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, 1996

                                       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. [ ]

     The  aggregate  market value of voting stock held by  nonaffiliates  of the
Registrant,  was  approximately  $73,046,649  (based upon the closing  price for
shares of the  Registrant's  Common  Stock as  reported by the  National  Market
System  of the  National  Association  of  Securities  Dealers,  Inc.  Automated
Quotations  System on February  29,  1996).  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 December 31, 1996,  approximately  9,564,875  shares of Common Stock, no
par value, were outstanding.



<PAGE>



                                                                       1996 10-K
                 Information Storage Devices, Inc.

                               INDEX

              INFORMATION STORAGE DEVICES, INC. (ISD)


   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.................................11


   PART II

   Item 5. MARKET FOR REGISTRANT'S COMMON
           EQUITY AND RELATED STOCKHOLDER MATTERS..............11
   Item 6. SELECTED FINANCIAL DATA.............................12
   Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
           FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......12
   Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........18
   Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
           ON ACCOUNTING AND FINANCIAL DISCLOSURE..............32

   PART III

   Item 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE
           REGISTRANT..........................................32
   Item 11.EXECUTIVE COMPENSATION..............................34
   Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
           OWNERS AND MANAGEMENT...............................36
   Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......37

   PART IV

   Item 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
   14.     REPORTS ON FORM 8-K.................................38
<PAGE>


  This report includes forward looking statements that involve a number of risks
and  uncertainties.  Actual results could differ materially from those discussed
in these statements.  See "Other Factors That May Affect Operating  Results" for
discussion of such factors,  among others,  which could cause actual  results to
differ materially.

Item 1.    BUSINESS

The Company

  ISD  designs,  develops  and markets  single-chip  integrated  circuit  ("IC")
products  for voice  recording  and  playback  using the  Company's  proprietary
ChipCorder(R)  high-density  storage technology and its mixed signal (analog and
digital)  expertise.  The Company believes that its products  provide  customers
with high quality voice recording and playback  functions.  These functions have
enabled the Company's customers to develop many diverse applications. ISD offers
six  product  families  incorporating  its  ChipCorder  technology.  The Company
directs its marketing and product  development  efforts towards products for the
communications, consumer and industrial markets. The Company was incorporated in
California in December 1987.

  Volume  production  shipments  commenced  in 1992 and revenue  grew every year
until  1996.  In February  1995,  ISD had its initial  public  offering  and the
Company did a follow-on offering in September 1995.

Markets, Applications and Customers

  ISD's  mission  is  to  provide  essential   products  to  the  communications
marketplace using its proprietary  multi-level storage and related technologies.
The Company also  provides  voice record and playback  products for the consumer
and  industrial  markets.  The Company  believes  that its  technology  provides
significant  advantages  over its competitors  with single chip,  superior sound
quality, low power consumption,  no software required,  cost-effective,  easy to
use, non-volatile, solid-state voice recording and playback solutions.

   Sales to the Company's top ten customers accounted for 85% of net revenues in
1996 compared to 66% in 1995,  and 70% in 1994.  The top five  customers in 1996
were  Motorola,  Marubun  (the  Company's  Japanese  distributor),   Sanyo,  Yes
Entertainment and Sequoia (the Company's United Kingdom distributor), accounting
for 29%,  23%, 8%, 8%, and 5% of net  revenues,  respectively.  Marubun's  three
largest customers were Toshiba, Sharp, and Sanyo; Sequoia's largest customer was
Panasonic.

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 music on hold 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 already been designed  into pocket  recorders and
telephone answering machines. Along with offering true 3-volt operation, the new
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's Microwire.

  The  largest   single   application   for  the   Company's   products  in  the
communications   market  is   currently   the  cellular   phone.   A  number  of
<PAGE>

manufacturers,  including  Asahi/PhoneMate,  GE Thomson,  Pioneer, Sanyo, Sharp,
Sony 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 or voice memos directly into the phone. Other
representative applications for ChipCorder products in the communications market
include mobile  radios,  caller ID devices and telephone  announcement  systems,
personal handy phones and voice pagers.

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.

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

  The Company currently offers six product families incorporating its ChipCorder
technology:  the  ISD1000A,  ISD1100,  ISD1200,  ISD1400,  ISD2500 and  ISD33000
series. These products are available in die or packaged form and range in retail
list price from $1.30 to approximately $12.00 per unit.

  The Company's first 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  Company's  latest  product  family,  the  ISD33000  series,  offers
substantially  longer voice  recording and playback  durations.  This family has
enabled the  development of a wide variety of product  applications  and is well
suited for 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, which provide users complex messaging and addressing capability.
<PAGE>

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 New York and
Texas.

  In North America, the Company has 20 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.

  Internationally,  the Company has 28 distributors located in Australia, China,
Hong Kong, Israel,  Japan,  Korea, South Africa,  Taiwan,  Singapore,  and every
major  country in Europe.  The Company  relies on its  distributors  for product
promotion and customer  support,  including  identification  and  development of
customers,  applications support,  stocking and media promotion,  such as public
relations  and  advertising  activities.   The  Company's  agreements  with  its
international  distributors  are  renewable  on an  annual  basis,  but  can  be
terminated or discontinued at will.

  Export sales (sales outside North America) constituted  approximately 58%, 65%
and 65% of the Company's net revenues for 1994, 1995 and 1996, 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, 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 1994,  1995 and 1996,  sales to the
Company's top ten customers,  including  those  discussed  below,  accounted for
approximately 70%, 66% and 85%, respectively, of the Company's net revenues. The
Company  has an  agreement  with  Sanyo  for the  distribution  of a  customized
20-second  product  to the  telephone  answering  device  market in Japan.  This
agreement  terminates  in February  2000 and is subject to renewal  periodically
upon agreement of both parties.  Sales to Sanyo  constituted  25%, 10% and 8% of
the  Company's  net revenues  for 1994,  1995 and 1996,  respectively.  Sales to
Motorola,  primarily for use in its MicroTAC Elite cellular phone, accounted for
18% of the  Company's  net  revenues in 1994,  sales to Marubun,  the  Company's
Japanese distributor, and Motorola, accounted for 16% and 13%, respectively,  of
the Company's  net revenues in 1995 and 23% and 29%  respectively  in 1996.  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  significant changes in the
composition  of its  major  customer  base from  year to year and  expects  this
pattern to continue  as certain  customers,  particularly  those that design and
sell  novelty  products in the  consumer  market,  increase  or  decrease  their
purchases of the Company's products as a result of fluctuations in market demand
for such customer's products. For example,  Hallmark accounted for 29% and 5% of
the Company's net revenues in the first two quarters of 1994, accounted for none
of the Company's net revenues in 1995 and is not expected to account for <PAGE>

significant  Company revenues in the future.  Motorola  accounted for 18% of the
Company's  net  revenues in 1994,  13% in 1995 and 29% in 1996. A portion of the
decline in the  Company's  sales to Motorola in 1995  resulted from the grant by
the Company to Samsung of a license to manufacture and sell ChipCorder  products
directly to certain customers of the Company in return for Samsung's  allocating
additional  foundry  capacity to the Company and the  designation of Motorola as
one of the  customers  to which  Samsung  may sell.  The  license  to Samsung to
manufacture  and sell  ChipCorder  products  directly to certain  customers  was
terminated  during 1996. 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  operating  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 novelties,  toys 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  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.  During the production  phase,  the
Company  offers its expertise in  integrated  circuit  assembly  services to its
customers.  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 design manuals 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  devices,  ISD
offers four evaluation tools and two sound development and programming  systems.
These tools allow users to record and play back  messages  and create,  edit and
mass program ISD devices with accurate message location.

Technology

  The Company's  technology  differentiation  lies in its patented technique for
storing multilevel  signals. 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.  Most  ChipCorder  products  use  nonvolatile  memory  and thus 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
<PAGE>

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,
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 pricing,
wafer volume and future technology improvements.

  The Company  announced,  in February 1996, the successful  demonstration of 4X
nonvolatile digital storage using multilevel storage technology. ISD showed that
it is possible to store four bits of digital data per single memory cell,  equal
to 16 distinct voltage levels, or two to the fourth power.  Traditional  digital
memory stores one bit per transistor  cell. The advantage of this  technological
advancement could lead to substantial cost savings,  given that 75 percent fewer
memory cells are required to store a given amount of information.

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 two 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  currently  Samsung in Korea.  The  Company  also uses Sanyo in Japan for the
manufacture of a customized 20-second product for the telephone answering device
market  in Japan.  Sanyo  purchases  all of its  production  of this  customized
product for its own use or for distribution to its customers. In the manufacture
of this product,  Sanyo uses the process  technology of Atmel.  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,  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 Samsung.  The Company has  qualified an
additional wafer  fabrication  facility at Samsung.  If the Company receives its
desired  allocation,  use of this  facility  should  increase the  production at
Samsung.  In  connection  with the increase in capacity at Samsung,  the Company
granted  Samsung the right to use the Company's  technology in certain  end-user
products  distributed  by Samsung.  The Company has  qualified  another  foundry
supplier,  ROHM Co., Ltd. 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 Sanyo or Samsung 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 Sanyo to continue to use the Atmel process  technology,  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


<PAGE>

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,  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.  Currently all of the Company's agreements
with its offshore wafer fabrication and assembly  facilities provide for pricing
and payment in U.S. dollars.

  ChipCorder  products  are  designed  using the process  specifications  of the
Company's foundries.  Currently,  the foundries use CMOS process technology with
1.5 micron,  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.   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.  In 1996, the Company
transferred  all production of the ISD2500 series from a 1.2 micron process to a
0.8 micron process. 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 ICs 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 per wafer or die basis.  The price of each wafer is typically fixed, as
long as the die yield of such wafer reaches a specified  minimum  level.  As the
number of good die per wafer  increases,  the price per  product to the  Company
decreases.  Conversely,  as manufacturing  yields  decrease,  the number of good
products  purchased  for the price of a wafer  decreases,  resulting in a higher
price to the  Company  per  product.  In  addition,  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 a smaller  geometry 1.2 micron process and on its ISD2500
series  as it was  converted  to the 0.8  micron  process.  Current  levels  are
variable  and the Company is  continuing  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

<PAGE>

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 are tested by either  Samsung or the  Company.
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,  the Philippines or Thailand.  The Company  qualifies and monitors
assembly  contractors using procedures  similar in scope to those used for wafer
procurement.  Since a  significant  percentage of Company sales are in die form,
the Company  also  employs  several "die  preparation"  subcontractors  that are
located in Taiwan 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.

  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 9000  certification  in  October  of 1996.  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.  During 1996, the Company achieved three
volt  operation  on its ISD33000  product and  demonstrated  4x digital  storage
resolution.  As a  result,  the  Company  believes  that  continued  significant
expenditures  for research and  development  will be required in the future.  In
particular, the Company expects to develop more products with improved features,
including  greater  analog  storage  resolution  and  faster  writing  speeds on
extended duration 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

<PAGE>

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 1994,  1995 and 1996 were  approximately
$3.2 million, $6.6 million and $11.8 million,  respectively.  As of December 31,
1996,  the Company had 38 full-time and contract  employees  engaged in research
and development.

Backlog

  As of December  31,  1996,  the  Company's  total  backlog  was $6.8  million,
compared  to $18.4  million as of  December  31,  1995.  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.

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 eleven patents granted
(including one patent that was acquired), fifteen patents pending and one patent
application 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 March 2013.  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 fifty-seven patents in Europe,  Japan and elsewhere,  has
one  European  patent  granted,  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  and plans to apply for
additional such  registrations.  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 three  trademarks  registered  in the United  States and has
eight additional  United States  applications  pending.  The Company attempts to
protect its circuit designs, software, trade secrets, and other proprietary

<PAGE>

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 Company  encourages its major customers to display the ChipCorder logo on,
and include  ChipCorder  promotional  materials  with,  their  products  through
trademark  licenses.  The Company has entered  into a licensing  agreement  with
Medtronic, Inc. ("Medtronic"), under which Medtronic has an exclusive license to
use the Company's  technology in certain medical devices. In connection with the
increase in capacity at Samsung,  the Company  granted  Samsung the right to use
the Company's technology in certain end-user products distributed by Samsung.

  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.

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 the ability of the Company 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,

<PAGE>

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, 1996,  the Company had 134  full-time,  1 part-time  and 16
contract/temporary employees. This included 65 employees in manufacturing, 24 in
finance and  administration,  24 in sales and marketing,  and 38 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.  In addition,  certain of the Company's  key  management
personnel have only recently  become  associated  with the Company.  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.


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  believes  that its current  space will be
adequate for at least the next 12 months.


Item 3.    LEGAL PROCEEDINGS

  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 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

<PAGE>

the parties.  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.


