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, 2000
|_| 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)
855 Jarvis Drive, Suite 100, Morgan Hill, California 95037
(Address of principal executive offices, including zip code)
(408) 852-8000
(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 or in
definitive proxy or information statements incorporated by reference in Part III
of the From 10-K. ___
The approximate aggregate market value of the Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock reported on the Nasdaq SmallCap Market on March 13, 2001 was $5,151,000.
Shares of Common Stock held by persons who hold more than 10% of the outstanding
shares and shares held by officers and directors of the Registrant have been
excluded because such persons may be deemed to be affiliates. This determination
is not necessarily conclusive.
The number of shares of Common Stock outstanding as March 13, 2001 was
4,741,060.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Form 10-K will be incorporated by
reference from certain portions of Castelle's proxy statement relating to the
2001 Annual Meeting of Shareholders (the "Proxy Statement") or will be provided
in an amendment to this Form 10-K to be filed with the SEC no later than April
30, 2001.
CASTELLE
FORM 10-K
TABLE OF CONTENTS
PAGE
PART I ....................................................................................................1
ITEM 1. BUSINESS........................................................................................1
ITEM 2. PROPERTIES.....................................................................................22
ITEM 3. LEGAL PROCEEDINGS..............................................................................22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS..........................................22
PART II ...................................................................................................23
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS...........................23
ITEM 6. SELECTED FINANCIAL DATA........................................................................24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATION..........25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........32
PART III ...................................................................................................33
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................33
ITEM 11. EXECUTIVE COMPENSATION.........................................................................33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................33
PART IV ...................................................................................................34
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................34
SIGNATURES ...................................................................................................36
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, that are based on our current expectations
about our company and our industry, including the ability of the Company to
continue to (i) develop, introduce and achieve market acceptance of new
products, (ii) be profitable, (iii) be cash flow positive, (iv) improve on
working capital, (v) control operating expenses, (vi) maintain proper inventory
levels, (vii) deliver quality customer support and (viii) keep accounts payable
current. We use words such as "plan," "expect," "intend," "believe,"
"anticipate," "estimate" and other similar expressions to identify some
forward-looking statements, but not all forward-looking statements include these
words. All of our forward-looking statements involve risks and uncertainties.
The Company's actual results could differ significantly from our expectations
and from the results expressed in or implied by these forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed elsewhere in this Annual Report on Form 10-K. We
urge you to consider these cautionary statements carefully in evaluating our
forward-looking statements. Except as required by law, we undertake no
obligation to publicly update any forward-looking statements to reflect
subsequent events and circumstances.
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 Annual Report
on Form 10-K.
INTRODUCTION
Castelle was incorporated in California in 1987, and its principal
offices are located at 855 Jarvis Drive, Suite 100, Morgan Hill, California
95037. Unless the context otherwise requires, references in this Form 10-K to
"we," "us," or the "Company" refer to Castelle. The Company's telephone number
is (408) 852-8000. Castelle(R), LANpress(R) and JetPress(R) are registered
trademarks and InfoPressTM is a trademark of the Company. This Annual Report on
Form 10-K includes trademarks and trade names of other companies.
The Company designs, develops, markets and supports server appliances
providing office messaging solutions and other shared services. The Company's
current products are focused on two areas: fax messaging products and print
servers. The Company's products consist of FaxPress, an integrated
hardware/software network faxing solution; OfficeDirect, an integrated email/fax
messaging system, InfoPress, an enterprise-level fax-on-demand software product,
and LANpress print servers.
The Company's products have historically centered on fax and print
servers and related technologies. Starting in 1997, the Company's revenues have
declined as competition increased, primarily with the print server products in
the Asia Pacific Region, while at the same time the Internet and other
networking technologies advanced. As a result, the Company experienced annual
operating losses during 1997 through 1999. During the past two years, management
has redirected the Company's efforts to focus on server appliances and on
development efforts to integrate existing and future products with the Internet
and emerging networking technologies. Through restructuring and implementing
numerous cost reductions, the Company was able to report an operating profit in
the fourth quarter of 1999 and in each of the four quarters of fiscal 2000.
1
Castelle's objective is to be a leading worldwide supplier of server
appliances providing office messaging solutions and other shared services. The
Company's specialized networking products allow network administrators to
deploy complex networking applications without the cost and time required to
install server-based software solutions. Castelle pioneered server appliances,
establishing a benchmark for "plug and play" and ease of use with its fax and
print server product families. Castelle products are installed in most Fortune
1000 companies, and in small and medium sized businesses worldwide. Castelle is
now applying its proven technology to expand its line of server appliances to
provide Internet and Intranet messaging and communication solutions for small
and medium enterprises, and departments of large corporations.
The Company has adapted its products for use with the Internet and will
continue to focus on the effect of the Internet on network productivity. The
Company's FaxPress fax servers provide an essential component of a corporate
unified messaging solution. The Company has developed Internet fax capability
with its FaxPress and InfoPress servers and Internet print capability with its
LANpress print servers.
Castelle sells its products through multiple channels, 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, and also distributes its products
through an on-line store on its Web site. The Company's distributors sell
Castelle's products to value-added resellers ("VARs"), e-commerce vendors and
other resellers. The Company's two major domestic distributors are Ingram Micro,
Inc. ("Ingram") and Tech Data Corporation ("Tech Data") and its largest
international distributor in Japan is Macnica Corporation ("Macnica"). As part
of the Company's e-commerce strategy, it is attempting to develop close
relationships with such mass market vendors as CDW, Insight, FirstChoice, and
buy.com. The Company also has relationships with certain original equipment
manufacturers and sells software and upgrades directly to end-users.
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 Annual Report on Form 10-K. Additional
risks and uncertainties not presently known to the Company or that the Company
currently deems immaterial also may impair the Company's business 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 sales will often reflect orders shipped in the same quarter in which
they are received. The Company's backlog at any given time is not necessarily
indicative of actual sales for any succeeding period. In addition, significant
portions 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. The
2
Company's performance in any quarter is not necessarily indicative of its
performance in any subsequent quarter.
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, 2000, had an accumulated deficit of $24 million. The development
and marketing by the Company of its current and new products will continue to
require substantial expenditures. Although the Company returned to profitability
in 2000, 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."
Nasdaq SmallCap Listing; Risk associated with Limited Market
The Company's Common Stock has been listed on the Nasdaq SmallCap
Market since April 1999. In order to maintain its listing on the Nasdaq SmallCap
Market, the Company must maintain total assets, capital and public float at
specified levels, and generally must maintain a minimum bid price of $1.00 per
share. If the Company fails to maintain the standard necessary to be quoted on
the Nasdaq SmallCap Market, the Company's Common Stock could become subject to
delisting. If the Common Stock is delisted, trading in the Common Stock could be
conducted on the OTC Bulletin Board or in the over-the-counter market in what is
commonly referred to as the "pink sheets." If this occurs, a shareholder will
find it more difficult to dispose of the Common Stock or to obtain accurate
quotations as to the price of the Common Stock. Lack of any active trading
market would have an adverse effect on a shareholder's ability to liquidate an
investment in the Company's Common Stock easily and quickly at a reasonable
price. It might also contribute to volatility in the market price of the
Company's Common Stock and could adversely affect the Company's ability to raise
additional equity or debt financing on acceptable terms or at all. Failure to
obtain desired financing on acceptable terms could adversely affect the
Company's business, 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 and the emergence of the
Internet and other communication technologies. 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 cost estimates or that new
3
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 print servers. 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 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.
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's 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. 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.
See "Business -- Research and Product Development."
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 the prices of
products. The Company currently competes principally in the market for network
fax servers and network print 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
4
print server products will continue to decline, as the market for these products
becomes increasingly competitive. Any material reduction in the average selling
prices of the Company's products 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 the Company.
The Company also experiences competition from a number of other software,
hardware and service 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. In the fax server market the
Company competes with companies such as Applied Voice Technology, Inc., Omtool,
Ltd. and Computer Associates International, Inc. There can be no assurance that
competitors will not introduce products incorporating technology more advanced
than the technology used by the Company in its products. 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 in the print server market 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 24% and 31% of the Company's net sales in 2000 and
1999, respectively. The Company sells its products in approximately 40 foreign
countries through approximately 50 international distributors. Macnica, the
Company's principal Japanese distributor, accounted for approximately 61% and
60% of the Company's international sales in 2000 and 1999, 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 laws 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 primarily
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."
5
Lack of Product Revenue Diversification
The Company derives substantially all of its sales from its fax and
print server products. The Company is leveraging its expertise in these areas to
develop new messaging features and products to support greater integration into
corporate network environments and with Internet communications. See "Business
-- Research and Product Development." The Company expects that its current
products will continue to account for a majority of the Company's sales in the
near future. A decline in demand for these products as a result of competition,
technological change or other factors, or a delay in the development and market
acceptance of new features and products, would have a material adverse effect on
the Company's business, operating results and financial condition.
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 products 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. The Company's distributors sell
Castelle's products to VARs, e-commerce vendors and other resellers. The
distribution of personal computers and networking products has been
characterized by rapid change, including consolidations due to the financial
difficulties of 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 distributors typically represent other
products that are complementary to, or compete with, those of the Company. In
particular, certain of its competitors, including Hewlett-Packard and Intel,
sell a substantially higher dollar volume of products through several of the
Company's large U.S. 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."
