UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-220-20
CASTELLE
(Exact name of Registrant as specified in its charter)
California 77-0164056
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3255-3 Scott Boulevard, Santa Clara, California
95054 (Address of principal executive offices,
including zip code)
(408) 496-0474
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in any amendment to this Form 10-K.
The approximate aggregate market value of the voting common equity held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock reported on the Nasdaq National Market was $6,822,000 as of February 20,
1998.
The number of shares of Common Stock outstanding as of February 20, 1998 was
4,490,047.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits filed with the Registrant's Registration Statement on Form SB-2
(Registration No. 33-99628-LA-), as amended, are incorporated herein by
reference into Part IV of this Report and portions of the proxy statement to be
filed in connection with the annual meeting to be held April 29, 1998 are
incorporated herein by reference into Part III of this Report.
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PART I
ITEM 1. BUSINESS
The following summary should be read in conjunction with, and is
qualified in its entirety by, the more detailed information and Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Report.
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Castelle's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed herein under "Risk Factors" as
well as in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
INTRODUCTION
Castelle (the "Company") designs, develops, markets and supports
network enhancement products, both software and hardware, that improve the
productivity, performance and functionality of local area networks ("LANs") and
enhance the LAN user's ability to communicate. The Company's current products
include FaxPress fax server systems, LANpress print servers and InfoPress
fax-on-demand software.
In recent years, organizations have increasingly interconnected
personal computers into LANs. Originally, these LANs consisted of a dedicated
personal computer, called a file server, on which the network operating system
was installed, and multiple personal computers on which the users of the LAN ran
their applications. The network operating system on the file server provided the
server administration and basic file and print sharing. As networks have
proliferated throughout organizations and client/server architectures have
gained acceptance, LANs have become increasingly complex, the size and
multimedia intensity of files being communicated have increased and the
applications operating on the LAN have become more critical to the success of
the business enterprise. These factors have caused network administrators to
seek network enhancement products which can improve network performance, enhance
the functionality of the current installed base of network hardware and convert
single-user resources such as stand-alone printers and telephone lines into
shared LAN resources in a cost-effective manner. The Company has developed its
line of network enhancement products to address these needs.
The Company's objective is to be a leading worldwide supplier of
network enhancement solutions. Key elements of the Company's strategy to achieve
this objective include: maintaining market focus in order to provide the Company
with a competitive edge in innovation and time-to-market relative to its larger
competitors; broadening its software offerings to leverage its installed base of
fax, fax-on-demand and print servers; continuing to develop products that are
widely compatible with leading network operating systems and adapting those
products for remote access and Internet connectivity capabilities; strengthening
and maintaining its domestic and international distribution network; and
expanding existing relationships and fostering new alliances to augment the
Company's product offerings that enable the Company to respond quickly to
technological changes.
The Company has adapted its products for use with the Internet and on
the World Wide Web (the "Web"), and will continue to focus on the effect the
Internet has had on network productivity. For example, the Company has developed
Internet fax capability with its FaxPress fax server, Internet print capability
with its LANpress print servers, and Web-to-fax capabilities with its InfoPress
fax-on-demand server.
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The Company distributes its products primarily through a two-tier,
domestic and international distribution network, with its distributors selling
Castelle's products to value-added resellers ("VARs"), retailers and other
resellers. The Company's three major domestic distributors include Ingram Micro,
Inc. ("Ingram"), Tech Data Corporation ("Tech Data") and Merisel, Inc
("Merisel"). The Company's two major international distributors include Macnica
Corporation ("Macnica") in Japan and Azlan Group PLC ("Azlan") in the United
Kingdom. The Company also has relationships with certain original equipment
manufacturers and sells software and upgrades directly to end users.
In November 1996 Ibex Technologies, Inc. ("Ibex") merged with and into
the Company. Ibex designed, developed and marketed fax-on-demand, fax-gateway,
fax broadcast and Web/fax applications sold directly and through value-added
resellers. "Fax-on-Demand" is the ability to use a touch-tone phone and a fax
machine to request and receive hard copies of documents on demand. Although
there are a wide variety of applications installed, the two most common
applications are customer support and literature fulfillment applications.
The Company was incorporated in California in 1987, and its principal
offices are located at 3255-3 Scott Boulevard, Santa Clara, California 95054.
The Company's telephone number is (408) 496-0474. Castelle(R), LANpress(R) and
JetPress(R) are registered trademarks and FaxPressTM is a trademark of the
Company. This Report includes trademarks and trade names of other companies.
RISK FACTORS
Shareholders or investors considering the purchase of shares of the
Company's Common Stock should carefully consider the following risk factors, in
addition to other information in this Report.
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed herein as well as in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Fluctuations in Operating Results
The Company's revenue and operating results have fluctuated in the past
and the Company's future revenues and operating results are likely to do so in
the future, particularly on a quarterly basis.
The Company's operating results may vary significantly from quarter to
quarter due to a variety of factors, including changes in the Company's product
and customer mix, constraints in the Company's manufacturing and assembling
operations, shortages or increases in the prices of raw materials and
components, changes in pricing policy by the Company or its competitors, a
slowdown in the growth of the networking market, seasonality, timing of
expenditures and economic conditions in the United States, Europe and Asia. The
Company's backlog at any given time is not necessarily indicative of actual
sales for any succeeding period. The Company's sales will often reflect orders
shipped in the same quarter in which they are received. In addition, a
significant portion of the Company's expenses are relatively fixed in nature,
and planned expenditures are based primarily on sales forecasts. Therefore, if
the Company inaccurately forecasts demand for its products, the impact on net
income may be magnified by the Company's inability to adjust spending quickly
enough to compensate for the net sales shortfall. Future demand for the
Company's products may be stronger during the last quarter of each year than the
first quarter of the succeeding year as the sales personnel of the Company's
distributors seek to meet their annual sales quotas. The Company's performance
in any quarter is not necessarily indicative of its performance in any
subsequent quarter.
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Other factors contributing to fluctuations in the Company's quarterly
operating results include changes in the demand for the Company's products,
customer order deferrals in anticipation of new versions of the Company's
products, the introduction of new products and product enhancements by the
Company or its competitors, the effects of filling the distribution channels
following such introductions, potential delays in the availability of announced
or anticipated products, the mix of license and service revenue, the
commencement or conclusion of significant development contracts, changes in
foreign currency exchange rates, the timing of acquisitions and associated
costs, and the timing of significant marketing and sales promotions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
History of Losses; Accumulated Deficit
The Company has experienced significant operating losses and, as of
December 31, 1997, had an accumulated deficit of $13.8 million. The development
and marketing by the Company of new products will continue to require
substantial product development and other expenditures. Although the Company had
been profitable in 1996 and 1995, the Company sustained a loss in 1997 and there
can be no assurance that growth in net sales or profitability will be achieved
or sustained in future years. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Rapid Technological Change; Risks Associated with New Products
The market for the Company's products is affected by rapidly changing
networking technology and evolving industry standards. The Company believes that
its future success will depend upon its ability to enhance its existing products
and to develop and introduce new products which conform to or support emerging
network telecommunications standards, are compatible with a growing array of
computer and peripheral devices, support popular computer and network operating
systems and applications, meet a wide range of evolving user needs and achieve
market acceptance. There can be no assurance that the Company will be successful
in these efforts. The Company has incurred, and the Company expects to continue
to incur, substantial expenses associated with the introduction and promotion of
new products. There can be no assurance that the expenses incurred will not
exceed research and development budgets or that new products will achieve market
acceptance and generate sales sufficient to offset development costs. In order
to develop new products successfully, the Company is dependent upon timely
access to information about new technological developments and standards. There
can be no assurance that the Company will have such access or that it will be
able to develop new products successfully and respond effectively to
technological change or new product announcements by others. Furthermore, the
Company expects that printer and other peripheral manufacturers will add
features to their products that make them more network accessible, which may
reduce demand for the Company's network enhancement devices. There can be no
assurance that products or technologies developed by others will not render the
Company's products non-competitive or obsolete. The fax-on-demand market in
general has been negatively affected by the growth of the Web and the Internet.
Although the Company has new web/fax/email products in development, there can be
no assurance these products will compete successfully. Complex products such as
those offered by the Company may contain undetected or unresolved hardware
defects or software errors when they are first introduced or as new versions are
released. Changes in the Company's or its suppliers' manufacturing processes or
the inadvertent use of defective components by the Company or its suppliers
could adversely affect the Company's ability to achieve acceptable manufacturing
yields and product reliability. The Company has in the past discovered hardware
defects and software errors in certain of its new products and enhancements
after their introduction. Although the Company has not experienced material
adverse effects resulting from any such errors to date, there can be no
assurance that despite testing by the Company and by third-party test sites,
errors will not be found in future releases of the Company's products, which
would result in adverse product reviews and negatively affect market acceptance
of these products.
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The introduction of new or enhanced products requires the Company to
manage the transition from older products. The Company must manage new product
introductions so as to minimize disruption in customer ordering patterns, avoid
excessive levels of older product inventories and ensure that adequate supplies
of new products can be delivered to meet customer demands. The Company has from
time to time experienced delays in the shipment of new products. There can be no
assurance that future product transitions will be managed successfully by the
Company. See "Business -- Products," "-- Research and Product Development," and
"-- Sales, Marketing and Distribution."
Key Personnel
The Company' success depends to a significant degree upon the continued
contributions of the Company's key management, marketing, product development
and operational personnel. The success of the Company will depend to a large
extent upon its ability to retain and continue to attract highly skilled
personnel. Competition for employees in the computer industry is intense, and
there can be no assurance that the Company will be able to attract and retain
enough qualified employees. If the business of the Company grows, it may become
increasingly difficult for it to hire, train and assimilate the new employees
needed. The Company's inability to retain and attract key employees could have a
material adverse effect on the Company's product development, business,
operating results and financial condition. The Company does not carry key person
life insurance with respect to any of its personnel.
Competition and Price Erosion
The network enhancement products and computer software markets are
highly competitive, and the Company believes that such competition will
intensify in the future. The competition is characterized by rapid change and
improvements in technology along with constant pressure to reduce prices. The
Company currently competes principally in the market for network print servers
and network fax servers and fax-on-demand software. Increased competition,
direct and indirect, could adversely affect the Company's business and operating
results through pricing pressure, loss of market share and other factors. In
particular, the Company expects that, over time, average-selling prices for its
print server products will decline, as the market for these products becomes
increasingly competitive. Any material reduction in the average selling prices
of the Company's products would require the Company to increase unit sales in
order to avoid a reduction in net sales and would adversely affect gross
margins. There can be no assurance the Company will be able to maintain the
current average selling prices of its products or the related gross margins.
The principal competitive factors affecting the market for the
Company's products include product functionality, performance, quality,
reliability, ease of use, quality of customer training and support, name
recognition, price, and compatibility and conformance with industry standards
and changing operating system environments. Several of the Company's existing
and potential competitors, most notably the Hewlett-Packard Company
("Hewlett-Packard") and Intel Corporation ("Intel"), have substantially greater
financial, engineering, manufacturing and marketing resources than does the
Company. The Company also experiences competition from a number of other
companies. In addition to its current competitors, the Company may face
substantial competition from new entrants into the network enhancement market,
including established and emerging computer, computer peripherals,
communications and software companies. As the Company develops and introduces
more fax server software products, it is experiencing increasing competition
from companies such as Applied Voice Technology, Inc. ("Applied Voice"), Omtool,
Ltd. ("Omtool") and Computer Associates International, Inc. ("Computer
Associates"). There can be no assurance that competitors will not introduce
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products incorporating technology more advanced than that of the Company. In
addition, certain competing methods of communications such as the Internet or
electronic mail could adversely affect the market for fax products. Certain of
the Company's existing and potential competitors are manufacturers of printers
and other peripherals, and these competitors may develop closed systems
accessible only through their own proprietary servers. There can be no assurance
that the Company will be able to compete successfully or that competition will
not have a material adverse effect on the Company's business, operating results
and financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
International Sales
Sales to customers located outside Canada and the United States
accounted for approximately 47% and 53% of the Company's net sales in 1997 and
1996, respectively. The Company sells its products in 44 foreign countries
through approximately 89 international distributors. Macnica, the Company's
principal Japanese distributor, and Azlan, the Company's principal United
Kingdom distributor, accounted for approximately 68% and 11% of the Company's
international sales in 1997, respectively, and 63% and 11% of the Company's
international sales in 1996, respectively. The Company expects that
international sales will continue to represent a significant portion of the
Company's product revenues and that the Company will be subject to the normal
risks of international sales, such as export laws, currency fluctuations, longer
payment cycles, greater difficulties in accounts receivable collections and the
requirement of complying with a wide variety of foreign laws. See also
"Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses." Although
the Company has not previously experienced any difficulties under foreign law in
exporting its products to other countries, there can be no assurance that the
Company will not experience such difficulties in foreign countries in the
future. In addition, because the Company invoices its foreign sales in U.S.
dollars, fluctuations in exchange rates could affect demand for the Company's
products by causing its prices to be out of line with products priced in the
local currency. Additionally, any such difficulties would have a material
adverse effect on the Company's international sales and a resulting material
adverse effect on the Company's business, operating results and financial
condition. The Company may experience fluctuations in European sales on a
quarterly basis because European sales may be weaker during the third quarter
than the second quarter due to extended holiday shutdowns in July and August.
See "Business -- Sales, Marketing and Distribution."
Product Transition; Risk of Product Returns and Inventory Obsolescence
From time to time, the Company may announce new products, product
versions, capabilities or technologies that have the potential to replace or
shorten the life cycles of existing products. The release of a new product or
product version may result in the write-down of product in inventory if such
inventory becomes obsolete. The Company has in the past experienced increased
returns of a particular product version following the announcement of a planned
release of a new version of that product. Although the Company provides an
allowance for anticipated returns, and believes its existing policy results in
the establishment of an allowance that is currently adequate, there can be no
assurance that product returns will not exceed such allowance in the future and
will not have a material adverse effect on the Company's business, operating
results and financial condition.
Concentration of Distributors; Distribution Risks
The Company sells its products primarily through a two-tier domestic
and international distribution network, with the Company's distributors selling
the Company's products to VARs, retailers and other resellers. The personal
computer and networking products distribution industry has been characterized by
rapid change, including consolidations due to the financial difficulties of
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distributors and the emergence of alternative distribution channels. In
addition, an increasing number of companies are competing for access to these
channels. The Company's five largest distributors accounted for 68% of its net
sales in 1997 and 70% of the Company's net sales in 1996. Macnica, the Company's
principal Japanese distributor, and Ingram, the Company's largest domestic
distributor, accounted for approximately 32% and 14% of the Company's net sales
in 1997, respectively, and 33% and 15% of the Company's net sales in 1996. The
Company's distributors typically represent other product lines that are
complementary to, or compete with, those of the Company. While the Company
attempts to encourage its distributors to focus on its products through
marketing and support programs, these distributors may give higher priority to
products of other suppliers, thereby reducing the efforts they devote to selling
the Company's products. In particular, certain of its competitors, including
Hewlett-Packard and Intel, sell a substantially higher total dollar volume of
products through several of the Company's large United States distributors and,
as a result, the Company believes such distributors give higher priority to
products offered by such competitors. The Company's distributors are not
contractually committed to future purchases of the Company's products and could
discontinue carrying the Company's products at any time for any reason. In
addition, because the Company is dependent on a small number of distributors for
a significant portion of the sales of its products, the loss of any of the
Company's major distributors or their inability to satisfy their payment
obligations to the Company could have a significant adverse effect on the
Company's business, operating results and financial condition. The Company has a
stock rotation policy with certain of its distributors that allows them to
return marketable inventory against offsetting orders. Should the Company reduce
its prices, the Company credits certain of its distributors for the difference
between the purchase price of products remaining in their inventory and the
Company's reduced price for such products. In addition, due to industry
conditions or the actions of competitors, inventory levels of the Company's
products held by distributors could become excessive resulting in product
returns and inventory write-downs. There can be no assurance that in the future
returns and price protection will not have a material adverse effect on the
Company's business, operating results and financial condition. See "Business --
Sales, Marketing and Distribution" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Lack of Product Revenue Diversification
The Company derives substantially all of its sales from its fax and
print server product lines. During 1997 and 1996, both product lines represented
94% and 95%, respectively, of total net sales. The Company expects that these
hardware and software products will continue to account for a majority of the
Company's sales in the future. A decline in demand for these products as a
result of competition, technological change or other factors would have a
material adverse effect on the Company's business, operating results and
financial condition.
