<PAGE>
 
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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             ----------------------
                                   FORM 10-K
(Mark One)
[X]  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
     THE SECURITIES EXCHANGE ACT OF 1934.

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[_]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
     THE SECURITIES EXCHANGE ACT OF 1934.

          FOR THE TRANSITION PERIOD FROM ____________ TO ____________
                         COMMISSION FILE NUMBER 0-26312

                           TELCOM SEMICONDUCTOR, INC.
             (Exact name of registrant as specified in its charter)

           DELAWARE                                   94-3186995
(State or other jurisdiction of         (I.R.S. Employer Identification Number)
incorporation or organization)
 
1300 TERRA BELLA AVENUE,                               94039-7267
MOUNTAIN VIEW, CALIFORNIA                              (Zip Code)
(Address of principal executive offices)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (650) 968-9241
        SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
                         COMMON STOCK, $.001 PAR VALUE

     Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 [_]

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10K or
any amendment to this Form 10K. [_]
 
     The aggregate market value of the voting stock held by persons other than
those who may be deemed affiliates of the Company as of February 25, 1998, was
approximately $127,411,400. Shares of Common Stock held by each executive
officer and director and by each person who owns 5% or more of the outstanding
Common Stock have been excluded in that such persons may under certain
circumstances be deemed to be affiliates.  This determination of executive
officer or affiliate status is not necessarily a conclusive determination for
other purposes.

     The number of  shares of the Registrant's Common Stock outstanding as of
February 25, 1998 was 16,474,512.

                       DOCUMENT INCORPORATED BY REFERENCE

     Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of
Stockholders to be held April 16, 1998 are incorporated by reference in Part III
of this Form 10-K.

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                               TABLE OF CONTENTS

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                                                                                                       PAGE
                                                                                                       ----
 
PART I
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Item 1.         Description of Business.............................................................        1
Item 2.         Description of Property.............................................................       11
Item 3.         Legal Proceedings...................................................................       12
Item 4.         Submission of Matters to a Vote of Security Holders.................................       12
 
PART II
Item 5.         Market for the Registrant's Common Equity and Related Stockholder Matters...........       13
Item 6.         Selected Consolidated Financial Data................................................       14
Item 7.         Management's Discussion and Analysis of Financial Condition and Results of
                Operations..........................................................................       15
Item 8.         Financial Statements................................................................       19
Item 9.         Changes in and Disagreements with Accountants on Accounting and Financial
                Disclosure..........................................................................       36
 
PART III
Item 10.        Directors and Executive Officers of the Registrant..................................       37
Item 11.        Executive Compensation..............................................................       37
Item 12.        Security Ownership of Certain Beneficial Owners and Management......................       37
Item 13.        Certain Relationships and Related Transactions......................................       37
 
PART IV
Item 14.        Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................       38
SIGNATURES..........................................................................................       39
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                                    PART I
                                    ------

     This Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934.  Actual results could differ materially from
those projected in the forward-looking statements as a result of the risk
related factors set forth herein.

ITEM 1.  DESCRIPTION OF BUSINESS
--------------------------------

     TelCom Semiconductor, Inc. (the "Company") designs, develops, manufactures
and markets a diversified portfolio of high-performance standard analog
integrated circuits for a wide variety of applications in the industrial,
communications, computer, and medical markets.  The Company's products comprise
three principal product families: power management products, such as switch mode
power supply controllers, whose function is to conserve power; mixed signal
products, which are analog devices with some digital control functionality, such
as display analog/digital converters;  and smart sensors, such as solid state
thermal management devices.  Within each family, the Company markets proprietary
and selected second source products offering a range of performance,
functionality and price.

     TelCom produces the substantial majority of its wafers at its manufacturing
facility in Mountain View, California.  The Company believes that its in-house
wafer fabrication facility provides a competitive advantage because it
facilitates close collaboration between design and process engineers, provides
control over wafer supply, offers the potential for lower manufacturing costs
and accelerates product introduction.  The Company utilizes CMOS, Bipolar and
BiCMOS process technologies, which are tailored to meet product specifications
and customer requirements.  TelCom performs final testing at, and ships its
products from, its facility in Hong Kong.

     The Company was organized in Delaware in June 1993 and began operations in
December 1993 after purchasing the semiconductor operations of Teledyne, Inc.
("Teledyne") which principally consisted of its Teledyne Components division
("Teledyne Components").  The Company's principal executive offices are located
at 1300 Terra Bella Avenue, Mountain View, California 94039, and its telephone
number is (650) 968-9241.

STRATEGY

     TelCom's objective is to be a leading provider of high performance analog
circuits for a wide variety of applications in high growth markets.  To achieve
this objective, the Company has adopted the following strategies:

     Customer Driven Marketing and Product Development.  TelCom seeks to
identify customers that are leaders in each of the Company's targeted market
segments, work with these customers to understand their analog device
applications and needs, and develop for these customers product solutions that
offer a combination of high performance, increased functionality and cost
savings.  The Company believes that working with market leaders can  result in
early adoption of its products by such customers and maximize product sales.  In
working with market leaders, the Company directs its efforts toward products
that have the potential to become industry standard products, since other
industry participants often tend to adopt products used by market leaders.
After penetrating both market leaders and other industry participants, the
Company's strategy is to use its distribution network to offer the same products
to potential customers with similar needs in other industries.

     Build Product Families.  TelCom's current products comprise three principal
product families: mixed signal products, which are analog devices with some
digital control functionality, such as display analog/digital converters; power
management products, such as switch mode power supply controls whose function is
to conserve power and smart sensors, such as solid state thermal management
devices that can shut off expensive microprocessor-based systems when
temperatures exceed a specified threshold.  The Company's product strategy is to
introduce new proprietary products and selected second source products within
its principal product families in order to increase the range of performance and
capabilities of its products and to address a broad spectrum of customer
applications.

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     Maintain Technological Leadership.  The Company seeks to utilize its design
engineers and its process expertise to produce feature rich analog circuits at
competitive prices.  TelCom has built a team of experienced analog design
engineers who combine their industry expertise with computer-aided design
technology to design products to meet exacting customer requirements in a timely
manner.  The Company is continually developing new manufacturing technologies to
enable production of the more sophisticated devices being designed by its
designers.

CUSTOMERS AND MARKETS

     TelCom's marketing strategy is to identify leading customers within each of
its targeted market segments, work with these customers to understand their
analog device applications, and develop jointly with these customers product
solutions that offer a combination of high performance, increased functionality
and cost savings.  An additional benefit of working with leading customers is
the ability to gain insight into their next generation product requirements and
to identify second source product needs that the Company may be in a position to
fulfill.  TelCom believes that its relationships with market leaders, such as
Motorola in the cellular telephone market and Compaq Computer in the PC market,
enable the Company to sell such product solutions to other significant
participants in such markets.  TelCom also relies on its worldwide distribution
network to accumulate information about other possible applications for the
Company's products.

     As described below, the Company's products are used in a broad range of
applications within the industrial, communications and computer markets.  The
Company also develops products for the automotive and medical markets.

     Communications Market.  The proliferation of hand-held communications
devices such as cellular telephones, pocket pagers and personal two-way radios
has created a demand for analog devices that monitor and reduce power
consumption.  TelCom offers a range of analog circuits to address the demands of
these products for longer battery life.  These circuits include battery full/low
charge detection and DC-DC converters for the generation of voltages to drive
liquid crystal displays, including backlighting.  These devices are offered in
miniature packages resulting in savings in space and weight.  The Company's
family of high current MOSFET drivers are used with TelCom's switch mode power
supply controllers to regulate AC to DC power in cellular base stations, PBX and
telephone and data communication equipment.

     Computer Market.  The rapid adoption of networked PCs, workstations and
servers and the deployment of machines using high performance microprocessors
have given rise to the need for reliable temperature rise detection for power
supply shutdown and fan speed control.  As part of its smart sensor product
family, TelCom has a patented solid state temperature sensor that facilitates
rapid temperature rise detection that can be used for controlled shutdown of
equipment with no loss of data or destruction of critical or expensive
components.  This trend to protect critical components by replacing older
mechanical solutions with high performance analog devices is extending into
notebook computers, modular power supplies and industrial and consumer product
temperature alarms.  The reliability and robust nature of silicon make analog
devices preferable to mechanical devices in many respects.  TelCom also makes
power analog circuits for use in laptop/notebook computers, palmtop computers,
personal digital assistants, pocket organizers, facsimile modems and CD-ROM
products.  These products offer low operating current and/or high current drive
capability for deriving additional voltages from battery or line powered
equipment.

     Industrial Market.  Increased demand for precision and reliability has
resulted in higher semiconductor content in industrial instruments and
manufacturing equipment.  TelCom offers a broad range of integrating analog to
digital converters that address the measurement of DC and AC voltages and
currents, resistance and capacitance.  These devices are commonly used in
digital multimeters, panel meters, temperature meters, digital scales and
digital oscilloscopes.  This broad line of power management circuits offer the
ability to detect and regulate voltages for use in battery and line powered
industrial equipment.

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PRODUCTS

     The Company offers a diversified portfolio of over 600 products for a wide
range of market applications to reduce its dependence on any single product,
industry or application.  The Company's product strategy is to introduce new
proprietary products and selected second source products within its principal
product families in order to increase the range of performance and capabilities
of its products and to address a broad spectrum of customer applications.

     Power Management Products.  TelCom is focusing a significant portion of its
design resources on power management products, which comprise the Company's core
product area.  The primary power management circuits offered by the Company are
MOSFET power drivers, BICMOS switch mode power supply controllers, DC-DC
converters and CMOS voltage detectors (including microprocessor supervisory
circuits).  TelCom is also developing very low quiescent current DC-DC switching
regulators and voltage detectors, and is modifying its existing Bipolar process
to allow it  to address the higher current and voltage marketplace.  The Company
already has a broad line of CMOS drivers and has plans to increase products
within this family.  The Company's power management product family also includes
low quiescent current CMOS LDO (low drop-out) regulators offering dropout
voltages (minimum voltage needed across the device to maintain output voltage
regulation) of 50 milli-volts to maximize the time before the battery is
exhausted.  The Company pioneered the introduction of a CMOS version of a
pervasive Bipolar PWM (pulse width modulator) circuit for power supply
applications.  This low power alternative to the Bipolar competition addresses
high end market applications, such as telephone line repeaters, where cost
sensitivity is balanced by the need for power conservation.

     Mixed Signal Products.  TelCom's mixed signal semiconductors (which are
distinct from mixed signal devices that incorporate analog and digital
semiconductors in a single device) include system A/D converters, display A/D
converters, voltage references and chopper stabilized amplifiers.  The Company
is expanding its position as a supplier of integrating A/D converters by
introducing devices with higher accuracy (resolution) and increased
functionality.  The Company is also developing relationships with customers in
the field of portable measuring instrumentation used in temperature monitoring,
automotive diagnostics and field test equipment.  Mixed signal products are
integral to the A/D interface found in a wide range of applications, such as
precision scales and tympanic thermometers.  Process control and data
acquisition systems also benefit from the inherent capability of dual slope A/D
converters to reject line interference.  The Company's chopper stabilized
amplifiers are used in precision amplification of very low level signals in the
microvolt (1 millionth of a volt) range often encountered with strain gauges.
These amplifiers have extremely low drift over both temperature and time.  By
using its BICMOS and CMOS processes, the Company's products span a wide range of
currents from milliamps to amps.

     Smart Sensor Products.  The increasing trend towards lightweight, high
performance PCs and other products has necessitated smaller enclosures and
faster microprocessors, resulting in a significant increase in the amount of
heat generated within such products.  TelCom's range of solid state thermal
management devices is aimed at monitoring and warning of fault conditions and
solving thermal management problems.  For example, the Company's proprietary
TC620 temperature sensor protects advanced microprocessor-based systems by
monitoring the temperature of the microprocessor and automatically turning off
the system when the system temperature exceeds a specified threshold.
 
     The Company's success depends upon its ability to develop new analog
circuits for existing and new markets, to introduce such products in a timely
manner and to have such products gain market acceptance. The development of new
analog circuits is highly complex and from time to time the Company has
experienced delays in developing and introducing new products.  Successful
product development and introduction depends on a number of factors, including
proper new product definition, timely completion of design and testing of new
products, achievement of acceptable manufacturing yields and market acceptance
of the Company's and its customers' products.  Moreover, successful product
design and development is dependent on the Company's ability to attract, retain
and motivate qualified analog design engineers, of which there is a limited
number.  There can be no assurance that the Company will be able to meet these
challenges or adjust to changing market conditions as quickly and cost-
effectively as necessary to compete successfully.  Due to the complexity and
variety of analog 

                                       3
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circuits, the limited number of analog circuit designers and the limited
effectiveness of computer-aided design systems in the design of analog circuits,
there can be no assurance that the Company will be able to successfully develop
and introduce new products on a timely basis. Although the Company seeks to
design products that have the potential to become industry standard products,
there can be no assurance that any products introduced by the Company will be
adopted by such market leaders, or that any products initially accepted by the
Company's customers that are market leaders will become industry standard
products. The Company's failure to develop and introduce new products
successfully could materially and adversely affect its business and operating
results.

     The Company's results of operations are dependent on the balance between
sales of relatively higher margin but lower volume proprietary products and
relatively higher volume but lower margin second source products.  In order to
improve its margins, sales of proprietary products must in the future represent
a greater percentage of the Company's net revenues, requiring the Company to
successfully develop, introduce and market new proprietary products.  There can
be no assurance that the Company will be successful in developing new
proprietary products with the features and functionality that customers in its
key markets will demand.

DESIGN AND PROCESS TECHNOLOGY

     Design Technology.  The design of analog circuits involves the design and
interconnection of a variety of circuits and features to achieve the desired
function.  The specific placement and interrelationship of these circuits is
both complex and critical to the performance of the analog circuit.  Computer-
aided design and engineering tools, which have proliferated and enhanced the
design effort for digital integrated circuits, have proven to be useful but less
effective for analog devices.  Consequently, analog circuit design has
traditionally been highly dependent on the skills and expertise of individual
design engineers.  The Company's design engineers principally focus on
developing next generation standard products, using computer simulation models
to design products that both meet the high performance characteristics required
by customers and adjust for process and temperature variations.  TelCom's new
product development strategy emphasizes a broad line of standard products that
are based on customer input and needs.  The Company is currently developing
products to further expand the number of offerings within each of the mixed
signal, power management and smart sensor product families.

