctual  payment of the principal of
or the interest under any of the Loan Documents; or

5.2 Any default shall occur under any of the Loan Documents; or

5.3 Borrower shall default in the due  performance or observance of any covenant
or condition of the Loan Documents; or

5.4 Any guaranty or subordination agreement required hereunder shall be breached
or become ineffective,  or any guarantor or subordinating  creditor shall die or
disavow  or  attempt  to revoke or  terminate  such  guaranty  or  subordination
agreement; or

5.5 There shall be a change in ownership or control of ten percent (10%) or more
of the  issued  and  outstanding  stock of  Borrower  or any  guarantor,  or (if
Borrower is a  partnership)  there shall be a change in  ownership or control of
any general partner's interest.

6. MISCELLANEOUS PROVISIONS

6.1 The rights,  powers and remedies given to Bank hereunder shall be cumulative
and not alternative and shall be in addition to all rights,  powers and remedies
given to Bank by law against  Borrower or any other  person,  including  but not
limited to Bank's rights of setoff and banker's lien.

6.2 Any  forbearance or failure or delay by Bank in exercising any right,  power
or  remedy  hereunder  shall not be deemed a waiver  thereof  and any  single or
partial  exercise of any right,  power or remedy  shall not preclude the further
exercise  thereof.  No waiver  shall be  effective  unless it is in writing  and
signed by an officer of Bank.

6.3 The benefits of this Agreement  shall inure to the successors and assigns of
Bank and the permitted successors and assigns of Borrower, and any assignment by
Borrower without Bank's consent shall be null and void.

6.4 This Agreement and all other agreements and instruments  required by Bank in
connection  herewith shall be governed by and construed according to the laws of
the State of California.

6.5 Should any one or more  provisions  of this  Agreement be  determined  to be
illegal or unenforceable,  all other provisions nevertheless shall be effective.
In the event of any conflict  between the  provisions of this  Agreement and the
provisions of any note or  reimbursement  agreement  evidencing any indebtedness
hereunder, the provisions of such note or reimbursement agreement shall prevail.

<PAGE>

6.6 Except for documents and instruments  specifically  referenced herein,  this
Agreement  the entire  agreement  between Bank and Borrower  regarding the Trade
Facility and all prior  communications  verbal or written  between  Borrower and
Bank shall be of no further effect or evidentiary value.

6.7 The section and subsection  headings herein are for convenience of reference
only and shall not limit or otherwise affect the meaning hereof.

6.8 This Agreement may be amended only in writing signed by all parties hereto.

6.9 Borrower and Bank may execute one or more  counterparts  to this  Agreement,
each of which shall be deemed an original,  but taken  together shall be one and
the same instrument.

6.10 Any notices or other communications provided for or allowed hereunder shall
be effective  only when given by one of the  following  methods and addressed to
the respective party at its address given with the signatures at the end of this
Agreement and shall be considered to have been validly given: (a) upon delivery,
if  delivered  personally;  (b) upon  receipt,  if mailed,  first class  postage
prepaid, with the United States Postal Service; (c) on the next business day, if
sent  by  overnight  courier  service  of  recognized  standing;  and  (d)  upon
telephoned confirmation of receipt, if telecopied.


<PAGE>



7. ADDITIONAL PROVISIONS

The  following  additional  provisions,  if any,  are hereby made a part of this
Agreement:

N/A

 THIS AGREEMENT is executed on behalf of the parties as of July 24, 1997


Union Bank of California, N.A. ("Bank")        (" Borrower ")

By:  /S/ Jerry Iwata                           Information Storage Devices, INC.