6
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 single sources. Other product components 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. Other than an agreement with Sercomm
Corporation to manufacture certain print server products, the Company does not
have material long-term supply contracts with third parties or any other sole or
limited source vendors and subcontractors, 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 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 supplier of certain print
server products is SerComm. There can be no assurance that these products will
produce gross margins comparable to those of the Company's internally generated
products or that the parties with which the Company contracts will continue to
provide the quantities and quality of products needed by the Company or that
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.
7
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
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 or 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. There can be no assurance
that third parties will not assert infringement claims against the Company 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 claims. 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
8
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.
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 March 13, 2001, the Company's officers and directors and their
affiliates beneficially owned approximately 25% 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 server appliances
providing office messaging solutions and other shared services. The Company's
current products are focused on two areas: fax and integrated messaging
products, including a range of software enhancements, and print servers. The
9
Company's products consist of FaxPress, an integrated hardware/software network
faxing solution; OfficeDirect, an integrated fax/email messaging system;
InfoPress, an enterprise-level fax-on-demand software product and LANpress
print servers. See "Business -- Research and Product Development."
The Company's products have historically centered on fax and print
servers and related technologies. Starting in 1997, the Company's revenues
have declined as competition increased, primarily with the print server
products in the Asia Pacific Region, while at the same time the Internet and
other networking technologies advanced. As a result, the Company experienced
annual operating losses during 1997 through 1999. During the past two years,
management has redirected the Company's efforts to focus on server appliances
and on development efforts to integrate existing and future products with the
Internet and emerging networking technologies. Through the introduction of the
enhanced fax messaging products that generate higher gross profits,
restructuring and implementing numerous cost reductions, the Company was able
to report operating profits in the fourth quarter of 1999 and in each of the
four quarters of fiscal 2000.
Industry Background
In the mid-1980s, organizations began to interconnect personal
computers into local area networks (LANs) in order to allow work groups to share
files and peripherals such as printers. As LANs have proliferated throughout
organizations and client/server architectures have gained acceptance, they have
become increasingly complex, the size and multimedia intensity of files being
transmitted has increased and the applications operating on the computer
networks have become more critical to the success of the business enterprise.
The proliferation of the Internet and Intranets and popularity of electronic
communications expanded the role of LAN's as a means to provide common access to
the Internet, email and other messaging applications. Installation, maintenance
and administration of LAN equipment has always required a staff of highly
skilled professionals. The costs associated with LANs and related equipment are
significant and affordable only for larger organizations. Many small and medium
sized businesses were not able to invest in necessary equipment and support
staff. This created the need for specialized networking equipment that would
allow network administrators to deploy complex networking applications without
the cost and time required to install server-based software solutions. These
devices are known in the industry as "Server Appliances" or "Thin Servers". A
server appliance is an integrated software/hardware solution designed to reduce
the complexity and cost for a specific server based application. Internet
routers, email servers, remote access servers, communication servers, and print
servers are examples of the server appliances used by businesses today.
Castelle pioneered server appliances, establishing a benchmark for
"plug and play" and ease of use with its fax and print server product families.
Fax Messaging Products: The increasing popularity of email and the
Internet provided a boost to all types of electronic communications as
many users and organizations became more comfortable and accustomed to
their use. To further simplify and improve inter- and
intra-organizational communications, corporate MIS departments are
looking for ways to integrate different types of messaging into a
unified messaging environment. Fax remains one of the key business
communication tools and is one of the essential components of the
corporate messaging environment. In corporate communication
infrastructures, fax is being integrated into email. To facilitate
this capability companies install email-integrated fax server systems.
Fax servers allow users to send and receive faxes as easily as emails,
using the same email application for both types of messages. A fax
server can sort incoming faxes directly and deliver them
electronically and confidentially to the electronic mailboxes of the
intended recipients. Fax servers can also be used as an independent
network shared messaging system in environments that
10
require high volume incoming and outgoing faxes. Users are able to
send and receive faxes directly from their computers or workstations,
elimination the need to print a document, take it to a stand-alone fax
machine and wait for its transmission. Fax servers can help reduce fax
transmission costs by sending non-urgent faxes at an "off-peak"
telephone rates and by utilizing a Fax-over-Internet technology.
These fax servers can be implemented using complex software that
require Windows NT or UNIX systems and specialized expensive fax
modems. The other approach is a dedicated fax server appliance, such
as the Castelle FaxPress.
Automated delivery of information is another popular application of
the fax technology. Fax-on-demand is the ability to use a touch-tone
phone and a fax machine to request and receive 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 information-on-demand customer.
Castelle's InfoPress product line provides a comprehensive solution
for automated information delivery via fax and email.
Integrated Messaging Servers. Proliferation of various types of
electronic communications created a need for unified messaging
systems. Instead of using single-function software programs for
different types of messages, such as emails and faxes, many users
prefer to use a single application such as Microsoft Outlook for all
messages. Integrating different systems to handle various message
types can be complex and expensive. To simplify this process,
next-generation messaging servers, such as Castelle's OfficeDirect
Messaging Server, provide both email and fax capabilities in one
integrated system.
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.
Server appliances, such as communications/messaging servers and print servers,
have emerged to gain significant market acceptance due to their ability to
significantly reduce complexity and cost associated with the installation and
maintenance of networking systems. These appliances also make the complex
functionality of Internet and Intranet communications available and affordable
to many smaller businesses. As MIS professionals in larger organizations and
business owners of smaller enterprises continue to recognize the benefits of
server appliances to provide such critical functionality as Internet and
Intranet communications, remote access, scanning, electronic mail and related
functions, the Company believes that the demand for such network systems will
increase.
11
Castelle Strategy
Castelle's objective is to be a leading worldwide supplier of server
appliances providing office messaging solutions and other shared services.
Castelle pioneered server appliances, establishing a benchmark for "plug and
play" and ease of use with its fax and print server product families. Castelle
products are installed in most Fortune 1000 companies, and in small and medium
sized businesses worldwide. Castelle is now applying its proven technology to
the office, integrating desktop messaging, Internet connectivity, print and
other shared services.
Focus on Server Appliances: The Company focuses exclusively on
providing innovative, reliable, easy-to-use network 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.
Focus on Messaging and Communications: The Company focuses on
developing application solutions for inter and intra-company
communications. The Company believes that its focus on application
servers rather than on infrastructure systems enables the Company to
offer products that bring higher value services to customers and
provide a higher margin to the Company.
Expand Product Line: The Company is leveraging its expertise in server
appliances to offer new easy-to-use, cost-effective solutions. The
Company continues to expand both its fax and print server products and
apply its proven technology to other areas.
Focus on E-commerce and Other High Volume Distribution Channels: The
Company has established a two-tier domestic and international
distribution network of leading national and regional network product
distributors and resellers including Ingram Micro and TechData.
Castelle's products are well suited for sale by e-commerce vendors and
the Company has been successful working with leading suppliers such as
CDW, buy.com, Insight, MicroWarehouse domestically and Software Catalog
and W-Store in Europe. The Company also sells through OEM vendors such
as Fujitsu Ltd. in Japan (" Fujitsu") and Veritek ("Veritek") in Korea.
The Company is focused on maintaining and strengthening its current
distribution network in North America, Europe and Asia-Pacific regions.
Leverage Strategic Relationships: The Company augments its product
offerings 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 range of server appliance products
that enhance network productivity, performance and functionality. The Company's
current products are grouped into two areas: fax messaging products, including
a range of software enhancements, and print servers.
Fax Messaging Products: The Company offers the FaxPress family of
email-integrated fax server appliances. The Company positions the
FaxPress as the easiest way to add faxing to your network
12
and integrate fax with email. FaxPress allows network users to send,
receive, route, print, store, edit and retrieve fax transmissions from
their own personal computers on a local area network. FaxPress can be
integrated into an email system creating a unified fax/email messaging
environment. FaxPress enables users to transmit documents directly to
a fax device as easily as if they were printing to a laser printer or
sending an email message. The product also provides network
administration features like control, monitoring, logging or
configuration. The Company's fax server products are designed to
comply with current regulatory standards in the United States, Europe
and the Pacific Rim. During fiscal 2000 and 1999, fax products
represented 86% and 78%, respectively, of total net sales.
Key features of the FaxPress products (configured with its
current software versions) include:
Easy Installation and maintenance: FaxPress is a fax server
appliance that is packaged with all necessary hardware and
software. The hardware system is a small box with an
integrated 10/100 Base-T Ethernet interface and one to eight
intelligent fax modems. The FaxPress includes all required
system and client software.
Support for popular network operating environments: FaxPress
operates in any local area network based on Microsoft
Windows 98, ME and 2000; Windows NT and NT Terminal Server;
Novell NetWare or Linux servers.
Ability to create unified fax/email messaging environment:
FaxPress has the ability to integrate fax into a corporate
email system, allowing users to send and receive faxes in
the same manner as emails. FaxPress supports Microsoft
Exchange/Outlook, Lotus Notes, Novell GroupWise, Netscape
and other SMTP compatible systems. Castelle's unique
Exchange Direct interface offloads fax processing from MS
Exchange Server while maintaining tight integration with the
Outlook client.