                          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, 1996, there were  approximately  169 shareholders of record
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>
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


1995                                    High             Low
------------------------------------------------------------

First Quarter (from February 8, 1995)   $28.000      $19.250
Second Quarter                          $29.125      $20.750
Third Quarter                           $27.500      $19.500
Fourth Quarter                          $26.000      $ 8.000
</TABLE>


<TABLE>
<CAPTION>

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

Years Ended December 31,             1992      1993      1994     1995      1996
-------------------------------------------------------------------------------
(Amounts in thousands,except per share amounts)

Statement of Operations Data:
Net revenues                       $5,232    $22,48    $38,80   $55,46   $41,339
Net income (loss)                 (3,049)        21     4,021    5,812   (8,971)
Net income (loss) per share       $(2.87)    $ 0.00     $0.63    $0.64   ($0.92)
Shares used in per share
computation                         1,064     5,300     6,385    9,084     9,788

Balance Sheet Data:
Cash, cash equivalents and
short-term investments               $445    $5,789    $7,605  $75,094   $55,544
Working capital (deficit)           (237)     6,789     9,735   79,279    65,102
Total assets                        3,165    13,691    22,268  105,430    78,865
Long-term liabilities                 328       388     1,775    2,958     1,986
Total shareholders' equity            389     8,094    12,220   87,453    70,301
</TABLE>
<PAGE>

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.


<TABLE>
<CAPTION>
<S>              <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>
                                          Quarters Ended
                 ---------------------------------------------------------------
                 Apr1,   Jul1,   Sep30,  Dec31,  Mar30,  Jun28,  Sep28,  Dec31,
                 1995    1995     1995    1995    1996    1996    1996    1996
                 ----    ----     ----    ----    ----    ----    ----    ----

Net revenues.... $13,005 $14,234 $15,546 $12,682 $12,335 $11,183 $ 8,153 $ 9,668
Gross margin.....  4,717   5,361   6,308   5,245   2,907   4,029    (66)   2,195
Income (loss)from
operations......   1,542   1,646   2,358     867 (3,822)   (258) (5,348) (3,499)
Net income (loss)  1,089   1,324   1,719   1,681 (1,977)     191 (5,743) (1,442)
Net income (loss)
per share........  $0.14   $0.15   $0.19   $0.15 $(0.19)   $0.02 $(0.60) $(0.15)
Shares  used  in
computing per
shares amounts..   7,680   8,688   8,949  11,022  10,235   9,886   9,661   9,552
</TABLE>

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

  This report includes forward looking statements that involve a number of risks
and  uncertainties.  Actual results could differ materially from those discussed
in these statements. See "Other Factors That May Affect Operating Results" for a
discussion of such factors,  among others,  which could cause actual  results to
differ materially.

RESULTS OF OPERATIONS

Net Revenues

  The Company had net  revenues of $41.3 in 1996  compared to $55.5  million for
1995, a decrease of 25%. Net revenues in 1995  increased  43% from $38.8 million
for 1994.  The  decrease  in net  revenues  for 1996  reflects  softness  in the
consumer market for the Company's  products  throughout the entire year compared
to the strong  demand  experienced  in the  consumer  market both in 1995 and in
1994. The consumer market accounted for about $9 million of net revenues in 1996
compared  to  about  $25   million  in  1995  and  $16  million  in  1994.   The
communications  market grew to about $30  million in 1996  compared to about $28
million in 1995 and $21 million in 1994. The growth in net revenues in both 1995
and 1994 reflected  increased  volume of ChipCorder  products sold both into the
communications  market and the consumer  market.  In 1996,  volume  continued to
increase  in  the  communications  market  but  decreased  significantly  in the
consumer market.  The Company reduced prices on all existing ISD products during
the year (as explained in the `Gross Margin'  section  below).  As the Company's
products mature, their average selling prices tend to decline.

  Sales by market segment for 1996 were 72% communications,  21% consumer and 7%
industrial  compared to 50%  communications,  45% consumer and 5% industrial for
1995 and 54%  communications,  42%  consumer  and 4%  industrial  for 1994.  The
Company's  communications customers in 1996 continued representing such products
as telephone  answering  machines,  cellular  phones,  personal handy phones and
pagers.  Products for consumer customers in 1996 consisted primarily of personal
memory recorders, cameras, photo frames, books, educational toys and novelties.
<PAGE>

  Sales to the Company's top ten customers  accounted for 85% of net revenues in
1996  compared to 66% in 1995 and 70% in 1994.  The top five  customers  in 1996
were  Motorola,  Marubun  (the  Company's  Japanese  distributor),   Sanyo,  Yes
Entertainment and Sequoia (the Company's United Kingdom distributor), accounting
for 30%, 23%, 8%, 8%, and 5% 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  significant  changes in the composition of its
major  customer  base from year to year and expects  this pattern to continue as
certain  customers,  particularly those that design and sell novelty products in
the consumer  market,  increase or decrease  their  purchases  of the  Company's
products  as a result of  fluctuations  in  market  demand  for such  customer's
products.  The loss of, or significant  reduction in purchases by, current major
customers  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  1996  were  65%  compared  to 65% in 1995 and 58% in 1994.
Geographically,  sales to Asia were 54% in 1996  compared to 58% in 1995 and 53%
in 1994, and sales to Europe  increased to 12% in 1996 from 7% in 1995 and 5% in
1994.  Japan  accounted for 31% of total sales in 1996 versus 27% a year earlier
and 28% in 1994.  North American sales were 35% in 1996, 35% in 1995, and 42% in
1994. 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,  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 product is sold by the distributor.

Gross Margin

  Gross margin decreased to 22% in 1996 compared to 39% in 1995 and 33% in 1994.
The decrease in 1996 was caused by the reduction in average selling prices while
product costs were not reduced as originally  planned  because of the delay with
the  conversion  to the  smaller  and  less  costly  0.8  micron  process.  This
conversion  had been planned for  completion  by the end of the first quarter of
1996, but, because of process  difficulties,  the conversion was delayed and not
completed  until the beginning of the fourth  quarter of 1996.  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 that year.  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 $11.8 million in 1996
compared to $6.6 million in 1995 and $3.2 million in 1994. R&D expenditures as a
percent of net revenues were 28.6% in 1996 compared to 11.8% in 1995 and 8.3% in
1994.  This increase in expenditures  was caused by continued  investment in the
development  of new  products  and by  costs  associated  with  bringing  up new
technologies  and new foundries.  The Company  expects  research and development
expenses to increase in absolute dollars.

  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

<PAGE>

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 1996 to
$10.2 million from $8.7 million in 1995 and $5.2 million in 1994.  SG&A expenses
as a percent of net revenues grew to 24.6% in 1996 compared to 15.6% in 1995 and
13.4% in 1994.  The growth in SG&A  expenses  in 1996 came from the  addition of
staff  to  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.  The growth in SG&A expenses in 1995
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 but will decrease as a percentage of net revenues.

Other Income (Expense)

  Net  interest  and other  income was $2.4  million  for 1996  compared to $1.8
million for 1995,  and net  interest and other  expense of $91,000 in 1994.  The
interest income in 1996 and 1995 was earned primarily from the investment of the
proceeds  from the initial  public  offering in February  1995 and the follow-on
offering in September 1995.

Provision for Income Taxes

  For  fiscal  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% and 3% for 1995 and 1994, respectively.  The provision for 1995
and 1994  reflects  the  utilization  of federal  and state net  operating  loss
("NOL") and tax credit carryforwards.

  At  December  31,  1996,  the Company had  established  a valuation  allowance
against their gross  deferred tax asset of $4,156,000.  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 7 of Notes to  Financial
Statements) and  uncertainties  regarding future operations due to the increased
competition within the Company's industry.

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 $9  million  based on  eligible  accounts
receivable  and $15 million based on eligible  investments,  with a term through
June  30,  1997.  At  December  31,  1996,  the  Company's  borrowing  base  was
approximately $13.9 million and there were no borrowings  outstanding under this
line of credit.

  The Company's operating  activities used net cash of $11.2 million in 1996 and
provided net cash of $4.6 million in 1995 and $4.0 million  1994.  Net cash used
for  operations in 1996 was  primarily the result of the Company's  loss for the
year. In 1995 and 1994 the cash provided by operations  was primarily the result
of the Company's  net income in each of those years.  Cash provided by investing
activities  was $14.2 million in 1996 compared to cash used of $51.2 million and
$1.3  million  in 1995  and  1994,  respectively.  In 1996 and  1995,  investing
activities  consisted  principally of the purchase and maturity of  investments.
Cash used for financing  activities was $10.3 million in 1996 and $.9 million in
1994.  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.
<PAGE>

  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,  1996 the Company had  repurchased
1,077,000 shares at an average price of $9.02 per share.

  At December 31, 1996, the Company had cash, cash  equivalents,  and short-term
investments of $55.5 million and working  capital of $65.1 million.  The Company
believes cash generated from  operations,  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 report includes forward looking statements that involve a number of risks
and uncertainties.  The Company's operating results are subject to quarterly and
annual  fluctuations  due to a variety  of  factors.  The  following  includes a
discussion of factors that,  among other factors,  could cause actual results to
differ  materially.  All of  the  Company's  products  are  manufactured  by two
independent  foundries.  The  Company's  primary  supplier is currently  Samsung
Electronics Co., Ltd. ("Samsung") in Korea. The Company also uses Sanyo Electric
Co.,  Ltd.  ("Sanyo")  to  manufacture  a customized  product  using the process
technology of Atmel Corporation ("Atmel"). Sanyo purchases all of its production
of  this  product  for its own use or for  distribution  to its  customers.  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
high 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.  The Company has qualified another foundry supplier,  ROHM Co., Ltd. and
is in the process of finalizing the design for the first product. However, 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 Sanyo or Samsung as a  supplier,  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.

  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.  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 ChipCorder products at Samsung. Prior to its February 1995 initial
public  offering,  the Company  received an opinion from its patent counsel 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.  All the causes of action  alleged in the
complaint appear to be based on the same circumstances alleged in the January

<PAGE>

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.  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.

  The  fabrication  of ICs 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   consumer,
communications  and industrial  markets.  For example,  Motorola uses one of the
Company's  products to add a record and playback  feature to its MicroTAC  Elite
cellular  phones.  If the market for  MicroTAC  Elite phones fails to develop as
expected,  the Company's sales would be negatively  impacted.  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
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

<PAGE>

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.

  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.


<PAGE>


Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

                      BALANCE SHEETS
           (In thousands, except share amounts)


                       ASSETS

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

  Current assets:
    Cash and cash equivalents.......     $21,927  $29,202
    Short-term investments..........      33,617   45,892
    Accounts receivable, net of
      allowance for doubtful
      accounts of $600 and $275,
      respectively..................       3,203    7,554
    Inventories.....................      10,059    9,809
    Prepaid expences and other
      current assets................       2,874    1,841
                                           -----   ------
            Total current assets....      71,680   94,298
                                          ------   ------
  Property and equipment, at cost:
    Furniture, fixtures and leasehold
      improvements..................         796      563
    Equipment.......................      11,063    8,325
                                          ------   ------
                                          11,859    8,888
    Less -- Accumulated depreciation     (6,024)  (3,644)
                                         -------   ------
            Net property and equipment     5,835    5,244
                                         -------   ------
  Other assets, net.................       1,200    1,355
  Long-term investments.............         150    4,533
                                         =======   ======
                                         $78,865 $105,430
                                         ======= ========

        LIABILITIES AND SHAREHOLDERS' EQUITY

  Current liabilities:
    Current portion of capitalized
     lease obligations..............      $1,270   $1,089
    Accounts payable................       3,153    9,784
    Accrued liabilities.............         856    2,312
    Deferred revenue................       1,299    1,834
                                          ------   ------
            Total current liabilities      6,578   15,019
                                          ------   ------
  Long-term liabilities:
    Capitalized lease obligations,
     net of current portion.........       1,814    2,630
    Other long-term liabilities.....         172      328
                                          ------   ------
            Total long-term
             liabilities............       1,986    2,958
                                          ------   ------
  Commitments and contingencies (Note 5)
  Shareholders' equity:
    Preferred stock, no par value -
       Authorized -- 5,000,000 shares
       Outstanding -- no shares.....         ---      ---
    Common stock, no par value-
       Authorized -- 22,000,000 shares
       Outstanding -- 9,564,875 and
         10,424,470 shares, respectively  78,261   86,256
    Deferred compensation...........       (332)    (116)
    Retained earnings (deficit).....     (7,658)    1,313
    Unrealized gain on investments..          30       --
                                          ------   ------
            Total shareholders' equity    70,301   87,453
                                          ------   ------
                                         $78,865 $105,430
                                         =======  =======
</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,
                                          -------------------------
                                          1996       1995      1994
                                          ----       ----      ----

  Net revenues...................      $41,339    $55,467   $38,805

  Cost of revenues...............       32,274     33,836    26,107
                                        ------     ------    ------
  Gross margin...................        9,065     21,631    12,698
                                        ------     ------    ------
  Operating expenses:
   Research and development......       11,817      6,550     3,234
   Sales, general and administrative    10,175      8,668     5,212
                                        ------     ------    ------
         Total operating expenses.      21,992     15,218     8,446
                                        ------     ------    ------
  Income (loss) from operations...    (12,927)      6,413     4,252
                                      --------     ------    ------
  Other income (expense):
   Interest expense...............       (473)      (536)     (278)
    Interest income...............       2,901      2,340       188
    Other, net....................        (14)        (2)       (1)
                                       -------     ------    ------
         Total other income
          (expense), net..........       2,414      1,802      (91)
                                       -------     ------    ------
  Income (loss) before provision
   (benefit) for income taxes.....    (10,513)      8,215     4,161
  Provision (benefit) for income
   taxes..........................     (1,542)      2,403       140
                                      --------     ------    ------
  Net income (loss)...............    ($8,971)     $5,812    $4,021
                                      ========     ======    ======
  Net income (loss) per share.....     ($0.92)      $0.64     $0.63
                                      ========     ======    ======
  Shares used in computing per
   share amounts..................       9,788      9,084     6,385
                                      ========     ======    ======
</TABLE>

The accompanying notes are an integral part of these statements.