     Process Technology.  Since TelCom has its own wafer fabrication facility,
the Company can design and produce analog circuits using multiple manufacturing
processes which can be tailored to optimize product performance, minimize
manufacturing cost and increase production flexibility.  The Company believes
that this flexibility allows the Company's designers to select the optimal
process technology for a given product and function.  At its wafer fabrication
facility, TelCom utilizes CMOS, Bipolar and BICMOS process technologies.  The
process technology used for a particular product is driven by product
specifications and customer requirements.  CMOS technology is the technology
best suited for low power battery operated applications, and has the advantages
of low power consumption and high packing density.  A substantial majority of
the Company's current products utilize some version of the CMOS process.
Bipolar technology is utilized where precision analog elements are required and
is best suited for high gain, high speed, high precision and high voltage
product applications.  The availability of the Company's Bipolar process
provides additional flexibility for the Company's design engineers.  The
Company's voltage reference products utilize the Company's Bipolar process.  The
Company also has the capability to run a BICMOS process which merges the Bipolar
and CMOS technologies.

     The markets for the Company's products are characterized by rapid
technological change and frequent new product introductions.  To remain
competitive, the Company must develop or obtain access to new semiconductor
process technologies in order to reduce die size, increase die performance and
functional complexity and improve manufacturing yields. In order to have access
to new semiconductor process technologies, particularly for products requiring
submicron processing, the Company made an investment in IC WORKS, Inc. in
November 1995 which was to provide the Company with a supply of submicron wafers
for a five year period. In 1997, the Company was able to design and have
manufactured several new products at the IC WORKS foundry. However, due to
financial issues, IC WORKS is scheduled to shut down its wafer manufacturing
foundry in April 1998. In order to have continued access to this type of
manufacturing capability, the Company is in the process of qualifying a new
foundry to replace the IC WORKS capability. There can be no assurance that such
other foundry will be qualified in a timely manner or the transition to such
foundry will not delay production of certain products.

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     Semiconductor design and process methodologies are subject to rapid
technological change, requiring large expenditures for research and development.
If the Company is unable to develop or obtain access to advanced wafer
processing technologies as they become needed, or is unable to define, design,
develop and introduce competitive new products on a timely basis, its future
operating results will be materially and adversely affected.  In addition, the
Company's ability to compete successfully depends on being able to use advanced
analog process technologies to manufacture its products.  There can be no
assurance that the analog process technology utilized by the Company will not
become obsolete.

SALES, DISTRIBUTION AND MARKETING

     The Company's sales and marketing effort is focused on the development of
relationships with leading companies in its targeted markets, and its sales and
marketing resources are deployed to establish and enhance such relationships.
TelCom currently employs sales managers and application engineers in sales,
marketing and applications organizations in the United States, Europe, and Asia.

     The Company's products are sold to over 5,000 end-user customers throughout
the world, either directly or through its distributor network.  Sales to
customers in North America, Europe and Asia accounted for 37%, 25% and 38%,
respectively, of the Company's net sales for 1996, and 35%, 32% and 33%,
respectively, of the Company's net sales for 1997.  The Company's two largest
OEM customers, Motorola and Compaq Computer, accounted for 12% and 9%,
respectively, of the Company's net sales for 1996, and 30% and 7%, respectively,
of the Company's net sales for 1997.  The Company anticipates that it will
continue to be dependent or may increase its dependence on a number of key
customers and distributors for a significant portion of its net sales.  The
reduction, delay or cancellation of orders from one or more significant
customers for any reason could materially and adversely affect the Company's
operating results.

     The Company sells its products through a direct sales staff and a worldwide
network of independent sales representatives and distributors.  The direct sales
staff works with leading customers to determine customer requirements and
interfaces with design engineers to achieve client solutions and also manages
the Company's network of sales representatives and distributors.  The Company
sells its products in Europe through an independent sales representative firm
and various independent stocking representative/distributor firms.  Sales in
Asia are handled through various independent stocking representative/distributor
firms.  The stocking representatives/distributor firms may buy and stock the
Company's products for resale or act as the Company's agent in arranging for
direct sales from the Company to an OEM customer. The Company's sales
organization provides direction and support to the independent sales
representative firms, the distributor firms and the overseas independent
stocking representatives/distributor firms.

     The Company currently utilizes independent sales representative firms at
various locations in the United States and Canada.  The Company also sells its
products through national distributor firms.  Sales through Future Electronics,
the Company's principal national distributor, accounted for 12% and 10% of the
Company's net sales for 1996 and 1997, respectively.  Consistent with standard
industry practice, the national and regional distributor firms are entitled to
certain price rebates and are allowed to return to the Company a portion of the
products purchased by them.  The Company's distributors sell competitors'
products and are not within the control of the Company.  Loss of one or more of
the Company's current distributors or disruption in the Company's sales and
distribution channels could materially and adversely affect the Company's
business and operating results.

     The Company has contracts with all of its international distributors, the
material terms of which typically include the following:  (a) the distributor is
appointed as a non-exclusive authorized distributor for a designated territory,
(b) the distributor may return up to 5-10% of its net sales in the prior 6-12
month period as a credit against a new order of equal or greater amount of
product, (c) the distributor is obligated to meet certain information reporting
requirements, (d) the term of the contract is one year and is automatically
renewable for one year periods and (e) the contract may be terminated at any
time by either party upon 30 days' written notice.  The Company also has
contracts with its national distributors, including Future Electronics, which
are substantially similar to the international distributor agreements.

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<PAGE>
 
     International sales accounted for approximately 63% and 65% of the
Company's net sales for 1996 and 1997, respectively.  The Company expects
international sales to continue to represent a significant portion of product
sales.  International sales and operations involve various risks, including
unexpected changes in regulatory requirements, tariffs and other barriers and
restrictions, and the burdens of complying with a variety of foreign laws.  The
Company is also subject to general political risks in connection with its
international operations, such as political and economic instability.  In
addition, because a substantial majority of the Company's international sales
are denominated in United States dollars, increases in the value of the dollar
would increase the price in local currencies of the Company's products in
foreign markets and make the Company's products relatively more expensive than
competitors' products, the sales of which are denominated in local currencies.
There can be no assurance that regulatory, political and other factors will not
adversely affect the Company's operations in the future or require the Company
to modify its current business practices.

     The Company attempts to stock products in quantities that are sufficient to
meet customer demand.  Due to the fairly long product manufacturing cycle
characteristic of semiconductor manufacturing and the inherent imprecision in
forecasting customer demand, product inventories may not always correspond to
product demand, leading to shortages or surpluses of certain products.  The
Company warrants that its products are free from defects in workmanship and
materials for one year and that they meet the published specifications.
Warranty expenses to date have been nominal.

MANUFACTURING

     A substantial majority of the Company's wafers are manufactured at its
facility in Mountain View, California.  This 70,000 square foot manufacturing
facility contains a 9,000 square foot clean room.  Certain production processes,
such as epitaxial services, ion implantation, background and backside gold
application, are performed by local subcontractors.  The Mountain View clean
room facility consists of Class 100 through Class 10,000 areas depending on the
specific area of the clean room (a Class 100 clean room has fewer than 100
foreign particles larger than 0.5 micron in size in each cubic foot of space).
This facility produced an average of approximately 3,460 wafers per month during
the fourth quarter of 1997.  All of the Company's production utilizes 5 inch
wafers.  The Company believes that during the fourth quarter of 1997, it was
utilizing approximately 67% of its production capacity at that time.

     The Company currently manufactures a substantial majority of its products
at its wafer fabrication facility in Mountain View, California.  During periods
of decreased demand, high fixed wafer fabrication costs could have a material
adverse effect on the Company's financial condition or results of operations.
For example, in the fourth quarter of 1996, the Company's operating results were
adversely impacted due to lower factory utilization at the Company's
manufacturing facility.  Furthermore, the Company is dependent on a number of
local subcontractors for certain of its manufacturing processes.  For example,
Reaction Technology, Inc. provides epitaxial services for approximately 70% of
the Company's wafers.  The failure of any of these subcontractors to perform
these processes on a timely basis could result in manufacturing delays, which
could materially adversely affect the Company's results of operations.
Currently, the Company purchases on a purchase order basis 5 inch wafers from
only two suppliers, Komatsu Silicon USA Inc. and L.G. International, and such
supply is subject to long ordering lead times. Any disruption or termination of
supply from either of these suppliers could have a material adverse effect on
the Company's financial condition and results of operations.

     In 1997, approximately 97% of the Company's sales were from wafers
manufactured at its Mountain View facility. Going forward, however, many of the
Company's new products will be manufactured by outside wafer foundries. At the
present time, there are several wafer foundries that are capable of supplying
the Company's needs at acceptable prices. There can be no assurance that the
Company will always be able to find the necessary foundry capacity. For example,
in 1995, there was a scarcity of world wide submicron foundry capacity. If that
condition were to be repeated in the future, the Company's ability to secure
wafer capacity would be adversely affected and its wafer costs would likely
increase. Such actions would have a material adverse affect on the Company's
business and results of operations.

     After fabrication and initial testing at the Company's Mountain View,
California facility, wafers are sent to 

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<PAGE>
 
the Company's wholly-owned subsidiary in Hong Kong which distributes them to
contract assembly houses, primarily in Malaysia and Thailand, to be packaged.
Upon completion of the packaging operation, the units are returned to TelCom
Hong Kong for final testing and are then shipped to customers worldwide. The
Hong Kong facility, which is leased by the Company, is approximately 30,000
square feet and is presently testing approximately eight million units per
month.

     The packaging of the Company's products is performed by a limited group of
subcontractors and certain of the raw materials included in such products are
obtained from a limited group of suppliers. Although the Company seeks to reduce
its dependence on its sole and limited source suppliers, disruption or
termination of any of these sources could occur and such disruptions could have
a material adverse effect on the Company's financial condition or results of
operations.  Moreover, a prolonged inability to obtain raw materials could have
a material adverse effect on the Company's financial condition or results of
operations and could result in damage to customer relationships.  The Company
also depends on third party subcontractors, and  all of the Company's products
are currently assembled by independent third parties in Asia.  In the event that
any of the Company's subcontractors were to experience financial, operational,
production or quality assurance difficulties resulting in a reduction or
interruption in supply to the Company, the Company's operating results would be
adversely affected until alternate subcontractors, if any, became available.

     TelCom designs and manufactures its own test equipment which can test both
the individual die in wafer form and the finished assembled unit.  The Company
believes the cost of its in-house tester is substantially less than the cost of
purchasing an equivalent tester from an outside vendor.  In addition to the cost
advantages, the Company can also standardize its operations on one tester type
and can therefore upgrade tester capability more easily than if it had purchased
different testers from more than one vendor.  The Company believes it is better
able to meet its internal demand for test capacity by building its own testers
because it is not subject to long lead times from outside vendors in times of
rising demand for such equipment.  The Company could purchase testers from
outside vendors if it experienced problems in producing its own testers, but
such equipment would be more costly.

     The fabrication of integrated circuits is a highly complex and precise
process.  Minute impurities, contaminants in the manufacturing environment,
difficulties in the fabrication process, defects in the masks used to print
circuits on a wafer, manufacturing equipment failure, wafer breakage or other
factors can cause a substantial percentage of wafers to be rejected or numerous
die on each wafer to be nonfunctional.  The majority of the Company's costs of
manufacturing are relatively fixed, and, consequently, the number of shippable
die per wafer for a given product is critical to the Company's results of
operations.  To the extent the Company does not achieve acceptable manufacturing
yields or experiences product shipment delays, its financial condition or
results of operations would be materially and adversely affected.  The Company
has from time to time in the past experienced lower than expected production
yields, which have delayed product shipments and adversely affected gross
margins.  For example, in the quarter ended December 31, 1996, the Company
experienced lower production volumes in order to reduce inventories, which
adversely effected gross margins.  Moreover, there can be no assurance that the
Company in general will be able to maintain acceptable manufacturing yields in
the future.  In order to meet anticipated future demand, the Company believes
that it will need to increase its manufacturing capacity.  Failure to do so
could result in a loss of customers, which could materially adversely affect the
Company's financial condition or results of operations.

RESEARCH AND DEVELOPMENT

     The ability of the Company to compete successfully will depend
substantially on its ability to define, design, develop and introduce on a
timely basis new products offering design or technology innovations.  Research
and development in the analog integrated circuit industry is characterized
primarily by circuit design and product engineering that enables new
functionality or improved performance.  The Company's research and development
efforts are also directed at improving process technologies, reducing the cost
of existing manufacturing processes, developing new process capabilities to
manufacture new products and adding new features to existing products.  With
respect to more established products, the Company's research and development
efforts also include product redesign, shrinkage of device size and reduction of
mask steps in order to improve yields per wafer and reduce per device costs.

                                       7
<PAGE>
 
     As of December 31, 1997, the Company had 19 employees engaged in research
and development.  The Company's research and development efforts are dependent
upon attracting and retaining qualified analog design engineers, of which there
is a limited supply.  The Company also utilizes independent contractors for
certain research and development projects.

     In 1995, 1996 and 1997, the Company spent approximately $2.6 million, $4.3
million and $5.5 million, respectively, on research and development.  The
Company expects that it will continue to invest substantial funds in research
and development activities.  There can be no assurance that the Company will be
able to identify new product opportunities successfully and develop and bring to
market such new products or that the Company will be able to respond effectively
to new technological changes or new product announcements by others.  There also
can be no assurance that the Company's new products will be accepted by the
market.  Moreover, the end markets for the Company's new products, such as the
communications and computer markets, are subject to rapid technological change
and there can be no assurance that as such markets change the Company's product
offerings will remain current and suitable for them.