Title:  Assistant Vice President               /S/  Felix Rosengarten

Printed Name: Jerry Iwata                      By: Felix Rosengarten

                                               Title: Chief Financial Officer

Address                                        where  notices  to Bank are to be
                                               sent:  Address  where  notices to
                                               Borrower are to be sent:

UNION BANK OF CALIFORNIA, N.A.                 2045 HAMILTON AVENUE
495 S. MATHILDA AVENUE                         SAN JOSE, CA 95125
SUNNYVALE, CA 94086

Attn: Jerry Iwata.                             Attn: Felix Rosengarten



Fax Number: (408) 738-5353                     Fax Number (408) 369-2577
Telephone No. ( 408) 738-4903                  Telephone No. (408) 369-2428



<PAGE>


ALTERNATIVE DISPUTE
RESOLUTION AGREEMENT

THIS ALTERNATIVE DISPUTE RESOLUTION AGREEMENT  ("Agreement") is made and entered
into  as of the  24th  day of  July  ,  1997  by  and  between  the  undersigned
("Obligor") and United Bank of California. N.A ("Bank")

(Obligor  and Bank  herein  collectively,  the  "Parties"  and  individually,  a
"Party").  Initially  capitalized  terms  used in this  Agreement  which are not
otherwise  defined  herein  shall  have the  respective  meanings  set  forth in
Paragraph 7 of this Agreement.

1. CLAIMS SUBJECT TO ARBITRATION OR JUDICIAL REFERE.N'CE.

(a) Any  Claim  other  than  it  Claim  that  arises  out of or  relates  to any
    obligation  under any Subject  Document that is secured in whole or in part,
    be an interest in real property  shall at the written  request of any Party,
    be determined by Arbitration.

(b) Any Claim that arises out of or relates to any obligation  under any Subject
    Document  that is  secured  in  whole  or in part.  by an  interest  in real
    property  shall be determined by  Arbitration  only with the consent of both
    Parties.  If both Parties do consent to the  determination of any such Claim
    by Arbitration.  then such Claim shall, at the written request of any Party,
    be determined by Reference.

(c) The  determination  as to whether or not a Claim arises out of or relates to
    any  obligation  under any Subject  Document  that is secured in whole or in
    part,  by an  interest  in real  property  shall  be made  at the  time  the
    arbitrator or referee is secured pursuant to Paragraph 7 of this Agreement.

2. SELECTION OF ARBITRATOR OR REFEREE.  Within 30 days after written demand.  or
within 30 days after  commencement  by any Party, of any lawsuit subject to this
Agreement,  the Parties shall select a single neutral arbitrator pursuant to the
Commercial  Arbitration Rules of the AAA or a single neutral referee pursuant to
the Judicial Reference Procedures of the AAA. However, the arbitrator or referee
selected must be a retired state or federal court judge with at least five years
of  judicial  experience  in civil  matters.  In the  event  that the  selection
pursuant to such Commercial  Arbitration Rules or Judicial Reference  Procedures
does not result in the  appointment of a single  neutral  arbitrator or a single
neutral  referee  within o 30 days,  any such  Party may  petition  the court to
appoint a single neutral  arbitrator or single neutral referee with the judicial
experience described above. The Parties shall equally bear the fees and expenses
of the arbitrator or referee unless the arbitrator or referee otherwise provides
in the award or statement of decision.

3. CONDUCT OF ARBITRATION OR REFERENCE

(a) Except as provided in this Agreement,  the arbitrator  shall have the powers
    provided under Applicable State Law and the Commercial  Arbitration Rules of
    the AAA, and the referee  shall have the powers  provided  under  Applicable
    State Law and the Judicial Referee Procedures of the AAA.

(b) The arbitrator or referee shall challenge the legality or  enforceability of
this Agreement.

(c) The  arbitrator  or retiree  shall apply the rules of  existence to the same
extent as they would he applied in a court of law.

(d) A Party may not conduct  discovery  unless the  arbitrator or referee grants
    such Party leave to do so upon a showing of good cause.  All discovery shall
    be  completed  within 90 days after the  appointment  of the  arbitrator  or
    referee, except upon a showing of good cause by any Party. The arbitrator or
    retiree shall limit discovery to non-privileged material that is relevant to
    the issues to be determined by the arbitrator or referee.