Integration with many popular accounting and CRM
applications: FaxPress is available with the
Reform-for-FaxPress software package ("Reform") from FabSoft
that allows users to send faxes from many popular
accounting, financial and payroll systems including Oracle,
SAP, PeopleSoft, Great Plains, ACCPAC, and Macola. Reform
can support any application that supports form printing.
Ability to send faxes from many applications: Easy faxing
from within any Windows, Windows 95/98 and Windows NT/2000
application such as Microsoft Office and Lotus Smart Suite.
Electronic delivery of faxes to desktops: FaxPress supports
several methods to deliver incoming faxes direct to the
email or fax inbox of the intended recipient. Such methods
include DID (Direct Inward Dialing), DTMF (Dual Tone
Multifrequency), T.30 sub-addressing, OCR (Optical Character
Recognition) routing, line routing.
Internet faxing capabilities reduce transmission costs:
FaxPress enables users to connect several units via the
Internet or the Intranet to form a private Fax-over-IP
network that can significantly reduce the cost of fax
transmissions.
Integration into custom applications: The Company provides a
software development kit which allows programmers to
integrate faxing functions into
13
their current applications or to create new customized
applications that use the FaxPress server.
Software Options: The Company offers a range of value-added
software options which increase the functionality of
Castelle's FaxPress systems and enables 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 $1,375.
The Company offers a family of FaxPress fax server systems ranging
from entry-level products targeted to small businesses with under 50 users
to high-end fax solutions capable of supporting enterprise-wide
installations. The suggested U.S. list prices for FaxPress fax server
products range from $1,495 to $9,995. The server pricing is based on
hardware model, with no per-user costs. The FaxPress 2500, 5000 and 7000
family come with the FaxPress 6.x PRO version that adds integration with
popular email packages, and many advanced fax management and integration
features. FaxPress 6.x PRO is optional on FaxPress SBE. The following table
summarizes the Company's FaxPress system products:
-------------------------------
Network Environment
----------------------------------------------------------------------------------------------
Number of Email NetWare Windows NT/2000
Modems Integration Network 3.x, 4.x, 5.x (IPX,IP)
Product Model Topology (IPX)
-----------------------------------------------------------------------------------------------
FaxPress SBE 1 Optional Ethernet |X| |X|
FaxPress 2500 2 |X| Ethernet |X| |X|
FaxPress 5000 4 or 8 |X| Ethernet |X| |X|
FaxPress 7000 8 |X| Ethernet |X| |X|
-----------------------------------------------------------------------------------------------
Information-on-demand systems: InfoPress software enables the access of
information via any touch-tone phone and a fax machine and allows the
dissemination of information via "broadcasting" to a select database of fax
numbers. InfoPress allows companies to use one source of documents in a
Castelle document library and to automatically publish the documents using
either the fax-on-demand and/or email-on-demand methods.
Castelle's InfoPress is a software product designed to operate on the
Microsoft Windows NT/2000 platform. The system utilizes voice and fax
processing hardware, as well as telephone system interface (analog or T1)
hardware with as few as two and as many as 288 ports that are actually
deployed at a customer site.
Fax-on-Demand: Fax-on-demand allows a user to request and receive
information on demand by dialing a telephone number. The user
interacts with a series of voice prompts to select specific documents,
by simply using the telephone keypad, and requesting delivery of these
documents to a fax number.
Email-on-Demand: Email-on-demand allows a user to request and receive
information on demand by using email. Auto-reply email exists today,
but is limited to receiving one document, usually in text format. The
main benefit of email-on-demand is the ability to share the document
library with fax-on-demand.
14
Web Integration: InfoPress supports Web HTML documents in the document
library. The documents are automatically rendered into a fax document
when required.
Integrated Messaging Products: In 2000, Castelle introduced the
OfficeDirect family of products designed to provide integrated email and
fax communications to small offices. The OfficeDirect family consists of
the OfficeDirect Messaging Server.100 and OfficeDirect Storage Server.100.
The OfficeDirect Messaging Server is an integrated e-mail/fax messaging
server appliance tailored to meet the needs of small offices or workgroups
that need to provide robust communication services to network users. It
combines an SMTP and POP3 e-mail server with a full-featured fax server in
a plug-n-forget, easy-to-use, economical system, which includes all
necessary hardware and software. The OfficeDirect Messaging Server
integrates e-mail and fax services into the Microsoft Outlook client
software. The OfficeDirect Storage Server is a complimentary product to the
messaging server and provides convenient and reliable storage for the
network system files and messages. It also provides generic network storage
and printer sharing to network users.
Print Servers: Printer sharing continues to be one of the important
benefits of computer networking. Print servers are the most efficient and
economical way of sharing printers on networks. While demand for print
servers in various sizes of businesses continues to grow, the market is
very competitive. Castelle has been involved in the print server business
for more than ten years. After continuous improvements on the cost and
feature set, Castelle's LANpress has become a well-received print server
product line. Our latest print server models incorporate a RISC
microprocessor, Fast Ethernet, Windows 2000, Internet Printing and many
other attractive new features. Castelle LANpress JR is the world's smallest
print server commercially available today. It's similar in size to that of
a standard printer cable connector. The suggested U.S. list price for
LANpress print servers ranges from $149 to $345. During fiscal 1999 and
2000, print server products represented 20% and 14%, respectively, of total
net sales.
The following table summarizes the Company's line of LANpress external
print servers:
-------------------------------------------------
Network Environment
-------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
Ethernet Windows Flash
Product Configuration Network NetWare UNIX 95/98/ Apple Upgrade Internet
Interface 3.x, TCP/IP NT/2000 Ethertalk Capability Printing
4.x, 5.x
----------------------------------------------------------------------------------------------------------------------
LANpress JR 10/100 MP (1) 10/100 |X| |X| |X| |X| |X| |X|
LANpress 3P/100 10/100 |X| |X| |X| |X| |X| |X|
LANpress Jr. MP (2) 10 |X| |X| |X| |X| |X| |X|
LANpress 2000 2+1 MP (3) 10/100 |X| |X| |X| |X| |X| |X|
----------------------------------------------------------------------------------------------------------------------
(1) 1 Centronics parallel port
(2) Connects directly to port on Printer
(3) Numbers refer to the number of parallel and serial port connections, respectively.
15
Research and Product Development
The Company has invested substantially in research and product development.
The Company believes its future performance will depend in large part on its
ability to enhance its current products, to expand its product offerings, to
maintain technological competitiveness and meet an expanding range of customer
requirements.
Castelle continues to invest in enhancing its server appliance product
lines 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. The changing corporate communications/messaging environment and
increasing demand for easy-to-use networking systems define these needs. The
development efforts are focused on enhancing functionality of existing products
and developing other systems to expand our product offerings. The Company is
leveraging its unique technology and engineering expertise in server appliances,
networking, and client and server software to develop a new line of office
messaging server appliances. The Company's development efforts are focusing on
high value applications, while relying on its partners to provide basic
functionality for some of its product lines.
In the year 2000, the Company developed new versions of its FaxPress
servers offering simpler integration with PBX's and email systems. The FaxPress
7500 offers 8 lines of fax and a 4-channel integrated DID or E&M converter that
significantly simplifies implementation of a fax system that provides automated
delivery of incoming faxes into individual mailboxes.
The current FaxPress fax server product line is continuously enhanced to
offer greater integration into corporate networking environments with such
features as:
o Integrated storage for system files and messages;
o Integrated email interfaces;
o Network-environment-independent operation; and
o Always-on operation.
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. See "Business -- Risk Factors -- Key
Personnel."
Sales, Marketing and Distribution
Castelle sells its products through multiple channels, 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 in Japan. Software enhancements and options that
complement the FaxPress products are primarily marketed directly by the Company
to registered end users. The direct sales group works closely with distributors
and VARs in qualifying sales opportunities for the fax and print server
products. The Company also sells some products through the on-line store on its
Web site. The Company's European headquarters located in the UK provides sales
and support services for Europe.
Demand for Castelle's products is created through a variety of marketing
programs. These programs are targeted toward end-users to stimulate demand for
the products and toward distributors, resellers, VARs
16
and e-commerce vendors to promote the product in the sales channel. These
programs include targeted and active participation in industry networking and
communication trade shows, as well as advertising in associated publications.
The Company increases awareness of Company products by Internet marketing via
targeted e-advertising, publishing and sponsoring email newsletters, enhancing
its Web presence, print advertising, conducting direct mail campaigns, offering
seminars, trade shows and conferences and other forms of public relations
efforts. To further expand its Internet marketing efforts, the Company has
deployed an e-marketing system by MarketFirst Software to better respond to
customers who contact the Company via the Internet. The Company's Web site has
been updated and designed to assist customers in obtaining information about
Castelle products and contacting Castelle sales personnel, and offers selected
products and services through the Company's on-line store.
The Company's products are well suited for sale by e-commerce vendors, and
the Company has experienced success working with leading suppliers such as CDW,
buy.com, Insight, MicroWarehouse domestically and Software Catalog and W-Store
in Europe.
The Company's five largest distributors accounted for approximately 43% of
the Company's net sales in fiscal 2000 and 42% of its net sales in fiscal 1999.