INTELLECTUAL PROPERTY

     The Company's success depends in part on its ability to obtain patents and
licenses and to preserve other intellectual property rights covering its
manufacturing processes, products and development and testing tools.  The
Company seeks patent protection for those inventions and technologies for which
it believes such protection is suitable and is likely to provide a competitive
advantage to the Company.  The Company currently holds 12 United States patents
on semiconductor devices and methods with various expiration dates, none earlier
than May 2005.  The Company has applications for twelve United States patents
currently pending.  The Company also holds one foreign patent.  The process of
seeking patent protection can be long and expensive and there can be no
assurance that its current patents or any new patents that may be issued will be
of sufficient scope or strength to provide any meaningful protection or any
commercial advantage to the Company.  The Company may in the future be subject
to or initiate interference proceedings in the United States Patent and
Trademark office, which can demand significant financial and management
resources.  There can be no assurance that the Company's competitors will not
independently develop or patent substantially equivalent or superior
technologies.

     Although the Company is not currently a party to any material litigation,
the semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights.  There can be no assurance that
any patent owned by the Company will not be invalidated, circumvented or
challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future patent
applications will be issued with the scope of the claims sought by the Company,
if at all.  In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries.

     As is typical in the semiconductor industry, the Company has from time to
time received, and may in the future receive, communications from third parties
asserting patents, maskwork rights, or copyrights on certain of the Company's
products and technologies.  Although the Company is not currently a party to any
material litigation, in the event a third party were to make a valid
intellectual property claim and a license relating to such intellectual property
was not available on commercially reasonable terms, the Company's operating
results could be materially and adversely affected.  Litigation, which could
result in substantial cost to the Company and diversion of its resources, may
also be necessary to enforce patents or other intellectual property rights of
the Company or to defend the Company against claimed infringement of the rights
of others.  The failure to obtain necessary licenses or the occurrence of
litigation relating to patent infringement or other intellectual property
matters could have a material adverse effect on the Company's business and
operating results.  There can be no assurance that the steps taken by the
Company to protect its intellectual property will be adequate to prevent
misappropriation or that others will not develop competitive technologies or
products.

                                       8
<PAGE>
 
COMPETITION

     The analog semiconductor industry is highly competitive and subject to
rapid technological change.  Significant competitive factors in the analog
market for standard products include product features, performance, price, the
timing of product introductions, the emergence of new computer standards,
quality and customer support.  The Company believes that it competes favorably
in each of these areas.

     Because the standard products market for analog integrated circuits is
diverse and highly fragmented, the Company encounters different competitors in
various product markets.  The Company's principal competitors include Linear
Technology Corporation, Maxim Integrated Products and Harris Semiconductor in
one or more of its product areas.  Other competitors include Motorola, National
Semiconductor Corporation, Unitrode Corporation and certain Japanese
manufacturers.  Each of these companies has substantially greater technical,
financial and marketing resources and greater name recognition than the Company.
Due to the increasing demands for analog circuits, the Company expects
intensified competition from existing analog circuit suppliers and the entry of
new competition.  Increased competition could adversely affect the Company's
financial condition or results of operations.

     There can be no assurance that the Company will be able to compete
successfully in the future or that competitive pressures will not adversely
affect the Company's results of operations.  Competitive pressures could reduce
market acceptance of the Company's products and result in price reductions and
increases in expenses that could adversely affect the Company's business,
financial condition or results of operations.

BACKLOG

     The Company's backlog consists of distributor and OEM customer orders
required to be shipped within six months following the order date.  Customers
may generally cancel or reschedule orders to purchase products without
significant penalty to the customer.  As a result, the quantities of the
Company's products to be delivered and their delivery schedules are frequently
revised by customers to reflect changes in their needs.  Since backlog can be
canceled or rescheduled without significant penalty, the Company does not
believe its backlog is a meaningful indicator of future revenue.

EMPLOYEES

     As of December 31, 1997, the Company had 321 full-time employees, 238 of
whom were engaged in manufacturing (including testing, quality and materials
functions), 19 in research and development, 30 in marketing and sales, and 34 in
finance and administration.  Of such employees, 133 are located in Hong Kong and
7 are located in Europe.  The Company's employees are not represented by any
collective bargaining agreements, and the Company has never experienced a work
stoppage.  The Company believes that its employee relations are good.

     The Company's success depends to a significant extent upon the continued
service of its executive officers and other key management and technical
personnel, particularly its analog design engineers, and on its ability to
continue to attract, retain and motivate qualified personnel, particularly
experienced circuit designers, systems applications engineers and sales
managers.  The competition for such employees is intense.  The loss of the
services of one or more of the Company's design engineers, of which there is a
limited number, executive officers or other key personnel or the Company's
inability to recruit replacements for such personnel or to otherwise attract,
retain and motivate qualified personnel could have a material adverse effect on
the Company.  There can be no assurance that the Company will be successful in
attracting and retaining key personnel.

                                       9
<PAGE>
 
EXECUTIVE OFFICERS

     The executive officers of the Company and certain information about them
are as follows:
<TABLE>
<CAPTION>
             Name                     Age                                   Position
-------------------------------    --------    -----------------------------------------------------------------
<S>                                  <C>         <C>
Phillip M. Drayer                        52      Chief Executive Officer and President
 
Naresh Batra                             48      Vice President, Strategic Marketing
 
Donald Herman                            40      Vice President, Human Resources
 
Edward D. Mitchell                       44      Vice President, Engineering and Chief Technical Officer
 
R. Michael O'Malley                      51      Vice President, Chief Operating Officer and Chief Financial
                                                 Officer
 
Daniel Riordan                           35      Vice President, Business Development and Worldwide Sales
 
Kenneth J. Rose                          48      Chief Accounting Officer and Corporate Controller
</TABLE>


     Phillip M. Drayer has been Chief Executive Officer, President and a
director of the Company since the Company commenced operations in December 1993.
From 1990 through 1993, Mr. Drayer was President and Chief Executive Officer of
Teledyne Components, a division of Teledyne.  From 1980 to 1990, he was
President and Chief Executive Officer for EPI Technologies, a semiconductor
testing company, and from 1976 to 1979, he was Manufacturing Manager at Mostek,
a semiconductor manufacturer.  Mr. Drayer earned his B.S.E.E. degree from Lamar
University and his J.D. degree from South Texas College of Law.  Mr. Drayer is a
member of the Texas bar.

     Naresh Batra has been Vice President, Strategic Marketing of the Company
since November 1997. From 1996 to 1997, he was with XaQti Corporation, a
semiconductor networking company, as Chief Executive Officer and President. From
1994 to 1996, he was with Sierra Semiconductor, a PC multimedia company, as Vice
President and General Manager. From 1988 to 1994 he was with Brooktree
Corporation, a semiconductor mixed signal company, most recently serving as Vice
President of the ATE Division and from 1977 to 1988 he was with Texas
Instruments most recently serving as Director of Strategic Marketing. Mr. Batra
earned his M.S.E.E. from Marquette University and his M.B.A. from the University
of Dallas.

     Donald R. Herman has been Vice President, Human Resources of the Company
since February 1997. From 1996 to 1997, he was with VLSI Technology, a
semiconductor manufacturing company, as Worldwide Staffing Manager. From 1981 to
1996, he was employed at Schlumberger, LTD, a diversified technology company,
most recently serving as Director, Human Resources. Mr. Herman earned his B.S.
degree in mechanical engineering from Purdue University.

     Edward D. Mitchell has been Vice President, Engineering and Chief Technical
Officer of the Company since November 1996, was Vice President, Quality, Product
and Test Engineering from November 1994 to November 1996, and was Vice
President, Quality Management from December 1993 to November 1994.  From 1991
through 1993, he was Vice President, Quality Management for Teledyne Components.
From 1982 to 1990, he was with Seeq Technology, a semiconductor manufacturer,
most recently serving as Director of Quality and Reliability Assurance, and from
1980 to 1982, he was Product Engineering Supervisor for NEC Electronics, a
semiconductor manufacturer.  Prior thereto, he was employed at National
Semiconductor Corporation and Advanced Micro Devices in various engineering
positions.  Mr. Mitchell earned his B.S.E.E. degree from the University of
California at Berkeley.

     R. Michael O'Malley has been Chief Operating Officer of the Company since
January 1997, and has also been Vice President, Finance and Administration and
Chief Financial Officer of the Company since December 

                                       10
<PAGE>
 
1993. From 1991 to 1993, he was Vice President, Finance and Operations for
Concurrent Logic, a semiconductor manufacturer, and from 1989 to 1990, he was
Executive Vice President and Chief Financial Officer for Dest Corporation, a
computer peripherals company. He was also Vice President, Finance and Chief
Financial Officer at Domain Technology, a manufacturer of media for disk drives,
from 1987 to 1989, and Vice President, Finance and Chief Financial Officer at
Linear Technology Corporation, a semiconductor manufacturer, from 1982 to 1987.
Mr. O'Malley earned his B.S. degree from the University of Virginia and his
M.B.A. degree from Stanford University.

     Daniel W. Riordan has been Vice President, Business Development and
Worldwide Sales of the Company since December 1997. From 1995 to 1997, he was
with C-Cube Microsystems, a semiconductor manufacturing company, as Director of
Sales for North America and Worldwide PC activities. From 1992 to 1995, he was
employed at Sierra Semiconductor, a PC multimedia company, most recently serving
as Director, Asia/Pacific Sales. Prior thereto, he held various positions in
sales at Burr Brown Corporation, a semiconductor company. Mr. Riordan earned his
M.B.A. from Phoenix and his B.S.E.L. degree from California Polytechnic
University at San Luis Obispo.

     Kenneth J. Rose has been Chief Accounting Officer of the Company since
December 1995 and has also been Corporate Controller of the Company since
December 1993.  From 1990 to 1993, he was Vice President, Finance and
Administration of Teledyne Components.  From 1985 to 1990, he was Vice
President, Finance and Administration of Teledyne CME, a division of Teledyne.
From 1982 to 1985, he was Controller of Teledyne Micronetics, a division of
Teledyne.  Prior thereto, he held various positions in accounting at Teledyne
Ryan Aeronautical, a division of Teledyne.  Mr. Rose earned his B.S. degree from
the University of San Diego.

ITEM 2.  DESCRIPTION OF PROPERTY
---------------------------------

     The Company's main executive, administrative, manufacturing and technical
offices are located in a 70,000 square foot facility in Mountain View,
California.  The lease on this facility expires in December 1998 and has a five-
year renewal option.  The Company fabricates its wafers at this facility.  Its
activities are subject to federal, state and local environmental and land use
regulations.  The Company also leases 30,000 square feet of additional space in
Hong Kong in which it conducts testing and from which it ships products to
customers worldwide.  The lease on the Hong Kong facility expires in July 2000.
The Company believes that its existing facilities are adequate to meet its needs
for at least the next 12 months.

     Federal, state and local regulations impose various controls on the
storage, handling, discharge and disposal of chemicals and gases used in the
Company's manufacturing process and on the facility occupied by the Company.
The Company believes that its activities conform to present environmental and
land use regulations applicable to its operations and its current facilities.
Increasing public attention has, however, been focused on the environmental
impact of semiconductor operations and the risk to neighbors of chemical
releases from such operations.  There can be no assurance that applicable land
use and environmental regulations will not in the future impose the need for
additional capital equipment or other process requirements upon the Company or
restrict the Company's ability to expand its operations.  In this regard, in
1995 the City of Mountain View, where the Company's wafer fabrication facility
is located, adopted an ordinance which restricts the storage and use of
hazardous materials within the proximity of certain sensitive uses, including
hospitals, day care facilities and schools.  Although TelCom's existing
operations are not affected by such ordinance, there can be no assurance that
this ordinance will not materially adversely affect the Company's future
operations.  The adoption of this ordinance or similar measures or any failure
by the Company to comply with applicable environmental and land use regulations
or to restrict the discharge of hazardous substances could subject the Company
to future liability or cause its manufacturing operations to be curtailed or
suspended.

     The Company acquired the semiconductor manufacturing operations of
Teledyne, Inc. previously conducted at the Company's facility.  The
semiconductor manufacturing operations conducted by Teledyne Components at the
facility allegedly contaminated the soil and groundwater of the facility and the
groundwater of properties located down-gradient of the facility.  Although the
Company was indemnified by Teledyne as part of the acquisition transaction
against, among other things, any liabilities arising from such contamination,
there can be 

                                       11
<PAGE>
 
no assurance that claims will not be made against the Company or that such
indemnification will be available or will provide meaningful protection at the
time any such claim is brought. To the extent the Company is subject to a claim
which is not covered by the indemnity from Teledyne or as to which Teledyne is
unable to provide indemnification, the Company's financial condition or results
of operations could be materially and adversely affected. Although the Company
may be considered a successor in interest to Teledyne's operations at the
Mountain View facility, the Company believes that it is unlikely to be subject
to any material environmental liabilities relating to the operations of the
facility conducted by Teledyne because (i) the Company has received no notice
from any regulatory authority or any other person claiming that the Company is
responsible for the contamination caused by Teledyne or the cost of any clean-up
relating thereto and (ii) the Company is indemnified by Teledyne under the
acquisition agreements and lease between the Company and Teledyne with respect
to any such liabilities.

ITEM 3.  LEGAL PROCEEDINGS
--------------------------

     None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-------------------------------------------------------------

     Not Applicable.

                                       12
<PAGE>
 
                                    PART II
                                    -------

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
--------------------------------------------------------------------------
         MATTERS
         -------

     The Company effected the initial public offering of its Common Stock on
July 27, 1995.  As of February 25, 1998, there were approximately 3,960
beneficial holders of the Company's Common Stock.  The Company's Common Stock is
listed for quotation in the Nasdaq National Market under the Symbol "TLCM."  The
following table sets forth for the periods indicated, the high and low prices of
the Company's Common Stock as quoted in the Nasdaq National Market.

<TABLE>
<CAPTION>
                                                                  High                      Low
                                                                --------                  --------
<S>                                                         <C>                       <C>
Fiscal year ended December 31, 1995
     Third Quarter                                                 16                       10 1/4
     Fourth Quarter                                                11 1/4                    6 1/4
 
Fiscal year ended December 31, 1996
     First Quarter                                                  7  3/8                   4
     Second Quarter                                                 7  1/8                   4  3/8
     Third Quarter                                                  5  13/16                 4  1/4
     Fourth Quarter                                                 5  1/2                   3  1/4
 
Fiscal year ended December 31, 1997
     First Quarter                                                  5  3/4                   4  1/8
     Second Quarter                                                 7  1/2                   4
     Third Quarter                                                 16  7/8                   7  1/2
     Fourth Quarter                                                13  1/2                   6  13/16
</TABLE>

     The trading price of the Company's Common Stock is expected to continue to
be subject to wide fluctuations in response to quarter-to-quarter variations in
operating results, announcements of technological innovations or new products by
the Company or its competitors, general conditions in the computer and
electronic industries, changes in earnings estimates or recommendations by
analysts, or other events or factors.  In addition, the public stock markets
have recently experienced extreme price and trading volume volatility.  This
volatility has significantly affected the market prices of securities of many
high technology companies for reasons frequently unrelated to the operating
performance of the specific companies.  These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.