Dependence on Suppliers and Subcontractors
The Company's products incorporate or require components or
sub-assemblies procured from third-party suppliers. Certain of these components
or sub-assemblies are available only from a single source, and others are
available only from limited sources. Certain key components of the Company's
products, including a modem chip set from Rockwell International Corporation
("Rockwell") and a microprocessor from Motorola, Inc. ("Motorola"), are
currently available from only single sources. Other components of the Company's
products are currently available from only a limited number of sources. In
addition, the Company subcontracts a substantial portion of its manufacturing to
third parties, and there can be no assurance that these subcontractors will be
able to support the manufacturing requirements of the Company. The Company does
not have material long-term supply contracts with these or any other sole or
limited source vendors and subcontractors other than an agreement with SerComm
Corporation ("SerComm"), and otherwise purchases components or sub-assemblies on
a purchase order basis. The Company's ability to obtain these components and
sub-assemblies is dependent upon its ability to accurately forecast customer
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demand for its products and to anticipate shortages of critical components or
sub-assemblies created by competing demands upon suppliers. If the Company were
unable to obtain a sufficient supply of high-quality components or
sub-assemblies from its current sources, the Company could experience delays in
obtaining such components or sub-assemblies from other sources. Resulting delays
or reductions in product shipments could adversely affect the Company's
business, operating results and financial condition and damage customer
relationships. Furthermore, a significant increase in the price of one or more
of these components or sub-assemblies or the Company's inability to lower
component or sub-assembly prices in response to competitive price reductions
could adversely affect the Company's business, operating results and financial
condition.
The Company augments its product offerings by obtaining access to
third-party products and technologies in areas outside of its core competencies
or where the Company believes internal development of products and technologies
is not cost-effective. The Company's third-party product supplier is SerComm for
certain of the Company's print server products. There can be no assurance that
these products will produce gross margins comparable to those of the Company's
internally generated products. The Company's agreement with its third-party
product supplier has a limited term of two years, subject to earlier termination
upon the occurrence of certain events. Extensions of the terms of this agreement
require the consent of both the Company and its supplier. The Company
experienced a supply shortage during the fourth quarter of 1997 for a
proprietary chip. This shortage reduced the Company's sales for the quarter by
approximately $800,000, as a result of the Company's inability to fulfill orders
in backlog for several print server products. Although the chip again became
available in sufficient quantities during the first quarter of 1998, the Company
has also taken action to reduce its risk by engineering this chip out of new and
future versions of these products. There can be no assurance that the parties
with which the Company contracts will continue to provide the quantities and
quality of products needed by the Company or they will upgrade their respective
products on a timely basis. The termination of the Company's relationships with
third-party product suppliers and with SerComm, in particular, could result in
delays or reductions in product shipments, which could have a material adverse
effect on the Company's business, operating results and financial condition. See
"Business -- Manufacturing."
Government Regulation
Certain aspects of the networking industry in which the Company
competes are regulated both in the United States and in foreign countries.
Imposition of public carrier tariffs, taxation of telecommunications services
and the necessity of incurring substantial costs and expenditure of managerial
resources to obtain regulatory approvals, particularly in foreign countries
where telecommunications standards differ from those in the United States, or
the inability to obtain regulatory approvals within a reasonable period of time,
could have a material, adverse effect on the Company's business, operating
results and financial condition. The Company's products must comply with a
variety of equipment, interface and installation standards promulgated by
communications regulatory authorities in different countries. Changes in
government policies, regulations and interface standards could require the
redesign of products and result in product shipment delays which could have a
material, adverse impact on the Company's business, operating results and
financial condition.
Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses
The Company's success depends to a certain extent upon its
technological expertise and proprietary software technology. The Company relies
upon a combination of contractual rights and copyright, trademark and trade
secret laws to establish and protect its technologies. Despite the precautions
taken by the Company, it may be possible for unauthorized third parties to copy
the Company's products or to reverse engineer or obtain and use information that
the Company regards as proprietary. In addition, the laws of some foreign
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countries either do not protect the Company's proprietary rights or offer only
limited protection. Given the rapid evolution of technology and uncertainties in
intellectual property law in the United States and internationally, there can be
no assurance that the Company's current or future products will not be subject
to third-party claims of infringement. Any litigation to determine the validity
of any third-party claims could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel, whether
or not such litigation is determined in favor of the Company. In the event of an
adverse result in any such litigation, the Company could be required to expend
significant resources to develop non-infringing technology or to obtain licenses
to the technology that is the subject of the litigation. There can be no
assurance that the Company would be successful in such development or that any
such licenses would be available. The Company also relies on technology licenses
from third parties. There can be no assurance that these licenses will continue
to be available to the Company upon reasonable terms, if at all. Any impairment
or termination of the Company's relationship with third-party licensors could
have a material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company's precautions
will be adequate to deter misappropriation or infringement of its proprietary
technologies. Furthermore, while the Company has obtained federal registration
for many of its trademarks in the United States, certain of its trademarks have
not been registered in the United States, and the Company has not registered any
of its trademarks in foreign jurisdictions. There can be no assurance that the
Company's use of such registered trademarks will not be contested by third
parties in the future. See "Business-Research and Product Development" and
"-Proprietary Rights."
The Company has received, and may receive in the future, communications
asserting that its products infringe the proprietary rights of third parties or
seeking indemnification against such infringement. The Company is not aware that
any of its products, trademarks, or other proprietary rights infringe the
property rights of third parties. However, there can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products or that any such assertion may not
require the Company to enter into royalty arrangements or result in costly
litigation. As the number of software products in the industry increases and the
functionality of these products further overlap, the Company believes that
software developers may become increasingly subject to infringement clams. Any
such claims, with or without merit, can be time consuming and expensive to
defend. There can be no assurance that any such intellectual property litigation
that may be brought in the future will not have a material adverse effect on the
Company's business, operating results and financial condition. As a result of
such claims or litigation, it may become necessary or desirable in the future
for the Company to obtain licenses relating to one or more of its products or
relating to current or future technologies, and there can be no assurance that
it would be able to do so on commercially reasonable terms. See
"Business-Research and Product Development" and "-Proprietary Rights."
Possible Volatility of the Company's Common Stock Price
The price of the Company's Common Stock has fluctuated widely in the
past. Sales of substantial amounts of the Company's Common Stock, or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Company's Common Stock. The management of the Company believes
that such past fluctuations may have been caused by the factors identified above
as well as announcements of new products, quarterly fluctuations in the results
of operations and other factors, including changes in the condition of the
personal computer industry in general. These fluctuations, as well as general
economic, political and market conditions, such as recessions or international
currency fluctuations, may adversely affect the market price of the Company's
Common Stock. Stock markets have experienced extreme price volatility in recent
years. This volatility has had a substantial effect on the market prices of
securities issued by the Company and other high technology companies, often for
reasons unrelated to the operating performance of the specific companies. The
Company anticipates that prices for Castelle Common Stock may continue to be
volatile. Such future stock price volatility for Castelle Common Stock may
provoke the initiation of securities litigation which may divert substantial
management resources and have an adverse effect on the Company's business,
operating results and financial condition.
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Future Capital Requirements
Although the Company believes that its existing capital resources,
expected cash flows from operations and available lines of credit will be
sufficient to meet its anticipated capital requirements at least through the
next 12 months, the Company may be required to seek additional equity or debt
financing. The timing and amount of such capital requirements cannot be
determined at this time and will depend on a number of factors, including demand
for the Company's existing and new products and changes in technology in the
networking industry. There can be no assurance that such additional financing
will be available on satisfactory terms when needed, if at all. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations --Liquidity and Capital Resources."
Voting Control by Officers, Directors and Affiliates
At February 20, 1998, the Company's officers and directors and their
affiliates beneficially owned approximately 49% of the outstanding shares of
Common Stock. Accordingly, together they had the ability to significantly
influence the election of the Company's directors and other corporate actions
requiring shareholder approval. Such concentration of ownership may have the
effect of delaying, deferring or preventing a change in control of the Company.
Certain Charter Provisions
The Company's Board of Directors has authority to issue up to 2,000,000
shares of Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares without any further vote
or action by the shareholders. The rights of the holders of the Company's Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of the
outstanding voting stock of the Company, thereby delaying, deferring or
preventing a change in control of the Company. Furthermore, such Preferred Stock
may have other rights, including economic rights, senior to the Common Stock,
and as a result, the issuance thereof could have a material adverse effect on
the market value of the Company's Common Stock.
BUSINESS
General
Castelle designs, develops, markets and supports network enhancement
products, both software and hardware, that improve the productivity, performance
and functionality of LANs and enhance the LAN user's ability to communicate. The
Company's current products include FaxPress fax server systems, LANpress print
servers and FactsLine fax-on-demand software. See "Research and Product
Development."
In November 1996 Ibex merged with and into the Company. As a result of
the transaction, 790,617 shares of the Company's Common Stock were issued in
exchange for all of the outstanding Ibex common stock and preferred stock and
59,345 shares of the Company's Common Stock were reserved for issuance upon
exercise of outstanding options to purchase Ibex common stock assumed by the
Company in connection with the transaction. Ibex designed, developed and
marketed fax-on-demand, fax-gateway, fax broadcast and Web/fax applications sold
directly and through value-added resellers.
9.
<PAGE>
Industry Background
In the mid-1980s, organizations began to interconnect personal
computers into LANs in order to allow work groups to share files and peripherals
such as printers. Originally, these LANs consisted of a dedicated personal
computer, called a file server, on which the network operating system was
installed, and multiple personal computers on which users of the LAN ran their
applications. The network operating system on the file server provided the
server administration and basic file and print sharing. As networks have
proliferated throughout organizations and client/server architectures have
gained acceptance, LANs have become increasingly complex, the size and
multimedia intensity of files being transmitted has increased and the
applications operating on the LAN have become more critical to the success of
the business enterprise. These factors have caused network administrators to
seek network enhancement products which can improve network performance, enhance
the functionality of the current installed base of network hardware and convert
single-user resources such as stand-alone printers and telephone lines into
shared LAN resources in a cost-effective manner. Fax servers and print servers
are two of the primary network enhancement solutions that have emerged to
provide cost-effective improvements in network performance and functionality.
Fax Servers: Fax machines typically used in business environments are
characterized by relatively low quality transmissions, low data
transmission rates and the inability to send and receive faxes
simultaneously. Fax machines also require labor-intensive sorting,
copying and routing of faxes in paper form. Alternatively, a dedicated
personal computer with a fax modem, while able to store incoming faxes
electronically and improve fax quality, is not economical in a LAN
environment because each user must have his or her own fax modem and
dedicated telephone line. Fax servers have emerged as an economical
alternative for providing high performance faxing capability to network
users. A fax server connects a LAN to one or more telephone lines,
enabling a large number of users to share dedicated telephone lines.
Users are able to send faxes directly from their computers or
workstations, eliminating the need to print a document, take it to a
stand-alone fax machine and wait for its transmission. In addition, a
fax server can sort incoming faxes and route them electronically and
confidentially directly to the electronic mailboxes of the intended
recipients and store non-urgent outgoing faxes for automatic
transmission at an "off-peak" time when telephone rates are lower.
Print Servers: The sharing of printers, a basic benefit of a LAN, has
traditionally been provided by connecting a printer either to a network
file server or to a dedicated personal computer on the network.
However, direct connection to the file server has several
disadvantages, including the risk of the file server being overburdened
by the processing required to print large or graphically complex files,
lower print transfer speeds and location inflexibility. Similarly,
printer connection to a dedicated personal computer, while providing
better location flexibility, is more costly and offers substantially
lower print file transfer speed than a dedicated print server can
provide. A print server directly connects one or more printers to a
LAN, providing a cost-effective, high-speed solution to the demand for
shared print resources on a LAN. In addition to providing location
flexibility and convenience, print servers improve network performance
by relieving the burden on the file server. Furthermore, print servers
enable users to access essential information about the status of the
printer and their print files and to select their desired printer
configuration.
Fax-On-Demand: Fax-on-Demand is the ability to use a touch-tone phone
and a fax machine to request and receive hard copies of documents on
demand. Although there are a wide variety of applications installed,
the two most common applications are customer support and literature
fulfillment applications. The largest industry using fax-on-demand is
the high-technology sector, with applications also installed in travel,
government, newspapers, manufacturing and non-profit organizations.
Essentially, any company with information to disseminate publicly is a
potential fax-on-demand customer.
10.
<PAGE>
Network enhancement solutions, such as fax servers and print servers,
have emerged to gain significant market acceptance due to their ability to
improve network performance and personal productivity, enhance network
functionality and preserve the investment many companies have made in network
hardware. The Company believes that as the client/server computing model
continues to gain acceptance and applications which are critical to the business
enterprise continue to be ported from mainframes and minicomputers to LANs,
corporate processes will become more dependent on the LAN and the performance
enhancement that can be achieved on the corporate LAN will more directly impact
overall productivity. As LAN users and network managers continue to recognize
the benefits of network enhancement products, and as additional network
functionality such as facsimile/document communication across the Internet,
remote access, scanning, electronic mail and multimedia communications continue
to emerge, the Company believes that the demand for such network enhancement
products will increase.
Castelle Strategy
Castelle's objective is to be a leading worldwide supplier of network
enhancement solutions. The Company intends to continue to provide innovative
products focused on enhancing the LAN user's ability to communicate. Key
elements of the Company's strategy include:
Focus on Network Enhancement Products - The Company focuses exclusively
on providing innovative, reliable, easy-to-use network enhancement
products. Since its inception, the Company has focused on developing
networking products that utilize advanced software to tightly integrate
proprietary hardware systems with standard computing platforms. As a
result, the Company believes it has developed a high level of expertise
in networking, software development, hardware design and telephony
technology. The Company plans to capitalize on these attributes by
continuing to focus on providing network enhancement products that
enable users to communicate more effectively.
Broaden Software Offerings - In order to leverage its significant
installed base of fax and print servers, the Company is developing a
range of value-added software options which increase the functionality
of Castelle's products and enable them to address specialized
applications. Examples of applications currently available include
electronic mail gateways, optical character recognition/image
enhancement software and billing/analysis and other management utility
software. Utilizing an extensive internal database of over 6,000
corporate end-users of Castelle products, the Company is marketing
these products through a direct telemarketing team.
Expand Product Line - The Company is leveraging its expertise in
easy-to-use, cost-effective enhancement solutions to offer new network
and communications enhancement products. The Company continues to
expand both its fax server and print server product lines.
Strengthen and Maintain Distribution Channels - The Company has
established a two-tier domestic and international distribution network
of leading national and regional network product distributors and
resellers. The Company also sells through OEM vendors such as Fujitsu
Ltd. ("Fujitsu"). The Company is focused on maintaining and
strengthening its current distribution network in North America,
Europe, the Asia-Pacific and Latin America regions.
11.