Ingram, the Company's largest domestic distributor, one single end-customer and
Macnica, the Company's principal Japanese distributor, accounted for
approximately 17%, 15% and 15%, respectively, of the Company's net sales in 2000
and 12%, 3% and 18%, respectively, of its net sales in 1999. Sales to customers
located in the Pacific Rim and Europe comprised approximately 24% and 31% of the
Company's net sales in fiscal 2000 and fiscal 1999, respectively. In 2000, the
Company terminated its agreement with Merisel, a domestic distributor, due to
the change in the distributor's business strategy, which was not in line with
the Company's. The Company's distributors typically represent other products
that are complementary to or compete with those of the Company. While the
Company attempts to encourage its distributors to focus on Castelle's products
through a variety of marketing and support programs, our distributors may give
higher priority to products of other suppliers, thereby reducing the efforts
they devote to selling our products. In particular, certain of our competitors,
including Hewlett-Packard and Intel, sell a substantially higher total dollar
volume of products through several of the Company's large U.S. 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. The
Company has a stock rotation policy with certain of its distributors that allows
them to return marketable inventory against offsetting orders. In the event that
the Company reduces 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. See "Business --
Risk Factors - Dependence on Suppliers and Subcontractors."
Customer Service and Support
The Company provides customers with support services, which are available
to assist customers with installation, use and operation issues that will ensure
smooth and reliable operation of Castelle products. The Company's network
engineers, located at corporate headquarters, provide technical support via
telephone, fax and email during normal Company business days from 6:00 a.m. to
5:00 p.m. (Pacific Time). As part of the Company's global partner program, VARs
have access to "priority technical support" via a special toll-free number that
provides immediate access to Castelle network engineers. Support is provided
under warranty as well as with different extended software and hardware support
agreements sold directly to the customer by the Company. The Company also has
other customer support, including a Web site as well as an internal help desk
system. The Company has an automated call management distribution system that
provides improved levels of support to help resolve customer issues.
17
Manufacturing
The Company's current in-house manufacturing operations consist primarily
of material planning, assembly, final testing, 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 manufacture 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 Conexant, and
microprocessors from Motorola, are currently available from 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. 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. See "Business -- Risk Factors - Dependence on Suppliers and
Subcontractors."
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."
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
18
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 registered some 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 March 1, 2001, the Company employed a total of 68 full-time
equivalent personnel, 14 in manufacturing, 19 in sales and marketing, 9 in
engineering, 14 in customer service and 12 in finance and administration. The
Company has not experienced a work stoppage, no employees are represented by a
labor organization and the Company considers its employee relations to be good.
19
Executive Officers
The names of the executive officers of the Company and their ages as of
March 1, 2001 are set forth below:
Name Age Position
Donald L. Rich 59 Chairman of the Board, President, Chief Executive Officer
Paul Cheng 52 Vice President, Finance and Administration, Chief
Financial Officer and Secretary
Eric Chen 48 Vice President, Engineering
Edward J. Heinze 55 Vice President, Sales, Americas
Michael Petrovich 39 Vice President, International Sales
Boris Elpiner 47 Vice President, Marketing
Donald L. Rich
Mr. Rich joined the Company in November 1998 and has served as Chief
Executive Officer and President from November 1998 to the present. Mr. Rich
became Chairman of the Board in May 1999. Mr. Rich has served as Chief
Financial Officer from April 1999 to March 2001 and Secretary from February
2000 to March 2001. From January 1997 until November 1998, Mr. Rich was
self-employed as a consultant. From 1993 through 1997, Mr. Rich was Chief
Executive Officer and President of Talarian Corporation, a provider of
communications middleware software. Prior to that, he held various sales
and marketing management positions at Integrated Systems, Inc. and
International Business Machines Corporation. Mr. Rich holds a BS degree in
Mechanical Engineering from Purdue University and an MBA from the Stanford
Graduate School of Business.
Paul Cheng
Mr. Cheng joined the Company in April 2000 and has served as Vice
President, Finance and Administration since that time. In March 2001, Mr.
Cheng was appointed as Chief Financial Officer and Secretary. Mr. Cheng
brings more than 20 years of financial experience from a successful career
that was launched in Hong Kong where he was the Plant Controller of
Fairchild Semiconductor operations. Before joining Castelle, he served as
the Vice President of Finance and Administration at Eclipse International,
Inc., a systems development company, from April 1997 to March 2000. In
addition, he has held various executive positions including the Vice
President of Finance at Quintus Corporation, a developer of customer
relations management software from December 1993 to August 1995 and
Corporate Controller at Power Integration, Inc., a semiconductor
manufacturer from October 1995 to March 1997. Mr. Cheng is a member of the
Chartered Certified Accountants and holds a BS degree in Accounting from
the Baptist College in Hong Kong.
20
Eric Chen
Mr. Chen joined the Company in 1989 and was appointed Vice President,
Engineering in May 2000. Mr. Chen initially worked on software development
projects including developing the first FaxPress e-mail gateways, porting
FaxPress to non-Novell platforms, and the first menu-driven installation
and configuration programs for both FaxPress and LANpress. Most recently,
Mr. Chen has been the Director of Print Server Product Marketing and
Business Unit and has managed the engineering development and manufacturing
business relationships with Castelle partners. Before joining Castelle, Mr.
Chen was with 3COM, a network solutions provider. Mr. Chen has a BS in
Engineering from Taiwan and an MS in Computer Science from the University
of Massachusetts.
Edward J. Heinze
Mr. Heinze has been with Castelle Inc. since 1994. Mr. Heinze was
appointed Vice President, Sales, Americas in January 2000. Prior to his
appointment to Vice President, Mr. Heinze served Castelle as Product
Manager of the Fax Product Line, and Regional Sales Manager. Before joining
Castelle, Mr. Heinze served in several capacities at Visual/White Pine
Software, a software developer, including Vice President of Sales. Prior to
his tenure at White Pine, he was Chief Operations Officer for XMARK, a
computer systems manufacturer, and Vice President of Sales and Marketing at
EIT, Millicom, Olympia, and Ontel. He holds a BS degree from Waynesburg
College.
Michael Petrovich
Mr. Petrovich, Vice President, International Sales, joined Castelle in
1992. He was appointed Vice President, International Sales in October 2000.
Prior to joining Castelle, Mr. Petrovich was the marketing communications
manager for Novell's National Reseller Organization, a software company. In
this role Mr. Petrovich focused on business strategies and development of
Novell's direct reseller sales channel. Before joining Novell, Mr.
Petrovich held sales and marketing positions at Excelan, a LAN
manufacturer, and International Microcircuits Incorporated, a semiconductor
company. Since joining Castelle, Mr. Petrovich has concentrated on
developing the Asia Pacific marketplace and its distribution sales channel.
Most recently Mr. Petrovich has taken on the responsibilities for all sales
outside the Americas, including Asia and Europe. Mr. Petrovich holds a BA
in Behavioral Sciences from San Jose State University.
Boris Elpiner
Mr. Elpiner, Vice President, Marketing is one of the members of the
original management team. He joined Castelle's technical staff in 1988 and
has been responsible for the hardware design of FaxPress and several other
products. In 1990, Mr. Elpiner assumed the role of the print server product
line manager, and later the fax server product line manager. He left
Castelle in 1995 and until 1999 worked for Global Village Communications, a
communications systems provider and Cadence Design Systems, a systems
design company. In 1999 Mr. Elpiner rejoined Castelle to lead our marketing
efforts and assist with the strategic product direction for the Company. He
was appointed Vice President, marketing in October 2000. Before joining
Castelle in 1988, Mr. Elpiner worked for Daisy Systems, MCC Powers,
Matsushita Electric, and Northern Telecom. Mr. Elpiner has an MSEE from the
Moscow Institute of Telecommunications and a Masters in Engineering
Management from Northwestern University.
21
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 Morgan Hill, California in
approximately 16,600 square-feet of leased office space. The Company occupies
this facility under a lease, the term of which expires in December 2005. The
Company moved into this new facility in December 2000 from the previous location
in Santa Clara, California, after the Santa Clara lease expired. The Company
also occupies an additional 2,000 square-feet of leased office space located in
El Dorado Hills, California. This facility is under a lease, expiring in March
2001. The Company does not have any intention to extend the lease, but instead,
will consolidate the El Dorado Hills operations with the headquarters in Morgan
Hill. In addition, the Company rents office space for sales and customer support
offices in Illinois, Pennsylvania and the United Kingdom. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Subsequent to our Annual Meeting of Shareholders held on May 10, 2000,
there were no matters submitted to a vote of securities holders in the remainder
of fiscal 2000. The voting results from the Annual Meeting of Shareholders were
included in the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock (Nasdaq symbol "CSTL") began trading on the
Nasdaq National Market on December 20, 1995 and was transferred to the Nasdaq
SmallCap Market as of April 1999. The following table shows the intraday high
and low sale prices per share of Castelle's Common Stock as reported on the
Nasdaq National Market for the periods indicated prior to April 1999 and as
reported on the Nasdaq SmallCap Market for the periods indicated after April
1999. Such quotations do not include retail markups, markdowns or commissions.
FISCAL 1999 HIGH LOW
First Quarter $1.50 $0.50
Second Quarter $1.16 $0.38
Third Quarter $1.25 $0.62
Fourth Quarter $2.38 $0.88
FISCAL 2000 HIGH LOW
First Quarter $4.00 $1.13
Second Quarter $2.13 $1.16
Third Quarter $1.88 $1.00
Fourth Quarter $1.44 $0.75
As of December 31, 2000, there were 116 holders of record of the Company's
Common Stock. On March 13, 2001 the last sale price reported on the Nasdaq
SmallCap Market for the Company's Common Stock was $1.31 per share.