<PAGE>

(e) The arbitrator or referee shall  determine the time of the hearing and shall
    designate  its location  based upon the  convenience  of the.  arbitrator or
    referee,  the Parties and any  witnesses.  However,  such  hearing  shall be
    commenced  within  30  days  after  completion  of  discovery,   unless  the
    arbitrator or referee  grants a continuance  upon a showing of good cause by
    any Party. At least 7 days before the date set for such hearing, the Parties
    shall  exchange  copies of exhibits to be offered as evidence,  and lists of
    the witnesses who will testify, at such hearing. Once commenced, the hearing
    shall proceed day to day until  completed,  unless the arbitrator or referee
    grants a  continuance  upon a showing of good cause by any Party.  Any Party
    may  cause to be  prepared,  at its  expense,  a  written  transcription  or
    electronic recordation of such hearing.

(f) Subject to the provisions of this  Agreement,  the arbitrator may award,  or
    the referee may report, a statement of decision  providing for any remedy or
    relief,  including  without  limitation  judicial  foreclosure,   deficiency
    judgment and  equitable  relief,  and give effect to all legal and equitable
    defenses,  including without limitation statutes of limitation,  the statute
    of frauds, waiver and estoppel.

(g) The award of the  arbitrator  or the  statement  of  decision of the referee
    shall be  supported  by written  findings  of' fact and  conclusions  of law
    delivered by the arbitrator or referee to the Parties concurrently with such
    award or statement of decision.

(h) In the event that punitive damages are permitted under Applicable State Law,
    the award of the  arbitrator or the statement of decision of the referee may
    provide for recovery of punitive  damages  provided  that the  arbitrator or
    referee  first  makes  written  findings  of fact  that  would  satisfy  the
    requirements  for recovery of punitive  damages under  Applicable State Law.
    Any such  punitive  damages  shall not exceed a sum equal to three times the
    amount of actual damages as determined by the arbitrator or referee.

(i) The  arbitrator  shall have the power to award or the referee shall have the
    power to report a statement of decision providing for reasonable  attorneys'
    fees (including a reasonable  allocation for the costs of in-house  counsel)
    and costs to the prevailing party.

(j)In the  event  that  Applicable  State  Law  provides  that  publications  or
   communications  made in a judicial  proceeding  are  subject to a  litigation
   privilege,  such  litigation  privilege  shall  apply to the same  extent  to
   publications or communications made in the Arbitration or Reference.

<PAGE>

4.  PROVISIONAL  REMEDIES,  SELF-HELP  AND  FORECLOSURE.  No  provision  of this
Agreement shall limit the right of any Party (a) to exercise  self-help remedies
including,  without  limitation,  set-off,  (b) to foreclose against or sell any
collateral, by power of sale or otherwise or (c) to obtain or oppose provisional
or ancillary remedies from a court of competent  jurisdiction  before,  after or
during the  pendency  of the  Arbitration  or  Reference.  The  exercise  of, or
opposition  to,  any  such  remedy  does not  waive  the  right of any  Party to
Arbitration or Reference pursuant to this Agreement.

5.  FINAL,   BINDING  AND  NONAPPEALABLE   JUDGMENT.   Any  court  of  competent
jurisdiction  shall,  upon the  petition of any Party,  confirm the award of the
arbitrator  and enter judgment in conformity  therewith.  Any court of competent
jurisdiction shall, upon the filing of the statement of decision of the referee,
enter  judgment   thereon.   Any  such  judgment  shall  be  final  binding  and
nonappealable.

6. MISCELLANEOUS.  In the event that multiple claims are asserted, some of which
are  found  not  subject  to this  Agreement,  the  Parties  agree  to stay  the
proceedings of the claims not subject to this  Agreement  until all other claims
are resolved in  accordance  with this  Agreement.  In the event that claims are
asserted  against  multiple  parties,  some of  whom  are  not  subject  to this
Agreement,  the Parties agree to sever the claims  subject to this Agreement and
resolve them in accordance with this Agreement.  In the event that any provision
of this Agreement is found to be illegal or unenforceable, the remainder of this
Agreement shall remain in full force and effect.  In the event of' any challenge
to the legality or enforceability of this Agreement,  the prevailing Party shall
be entitled to recover the costs arid expenses,  including reasonable attorneys'
fees incurred by it in connection  therewith.  Applicable State Law shall govern
the  interpretation  of this  Agreement.  This Agreement fully states all of the
terms and conditions of the Parties  agreement  regarding the matters  mentioned
in, or  incidental  to,  this  Agreement.  This  Agreement  supersedes  all oral
negotiations and prior writings concerning the subject matter hereof.