<PAGE>

<TABLE>
<CAPTION>

                       STATEMENTS OF SHAREHOLDERS' EQUITY
                      (In thousands, except share amounts)
<S>                             <C>         <C>        <C>         <C>       <C>          <C>           <C>            <C>
                                                                                          Retained
                                    Convertible                              Deferred     Earnings      Unrealized         Total
                                 Preferred Stock          Common Stock       Compen-     (Accumulated    Gain on       Shareholders'
                                Shares       Amount     Shares     Amount    sation       Deficit)      Investments        Equity
                                ------       ------     ------     ------    ------       --------      -----------        ------
Balance, December 31, 1993....  13,773,826  $16,369    1,083,172   $  245    $   --       $(8,520)         $    --        $ 8,094
 Common stock issued at in
  exchange for services
  rendered....................          --     (15)        2,500       25        --            --               --             10
 Common stock issued at as
  employee stock awards.......          --       --        3,250       29        --            --               --             29
 Sale of common stock pursuant
  stock option exercises for
  cash at.....................          --       --      148,915       51        --            --               --             51
 Deferred compensation related
  to stock option grants......          --       --           --      175     (175)            --               --             --
 Amortization of deferred
  compensation related to stock
  option grants...............          --       --           --       --        15            --               --             15
 Net income...................          --       --           --       --        --          4,021              --          4,021
                                   -------    -----      -------    -----      ----         ------           -----       --------
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'
  overallotment 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 purchse plan.          --       --        5,895      108       --             --               --           108
 Common stock issued upon
  secondary public offering and
  exercise of underwriter's
  overallotment 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
 Unrealized gain on
  investments.................          --       --           --      --        --             --               30            30
 Net loss.....................          --       --           --      --        --        (8,971)               --       (8,971)
                                   =======    =====    ========= =======    ======       ========            =====      ========
Balance, December 31, 1996              --     $ --    9,564,875 $78,261    $(332)       $(7,658)              $30       $70,301
                                   =======    =====    ========= =======    ======       ========            =====      ========
</TABLE>

   The accompanying notes are an integral part of these statements.


<PAGE>

<TABLE>
<CAPTION>

                                                   STATEMENTS OF CASH FLOWS
                                                         (In thousands)


<S>                                                    <C>        <C>           <C>
                                                             Years Ended December 31,
                                                          1996        1995         1994
                                                          ----        ----         ----

Cash flows from operating activities:
 Net income (loss)................................     ($8,971)     $5,812       $4,021
 Adjustments to reconcile net income (loss) to
  net cash provided by (used for) operating
  activities -- Depreciation and amortization.....        2,537      1,971          918
 Amortization of investment discount..............           39      (600)           --
 Compensation costs related to stock and stock
  option grants...................................          235         44           45
 Common stock issued for services rendered........           --         --           25
 Provision for allowance for doubtful accounts
  and returns.....................................          325        210           --
 Changes in assets and liabilities --
  Accounts receivable.............................        4,026    (2,053)      (2,003)
  Inventories.....................................        (249)    (6,042)      (1,391)
  Prepaid expenses and other assets...............      (1,079)    (1,521)        (142)
  Accounts payable................................      (6,630)      4,732          798
  Accrued liabilities.............................        (705)        410        1,173
  Deferred revenue................................        (535)      1,289          545
  Other long-term liabilities.....................        (156)        307           21
                                                         ------    -------      -------
   Net cash provided by (used for) operating
    activities....................................     (11,163)      4,559        4,010
                                                       --------    -------      -------
Cash flows from investing activities:
 Purchase of property and equipment...............      (2,479)    (1,296)      (1,058)
 Patent costs.....................................        (174)       (95)        (565)
 Purchases of investments.........................     (71,233)   (75,749)           --
 Proceeds from maturities and sale of investments.       88,099     25,924           --
 Proceeds from sale of property and equipment.....           --         --          308
                                                       --------    -------      -------
   Net cash provided by (used for) investing
    activities....................................       14,213   (51,216)      (1,315)
                                                       --------   --------      -------
Cash flows from financing activities:
 Proceeds from sale of common stock, net of
  issuance costs..................................          514     69,377           51
 Repurchase of common stock.......................      (9,712)         --           --
 Payments on capitalized lease obligations........      (1,127)    (1,123)        (602)
 Payment of stock issuance costs..................           --         --        (328)
                                                       --------    -------      -------
   Net cash proviced by (used for) financing
    activities....................................     (10,325)     68,254        (879)
                                                       --------    -------      -------
Net increase in cash and cash equivalents.........      (7,275)     21,597        1,816
Cash and cash equivalents at beginning of year....       29,202      7,605        5,789
                                                       ========    =======      =======
Cash and cash equivalents at end of year..........      $21,927    $29,202       $7,605
                                                       ========    =======      =======
Supplemental cash flow information:
 Cash paid for interest...........................         $472       $536         $278
                                                       ========    =======      =======
 Cash paid for income taxes.......................      $    --     $3,203       $3,203
                                                       ========    =======      =======
 Property and equipment acquired under capital
  leases..........................................         $491     $2,314       $2,274
                                                       ========    =======      =======

</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  single-chip  integrated  circuit  ("IC")
products  for voice  recording  and  playback  using the  Company's  proprietary
ChipCorder(R)  high-density  storage technology and its mixed signal (analog and
digital)  expertise.  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, 1996,  approximately  $27,685,000 of the Company's investments
in debt securities were classified as available-for-sale,  carried at fair value
and had contractual maturities ranging from one month to two years from the date
of purchase by the Company.  Approximately  $24,828,000 million of the Company's
investments were classified as  held-to-maturity,  carried at amortized cost and
had  contractual  maturities of less than one year beyond  December 31, 1996. At
December 31, 1996, 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, 1996 and December 31, 1995, is as follows (in thousands):


<PAGE>

<TABLE>
<CAPTION>


<S>                                                        <C>            <C>
   Available-for-Sale Securities:                            1996          1995
   ------------------------------                            ----          ----
   Government bonds...........................             $9,012         $  --
   Certificates of deposit....................              4,511            --
   Commercial paper...........................              9,378            --
   Bankers' acceptance notes..................                992            --
   Corporate debt securities..................              3,792            --
   Municipal debt securities..................                 --        16,130
                                                           ------        ------
        Total available-for-sale securities...             27,685        16,130
                                                           ------        ------
   Held-to-Maturity Securities:
   ----------------------------
   Commercial paper...........................             22,473        43,356
   Bankers' acceptance notes..................                 --         7,971
   Corporate debt securities..................                 --         1,010
   Municipal debt securities..................              2,355         7,620
                                                           ------        ------
        Total held-to-maturity securities.....             24,828        59,957
                                                           ======        ======
   Total investments in debt securities.......            $52,513       $76,087
</TABLE>
                                                           ======        ======

  Approximately  $18,896,000  and  $25,662,000  of the total  investment in debt
securities is included in cash equivalents on the accompanying balance sheets as
of December 31, 1996 and 1995,  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,
                                    ------------
                                1996         1995
                                ----         ----
   Work-in-process........    $6,157       $5,706
   Finished goods.........     3,902        4,103
                               -----        -----
                             $10,059       $9,809
                             -------       ------
</TABLE>

  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.


<PAGE>


  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.

  The Company currently buys approximately 90% of its products from one foundry.
Although  there  are  a  limited  number  of  foundries   available  that  could
manufacture  the Company's  products,  management  believes that other suppliers
could  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.

  Net Income (Loss) Per Share

  Net  income  (loss) per share has been  computed  using the  weighted  average
number of shares of common  stock,  common  equivalent  shares from  convertible
preferred  stock  (when  dilutive  using  the if  converted  method  at  date of
issuance)  and  common   equivalent  shares  from  stock  options  and  warrants
outstanding (when dilutive using the treasury stock method). Pursuant to certain
Securities and Exchange Commission Staff Accounting Bulletins, common and common
equivalent  shares issued during the twelve-month  period prior to the Company's
initial  public  offering have been included in the  calculation as if they were
outstanding  for all  periods  prior to and  including  the quarter in which the
offering was completed (even if  antidilutive  using the treasury stock method).
Net loss per share data has been computed  using the weighted  average number of
shares  outstanding  during each period;  dilutive common stock equivalents have
been  excluded from the  computation  as their effect would be to reduce the net
loss per share amount.

  Reclassifications

  Certain items from prior year financial  statements have been  reclassified to
conform with the current year presentation.

3....LINE OF CREDIT:

  In June 1996, the Company  entered into a revolving  line of credit  agreement
with a bank  under  which it can  borrow  up to  $24,000,000  based on  eligible
accounts receivable and eligible  investments.  The line of credit is secured by
substantially all of the Company's assets, bears interest at LIBOR plus 1.75%

<PAGE>

(7.5% at December 31, 1996) for borrowings based on eligible accounts receivable
and at LIBOR plus 1.5%  (7.3% at  December  31,  1996) for  borrowings  based on
eligible  investments and expires on June 30, 1997. At December 31, 1996,  there
were no  borrowings  outstanding  under  the line of  credit  and the  Company's
borrowing base was approximately $13,924,000.

4....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, 1996 and  December 31, 1995 was  approximately  $6,640,000  and  $6,133,000,
respectively.  Accumulated  amortization  of leased  equipment at such dates was
approximately  $3,955,000  and  $2,670,000,  respectively.  Future minimum lease
payments  together with the present  value of the  payments,  as of December 31,
1996, are as follows (in thousands):

   Years Ending December 31,
   -------------------------
<TABLE>
<CAPTION>
<S>                                                        <C>

   1997..................................................  $1,575
   1998..................................................   1,500
   1999..................................................     399
   2000..................................................      74
                                                               --
   Total minimum lease payments..........................   3,548
   Less -- Amount representing interest (9.4% - 14.6%)...   (464)
                                                            -----
   Present value of minimum lease payments...............   3,084
   Less -- Current portion............................... (1,270)
                                                          -------
   Long-term portion.....................................  $1,814
                                                          =======
</TABLE>

5....COMMITMENTS AND CONTINGENCIES:

  Operating Leases

  The  Company  leases  its  current  facilities  and  certain  equipment  under
operating  leases that  expire at various  dates  through  fiscal  2000.  Future
minimum  annual  rental  payments  under  operating  leases are as  follows  (in
thousands):

<TABLE>
<CAPTION>
<S>                                          <C>
 Year Ending December 31,
 ------------------------
   1997....................................  $1,064                                             873
   1998....................................     873
   1999....................................     719
   2000....................................       6
                                             ------
                                             $2,662
                                             ======
</TABLE>

  During the years ended December 31, 1996,  1995 and 1994, rent expense totaled
approximately $1,380,000, $807,000 and $172,000, 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

<PAGE>

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.  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.

6....EQUITY:

  In November 1994, the Company  effected a  one-for-three  reverse split of its
common  stock.  All  common  share and per  share  amounts  in the  accompanying
financial  statements  have been adjusted  retroactively  to give effect to this
reverse stock split.

  In February  1995,  the Company sold  1,725,944  shares of common stock in its
initial  public  offering  and  simultaneously  converted  13,773,826  shares of
preferred  stock into 4,591,240  shares of common stock as part of the offering.
Net proceeds  from the offering  were  approximately  $23,086,000.  In September
1995, the Company sold 2,407,781 shares of common stock in a follow-on offering.
Net proceeds to the Company were approximately $45,190,000.

  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,  1996 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, 1996,  the Company had reserved  shares of its common stock
for the following purposes:
<TABLE>
<CAPTION>
<S>                                        <C>
     1987 Stock Option Plan..............    208,453
     1994 Employee Stock Purchase Plan...     70,893
     1994 Equity Incentive Plan..........  2,080,481
     1994 Directors Stock Option Plan....    120,000
     Nonqualified stock options..........     42,500
                                           =========
                                           2,522,327
                                           =========
</TABLE>

  Employee Stock Purchase Plan

  In September 1994, the Company  approved the Employee Stock Purchase Plan. The
plan  reserved  up to  120,000  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,  1996,  49,107
shares have been issued  under this plan.  The  weighted  average  fair value of
shares sold in 1996 was $7.791.

  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 208,453 shares were outstanding  under this plan at December
31, 1996.

  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 2,000,000 shares for issuance under the terms of the

<PAGE>

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.

  Included in the options  granted  during 1994 were  options  granted in August
1994 and September  1994 to purchase  58,433 shares of common stock at $3.00 per
share  under the 1987  Plan.  The  Company  recorded  deferred  compensation  of
approximately  $175,000  for the  difference  between the option  price of these
options and $6.00 (fair  market  value of the common  stock at the date of grant
for  financial  reporting  purposes).  The  Company is  expensing  the  deferred
compensation ratably over the related vesting periods.