Dividend Policy
The Company has not paid cash dividends on its Common Stock. The Board of
Directors currently intends to retain any and all earnings for use in the
Company's business and the Company does not anticipate paying cash dividends in
the foreseeable future.
23
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 Annual Report on Form 10-K.
Years ended December 31,
..........................................................................
2000 1999 1998 1997 1996
-------------- ------------- -------------- ------------ ------------
(in thousands, except per share amounts)
INCOME STATEMENT DATA:
Net Sales $14,832 $16,116 $21,746 $25,343 $29,461
Gross Profit $9,380 $ 8,404 $11,598 $13,507 $14,468
Gross Profit as a % of Net Sales 63% 52% 53% 53% 49%
Net income/(loss) $732 ($3,555) ($7,534) ($6,895) $5,724
Net income/(loss) as a % of Net Sales 5% (22%) (35%) (27%) 19%
Net income/(loss) per share - diluted $0.14 ($0.78) ($1.67) ($1.54) $1.45
BALANCE SHEET DATA:
Cash and Cash Equivalents $3,893 $4,714 $3,924 $6,204 $8,161
Working Capital $3,876 $3,555 $6,763 $10,816 $13,163
Total Assets $8,543 $8,502 $12,494 $18,926 $27,303
Long-term Liabilities $63 -- $98 $52 --
Shareholders' Equity $4,683 $4,020 $7,501 $14,855 $21,616
Net loss for fiscal 1999, 1998 and 1997 included net charges for
restructuring and other non-recurring items of $400,000, $1.1 million and $6.1
million respectively, and a net benefit of $2.5 million in fiscal 1996. For
detailed information on these transactions see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Restructuring and
Other Charges and Amortization of Intangible Assets" and the Consolidated
Financial Statements and related Notes thereto included elsewhere in this Annual
Report on Form 10-K.
Quarterly Results of Operations
The following table sets forth certain unaudited consolidated quarterly
financial data for the eight quarters ended December 31, 2000. This information
is unaudited, but in the opinion of management, has been prepared substantially
on the same basis as the audited consolidated financial statements appearing
elsewhere in this report, and all necessary adjustments, consisting only of
normal recurring adjustments, hade been included in the amounts stated below to
present fairly the unaudited consolidated financial statements and the notes to
such statements appearing elsewhere in this report. The results of operations
for any quarter are not necessarily indicative of the results of operations for
any future period.
24
Selected Quarterly Data (unaudited)
Fiscal Year 2000, Quarter Ended
----------------------------------------------------------------------------
Mar 31 Jun 30 Sep 29 Dec 31
----------------------------------------------------------------------------
(in thousands, except per share data)
Revenue $4,100 $3,761 $3,730 $3,241
Gross profit 2,451 2,451 2,416 2,062
Profit from operations 168 214 224 59
Net profit 169 211 240 112
Net profit per share 0.03 0.04 0.05 0.02
Fiscal Year 1999, Quarter Ended
----------------------------------------------------------------------------
Apr 02 Jul 02 Oct 01 Dec 31
----------------------------------------------------------------------------
(in thousands, except per share data)
Revenue $4,468 $3,738 $4,017 $3,893
Gross profit 1,619 1,985 2,470 2,330
Profit/(loss) from operations (1,418) (1,462) (867) 97
Net profit/(loss) (1,411) (1,460) (798) 114
Net profit/(loss) per share (0.33) (0.31) (0.17) 0.02
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATION
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that are subject to
many risks and uncertainties that could cause actual results to differ
significantly from expectations. For more information on forward-looking
statements, refer to the "Special Note on Forward Looking Statements" at the
front of this Annual Report on Form 10-K.
Our products have historically centered on fax and print servers and
related technologies. Starting in 1997, our revenues have declined as
competition increased, primarily with the print server products in the Asia
Pacific Region, while at the same time the Internet and other networking
technologies advanced. As a result, we experienced annual operating losses
beginning from fiscal 1997 through fiscal 1999. During the past three years, we
have redirected our efforts to focus on server appliances and on development
efforts to integrate existing and future products with the Internet and emerging
networking technologies. We introduced our new products, the FaxPress 5000 in
February 1999, FaxPress 2500 in November 1999, FaxPress SBE in February 2000,
the FaxPress 7500 in September 2000 and the OfficeDirect family of products in
the fourth quarter of 2000. Through mainly the release of these enhanced
products in the fax messaging family, our gross profit improved and the total
cost of sales have decreased from 46.7% in fiscal 1997 to 36.8% in fiscal 2000.
In fiscal 1997, we announced and began to implement a restructuring plan,
which was mostly completed in fiscal 1999. As a result, operating expenses, not
including non-recurring restructuring charges, were reduced from $14.6 million
in fiscal 1997 to $14.1 million, $11.6 million and $8.7 million, respectively,
in fiscal 1998, 1999 and 2000.
25
With the gross profit improvement, restructuring and implementing numerous
other product cost reductions, we were able to report an operating profit in the
fourth quarter of fiscal 1999, and in each of the four quarters in fiscal 2000.
Additionally, increased cash management provided a positive cash flow in
fiscal 1999 and improved working capital in fiscal 2000.
Results of Operations
Comparison of Years Ended December 31, 2000 and 1999
Net Sales
Net sales consist of sales from product sales, which are
calculated net of returns and allowances, plus extended warranty
contracts, to distributors and end-users. Sales of products to
end-users are recognized upon shipment. Sales of products to
distributors who have limited stock rotation rights are also
recognized upon shipment, but are reduced by our estimates of
anticipated exchanges and returns, even though we require our
distributors to purchase additional products of equal value for the
rotated products. Revenue from the sale of extended warranty contracts
is recognized ratably over the period of the contracts.
Net sales decreased 8% to $14.8 million in fiscal 2000 from $16.1
million in fiscal 1999. The decline of $1.3 million in net sales
resulted primarily from lower sales of our print server products of
$1.1 million, or 35%, mainly to customers in the Asia Pacific region
and a slight decrease of $157,000, or 1%, in sales of our fax server
products mainly to the domestic channels.
International sales were $3.6 million in fiscal 2000 as compared
to $4.9 million in fiscal 1999, representing 24% and 31%,
respectively, of total net sales. Lower international sales were
largely due to reduced demand for our print server products in Europe
and Asia Pacific regions. Most of our international sales have been
denominated in U.S. dollars and thus could be adversely affected by
changes in demand resulting from fluctuations in currency exchange
rates.
Domestic sales were $11.1 million in fiscal 2000 and were
consistent with fiscal 1999, and represented 75% and 69%,
respectively, of total net sales for fiscal 2000 and fiscal 1999,
respectively.
In fiscal 2000, two distributors and one customer accounted for
approximately 17%, 15% and 15% of our net sales. In fiscal 1999, the
same two distributors and one customer accounted for approximately
12%, 18% and 3% of net sales, respectively.
Cost of Sales; Gross profit
Gross profit is equal to net sales less 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,
obsolescence and manufacturing costs and warranty expenses. Gross
profit increased to $9.4 million, or 63% of net sales, in fiscal 2000,
from $8.4 million, or 52% of net sales, in fiscal 1999. Efficiencies
realized from the restructuring in fiscal 1998 and fiscal 1999,
continuous product cost reductions and outsourcing of manufacturing
contributed to the improvements in gross profit in fiscal 2000. In
fiscal 1999, we also recognized $1.5 million of expenses related to
the disposal of obsolete inventory.
26
Research and Development
Research and development expenses consist primarily of
employee-related expenses and expensed material and facility costs
associated with the development of new products. Research and product
development expenses were $1.8 million and $2.7 million in fiscal 2000
and fiscal 1999, respectively, and represented 12% and 17% of net
sales for those periods. The absolute dollar amount of research and
product development expense decreased in fiscal 2000 due to improved
expense controls and staff reductions that occurred in fiscal 1999.
Research and development spending has supported existing products and
the development of unified messaging server appliances. However, we
continue to be committed to the development of highly competitive new
products and services through the efficient utilization of our
engineering resources.
Sales & Marketing
Sales and marketing expenses consist primarily of
employee-related expenses, commissions to sales representatives,
product promotion expenses, facilities expenses, including expenses
associated with our regional sales and support offices. Sales and
marketing expenses were $5.3 million and $6.7 million for fiscal 2000
and fiscal 1999, respectively, and represented 36% and 42% of net
sales for those periods. The reduction in expenses compared to fiscal
1999 was largely due to a reduction in personnel related costs,
occupancy and other cost savings.
General & Administrative
General and administrative expenses consist primarily of
employee-related expenses for administration, finance, human resources
and general management, as well as consulting, outside services, legal
and auditing expenses. General and administrative expenses were $1.7
million and $2.1 million for fiscal 2000 and fiscal 1999,
respectively, or 11% and 13% of net sales for those periods. The
decrease in expenses in fiscal 2000 was mostly due to lower legal and
personnel related costs.
Restructuring and Other Charges & Amortization of Intangible Assets
There were no restructuring and other charges recorded in fiscal
2000.