     The Company has not paid any cash dividends on its Common Stock and
currently intends to retain any future earnings for use in its business.
Accordingly, the Company does not anticipate that any cash dividends will be
declared or paid on the Common Stock in the foreseeable future.

                                       13
<PAGE>
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
--------------------------------------------

     The selected consolidated financial data of the Company set forth below
should be read in conjunction with the consolidated financial statements of the
Company, including the notes thereto, and Management's Discussion and Analysis
included elsewhere herein. The Company was organized in June 1993 to acquire
Teledyne Components, which was effected as of November 27, 1993. As a result,
the results of operations prior to the acquisition are not comparable to the
results of operations for subsequent periods. The consolidated statement of
operations data of the predecessor company for the period from January 1, 1993
through November 26, 1993 was prepared by the Company based on information
received from Teledyne, but was not reviewed by Teledyne. The pro forma results
of operations for the year ended December 31, 1993 are based upon assumptions
deemed reasonable by management and are not necessarily indicative of the
results of operations that would have been attained had the transactions
described in footnote (1) herein actually occurred on the dates indicated or of
future operating results.

<TABLE>
<CAPTION>
                                Predecessor                                    
                                  Company          Period from                 
                                Period from        November 27,     Pro Forma  
                                 January 1,           1993        Combined Year
                                1993 through         through          Ended                     Year Ended December 31,
                                November 26,       December 31,    December 31,     ----------------------------------------------
                                    1993               1993          1993 (1)          1994        1995        1996         1997
                                ------------       ------------   -------------     --------    --------    ---------    ---------
<S>                             <C>                <C>            <C>               <C>         <C>         <C>          <C>
Consolidated Statement of
Operations Data:
 
Net sales                           $18,251             $1,466        $ 19,831      $24,454     $39,004     $37,762      $55,435
Cost of sales                        14,102              1,117          15,146       17,209      24.680      26.801       31,175
          Gross profit                4,149                349           4,685        7,245      14,324      10,961       24,260
                                    -------             ------        --------       ------     -------     -------      -------
Operating expenses:                 
  Research and development              794                 84             858        1,214       2,649       4,271        5,455
  Selling, general and              
    administrative                    4,941                433           5,358        5,246       7,115       7,713        9,530
  Loss on foundry investment              -                  -               -            -           -           -        8,264
  Total operating expenses            5,735                517           6,216        6,460       9,764      11,984       23,249
                                    -------             ------        --------       ------     -------     -------      -------
Income (loss) from operations        (1,586)              (168)         (1,531)         785       4,560      (1,023)       1,011
Interest income (expense), net            -                  -               -           24         299         162         (288)
                                    -------             ------        --------       ------     -------     -------      -------
Income (loss) before income         
  taxes and extraordinary item       (1,586)              (168)         (1,531)         809       4,859        (861)         723
Provision (benefit) for income      
   taxes                                257                (42)            215          202       1,215        (233)       2,427
                                    -------             ------        --------       ------     -------     -------      -------
Income (loss) before                
   extraordinary item                (1,843)              (126)         (1,746)         607       3,644        (628)      (1,704)
Gain on early extinguishment        
   of debt                                -                  -               -          225           -           -            -
Net income (loss)                   $(1,843)            $ (126)        $(1,746)     $   832     $ 3,644     $  (628)     $(1,704)
                                    =======             ======         =======      =======     =======     =======      =======
                                    
                                    
Basic per share data (2):           
Income (loss) before                
   extraordinary item                                                               $  0.16     $  0.43     $ (0.04)     $ (0.11)
Gain on early extinguishment        
    of debt                                                                            0.06           -           -            -
                                                                                                                   -------------
Net income (loss)                                                                   $  0.22     $  0.43     $ (0.04)     $ (0.11)
                                                                                    =======     =======     =======      =======
                                    
Number of shares used to            
   compute basic per share data                                                       3,715       8,436      15,612       16,184
                                                                                    =======     =======     =======      =======
                                    
Diluted per share data (2):         
Income (loss) before                
   extraordinary item                                                               $  0.06     $  0.23     $ (0.04)     $ (0.11)
Gain on early extinguishment        
    of debt                                                                            0.02           -           -            -
                                                                                    -------     -------     -------      -------
Net income (loss)                                                                   $  0.08     $  0.23     $ (0.04)     $ (0.11)
                                                                                    =======     =======     =======      =======
                                    
Number of shares used to            
   compute diluted per share data                                                    10,212      15,703      15,612       16,184
                                                                                    =======     =======     =======      =======
</TABLE>

                                       14
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                December 31,
                                                       -----------------------------------------------------------
                                                             1993       1994        1995        1996        1997
                                                       -----------------------------------------------------------
                                                                               (in thousands)
<S>                                                        <C>         <C>        <C>         <C>         <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents                                  $ 1,373     $ 6,297     $15,849     $12,761     $17,110
Working capital                                              4,390      11,021      29,356      23,760      24,681
Total assets                                                10,356      18,797      49,805      58,012      53,684
Long-term portion of notes payable                           1,500         507       3,328      10,047       3,462
Mandatorily redeemable convertible preferred stock           5,120      13,479           -           -           -
Total stockholders' equity (deficit)                          (107)        738      37,059      36,926      36,421
</TABLE>

(1) The Company was organized in June 1993 as a Delaware corporation by members
    of the management team of Teledyne Components and began operations in
    December 1993 after purchasing Teledyne Components from Teledyne. The
    consolidated statement of operations data set forth above includes the
    results of operations for (i) the Company's predecessor for the period from
    January 1, 1993 through November 26, 1993 and (ii) the Company for the
    period from November 27, 1993 through December 31, 1993, as if the
    acquisition of Teledyne Components had been consummated as of January 1,
    1993. The pro forma adjustments to the historical information in this
    presentation include a decrease in depreciation expense of $437,000, an
    increase in rent expense of $254,000, and an increase in sales of $114,000
    and related cost of sales of $74,000.
 
(2) All per share amounts have been restated in accordance with Statement of
    Financial Accounting Standards No. 128, "Earnings Per Share". See Note 2 to
    the Notes to the Consolidated Financial Statements.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

     This Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of the risk
related factors set forth herein.

OVERVIEW

     The Company came into existence in December 1993 as a result of a
management-led buyout of the Teledyne Components division from Teledyne. The
Company manufactures both proprietary and second source products. Average
selling prices for the Company's proprietary products have tended to decline at
a slower rate than have those for the Company's second source products, which
are more susceptible to competitive pricing pressures. The Company generally
recognizes higher gross margins on its proprietary products than on its second
source products.

     In November 1995, the Company entered into certain agreements with IC
WORKS, Inc., a privately-held company located in San Jose, California. Pursuant
to such agreements, the Company purchased $3.0 million of preferred stock of IC
WORKS and provided $10.4 million in capital equipment. In return for this
investment, TelCom received a guarantee of submicron wafer capacity at specified
prices for a period of five years, projected to start in late 1997. The shortage
of wafer capacity projected in late 1995 has diminished and since late 1995,
substantial foundry capacity has been available worldwide while overall demand
has not increased proportionately. Consequently, wafer pricing has decreased
dramatically, which has changed the economic viability of the foundry business
in which the Company invested. As a result, in 1997, the Company recorded a loss
of $8.3 million on its foundry investment which consists of a $3.0 million write
down of the preferred stock, a loss on the sale of the equipment of $5.2
million, and $.1 million of costs associated with prepayment penalties on
financing of the equipment and legal fees. Pursuant to an agreement with IC
WORKS, Inc., in the fourth quarter of 1997, the Company sold the $10.4 million
of equipment at IC WORKS for $5.2 million and invested an additional $1.5
million in preferred stock of IC WORKS, Inc. This agreement terminates the
Company's operating agreement with IC WORKS and its wafer production arrangement
was amended to allow the Company to purchase wafers for a period of time prior
to finding an alternative supplier, up to April 1998.

     The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially and adversely affect net sales, gross
margins and operating income. These factors include the volume and timing of
orders received, changes in the mix of proprietary and second source products
sold, market acceptance of the Company's and its customers' products,
competitive pricing pressures, the Company's ability to introduce new products
on a timely basis, the timing and extent of research and development expenses,
fluctuations in manufacturing yields, cyclical semiconductor industry
conditions, the Company's access to advanced process technologies and the timing
and extent of process development costs. Historically in the semiconductor
industry, average selling prices of products have decreased over time. If the
Company is unable to introduce new products with higher margins, maintain its
product mix between proprietary and second source products or reduce
manufacturing cost to offset decreases in the prices of its existing products,
the Company's operating results will be adversely affected. The Company's
business is characterized by short-term orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without penalty to the
customer. Since most of the Company's backlog is cancelable without penalty, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand, which is highly unpredictable and can fluctuate
substantially. In addition, because of high fixed costs on the semiconductor
industry, the Company is limited  in its ability to reduce costs quickly in
response to any revenue shortfalls. As a result of the foregoing or other
factors, the Company has experienced and may in the future experience material
adverse fluctuations in its operating results on a quarterly or annual basis,
which have in the past and would in the future materially affect the Company's
business, financial condition and results of operations.

                                       15
<PAGE>
 
RESULTS OF OPERATIONS

     The following table sets forth certain consolidated statement of operations
data of the Company as a percentage of net sales.

<TABLE>
<CAPTION>
                                                              Year Ended December 31,
                                                     -------------------------------------------
                                                      1995               1996              1997
                                                     ------             ------            ------
<S>                                                  <C>                <C>               <C>
                                                                         
Net sales                                             100.0%             100.0%           100.0%
Costs of sales                                         63.3               71.0             56.3
                                                      -----                               
Gross margin                                           36.7               29.0             43.7
                                                      -----              -----            -----
Operating expenses:                                                                       
     Research and development                           6.8               11.3              9.8
     Selling, general and administrative               18.2               20.4             17.2
     Loss on foundry investment                           -                  -             14.9
Total operating expenses                               25.0               31.7             41.9
                                                      -----              -----            -----
Income (loss) from operations                          11.7               (2.7)             1.8
Interest income (expense), net                          0.8                0.4             (0.5)
                                                      -----              -----            -----
Income (loss) before taxes                             12.5               (2.3)             1.3
Provision (benefit) for income taxes                    3.1               (0.6)             4.4
Net income (loss)                                       9.3%              (1.7)%           (3.1)%
                                                      =====              =====            =====
</TABLE>
                                                                                

YEARS ENDED DECEMBER 31, 1997 AND 1996

     Net Sales.  Net sales in 1997 were $55.4 million, an increase of $17.6
million or 46.8%, compared to $37.8 million in 1996. The increase in net sales
was primarily due to higher sales volume in the Company's power management
product line. Net sales in 1997 for the Company's geographical areas of the
United States, Asia and Europe accounted for 35%, 33%, and 32%, respectively,
compared to 37%, 38%, and 25%, respectively, in 1996. Sales to the Company's two
largest OEM customers, Motorola and Compaq were $16.5 million or 30% and $4.1
million or 7%, respectively, of net sales in 1997 compared to $4.4 million or
12% and $3.1 million or 9%, respectively, of net sales in 1996.

     Gross Margin.  Gross margin increased to 43.7% in 1997 from 29.0% in 1996.
The increase in gross margin was caused by  increased production volume in the
Company's wafer fabrication facility due to higher demand, increased efficiency
in wafer fabrication and higher gross margins on sales of power management
products. The Company's ability  to increase gross margins will depend on the
successful introduction of its new proprietary products and increasing
manufacturing output at the Company's wafer fabrication facility to spread the
fixed costs over an increasing number of units, thereby reducing the fixed costs
per unit.

     Research and Development Expenses. Research and development expenses were
$5.5 million, or 9.8% of net sales, in 1997, compared to $4.3 million, or 11.3%
of net sales, in 1996. The increase in research and development expenses, in
absolute dollars, was primarily attributable to cost of wafers and associated
expense for new products, and costs associated with the purchase and maintenance
of computer-aided design (CAD) systems for design engineers. The Company expects
research and development expenses generally to increase in absolute dollars in
future periods although such expenses may fluctuate as a percentage of net
sales.

     Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $9.5 million, or 17.2% of net sales, in
1997 from $7.7 million, or 20.4% of net sales, in 1996. Selling, general and
administrative expenses increased, in absolute dollars, primarily as a result of
(i) the hiring of sales personnel, (ii) an increase in outside sales commissions
due to higher sales, and (iii) the distribution of management bonus and company
wide profit sharing to all employees. The Company expects selling, general and
administrative expenses generally to increase in absolute dollars in the future
periods although such expenses may fluctuate as a percentage of sales.

     Loss on Foundry Investment. In November 1995, the Company entered into
certain agreements with IC WORKS, Inc. a privately-held company located in San
Jose, California. Pursuant to these agreements, in 1996 the Company purchased
$3.0 million of preferred stock of IC WORKS and provided $10.4 million in
capital equipment. In return for this investment, the Company received a
guarantee of submicron wafer capacity at specified prices for a period of five
years, projected to start in late 1997. The shortage of wafer capacity projected
in late 1995 has diminished and since late 1995, substantial foundry capacity
has been available worldwide while overall demand has not increased
proportionately. Consequently, wafer pricing has decreased dramatically, which
has changed the economic viability of the foundry business in which the Company
invested. As a result, in 1997, the Company recorded a loss of $8.3 million on
its foundry investment which consists of a $3.0 million write down of the
preferred stock, a loss on the sale of the equipment of $5.2 million, and $.1
million of costs associated with 

                                       16
<PAGE>
 
prepayment penalties on financing of the equipment and legal fees. Pursuant to
an agreement with IC WORKS, Inc., in the fourth quarter of 1997, the Company
sold the $10.4 million of equipment at IC WORKS for $5.2 million and invested an
additional $1.5 million in preferred stock of IC WORKS, Inc. This agreement
terminates the Company's operating agreement with IC WORKS and its wafer
production arrangement was amended to allow the Company to purchase wafers for a
period of time prior to finding an alternative supplier, up to April 1998.