<PAGE>
Leverage Strategic Relationships - The Company augments its product
offering by establishing relationships with companies able to provide
products in areas outside of the Company's core technical competencies
or in instances where internal development of such products is not
cost-effective. The Company also establishes relationships with
numerous leaders in hardware and software technology to enable it to
keep abreast of, and respond quickly to, technological changes that may
affect the network enhancement market.
Products
The Company develops and markets a broad range of products that enhance
network productivity, performance and functionality. The Company's current
products include FaxPress fax server systems, LANpress print servers, InfoPress
fax-on-demand software and a range of software enhancements for its fax and
print server product lines.
Fax Servers
The Company's fax server product line includes FaxPress fax
server systems as well as FaxPress software. The Company's line of
FaxPress software includes client applications and interfaces for use
with the FaxPress system and software enhancements and options. The
Company's fax server products allow network users to send, receive,
route, print, store, edit and retrieve fax transmissions from their own
personal computers on a LAN. These fax server products enable all
network users to access fax services without requiring a large
investment in stand-alone fax machines, fax modem boards or additional
telephone lines. Network-based fax capability is a logical extension of
network printing capability, enabling users to transmit documents
directly to a fax device as easily as if they were printing to a laser
printer or sending an electronic mail message. Network fax servers
redirect fax output from applications running on a LAN user's personal
computer or workstation to a fax queue. The fax server then converts
the file to fax format and sends the fax to the intended recipient. The
Company's FaxPress products are designed to comply with regulatory
standards in the United States as well as Australia, Canada, Germany,
Hong Kong, Japan, Korea, the Netherlands, Denmark, Finland, Singapore,
Switzerland and the United Kingdom. The Company is seeking regulatory
clearance in a number of other countries. During 1997 and 1996, fax
servers represented 52% and 47%, respectively, of total net sales.
FaxPress Systems - Castelle's FaxPress fax server systems are
high-performance network-based fax solutions. FaxPress is a
compact, self-contained fax server that connects directly to a
LAN and is accompanied by software that is installed from any
personal computer or workstation on the LAN. FaxPress system
products are available in configurations that support one, two
or four dedicated telephone lines. In addition, FaxPress
system products can function as parallel and serial port print
servers. Key features of the FaxPress product line (configured
with its current software versions) include:
o Ability to send faxes from many applications: Easy
faxing from within any Windows, Windows 95 and Windows
NT application and certain electronic mail
applications. The server supports multiple
simultaneous clients on the network.
o Broad networking support: FaxPress servers install and
operate in both TCP/IP and SPX/IPX network
environments. FaxPress also support file servers with
Windows NT and Novell NetWare operating systems.
12.
<PAGE>
o Electronic routing of faxes: Electronic routing of
faxes enhances efficiency and confidentiality through
electronic delivery direct to the fax inbox of the
intended recipient.
o Retention of document formatting: Retention of all
text, fonts and graphics generated by PCL and other
leading document format languages. Any document that
can be printed to a Hewlett-Packard laser printer can
be faxed using the FaxPress system.
o Ability to use fax servers in tandem: Load sharing
between fax servers provides the capability to stack
up to five fax server units and share up to 20 modems
for outbound faxing.
o No waiting for document conversion: Internal image
processing by the FaxPress provides high image quality
and frees the personal computer for end-user
applications. The user does not have to wait for a
document to be converted to a fax image before using
the personal computer for other tasks.
o Group broadcasts/scheduled transmission: Delayed
sending feature allows users to send faxes during
"off-peak" hours, facilitating low-cost communications
for group broadcast and other uses.
The Company offers a family of FaxPress fax server
systems ranging from entry-level products to high-end fax
solutions capable of supporting over 500 users. The suggested
U.S. list prices for FaxPress fax servers range from $1,695 to
$6,395. The following table summarizes the Company's FaxPress
system product line:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
Network Environment
------------------------
Number Number of
of Micro- Memory Network NetWare Windows TCP/IP
Product Model Modems Processors (Megabytes) Topology 3.x, 4.x NT Support
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
OfficeConnect Fax 1 1 4 Ethernet |X| |X| |X|
FaxPress 1500 1 or 2 1 4 Ethernet |X| |X|
FaxPress 1500-N 1 or 2 1 8 Ethernet |X| |X| |X|
FaxPress 3000 2 or 4 2-3 4 Ethernet / |X| |X|
Token Ring
FaxPress 3500 2 or 4 2-3 8 Ethernet / |X| |X| |X|
Token Ring
----------------------------------------------------------------------------------------------------------------
</TABLE>
FaxPress Software - The Company's line of FaxPress software
includes client applications and interfaces for use with
FaxPress systems and software enhancements and options.
o Client Applications and Interfaces: The Company has
developed fax applications which reside on the LAN
user's personal computer and are included as part of
the Company's FaxPress products. The client
application allows a user to send and receive faxes,
includes support for user authentication, as well as
personal and corporate cover pages and phone books.
13.
<PAGE>
Software Enhancements and Upgrades: The Company
offers a range of value-added software options which
increase the functionality of Castelle's FaxPress
systems and enable the FaxPress to address
specialized applications. Software upgrades and
options are available to the installed base of
FaxPress units at prices ranging from $99 to $995.
The following table describes the available software
options:
---------------------------------------------------------------------------
Software Option Description
---------------------------------------------------------------------------
Castelle Internet Faxing Castelle Internet Faxing provides the
ability to send faxes to other FaxPress
units via the Internet.
Third Party Internet Faxing Provides the ability to deliver faxes to
select third party carriers of faxes over
the Internet.
Microsoft Exchange Gateway Integrates the FaxPress into Microsoft
Exchange, enabling users to send and
receive faxes from Exchange in addition to
sending documents in native format as fax
attachments.
Lotus Notes Gateway Integrates the FaxPress into Lotus Notes,
enabling users to send and receive faxes
from Lotus Notes.
Embedded Codes Gateway Enables mainframe computer users to send
faxes using the FaxPress server.
Optical Character Recognition/ Enables an incoming fax to be converted
Image Enhancement into an editable format. Image enhancement
capability enables the electronic editing
of a fax image to correct visual defects.
Billing and Analysis Software Analyzes and allocates cost of faxing by
user, department or customer and creates
"ready to print" reports.
FaxPress Print Server Software Enables the FaxPress to act as a network
print server.
---------------------------------------------------------------------------
Print Servers
The Company's print server products perform network-printing
services otherwise handled by a file server or a dedicated personal
computer. The Company offers a family of multi-protocol external and
internal print servers that enhance overall network performance by
reducing the burden on the file server or a dedicated personal
computer. During 1997 and 1996, print servers represented 42% and 48%,
respectively, of total net sales.
The Company believes its print servers provide a superior
method of connecting printers to a LAN for a number of reasons,
including:
o Network performance enhancement: The Company's print
servers enable substantially higher print file
transfer speeds than file servers while reducing the
data transfer and processing burden on file servers.
o Plug-and-play in a multi-protocol environment: The
Company's print servers offer easy installation and
configuration, with multiple protocols enabling a
seamless integration into a mixed network environment.
This is not possible using either a dedicated personal
computer or a file server.
14.
<PAGE>
o Location flexibility: The Company's print servers are
self-contained, can be located anywhere on a network
and can support printer-clustering as well as single
printer connectivity.
o Cost-effectiveness: The Company's print servers are
more cost-effective than dedicated personal computers
or direct file server connections.
o Compatibility: The Company's print servers are
compatible with printers from virtually all major
printer vendors and support leading network operating
systems on both the Ethernet (100 Base-T or 10 Base-T)
and Token Ring networks.
LANpress Products - The Company's LANpress products are
external print servers that are independent nodes on a
network. They represent superior methods of connecting
printers to a LAN due to their multi-protocol capabilities.
With a variety of configurations for a single printer or up to
4 printers, and support for NetWare (true NDS), UNIX, Windows
NT, Windows 95, Windows for Workgroups and AppleTalk, LANpress
is compatible with printers with standard parallel or serial
interfaces and is targeted at the large installed base of
stand-alone printers. LANpress has remote management and
configuration features enabling the network administrator to
check for print queues and status, locate sources of problems
and reconfigure units within the network from anywhere on the
LAN. LANpress selectively routes to all networked printers and
thereby improves the productivity of all printers across the
network. LANpress products can serve up to 56 print queues on
up to 16 file servers. LANpress was recently enhanced to
provide Internet printing capability. This allows the PCs to
submit emails and attachments to LANpress for printing via the
Internet. The suggested U.S. list price for LANpress print
servers ranges from $199 to $599.
The following table summarizes the Company's line of LANpress external
print servers:
<TABLE>
<CAPTION>
--------------------------------------------------
Network Environment
------------------------------------------------------------------------------------------------------------------
Ethernet Windows Flash
Product Configuration Network NetWare 2.x, UNIX TCP/IP 3.11 / Apple Upgrade Internet
Interface 3.x, 4.x 95 / NT Ethertalk Capability Printing
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
LANpress 1P/100 MP (1) |X| |X| |X| |X| |X| |X| |X|
LANpress 3P/100 (2) |X| |X| |X| |X| |X| |X| |X|
LANpress Jr. MP (3) |X| |X| |X| |X| |X| |X| |X|
LANpress 1P MP (1) |X| |X| |X| |X| |X| |X| |X|
LANpress 2+1 MP (4) |X| |X| |X| |X| |X| |X| |X|
LANpress 3+1 MP (2) |X| |X| |X| |X| |X| |X| |X|
OfficeConnect Print (5) |X| |X| |X| |X| |X|
------------------------------------------------------------------------------------------------------------------
</TABLE>
--------------------
(1)1 Centronics parallel port
(2)Numbers refer to the number of parallel and serial port connections,
respectively.
(3)Connects directly to port on Printer
(4)Numbers refer to the number of parallel and serial port connections,
respectively. The LANpress 2+1 MP also comes with a Token Ring network
interface.
(5)2 Centronics parallel ports
15.
<PAGE>
Fax-On-Demand
Castelle's fax-on-demand product suite consists of Windows
NT-based InfoPress, as well as the low-cost Fax-it-Back product
offering. Both InfoPress and Fax-it-Back fax-on-demand software enable
the access of information via a phone and a fax machine and allow the
dissemination of information via "broadcasting" to a select database of
fax numbers. InfoPress replaces an older Ibex product, FactsLine.
InfoPress Product - InfoPress allows companies to use one
source of documents in a Castelle document library and to
automatically publish the documents using the following
methods:
o Fax-on-Demand.
o Email-on-Demand.
Users can update one document, and the updated
document will automatically be sent via facsimile using the
Fax-on-Demand product, or via an enhanced auto-reply email
product called Email-on-Demand to the intended recipient. In
addition, Web delivery of the document is also possible. There
is no fax-on-demand or mail-server configuration needed when
documents are added or deleted.
The InfoPress product provides cost-effective,
automated and immediate information retrieval using tools that
everyone understands. Using the product, a technically savvy
consumer can access a document using the Web. Another person
can access the same document via email if he chooses. Still
another person, perhaps not connected to the Internet, can use
his touch-tone phone to select the same document to be faxed
to his fax machine.
The InfoPress product publishes documents
automatically. All document catalogs will be updated whenever
the user adds, changes, or deletes a document in the system.
Email-on-Demand - Email-on-Demand is the ability to use email
(local or Internet) to request and receive information on
demand. Auto-reply email exists today, but is limited to
receiving one document, usually in text format. The main
benefits of Email-on-Demand are:
o Email via Internet is more prevalent than usage of the
Web
o Email-on-demand can be done on an "off-line" basis.
Users can order documents, which will be delivered to
their email box. In other words, there is no waiting
to download documents on the Web and no "surfing" to
find documents.
Web Integration - InfoPress supports Web HTML documents in the
document library. The Web documents are automatically rendered
into a fax document when required.
Product Benefits - InfoPress also includes a "fax-it-to-me"
feature for Web and email users. Thus, users of the product
can access the same document source in the following ways:
o Select documents on the Web to fax (or forward them to
others via fax)
o Select documents in an email message, to be returned
via email
o Select documents in an email message, to be returned
via fax
16.
<PAGE>
o Select documents via a telephone keypad, to be
returned via fax (Fax-on-Demand)
Fax-It-Back - Castelle's entry-level Windows 95 fax-on-demand
system is specifically designed for small- to mid-size
organizations and departmental use and provides a professional
multi-line (one to four lines) system sturdy enough for
production fax-on-demand, yet affordable and easy for
non-technical staff to use.
Research and Product Development
The Company has made substantial investments in research and product
development. The Company believes its future performance will depend in large
part on its ability to enhance its current product line, maintain technological
competitiveness and meet an expanding range of customer requirements.
Castelle continues to invest in enhancing the FaxPress product line by
developing new versions of client and server software and server hardware. The
product feature set is driven by the increasing complexity of user needs because
of proliferating client and network environments, the continued importance of
Windows NT and the increasing importance of Internet faxing.
New versions of the client software will have enhancements in the user
interface, improvements in ease of use and ease of localization, be accessible
through a Web browser, include improved integration with NT and Netware network
environments and contain other enhancements. The client-server interface is
being enhanced to become an object-oriented model with Component Object Model
(COM) support. The server software will have enhanced performance, including
support for Simple Network Management Protocol (SNMP) network management.
Castelle will continue to further its strategy of supporting Internet Faxing
through its own FaxPress-to-FaxPress communication and interfaces to third party
Internet Fax providers. Castelle is also investing in developing a new
generation of the FaxPress hardware platform.
In the print server market, Castelle is developing a new miniaturized
LANpress print server product targeted at the Pacific Rim through OEM and
distribution channels and upgrading the hardware design of prior print server
products. The print server and fax server products will also share the same
hardware architecture, allowing these products to share basic server code and
hardware components resulting in operating efficiencies and reduced costs.
There can be no assurance that the Company will be successful in
developing and marketing the new software and hardware product versions or in
responding to other emerging technological developments or that any development
will achieve commercial acceptance. The Company is seeking and will continue to
seek to hire additional skilled development engineers. Such engineers are likely
to be in short supply, and the Company's business, operating results and
financial condition could be adversely affected if it encounters delays in
hiring or fails to retain the required skilled engineers. The Company's research
and product development expense for 1997 and 1996 was approximately $3.1 million
and $2.4 million, respectively, which was 12% and 8% of the Company's net sales.
The Company plans to continue to make significant investments in research and
product development.
17.
<PAGE>
Sales, Marketing and Distribution
Castelle sells its products through multiple channels, the channel used
being determined by the product, market and customer need. The Company has an
established two-tier domestic and international distribution network of leading
national and regional network product distributors and resellers. The Company
also sells through OEM vendors such as Fujitsu. Software enhancements and
options that complement the FaxPress product line are primarily marketed
directly by the Company to registered end-users. The direct sales group works
closely with the distributors and VARs in qualifying sales opportunities for the
fax server and print server product lines. The Company is maintaining its
distribution network in North America, Europe, the Asia-Pacific and Latin
America regions. The Company's European headquarters provides sales and support
services to a distributor network covering most European countries, with a
primary emphasis on the United Kingdom.
Demand for Castelle's products is created through targeted and active
participation in industry networking and communication trade shows, as well as
advertising in associated publications. The Company also increases awareness of
Company products through advertising, generating client leads, instituting
direct mail campaigns, sending Company newsletters, offering seminars, trade
shows and conferences and other forms of public relations efforts. The Company's
sales and marketing efforts are enhanced by a specific program designed to
encourage VARs and other resellers to promote and sell the Company's products.