In fiscal 1999, we recognized a restructuring charge of $402,000
for expenses associated with our exit from the Object-Fax NT product
line including the disposition of excess inventory, reductions in
personnel and the write-off of excess office space. This disposition
is expected to reduce our operating costs in future years.
In April 1998, we acquired the Object-Fax NT product from
Tolvusamskipti HF, an Icelandic corporation. A portion of the purchase
price was allocated to in-process research and development, and,
accordingly, we recorded a one-time charge against earnings in the
second quarter of fiscal 1998 of $1.1 million, as the technology
acquired had not reached technological feasibility and had no
alternative future use. We also recorded intangible assets of
$160,000, which were amortized over 12 months, resulting in a $120,000
charge in fiscal 1998. In determining the amount of in-process
research and development, we engaged an independent valuation firm to
conduct an appraisal of the acquired assets. The intangible assets
acquired, including in-process research and development, were valued
based on estimates of future cash flows discounted to their present
value at risk-adjusted rates of return.
27
Interest and other income, net
Interest and other income, net, was $73,000 and $99,000 in fiscal
2000 and fiscal 1999, respectively. The reduction in other income
reflected mostly higher translation losses from foreign currency
transactions in fiscal 2000, and higher bank and credit card
processing fees offset in part by higher interest income due to
changes in cash balances and interest rates.
Provision for Income Taxes
In fiscal 2000, our provision for incomes taxes was $6,000,
representing state taxes only. Our current income tax provision was
offset by the utilization of our net operating loss carry forward.
In fiscal 1999, our provision for income taxes was $4,000,
representing state taxes only. Because of our net loss in fiscal 1999,
there were no federal nor substantial state income taxes recognized.
Comparison of Years Ended December 31, 1999 and 1998
Net Sales
Net sales decreased 26% from $21.7 million in fiscal 1998 to
$16.1 million in fiscal 1999. The sales shortfall resulted primarily
from lower sales of our main product lines, including a $3.7 million
decrease in print server products in Asia, and our efforts to manage
down the inventory in the distribution channels. Sales in fiscal 1998
had been reduced by increases in the sales return allowance of $1.2
million.
International sales were $4.9 million and $8.3 million in fiscal
1999 and fiscal 1998, respectively, representing 31% and 38% and,
respectively, of net sales. Lower international sales were the result
of a reduction in general demand for our print server products in Asia
and increased local competition in Europe.
Domestic sales were $11.2 million in fiscal 1999, as compared to
$13.5 million in fiscal 1999, representing 69% and 62%, respectively,
of total net sales. This reduction of $2.3 million, or 17% was chiefly
due to managing down the inventory in the distribution channels.
In fiscal 1999, two separate distributors accounted for
approximately 18% and 12% of net sales. In fiscal 1998, the same
distributors accounted for approximately 26% and 15% of net sales,
respectively.
Cost of Sales; Gross profit
Gross profit decreased to $8.4 million, or 52% of net sales in
fiscal 1999, from $11.6 million, or 53% of net sales in fiscal 1998.
During fiscal 1999, we reduced manufacturing overhead by $400,000
through reduction of personnel and other cost savings, but recognized
$1.5 million of expenses related to disposal of obsolete inventory.
Research and Development
Research and development expenses were $2.7 million and $2.9
million in fiscal 1999 and fiscal 1998, respectively, representing 17%
and 13% of total net sales for those periods. The slight
28
reduction in research and development expenses in fiscal 1999 compared
to fiscal 1998 was mainly due to improved expense controls.
Sales & Marketing
Sales and marketing expenses were $6.7 million in fiscal 1999 and
$8.8 million in fiscal 1998, representing 42% and 40%, respectively,
of total net sales for those periods. The expense decline in was due
to a reduction in personnel, lower marketing promotion, trade show,
occupancy and other cost savings.
General & Administrative
General and administrative expenses were $2.1 million and $2.4
million for fiscal 1999 and fiscal 1998, respectively, or 13% and 11%
of net sales for those periods. The decrease in expenses in fiscal
1999 was chiefly due to a lower allowance for doubtful accounts and
overall cost savings, offset by increases in the amounts paid for
administrative salaries and bonuses.
Interest and other income, net
Interest and other income, net, was $99,000 and $174,000 in
fiscal 1999 and fiscal 1998, respectively. The higher interest income
reflected mostly higher cash balances in fiscal 1998.
Provision for Income Taxes
In fiscal 1999, our provision for income taxes was $4,000,
representing state taxes only. Because of our net loss in fiscal 1999,
there were no federal nor substantial state income taxes recognized.
In addition, the tax benefit for 1999 was entirely offset by an
increase in our valuation allowance against our deferred tax assets,
including the benefit from our net operating loss carry forward.
In the fourth quarter of 1998, due to the uncertainty surrounding
the realization of favorable tax attributes in future tax returns, we
provided a full valuation allowance against our deferred tax asset,
resulting in a non-recurring, non-cash charge of $4.0 million.
29
Liquidity and Capital Resources
Since our initial public offering of common stock in December 1995, our
principal source of funding has been cash from our operations, with some funding
from capital equipment lease lines. As of December 31, 2000, we had $3.9 million
of cash and cash equivalents, reduced from $4.7 million as of December 31, 1999.
The reduction in cash and cash equivalents in fiscal 2000 was attributable in
part to a cash settlement in early 2000 for $474,000 of a dispute with a vendor
and a $500,000 investment in December for leasehold improvements in our new
headquarters in Morgan Hill, California. Working capital, defined as current
assets less current liabilities, improved slightly to $4 million at December 31,
2000 from $3.6 million at December 31, 1999.
We have a $3.0 million secured revolving line of credit with a bank, which
expires in March 2001, pursuant to which we may borrow 100% against pledges of
cash at the bank's prime rate (9.50% at December 31, 2000). Borrowings under
this line of credit agreement are collateralized by all of our assets. We are in
compliance with the terms of the agreement, and at December 31, 2000 had no
borrowings under the line of credit. We expect to negotiate an extension of this
line of credit.
In December 1997, as a source of capital asset financing, we entered into a
loan and security agreement with a finance company for an amount up to $288,000.
The amounts borrowed are subject to interest of 10.11%, were repayable by
December 2000, and were partially collateralized by a certificate of deposit of
$125,000, which is included as restricted cash on the accompanying balance
sheet. The loan was completely paid off as of December 31, 2000. The restricted
cash was returned to us in February 2001.
In December 2000, as a source of capital asset financing, we entered into a
loan and security agreement with a finance company for an amount of $75,000.
This loan is subject to interest of 12.82% and is repayable by December 2006. As
of December 31, 2000, the future minimum payments are $72,000.
As of December 31, 2000, net accounts receivable were $2.1 million, an
increase from $1.5 million at December 31, 1999. The increase was mostly
attributable to slower than expected collections.
Net inventories as of December 31, 2000 were $1.4 million, consistent with
net inventories at December 31, 1999. Due to the continued decline in sales of
our print server products, we have less of the related components and finished
inventory, but have increased inventory in fiscal 2000 in relation to our
enhanced fax server and OfficeDirect products.
We acquired additional property and equipment of $593,000, $184,000, and
$223,000 in fiscal 2000, 1999 and 1998, respectively. The increase in property
and equipment in fiscal 2000 was largely a reflection of the investment of
leasehold improvements in our new headquarters, and excluded capital equipment
of $75,000 purchased through an equipment lease.
In fiscal 1998, we acquired the Object-Fax NT product line for a total
purchase price of $1.4 million, including $300,000 in cash and 440,000 shares of
Castelle Common Stock.
Although we believe that our existing capital resources and expected cash
flows from operations will be sufficient to meet its anticipated capital
requirements at least through the next 12 months, we 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 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.
30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We considered the provision of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." We had no
holdings of derivative financial or commodity instruments at December 31, 2000.
However, we are exposed to financial market risks, including changes in interest
rates and foreign currency exchange rates. While much of our revenue is
transacted in U.S dollars, some revenues and capital spending are transacted in
Pounds Sterling. These amounts are not currently material to our financial
statements; therefore we believe that foreign currency exchange rates should not
materially affect our overall financial position, results of operations or cash
flows. The fair value of our money market account or related income would not be
significantly impacted by increases or decreases in interest rates due mainly to
the highly liquid nature of this investment. However, sharp declines in interest
rates could seriously harm interest earnings on this account.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) The following financial statements of the Company and the report of
the Company's independent accountants are included in Item 14:
Page in
Form 10-K
Report of Independent Accountants............................................. F-1
Consolidated Balance Sheets as of December 31, 2000 and 1999.................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998......................................... F-3
Consolidated Statement of Shareholders' Equity for the years ended
December 31, 2000, 1999 and 1998......................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998......................................... F-5
Notes to Consolidated Financial Statements.................................... F-6
(b) The following financial statement schedules of Castelle for the years
ended December 31, 2000, 1999 and 1998 are filed as part of this Form
10-K and should be read in conjunction with the Company's Financial
Statements.
Page in
Form 10-K
Report of Independent Accountants............................................. F-1
Schedule II - Valuation and Qualifying Accounts............................... F-21
Schedules not listed above have been omitted because they are not
applicable or are not required or because the required information is
included in the Financial Statements or Notes thereto.
31
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Directors
The information required by this Item concerning the Company's directors is
incorporated by reference from the sections captioned "Proposal 1: Election of
Directors" contained in the Company's definitive Proxy Statement related to the
2001 Annual Meeting of Shareholders (the "Proxy Statement"), to be filed by the
Company with the Securities and Exchange Commission.