     Interest Income (Expense), Net. Net interest income decreased from $162,000
in 1996 to an expense of $288,000 in 1997, reflecting higher interest expense
associated with equipment financing.

     Income Taxes. The Company recorded an income tax provision of $2.4 million
in 1997 at an effective rate of 336% compared to an income tax benefit of
$233,000 in 1996 at an effective rate of 27%. The increase in the effective tax
rate is due to the non deductibility of certain foundry investment losses and a
tax charge relating to repatriation of certain of the Company's foreign
subsidiaries' undistributed earnings.

YEARS ENDED DECEMBER 31, 1996 AND 1995

     Net Sales.  Net sales in 1996 were $37.8 million, a decrease of $1.2
million or 3%, compared to $39.0 million in 1995. The decrease in net sales was
primarily due to lower sales volume in mixed signal commodity products and
temperature sensor products, experienced both in Asia and the United States.
These decreases in sales were partially offset by increased sales volume in Asia
in power management products. Net sales in 1996 for the Company's geographical
areas of the United States, Asia and Europe accounted for 37%, 38%, and 25%,
respectively, compared to 42%, 33%, and 25%, respectively, in 1995. Sales to the
Company's two largest OEM customers, Motorola and Compaq totaled $7.5 million in
1996 compared to $7.7 million in 1995.

     Gross Margin.  Gross margin decreased to 29.0% in 1996 from 36.7% in 1995.
The decrease in gross margin was primarily due to (i) lower factory utilization
of the Company's manufacturing facilities (ii) lower yields in wafer fabrication
and (iii) lower gross margins on high volume products in its power management
products.

     Research and Development Expenses. Research and development expenses were
$4.3 million, or 11.3% of net sales, in 1996, compared to $2.6 million, or 6.8%
of net sales, in 1995. The increase in research and development expenses was
primarily attributable to (i) increased staffing for design engineers and layout
designers, (ii) the higher level of mask sets and wafer runs for new products,
and (iii) costs associated with the purchase and maintenance of computer-aided
design (CAD) systems for design engineers.

     Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $7.7 million, or 20.4% of net sales, in
1996 from $7.1 million, or 18.2% of net sales, in 1995. Selling, general and
administrative expenses increased primarily as a result of the hiring of sales
personnel in all geographical areas and increased staffing levels in the
Company's management information system department.

     Interest Income, Net. Net interest income decreased from $299,000 in 1995
to $162,000 in 1996, reflecting higher interest expense associated with
equipment financing.

     Income Taxes. The Company recorded an income tax benefit of $233,000 in
1996 at an effective rate of 27% compared to $1.2 million of expense in 1995 at
a rate of 25%. The change in the effective tax rate was due primarily to the mix
of net income (loss) arising from the various geographical regions where tax
rates range from 17% to 50% and changes in the valuation allowance for net
deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

     In 1995, the Company generated approximately $4.0 million from operating
activities, principally from net income of $3.6 million, depreciation of $1.7
million, taxes payable of $1.6 million and current liabilities of $2.1 million.
These cash increases were primarily offset by growth in inventories and accounts
receivable of $2.4 million and $2.0 million, respectively, and an increase in
net deferred taxes of $600,000.

     The Company invested $9.6 million in capital equipment and leasehold
improvements in 1995. The Company financed part of this investment through notes
payable, which increased $3.9 million, on a net basis, in 1995.

     In 1996, the Company generated approximately $1.3 million from operating
activities, principally from depreciation of $3.3 million and a decrease in
accounts receivable of $900,000. These increases in cash were primarily offset
by taxes receivable of $1.4 million and taxes payable of $1.2 million. At
December 31, 1996, the Company had cash and cash 

                                       17
<PAGE>
 
equivalents of $12.8 million.

     The Company invested $13.7 million in capital equipment and leasehold
improvements of which $10.4 million was for purchases of capital equipment
pursuant to an agreement with IC WORKS, Inc. in 1996. The Company financed part
of this investment through notes payable, which increased $9.0 million on a net
basis.

     Pursuant to an agreement with IC WORKS, Inc., the Company invested $3.0
million in preferred stock of IC WORKS, Inc. in 1996.

     In 1997, the Company generated approximately $11.9 million from operating
activities, primarily from income before the loss on foundry investment,
depreciation of $4.1 million and a net increase of $1.2 million in working
capital items. The net increase in working capital primarily reflects a decrease
of income tax receivable of $1.4 million, due to collection of tax refunds
recorded in the prior year, an increase in accounts payable of $1.4 million, an
increase in taxes payable of $1.8 million, offset by an increase in accounts
receivable of $2.2 million, due to higher fourth quarter sales than the prior
year, and an increase in inventory of $1.8 million, due to an increase in
inventory in the Company's sensor product line. At December 31, 1997, the
Company had cash and cash equivalents of $17.1 million.

     Pursuant to an agreement with IC WORKS, Inc., in the fourth quarter of
1997, the Company sold the $10.4 million of equipment at IC WORKS for $5.2
million and invested an additional $1.5 million in preferred stock of IC WORKS,
Inc. This agreement terminates the Company's operating agreement with IC WORKS
and its wafer production arrangement was amended to allow the Company to
purchase wafers for a period of time prior to finding an alternative supplier,
up to April 1998.

     In 1997, the Company invested $7.6 million in capital equipment and
leasehold improvements. The Company financed $3.3 million of this investment
through notes payable and paid $10.8 million in principal payments of which $7.7
million was for equipment sold as part of the IC WORKS agreement and $3.1
million was principal payments on other equipment financing for prior years. The
Company expects capital expenditures of $8.0 million in 1998 and has commitments
related to such expenditures of $2.3 million.

     The Company believes that the existing cash and cash equivalents, expected
cash flow from operations and its existing financing sources will be sufficient
to support its operating and capital needs for the next twelve months. Any major
change in the nature of the Company's business, such as the acquisition of
products, the need for significant new capital expenditures or the acquisition
of an existing business, could change the Company's capital requirements. To the
extent the Company requires additional cash, there can be no assurances that the
Company will be able to obtain such financing on terms favorable to the Company,
or at all.

YEAR 2000 ISSUES

     There is a risk to the Company from unforeseen problems related to the
"Year 2000 issue." The "Year 2000 issue" arises because most computer systems
and programs were designed to handle only a two-digit year, not a four-digit
year. When Year 2000 begins, these computers may interpret "00" as the year 1900
and could either stop processing date-related computations or could process them
incorrectly. The Company has recently performed an initial assessment of its
information systems and does not anticipate any internal Year 2000 issues from
its own information systems, databases or programs. However, the Company could
be adversely impacted by Year 2000 issues faced by major distributors,
suppliers, customers, vendors, and financial service organizations with which
the Company interacts. The Company is in the process of developing a plan to
determine the impact that third parties who are not Year 2000 compliant may have
on the operations of the Company.

MARKET RISK DISCLOSURE

     Interest Rate Risk - The Company does not use derivative financial
instruments in its investment portfolio. At December 31, 1997, the Company's
investment portfolio is comprised of municipal government securities that mature
within one year. The Company places investments in instruments that meet high
credit quality standards. These securities are subject to interest rate risk,
and could decline in value if interest rates fluctuate. Due to the short
duration and conservative nature of the Company's investment portfolio, the
Company does not expect any material loss with respect to its investment
portfolio.

     Foreign Currency Exchange Rate Risk - Certain of the Company's sales, cost
of manufacturing and marketing are transacted in local currencies. As a result,
the Company's international results of operations are subject to foreign
exchange rate fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations. Gains and losses from such fluctuations have not
been material to the Company's consolidated results of operations.

                                       18
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS
----------------------------

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                                        
<TABLE>
<CAPTION>
                                                                                        Page
<S>                                                                                  <C>
Report of Independent Accountants....................................................        20
Consolidated Balance Sheets as of December 31, 1996 and 1997.........................        21
Consolidated Statements of Operations for the years ended                            
   December 31, 1995, 1996 and 1997..................................................        22
Consolidated Statements of Stockholders' Equity for the years ended                  
   December 31, 1995, 1996 and 1997..................................................        23
Consolidated Statements of Cash Flows for the years ended                            
   December 31, 1995, 1996 and 1997..................................................        24
Notes to Consolidated Financial Statements...........................................        25
</TABLE>

                                       19
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
     TelCom Semiconductor, Inc.

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of  stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of TelCom
Semiconductor, Inc. and its subsidiaries at December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements 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 of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audits 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.



PRICE WATERHOUSE LLP

San Jose, California
January 21, 1998

                                       20
<PAGE>
 
                           TELCOM SEMICONDUCTOR, INC.

                          CONSOLIDATED BALANCE SHEETS
                       (In thousands, except share data)

<TABLE>
<CAPTION>
                                                                  December 31,
                                                            -------------------------
                                                              1996              1997
                                                            -------           -------
<S>                                                         <C>               <C>
ASSETS
 
Current assets:
    Cash and cash equivalents                               $12,761           $17,110
    Marketable securities                                     5,202             2,469
    Accounts receivable, less allowance for doubtful                          
        accounts of $195 and $195                             5,288             7,452
    Inventory                                                 6,490             8,289
    Income taxes receivable                                   1,430                 -
    Deferred income taxes                                     1,635             1,167
    Other current assets                                        358               751
                                                            -------           -------
        Total current assets                                 33,164            37,238
                                                                              
Property and equipment, net                                  21,848            14,946
Other assets                                                  3,000             1,500
                                                            -------           -------
                                                                              
                                                                              
                                                            $58,012           $53,684
                                                            =======           =======
                                                                              
LIABILITIES AND STOCKHOLDERS' EQUITY                                          
                                                                              
Current liabilities:                                                          
    Current portion of notes payable                        $ 3,518           $ 2,641
    Accounts payable                                          2,042             3,461
    Accrued liabilities                                       2,006             2,460
    Deferred distributor income                               1,077             1,429
    Income taxes payable                                        761             2,566
                                                            -------           -------
        Total current liabilities                             9,404            12,557
                                                                              
Notes payable, net of current portion                        10,047             3,462
Deferred income taxes                                         1,635             1,244
                                                            -------           -------
                                                                              
        Total liabilities                                    21,086            17,263
                                                            -------           -------
                                                                              
Commitments and contingencies (Note 8)                            -                 -
                                                                              
Stockholders' equity:                                                         
      Preferred stock, $0.001 par value; 5,000,000                            
          shares authorized; none issued or outstanding           -                 -
     Common stock, $0.001 par value; 30,000,000                               
          shares authorized; 15,705,933 and 16,418,180                        
          shares issued and outstanding                          16                16
    Additional paid-in capital                               33,199            34,389
    Notes receivable from stockholders                          (11)               (2)
    Retained earnings                                         3,722             2,018
                                                                              
        Total stockholders' equity                           36,926            36,421
                                                                              
                                                                              
                                                            $58,012           $53,684
                                                            =======           =======
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       21
<PAGE>
 
                           TELCOM SEMICONDUCTOR, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (In thousands, except per share data)


<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                              -------------------------------
                                                1995        1996       1997
                                              -------     -------     -------
<S>                                             <C>       <C>         <C>
Net sales                                     $39,004     $37,762     $55,435
                                                                      
Cost of sales                                  24,680      26,801      31,175
                                              -------     -------     -------
                                                                      
Gross profit                                   14,324      10,961      24,260
                                              -------     -------     -------
                                                                      
Operating expenses:                                                   
    Research and development                    2,649       4,271       5,455
    Selling, general and administrative         7,115       7,713       9,530
    Loss on foundry investment                      -           -       8,264
                                              -------     -------     -------
                                                                      
          Total operating expenses              9,764      11,984      23,249
                                              -------     -------     -------
                                                                      
Income (loss) from operations                   4,560      (1,023)      1,011
Interest income                                   625         914         959
Interest expense                                 (326)       (752)     (1,247)
                                              -------     -------     -------
                                                                      
Income (loss) before income taxes               4,859        (861)        723
                                                                      
Provision (benefit) for income taxes            1,215        (233)      2,427
                                              -------     -------     -------
                                                                      
Net income (loss)                             $ 3,644     $  (628)    $(1,704)
                                              =======     =======     =======
                                                                      
Per share data:                                                       
  Net income (loss)                                                   
       Basic                                    $0.43      $(0.04)     $(0.11)
                                              =======     =======     =======
       Diluted                                  $0.23      $(0.04)     $(0.11)
                                              =======     =======     =======
                                                          
Number of shares used to compute per                      
   share data                                             
       Basic                                    8,436      15,612       16,184
                                              =======     =======     ========
       Diluted                                 15,703      15,612       16,184
                                              =======     =======     ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       22
<PAGE>
 
                           TELCOM SEMICONDUCTOR, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                 (In thousands)

<TABLE>
<CAPTION>
                                                   
                                                                         Notes                                  
                                   Common Stock       Additional      Receivable                       Total    
                               -------------------      Paid-in          From         Retained     Stockholders' 
                                 Shares     Amount      Capital      Stockholders     Earnings         Equity
                               --------     ------    ----------     ------------     --------     -------------    
<S>                              <C>        <C>       <C>            <C>              <C>          <C>
Balance at December 31, 1994      3,445        $ 3       $   306            $(277)     $   706           $   738
 
Sale of common stock              2,540          3        18,970                -            -            18,973
Conversion of mandatorily
    redeemable convertible
    preferred stock               9,562          9        13,470                -            -            13,479
Repurchase of common stock          (60)         -            (6)               6            -                 -
Payment on notes receivable
    from stockholders                 -          -             -              225            -               225
Net income                            -          -             -                -        3,644             3,644
                               --------     ------    ----------     ------------     --------     -------------    

Balance at December 31, 1995     15,487         15        32,740              (46)       4,350            37,059
 
Sale of common stock                313          1           486                -            -               487
Repurchase of common stock          (94)         -           (27)              27            -                 -
Payment on notes receivable
    from stockholders                 -          -             -                8            -                 8
Net loss                              -          -             -                -         (628)             (628)
                               --------     ------    ----------     ------------     --------     -------------    