Such promotion is encouraged by providing participants in the program with
technical support on a priority basis, product literature, on-site sales and
support training, sales leads, free software upgrades, and other forms of sales
promotions. In addition to its other activities, Castelle's marketing staff
employs various research methods, gathering information from many sources such
as VARS and other resellers, customers, distribution partners, OEM partners,
strategic partners, and press/publication groups. Product development, sales and
client services/support personnel benefit from the information gathered in
planning future products.
The Company's five largest distributors accounted for approximately 68%
of the Company's net sales in 1997 and 70% of its net sales in 1996. Macnica,
the Company's principal Japanese distributor, and Ingram Micro, the Company's
largest domestic distributor, accounted for approximately 32% and 14%,
respectively, of the Company's net sales in 1997 and 33% and 15%, respectively,
of its net sales in 1996. Sales to customers located in the Pacific Rim and
Europe made up approximately 47% and 53% of the Company's net sales in 1997 and
1996, respectively. The Company's distributors typically represent other product
lines that are complementary to or compete with, those of the Company. While the
Company attempts to encourage its distributors to focus on its products through
marketing and support programs, these distributors may give higher priority to
products of other suppliers, thereby reducing the efforts they devote to selling
the Company's products. In particular, certain of its competitors, including
Hewlett-Packard and Intel, sell a substantially higher total dollar volume of
products through several of the Company's large United States distributors and,
as a result, the Company believes such distributors give higher priority to
products offered by such competitors. The Company's distributors are not
contractually committed to future purchases of the Company's products and could
discontinue carrying the Company's products at any time for any reason. In
addition, because the Company is dependent on a small number of distributors for
a significant portion of the sales of its products, the loss of any of the
Company's major distributors or their inability to satisfy their payment
obligations to the Company could have a significant adverse effect on the
Company's business, operating results and financial condition. The Company has a
stock rotation policy with certain of its distributors that allows them to
return marketable inventory against offsetting orders. Should the Company reduce
its prices, the Company credits certain of its distributors for the difference
between the purchase price of products remaining in their inventory and the
Company's reduced price for such products. In addition, due to industry
conditions or the actions of competitors, inventory levels of the Company's
products held by distributors could become excessive resulting in product
returns and inventory write downs.
18.
<PAGE>
Customer Service and Support
The Company provides customers with service support, which is available
at all times to assist customers with installation, use and operation issues.
The Company has network engineers at corporate headquarters as well as in the
field. Support is provided under warranty as well as with different extended
software and hardware support agreements sold directly to the customer by the
Company. An electronic bulletin board is available on a 24-hour basis to assist
customers in obtaining data about Company products. The Company also has other
customer support activities, including a Web site as well as an internal help
desk system. The Company has established a call management, automated call
distribution ("ACD") system to provide improved levels of support to help
resolve customer issues.
Competition
See "Business -- Risk Factors -- Competition and Price Erosion" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations."
Manufacturing
The Company's current in-house manufacturing operations consist
primarily of material planning, final test and assembly, quality control and
service repair. Certain of the Company's manufacturing operations are performed
by third party manufacturers that provide customized, integrated manufacturing
services, including procurement, manufacturing and associated printed circuit
board assembly. The Company also relies on SerComm to provide it with certain of
its print server products. These arrangements enable the Company to shift
certain costs to such providers, thereby allowing the Company to focus resources
on its product development efforts. The failure of such manufacturers,
particularly SerComm, to meet their contractual commitments to the Company could
cause delays in product shipments, thereby potentially adversely affecting the
Company's business, operating results and financial condition.
The Company does not currently have any material long-term supply
contracts with any of its manufacturing subcontractors or component suppliers
other than an agreement with SerComm relating to the manufacture of print
servers. Other than its relationship with SerComm, the Company purchases
components on a purchase order basis. The Company owns all engineering, sourcing
documentation, functional test equipment and tooling used in manufacturing its
products, except for the products which are produced by SerComm, and believes
that it could shift product assembly to alternate suppliers if necessary.
Certain key components of the Company's products, including a modem chip set
from Rockwell, and a microprocessor from Motorola, are currently available from
only single sources. Other components of the Company's products are currently
available from only a limited number of sources. In addition, the Company
subcontracts a substantial portion of its manufacturing to third parties, and
there can be no assurance that these subcontractors will be able to support the
manufacturing requirements of the Company. The Company's ability to obtain these
components or sub-assemblies is dependent upon its ability to accurately
forecast customer demand for its products and to anticipate shortages of
critical components or sub-assemblies created by competing demands upon
suppliers. If the Company were unable to obtain a sufficient supply of
high-quality components or sub-assemblies from its current sources, the Company
could experience delays in obtaining such components or sub-assemblies from
other sources. Resulting delays or reductions in product shipments could
adversely affect the Company's business, operating results and financial
condition and damage customer relationships. See "Business -- Risk Factors -
Dependence on Suppliers and Subcontractors." Furthermore, a significant increase
in the price of one or more of these components or sub-assemblies or the
Company's inability to lower component or sub-assembly prices in response to
competitive price reductions could adversely affect the Company's business
operating results and financial condition.
19.
<PAGE>
Proprietary Rights
The Company's success depends to a certain extent upon its
technological expertise and proprietary software technology. The Company relies
upon a combination of contractual rights and copyright, trademark and trade
secret laws to establish and protect its technologies. Additionally, the Company
generally enters into confidentiality agreements with those employees,
distributors, customers and suppliers who have access to sensitive information
and limits access to and distribution of its software documentation and other
proprietary information. Because of the rapid pace of technological change in
the LAN product industry, the Company believes that patent protection for its
products is less significant to its success than the knowledge, ability and
experience of its employees, the frequent introduction and market acceptance of
new products and product enhancements, and the timeliness and quality of support
services provided by the Company. See "Risk Factors --Dependence on Proprietary
Rights; Uncertainty of Obtaining Licenses."
Despite the precautions taken by the Company, it may be possible for
unauthorized third parties to copy certain portions of the Company's products or
to reverse engineer or obtain and use information that the Company regards as
proprietary. There can be no assurance that the Company's precautions will be
adequate to deter misappropriation or infringement of its proprietary
technologies. Furthermore, while the Company has obtained federal registration
for many of its trademarks in the United States, certain of its trademarks have
not been registered in the United States and the Company has not registered any
of its trademarks in foreign jurisdictions. There can be no assurance that the
Company's use of such unregistered trademarks will not be contested by third
parties in the future. In addition, the laws of some foreign countries either do
not protect the Company's proprietary rights or offer only limited protection.
Given the rapid evolution of technology and uncertainties in intellectual
property law in the United States and internationally there can be no assurance
that the Company's current or future products will not be subject to third-party
claims of infringement. Any litigation to determine the validity of any
third-party claims could result in significant expense to the Company and divert
the efforts of the Company's technical and management personnel, whether or not
such litigation is determined in favor of the Company. In the event of an
adverse result in any such litigation, the Company could be required to expend
significant resources to develop non-infringing technology or to obtain licenses
to the technology that is the subject of the litigation. There can be no
assurance that the Company would be successful in such development or that any
such licenses would be available. The Company also relies on technology licenses
from third parties. There can be no assurance that these licenses will continue
to be available to the Company upon reasonable terms, if at all. Any impairment
or termination of the Company's relationship with third-party licensors could
have a material adverse effect on the Company's business, operating results and
financial condition.
Government Regulation
See "Business -- Risk Factors -- Government Regulations."
Employees
As of December 31, 1997, the Company employed a total of 102 full-time
equivalent personnel, 24 in manufacturing, 30 in sales and marketing, 21 in
engineering, 15 in customer service and 12 in finance and administration. The
Company intends to continue to hire additional personnel in connection with the
expansion of its operations. The Company has never had a work stoppage, no
employees are represented by a labor organization and the Company considers its
employee relations to be good.
The Company has entered into confidentiality agreements with its
employees (including its officers) that prohibit disclosure of confidential
information to anyone outside of the Company both during and subsequent to
employment and require disclosure to the Company of ideas, discoveries or
inventions relating to or resulting from the employee's work for the Company and
assignment to the Company of all proprietary rights to such ideas, discoveries
or inventions.
20.
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Executive Officers
The names of the executive officers of the Company and their ages as of
February 20, 1998 are set forth below:
Name Age Position
Arthur H. Bruno 64 Chairman of the Board and Chief Executive
Officer
Jerome J. Burke 57 President and Chief Operating Officer
Randall I. Bambrough 42 Chief Financial Officer, Vice President of
Finance and Administration and Secretary
Prasad Raje 32 Chief Technical Officer, Vice President of
Engineering
Arthur H. Bruno
Mr. Bruno served as the Company's Chairman of the Board since October 1993,
as Chief Executive Officer from October 1993 through April 1997 and from
November 1997 to the present, and as President from October 1993 through
April 1997. From February 1996 to the present he has served as the Chairman
of the Board and as a director of Ashlar, a privately-held maker of
computer-aided design software. From 1991 to 1993, he was Chairman of the
Board and Chief Executive Officer of White Pine Software Inc., a desktop
connectivity company. From 1989 to 1991, he was the Chairman of the Board
and Chief Executive Officer of Wellsley Medical Management Corporation, a
primary care medical service provider. From 1986 to 1989, he was the
Chairman of the Board and Chief Executive Officer of Visual Technology
Incorporated, the predecessor to White Pine Software Inc. Mr. Bruno has
served as a director of White Pine Software, Inc. since February 1994 and
is also a director of several privately held companies.
Jerome J. Burke
Mr. Burke joined the Company in December 1993 and has served as President
and Chief Operating Officer from November 1997 to the present. He served as
the Company's Executive Vice President from December 1993 to November 1997.
From 1988 through November 1993, Mr. Burke was Executive Vice President of
Sales and Marketing of White Pine Software Inc. and its predecessor, Visual
Technology Incorporated.
Randall I. Bambrough
Mr. Bambrough joined the Company in June 1992 and was named to his current
positions in August 1995. From October 1990 until joining the Company, Mr.
Bambrough was a self-employed financial consultant. Prior to that time, Mr.
Bambrough was employed by Daisy Systems, Inc., an electronic design
automation software company, and Iomega Corporation, a disk drive
manufacturer, in various financial management positions.
Prasad Raje
Dr. Raje joined the Company in May 1997 and was appointed to the position
of Vice President of Engineering and Chief Technical Officer. Prior to
joining the Company, Dr. Raje was an engineering manager with
Hewlett-Packard Company from 1995 to 1997 and a member of the technical
staff from 1991 to 1995. Dr. Raje was a founder of Internet Information
Systems, one of the early web-site development companies in 1994 and has
served as its President from that date through the present. Dr. Raje
received his Ph.D. and MS degree, both in Electrical Engineering, from
Stanford University.
21.
<PAGE>
Other Key Employees
In addition to directors and executive officers, the Company has the
following key employees:
Ney Grant has served as the President of the Company's Ibex division
since the acquisition of Ibex by the Company in November 1996. Mr. Grant was a
co-founder of Ibex in 1989 and served as its President from 1990 through the
Company's merger with and into Castelle in 1996. From 1988 to 1989, Mr. Grant
was a product marketing manager at Genesis Electronics Corp. a manufacturer of
voice mail systems. From 1986 to 1988, Mr. Grant served as general manager at
Heuristics, Inc., an industrial software company. Mr. Grant holds an engineering
degree from the University of California, Santa Barbara and an MBA from the
University of California, Davis.
Donald Masulis, a founder of the Company, has served as Director of
Technology since October 1993. Mr. Masulis is responsible for the software
development of various versions of the FaxPress and LANpress products and
directs the Company's product quality assurance program. Mr. Masulis holds a
Master of Science degree in Industrial Engineering and Operations Research from
the University of California at Berkeley and a Bachelor of Science degree in
Information and Computer Science from the University of California at Irvine.
ITEM 2. PROPERTIES
The Company's headquarters, including its executive offices and
corporate administration, development, manufacturing, marketing, sales and
technical services/support facilities, are located in Santa Clara, California
with an aggregate of approximately 21,400 square feet of floor space. The
Company occupies this facility under a lease, the term of which expires in
October 2000. The Company also occupies an additional 5,200 square feet of floor
space that is located in El Dorado Hills, California. This facility is under a
lease, the term of which expires in the year 2000. In addition, the Company
rents office space for sales and customer support offices in Florida, Illinois,
Pennsylvania, the United Kingdom and the Netherlands. The Company believes its
existing facilities will be adequate to meet its requirements for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation and is not aware
of any pending or threatened litigation against the Company that could have a
material adverse effect on the Company's business, operating results and
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Not applicable.
22.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock (Nasdaq symbol "CSTL") began trading on the
Nasdaq National Market on December 20, 1995. Listed below are the high and low
sale prices on the Nasdaq National Market for the periods indicated. Such
quotations do not include retail markups, markdowns or commissions.
FISCAL 1996 HIGH LOW
First Quarter $9-1/4 $7
Second Quarter $9-3/4 $7-1/4
Third Quarter $8 $6-1/2
Fourth Quarter $6-7/8 $5-1/4
FISCAL 1997 HIGH LOW
First Quarter $8-1/2 $5-1/4
Second Quarter $6-3/4 $3-7/8
Third Quarter $5-1/16 $3-1/2
Fourth Quarter $6-1/4 $1-5/8
As of December 31, 1997, there were 124 holders of record of the
Company's Common Stock, which does not include those who held in street or
nominee name. On February 20, 1998, the last sale price reported on the Nasdaq
National Market for the Company's Common Stock was $3 per share.
Dividend Policy
The Company has not paid cash dividends on its Common Stock and does
not plan to pay cash dividends for the foreseeable future.
Use of Proceeds from Registered Securities
On December 19, 1995, the Company's registration statement on Form SB-2
(Registration No. 33-99628-LA-) became effective. The offering commenced on the
same date and terminated upon the sale of the securities offered for sale. The
managing underwriters for the offering were Unterberg Harris and RvR Securities
Corp. One million one hundred fifty thousand shares of no par common stock, with
an aggregate value of $8.1 million, were registered and sold on behalf of the
Company. Expenses incurred for the Company's account in connection with the
offering included $564,000 in underwriting discounts and commissions, $15,000 in
underwriters' expenses and $609,000 in other expenses. The payments were made to
persons who were not officers, directors and owners of 10% or more of any class
of equity securities of the Company or affiliates. Net proceeds to the Company
after deducting the expenses identified above were $6.9 million. Since the
effective date of the registration statement, the Company has utilized all $6.9
million of the net proceeds for the following purposes, $1.5 million to repay
indebtedness, $1.0 million for technology and other capital asset acquisitions,
$1.4 million for higher levels of research and development, and $3.0 million to
expand sales and marketing activities worldwide. The payments were made to
persons who were not officers, directors and owners of 10% or more of any class
of equity securities of the Company or affiliates.
23.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information has been derived from the
audited Consolidated Financial Statements. The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
Notes thereto included elsewhere in this Report. Information with respect to the
three years ended December 31, 1996, 1995 and 1994 has been restated to account
for Ibex as a purchase. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Restatement of Financial Results" and
Notes 3 and 13 to the Consolidated Financial Statements thereto included
elsewhere in this Report.