Identification of Executive Officers
The information required by this Item concerning the Company's executive
officers is set forth in Part I of this Report.
Compliance with Section 16(a) of the Exchange Act
The information required by this Item is incorporated by reference from the
section captioned "Compliance with Section 16(a) of the Securities and Exchange
Act of 1934" contained in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
section captioned "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from the
sections captioned "Certain Transactions" and "Executive Compensation" contained
in the Proxy Statement.
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on
Form 10-K:
1. Consolidated Financial Statements required to be filed by Item 8
of Form 10-K. See the list of Financial Statements contained in
Item 8 of this Report.
2. Financial Statement Schedules required to be filed by Item 8 of
Form 10-K. See the list of Financial Statement Schedules
contained in Item 8 of this Report.
(b) Reports on Form 8-K - None
(c) Exhibits
3.1(1) Amended and Restated Articles of Incorporation of the Company.
3.2 Amended and Restated Bylaws of the Company, as amended
through January 25, 2001.
4.1 Reference is made to Exhibits 3.1 and 3.2.
10.1(2)* 1995 Non-Employee Directors' Stock Option Plan, as amended,
and form of Director Stock Option Agreement.
10.2(1)* Form of Indemnity Agreement between the Registrant and each
of its directors and executive officers.
10.3(1) OEM Purchase Agreement dated May 23, 1995, by and between
the Registrant and SerComm Corporation.
10.4(1) Distribution Agreement dated February 26, 1990, by and
between the Registrant and Ingram Micro D Inc.
10.5(1) Distributor Contract dated June 25, 1991, as amended
June 25,1991, by and between the Registrant and Tech Data
Corporation.
10.6(1) Distribution Agreement dated March 26, 1992, as amended
March 26, 1992, by and between the Registrant and
Merisel, Inc.
10.7(1) Distributor Agreement dated October 1, 1990, by and between
the Registrant and Vitek.
10.8(1) International Distributor Agreement dated February 24,
1994, by and between the Registrant and Macnica.
10.9(3)* 1988 Equity Incentive Plan, as amended and form of option
agreements.
10.11(2)*Form of Executive Severance and Transition Benefits
Agreement between the Company and Messier. D. Rich.
10.12(4)*Employment agreement between the Company and Messier. D.
Rich.
11.1 Computation of Net Income (Loss) Per Share. Reference is
made to page F-20 of the Notes to Consolidated Financial
Statements.
23.1 Consent of PricewaterhouseCoopers LLP.
24.1 Power of Attorney. Reference is made to the signature page.
------------------
(1) 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.
(2) Filed as an exhibit to the Company Form 10-K for the fiscal year ended
December 31, 1999 and incorporated herein by reference.
(3) Filed as an exhibit to the Company's Form 10-Q for the period ended
March 31, 2000 and incorporated herein by reference.
34
(4) Filed as an exhibit to the Company's Form 10-K for the fiscal year
ended December 31, 1998 and incorporated herein by reference.
* Indicates management contracts or compensatory plans or arrangements
filed pursuant to Item 601(b)(10) of Regulation S-K.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, an amended, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized on the thirtieth day of March 2001.
By: /S/ DONALD L. RICH
-----------------------------------------------
Donald L. Rich
Chief Executive Officer and President
KNOW BY ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Donald L. Rich, as his true and lawful
attorney-in-fact and agent, with full power of substitution for him, and in his
name in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent, 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 attorney-in-fact and
agent, 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 Annual Report on Form 10-K has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates indicated:
Name Title Date
/S/ DONALD L. RICH Chairman of the Board and Director, March 29, 2001
------------------
Donald L. Rich Chief Executive Officer, President (principal executive
officer)
/S/ PAUL CHENG Vice President, Finance and Administration, Chief March 29, 2001
-------------- Financial Officer (principal accounting officer),
Paul Cheng Secretary
/S/ PETER TIERNEY Director March 29, 2001
-----------------
Peter Tierney
/S/ SCOTT MCDONALD Director March 29, 2001
------------------
Scott McDonald
/S/ ROBERT HAMBRECHT Director March 29, 2001
--------------------
Robert Hambrecht
/s/ JACK HOWARD Director March 29, 2001
---------------
Jack Howard
36
Castelle and Subsidiaries
Consolidated Financial Statements
as of December 31, 2000 and 1999
and for each of the three years in the
period ended December 31, 2000
Report of Independent Accountants
To the Board of Directors and
Shareholders of Castelle
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the consolidated financial position of
Castelle and subsidiaries at December 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with generally accepted accounting
principles in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
San Jose, California
February 14, 2001
Castelle and Subsidiaries
Consolidated Balance Sheets
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
December 31,
....................................
2000 1999
---------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 3,893 $ 4,714
Restricted cash 125 125
Accounts receivable, net of allowance for doubtful accounts
of $285 in 2000 and $493 in 1999 2,083 1,525
Inventories 1,363 1,411
Prepaid expenses and other current assets 209 262
---------------- -----------------
Total current assets 7,673 8,037
Property and equipment, net 768 387
Other, net 102 78
---------------- -----------------
Total assets $ 8,543 $ 8,502
================ =================
Liabilities and Shareholders' Equity
Current liabilities:
Long-term debt, current portion $ 9 $ 98
Accounts payable 1,014 1,336
Accrued liabilities 2,681 3,048
---------------- -----------------
Total current liabilities 3,704 4,482
Long-term debt, net of current portion 63 -
---------------- -----------------
Total liabilities 3,767 4,482
---------------- -----------------
Commitments (see Note 5)
Shareholders' Equity:
Preferred stock, no par value:
Authorized: 2,000 shares in 2000 and 1999
Issued and outstanding: none in 2000 and 1999 - -
Common stock, no par value:
Authorized: 25,000 shares
Issued and outstanding: 4,741 shares in 2000
and 4,641 shares in 1999 28,976 29,002
Deferred compensation (17) (67)
Accumulated deficit (24,183) (24,915)
---------------- -----------------
Total shareholders' equity 4,776 4,020
---------------- -----------------
Total liabilities and shareholders' equity $ 8,543 $ 8,502
================ =================
F-2
The accompanying notes are an integral part of these financial statements.
Castelle and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per share data)
-----------------------------------------------------------------------------------------------------------------------
Years Ended December 31
........................................................
2000 1999 1998
----------------- ----------------- -----------------
Net sales $ 14,832 $ 16,116 $ 21,746
Cost of sales 5,452 7,712 10,148
----------------- ----------------- -----------------
Gross profit 9,380 8,404 11,598
----------------- ----------------- -----------------
Operating expenses:
Research and development 1,759 2,741 2,878
Sales and marketing 5,293 6,732 8,776
General and administrative 1,663 2,139 2,443
Amortization of intangible assets - 40 120
Restructuring and other charges - 402 1,124
----------------- ----------------- -----------------
8,715 12,054 15,341
----------------- ----------------- -----------------
Operating income/(loss) 665 (3,650) (3,743)
Interest income, net 195 126 170
Other income (expense), net (122) (27) 4
----------------- ----------------- -----------------
Income/(loss) before provision for
income taxes 738 (3,551) (3,569)
Provision for income taxes 6 4 3,965
----------------- ----------------- -----------------
Net income/(loss) $ 732 $ (3,555) $ (7,534)
================= ================= =================
Net income/(loss) per common share - basic $ 0.16 $ (0.78) $ (1.67)
================= ================= =================
Shares used in per share calculation - basic 4,664 4,579 4,507
================= ================= =================
Net income/(loss) per common share - diluted $ 0.14 $ (0.78) $ (1.67)
================= ================= =================
Shares used in per share calculation - diluted 5,080 4,579 4,507
================= ================= =================
F-3
The accompanying notes are an integral part of these financial statements.
Castelle and Subsidiaries
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 2000, 1999 and 1998
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Notes
Receivable
for
Purchase
of
Common Stock Common Deferred Accumulated
.......................... Stock Compensation Deficit Total
Shares Amount
------------ ------------ ----------- ------------- ------------ ------------
Balances, December 31, 1997 4,490 $ 28,955 $ (274) $ - $ (13,826) $ 14,855
Repurchase of common stock (293) (384) - - - (384)
Issuance of common stock through
exercise of stock options 40 12 - - - 12
Issuance of common stock in
connection with acquisitio 100 500 - - 500
Deferred compensation related to options issued to - 160 - (160) - -
consultant
Amortization of deferred compensation - - - 40 - 40
Compensation expense related to fully vested
options
granted to consultant - 12 - - - 12
Net loss - - - - (7,534) (7,534)
------------ ------------ ----------- ------------- ------------ ------------
Balances, December 31, 1998 4,337 $ $ (274) $ (120) $ (21,360) $ 7,501
29,255
Issuance of common stock through
exercise of stock options 17 10 - - - 10
Issuance of common stock in
connection with acquisition 340 - - - - 0
Amortization of deferred compensation 53 53
Repayment of notes receivable - - 11 - - 11
Cancellation of notes receivable 263 263
Retirement of restricted stock (53) (263) - - - (263)
Net loss - - - - (3,555) (3,555)
------------ ------------ ----------- ------------- ------------ ------------
Balances, December 31, 1999 4,641 $ 29,002 $ - $ (67) $ (24,915) $ 4,020
------------ ------------ ----------- ------------- ------------ ------------
Issuance of common stock through
exercise of stock options 30 24 - - - 24
Exchange of warrants
for common stock 70 - - - - -
Deferred compensation related to options issued to - 17 - (17) - -
consultant
Write-off of deferred compensation
related to cancelled options - (67) - 67 - -
Net - - - - 732 732
income
------------ ------------ ----------- ------------- ------------ ------------
Balances, December 31, 2000 4,741 $ 28,976 $ - $ (17) $ (24,183) $ 4,776
============ ============ =========== ============= ============ ============
F-4
The accompanying notes are an integral part of these financial statements.