Balance at December 31, 1996     15,706         16        33,199              (11)       3,722            36,926
 
Sale of common stock                712          -         1,190                -            -             1,190
Payment on notes receivable
    from stockholders                 -          -             -                9            -                 9
Net loss                              -          -             -                -       (1,704)           (1,704)
                               --------     ------    ----------     ------------     --------     -------------     
 
Balance at December 31, 1997     16,418        $16       $34,389            $  (2)     $ 2,018           $36,421
                               ========     ======    ==========     ============     ========     =============
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       23
<PAGE>
 
                           TELCOM SEMICONDUCTOR, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                              Year Ended December 31,
                                                         --------------------------------------------------------------
                                                                 1995                   1996                  1997
                                                         -----------------      -----------------      ----------------
<S>                                                        <C>                    <C>                    <C>
Cash flows from operating activities:
Net income (loss)                                                 $  3,644               $   (628)             $ (1,704)
Adjustments to reconcile net income (loss) to net
   cash provided by (used for) operating activities:
      Loss on foundry investment                                         -                      -                 8,264
      Depreciation and amortization                                  1,731                  3,335                 4,113
      Deferred income taxes                                           (644)                   644                    77
      Changes in assets and liabilities:
           Accounts receivable                                      (2,029)                   945                (2,164)
           Inventory                                                (2,447)                   392                (1,799)
           Income taxes receivable                                       -                 (1,430)                1,430
           Other current assets                                        (16)                  (184)                 (393)
           Accounts payable                                            434                   (125)                1,419
           Accrued liabilities                                         826                     98                   454
           Deferred distributor income                                 872                   (575)                  352
           Income taxes payable                                      1,613                 (1,164)                1,805
                                                         -----------------      -----------------      ---------------- 

Net cash provided by operating activities                            3,984                  1,308                11,854
                                                         -----------------      -----------------      ----------------
 
Cash flows from investing activities:
      Purchases of property and equipment                           (9,560)               (13,651)               (7,574)
      Investment in IC WORKS, Inc.                                       -                 (3,000)               (1,500)
      Net proceeds from sale of equipment at IC Works,                   -                      -                 5,099
       Inc.
      (Purchases) sales of marketable securities                    (7,990)                 2,788                 2,733
                                                         -----------------      -----------------      ----------------
Net cash used for investing activities                             (17,550)               (13,863)               (1,242)
                                                         -----------------      -----------------      ----------------
 
Cash flow from financing activities:
      Proceeds from sale of common stock                            18,973                    487                 1,190
      Payment on notes receivable from stockholders                    225                      8                     9
      Proceeds from issuance of notes payable                        4,662                 11,011                 3,333
      Principal payments on notes payable                             (742)                (2,039)              (10,795)
                                                         -----------------      -----------------      ----------------
Net cash provided by (used for) financing activities                23,118                  9,467                (6,263)
                                                         -----------------      -----------------      ----------------
 
Net increase (decrease) in cash and cash
      equivalents                                                    9,552                 (3,088)                4,349
 
Cash and cash equivalents at the beginning of period                 6,297                 15,849                12,761
                                                         -----------------      -----------------      ----------------
 
Cash and equivalents at the end of period                         $ 15,849               $ 12,761              $ 17,110
                                                         =================      =================      ================
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       24
<PAGE>
 
                           TELCOM SEMICONDUCTOR, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   (amounts in thousands, except share data)

Note 1 - The Company and Basis of Presentation:

     TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high performance analog
integrated circuits for the use in a wide variety of electronic systems. The
Company was organized in Delaware in June 1993 and began operations in December
1993 after the management-led buyout of the semiconductor operations of
Teledyne, Inc. The Company has operations in the United States, Hong Kong and
Germany. The Company operates and reports financial results on a 52-53 week
fiscal year. During 1997, the Company changed its fiscal year end from the last
Friday of December to the Friday closest to the last day of December. Fiscal
year 1997 is a 53 week year ended on January 2, 1998. Fiscal 1995 and 1996 are
52 week years ended on December 29, 1995 and December 27, 1996, respectively.
For convenience, the Company has presented its fiscal year as ending on December
31.

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

Note 2 - Summary of Significant Accounting Policies:

     Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All material intercompany accounts and
transactions have been eliminated.

     Revenue Recognition

     Revenue from product sales to customers other than domestic distributors is
recognized upon shipment. The Company estimates returns from these customers and
provides an allowance at the time revenue is recognized. Sales to domestic
distributors are generally subject to agreements allowing certain rights of
return and price protection with respect to unsold merchandise held by each
distributor. The Company defers recognition of revenue and related gross margin
on the sales to domestic distributors until the product is sold by these
distributors.

     Sales to Significant Customers

     Sales to one customer represented 10%, 12% and 30% of the Company's net
sales for the year ended December 31, 1995, 1996 and 1997, respectively.
Accounts receivable from this customer totaled $1,645 and $777 at December 31,
1996 and 1997, respectively. Sales to two other customers represented 11% and
10%, 12% and 9%, and 10% and 7% of the Company's net sales for the years ended
December 31, 1995, 1996 and 1997, respectively.

     Cash Equivalents

     All highly liquid investments purchased with an original maturity of three
months or less are considered to be cash equivalents. The fair values of these
investments approximated their costs at the respective balance sheet dates.


     Marketable Securities

     At December 31, 1996 and 1997, the Company's marketable securities, which
are municipal government obligations, are classified as available for sale and
are reported at fair market value, which approximates cost at the respective
dates. All marketable securities at December 31, 1997 mature in less than one
year. Realized gains and losses are based on the book value of the specific
securities sold and were not material in 1995, 1996 and 1997.

                                       25
<PAGE>
 
     Foreign Currency Translation

     The functional currency of the Company's foreign entities is the U.S.
dollar; however, certain of the Company's costs and expenses are paid in
currencies other than the U.S. dollar. The Company does not currently hedge
against foreign currency exchange rate fluctuations and gains and losses arising
from the translation of foreign currency balances and transactions are included
in consolidated results of operations. Gains and losses from such fluctuations
have not been material to the Company's consolidated results of operations.

     Inventory

     Inventory is stated at the lower of cost, determined on a first-in, first-
out basis, or market.

     Property and equipment

     Equipment acquired pursuant to the management-led buyout from Teledyne,
Inc. aggregating $2,167 is stated at fair value at the date of purchase less the
excess of the fair value of all net assets acquired over the purchase price. All
other equipment and leasehold improvements are stated at cost. Depreciation is
computed using the straight-line method with estimated useful lives of three to
five years for equipment. Leasehold improvements consist of improvements to the
Company's facilities and are amortized over the remaining term of the lease or
useful life of the asset, whichever is less.

     Concentration of Credit Risk

     Financial instruments that potentially subject the Company to significant
concentration of credit risk consist principally of trade accounts receivable.
The Company sells its integrated circuits to customers throughout the world. The
Company performs ongoing credit evaluations of its customers' financial
condition and, generally, requires no collateral from its customers. The Company
maintains an allowance for uncollectable accounts receivable. The Company's
write-offs of accounts receivable have not been significant in 1995, 1996 and
1997. Five customers accounted for 61% and 56% of the Company's gross accounts
receivable at December 31, 1996 and 1997, respectively.

     Net Income (Loss) Per Share

     The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") during the fourth quarter of fiscal 1997. This
statement simplifies the standards for computing earnings per share (EPS)
previously defined in Accounting Principles Board Opinion No. 15 "Earnings Per
Share". All prior-period earnings per share data has been restated in accordance
with SFAS 128. SFAS 128 requires presentation of both Basic EPS and Diluted EPS
on the face of the income statement. Basic EPS is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Diluted EPS
gives effect to all dilutive potential common shares outstanding during the
period including stock options, using the treasury stock method, and convertible
preferred stock, using the if-converted method. In computing Diluted EPS, the
average stock price for the period is used in determining the number of shares
assumed to be purchased from the exercise of stock options.

                                       26
<PAGE>
 
     Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31,
                                                                  ------------------------------------------------------------
                                                                         1995                 1996                   1997
                                                                  -----------------    ----------------      ----------------- 
 
<S>                                                                 <C>                  <C>                   <C>
Net income (loss) available to common shareholders                          $ 3,644             $  (682)               $(1,704)
                                                                  =================    ================      =================
 
Weighted average common shares outstanding (basic)                            8,436              15,612                 16,184
 
Convertible preferred stock                                                   5,578
Effect of dilutive warrants and options                                       1,689
                                                                  -----------------    ----------------      ----------------- 
Weighted average common shares outstanding (diluted)                         15,703              15,612                 16,184
                                                                  =================    ================      =================
 
Earnings per share:
 
Basic                                                                       $  0.43             $ (0.04)               $ (0.11)
                                                                  =================    ================      =================
 
Diluted                                                                     $  0.23             $ (0.04)               $ (0.11)
                                                                  =================    ================      =================
</TABLE>

     Options to purchase 106 shares of common stock at $8.75 per share were
outstanding at December 31, 1995 but were not included in the computation of
diluted EPS because the options' exercise price was greater than the average
market price of the common shares. Due to the Company's net loss from continuing
operations in 1996 and 1997, a calculation of EPS assuming dilution is not
required. At December 31, 1996, there were 2,509 options and warrants
outstanding to purchase common stock at a weighted average price of $2.38 per
share. At December 31, 1997, there were 2,386 options and warrants outstanding
to purchase common stock at a weighted average price of $4.40 per share.

     Stock-Based Compensation

     The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees." The Company's policy is to grant
options with an exercise price equal to the quoted market price of the Company's
stock on the date of the grant. Accordingly, no compensation cost has been
recognized in the Company's statements of operations. The Company provides
additional pro forma disclosures as required under Statement of Financial
Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based
Compensation."

     Recently Issued Accounting Standards

     In June 1997, the Financial Accounting Standards Board issued two new
Statements of Financial Accounting Standards ("SFAS"). SFAS No. 130, "Reporting
Comprehensive Income," establishes standards for reporting and display of
comprehensive income within a financial statement. This Statement requires the
Company to report additional information on comprehensive income to supplement
the reporting of income. SFAS No. 130 is effective for both interim and annual
periods beginning after December 15, 1997. Comparative financial statements
provided for earlier periods are required to be reclassified so that
comprehensive income is displayed in a comparative format for all periods
presented. SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," establishes standards for reporting information about
operating segments in annual and interim financial statements. This Statement
also establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS No. 131 is effective for financial
statements for period beginning after December 15, 1997. The Company will adopt
SFAS No. 130 for the first quarter of 1998 and does not expect its provisions to
have a material effect on the Company's presentation of its consolidated
financial statements. The Company will adopt SFAS No. 131 as of the year ending
December 31, 1998 and is currently studying its provisions.

                                       27
<PAGE>
 
Note 3 - Balance Sheet Details:

 
<TABLE>
<CAPTION>
                                                                            December 31,
                                                          ---------------------------------------------
                                                                 1996                      1997
                                                          -----------------           -----------------
<S>                                                        <C>                       <C>
Inventory:
            Raw materials                                            $1,174                      $  871
            Work-in-process                                           2,233                       4,385
            Finished goods                                            3,083                       3,033
                                                          -----------------           -----------------
 
                                                                     $6,490                      $8,289
                                                       ====================      ======================

     Property and equipment:
            Equipment                                               $13,222                     $20,081
            Leasehold Improvements                                    2,228                       2,708
                                                          -----------------           -----------------
                                                                     15,450                      22,789
            Accumulated depreciation                                 (5,698)                     (9,811)
                                                          -----------------           ----------------- 
                                                                      9,752                      12,978
            Equipment for I.C. WORKS, Inc.                           10,363                           -
            Construction in progress                                  1,733                       1,968
                                                          -----------------           -----------------
 
                                                                    $21,848                     $14,946
                                                        ====================         ==================

     Accrued liabilities:
            Payroll and related                                      $1,396                      $1,667
            Other                                                       610                         793
                                                          -----------------           -----------------
 
                                                                     $2,006                      $2,460
                                                       ====================        ====================
</TABLE>
                                                                               
Note 4 - Notes Payable:

     The Company financed its acquisition of certain equipment with secured
notes payable bearing interest ranging from 9% to 13% per annum and payable in
equal monthly installments of principal and interest. At December 31, 1997,
future maturities of notes payable are as follows:

<TABLE>
<S>                                                          <C>
     1998                                                    $2,641
     1999                                                     1,859
     2000                                                       852
     2001                                                       751
                                                            ------- 
                                                              6,103
     Less: current portion                                    2,641
                                                            -------   
 
                                                             $3,462
                                                            =======
</TABLE>



     The net book value of the equipment pledged under these notes amounted to
$7,064 at December 31, 1997.

                                       28
<PAGE>
 
Note 5 - Income Taxes:

     The Company accounts for income taxes under an asset and liability approach
that requires recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or income tax returns. Provisions are made for
estimated United States and foreign income taxes, less available tax credits and
deductions, which may be incurred on the remittance of certain of the Company's
foreign subsidiaries' undistributed earnings. Deferred taxes have not been
provided for the cumulative undistributed earnings of foreign subsidiaries which
are considered by management to be permanently reinvested.