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

                                       December 31,
                                       ------------
                                      1996      1995
                                      ----      ----
   Net Income (loss):
     As reported                      $(8,971)  $5,812
     Pro forma                        (12,558)  $4,939
   Net Income (loss) per share:
     As reported                      $ (0.92)  $ 0.64
     Pro forma                        $ (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, 1996,  1995 and 1994
and changes during the years then ended is presented below:
<PAGE>
<TABLE>
<CAPTION>

<S>                                <C>         <C>        <C>        <C>        <C>         <C>
                                         1996                   1995                  1994
                                         ----                   ----                  ----
                                               Weighted              Weighted               Weighted
                                                Average               Average                Average
                                               Exercise              Exercise               Exercise
                                       Shares     Price     Shares      Price      Shares      Price
                                       ------     -----     ------      -----      ------      -----

Outstanding  at beginning of year    1,406,133   $ 8.98     634,897    $ 1.56     619,651      $ .56
  Granted                            2,465,998     7.51   1,450,519     12.78     181,319       4.20
  Exercised                          (174,193)     1.00   (207,199)      1.84   (148,915)        .32
  Forfeited                        (1,645,993)    10.06   (472,084)     15.18    (17,158)        .80
                                   -----------            ---------             ---------
Outstanding at end of year           2,051,945   $ 6.74   1,406,133    $ 8.98     634,897      $1.56
                                   ===========            =========             =========
Exercisable at end of year             391,542              329,601               169,814
Weighted average fair value
 of options granted                      $3.27                $4.13
Options available for grant            399,489              219,494                59,306

</TABLE>

<TABLE>
<CAPTION>

                                December 31, 1996
                                           -------------------------------------------
                                           Options Outstanding     Options Exercisable
<S>                      <C>           <C>                <C>                   <C>               <C>
                                           -------------------------------------------
                                       Wtd. Avg.            Wtd. Avg.                             Wtd. Avg.
                                        exercise           years left                              exercise
  Exercise Prices          Number          price          to exercise           Number                price
  ---------------------------------------------------------------------------------------------------------
  $ .38 - $ 3.00           198,435       $   1.22               2.0             123,758             $  1.12
   6.00 -   8.50         1,730,782           6.94               9.3             196,135                7.60
   9.00 -  10.50            82,728           9.45               4.8              55,507                9.17
  15.00 -  25.25            40,000          19.40               7.4              16,142               18.89
                         ---------                                              -------
  $ .38 - $25.25         2,051,945       $   6.74               8.4             391,542             $ 6.24
                         =========                                              =======
</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 1995 and 1996,  respectively:  risk-free interest
rates of 6.45% and 5.57%;  expected dividend yields of 0%; expected lives of 1.5
years; expected volatility of 47% and 82%.

  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.

  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. <PAGE>

  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.

7.   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,
                                                                       ------------
                                                                1996       1995     1994
                                                                ----       ----     ----
   Current payable (benefit):
    Federal.............................................    $(2,314)     $3,029       90
    State...............................................       (185)        331       50
                                                             -------     ------     ----
             Total current..............................     (2,499)      3,360      140
                                                             -------     ------     ----
   Deferred (benefit):
    Federal.............................................         752      (629)       --
    State...............................................         205      (328)       --
                                                              ------      -----     ----
             Total deferred.............................         957      (957)       --
                                                              ------      -----     ----
             Total provision (benefit) for income taxes.    $(1,542)     $2,403     $140
                                                            ========     ======     ====
</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):

                                                                    Years Ended
<TABLE>
<CAPTION>
<S>                                                         <C>          <C>     <C>
                                                                    December 31,
                                                                    ------------
                                                                1996       1995     1994
                                                                ----       ----     ----
   Provision (benefit) computed at Federal statutory rate.  $(3,680)     $2,875   $1,456
   State income taxes, net of Federal tax benefit.........     (636)        497      114
   Nondeductible expenses.................................        36          2       19
   Tax credits............................................        --      (274)       --
   Change in valuation allowance..........................     3,565    (1,205)  (1,539)
   Other..................................................     (827)        508       90
                                                            --------    -------  -------
             Total provision, (benefit) for income taxes..  $(1,542)     $2,403     $140
                                                            ========    =======  =======
            Effective tax rate............................     (15%)        29%       3%
                                                            ========    =======  =======
</TABLE>

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

<TABLE>
<CAPTION>
<S>                                                                               <C>      <C>
                                                                                        As of
                                                                                     December 31,
                                                                                     1996    1995
                                                                                     ----    ----

   Federal net operating loss carryforwards......................................   $ 833    $560
   State net operating loss carryforwards........................................     234      16
   Tax credit carryforwards......................................................   1,322     183

<PAGE>

   Cumulative temporary differences:
     Deferred revenue............................................................     225     346
     Patent costs................................................................   (141)    (95)
     Depreciation expense........................................................   (403)    (13)
     Research and development costs..............................................      --     123
     Reserve for doubtful accounts and returns...................................     204      --
     Inventory reserves..........................................................   1,543      --
     Accrued vacation............................................................     142     124
     Other temporary differences.................................................     197     304
                                                                                    -----    ----
  Total deferred income tax asset................................................  $4,156  $1,548
   Valuation allowance........................................................... (4,156)   (591)
                                                                                  -------  ------
   Net deferred income tax asset.................................................      --    $957
                                                                                  =======  ======
</TABLE>

  The Company's net operating loss ("NOL") and tax credit  carryforwards  expire
at various dates through  2011.  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, 1996, use
of federal NOL  carryforwards  of  approximately  $2.6 million 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,  1996,  the Company had  established  a valuation  allowance
against their gross  deferred tax asset of $4,156,000.  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.

8....EXPORT SALES AND SIGNIFICANT CUSTOMERS:

  The Company  operates in a single  industry  segment.  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,
                                       ------------
                                     1996  1995  1994
                                     ----  ----  ----
      United States...............    35%   35%   42%
   Export:
    Asia..........................    54    58    53
    Europe........................    11     7     5
                                     ----  ----  ----
                                     100%  100%  100%
                                     ----  ----  ----
</TABLE>

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

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

                                        Years Ended
                                       December 31,
                                       ------------
                                     1996  1995  1994
                                     ----  ----  ----
   Sanyo..........................     8%   10%   25%
   Motorola.......................    29%   13%   18%
   Marubun........................    23%   16%   --
</TABLE>


<PAGE>


To Information Storage Devices, Inc.:

  We have  audited  the  accompanying  balance  sheets  of  Information  Storage
Devices,  Inc. (a California  corporation) as of December 31, 1996 and 1995, and
the related  statements of operations,  shareholders'  equity and cash flows for
each of the three years in the period ended December 31, 1996.  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, 1996 and 1995, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1996, 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 15, 1997


<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  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 four (4).
<TABLE>
<CAPTION>
<S>
  <C>                 <C>     <C>                             <C>   <C>

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

  David L. Angel       57     Chairman of the Board of the          1991
                              Company; Chief Executive Officer
                              of the Company

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

  Eugene J. Flath      60     General Partner of AVI Management     1988
                              Partners

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

  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
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. 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.

  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.

<PAGE>

Board of Directors' Meetings and Committees

  The Board of Directors met 13 times,  including telephone conference meetings,
during fiscal 1996. No director  attended fewer than 75% of the aggregate of the
total number of meetings of the Board of  Directors  (held during the period for
which he was a director) and the total number of meetings held by all committees
of the Board of Directors on which he served (during the period that he served).

  Standing committees of the Board of Directors include an Audit Committee and a
Compensation  Committee.  The  Board of  Directors  does  not have a  nominating
committee or any committee performing similar functions.

  Messrs.  Bamber and Zieber are currently  the members of the Audit  Committee.
The Audit Committee met one time during 1996. The Audit Committee meets with the
Company's independent public accountants to review the adequacy of the Company's
internal control systems and financial reporting procedures,  review the general
scope of the  Company's  annual  audit and the fees  charged by the  independent
public accountants,  review and monitor the performance of non-audit services by
the Company's  independent public accounts,  review the fairness of any proposed
transaction between any officer,  director or other affiliate of the Company and
the Company and, after such review,  makes  recommendations to the full Board of
Directors  and performs  such further  functions as may be required by any stock
exchange or  over-the-counter  market upon which the  Company's  Common Stock is
listed.

  In 1996,  Messrs.  Flath (except for the period from March 20 through  October
28),  Bamber and Zieber (from March 20 through the present)  were the members of
the Company's  Compensation  Committee.  The Compensation Committee met nine (9)
times during fiscal 1996. The Compensation  Committee  administers the Company's
1987 Stock Option  Plan,  1994 Equity  Incentive  Plan and 1994  Employee  Stock
Purchase Plan and  determines the salaries and other  compensation  for officers
and other employees of the Company.

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 granted,  on the date such
non-employee  director first joined the Board of Directors,  an option under the
Directors  Plan to purchase  7,500  shares of Common  Stock.  Each  non-employee
director was granted an additional option for 7,500 shares on his anniversary of
joining the Board of Directors.  Accordingly,  Mr. Bamber  received an option to
purchase  7,500 shares on March 30, 1995,  his fifth  anniversary of joining the
Board of Directors;  Mr. Zieber  received an option to purchase  7,500 shares on
July 13, 1995,  the date he first joined the Board of  Directors;  and Mr. Flath
received an option to purchase  7,500  shares on October 11,  1995,  his seventh
anniversary of joining the Board of Directors.  The right to purchase 25% of the
shares  subject  to  currently  outstanding  options  will  vest for  each  year
following the date of grant that the non-employee  director continuously remains
a director of the Company.

  The Directors Plan was amended effective March 21, 1996.  Subsequent grants of
options to purchase 7,500 shares were made to each  non-employee  director as of
such date and will be made each January 1 thereafter. The right to purchase 100%
of the shares  subject to currently  outstanding  options will vest ratably on a
monthly basis  throughout the Company's fiscal year, which is the calendar year,
for  each  year  following  the date of grant  that  the  non-employee  director
continuously  remains a  director  of the  Company.  Each  option  granted  to a
director under the amended  Directors Plan from March 21, 1996 and in the future
will vest monthly and become  exercisable as to all of the shares issuable under
such option at the end of each Company fiscal year,  which is the calendar year.
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

<PAGE>

Common Stock is reserved for issuance under the Directors Plan,  37,500 of which
were subject to outstanding  options as of December 31, 1997.  Accordingly,  Mr.
Bamber  received  an option to purchase  7,500  shares on March 21, 1996 and Mr.
Zieber  received an option to purchase  7,500  shares on March 21,  1996,  which
shares were fully  vested on December 31,  1996.  On March 20,  1996,  Mr. Flath
became an employee of the Company and was therefore ineligible for option grants
under the  Directors  Plan.  In connection  with his  employment,  Mr. Flath was
granted an option to purchase 50,000 shares of the Company's  Common Stock under
the Company's 1994 Equity Incentive Plan. Messrs.  Zieber, Flath and Bamber each
received options to purchase 7,500 shares under the Directors Plan on January 1,
1997.

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 (together, the "Named Officers") during 1996.


                          Summary Compensation Table

                              Annual Compensation
                              -------------------

 <TABLE>
<CAPTION>
<S>                                <C>            <C>          <C>
                                    All Other
   Name and Principal Position     Salary(1)       Bonus       Compensation
   ---------------------------     ---------       -----       ------------
David L. Angel................       175,000          --         235,245(2)
 Chairman and Chief Executive
 Officer
Carl Palmer...................       125,000      20,000          23,576(3)
 Vice President, Engineering
Ross Hayden...................        95,017          --          55,488(4)
 Vice President, Sales
Jim Brennan...................       140,400          --                 --
 Vice President, Technology and
 Development
Felix J. Rosengarten..........       130,000          --           8,525(5)
 Vice President, Finance and
 Administration, and Chief
 Financial Officer
</TABLE>

-------------

(1)David Angel's salary is currently $249,000, Carl Palmer's salary is currently
   $155,000,  Ross Hayden's salary is currently $95,017, Jim Brennan's salary is
   currently $155,000 and Felix Rosengarten's salary is currently $155,000.

(2)Represents  compensation  in connection  with the sale of the Company's stock
   issued  upon the  exercise  of stock  options in the amount of  $213,000  and
   payment for vacation accrued in excess of 20 days in the amount of $22,245.

(3)  Represents  compensation  for relocation in the amount
   of $23,576.

(4)Represents  compensation  in connection  with the sale of the Company's stock
   issued  upon the  exercise  of stock  options in the  amount of  $17,750  and
   commissions in the amount of $37,738.

(5)Represents  payment for  vacation  accrued in excess of 20 days in the amount
   of $8,525.

Option Grants in 1996

  The following table sets forth certain information  concerning the exercise of
options by each of the Named  Officers  during  1996,  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, 1996. Also reported are values of "in-the-money" options that

<PAGE>

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,  1996  ($7.375  per  share),  based  on the  closing  price of the
Company's  stock on  December  31,  1996.  No  stock  appreciation  rights  were
exercised during 1996, and no stock appreciation  rights were outstanding at the
end of the year.