<TABLE>
<CAPTION>
Fiscal Years ended December 31,
-------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ -------------- ------------- ------------- --------------
(in thousands, except per share amounts)
INCOME STATEMENT DATA:
<S> <C> <C> <C> <C> <C>
Net Sales $25,343 $29,461 $25,082 $19,486 $17,787
Gross Profit $13,507 $14,468 $11,511 $7,983 $6,441
Gross Profit as a % of Net Sales 53% 49% 46% 41% 36%
Net Income/(Loss) ($6,895) $5,724 $2,024 ($378) ($4,795)
Net Income/(Loss) as a % of Net Sales (27%) 19% 8% (2%) (27%)
Net Income/(Loss) per share - diluted ($1.54) $1.45 $0.78 ($0.16) ($12.11)
BALANCE SHEET DATA:
Cash and Cash Equivalents $6,204 $8,161 $7,268 $907 $1,882
Working Capital 10,816 13,163 8,912 884 (765)
Total Assets 18,926 27,303 14,728 7,124 8,623
Long-term Liabilities 52 -- 75 354 2,261
Stockholders Equity 14,855 21,616 9,289 1,355 (1,264)
</TABLE>
Net income for 1997 and 1993 included net charges for restructuring and
other non-recurring items of $6.1 million and $615,000, respectively, and a net
benefit of $2.5 million in 1996. For detailed information on these transactions
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations Restatement of Financial Results - Restructuring and Other Charges
and Amortization of Intangible Assets" and the Consolidated Financial Statements
and related Notes thereto included elsewhere in this Report. Excluding the
restructuring and other items referenced above, net income (loss) and net income
(loss) per share on a diluted basis would have been has follows:
<TABLE>
<CAPTION>
Fiscal Years ended December 31,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- -------------- ------------- ------------- --------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net Income/(Loss)
excluding
restructuring and
non-recurring items ($829) $3,215 $2,024 ($378) ($4,180)
Net Income/(Loss) per
share, diluted,
excluding
restructuring and
non-recurring items ($0.19) $0.82 $0.78 ($0.16) ($10.56)
</TABLE>
24.
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATION
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Castelle's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this section as well as in
the section entitled "Business - Risk Factors." All information with respect to
1996 and 1995 has been restated. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Restatement of Financial
Results" and Notes 3 and 13 of the Consolidated Financial Statements thereto
included elsewhere in this Report.
Results of Operations
Overview
During the last six months of 1997, the Company experienced a
decrease in net sales and units shipped, particularly for its print
server products, some of which was attributable to a component shortage
experienced in the fourth quarter of 1997 and business conditions in
Asia. This overall decline in demand and the resulting losses, coupled
with intense competition throughout the industry, lead to the Company's
decision to implement a restructuring of its operations intended to
improve the Company's competitiveness and restore its profitability.
Net Sales
Net sales decreased 14% to $25.3 million in 1997 from $29.5
million in 1996. The decline of $4.2 million in net sales resulted
primarily from lower sales of the Company's print server products,
specifically in Japan due to increased local competition, price erosion
and a component shortage in the fourth quarter of 1997 which impacted
the ability of the Company to fill orders for print servers and
increased local competition in Europe. Print server product sales
declined 25% to $10.7 million in 1997 from $14.2 million during 1996,
approximately $800,000 of the shortfall is attributed to the component
shortage.
In 1996 net sales increased 18% to $29.5 million from $25.1
million in 1995. This increase was principally due to an increase in
sales of the FaxPress product line, principally the FaxPress 2000 and
FaxPress 3000, and increased demand for print servers in Japan.
International sales were $11.9 million, $15.5 million and
$13.0 million in 1997, 1996 and 1995, respectively, representing 47%,
53% and 52%, respectively, of net sales in 1997, 1996 and 1995. Lower
international sales in 1997 was the result of a combination of a
reduction in demand for the Company's products in Asia, the component
shortage identified above and increased local competition in Europe.
Although all of the Company's international sales to date have been
denominated in U.S. dollars, such sales could be adversely affected by
changes in demand resulting from fluctuations in currency exchange
rates.
25.
<PAGE>
Cost of Sales
Cost of sales includes cost of materials, including
components, manuals, diskettes, packaging materials, assembly and
shipping, as well as certain royalties. Cost of sales also includes
compensation costs and overhead related to the Company's manufacturing
operations and warranty expenses. Cost of sales were $11.8 million,
$15.0 million and $13.6 million in 1997, 1996 and 1995, respectively,
and represented 47%, 51% and 54% of net sales for those years. Most
significantly, cost of sales has decreased as a percentage of net sales
each year resulting in improving gross margins. The decrease in cost of
sales as a percentage of net sales is primarily attributable to changes
in product mix resulting in a higher proportion of net sales derived
from higher margin fax server products. Further, in 1997, sales of
products acquired from Ibex, principally software, helped to favorably
impact gross margins. This improvement was somewhat offset by
unfavorable overhead absorption, due to lower volumes.
Research & Development
Research and product development expenses were $3.1 million,
$2.4 million and $2.0 million in 1997, 1996 and 1995, respectively, and
represented 12%, 8% and 8% of net sales for those periods. Most of the
Company's product development efforts during these periods were focused
on fax-related products, although much of the resultant technology has
application to the further development of the Company's print server
products. A significant percentage of the Company's research and
product development expenses are related to software development. The
increase in research and development expenses in 1997 was mainly due to
the integration of Ibex development efforts. The Company anticipates
that the absolute dollar amount of research and product development
expense will decrease slightly in 1998. However, the Company continues
to be committed to the development of highly competitive new products
and services through the efficient utilization of its engineering
resources.
Sales & Marketing
Sales and marketing expenses were $9.2 million, $7.4 million
and $5.6 million for 1997, 1996 and 1995, respectively, and represented
36%, 25% and 23% of net sales for those periods. Sales and marketing
expenses increased in 1997 compared to 1996 due to the integration of
the Ibex sales organization and an increase in the number of sales and
marketing personnel. However, during the third quarter of 1997 the
Company determined that it was not receiving an appropriate return in
improved sales for the investment made. As a result, the Company
reorganized the sales and marketing activities, streamlining operations
and reducing staff.
In 1996, the growth of sales and marketing expenses compared
with similar expenses in 1995 was due to increases in the number of
sales and marketing personnel, additional sales and advertising
promotional expenses and facilities-related expenses needed to address
sales opportunities and support customers using the Company's products.
General & Administrative
General and administrative expenses were $2.3 million, $1.6
million and $1.4 million for 1997, 1996 and 1995, respectively, or 9%,
5% and 6% of net sales for those periods. The increase in 1997 expenses
over 1996 expenses was due to increased utilization of professional
services and incorporating Ibex-related expenses. As a result of the
Company's restructuring, it anticipates that the absolute dollar amount
of general and administrative expense will decrease slightly in 1998.
Restructuring and Other Charges and Amortization of Intangible Assets
In the third quarter of 1997, the Company restructured its
operations to streamline activities and focus on key products to reduce
ongoing costs. As a result, the Company recorded a $1.2 million charge
to account for implementing and completing the restructuring plan. This
was in addition to a charge of $5.0 million associated with the
write-off of the Ibex goodwill and related intangibles. The total
restructuring charge of $6.2 million included relocation of the
Company's European office, exit from certain lines of business, a
workforce reduction, the write-off of certain assets relating to Ibex
and other estimated restructuring costs. In addition, charges of
$574,000 were related to the amortization of intangible assets and
goodwill associated with the Company's acquisition of Ibex. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations - Restatement of Financial Results" for further
details concerning the Ibex asset write-off.
26.
<PAGE>
In the fourth quarter of 1996, a total of $1.2 million in
other charges was booked due to a $1.1 million write-off of Ibex's
in-process research and development, and $96,000 of amortization for
the intangible assets and goodwill associated with the Company's
acquisition of Ibex in November 1996. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations --
Restatement of Financial Results" for further details.
Interest Income/(Expense), net
Net interest income was $288,000 in 1997, down from $340,000
in 1996, due to a decrease in cash balances as a result of the loss
incurred in 1997. In 1995, net interest expense was $296,000 due to the
interest expense associated with the Company's outstanding debt prior
to the Company's initial public offering in December 1995. Cash
generated from the public offering was used to retire the Company's
outstanding debt during 1995.
Provision/Benefit from Taxes
The Company recorded a net benefit from income taxes in 1997
and 1996 of $732,000 and $3.5 million, respectively. These amounts
reflect the recognition of various deductible deferred assets,
including prior years' net operating loss carry forwards, business tax
credits and various temporary accounting differences. See Note 9 of
Notes to Consolidated Financial Statements for a discussion of the
Company's provision for income taxes.
Liquidity and Capital Resources
Since its inception in 1987, Castelle has funded its operations
primarily through the issuance of capital stock and the assumption of bank debt.
As of December 31, 1997, the Company had $6.2 million of cash and cash
equivalents, down from $8.2 million for the same period in 1996. Working capital
decreased to $10.8 million at December 31, 1997 from $13.2 million at December
31, 1996. The decrease in cash, cash equivalents and working capital is
primarily due to the operating loss incurred in 1997.
The Company has a $3.0 million secured revolving line of credit with a
bank, which expires in July 1998, pursuant to which the Company may borrow 100%
against pledges of cash at the bank's prime rate (8.50% at December 31, 1997).
Borrowings under this line of credit agreements are collateralized by all of the
assets of the Company. Under the terms of the loan agreement, the Company is
restricted from loaning money or assets or entering into any mergers or
acquisitions where the total consideration exceeds $15,000,000, without the
bank's consent. The Company is in compliance with the terms of the agreement,
and at December 31, 1997 has no borrowings under the line of credit.
In December 1997, as a source of capital asset financing, the Company
entered into a loan and security agreement with a finance company for an amount
up to $288,000. As of December 31, 1997, the Company had drawn $146,000 against
this amount. The loan is subject to an interest rate of 10.11%, is repayable by
December 2000 and is collateralized by a certificate of deposit of $125,000.
27.
<PAGE>
As of December 31, 1997, net accounts receivable were $3.3 million,
down from $5.8 million for the same period in 1996. The reduction in accounts
receivable is mainly attributed to lower sales in the fourth quarter of 1997 and
to a lesser degree, an improvement in days sales outstanding ("DSO"). In 1997
the average DSO improved 14% to 55, from 64 at the end of 1996.
Net inventories as of December 31, 1997 were $3.8 million, up from $2.8
million in 1996. The increase was primarily the result of lower actual unit
shipments than forecasted coupled with a component shortage that caused
work-in-process and other raw material levels to increase. The aforementioned
factors can also be seen in the lower level of inventory turnover in 1997
compared to 1996. Inventory turnover for the year-ended 1997 was 2.8, down from
5.1 in 1996. The components causing the shortage again became available in
sufficient quantities in the first quarter of 1998.
In connection with the purchase of the ACD system and an upgrade to the
Company's internal network infrastructure, Castelle acquired additional capital
equipment of $732,000 in 1997. Capital equipment spending in 1996 and 1995 were,
$364,000 and $195,000, respectively.
Although the Company believes that its existing capital resources,
expected cash flows from operations and available lines of credit will be
sufficient to meet its anticipated capital requirements at least through the
next 12 months, the Company may be required to seek additional equity or debt
financing. The timing and amount of such capital requirements cannot be
determined at this time and will depend on a number of factors, including demand
for the Company's existing and new products and changes in technology in the
networking industry. There can be no assurance that such additional financing
will be available on satisfactory terms when needed, if at all.
Restatement of Financial Results
Following discussions with the Securities and Exchange Commission
("SEC"), the Company has restated prior reported financial results for the first
three quarters of 1997 and for 1996, 1995 and 1994 to reflect a change in the
method of accounting for the acquisition of Ibex in November 1996 from
pooling-of-interests accounting to purchase accounting. The SEC has advised the
Company that in its view the acquisition did not qualify as a
pooling-of-interests for technical reasons and must be accounted for as a
purchase. This conclusion was reached following initial questions raised by the
SEC after a review of the Company's financial statements in the fourth quarter
of 1997 and extensive subsequent discussions between the Company and the SEC
which continued through February 1998. Due to the SEC's conclusions, the Company
has now restated its financial statements for the years 1994, 1995 and 1996 as a
whole and for the first three quarters of 1997 to account for the November 1996
Ibex acquisition using the purchase method of accounting as follows:
<TABLE>
<CAPTION>
First
Prior Years Three Quarters Of 1997 Nine
---------------------------------------- ----------------------------------------- Months
1994 1995 1996 1st Qtr 2nd Qtr 3rd Qtr Of 1997
------------- ------------ ----------- ------------ ------------ ------------ ------------
(in thousands, except per share amounts)
Net Sales:
<S> <C> <C> <C> <C> <C> <C> <C>
As reported $ 22,194 $ 28,173 $ 32,725 $ 6,419 $ 7,002 $ 6,597 $ 20,018
As restated $ 19,486 $ 25,082 $ 29,461 $ 6,419 $ 7,002 $ 6,597 $ 20,018
Net Income (loss):
As reported $ (166) $ 2,083 $ 5,643 $ 367 $ 74 $ (1,490) $ (1,049)
As restated $ (378) $ 2,024 $ 5,724 $ 80 $ (213) $ (5,832) $ (5,965)
Net Income (loss) per share:
As reported $ (0.17) $ 0.59 $ 1.20 $ 0.08 $ 0.02 $ (0.33) $ (0.24)
As restated $ (0.16) $ 0.78 $ 1.45 $ 0.02 $ (0.05) $ (1.30) $ (1.34)
</TABLE>
28.
<PAGE>
In connection with the restatement of the Ibex acquisition using
purchase accounting instead of pooling-of-interests accounting, the Company
recorded in the fourth quarter of 1996 net tangible assets and identified
intangible assets acquired from Ibex at their fair market value at that time of
$142,000 and $2.7 million, respectively, and recorded goodwill in the amount of
$3.0 million. In addition, a charge of $1.1 million was taken in the same
quarter to reflect a write-off of Ibex's in-process research and development. A
charge of $1.4 million relating to the acquisition costs of Ibex, originally
booked in the fourth quarter of 1996, was reversed and included as part of the
purchase price. Net sales for 1996, with related expenses and income, were
reduced to reflect only one month of Ibex revenues rather than the 12 months
previously recorded. 1994 and 1995 net sales, with related income and expenses,
for Ibex were removed. Amortization charges with respect to the assets and
goodwill acquired from Ibex were recorded in December 1996 and the first and
second quarters of 1997, resulting in decreases in the net income previously
reported in the amounts of $96,000, $287,000 and $287,000, respectively.
Subsequently, the balance of the goodwill, $2.6 million, and the remaining value
of intangible assets, $2.4 million, were entirely written off during the third
quarter of 1997. This was done when the Company suffered significant losses on
its current Ibex products due to increasing competition from Internet-based
applications and determined that the primary product under development by Ibex
was not economically feasible. As a result, a restructuring charge previously
taken in the third quarter of 1997 was increased from $1.2 million to $6.2
million. Further, as a result of the restructuring write-off for the Ibex
intangible assets and goodwill, the Company booked a benefit from taxes of
$732,000 in the third quarter of 1997.
Because the intangible assets and goodwill recorded in connection with
the Ibex acquisition as restated were entirely written-off by the end of the
third quarter of 1997, the restatement had no impact on the financial results
for the fourth quarter of 1997 and will not have any impact on the Company's
financial results for 1998 or subsequent years. Furthermore, the restatement had
no impact on cash or cash equivalent balances during the previous reporting
periods nor will it have any impact on cash flow for future periods.
Year 2000 Issue
The Company is in the process of conducting a comprehensive review of
its computer systems to identify those that could be adversely affected by the
Year 2000 issue and is developing an implementation plan to resolve any problem.
The Year 2000 issue refers to the inability of many computer systems to process
accurately dates later than December 31, 1999. Date codes in many programs are
abbreviated to allow only two digits for the year, e.g. "98" for the year 1998.