     The components of income (loss) before income taxes were as follows:

<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                          --------------------------------------------------------------
                                                                 1995                  1996                   1997
                                                          -----------------     ----------------      ------------------  
     <S>                                                        <C>                   <C>                   <C>
     U.S.                                                            $1,872              $(2,597)                $(1,414)
     Foreign                                                          2,987                1,736                   2,137
                                                          -----------------     ----------------      ------------------ 
     Income before taxes                                             $4,859              $  (861)                $   723
                                                          =================     ================      ==================
</TABLE>


     The components of the provision (benefit) for income taxes were as follows:

<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                          --------------------------------------------------------------
                                                                 1995                  1996                   1997
                                                          -----------------     ----------------      ------------------  
     <S>                                                    <C>                   <C>                   <C>
     Current:                                       
      U.S.                                                         $1,367               $(1,060)                 $1,253
      Foreign                                                         175                   174                     590
      State                                                           317                     9                     507
                                                        -----------------      ----------------      ------------------ 
                                                                    1,859                  (877)                  2,350
                                                        -----------------      ----------------       ----------------- 
                                          
     Deferred:
                                          
      U.S.                                                           (644)                  644                      77
                                                        -----------------      ----------------       ----------------- 
                                                                     (644)                  644                      77
                                                        -----------------      ----------------       ----------------- 
                                          
                                                                   $1,215                 $(233)                 $2,427
     Provision (benefit) for income taxes               =================       ===============       =================
</TABLE>

                                       29
<PAGE>
 
     The components of deferred taxes are as follows:

<TABLE>
<CAPTION>
                                                                                       December 31,
                                                                    ------------------------------------------------
                                                                            1996                          1997
                                                                    -------------------         -------------------- 
 <S>                                                               <C>                            <C>
     Property and equipment                                                     $(1,635)                     $  (588)
     Unremitted earnings of foreign subsidiaries                                      -                         (400)
     Other                                                                            -                         (256)
                                                                    -------------------         -------------------- 
 
        Gross deferred tax liabilities                                           (1,635)                      (1,244)
                                                                    -------------------         -------------------- 
 
     Reserves and other non-deductible expenses                                     979                        1,060
     Research and development credit carryforwards                                  356                          684
     Deferred distributor income                                                    145                          268
     Net operating loss carryforwards                                               471                            -
     Other                                                                           33                          192
                                                                    -------------------         -------------------- 
   
        Gross deferral tax assets                                                 1,984                        2,204
                                                                    -------------------         -------------------- 
      Deferred tax asset valuation allowance                                       (349)                      (1,037)
                                                                    -------------------         -------------------- 
 
                                                                                $     -                      $   (77)
                                                                =======================        =====================
</TABLE>


     Due to the uncertainty of the realization of a portion of deferred tax
assets, the Company has provided a valuation allowance on these assets at
December 31, 1996 and 1997. Upon recognition of  the Company's deferred tax
assets, approximately $1,000 will be credited directly to equity as a result of
previous exercises of non qualified stock options and disqualifying dispositions
of incentive stock options.

     The provision (benefit) for income taxes differs from the amount computed
by applying the U.S. statutory federal rate to income before extraordinary item
as a result of the following:

<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                ------------------------------------------------------------------
                                                        1995                    1996                   1997
                                                ------------------      -----------------     -------------------- 
 
<S>                                               <C>                     <C>                   <C>
      Tax at statutory rate                                 $1,701                  $(301)                  $  253
      Differential in rates on earnings of  
        foreign operations                                    (212)                   (36)                    (158)
      State taxes                                              124                      -                      507
      Loss on foundry investment                                 -                      -                    1,050
      Change in valuation allowance                           (299)                   192                      688
      Research and development credits                        (239)                   (55)                       -
      Other                                                    140                    (33)                      87
                                                ------------------      -----------------     -------------------- 

                                                            $1,215                  $(233)                  $2,427
                                                ==================      =================     ====================
</TABLE>

Note 6 - Preferred Stock:

     The Company has authorized 5,000,000 shares of undesignated Preferred
Stock. The Board of Directors has the authority to issue the undesignated
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions granted to or imposed upon any wholly unissued
shares of undesignated Preferred Stock and to fix the number of shares
constituting any series in the designations of such series, without any further
vote or action by the stockholders. The Board of Directors, without stockholder
approval, can issue Preferred Stock with voting and conversion rights which
could adversely affect the voting power of the holders of Common Stock. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company. The Company has no present plan
to issue Preferred Stock.

                                       30
<PAGE>
 
Note 7 - Common Stock:

     Common Stock

     Prior to the initial public offering of its Common Stock, all of  the
Company's Common Stock was issued to certain directors, officers and employees
of the Company. At December 31, 1996 and 1997, proceeds from the sale of Common
Stock was received in the form of stockholder notes receivable totaling $11 and
$2, respectively. The notes bear simple interest at rates ranging from 5.07% to
7.05% per annum and a portion of the amount due under such notes provides for
full recourse against the purchaser and the full amount of each note is secured
by the underlying shares of Common Stock. All principal and accrued interest on
the notes is payable on December 20, 1998.

     Common Stock Option Agreement

     In December 1993, the Company granted to certain entities affiliated with
U.S. Venture Partners (collectively USVP) options to purchase an aggregate of
237,500 shares of the Company's Common Stock. The purchase price for the option
shares is $0.10 per share. During January 1997, USVP elected to exercise its
options to purchase all 237,500 shares. As provided in the option agreement,
USVP received a reduced number of shares in exchange for the aggregate exercise
price due, resulting in the issuance by the Company of 233,183 shares to USVP.

     Employee Stock Option Plan

     In February 1994, the Company adopted its 1994 Stock Option Plan (the
"Option Plan") which provides for the granting of incentive stock options and
nonstatutory stock options to officers, employees and consultants of the
Company. Incentive stock options are granted at an amount not less than 100% of
the fair market value of the stock on the grant date. During 1995, the Board of
Directors and shareholders approved an increase to the number of shares that may
be issued under the option plan from 1,650,000 shares to 2,050,000 shares.
During 1996, the Board of Directors and shareholders approved an increase to the
number of shares that may be issued under the plan from 2,050,000 shares to
2,800,000 shares. During 1997, the Board of Directors and shareholders approved
an increase to the number of shares that may be issued under the plan from
2,800,000 shares to 3,300,000 shares. At December 31, 1995, options to purchase
56,166 shares had been granted subject to such approval and are included in the
table below. In January 1996, the Board of Directors approved an option exchange
program whereby certain employees were able to exchange their existing options
to purchase an aggregate of 418,500 shares of Common Stock at exercise prices
ranging from $6.00 to $8.75 for new options to purchase an aggregate of 418,500
shares at $4.87 per share. Generally all employees exchanged their existing
options for new options. Options generally vest over a four year period. Option
terms may not exceed ten years from the date of grant and unexercised options
expire upon termination of employment. At December 31, 1997, 845,310 options
were exercisable. The weighted average fair value of options granted during
1995, 1996 and 1997 was $2.43, $2.08 and $3.78, respectively.

                                       31
<PAGE>
 
     The Option Plan activity is summarized as follows:

 
<TABLE>
<CAPTION>
                                                                                     Options Outstanding
                                                                           -------------------------------------
                                                        Shares
                                                       Available                                    Price
                                                       For Grant                 Shares           Per Share
                                                   -----------------         --------------    ----------------- 
 <S>                                               <C>                        <C>              <C>
      Balance at December 31, 1994                           587,600              1,062,400       $ 0.10 - $0.25
      Increase in authorized shares                          400,000
      Options granted                                     (1,182,350)             1,182,350       $ 0.30 - $8.75
      Options exercised                                            -                (43,515)      $ 0.10 - $0.25
      Options canceled                                       138,584               (138,584)      $ 0.10 - $8.75
                                                   -----------------         --------------    -----------------  
 
      Balance at December 31, 1995                           (56,166)             2,062,651       $ 0.10 - $8.75
      Increase in authorized shares                          750,000
      Options granted                                     (1,048,500)             1,048,500       $ 3.88 - $4.94
      Options exercised                                            -               (242,202)      $ 0.10 - $3.25
      Options canceled                                       732,899               (732,899)      $ 0.10 - $8.75
                                                   -----------------         --------------    -----------------         

      Balance at December 31, 1996                           378,233              2,136,050       $ 0.10 - $4.94
      Increase in authorized shares                          500,000
      Options granted                                       (999,743)               999,743       $4.31 - $15.94
      Options exercised                                            -               (327,140)      $ 0.10 - $4.94
      Options canceled                                       474,315               (474,315)      $0.10 - $13.25
                                                   -----------------         --------------    -----------------         

      Balance at December 31, 1997                           352,805              2,334,338
                                                ====================       ================
</TABLE>


     Director Stock Option Plan

     During 1996, the Company adopted and approved the Company's 1996 Director
Stock Option Plan (the "Director Plan") with 100,000 shares of Common Stock
reserved for issuance thereunder. Under the Director Plan, each non-employee
director who joins the Board will automatically be granted a non-statutory
option to purchase 12,000 shares of Common Stock on the date upon which such
person first becomes a director. In addition, each non-employee director will
automatically receive a non-statutory option to purchase 3,000 shares of Common
Stock upon such director's annual re-election to the Board, provided the
director has been a member of the Board for at least six (6) months upon the
date of reelection. The exercise price of each option granted under the Director
Plan must be equal to the fair market value of the Common Stock on the date of
the grant. The 12,000 share grant vests at the rate of  twenty-five percent
(25%) of the option shares upon the first anniversary of the date of grant and
as to twenty-five (25%) of the shares each year thereafter and the 3,000 share
grant vests monthly over a twelve (12) month period. Options granted under the
Director Plan have a term of ten (10) years unless terminated sooner, whether
upon termination of the optionee's status as a director or otherwise pursuant to
the Director Plan. Options for 9,000 shares were granted under the Director Plan
in each of 1996 and 1997. The weighted average fair values of the options
granted during 1996 and 1997 was $4.83 and $3.22 per share, respectively. At
December 31, 1997, 14,250 options are exercisable. The Board believes that the
Director Plan is necessary to attract and retain highly qualified individuals to
serve as non-employee members of the Board of Directors.

                                       32
<PAGE>
 
     Information relating to stock options outstanding under the Option Plan and
Director Plan at December 31, 1997 is as follows:

<TABLE>
<CAPTION>
                                                                           Options outstanding
                                                -----------------------------------------------------------------------
                                                                               Weighted
                                                                                average                  Weighted
                                                       Number                  remaining                 average
                                                     outstanding           contractual life           exercise price
                                                -------------------      -------------------     ----------------------
 
Range of exercise prices:
<S>                                               <C>                      <C>                     <C>
     $  0.10 - $   0.30                                     400,939               6.6  years                     $ 0.18
     $  1.50                                                258,638               7.3  years                     $ 1.50
     $  3.25 - $   3.88                                     291,670               8.3  years                     $ 3.59
     $  4.25 - $   4.94                                     631,848               8.5  years                     $ 4.67
     $  5.00 - $   6.38                                     233,700               9.1  years                     $ 5.06
     $  7.00 - $   8.56                                     467,043               9.8  years                     $ 7.95
     $ 11.88 - $  15.94                                      68,500               9.7  years                     $13.68
                                                  -----------------
 
                                                          2,352,338               8.4  years                     $ 4.38
                                                ===================
</TABLE>

<TABLE>
<CAPTION>
                                                                                  Options exercisable
                                                                    ------------------------------------------------
                                                                                                      Weighted
                                                                             Number                   average
                                                                          exercisable              exercise price
                                                                     --------------------     ----------------------
 
Range of exercise prices:
<S>                                                                    <C>                      <C>
     $0.10 - $0.30                                                                344,422                      $0.17
     $1.50                                                                        168,432                      $1.50
     $3.25 - $3.88                                                                128,012                      $3.48
     $4.25 - $4.79                                                                196,414                      $4.78
     $5.02 - $6.38                                                                 22,280                      $5.57
                                                                     --------------------
 
                                                                                  859,560                      $2.12
                                                                     ====================
</TABLE>
                                                                               
     The fair value of each option is estimated on the date of grant using the
Black-Scholes model with the following assumptions used for grants during 1995,
1996 and 1997: annual dividend yield of 0.0% for all periods; risk-free annual
interest rates of 6.05% to 7.36% for options granted during the year ended
December 31, 1995, 5.38% to 6.51% for options granted during the year ended
December 31, 1996 and 5.87% to 6.67% for options granted during the year ended
December 31, 1997; a weighted average expected option term of five years for all
periods; and an expected volatility factor of 60% for all years.

     Employee Stock Purchase Plan

     In May 1995, the Company adopted its 1995 Employee Stock Purchase Plan
("Purchase Plan"). Under the Purchase Plan, an eligible employee may purchase
shares of Common Stock from the Company through payroll deductions of up to 10%
of their base compensation plus commissions, at a price per share equal to 85%
of the fair market value as of the first day or the last day, whichever is
lower, of each six-month offering period under the Purchase Plan up to two years
prior to the last day of each offering period. The offering periods commence on
July and January. The Company has reserved 200,000 shares of Common Stock for
issuance under the Purchase Plan. During 1996, the Purchase Plan was amended to
increase the shares reserved for issuance by 200,000 shares, bringing the total
number of shares issuable under the Purchase Plan to 400,000. At December 31,
1997, 210,293 shares of Common Stock had been issued under the Purchase Plan,
and 189,707 shares remained available for future issuance under the Purchase
Plan.

     The fair value of each stock award is estimated on the date of grant using
the Black-Scholes model with the following assumptions used for grants during
1995, 1996 and 1997: annual dividend yield of 0.0% for all periods; risk-free
annual interest rates of 6.31% to 5.66% for stock awards granted during the year
ended December 31, 1995, 5.18% to 5.46% for stock awards granted during the year
ended December 31, 1996 and 5.49% to 5.66% for stock awards granted during the
year ended December 31, 1997; a weighted average expected stock award term of
six months for all periods; and an expected volatility 

                                       33
<PAGE>
 
factor of 60% for all years.
 
Fair Value Disclosures

     Had compensation cost for the Company's stock option and stock purchase
plans been determined based on the fair value of the options at the grant dates
using the Black-Scholes model as provided by FAS 123, the Company's net income
(loss) and net income (loss) per share for the years ended December 31, 1995,
1996 and 1997 would have been as follows:

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31,
                                                          -------------------------------------------------------------------------
                                                                     1995                       1996                       1997
                                                          ------------------------     --------------------     -------------------
 
Net income (loss):
<S>                                                         <C>                          <C>                      <C>
        As reported.................................                        $3,644                  $  (628)              $(1,704)
        Pro forma...................................                        $3,536                  $(1,346)              $(3,022)
 
 
Net income (loss) per share:
        As reported.................................
              Basic                                                         $ 0.43                  $ (0.04)             $  (0.11)
              Diluted                                                       $ 0.23                  $ (0.04)             $  (0.11)
        Pro forma...................................
              Basic                                                         $ 0.42                  $ (0.09)             $  (0.19)
              Diluted                                                       $ 0.23                  $ (0.09)             $  (0.19)
</TABLE>

     The pro forma amounts reflect compensation expenses related to 1995, 1996
and 1997 employee and director option grants and employee stock purchase plan
awards only. In future years, the annual compensation expense will increase due
to the expense associated with future grants.
 