  Aggregate Option Exercises in 1996 and Fiscal Year-End Option Values
<TABLE>
<CAPTION>

                                                         Number of
                                                    Securities Underlying         Value of Unexercised
                                                    Unexercised Options           In-the-Money Options
                                                    at Fiscal Year-End(#)         at Fiscal Year-End
                                                    ---------------------         ------------------
<S>                      <C>          <C>          <C>          <C>             <C>           <C>
                           Shares
                         Acquired on     Value
     Name                Exercise(#)  Realized(1)  Exercisable  Unexercisable   Exercisable   Unexercisable
     ----                -----------  -----------  -----------  -------------   -----------   -------------
David L. Angel.......      46,875      $540,781      65,972        199,361       $486,543       $1,470,287
Carl Palmer..........          --         $--          --           57,500          $--           $424,062
Ross Hayden..........       2,000       $23,750       8,750         49,894        $64,531         $367,968
Jim Brennan..........          --         $--          --           18,750          $--           $138,281
Felix J. Rosengarten.      10,000       $80,000      45,833         75,666       $338,018         $558,036
</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.

 NEW PLAN BENEFITS

  The  following  table  sets  forth the  grant of  options  received  under the
Incentive  Plan,  the Directors  Plan and the Employee Stock Purchase Plan as of
December 31, 1996 by (i) the Named Officers, (ii) all current executive officers
as a group,  (iii) all current  directors  who are not  executive  officers as a
group,  and (iv) all  employees,  including  all officers who are not  executive
officers, as a group.

  The grants of options under the Incentive  Plan are made at the  discretion of
the Board of Directors.  Accordingly, future grants under the Incentive Plan are
not determinable and have not been set forth in the table.

<TABLE>
<CAPTION>

                                     Stock Purchase Plan(1)    Directors Plan(2)
                                     ----------------------    -----------------

<S>                                        <C>      <C>        <C>      <C>
                                        Purchase    Number    Purchase    Number
                                         Price        of       Price        of
  Name and Position                    (per share)  Shares  (per share)   Shares
  -----------------                    -----------  ------  -----------   ------
David L. Angel..........................    --        --         --         --
 Chairman and Chief Executive Officer
Carl Palmer.............................   $8.181     753        --         --
 Vice President, Engineering
Ross Hayden.............................   $8.537   1,113        --         --
 Vice President, Sales
Jim Brennan.............................   $8.529   1,619        --         --
 Vice President, Technology and
 Development
Felix J. Rosengarten....................   $8.556   1,601        --         --
 Vice President, Finance and
 Administration and Chief Financial
 Officer

<PAGE>

All current executive officers as a group
 (8) persons.............................  $8.543   7.378        --         --
All current directors who are not
 executive officers as a group (3) persons    --      --       $8.375     15,000
All employees, including officers who
 are not executive officers, as a group..  $8.528  43,212        --         --
</TABLE>

(1) Represents shares actually  purchased under the Employee Stock Purchase Plan
in 1996. Purchases under this plan are voluntary.  Accordingly, future purchases
under this plan are not determinable.

(2) Represents  options  actually  granted under the Directors Plan in 1996. The
grant of options under the  Directors  Plan is not  discretionary.  The exercise
price of  options  to be  granted  in the  future  under the  Directors  Plan is
unknown,  as the  exercise  price is equal to fair  market  value on the date of
grant.

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, 1996, 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>

                                                                      Shares Beneficially
                                                                             Owned (1)
                                                                      -------------------
<S>                                                                     <C>      <C>
        Name of Beneficial Owner                                        Number   Percent
        ------------------------                                        ------   -------
Frederick B. Bamber
     Technologies for Information & Publishing, L.P.(2)...............   561,708    5.9%
David L. Angel(3).....................................................   176,153    1.8%
Gene J. Flath(4)......................................................   106,974    1.1%
Felix J. Rosengarten(5)...............................................    89,030    *
Frederick L. Zieber(6)................................................    18,437    *
Jim Brennan(7)........................................................    14,187    *
Carl Palmer(8)........................................................    10,907    *
Ross Hayden(9)........................................................     7,764    *
All executive officers and directors as a group (12 persons)(10)...... 1,166,247    12.2%

----------------
 * less than 1%
</TABLE>

 (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 March 31, 1997 are deemed to be outstanding and
   to be  beneficially  owned by the person holding such options or warrants 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)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  14,062  shares  subject to
   options exercisable within 60 days of March 31, 1997.
<PAGE>

  (3)    Includes 58,112 shares subject to options exercisable within 60 days of
         March 31, 1997.  Mr. Angel is Chairman of the Board, Chief Executive
         Officer and a director of the Company.

(4)  Includes 55,468 shares subject to options exercisable within 60 days of
     March 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.

 (5) Includes 57,332 shares subject to options exercisable within 60 days of
     March 31, 1997.  Mr. Rosengarten is Vice President, Finance and
     Administration, and Chief Financial Officer of the Company.

 (6) Includes 13,437 shares subject to options exercisable within 60 days of
     March 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.

(7)  Includes 12,187 shares subject to options exercisable within 60 days of
     March 31, 1997.  Mr. Brennan is Vice President, Technology and Development,
     of the Company.

(8)  Includes 9,167 shares subject to options exercisable within 60 days of
     March 31, 1997.  Mr. Palmer is Vice President, Engineering, of the Company.

(9)  Includes 7,714 shares subject to options exercisable within 60 days of
     March 31, 1997.  Mr. Hayden is Vice President, Sales of the Company.

(10) Includes the shares  subject to options  stated to be included in footnotes
   (2),  (3), (4),  (5),  (6),  (7), (8) and (9) and 105,446  additional  shares
   subject to options exercisable within 60 days of March 31, 1997.

Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  Since  January  1,  1996,  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 below and in "Executive Compensation" above.

  In January 1996, the Company  entered into option  amendment  agreements  with
certain  of the  Company's  officers  and key  employees  that  provide  for the
acceleration  of  vesting of  options  granted  under the 1994 Plan and the 1987
Plan.

  In January 1996, the Company entered into  employment  agreements with certain
of the  Company's  officers  and the same key  employees  that  provide for: (i)
salary at their  current  rates;  (ii)  bonuses  as  determined  by the Board of
Directors;  and (iii) the payment of severance  pay equal to 2.5 times salary in
the event (a) of any corporate  reorganization  or business  combination that is
not approved by the Board and in which the  beneficial  ownership of 50% or more
of ISD's outstanding  voting stock is transferred or (b) that a person or entity
or  group  of  persons  or  entities  acquires  15% or  more  of  the  Company's
outstanding stock pursuant to a tender or exchange offer that the Board does not
recommend  and that the  shareholders  of the Company  accept or a change in the
composition  of the  Company's  Board of  Directors  by  reason  of a  contested
election.

                          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
Accounts  are   incorporated   by  reference  to  the  1995  Annual   Report  to
Shareholders:
<PAGE>
<TABLE>
<CAPTION>

                                                                     Page(s) in
                                                                  Annual Report
                                 to Stockholders
<S>                                                             <C>   <C>
                                                                ---------------
Balance Sheets at December 31, 1996 and 1995.................         18
Statements of Operations for the years ended
 December 31, 1996, 1995, and 1994...........................         19
Statements of Stockholders' Equity for the years ended
 December 31, 1996, 1995, and 1994...........................         20
Statements of Cash Flows for the years ended
 December 31, 1996, 1995, and 1994...........................         21
Notes to Financial Statements................................         22
Report of Independent Public Accountants.....................         31
</TABLE>

     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 -
                                  INDEX TO EXHIBITS
<TABLE>
<CAPTION>
<S>     <C>      <C>
        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(1) 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(2)
         4.01 -- Form of Specimen  Certificate for Registrant's  Common Stock(1)
         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(2)
        10.01 -- Registrant's 1987 Stock Option Plan, as amended, and related
                  documents(3)
        10.02 -- Registrant's 1994 Equity Incentive Plan, as amended, and
                  related documents(4)
        10.03 -- Registrant's 1994 Directors Stock Option Plan and related
                  documents
        10.04 -- Registrant's 1994 Employee Stock Option Plan and related
                  documents(1)
        10.05 -- Form of Indemnification Agreement entered into with each of
                  Registrant's directors and executive officers(1)
        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(3) as
                  of July 15, 1993, as amended(1)
<PAGE>
        10.11     -- Distributor Agreement between Registrant and Sanyo Electric
                  Co., Ltd., dated October 29, 1991 with Addendum thereto(1)
        10.13 -- License Agreement between Registrant and Medtronic, Inc., dated
                  March 24, 1993(1)
        10.14 -- Development Agreement between Registrant and Medtronic, Inc.,
                  dated March 24, 1993(1)
        10.15 -- Supply Agreement between Registrant and Medtronic, Inc., dated
                  March 24, 1993(1)
        10.17     -- Acceptance,  Letter of Credit,  Loan and Security Agreement
                  between   Registrant  and  Union  Bank  dated  June  15,  1995
                  (includes related Summary Schedule)(1)
        10.21    -- Acceptance,  Letter of Credit,  Loan and Security Agreements
                 between  Registrant  and  Union  Bank  dated  August  31,  1995
                 (includes related Summary Schedules)(1)
        10.22     -- Agreement for Contract Manufacturing between Registrant and
                  Rohm Electronics, a Division of Rohm Corporation,  dated as of
                  November 27, 1995(3)
        10.23     -- Form of Employment Agreement dated January 19, 1996 between
                  Registrant  and all of the  Company's  executive  officers and
                  certain key employees(5)
        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
        11.01 -- Statement of Computation of Earnings Per Share
        23.01 -- Consent of Arthur Andersen LLP, Independent Public Accountants
     ----------
</TABLE>
<TABLE>
<CAPTION>
<S>  <C> <C>

     (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 8-K filed on or about January 5, 1996.

     (3)  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.

     (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 March
          31, 1996.
</TABLE>

(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 21, 1997



  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,            March 21, 1997
                              Chief Executive Officer
------------------------      and Director
David L. Angel                (Principle Executive Officer)


/S/ FELIX J. ROSENGARTEN      Vice President, Finance           March 21, 1997
                              and Administration, and
------------------------      Chief Financial Officer
Felix J. Rosengarten          (Principle Financial Officer)


/S/  FREDERICK B. BAMBER      Director                          March 21, 1997
------------------------
Frederick B. Bamber


/S/ EUGENE J. FLATH           Director                          March 21, 1997
------------------------
Eugene J. Flath


/S/ FREDERICK L. ZIEBER       Director                          March 21, 1997
------------------------
Frederick L. Zieber
</TABLE>




<PAGE>





                                  EXHIBIT 11.01


                    INFORMATION STORAGE DEVICES, INC.

             Statement of Computation of Earnings Per Share

                 (in thousands, except per share amounts)




<TABLE>
<CAPTION>

                                   Years Ended
                                  December 31,
                                                         -------------------

<S>                                                  <C>        <C>      <C>
                                                       1996      1995     1994
                                                      ------    ------   ------

Net income (loss)                                    ($8,971)   $5,812   $4,021
                                                     ========   ======   ======
Weighted average common stock outstanding               9,788    8,303    1,145
Common stock equivalents:
     Convertible preferred stock                           --       --    4,591
     Stock options                                         --      733      268
     Warrants                                              --       48       41
     Shares required to be included
      under SAB 83                                         --       --      340
                                                       ------   ------   ------
Total shares used in computing net income (loss)
 per share                                              9,788    9,084    6,385
                                                       ======   ======   ======
Net income (loss) per share                            ($.92)     $.64   $  .63
                                                       ======   ======   ======

</TABLE>


<PAGE>


                                   Schedule II



<TABLE>
<CAPTION>

                                  INFORMATION STORAGE DEVICES, INC.

                                  VALUATION AND QUALIFYING ACCOUNTS
                                             (in thousands)


                                                         Additions
<S>                                  <C>               <C>                <C>           <C>
                                        Balance at     Charged to Costs                 Balance at
Description                          Beginning of Year   and Expenses     Deductions    End of Year
-----------                          -----------------   ------------     ----------    -----------
Year ended December 31, 1994
 Allowance for doubtful accounts.....      $ 213            $  11             $(148)         $76

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
     Allowance for
</TABLE>





<PAGE>


                         INFORMATION STORAGE DEVICES, INC.

                         1994 DIRECTORS STOCK OPTION PLAN

                          As Adopted September 12, 1994
                        As Amended Through March 21, 1996


         1.     Purpose.  This 1994  Directors  Stock  Option  Plan (this  
"Plan") is  established  to provide equity  incentives for  nonemployee  members
of the Board of Directors of Information  Storage  Devices,  Inc. (the  
"Company"),  who are described in Section 6.1 below, by granting such persons 
options to purchase shares of stock of the Company.

         2. Adoption and Shareholder Approval.  This Plan shall become effective
on the closing of the first  registration of the Company's Common Stock for sale
to the public under the Securities Act (the "Effective  Date").  This Plan shall
be approved by the shareholders of the Company, consistent with applicable laws,
within  twelve (12)  months  after the date this Plan is adopted by the Board of
Directors of the Company (the "Board"). Options ("Options") may be granted under
this Plan after the Effective Date provided that, in the event that  shareholder
approval is not obtained within the time period provided herein,  this Plan, and
all Options granted  hereunder,  shall terminate.  No Option that is issued as a
result of any  increase in the number of shares  authorized  to be issued  under
this Plan shall be exercised  prior to the time such  increase has been approved
by the shareholders of the Company and all such Options granted pursuant to such
increase shall similarly terminate if such shareholder approval is not obtained.
So long as the Company is subject to Section  16(b) of the  Securities  Exchange
Act of 1934, as amended,  (the "Exchange  Act") the Company will comply with the
requirements of Rule 16b-3 with respect to shareholder approval.