7. DEFINED TERMS. As used in this Agreement,  the following terms shall have the
respective meanings set forth below:

(a) "AAA" shall mean the American Arbitration Association.

(b)"Applicable  State  Law " shall  mean  the law of the  state  in  which  this
   Agreement is executed by Obligor;  provided however,  that if any Party seeks
   (i) to exercise self-help  remedies,  including without  limitation  set-off,
   (ii) to  foreclose  against  or sell  any  collateral,  by  power  of sale or
   otherwise or (iii) to obtain or oppose provisional or ancillary remedies from
   a court of competent jurisdiction before, after or during the pendency of the
   Arbitration  or  Reference,  the law of the state  where such  collateral  is
   located  shall  govern  the  exercise  of or  opposition  to such  rights and
   remedies.

<PAGE>

(c)"Arbitration" shall mean an arbitration  conducted pursuant to this Agreement
   in accordance with Applicable State Law, and under the Commercial Arbitration
   Rules of the  AAA,  as in  effect  at the time  the  arbitrator  is  selected
   pursuant to paragraph 2 of this Agreement.

(d)"Claim" shall mean any claim, cause of action, action, dispute or controversy
   between or among the Parties  including any claim,  cause of action,  action,
   dispute or  controversy  alleged in or subject to a lawsuit  between or among
   the Parties which arises out of or relates to:

   (i) any of' the Subject Documents,

   (ii) any negotiations,  correspondence or communications  relating to any of'
   the Subject Documents, whether or not incorporated into the Subject Documents
   or any indebtedness evidenced thereby.

   (iii) the  administration  or  management  of the  Subject  Documents  or any
   indebtedness evidenced thereby or

   (iv ) any alleged  agreements,  promises,  representations or transactions in
   connection  therewith,  including  but not  limited  to any  claim,  cause of
   action,  action,  dispute or controversy which arises out of or is based upon
   an alleged tort or other breach of legal duty.

(e)"Reference"  shall  mean a  judicial  reference  conducted  pursuant  to this
   Agreement  in  accordance  with  Applicable  State Law and under the Judicial
   Reference  Procedures  of the AAA,  as in effect at the time the  referee  is
   selected pursuant to paragraph 2 of this Agreement.

(l') "Subject  Documents"  shall  mean any and all  documents,  instruments  and
   agreements previously, concurrently or hereafter executed by Obligor in favor
   of' Bank,  or between  Obligor and Bank,  which  incorporate  by reference an
   alternative  dispute resolution  agreement or another agreement providing for
   the  resolution  of Claims  between or among the  Parties by  arbitration  or
   judicial reference, any and all related documents instruments and agreements,
   and  any  and  all  extensions,   renewals,  amendments,   substitutions  and
   replacements of any of the foregoing;  and "Subject  Document" shall mean any
   one of such Subject Documents

8.  WAIVER  OF RIGHT TO TRIAL BY JURY.  In  connection  with an  Arbitration  or
Reference  or any other  action or  proceeding,  the Parties  hereby  expressly,
intentionally and deliberately  waive any right they may otherwise have to trial
by jury of any Claim.

This  Agreement  is duly  executed by the  Parties as of the date first  written
above.

INFORMATION STORAGE DEVICES, INC.       Union Bank of California, N.A.  ("Bank")

By:  /S/ Felix Rosengarten              /S/  Jerry Iwata

Felix Rosengarten                       Jerry Iwata
Chief Financial Officer                 Assistant Vice President