Unless these programs are modified to handle the century date change, they will
likely interpret the year "00", that is, the year 2000, as the year 1900. The
Year 2000 issue creates risk for the Company from unforeseen problems in its own
computer systems as well as in computer systems of third parties with whom the
Company does business worldwide, including banks and credit processing entities,
factories and others. The Company presently believes that, with modifications to
existing software and conversions to new software that the Company plans to
implement over the next year, the Year 2000 issue will not pose significant
operational problems for the Company's own computer systems as so modified and
converted. However, if such modifications and conversions are not completed
timely, the Year 2000 issue may have a material adverse impact on the operations
of the Company. In addition, the Company cannot give assurance the third parties
with whom it does business will address any Year 2000 issues in their own
systems on a timely basis. Their failure to do so could also have a material
adverse impact on the Company.
29.
<PAGE>
The Company has completed a comprehensive review of its products, both
firmware and software, to insure that they are Year 2000 compliant. This was
done to insure that the Company's products are free of any Year 2000 issues
discussed above. The Company believes that the more recent versions of its
products are Year 2000 compliant, meaning that users of its products should not
experience performance difficulties as a result of the need to process dates
later than December 31, 1999. In order to avoid difficulties, users will need to
install the versions of the Company's software which are Year 2000 compliant.
For example, FaxPress systems require a software and firmware release of at
least version 3.7.3 and InfoPress requires that at least version 2.0 be
installed for compliance with Year 2000 requirements. The Company provides
upgrade kits to allow customers to install these versions. The Company's
products work in conjunction with network operating systems such as Novell
NetWare and Microsoft Windows 95/NT, and while these products appear to be Year
2000 compliant, the Company does not accept responsibility for Year 2000
compliance of any network operating system. If modifications and upgrades to
these network operating systems are not completed timely, the Year 2000 issue
may have a material adverse impact on the Company's business, operating results
and financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements of the Company and the report of the
Company's independent accountants are included in Item 14:
Report of Coopers & Lybrand LLP, Independent Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995
Consolidated Statement of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995 Consolidated
Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
30.
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information with respect to executive officers is set forth in
Part I of this Report. Additional information required by this Item is
incorporated herein by reference to the sections entitled "Directors" and
"Compliance with Section 16(a) of the Securities and Exchange Act of 1934" of
the Proxy Statement related to the Company's 1998 Annual Meeting of Stockholders
to be filed by the Company with the Securities and Exchange Commission (the
"Definitive Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the sections entitled "Executive Compensation" and "Certain
Transactions" of the Company's Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the sections entitled "Security Ownership of Certain Beneficial
Owners and Management" of the Company's Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by
reference to the sections entitled "Certain Transactions" and "Compensation
Committee Interlocks and Insider Participation" of the Company's Definitive
Proxy Statement.
31.
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Financial Statements
Page in
Form 10-K
---------
Report of Independent Accountants.................................... F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996......... F-2
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995.................................... F-3
Consolidated Statement of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995.............................. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.................................... F-5
Notes to Consolidated Financial Statements........................... F-6
All schedules are omitted because they are not applicable, or
not required, or because the required information is included in the
financial statements or notes thereto.
(b) Exhibits
2.1(1) Agreement and Plan of Merger, dated as of August 22, 1996 among
Castelle, Ibex Technologies, Inc. and Certain Shareholders of Ibex
Technologies, Inc.
3.1(2) Amended and Restated Articles of Incorporation of the Company.
3.4(2) Amended and Restated Bylaws of the Company.
4.1 Reference is made to Exhibits 3.1 and 3.4.
4.2 Fifth Amended and Restated Registration Rights Agreement dated
November 20, 1996 by and among the Registrant and certain holders of
the Company's Common Stock and Warrants to purchase Common Stock.
10.2(2)* 1995 Outside Directors' Stock Option Plan, and form of Director
Stock Option Agreement.
10.3(3) Warrant for Common Stock issued to Unterberg Harris.
10.4(2)* Form of Indemnity Agreement between the Registrant and each of its
directors and executive officers.
10.5(2) Form of Reseller and Development Agreement dated September 8, 1995,
by and between the Registrant and Tobit Software International GmbH.
10.6(2) License Agreement dated June 9, 1995, by and between the Registrant
and 3Com Limited.
10.7(2) OEM Purchase Agreement dated May 23, 1995, by and between the
Registrant and SerComm Corporation.
------------------
(1) Filed as an exhibit to the Company's Form 8-K dated August 22, 1996 and
incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Registration Statement on Form
SB-2 (Reg. No. 33-99628-LA-) or amendments thereto and incorporated
herein by reference.
(3) Filed as an exhibit to the Company's Form 10-KSB for the fiscal
year-ended December 31, 1995 and incorporated herein by reference.
* Indicates management contracts or compensatory plans or arrangements
filed pursuant to Item 601(b)(10) of Regulation S-K.
32.
<PAGE>
10.8(2) Distribution Agreement dated February 26, 1990, by and between the
Registrant and Ingram Micro D Inc.
10.9(2) Distributor Contract dated June 25, 1991, as amended June 25, 1991,
by and between the Registrant and Tech Data Corporation.
10.10(2) Distribution Agreement dated March 26, 1992, as amended March 26,
1992, by and between the Registrant and Merisel, Inc.
10.11(2) Distributor Agreement dated October 1, 1990, by and between the
Registrant and Vitek.
10.12(2) International Distributor Agreement dated February 24, 1994, by and
between the Registrant and Macnica.
10.13(2) International Distributor Agreement dated July 13, 1992, by and
between the Registrant and Azlan Ltd.
10.14(3)* 1988 Equity Incentive Plan, as amended.
10.15(3) Warrant for Common Stock issued to RvR Securities Corp.
10.16(4)* Form of Executive Severance and Transition Benefits Agreement
between the Company and Messrs. R. Prasad, P. Raje, R. Singh and Ms.
S. Anand.
10.17(4) Form of Executive Severance and Transition Benefits Agreement
between the Company and Messrs. R. Bambrough and J. Burke.
10.18* Letter from the Company to Roy Prasad dated November 12, 1997
concerning modification of severance terms (reference is made to
page E-1).
11.1 Computation of Net Income (Loss) Per Share. Reference is made to
page F-22 of the Notes to Consolidated Financial Statements.
24.1 Consent of Coopers & Lybrand LLP (reference is made to page E-2).
25.1 Power of Attorney. Reference is made to the signature page. (page
34)
27.1 Financial data schedule (reference is made to page E-3).
(c) No reports on Form 8-K were filed for the quarter ended December 31, 1997.
------------------
(1) Filed as an exhibit to the Company's Form 8-K dated August 22, 1996 and
incorporated herein by reference.
(2) Filed as an exhibit to the Company's Registration Statement on Form
SB-2 (Reg. No. 33-99628-LA-) or amendments thereto and incorporated
herein by reference.
(3) Filed as an exhibit to the Company's Form 10-KSB for the fiscal
year-ended December 31, 1996 and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Form 10-Q for the period ended
September 26, 1997 and incorporated herein by reference.
* Indicates management contracts or compensatory plans or arrangements
filed pursuant to Item 601(b)(10) of Regulation S-K.
33.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
By: /S/ ARTHUR H. BRUNO
Arthur H. Bruno
Chief Executive Officer and President
March 13, 1998
KNOW BY ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Arthur H. Bruno and Randall I. Bambrough,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution for him, and in his name in any and all capacities, to
sign any and all amendments to this Report, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, and any of them, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ ARTHUR H. BRUNO Chairman of the Board, Chief Executive Officer, March 13, 1998
------------------- President and Director (principal executive
Arthur H. Bruno officer)
/s/ RANDALL I. BAMBROUGH Chief Financial Officer, Vice President, Finance March 13, 1998
------------------------ and Administration and Secretary (principal
Randall I. Bambrough financial and accounting officer)
/s/ JOHN FREIDENRICH Director March 13, 1998
--------------------
John Freidenrich
/s/ ALAN KESSMAN Director March 13, 1998
----------------
Alan Kessman
</TABLE>
34.
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Castelle:
We have audited the accompanying consolidated balance sheets of Castelle and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Castelle and subsidiaries as of December 31, 1997 and 1996, 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.
As discussed in Note 3, the Company has restated the financial statements to
reflect the acquisition of Ibex as a purchase transaction. Previously issued
financial statements reflected that acquisition as a pooling of interests
transaction.
COOPERS & LYBRAND L.L.P.
San Jose, California
February 6, 1998
F-1
<PAGE>
CASTELLE AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
-----
<TABLE>
<CAPTION>
December 31,
-------------------------------
ASSETS 1997 1996
------------- -------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 6,204 $ 8,161
Restricted cash 125
Accounts receivable, net of allowance for doubtful accounts of $490
in 1997 and $467 in 1996 3,273 5,783
Inventories 3,786 2,841
Prepaid expenses and other current assets 573 626
Deferred income taxes 874 1,439
----------- -----------
Total current assets 14,835 18,850
Property and equipment, net 938 593
Goodwill, net 2,955
Other, net 93 2,777
Deferred income taxes 3,060 2,128
----------- -----------
Total assets $ 18,926 $ 27,303
=========== ===========
LIABILITIES
Current liabilities:
Long-term debt, current portion $ 87
Accounts payable 1,312 $ 1,862
Accrued liabilities 2,620 3,825
----------- -----------
Total current liabilities 4,019 5,687
Other long-term liabilities 52
----------- -----------
Total liabilities 4,071 5,687
----------- -----------
Commitments (Note 5)
SHAREHOLDERS' EQUITY
Preferred stock, no par value:
Authorized: 2,000 shares in 1997 and 1996
Issued and outstanding: none in 1997 and 1996 - -
Common stock, no par value:
Authorized: 25,000 shares
Issued and outstanding: 4,490 shares in 1997 and 4,420 shares in 1996 28,955 28,843
Notes receivable for purchase of common stock (274) (296)
Accumulated deficit (13,826) (6,931)
----------- -----------
Total shareholders' equity 14,855 21,616
----------- -----------
Total liabilities and shareholders' equity $ 18,926 $ 27,303
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-2
<PAGE>
CASTELLE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
-----
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Net sales $ 25,343 $ 29,461 $ 25,082
Cost of sales 11,836 14,993 13,571
----------- ----------- -----------
Gross profit 13,507 14,468 11,511
----------- ----------- -----------
Operating expenses:
Research and development 3,141 2,357 2,018
Sales and marketing 9,180 7,357 5,641
General and administrative 2,296 1,566 1,405
Amortization of intangible assets 574 96
Restructuring and other charges 6,224 1,079
----------- ----------- -----------
21,415 12,455 9,064
----------- ----------- -----------
Operating income (loss) (7,908) 2,013 2,447
Interest income (expense), net 288 340 (296)
Other income (expense), net (7) (157) (53)
----------- ----------- -----------
Income (loss) before (benefit from) provision
for income taxes (7,627) 2,196 2,098
(Benefit from) provision for income taxes (732) (3,528) 74
----------- ----------- -----------
Net income (loss) $ (6,895) $ 5,724 $ 2,024
=========== =========== ===========
Net income (loss) per common share - basic $ (1.54) $ 1.55 $ 2.73
=========== =========== ===========
Shares used in per share calculation - basic 4,470 3,701 742
=========== =========== ===========
Net income (loss) per common share - diluted $ (1.54) $ 1.45 $ 0.78
=========== =========== ===========
Shares used in per share calculation - diluted 4,470 3,942 2,599
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
<PAGE>
CASTELLE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
-----
<TABLE>
<CAPTION>
Notes
Receivable
for
Preferred Stock Common Stock Purchase of
-------------------- ------------------- Common Accumulated
Shares Amount Shares Amount Stock Deficit Total
-------- --------- ------- ---------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1995, as
previously reported 22,349 $15,860 1,228 $ 660 $ (130) $ (14,428) $ 1,962
Adjustment for change in
accounting for Ibex transaction
(Note 3) (788) (356) (251) (607)
-------- --------- ------- ---------- ------- --------- ---------
Balances, January 1, 1995, as 22,349 15,860 440 304 (130) (14,679) 1,355
restated
Issuance of common stock through:
Exercise of stock options 2 1 1
Exercise of purchase rights 52 263 (263)
Initial public offering, net
of issuance costs 1,000 5,886 5,886
Exercise of warrants 7 7 7
Conversion of preferred shares (22,349) (15,860) 1,970 15,860
Other 17 17
Repurchase of common stock (15) (15) 14 (1)
Net income 2,024 2,024
-------- --------- ------- ---------- ------- --------- ---------
Balances, December 31, 1995 - - 3,456 22,323 (379) (12,655) 9,289
Issuance of common stock through:
Exercise of stock options 23 10 10
Exercise of underwriter's
overallotment option 150 976 976
Issuance of common stock in
connection with acquisition 791 5,535 5,535
Repurchase of common stock (1) (1)
Repayment of notes receivable 83 83
Net income 5,724 5,724
-------- --------- ------- ---------- -------- --------- ---------
Balances, December 31, 1996 - - 4,420 28,843 (296) (6,931) 21,616
Issuance of common stock through
exercise of stock options 70 112 112
Repayment of notes receivable 22 22
Net loss (6,895) (6,895)
-------- --------- ------- ---------- -------- --------- ---------
Balances, December 31, 1997 - $ - 4,490 $ 28,955 $ (274) $(13,826) $ 14,855
======== ========= ======= ========== ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
<PAGE>
CASTELLE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
-----
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1997 1996 1995
---------- ---------- -----------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) $ (6,895) $ 5,724 $ 2,024
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities:
Depreciation and amortization 967 346 594
Purchased in-process research and development 1,079
Write-off of goodwill and other intangible assets 5,074
Provision for doubtful accounts and sales returns 220 (11) 75
Provision for excess and obsolete inventory 412 29 323
Changes in assets and liabilities:
Accounts receivable 2,289 (2,280) (1,039)
Inventories (1,357) 795 (1,225)
Prepaid expenses and other current assets 53 (19) (174)
Accounts payable (550) (876) 1,626
Accrued liabilities and other long-term liabilities (1,205) 311 800
Deferred income taxes (367) (3,567)
---------- ---------- -----------
Net cash (used in) provided by operating activities (1,359) 1,531 3,004
---------- ---------- -----------
Cash flows from investing activities:
Acquisition of property and equipment (732) (364) (195)
Cash portion of Ibex acquisition, net of cash acquired (1,159)
(Increase) decrease in other assets (14) 41 (24)
---------- ---------- -----------
Net cash used in investing activities (746) (1,482) (219)
---------- ---------- -----------
Cash flows from financing activities:
(Increase) decrease in restricted cash (125) 426
Proceeds from notes payable 146
Repayment of notes payable (7) (193) (1,123)
Proceeds from bank borrowings 18,933
Repayment of bank borrowings (20,509)
Principal payments on capitalized leases (31) (44)
Proceeds from collection of note receivable for stock 22 83
Proceeds from issuance of common stock and warrants, net of
repurchases 112 985 5,893
---------- ---------- -----------
Net cash provided by financing activities 148 844 3,576
---------- ---------- -----------
Net (decrease) increase in cash and cash equivalents (1,957) 893 6,361
Cash and cash equivalents, beginning of period 8,161 7,268 907
---------- ---------- -----------
Cash and cash equivalents, end of period $ 6,204 $ 8,161 $ 7,268
========== ========== ===========
Supplemental information:
Cash paid during the period for:
Interest $ 3 $ 6 $ 217
Income taxes $ 123 $ 86 $ 57
Noncash investing and financing activities:
Issuance of common stock in exchange for notes receivable $ 263
Repurchase of common stock in exchange for notes receivable $ 14
Issuance of common stock on conversion of preferred stock $ 15,860
Conversion of preferred stock to common stock in connection
with merger $ 300
Issuance of common stock for acquisition of Ibex $ 5,535
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
<PAGE>
CASTELLE AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----
1. Business and Organization of the Company:
Castelle (the Company) designs, develops, markets and supports network
enhancement products, both software and hardware, that improve the
productivity, performance and functionality of local area networks (LANs)
and enhance the LAN user's ability to communicate. The Company's current
products include FaxPress fax server systems, LANpress print servers and
FactsLine fax-on-demand software. The Company distributes its products
primarily through a two-tier, domestic and international distribution
network, with its distributors selling Castelle's products to value-added
resellers, system integrators, retailers and other resellers in the United
States, Europe and the Pacific Rim. The Company also has relationships
with selected original equipment manufacturers and sells software
enhancements and upgrades directly to end users.