         3. Types of Options and Shares.  Options  granted under this Plan shall
be  nonqualified  stock  options  ("NQSOs").  The  shares  of stock  that may be
purchased  upon exercise of Options  granted under this Plan (the  "Shares") are
shares of the Common Stock of the Company.

         4. Number of Shares.  The  maximum  number of Shares that may be issued
pursuant  to  Options  granted  under this Plan is  120,000  Shares,  subject to
adjustment as provided in this Plan. If any Option is terminated  for any reason
without being  exercised in whole or in part, the Shares  thereby  released from
such Option shall be available  for purchase  under other  Options  subsequently
granted under this Plan. At all times during the term of this Plan,  the Company
shall reserve and keep  available  such number of Shares as shall be required to
satisfy the requirements of outstanding Options under this Plan.

         5. Administration. This Plan shall be administered by the Board or by a
committee of not less than two members of the Board appointed to administer this
Plan (the "Committee").  As used in this Plan, references to the Committee shall
mean either such  Committee or the Board if no Committee  has been  established.
The interpretation by the Committee of any of the provisions of this Plan or any
Option  granted  under this Plan shall be final and binding upon the Company and
all persons having an interest in any Option or any Shares purchased pursuant to
an Option.

         6.     Eligibility and Award Formula.

                6.1 Eligibility. Options may be granted only to directors of the
Company  who are not  employees  of the  Company or any  Parent,  Subsidiary  or
Affiliate of the  Company,  as those terms are defined in Section 17 below (each
an "Optionee").

                6.2   Initial  Grant.  Each  Optionee who on or after the 
Effective  Date becomes a member of the Board will  automatically  be granted an
Option for 7,500 Shares (the  "Initial  Grant").  Initial  Grants shall be made
on the date such Optionee first joins the Board.
<PAGE>

                6.3 Succeeding Grants. Each year following the effective date of
the amendment to this Plan giving effect hereto ("Amendment  Effective Date") on
January 1 of such year,  if the  Optionee  is still a member of the  Board,  the
Optionee  will  automatically  be  granted  an  Option  for  7,500  Shares  (the
"Succeeding Grant").

                6.4 Maximum  Shares.  The  maximum  number of Shares that may be
issued to any one Optionee  under this Plan is 30,000.  No grant will be made if
such  grant will  cause the  number of Shares  issued or subject to  outstanding
Options under this Plan to exceed the number specified in Section 4 above.

         7.     Terms and Conditions of Options.  Subject to the following and
to Section 6 above:

                7.1 Form of Option  Grant.  Each Option  granted under this Plan
shall be evidenced by a written Stock Option Grant ("Grant") in such form (which
need not be the same for each Optionee) as the Committee shall from time to time
approve,  which  Grant  shall  comply  with  and be  subject  to the  terms  and
conditions of this Plan.

                7.2  Vesting.   Options   granted   under  this  Plan  shall  be
exercisable  as they vest.  The date an Optionee  receives an Initial Grant or a
Succeeding  Grant is  referred  to in this  Plan as the  "Start  Date"  for such
Option.  Except as otherwise  provided in this Section 7.2,  each Initial  Grant
granted prior to the Amendment  Effective Date will fully vest as to twenty-five
percent  (25%) of the  Shares at the end of each full year  following  the Start
Date,  so long as the Optionee  continuously  remains a director of the Company.
Except as otherwise  provided in this Section 7.2, each Succeeding Grant granted
prior to the Amendment  Effective Date will vest as to twenty-five percent (25%)
of the Shares at the end of each full year  following the Start Date, so long as
the Optionee continuously remains a director of the Company. Except as otherwise
provided in this Section 7.2,  each Initial  Grant or  Succeeding  Grant granted
following the Amendment  Effective  Date will vest ratably at the end of each of
the twelve months following the Start Date and will be fully vested on the first
anniversary  of the Start Date, so long as the Optionee  continuously  remains a
director of the Company until each such first anniversary.  Any Initial Grant or
Succeeding  Grant  made  during  the  calendar  year of 1996 will vest  fully on
December 31, 1996, with options vesting monthly following the Start Date.

                7.3 Exercise Price. The exercise price of an Option shall be the
Fair Market Value (as defined in Section  17.4) of the Shares,  at the time that
the Option is granted.

                7.4  Termination  of Option.  Except as  provided  below in this
Section,  each  Option  shall  expire ten (10)  years  after the Start Date (the
"Expiration  Date"). The Option shall cease to vest if the Optionee ceases to be
a member of the Board.  The date on which the Optionee  ceases to be a member of
the Board  shall be  referred  to as the  "Termination  Date".  An Option may be
exercised after the Termination Date only as set forth below:

                      (a)  Termination  Generally.  If the  Optionee  ceases  
to be a member  of the Board for any reason except death or disability,  each 
Option,  to the extent (and only to the  extent)  that  it  would  have  been 
exercisable  by the  Optionee  on the Termination Date, may be exercised by the
Optionee within three (3) months after the Termination Date, but in no event 
later than the Expiration Date.

                      (b) Death or  Disability.  If the  Optionee  ceases to be
a member of the Board  because of the death of the  Optionee  or the  disability
of the  Optionee  within  the meaning of Section  22(e)(3) of the Internal
Revenue  Code of 1986,  as amended (the "Code"), each Option, to the extent (and
only to the extent) that it would have been exercisable by the Optionee on the
Termination  Date, may be exercised by the Optionee (or the  Optionee's  legal 
representative) within twelve (12) months after the Termination Date, but in no
event later than the  Expiration Date.

         8.     Exercise of Options.

                8.1  Notice.  Options may be  exercised  only by delivery to the
Company of an exercise agreement in a form approved by the Committee stating the
number of Shares being  purchased,  the  restrictions  imposed on the Shares and
such representations and agreements  regarding the Optionee's  investment intent

<PAGE>

and access to  information  as may be  required  by the  Company to comply  with
applicable  securities laws, together with payment in full of the exercise price
for the number of Shares being purchased.

                8.2  Payment.  Payment for the Shares may be made (a) in cash or
by check;  (b) by  surrender  of shares of Common Stock of the Company that have
been owned by the  Optionee  for more than six (6)  months  (and which have been
paid for within the meaning of SEC Rule 144 and,  if such shares were  purchased
from the Company by use of a promissory note, such note has been fully paid with
respect to such  shares) or were  obtained  by the  Optionee  in the open public
market,  having a Fair Market Value equal to the  exercise  price of the Option;
(c) by waiver of  compensation  due or  accrued  to the  Optionee  for  services
rendered;  (d) provided  that a public  market for the  Company's  stock exists,
through a "same day sale" commitment from the Optionee and a broker-dealer  that
is a member of the National  Association of Securities Dealers (a "NASD Dealer")
whereby the  Optionee  irrevocably  elects to exercise  the Option and to sell a
portion of the Shares so purchased to pay for the exercise price and whereby the
NASD  Dealer  irrevocably  commits  upon  receipt of such  Shares to forward the
exercise  price  directly to the Company;  (e) provided that a public market for
the Company's stock exists,  through a "margin" commitment from the Optionee and
a NASD Dealer whereby the Optionee irrevocably elects to exercise the Option and
to pledge  the Shares so  purchased  to the NASD  Dealer in a margin  account as
security  for a loan from the NASD Dealer in the amount of the  exercise  price,
and whereby the NASD Dealer  irrevocably  commits upon receipt of such Shares to
forward the exercise price directly to the Company; or (f) by any combination of
the foregoing.

                8.3  Withholding  Taxes.  Prior to  issuance  of the Shares upon
exercise of an Option, the Optionee shall pay or make adequate provision for any
federal or state withholding obligations of the Company, if applicable.

                8.4  Limitations  on  Exercise.   Notwithstanding  the  exercise
periods set forth in the Grant, exercise of an Option shall always be subject to
the following limitations:

                      (a)    An Option  shall not be  exercisable  until such
time as the Plan or, in the case of Options granted  pursuant to an amendment to
the number of shares that may be issued pursuant to the Plan, the amendment has
been approved by the shareholders of the Company in accordance with Section 15
hereof.

                      (b)    An Option shall not be exercisable unless such 
exercise is in  compliance  with the Securities  Act, and all applicable state
securities  laws, as they are in effect on the date of exercise.

                      (c)    The  Committee  may  specify a  reasonable  minimum
number of Shares that may be purchased on any exercise of an Option, provided
that such minimum  number will not prevent the Optionee from exercising the full
number of Shares as to which the Option is then exercisable.

         9.  Nontransferability of Options. During the lifetime of the Optionee,
an  Option  shall  be  exercisable  only by the  Optionee  or by the  Optionee's
guardian or legal  representative,  unless otherwise permitted by the Committee.
No Option may be sold, pledged, assigned, hypothecated,  transferred or disposed
of in any manner other than by will or by the laws of descent and distribution.

         10.  Privileges of Stock  Ownership.  No Optionee shall have any of the
rights of a  shareholder  with respect to any Shares  subject to an Option until
the Option has been validly exercised. No adjustment shall be made for dividends
or  distributions or other rights for which the record date is prior to the date
of exercise,  except as provided in this Plan. The Company shall provide to each
Optionee a copy of the annual financial  statements of the Company, at such time
after the close of each fiscal  year of the Company as they are  released by the
Company to its shareholders.

         11.  Adjustment  of  Option  Shares.  In the event  that the  number of
outstanding  shares  of  Common  Stock  of the  Company  is  changed  by a stock
dividend,  stock split,  reverse stock split,  combination,  reclassification or
similar change in the capital  structure of the Company  without  consideration,
the number of Shares  available under this Plan and the number of Shares subject

<PAGE>

to outstanding Options and the exercise price per share of such Options shall be
proportionately  adjusted,  subject  to any  required  action  by the  Board  or
shareholders  of the Company and compliance  with  applicable  securities  laws;
provided,  however, that no certificate or scrip representing  fractional shares
shall be issued upon  exercise of any Option and any  resulting  fractions  of a
Share shall be rounded up to the nearest Share.

         12.    No Obligation to Continue as Director.  Nothing in this Plan or
any Option  granted under this Plan shall confer on any Optionee any right to 
continue as a director of the Company.

         13.  Compliance  With Laws.  The grant of Options  and the  issuance of
Shares upon  exercise of any Options  shall be subject to and  conditioned  upon
compliance with all applicable requirements of law, including without limitation
compliance with the Securities Act,  compliance with all other  applicable state
securities  laws and compliance  with the  requirements of any stock exchange or
national  market system on which the Shares may be listed.  The Company shall be
under no obligation to register the Shares with the SEC or to effect  compliance
with the registration or qualification requirement of any state securities laws,
stock exchange or national market system.

         l4.  Acceleration  of  Options.  In  the  event  of  a  dissolution  or
liquidation  of the Company,  a merger in which the Company is not the surviving
corporation,  the sale of substantially all of the assets of the Company, or any
other transaction which qualifies as a "corporate transaction" under Section 424
of the Code wherein the  shareholders of the Company give up all of their equity
interest in the Company, the vesting of all options granted pursuant to the Plan
will  accelerate  and the options will become  exercisable  in full prior to the
consummation of such event at such times and on such conditions as the Committee
determines.

         15.  Amendment or  Termination  of Plan.  The Committee may at any time
terminate  or amend  this  Plan but not the  terms  of any  outstanding  option;
provided,  however,  that the Committee  shall not,  without the approval of the
shareholders of the Company, increase the total number of Shares available under
this Plan (except by operation of the  provisions of Sections 4 and 11 above) or
change the class of persons eligible to receive Options. Further, the provisions
in  Sections 6 and 7 of this Plan shall not be amended  more than once every six
(6)  months,  other  than to comport  with  changes  in the Code,  the  Employee
Retirement  Income  Security  Act or the  rules  thereunder.  In  any  case,  no
amendment of this Plan may adversely affect any then outstanding  Options or any
unexercised portions thereof without the written consent of the Optionee.

         16.    Term of Plan.  Options may be granted pursuant to this Plan from
time to time within a period of ten (10) years from the date this Plan is
adopted by the Board.

         17.    Certain  Definitions.  As used in this Plan,  the  following  
terms shall have the following meanings:

                17.1 "Parent" means any corporation  (other than the Company) in
an unbroken chain of corporations ending with the Company if, at the time of the
granting of the Option,  each of such  corporations  other than the Company owns
stock  possessing 50% or more of the total combined  voting power of all classes
of stock in one of the other corporations in such chain.

                17.2 "Subsidiary" means any corporation (other than the Company)
in an unbroken chain of corporations  beginning with the Company if, at the time
of  granting  of the  Option,  each of the  corporations  other  than  the  last
corporation in the unbroken chain owns stock  possessing  fifty percent (50%) or
more of the total  combined  voting  power of all classes of stock in one of the
other corporations in such chain.

                17.3  "Affiliate"  means  any  corporation  that  directly,   or
indirectly through one or more intermediaries,  controls or is controlled by, or
is under common control with, another  corporation,  where "control"  (including
the terms "controlled by" and "under common control with") means the possession,
direct or indirect,  of the power to cause the direction of the  management  and
policies of the corporation, whether through the ownership of voting securities,
by contract or otherwise.