Note 8 - Commitments and Contingencies:

     The Company occupies its present principal facilities under non-cancelable
operating leases expiring December 1998 and July 2000. One of these lease
agreements also provides the Company an option to extend the lease term through
December 2003 at 95% of the then prevailing fair rental value of the premises
for the renewal period. In addition, the Company is required to pay taxes,
insurance and maintenance expenses.

     Future minimum lease payments under non-cancelable leases at December 31,
1997 are as follows:

          Year Ending December 31,
          ------------------------
<TABLE>
<CAPTION>
 
<S>                                                <C>
          1998                                     $  682
          1999                                        283
          2000                                        149
                                                  -------
          Minimum lease payments                   $1,114
                                                  =======
</TABLE>


     Rent expense for the years ended December 31, 1995, 1996 and 1997 was $568,
$745 and $767, respectively.

                                       34
<PAGE>
 
Note 9 - Geographic Information:

     The Company operates in one industry segment. The following is a summary of
the Company's operations:
 
<TABLE>
<CAPTION>
                                                                        Year Ended December 31,
                                                  ------------------------------------------------------------------
                                                        1995                    1996                     1997
                                                  ----------------        ----------------          ----------------
<S>                                            <C>                       <C>                     <C>
Sales to third-party customers in:
      United States                                        $16,233                 $14,088                  $19,420
      Asia                                                  12,775                  14,122                   18,367
      Europe                                                 9,996                   9,552                   17,648
                                                  ----------------        ----------------          ---------------  
                                                           $39,004                 $37,762                  $55,435
                                                  ================        ================          ===============
 
Intercompany sales transactions
    eliminated in consolidation                            $27,047                 $33,404                  $48,315
                                                  ================        ================          ===============
 
Operating income:
      United States                                        $ 1,573                 $(2,785)                 $(1,186)
      Asia                                                   2,636                   1,507                    1,488
      Europe                                                   351                     255                      709
                                                  ----------------        ----------------          ---------------  
                                                           $ 4,560                 $(1,023)                 $ 1,011
                                                  ================        ================          ===============


                                                                                         December 31,
                                                                          -----------------------------------------
                                                                                 1996                     1997
                                                                          ----------------          --------------- 
Identifiable assets:
      United States                                                                $46,334                  $37,295
      Asia                                                                          11,498                   15,553
      Europe                                                                           180                      836
                                                                           ----------------         --------------- 
 
                                                                                   $58,012                  $53,684
                                                                           ===============          ===============
</TABLE>
                                                                               

Note 10 - Supplemental Disclosure of Cash Flow Information

<TABLE>
<CAPTION>

                                                                        Year Ended December 31,
                                                  ------------------------------------------------------------------
                                                        1995                    1996                     1997
                                                  ----------------        ----------------          ----------------
<S>                                               <C>                     <C>                       <C> 
Cash paid during the year for:
 
      Interest                                                $326                  $  752                   $1,247
      Income taxes (received, net)                             211                   1,828                     (885)

Non-Cash financing activities
 
      Mandatorily redeemable convertible
       preferred stock converted to
       Common Stock                                        $13,479                  $    -                   $    -
</TABLE>

Note 11 - Loss on Foundry Investment

     In November 1995, the Company entered into certain agreements with IC
WORKS, Inc. a privately-held company located in San Jose, California. Pursuant
to these agreements, in 1996 the Company purchased $3.0 million of preferred
stock of IC WORKS and provided $10.4 million in capital equipment. In return for
this investment, TelCom received a guarantee of submicron wafer capacity at
specified prices for a period of five years, projected to start in late 1997.
The shortage of wafer capacity projected in late 1995 has diminished and since
late 1995, substantial foundry capacity has been available worldwide while
overall demand has not increased proportionately. Consequently, wafer pricing
has decreased dramatically, which has changed the economic viability of the
foundry business in which the Company invested. As a result, in the first
quarter of 1997, 

                                       35
<PAGE>
 
the Company recorded an impairment loss on its foundry investment of $8.0
million, consisting of a $3.0 million write down of the preferred stock and a
$5.0 million impairment write down of the equipment. In the fourth quarter of
1997, pursuant to an agreement with IC WORKS, the Company sold the $10.4 million
dollars of equipment at IC WORKS for $5.2 million and invested an additional
$1.5 million in preferred stock of IC WORKS, Inc. This agreement terminates the
Company's operating agreement with IC WORKS and its wafer production arrangement
was amended to allow the Company to purchase wafers for a period of time prior
to finding an alternative supplier, up to April 1998. As a result of these
events and transactions, the Company recorded a loss of $8.3 million on its
foundry investment in 1997 (of which $8.0 million was recorded in the first
quarter of 1997), which consists of a $3.0 million write down of the preferred
stock, a loss on the sale of the equipment of $5.2 million, and $.1 million of
costs associated with prepayment penalties on financing of the equipment and
legal fees. Two of the Company's directors who served during 1997 also served as
directors of IC WORKS. Purchases from IC WORKS during 1997 aggregated $1.7
million and accounts payable to IC WORKS at December 31, 1997 was $.2 million.
 
ITEM 9.  CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND
-----------------------------------------------------------------------
         FINANCIAL  DISCLOSURE
         ---------------------

     Not applicable.

                                       36
<PAGE>
 
                                    PART III
                                    --------

     Certain information required by Part III is omitted from this Report on
Form 10-K in that the Registrant will file its definitive Proxy Statement for
its Annual Meeting of Stockholders to be held on April 16, 1998, pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Proxy
Statement"), not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included in the Proxy Statement is
incorporated herein by reference.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------

      (a)       Executive Officers -- See the section entitled "Executive
                Officers" in Part I, Item 1 hereof.

      (b)       Directors -- The information required by this Item is
                incorporated by reference to the section entitled "Election of
                Directors" in the Proxy Statement.

     The disclosure required by Item 405 of Regulation S-K is incorporated by
reference to the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement.

ITEM 11.  EXECUTIVE COMPENSATION
--------------------------------

     The information required by this Item is incorporated by reference to the
sections entitled "Compensation of Executive Officers" and "Compensation of
Directors" in the Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------

     The information required by this Item is incorporated by reference to the
sections entitled "Principal Share Ownership" and "Security Ownership of
Management" in the Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
 
     The information required by this Item is incorporated by reference to the
section entitled "Certain Transactions" in the Proxy Statement.

                                       37
<PAGE>
 
                                    PART IV
                                    -------

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

14(a) Exhibits

<TABLE>
<CAPTION>
Exhibit
Number                                                             Description of Document
---------------     ---------------------------------------------------------------------------------------------------------------
 
<S>                   <C>
3.1+                  Restated Certificate of Incorporation of Registrant.
 
3.2+                  Bylaws of Registrant.
 
3.3+                  Certificate of Ownership and Merger merging TelCom Semiconductor, Inc., a California Corporation, with and
                      into TelCom Semiconductor, Inc., a Delaware Corporation

10.1+                 Form of Indemnification Agreement for Executive Officers and Directors.
 
10.2+*                1994 Stock Option Plan and form of Stock Option Agreement.
 
10.3+*                Employee Stock Purchase Plan and form of Subscription Agreement.
 
10.4+                 Investor Rights Agreement dated as of December 20, 1993 by and among the Registrant and certain investors,
                      including amendments thereto.
 
10.5+                 Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue,
                      Mountain View, California.
 
10.6+                 Tenancy Agreements dated September 16, 1992 related to a portion of the premises located at the Jing Wah
                      Building No. 10 Sam Chuk Street, Hong Kong.
 
10.7+                 Loan and Security Agreement dated November 17, 1994 between the Registrant and PhoenixCor Corporation
 
10.8+                 Authorized Distributor Agreement between Future Electronics, Inc. and the Registrant.
 
10.9+                 1995 Distributor/Sales Representative Warrant Plan.
 
10.10+                First Amendment to Lease dated as of July 10, 1995.
 
10.11++               Operating Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
 
10.12++               Wafer Production Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
 
10.13+++              Amendment to Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue,
                      Mountain View, California
 
10.14++++             Tenancy Agreements dated July 28, 1997 related to a portion of the premises located at the Jing Wah Building
                      No. 10 Sam Chuk Street, Hong Kong.

10.15+++++            Director Option Plan
 
21.1+                 List of subsidiaries.
 
23.1                  Consent of Price Waterhouse LLP. Independent Accountants
 
27.1                  Financial Data Schedule
</TABLE>


+       Incorporated by reference from the Registrant's Registration Statement
        on Form SB-2 (file no. 33-93840-LA), as amended, filed on June 22, 1995.

++      Incorporated by reference from the Registrant's Quarterly Report on Form
        10-QSB for the period ended September 30, 1995.

+++     Incorporated by reference from the Registrant's Annual Report on Form
        10-KSB for the period ended December 31, 1995.

++++    Incorporated by reference from the Registrant's Annual Report on Form
        10-Q for the period ended June 30, 1997.

+++++   Incorporated by reference from the Registrant's Registration Statement
        on Form S8 (file no. 333-31433), as amended, filed on June 22, 1995.

*       Management contract or compensatory plan or arrangement required to be
        filed as an exhibit to this form.

14 (b) Reports on Form 8-K: Report on Form 8K dated December, 1997 with respect
to a change in the Company's fiscal year end from the last Friday of December to
the Friday closest to December 31 of each year.
 

                                       38
<PAGE>
 
                                   SIGNATURES

     In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934 (the "Exchange Act"), the Registrant caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Mountain
View, State of California, on March 11, 1998.

                                      TELCOM SEMICONDUCTOR, INC.



                                      By:       /s/ Phillip M. Drayer
                                          --------------------------------
                                                    Phillip M. Drayer
                                          Chief Executive Officer and President


                               POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Phillip M. Drayer and R. Michael
O'Malley, and each of them acting individually, as his attorney-in-fact, each
with full power of substitution for him in any and all capacities, to sign any
and all amendments to this report on Form 10-K, and file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our attorney to any and all amendments to said Report.

     In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.


<TABLE>
<CAPTION>
         Signature                                                Title                                        Date
----------------------------                ------------------------------------------------         ----------------------
<S>                                          <C>                                                     <C>  
/s/ Phillip M. Drayer                         Chief Executive Officer and President                    March 11, 1998
----------------------------                  (Principal Executive Officer) and Director  
    Phillip M. Drayer                               
 
 
/s/ R. Michael O'Malley                       Vice President, Chief Operating Officer and              March 11, 1998
----------------------------                  Chief Financial Officer (Principal Financial
    R. Michael O'Malley                       Officer) 
                                              
 
/s/ Kenneth J. Rose                           Chief Accounting Officer and Corporate                   March 11, 1998
----------------------------                  Controller (Principal Accounting Officer)
    Kenneth J. Rose                          
 
 
/s/ Donald E. Fowler                          Director                                                 March 11, 1998
----------------------------
    Donald E. Fowler
 
 
/s/ Frank Gill                                Director                                                 March 11, 1998
----------------------------
    Frank Gill
 
 
/s/ T. Peter Thomas                           Director                                                 March 11, 1998
----------------------------
    T. Peter Thomas
</TABLE>

                                       39
<PAGE>
 
<TABLE>
<CAPTION>
                                                    TELCOM SEMICONDUCTOR, INC.

                                                         INDEX TO EXHIBITS
                                                         -----------------
<S>                                                      <C>                                                           <C> 
                                                                                                                       Sequentially
Exhibit                                                                                                                  Numbered
Number                                                   Description of Document                                           Page
 
<S>                   <C>                                                                                             <C>
3.1+                  Restated Certificate of Incorporation of Registrant.
 
3.2+                  Bylaws of Registrant.
 
3.3+                  Certificate of Ownership and Merger merging TelCom Semiconductor, Inc., a California
                      Corporation, with and into TelCom Semiconductor, Inc., a Delaware corporation
 
10.1+                 Form of Indemnification Agreement for Executive Officers and Directors.
 
10.2+*                1994 Stock Option Plan and form of Stock Option Agreement.
 
10.3+*                Employee Stock Purchase Plan and form of Subscription Agreement.
 
10.4+                 Investor Rights Agreement dated as of December 20, 1993 by and among the Registrant and
                      certain investors, including amendments thereto.
 
10.5+                 Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella
                      Avenue, Mountain View, California.
 
10.6+                 Tenancy Agreements dated September 16, 1992 related to a portion of the premises located at
                      the Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
 
10.7+                 Loan and Security Agreement dated November 17, 1994 between the Registrant and PhoenixCor
                      Corporation.
 
10.8+                 Authorized Distributor Agreement between Future Electronics, Inc. and the Registrant.
 
10.9+                 1995 Distributor/Sales Representative Warrant Plan.
 
10.10+                First Amendment to Lease dated as of July 10, 1995.
 
10.11++               Operating Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
 
10.12++               Wafer Production Agreement between the Registrant and IC Works, Inc. dated as of November 2,
                      1995.
 
10.13+++              Amendment to Lease Agreement dated December 20, 1993 related to premises located at 1300
                      Terra Bella Avenue, Mountain View, California.
 
10.14++++             Tenancy Agreements dated July 28, 1997 related to a portion of the premises located at the
                      Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
 
10.15+++++            Director Option Plan
 
21.1+                 List of subsidiaries.
 
23.1                  Consent of Price Waterhouse LLP. Independent Accountants                                                41
 
27.1                  Financial Data Schedule                                                                                 42
</TABLE>
-------------------------------------
+     Incorporated by reference from the Registrant's Registration Statement on
      Form SB-2 (file no. 33-93840-LA), as amended, filed on June 22, 1995.

++    Incorporated by reference from the Registrant's Quarterly Report on Form
      10-QSB for the period ended September 30, 1995.

+++   Incorporated by reference from the Registrant's Annual Report on Form
      10-KSB for the period ended December 31, 1995.

++++  Incorporated by reference from the Registrant's Annual Report on Form
      10-Q for the period ended June 30, 1997.

+++++ Incorporated by reference from the Registrant's Registration Statement on
      Form S8 (file no. 333-31433), as amended, filed on June 22, 1995.

*     Management contract or compensatory plan or arrangement required to be
      filed as an exhibit to this form.