2. Summary of Significant Accounting Policies:
Basis of Consolidation:
The consolidated financial statements include the accounts of Castelle
and its wholly owned subsidiaries in the United States and the
Netherlands. All intercompany balances and transactions have been
eliminated.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
Financial Instruments:
Cash equivalents consist of highly liquid investments with original or
remaining maturities at the date of purchase of three months or less.
Amounts reported for cash equivalents, receivables and other financial
instruments are considered to approximate fair values based upon
comparable market information available at the respective balance sheet
dates.
Continued
F-6
<PAGE>
CASTELLE AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----
2. Summary of Significant Accounting Policies, continued:
Financial Instruments, continued:
Financial instruments that potentially subject the Company to
concentrations of credit risks consist principally of cash, notes
receivable and trade accounts receivable. The Company maintains its
cash balances at a variety of financial institutions and has not
experienced any losses relating to any of its money market funds or
bank deposits.
Restricted Cash:
The Company considers cash equivalents used to collateralize loans to
be restricted. At December 31, 1997, long term restricted cash consists
of a 30 day certificate of deposit which is used to collateralize one
of the Company's notes.
Certain Risks and Concentrations:
Ongoing customer credit evaluations are performed by the Company, and
collateral is not required. The Company maintains allowances for
potential returns and credit losses, and such returns and losses have
generally been within management's expectations. Three customers
accounted for 67% of accounts receivable at December 31, 1997 and three
customers accounted for 54% of accounts receivable at December 31,
1996.
The Company's products include components subject to rapid
technological change. Significant technological change could adversely
affect the Company's operating results and subject the Company to
returns of product and inventory losses. While the Company has ongoing
programs to minimize the adverse effect of such changes and consider
technological change in estimating its allowances, such estimates could
change in the future. In addition, one of the Company's print server
products is currently manufactured by a single supplier and certain key
components are currently available from only single sources.
Inventories:
Inventories are stated at the lower of standard cost (which
approximates cost on a first-in, first-out basis) or market.
Continued
F-7
<PAGE>
2. Summary of Significant Accounting Policies, continued:
Property and Equipment:
Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is provided using the straight-line
method over the estimated useful lives of the respective assets,
generally three to seven years. Amortization of leasehold improvements
is provided on a straight-line basis over the life of the related asset
or the lease term, if shorter. Gains and losses upon asset disposal are
taken into income in the year of disposition.
Software Production Costs:
Costs related to the conceptual formulation and design of software
products are expensed as research and development while costs incurred
subsequent to establishing technological feasibility of software
products are capitalized until general release of the product.
Generally, technological feasibility is established upon completion of
a working model. No significant costs subsequent to such point have
been incurred, and all such costs have been expensed.
Revenue Recognition:
Product revenue is recognized upon shipment provided no significant
vendor obligations remain and collection of the resulting receivable is
deemed probable by management. The Company enters into agreements with
certain of its distributors which permit limited stock rotation rights.
These stock rotation rights allow the distributor to return products
for credit but require the purchase of additional products of equal
value. Revenues subject to stock rotation rights are reduced by
management's estimates of anticipated exchanges. Provisions for
estimated warranty costs, insignificant vendor obligations and
anticipated retroactive price adjustments are recorded at the time
products are shipped.
Advertising Costs:
Advertising costs, included in sales and marketing expenses, are
expensed as incurred and were $2,471,000, $2,304,000 and $914,000 in
1997, 1996 and 1995, respectively.
Foreign Currency Translation:
The functional currency of the Company's foreign subsidiary is the U.S.
dollar. Foreign currency gains and losses, which have not been
material, are reported in the statement of operations.
Continued
F-8
<PAGE>
2. Summary of Significant Accounting Policies, continued:
Net Income (Loss) Per Share:
The Company has adopted Statement of Financial Accounting Standards
No.128 (SFAS 128), "Earnings per Share," which supersedes APB Opinion
No. 15 (APB No. 15), "Earnings per Share," and which is effective for
all periods ending after December 15, 1997. SFAS 128 requires dual
presentation of basic and diluted earnings per share (EPS) for complex
capital structures on the face of the Statements of Operations. Basic
EPS is computed by dividing net income by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from the exercise or conversion of other securities
into common stock. For the year ended December 31, 1997, the effects of
the exercise of outstanding stock options were excluded from the
calculation of diluted EPS because their effect was antidilutive.
Restructuring:
In the quarter ended September 26, 1997, the Company announced and
began to implement a restructuring plan. The Company recorded a
$1,150,000 restructuring charge to account for the estimated costs of
implementing and completing the restructuring plan. Such charge was in
addition to the write-off of the Ibex goodwill and related intangibles
as discussed in Note 3. These costs consist of $402,000 to exit from
certain lines of business, $343,000 for the relocation of the Company's
European office, $340,000 for estimated employee termination costs
associated with reductions in the workforce, and $65,000 for other
estimated restructuring costs. As of December 31, 1997, the Company had
completed most of its restructuring plan with actual costs incurred of
$981,000. The remaining balance of $169,000 will be used to complete
the relocation of the Company's European office.
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 (SFAS 130), "Reporting
Comprehensive Income". This statement establishes requirements for
disclosure of comprehensive income and becomes effective for the
Company for fiscal years beginning after December 15, 1997, with
reclassification of earlier financial statements for comparative
purposes. Comprehensive income generally represents all changes in
shareholders' equity except those resulting from investments or
contributions by shareholders. The Company is evaluating alternative
formats for presenting this information, but does not expect this
pronouncement to materially impact the Company's results of operations.
Continued
F-9
<PAGE>
2. Summary of Significant Accounting Policies, continued:
Recent Accounting Pronouncements, continued:
In June 1997, The Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 (SFAS 131), "Disclosures
about Segments of an Enterprise and Related Information". This
statement establishes standards for disclosure about operating segments
in annual financial statements and selected information in interim
financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting
Standards No. 14, "Financial Reporting for Segments of a Business
Enterprise." The new standard becomes effective for fiscal years
beginning after December 15, 1997, and requires that comparative
information from earlier years be restated to conform to the
requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's
current reporting and disclosures.
In October 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition,"
which delineates the accounting for software product and maintenance
revenues. SOP 97-2 supersedes the Accounting Standards Executive
Committee Statement of Position 91-1, "Software Revenue Recognition,"
and is effective for transactions entered into in fiscal years
beginning after December 15, 1997. The Company is evaluating the
requirements of SOP 97-2 and the effects, if any on the Company's
current revenue recognition policies.
Continued
F-10
<PAGE>
3. Acquisition of Ibex Technologies, Restatement and Related Charges:
In November 1996, the Company acquired Ibex Technologies, Inc. (Ibex), a
company which designed, developed and marketed fax-on-demand, fax-gateway,
and fax broadcast applications. The Company issued 790,617 shares of its
common stock in exchange for all of the outstanding common stock of Ibex
and accounted for the transaction as a pooling of interests. In connection
with the acquisition of Ibex by the Company, the holders of Ibex preferred
stock negotiated a concession with other Ibex shareholders to receive
registration rights which were preferential to other Ibex shareholders.
Upon discussion with the staff of the Securities and Exchange Commission,
the Company has agreed that these preferential registration rights were
not consistent with the requirements for a pooling of interests.
Accordingly, the Company has agreed to restate its previously issued
financial statements to reflect the acquisition of Ibex using the purchase
method of accounting. The effect of changing the accounting for the Ibex
transaction on previously reported net income was to increase net income
in 1996 by $81,000 and to decrease net income in 1995 by $59,000. The
effect on previously reported diluted net income per share, which also
reflects a reduction in the weighted average number of shares outstanding
each year, was an increase in net income per share of $0.25 in 1996 and
$0.19 in 1995. See Note 13 for discussion of the restatement of the
fiscal quarters in 1997.
The total purchase price of Ibex, consisting of stock valued at $5,534,000
(based on the closing price at the closing date) plus direct costs
incurred of $1,430,000, was allocated to the net tangible and identified
intangible assets of Ibex, and to in-process research and development in
the amounts of $142,000, $2,739,000, and $1,079,000, respectively. The
identified intangible assets, consisting primarily of the fair value of
current technologies, customer lists, and the workforce, are being
amortized on a straight line basis over 5 years. The excess of the
purchase price plus direct costs incurred over the fair value of the
assets acquired was approximately $3,004,000 and has been recorded as
goodwill, which was being amortized on a straight line basis over 5 years.
The amount of the purchase price allocated to in-process research and
development relates to products for which technological feasibility had
not been established and for which there was no alternative future use.
Accordingly, the in-process research and development was written off at
the date of the acquisition and included as restructuring and other
charges on the accompanying statement of operations.
Continued
F-11
<PAGE>
3. Acquisition of Ibex Technologies, Restatement and Related Charges,
continued:
In 1997 Ibex suffered significant losses on its current products due to
increasing competition from internet based applications and determined
that its primary product under development was not economically feasible.
As a result, management has determined that the value assigned to goodwill
and other intangible assets is not currently recoverable and has therefore
written off such assets. The expense incurred in 1997, included as part of
the restructuring and other charges, was $5,073,000, which amount was net
of amortization recorded in 1997 of $574,000.
4. Balance Sheet Detail (in thousands):
Inventories:
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
----------- -----------
<S> <C> <C>
Raw material $ 1,544 $ 878
Work in process 486 212
Finished goods 1,756 1,751
----------- -----------
$ 3,786 $ 2,841
=========== ===========
Property and Equipment:
December 31,
-------------------------
1997 1996
----------- -----------
Production, test and demonstration equipment $ 746 $ 637
Computer equipment 2,740 2,185
Office equipment 361 315
Leasehold improvements 127 109
----------- -----------
3,974 3,246
Less accumulated depreciation and amortization (3,036) (2,653)
----------- -----------
$ 938 $ 593
=========== ===========
</TABLE>
Continued
F-12
<PAGE>
4. Balance Sheet Detail (in thousands), continued:
Property and Equipment, continued:
Equipment acquired under capital leases included in property and
equipment above consist of:
<TABLE>
<CAPTION>
December 31,
---------------------
1997 1996
--------- ---------
<S> <C> <C>
Equipment $ 151 $ 151
Less accumulated amortization (151) (151)
--------- ---------
$ - $ -
========= =========
Accrued Liabilities:
December 31,
--------------------------
1997 1996
------------ ------------
Accrued compensation $ 870 $ 893
Accrued sales and marketing 444 743
Accrued professional fees 126 58
Deferred revenue 252 239
Accrued income tax 234 427
Accrued acquisition costs 292
Other 694 1,173
------------ ------------
$ 2,620 $ 3,825
============ ============
</TABLE>
Continued
F-13
<PAGE>
5. Commitments:
The Company leases its facilities under a noncancelable operating lease
that expires in October 2000. The Company is responsible for certain
maintenance costs, taxes and insurance under the lease. Future minimum
payments under noncancelable operating leases are as follows (in
thousands):
1998 $ 300
1999 310
2000 268
------------
$ 878
============
Rent expense, including the facility lease and equipment rental, was
$332,000, $374,000 and $367,000 for 1997, 1996 and 1995, respectively.
6. Bank Borrowings:
The Company has a $3.0 million revolving line of credit with a bank which
expires in July 1998, pursuant to which the Company may borrow 100%
against pledges of cash at the bank's prime rate (8.50% at December 31,
1997). Borrowings under this line of credit agreement are collateralized
by all assets of the Company. Under the terms of the loan agreement, the
Company is restricted from loaning money or assets or entering any mergers
or acquisitions where the total annual consideration exceeds $15,000,000
without the bank's approval. The Company was in compliance with the terms
of the agreement at December 31, 1997, and at that date had no borrowings
under the line of credit.
7. Long-Term Debt:
In December 1997, the Company entered into a loan and security agreement
with a finance company for amounts up to $288,000. As of December 31,
1997, the Company had drawn $146,000 against this agreement. The amounts
borrowed are subject to interest of 10.11%, are repayable by December
2000, and are collateralized by a certificate of deposit of $125,000.
Continued
F-14
<PAGE>
7. Long-Term Debt, continued:
At December 31, 1997, future minimum payments are as follows (in
thousands):
Years Ending December 31,
1998 $ 87
1999 25
2000 27
---------
$ 139
=========
8. Common Stock:
In connection with the sale of common stock to two executives (152,815
shares at $0.20 per share in October 1994 and 52,500 shares at $5.00 per
share in April 1995), the Company has the right to repurchase the 205,315
shares at cost in the event of termination of service. These rights lapse
ratably through 1999. At December 31, 1997, 23,000 shares were subject to
the Company's repurchase right.
Non-Employee Directors' Stock Option Plan:
In November 1995, the Company's Board of Directors adopted the 1995
Non-Employee Directors' Stock Option Plan (Directors Plan). As of
December 31, 1997, 120,000 shares of the Company's common stock have
been reserved for issuance under the Directors Plan and activity under
the Plan is as follows (in thousands):
<TABLE>
<CAPTION>
Weighted
Average
Number Exercise Exercise
of Shares Price Total Price
------------ --------------- ---------- -------------
Balances, January 1, 1996
<S> <C> <C> <C> <C>
Options granted 10 $8.00 $ 80 $8.00
Options canceled (3) $8.00 (24) $8.00
------------ ---------- -------------
Balances, December 31, 1996 7 $8.00 56 $8.00
Options granted 6 $6.12 37 $6.12
Options canceled (3) $6.12-$8.00 (21) $7.00
------------ ---------- -------------
Balances, December 31, 1997 10 $6.12-$8.00 $ 72 $7.20
============ ========== =============
</TABLE>
At December 31, 1997 and 1996, 7,000 and 3,000 options, respectively,
were exercisable. At December 31, 1997 and 1996, 110,000 and 113,000
options, respectively, were available for grant under this plan.
Continued
F-15
<PAGE>
8. Common Stock, continued:
1988 Incentive Stock Plan:
Under the 1988 Incentive Stock Plan (1988 Plan), the Board of Directors
may grant either the right to purchase shares or options to purchase
shares of the Company's common stock at prices not less than the fair
market value at the date of grant for incentive stock options and 85%
of the fair market value for non-qualified options and purchase rights.
Options granted under the 1988 Plan generally become exercisable, and
the Company's right to repurchase shares issued and sold pursuant to
stock purchase rights lapses, at a rate of one-quarter of the shares
under option or purchased under stock purchase rights at the end of the
first year and thereafter ratably over the next three years and
generally expire seven years from the date of grant. As of December 31,
1997, there were no stock purchase rights outstanding, and no shares
purchased pursuant to stock purchase rights were subject to repurchase
by the Company.