                17.4 "Fair Market Value" shall mean,  as of any date,  the value
of a share of the  Company's  Common Stock  determined  by the Board in its sole
discretion,  exercised in good faith;  provided,  however, that where there is a
public market for the Common Stock, the Fair Market Value per share shall be the
average of the  closing  bid and asked  prices of the  Common  Stock on the last
trading  day prior to the date of  determination  as reported in The Wall Street
Journal  (or, if not so  reported,  as  otherwise  reported by the Nasdaq  Stock
Market)  or, in the event the Common  Stock is listed on a stock  exchange or on
the Nasdaq National Market, the Fair Market Value per share shall be the closing
price on the exchange or on the Nasdaq  National Market on the last trading date
prior to the date of determination as reported in The Wall Street Journal.



<PAGE>





                         INFORMATION STORAGE DEVICES, INC.

                    DIRECTORS NONQUALIFIED STOCK OPTION GRANT

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


Optionee:                                 ______________________________________

Address:                                  ______________________________________
                                          --------------------------------------

Total Shares Subject to Option:          _________________7,500_________________

Exercise Price Per Share:                 ______________________________________

Date of Grant:                            ______________________________________

Expiration Date:                          ______________________________________

</TABLE>

         1. Grant of Option.  Information  Storage  Devices,  Inc., a California
corporation   (the   "Company"),   has  granted  to  the  optionee  named  above
("Optionee") an option (this "Option") to purchase the total number of shares of
Common Stock of the Company set forth above (collectively,  the "Shares") at the
exercise price per share set forth above (the "Exercise Price"),  subject to all
of the terms and conditions of this Grant and the Company's 1994 Directors Stock
Option  Plan,  as amended to the date  hereof  (the  "Plan").  Unless  otherwise
defined herein,  capitalized  terms used herein shall have the meanings ascribed
to them in the Plan.

         2. Exercise and Vesting of Option.  Subject to the terms and conditions
of the Plan and this  Grant,  this  Option  shall be  exercisable  as it  vests.
Subject to the terms and conditions of the Plan and this Grant,  this Option (if
granted on or after  January 1, 1997)  shall vest  ratably at the end of each of
the twelve  months  following  the date of grant and will be fully vested at the
end of the first full year  following  the date of grant so long as the Optionee
continuously remains a member of the Board of Directors of the Company (a "Board
Member").

         3.  Restriction  on Exercise.  This Option may not be exercised  unless
such exercise is in compliance  with the 1933 Securities Act, and all applicable
state  securities  laws, as they are in effect on the date of exercise,  and the
requirements  of any  stock  exchange  or  national  market  system on which the
Company's  Common  Stock  may  be  listed  at the  time  of  exercise.  Optionee
understands that the Company is under no obligation to register, qualify or list
the Shares with the SEC, any state  securities  commission or any stock exchange
or national market system to effect such compliance.
<PAGE>

         4.     Termination of Option. Except as provided below in this Section,
this Option shall terminate and may not be exercised if Optionee ceases to be a
Board Member.  The date on which Optionee  ceases to be a Board Member shall be
referred to as the "Termination Date."

                4.1  Termination  Generally.  If  Optionee  ceases to be a Board
Member for any reason  except death or  disability,  this Option,  to the extent
(and only to the extent) that it would have been  exercisable by Optionee on the
Termination Date, may be exercised by Optionee within three (3) months after the
Termination Date, but in no event later than the Expiration Date.

                4.2 Death or Disability. If Optionee ceases to be a Board Member
because  of the death of  Optionee  or the  disability  of  Optionee  within the
meaning of Section 22(e)(3) of the Code, this Option, to the extent (and only to
the extent) that it would have been  exercisable by Optionee on the  Termination
Date, may be exercised by Optionee (or Optionee's legal  representative)  within
twelve (12) months after the  Termination  Date,  but in no event later than the
Expiration Date.

         5.     Manner of Exercise.

                5.1  Exercise  Agreement.  This Option shall be  exercisable  by
delivery to the Company of an executed  written  Directors Stock Option Exercise
Agreement in the form attached hereto as Exhibit A, or in such other form as may
be  approved by the  Committee,  which  shall set forth  Optionee's  election to
exercise some or all of this Option,  the number of Shares being purchased,  any
restrictions imposed on the Shares and such other representations and agreements
as may be required by the Company to comply with applicable securities laws.

                5.2  Payment.  Payment for the Shares may be made (a) in cash or
by check;  (b) by  surrender  of shares of Common Stock of the Company that have
been owned by  Optionee  for more than six (6) months  (and which have been paid
for within the meaning of SEC Rule 144 and, if such shares were  purchased  from
the  Company  by use of a  promissory  note,  such note has been fully paid with
respect to such  shares) or were  obtained  by the  Optionee  in the open public
market,  having a Fair Market Value equal to the  Exercise  Price of the Option;
(c) by waiver of compensation due or accrued to Optionee for services  rendered;
(d) provided  that a public market for the  Company's  stock  exists,  through a
"same day sale"  commitment  from the  Optionee  and a  broker-dealer  that is a
member of the  National  Association  of  Securities  Dealers (a "NASD  Dealer")
whereby the  Optionee  irrevocably  elects to exercise  the Option and to sell a
portion of the Shares so purchased to pay for the Exercise Price and whereby the
NASD  Dealer  irrevocably  commits  upon  receipt of such  Shares to forward the
Exercise  Price  directly to the Company;  (e) provided that a public market for
the Company's stock exists,  through a "margin" commitment from the Optionee and
a NASD Dealer whereby the Optionee irrevocably elects to exercise the Option and
to pledge  the Shares so  purchased  to the NASD  Dealer in a margin  account as
security  for a loan from the NASD Dealer in the amount of the  Exercise  Price,
and whereby the NASD Dealer  irrevocably  commits upon receipt of such Shares to
forward the Exercise Price directly to the Company; or (f) by any combination of
the foregoing.
<PAGE>

                5.3 Withholding  Taxes. Prior to the issuance of the Shares upon
exercise of this Option,  Optionee shall pay or make adequate  provision for any
applicable federal or state withholding obligations of the Company.

                5.4  Issuance of Shares.  Provided  that such notice and payment
are in form and substance  satisfactory to counsel for the Company,  the Company
shall cause the Shares to be issued in the name of Optionee or Optionee's  legal
representative.  To enforce any restrictions on Optionee's Shares, the Committee
may require Optionee to deposit all certificates,  together with stock powers or
other instruments of transfer approved by the Committee  appropriately  endorsed
in blank,  with the  Company or an agent  designated  by the  Company to hold in
escrow until such restrictions have lapsed or terminated,  and the Committee may
cause a legend or  legends  referencing  such  restrictions  to be placed on the
certificates.

         6.  Nontransferability  of Option. During the lifetime of the Optionee,
this Option shall be exercisable  only by Optionee or by Optionee's  guardian or
legal representative, unless otherwise permitted by the Committee. No Option may
be sold,  pledged,  assigned,  hypothecated,  transferred  or disposed of in any
manner other than by will or by the laws of descent and distribution.

         7.  Interpretation.  Any dispute  regarding the  interpretation of this
Grant  shall be  submitted  by Optionee  or the  Company to the  Committee  that
administers  the Plan,  which  shall  review  such  dispute at its next  regular
meeting.  The  resolution of such a dispute by the Committee  shall be final and
binding on the Company and on Optionee.  Nothing in the Plan or this Grant shall
confer on Optionee any right to continue as a Board Member.

         8. Entire  Agreement.  The Plan and the Directors Stock Option Exercise
Agreement are  incorporated  herein by this reference.  This Grant, the Plan and
the Directors Stock Option Exercise Agreement constitute the entire agreement of
the parties  hereto and supersede all prior  undertakings  and  agreements  with
respect to the subject matter hereof.



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

                         By:  ________________________________________________

                         Name: _______________________________________________

                         Title:  _____________________________________________


</TABLE>


<PAGE>



                               ACCEPTANCE

         Optionee hereby acknowledges receipt of a copy of the Plan,  represents
that Optionee has read and  understands  the terms and provisions  thereof,  and
accepts this Option subject to all the terms and conditions of the Plan and this
Grant.  Optionee  acknowledges  that there may be adverse tax consequences  upon
exercise of this Option or  disposition  of the Shares and that Optionee  should
consult a qualified tax advisor prior to such exercise or disposition.



                                       ---------------------------------
                                                   Optionee


<PAGE>








                                    Exhibit A


                    DIRECTORS STOCK OPTION EXERCISE AGREEMENT




<PAGE>





                                    Exhibit A
                       INFORMATION STORAGE DEVICES, INC.
                        1994 DIRECTORS STOCK OPTION PLAN
                   DIRECTORS STOCK OPTION EXERCISE AGREEMENT
                   -----------------------------------------
I hereby elect to purchase the number of shares of common stock as set 
forth below:

Optionee:                                           Number of Shares Purchased:
Social Security Number:                               Purchase Price per Share:
Address:                                              Aggregate Purchase Price:
                                                    Date of Stock Option Grant:
Type of Stock Option:Nonqualified                Exact Name of Title to Shares:
                     Stock Option


         Optionee hereby  delivers to the Company the Aggregate  Purchase Price,
to the extent  permitted  in the  Directors  Nonqualified  Stock Option Grant as
follows (check as applicable and complete):

[   ]    in cash (by check) in the amount of $__________________, receipt of 
         which is acknowledged by the Company;

[   ]    by  delivery  of  ___________  fully-paid,  nonassessable  and vested
         shares of the common  stock of the  Company  owned by  Optionee  for at
         least six (6) months prior to the date hereof (and which have been paid
         for within the meaning of SEC Rule 144), or obtained by Optionee in the
         open  public  market,  and owned free and clear of all  liens,  claims,
         encumbrances or security  interests,  valued at the current Fair Market
         Value of $_________ per share;

[   ]    by the waiver hereby of compensation due or accrued to Optionee for 
         services rendered in the amount of $______________________;

[   ]    through  a  "same-day-sale"  commitment,  delivered  herewith,  from
         Optionee  and  the  NASD  Dealer  named  therein,   in  the  amount  of
         $___________________; or

[   ]    through a "margin" commitment, delivered herewith from Optionee and the
         NASD Dealer named therein, in the amount of $---------------------.

         Market  Standoff  Agreement.  Optionee  agrees in  connection  with any
registration of the Company's  securities  that, upon the request of the Company
or the  underwriters  managing any public offering of the Company's  securities,
Optionee  will not sell or  otherwise  dispose of any Shares  without  the prior
written  consent of the  Company or such  underwriters,  as the case may be, for
such period of time from the effective date of such  registration as the Company
or the underwriters may specify for the Company's officers and directors.

         Tax Consequences. OPTIONEE UNDERSTANDS THAT OPTIONEE MAY SUFFER ADVERSE
TAX  CONSEQUENCES  AS A RESULT OF  OPTIONEE'S  PURCHASE  OR  DISPOSITION  OF THE
SHARES.   OPTIONEE   REPRESENTS   THAT  OPTIONEE  HAS  CONSULTED  WITH  ANY  TAX
CONSULTANT(S)  OPTIONEE  DEEMS  ADVISABLE  IN  CONNECTION  WITH THE  PURCHASE OR
DISPOSITION  OF THE SHARES AND THAT  OPTIONEE  IS NOT RELYING ON THE COMPANY FOR
ANY TAX ADVICE.

         Entire  Agreement.  The Plan and  Directors  Nonqualified  Stock Option
Grant are  incorporated  herein by reference.  This Agreement,  the Plan and the
Directors Nonqualified Stock Option Grant constitute the entire agreement of the
parties and supersede in their entirety all prior undertakings and agreements of
the Company and  Optionee  with  respect to the subject  matter  hereof,  and is
governed by California law except for that body of law pertaining to conflict of
laws.


Date:
                                      Signature of Optionee


<PAGE>




Spouse's Consent



         I  acknowledge  that I have read the  Directors  Stock Option  Exercise
Agreement (the "Agreement") and that I know its contents. I am aware that by the
Agreement's  provisions my spouse (the "Optionee")  agrees to sell the Number of
Shares  Purchased (as provided for in the Agreement and hereinafter  referred to
as  "Shares"),  including  any  community  property  interest I may have, on the
occurrence  of  certain  events.  I hereby  consent  to the  sale,  approve  the
provisions  of the  Agreement and agree that these Shares and any interest I may
have in them are  subject to the  provisions  of the  Agreement.  I will take no
action at any time to hinder  operation of the  Agreement on these Shares or any
interest I may have in them.


Spouse of Optionee


__________________________________        Date:____________________________


___________________________________       Date:____________________________
Optionee's Name





<PAGE>

[Employee Name]

November 19, 1996
Amended and Restated Employment Agreement
Page 5





                                                      Exhibit 10.25


                                 [ISD LETTERHEAD]

                                November 19, 1996



[EMPLOYEE NAME]
[EMPLOYEE ADDRESS]

                  Re:  Amended and Restated Employment Agreement With ISD

Dear [NAME]:  (See Attached Schedule)

         This letter will set forth the binding  agreement  of  employment  (the
"Agreement"),  effective as of November 19, 1996 (the "Effective Date"), between
you and Information  Storage Devices,  Inc., a California  corporation  ("ISD").
This letter  amends and restates in its entirety that certain  letter  agreement
signed by you and ISD dated January 19, 1996 regarding your employment with ISD.