Option activity under the 1988 Plan was as follows (in thousands):
<TABLE>
<CAPTION>
Weighted
Average
Number Exercise Exercise
of Shares Price Total Price
---------- --------------- ----------- ------------
<S> <C> <C> <C> <C>
Balances, January 1, 1995 100 $.20-$25.00 $ 43 $0.43
Options granted 184 $.20-$6.00 844 $4.58
Options canceled (20) $.20-$25.00 (29) $1.45
Options exercised (2) $.20-$18.00 (1) $0.57
---------- -----------
Balances, December 31, 1995 262 $.20-$6.00 857 $3.26
Options granted 197 $0.96-$7.75 1,075 $5.46
Options canceled (65) $.20-$7.75 (426) $6.54
Options exercised (9) $.20-$1.55 (10) $1.24
---------- -----------
Balances, December 31, 1996 387 $0.20-$7.75 1,496 $3.87
Options granted 1,184 $4.50-$5.75 5,476 $4.62
Options canceled (112) $0.20-$6.88 (5,677) $5.09
Options exercised (70) $0.20-$5.00 (112) $1.59
---------- -----------
Balances, December 31, 1997 1,389 $0.20-$7.75 $ 6,293 $4.53
========== ===========
</TABLE>
At December 31, 1997, 1996 and 1995, 694,000, 119,000 and 37,000
options outstanding, respectively, were exercisable.
Continued
F-16
<PAGE>
8. Common Stock, continued:
Stock Option Plans:
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been
recognized for the Non-Employee Directors' Stock Option Plan or the
1988 Incentive Stock Plan.
Had compensation cost for these Plans been determined based on the fair
value at the grant date for awards in 1997, 1996 and 1995 consistent
with the provisions of SFAS No. 123, the Company's net income and net
income per share for 1997, 1996 and 1995 would have been reduced to the
pro forma amounts indicated below (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Net income - as reported $ (6,895) $ 5,724 $ 2,024
=========== =========== ===========
Net income - pro forma $ (8,093) $ 5,586 $ 1,935
=========== =========== ===========
Net income per share - basic - as reported $ (1.54) $ 1.55 $ 2.73
=========== =========== ===========
Net income per share - basic - pro forma $ (1.81) $ 1.51 $ 2.67
=========== =========== ===========
Net income per share - diluted - as reported $ (1.54) $ 1.45 $ 0.78
=========== =========== ===========
Net income per share - diluted - pro forma $ (1.81) $ 1.42 $ 0.76
=========== =========== ===========
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes model with the following weighted average
assumptions for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ------------------ ------------------
<S> <C> <C> <C>
Risk-free interest rate 4.88%-5.30% 5.38%-6.75% 5.38%-6.75%
Expected life 5.6 years 3 years 3 years
Expected dividends - - -
Volatility 100% 60% 60%
</TABLE>
Continued
F-17
<PAGE>
8. Common Stock, continued:
Stock Option Plans, continued:
The options outstanding and currently exercisable by exercise price at
December 31, 1997 are as follows (in thousands, except years and per
share data):
<TABLE>
<CAPTION>
Options Currently
Options Outstanding Exercisable
- ------------------------------------------------------------------- -------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- ----------------------- -------------- ------------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
$0.20 71 3.3 years $0.20 62 $0.20
$1.55 5 1.7 years $1.55 5 $1.55
$3.41 - $5.75 1,215 3.9 years $4.63 586 $4.61
$6.00 - $8.00 107 5.3 years $6.68 48 $6.75
----------- ----------
$0.20-$8.00 1,398 4.0 years $4.55 701 $4.34
=========== ==========
</TABLE>
The weighted average fair value of options granted in 1997, 1996 and
1995 was $3.78, $3.41 and $1.98 per share, respectively.
Warrants:
The Company has outstanding fully exercisable warrants at December 31,
1997 as follows (in thousands except per share data):
Stock Under Exercise Number
Expiration Date Warrant Price of Shares
--------------------- --------------- ----------- ------------
December 2000 Common $8.40 100
March 2000 Common $1.00 133
March 1999 Common $3.00 15
The warrant holders have certain demand and registration rights as
specified in the warrant agreement. No warrants were exercised during
1997 and 1996. During 1995, 7,000 warrants were exercised.
Continued
F-18
<PAGE>
8. Common Stock, continued:
Note Receivable:
At December 31, 1997, the Company held notes receivable of $274,000,
which bear interest between 6.3% and 7.05% per annum, from two
executive officers or directors, issued in connection with the purchase
of common stock under restricted stock purchase agreements. The
principal and accrued interest on these notes are due at various dates
from October 1999 through September 2000.
9. Income Taxes:
The Company's (benefit from) provision for income taxes consists of
the following (in thousands):
Year Ended December 31,
-------------------------------------
1997 1996 1995
------------ ------------ ---------
Current:
Federal $ - $ 793 $ 56
State 130 18
Foreign 20
------------ ------------ ---------
- 943 74
------------ ------------ ---------
Deferred:
Federal (732) (4,062)
State (409)
------------ ------------ ---------
(732) (4,471) -
------------ ------------ ---------
$ (732) $ (3,528) $ 74
============ ============ =========
Continued
F-19
<PAGE>
9. Income Taxes, continued:
The Company's tax (benefit) provision differs from the (benefit)
provision computed using statutory income tax rates as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ----------- ---------
<S> <C> <C> <C>
Federal tax (benefit) at statutory rate $ (2,975) $ 778 $ 713
Permanent difference due to non-deductible expenses 1,586 228 12
State taxes, net of federal benefit (91) 251 98
Utilization of net operating loss carryforwards (1,829) (823)
Change in valuation allowance 834 (2,519)
General business credits (86) (123)
Other (314) 74
------------ ----------- ---------
$ (732) $ (3,528) $ 74
------------ ----------- ---------
</TABLE>
The components of the net deferred tax assets and liabilities are as
follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
----------- -----------
<S> <C> <C>
Inventory allowances and adjustments $ 158 $ 327
Accounts receivable allowances 475 483
Other liabilities and allowances 428 622
State income taxes 7
Net operating loss carryforwards 2,680 1,829
Ibex intangible assets (732)
Tax credit carryforwards 1,027 899
Depreciation 132
Valuation allowance (834)
----------- -----------
Total deferred tax assets $ 3,934 $ 3,567
=========== ===========
</TABLE>
Due to the uncertainty of realizing the tax benefit of the Company's
1997 net operating loss carryforward, the Company has placed a
valuation reserve against this deferred tax asset balance.
Continued
F-20
<PAGE>
9. Income Taxes, continued:
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $7,700,000 and $1,100,000 available to offset future federal
and California taxable income, respectively. These loss carryforwards
expire from 2003 through 2013.
The Tax Reform Act of 1986 substantially changed the rules relative to net
operating loss carryforwards in the event of an "ownership change" of a
corporation. Future changes in ownership may result in limitations on the
annual utilization of net operating loss carryforwards.
The Company's income before provision for income taxes is substantially
all from domestic operations.
10. Retirement Plan:
The Company has a voluntary 401(k) plan covering substantially all
employees. The plan provides for employer contributions at the discretion
of the Board of Directors. In 1997, 1996 and 1995, the Company made no
contributions to the plan.
11. Major Customers and Segment Information:
The Company operates in one industry segment and develops, markets and
supports network enhancement products.
The Company's export revenues, denominated in U.S. dollars, are
summarized as follows (in thousands):
Years Ended December 31,
-------------------------------------------
1997 1996 1995
------------- ------------- ------------
Europe $ 3,000 $ 4,800 $ 4,700
Pacific Rim 8,900 10,700 8,300
------------- ------------- ------------
$ 11,900 $ 15,500 $ 13,000
============= ============= ============
Continued
F-21
<PAGE>
11. Major Customers and Segment Information, continued:
Customers that individually accounted for greater than 10% of net sales
are as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------------------------
Customer 1997 1996 1995
----------- -------------- ----------- -------------- ------------ --------------
Amount Percentage Amount Percentage Amount Percentage
----------- -------------- ----------- -------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
A $ 2,604 10% $ 3,833 13% $ 2,761 11%
B 3,629 14% 4,419 15% 4,514 18%
C 8,147 32% 9,711 33% 7,300 29%
</TABLE>
12. Computation of Net (Loss) Income per Share:
Basic and diluted earnings per share are calculated as follows for 1997,
1996 and 1995 (in thousands except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------- -------------
Basic:
<S> <C> <C> <C>
Weighted average shares 4,470 3,701 742
============ ============= =============
Net (loss) income $ (6,895) $ 5,724 $ 2,024
============ ============= =============
Net (loss) income per share $(1.54) $1.55 $2.73
============ ============= =============
Diluted:
Weighted average shares 4,470 3,701 742
Common equivalent shares from stock options 241 133
Assumed conversion of preferred stock 1,724
------------ ------------- -------------
Shares used in per share calculation 4,470 3,942 2,599
============ ============= =============
Net (loss) income $ (6,895) $ 5,724 $ 2,024
============ ============= =============
Net (loss) income per share $(1.54) $1.45 $0.78
============ ============= =============
</TABLE>
The calculation of diluted shares outstanding for 1997 excludes
1,408,000 stock options as their effect was antidilutive in the
period.
Continued
F-22
<PAGE>
13. Restatement of Fiscal 1997 Quarters (unaudited):
The financial information as of and for the following fiscal quarters has
been restated to reflect the acquisition of Ibex as a purchase transaction
(in thousands, except per share data):
<TABLE>
<CAPTION>
March 28, June 27, September 26,
1997 1997 1997
---------- ---------- ------------
(unaudited)
Total assets:
<S> <C> <C> <C>
As reported $ 23,635 $ 23,081 $ 22,381
As restated $ 28,264 $ 27,423 $ 22,381
Total liabilities:
As reported $ 6,475 $ 5,791 $ 6,590
As restated $ 6,475 $ 5,791 $ 6,590
Total shareholders' equity:
As reported $ 17,160 $ 17,290 $ 15,791
As restated $ 21,789 $ 21,632 $ 15,791
Net sales:
As reported $ 6,419 $ 7,002 $ 6,597
As restated $ 6,419 $ 7,002 $ 6,597
Income (loss) before (benefit)
provision for income taxes:
As reported $ 611 $ 124 $ (1,490)
As restated $ 324 $ (163) $ (6,564)
Net income (loss):
As reported $ 367 $ 74 $ (1,490)
As restated $ 80 $ (213) $ (5,832)
Net income (loss) per shares
(diluted basis):
As reported $0.08 $0.02 ($0.33)
As restated $0.02 ($0.05) ($1.30)
Shares used in per share calculations
(diluted basis):
As reported 4,628 4,628 4,476
As restated 4,628 4,461 4,476
</TABLE>
Continued
F-23
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the consolidated financial statements of Castelle and subsidiaries
is included at page F-1 of this Form 10-K. In connection with our audits of such
financial statements, we have also audited the related financial statement
schedule included at page F-25 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
San Jose, California
February 6, 1998
F-24
<PAGE>
SCHEDULE II
CASTELLE AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deduction Period
------------ ---------- ------------ -------------
Year Ended December 31, 1995:
Deducted from asset accounts:
<S> <C> <C> <C> <C>
Allowance for doubtful accounts $ 428 $ 75 $ 74 $ 429
Allowance for excess and obsolete inventory $ 503 $ 733 $ 458 $ 778
Year Ended December 31, 1996:
Deducted from asset accounts:
Allowance for doubtful accounts $ 429 $ 149 $ 111 $ 467
Allowance for excess and obsolete inventory $ 778 $ 443 $ 414 $ 807
Year Ended December 31, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts $ 467 $ 107 $ 84 $ 490
Allowance for excess and obsolete inventory $ 807 $ 301 $ 713 $ 395
</TABLE>
F-25
<PAGE>
INDEX TO EXHIBITS
Exhibits
Number Description
-------- --------------------------------------------------------------------
10.18 Letter from the Company to Roy Prasad dated November 12, 1997
concerning modification of severance terms (reference is made to
page E-1).
11.1 Computation of Net Income (Loss) Per Share. Reference is made to
page F-22 of the Notes to Consolidated Financial Statements.
24.1 Consent of Coopers & Lybrand LLP (reference is made to page E-2).
25.1 Power of Attorney. Reference is made to the signature page. (page
34)
27.1 Financial data schedule (reference is made to page E-3).
<PAGE>
Exhibit 10.18
November 12, 1997
Mr. Roy Prasad
15768 Kavin Lane
Los Gatos, CA
95030
Dear Roy:
This letter will confirm that you have resigned your employment with Castelle
(the "Company") and your position as a Director of the Company effective this
date November 14, 1997 (the "Effective Date"). Pursuant to the Executive
Severance and Transition Benefits Agreement entered into between you and the
Company on September 22, 1997 (the "Benefits Agreement"), you are entitled to
severance benefits pursuant to Section 2.1 of the Benefits Agreement. Such
benefits are conditioned upon your execution of an effective Employee Agreement
and Release, as required by Section 3.2 of the Benefits Agreement.
As of the Effective Date, you hold two options to purchase shares of the
Company's common stock. The first option (the "First Option") is an incentive
stock option granted to you on August 18, 1997 at an exercise price of $4.50 per
share. A total of 22,222 shares have vested under the First Option as of the
Effective Date. The second option (the "Second Option") is a nonstatutory stock
option granted to you on August 18, 1997 at an exercise price of $4.50 per
share. A total of 37,671 shares have vested under the Second Option as of the
Effective Date. You may exercise the First Option and/or the Second Option with
respect to the vested shares set forth above at any time prior to date the
option terminates (the "Termination Date"). Notwithstanding the provisions of
Section 5 of your option agreements evidencing the First Option and the Second
Option, the Termination Date shall be the later of: (i) [twelve (12)] months
from the Effective Date or (ii) thirty (30) days after the date on which you
would incur no liability under Section 16 of the Securities Exchange Act of 1934
resulting from the exercise of your option(s). The vested portions of the First
Option and Second Option will terminate and cease to remain outstanding to the
extent not exercised prior to the Termination Date. However, as a result of the
foregoing amendment to your First Option, such option will no longer be treated
as an incentive stock option for tax purposes.
In addition, should a transaction involving Network Technology PLC occur within
twelve (12) months following the Effective Date, and should such transaction
constitute a Change in Control (as defined in Section 5.2 of the Benefits
Agreement) then the unvested portions of the First Option and Second Option will
accelerate and become immediately exercisable for all such unvested option
shares. This will provide you with the benefits under Section 2.2 of the
Benefits Agreement as if you had remained employed by the Company through the
date of such Change in Control.
You acknowledge that, except as otherwise modified herein, you will remain bound
by all of the terms, conditions and limitations of your option agreements and
the Company's 1988 Stock Option Plan to which your options are subject.
If you are in agreement with the terms of this letter, please sign and date both
copies that are enclosed and return one copy to me. Please also sign and date
the enclosed copies of the Employee Agreement and Release and return one copy to
me.
Sincerely,
/s/ Arthur Bruno
- --------------------------
ARTHUR BRUNO
Accepted and Agreed as of the 13th day of November, 1997
/s/ Roy Prasad
- --------------------------
Roy Prasad
enclosures
E-1
<PAGE>
Exhibit 24.1
CONSENT OF COOPERS & LYBRAND L.L.P.,
INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Castelle and subsidiaries on Form S-8 (File No. 333-06083) of our reports dated
February 6, 1998, on our audits of the consolidated financial statements and
financial statement schedule of Castelle and subsidiaries as of December 31,
1997 and 1996, and for each of the three years in the period ended December 31,
1997, which reports are included in this Annual Report on Form 10-K.
COOPERS & LYBRAND L.L.P.
San Jose, California
March 13, 1998
E-2
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
Exhibit 27.1
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's Financial Statements for the period ending December 31, 1997 included
in the Company's Form 10-KSB filed March 13, 1998 and is qualified in its
entirety by reference to such statements
E-3
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 6,204
<SECURITIES> 0
<RECEIVABLES> 3,763
<ALLOWANCES> 490
<INVENTORY> 3,786
<CURRENT-ASSETS> 14,835
<PP&E> 3,974
<DEPRECIATION> 3,036
<TOTAL-ASSETS> 18,926
<CURRENT-LIABILITIES> 4,019
<BONDS> 0
0
0
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</TABLE>