         1.  EMPLOYMENT AND DUTIES.  During the  Employment  Term, as defined in
Section 3 below, you will serve as (See Section  Schedule) of ISD. You will have
such duties and  authority  as are  customary  for, and  commensurate  with such
position,   including   ___________________________________,   and  such   other
reasonable  duties and  authority as the Board of Directors of ISD (the "Board")
prescribes  from time to time,  and you will comply with all reasonable and good
faith policies and directives of the Board in connection therewith.

         2.       COMPENSATION.

                  (a)  Salary.  For  your  services  hereunder,  ISD will pay as
salary to you the  amount of $(See  Attached  Schedule)  per  month  during  the
Employment Term, as defined in Section 3 below,  prorated for any partial month.
Such salary will be paid in conformity  with ISD's normal payroll  period.  Your
salary will be reviewed  by the Board from time to time at its  discretion,  and
you  will  receive  such  salary  increases,  if any,  as the  Board in its sole
discretion determines.

                  (b) Bonus. In addition to the salary set forth in Section 2(a)
hereof,  you will be  eligible  starting  in fiscal  1997,  for an annual  bonus
pursuant to a formula, and determined in accordance with criteria,  in each case
to be established by the Board and/or its Compensation Committee,  which formula
and criteria will be communicated to you in writing reasonably in advance of the
commencement of the performance period to which such bonus will relate.

                  (c) Other Benefits. You will be entitled to participate in and
receive  benefits under ISD's standard  benefits plans as in effect from time to
time, including medical insurance, sick leave, and vacation time, subject to and
on a basis consistent with the terms,  conditions and overall  administration of
such plans and ISD policies.

                  (d) Expenses.  During the term of your  employment  hereunder,
you will be entitled to receive prompt reimbursement from ISD for all reasonable
business-related expenses incurred by you, in accordance with ISD's policies and
procedures  as in effect  from  time to time,  provided  that you will  properly
account for such business expenses in accordance with ISD's policy.

                  (e) Deductions and  Withholding.  All amounts payable or which
become  payable  under any  provision of this  Agreement  will be subject to any
deductions  authorized  in writing by you and any  deductions  and  withholdings
required by law.

         3.       TERM OF EMPLOYMENT.

                  (a) Term.  This  Agreement  will  continue  in full  force and
effect from and including the Effective Date through and including  December 31,
1998, and thereafter will continue for successive one-year periods unless sooner
terminated  or extended as  hereinafter  provided (the period from the Effective
Date  through  the end of the  then-current  period  referred  to  herein as the
"Employment Term").

                  (b) Termination At End Of Then-Current  Two Year Period.  This
Agreement,  and  the  Employment  Term,  may be  terminated  at  the  end of any
then-current two or one year period as described in Section 3(a) hereof, whether
the initial two-year period or subsequent one-year periods, by written notice by
either  party to the other given no later than three (3) months prior to the end
of such then-current one-year period.

                  (c)  Termination  By You. You may terminate  this Agreement at
any time by giving ISD written  notice of your  resignation at least thirty (30)
days in advance,  provided  that no such advance  notice will be required if you
voluntarily terminate this Agreement as a result of occurrence of a Constructive
Termination Event, as described in Section 4(b) hereof.

                  (d) Termination for Cause. This Agreement may be terminated by
ISD prior to the expiration of the Employment Term solely for Cause  immediately
upon delivery of written notice to you of such termination. For purposes of this
Agreement, "Cause" means, in each case as determined in good faith by the Board,
your (i) personal  dishonesty,  willful misconduct,  or breach of fiduciary duty
involving  personal  profit,  and/or (ii)  willful  violation of any felony law,
and/or (iii)  willful  breach of a material  provision of this  Agreement  after
written notice,  in reasonable  detail as the alleged breach,  has been given to
you by the Board and you have had a reasonable opportunity to cure such breach.

                  (e)  Termination  Due to Death or Disability.  Your employment
hereunder  will  terminate  immediately  upon your  death.  In the event that by
reason of injury,  illness or other  physical or mental  impairment  you are (i)
completely  unable to  perform  your  services  hereunder  for more  than  three
consecutive  months,  or (ii) unable in the good faith  judgment of the Board to
perform  your  services  hereunder  for 50% or more of the  normal  working  day
throughout  six  consecutive  months,  then ISD may  terminate  your  employment
hereunder at the end of such three-month or six-month period, as applicable,  by
delivery to you of written notice of such termination,  specifying the effective
date of such termination.

                  (f)      Termination Upon Closing of Corporate Transaction.
This  Agreement  will  terminate automatically  upon the closing of a Corporate
Transaction  (as defined in Section 4(c) hereof) that occurs during the
Employment Term.

         4.       PAYMENTS AND BENEFITS AFTER TERMINATION OF EMPLOYMENT.

                  (a)  Termination   For  Death  or  Disability,   or  Voluntary
Termination.  Upon  termination  of your  employment  by ISD under  Section 3(e)
hereof for death or disability, or upon your voluntary termination of employment
pursuant to Section  3(c) hereof  (unless  such  voluntary  termination  is as a
result of  occurrence  of a  Constructive  Termination  Event,  as  described in
Section 4(b) hereof),  all salary and benefits  hereunder will cease immediately
upon the date of such  termination,  and you  will be  paid,  no later  than the
applicable  time  provided  by law,  all salary  accrued  and  payable,  and all
benefits  and bonus  amount  amounts  accrued  and  payable  under ISD  policies
relating thereto, as of the date of such termination.

                  (b)   Termination  By  You  As  A  Result  of  A  Constructive
Termination  Event. If you voluntarily  terminative  your employment by ISD as a
result of the occurrence of a  Constructive  Termination  Event,  as hereinafter
defined (in which case your written notice to ISD of such voluntary  termination
will  state  that it is as a  result  of the  occurrence  of  such  Constructive
Termination  Event),  you will be entitled to be paid an amount,  as  severance,
equal to your annual  salary  hereunder  as in effect  immediately  prior to the
occurrence  of such  Constructive  Termination  Event,  to be paid in six  equal
installments  each  paid on the date you  otherwise  would  have  been paid your
salary  had  your  employment  continued.  For  purposes  of this  Agreement,  a
"Constructive  Termination Event" will be deemed to have occurred at ISD's close
of business on the fourteenth  (14th) day after,  and including,  the first day,
that  any of the  following  actions  is taken  by ISD and  such  action  is not
reversed  in full by ISD within such  fourteen-day  period  unless  prior to the
expiration of such fourteen-day period you have otherwise agreed to the specific
relevant  event in writing:  (i) your  aggregate  ISD  benefits  are  materially
reduced (as such reduction and materiality are determined by customary  practice
within the semiconductor industry within the State of California) below those in
effect immediately prior to the effective date of such Constructive  Termination
Event,  and such  reduction  is not applied as part of an overall  reduction  in
benefits in which you are treated proportionally given your position,  length of
service,  income and other customary  relevant factors,  and/or (ii) your duties
and/or authority within ISD are materially  decreased or increased from those in
effect  immediately prior to such Constructive  Termination Event, in a way that
is adverse to you, as such  materiality  and  adverse  nature is  determined  by
customary  practice  within  the  semiconductor  industry  within  the  State of
California  and/or (iii) your title is changed to a title that,  under customary
practice within the semiconductor industry within the State of California, would
be considered to be a lower-level  title than your prior title,  and/or (iv) you
are required to perform your employment obligations with ISD (other than routine
travel in the ordinary  course of the ISD's  business)  at a location  more than
twenty-five  (25) miles away from your  principal  place of work for ISD as such
place of work was in  effect  immediately  prior to the  effective  date of such
Constructive Termination Event.

                  (c)      Termination on Closing of Corporate Transaction.

                           (i)      "Corporate Transaction" Defined.  For
purposes of this Section 4(c), a "Corporate Transaction" is defined as (i) a
merger or  acquisition in which ISD is not the surviving entity (except for a
merger of ISD into a wholly-owned subsidiary, and except for a transaction the
purpose of which is to change the State in which ISD is incorporated), (ii)
the sale,  transfer or other  disposition of all or substantially all of the 
assets  of  ISD  or  (iii)  any  other   corporate reorganization or business
combination, and in which the beneficial ownership of 50% or more of ISD's 
outstanding voting stock is transferred.

                           (ii)     Severance  Payment on  Closing  of Corporate
Transaction.  Upon the  closing of a Corporate  Transaction, provided you are
employed hereunder at the date of such closing,  then unless you and ISD have
agreed otherwise in writing, ISD will pay you, as a one-time, lump sum severance
payment,  an amount  equal to two and one-half (2 1/2) times your annual salary
hereunder  as in effect  immediately prior to such closing.

         5.       ACCELERATION OF OPTIONS.

                  (a)  Acceleration  of Options.  Subject to the  provisions  of
Section  5(b)  hereof,   immediately   prior  to  the  closing  of  a  Corporate
Transaction,  the  exerciseability  of each  option  granted to you to  purchase
shares  of ISD's  Common  Stock  that is  outstanding  immediately  prior to the
closing of such Corporate Transaction, will be automatically accelerated so that
each such option will,  immediately  prior to the closing date for the Corporate
Transaction,  become  fully  exerciseable  with  respect to the total  number of
shares issuable upon exercise  thereof and may be exercised prior to the closing
of such Corporate Transaction for all or any portion of such shares.

                  (b) Automatic  Nullification of Acceleration  Provisions Under
Certain  Conditions.  Notwithstanding  the provisions of Section 5(a) hereof, if
ISD proposes to close a Corporate  Transaction that requires,  as a condition of
such transaction,  that such Corporate Transaction be accounted for as a pooling
of interest,  and if, solely as a result of the  operation of the  provisions of
Section 5(a) hereof (together with the operation of any equivalent  provision of
any written  agreement or  agreements  entered into between ISD and any other of
ISD's executive officers), such Corporate Transaction is, or on its closing will
be, in the good faith judgment of the  independent  accountants of ISD and/or of
the  independent  accountants  of the other  party or parties to such  Corporate
Transaction,  which  determination  will  be  communicated  in  writing  to ISD,
prohibited  from  being  accounted  for as a pooling of  interest,  and that the
nullification  of the  provisions  of Section  5(a) would  allow such  Corporate
Transaction  to be accounted as a pooling of interests,  then the  provisions of
Section 5(a) hereof will be deemed to be nullified and void  automatically  upon
delivery of such written  determination  to ISD,  without any discretion on your
part or on the part of ISD, and such options will not  accelerate as provided in
Section 5(a) and instead will be exerciseable to the extent provided therein. If
such Corporate  Transaction does not close,  then the provisions of Section 5(a)
hereof will revive and apply again  thereafter,  subject still to the provisions
of this Section 5(b).

         6. MISCELLANEOUS.  This Agreement contains the entire understanding and
agreement  between the parties with respect to the subject  matter  hereof,  and
supersedes any and all prior  agreements,  negotiations and discussions  between
the parties  hereto with respect to the subject  matter  covered  hereby and may
only be modified by an  agreement  in writing  signed by ISD and you,  and which
states the intent of the parties to amend this  Agreement.  If any  provision of
this Agreement is held to be invalid or otherwise unenforceable,  in whole or in
part,  the remainder of such  provision and the remainder of this Agreement will
be enforced to the fullest extent  permitted by law.  Neither this Agreement nor
the rights or  obligations  hereunder  will be assignable by you. ISD may assign
this  Agreement  to any  successor  of ISD,  and upon such  assignment  any such
successor will be deemed  substituted  for ISD upon the terms and subject to the
conditions  hereof.  This  Agreement  will be binding  upon the  successors  and
assigns of the parties hereof and upon your heirs, executors and administrators.
This Agreement has been  negotiated and executed in, and will be governed by and
construed with the laws of, the State of California. Any notice, request, demand
or other  communication  required or  permitted  hereunder  will be deemed to be
properly  given when  personally  served in writing,  or when  deposited  in the
United States mail,  postage  prepaid,  addressed to ISD at the address shown at
the  beginning  of this  letter,  or to you at the address  shown  below,  or by
facsimile upon confirmation of receipt. Each party hereto may change its address
by written notice in accordance with this Section 6.



                                                     Sincerely,

                                                     David L. Angel
                                                     Chairman and CEO
                                                     [FELIX J. ROSENGARTEN,
                                                     V.P. and CFO SIGNS
                                                     FOR DAVE ANGEL]

ACCEPTED AND AGREED:



[NAME]
Date signed: ___________________, 1996
Address:

Facsimile:



<PAGE>


                         Information Storage Devices, Inc.

                       Schedule of Employment Agreement Terms



                            Position                       Salary
Name                        (Section 1)                    (Section 2(a))
----                        -----------                    --------------

David L. Angel              Chairman of the Board           $ 20,750
                            and CEO

Felix J. Rosengarten        Vice President, Finance and     $ 12,917
                            Administration, CFO

<PAGE>

                                     CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

                                                     ARTHUR ANDERSEN LLP

San Jose, California
March 20, 1997