Castelle and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2000, 1999 and 1998
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
....................................................
2000 1999 1998
---------------- ---------------- ----------------
Cash flows from operating activities:
Net income (loss) $ 732 $ (3,555) $ (7,534)
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating activities:
Depreciation and amortization 260 440 640
Purchased in-process research and development - - 1,124
Provision for doubtful accounts and sales returns (257) - 909
Provision for excess and obsolete inventory (80) 1,579 418
Compensation expense related to grant of stock options - 53 52
Loss on disposal of fixed assets (10) 81 40
Changes in assets and liabilities:
Accounts receivable (301) 1,947 (1,108)
Inventories 128 749 (371)
Prepaid expenses and other current assets 53 136 175
Other assets (24) 34 24
Accounts payable (322) (748) 772
Accrued liabilities (367) 333 95
Deferred income taxes - - 3,934
---------------- ---------------- ----------------
Net cash (used in)/provided by operating activities (188) 1,049 (830)
---------------- ---------------- ----------------
Cash flows from investing activities:
Acquisition of property and equipment (593) (184) (223)
Proceeds from sale of fixed assets 34 - -
Acquisition of Object-fax product line - - (910)
---------------- ---------------- ----------------
Net cash used in investing activities (559) (184) (1,133)
---------------- ---------------- ----------------
Cash flows from financing activities:
(Increase) decrease in restricted cash - - 142
Proceeds from notes payable - - (87)
Repayment of notes payable (98) (96) -
Proceeds from collection of note receivable for stock - 11 -
Proceeds from issuance of common stock and warrants, net of 24 10 (372)
repurchases
---------------- ---------------- ----------------
Net cash used in financing activities (74) (75) (317)
---------------- ---------------- ----------------
Net (decrease) increase in cash and cash equivalents (821) 790 (2,280)
Cash and cash equivalents, beginning of period 3,924 6,204
4,714
---------------- ---------------- ----------------
Cash and cash equivalents, end of period $ 3,893 $ 4,714 $ 3,924
================ ================ ================
Supplemental information:
Cash paid during the period for:
Interest $ 6 $ 19 $ 27
Income taxes $ 5 $ 47 $ 5
Noncash investing and financing activities:
Issuance of common stock for acquisition of Object-fax $ - $ - $ 500
product line
Note payable for fixed asset acquisition $ 75 $ - $ -
Warrants converted into common stock $ 70 $ - $ -
F-5
The accompanying notes are an integral part of these financial statements.
Castelle and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
1. Business and Organization of the Company
Castelle designs, develops, markets and supports server appliances providing
office messaging solutions and other shared services. The Company's current
products are focused on two areas: fax and integrated messaging products,
including a range of software enhancements, and print servers. The Company's
products consist of FaxPress, an integrated hardware/software network faxing
solution; OfficeDirect, an integrated fax/email messaging system; InfoPress, an
enterprise-level fax-on-demand software product and LANpress print servers.
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, e-commerce retailers and
other resellers in the United States, Europe and the Pacific Rim. The Company
also has relationships with selected original equipment manufactures 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, the United Kingdom 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 maturities
of three months or less.
Amounts reported for cash equivalents, receivables and other financial
instruments approximate fair values based upon comparable market information
available at the respective balance sheet dates.
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.
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 59% of accounts
receivable at December 31, 2000 and three customers accounted for 42% of
accounts receivable at December 31, 1999.
F-6
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.
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 recognized in the year of disposition.
Accounting for long-lived assets
The Company reviews property, equipment, goodwill and other intangible assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability is measured
by comparison of its carrying amount to future net cash flows the assets are
expected to generate. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the asset exceeds its fair market value.
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 if a signed contract exists, the fee
is fixed and determinable, collection of the resulting receivables is probable
and product returns are reasonably estimable. 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 and anticipated retroactive
price adjustments are recorded at the time products are shipped. The Company
recognizes revenue from the sale of extended warranty contracts ratably over the
period of the contracts.
In December 1999 the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101 "Revenue Recognition in Financial Statements"
which provides guidance on the recognition, presentation and disclosure of
revenue in financial statements filed with the SEC. SAB 101 outlines the basic
criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. The impact of SAB 101 has
not had a material impact on the financial position or results of operations of
the Company.
F-7
Advertising costs
Advertising costs, included in sales and marketing expenses, are expensed as
incurred and were $1,171,000, $889,000 and $1,963,000 in 2000, 1999 and 1998,
respectively.
Foreign currency translation
The functional currency of the Company's foreign subsidiary is the U.S. dollar.
Foreign currency translation gains and losses are reported in the statement of
operations. For fiscal 2000, the Company experienced a foreign currency loss of
$77,000. There were no significant foreign currency gains or losses in fiscal
1999 and 1998.
Net income/(loss) per share
Basic net income/(loss) per share is computed by dividing net income/(loss)
available to common shareholders by the weighted average number of common shares
outstanding for that period. Diluted net income/(loss) per share is computed
giving effect to all dilutive potential common shares that were outstanding
during the period. Dilutive potential shares consist of incremental common
shares issuable upon exercise of stock options and warrants.
Restructuring
In 1999, the Company recognized a restructuring charge of $402,000, including
the disposition of assets associated with the Company's exit from the ObjectFax
NT product line of $213,000, reducing headcount by 14 for a charge of $110,000,
the write-off of excess office space of $63,000 and other costs of $16,000. As
of December 31, 1999, the Company had made actual payments of $295,000. In
fiscal 2000, the Company continued to pay vacated lease payments of $23,000,
leaving a balance of $84,000 for future obligations.
Comprehensive income
Under Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" disclosure of comprehensive income and its components is
required in financial statements. Comprehensive income is the change in equity
from transactions and other events and circumstances other than those resulting
from investments by owners and distributions to owners. There are no significant
components of comprehensive income excluded from net income, therefore, no
separate statement of comprehensive income has been presented.
Segment information
The Company has determined that it uses one measurement of profitability of its
business for internal reporting, and therefore operates in one segment. The
Company's international operations in 2000, 1999 and 1998 are discussed in Note
11.
New accounting pronouncements
Under Statement of Financial Accounting Standards ("SFAS") 133, "Accounting for
Derivative Instruments and Hedging Activities," companies are required to
recognize all derivatives as either assets or liabilities in the statement of
financial position and to measure those instruments at fair value. Changes in
fair value shall be recognized currently in earnings. Management believes the
impact of SFAS No. 133 will not be material on the financial position or results
of operations of the Company. The Company will adopt SFAS No. 133, as amended,
in its first quarterly filing for fiscal 2001.
F-8
3. Acquisition of the Object-Fax NT Product Line
In April 1998, the Company completed its acquisition of the Object-Fax NT
product line, a facsimile software application designed for LAN's, WAN's and
Internet-based networks, from Tolvusamskipti HF, an Icelandic corporation. The
acquisition has been accounted for as a purchase, valued at approximately $1.4
million, included the exchange of $300,000 in cash, 100,000 shares of Castelle
common stock, and the right to receive either additional cash or the number of
shares of Castelle common stock on the date six months after the acquisition
necessary to make the fair market value of the common stock and additional cash
received in the transaction not less than $500,000. Since the value of the
Castelle common stock received in the transaction was less than $500,000 on the
date six months after the acquisition, an additional 339,560 shares of Castelle
common stock were issued to Tolvusamskipti HF on April 9, 1999. The results of
the operations of Object-Fax NT product line were included in the results of the
Company since acquisition. In connection with the acquisition, Castelle also
entered into asset acquisition agreements with Traffic USA, Inc. and Traffic
Software USA, Inc. in which Castelle acquired fixed assets and intellectual
property rights associated with the marketing, sales, distribution and support
of the Object-Fax NT software. In exchange for these assets, Castelle paid
$135,000 and agreed to pay a royalty on sales of the Object-Fax NT software, not
to exceed $75,000 or to be paid beyond 24 months after the acquisition.
Additionally, Castelle entered into consulting and non-competition agreements
with key employees of Traffic USA, Inc. and Traffic Software USA, Inc. A portion
of the purchase price was allocated to in-process research and development, and,
accordingly, the Company recorded a one-time charge against earnings in 1998 of
$1.1 million. The amount of the purchase price allocated to in-process research
and development related to products for which technological feasibility had not
been established and for which there was no alternative future use. Further, the
Company recorded intangible assets of $160,000, which were amortized over 12
months.
In 1999, the Company decided to discontinue the Object-FAX NT product line and
recorded a restructuring reserve of $402,000.
4. Balance Sheet Detail (in thousands)
Inventories:
December 31,
..................................
2000 1999
---------------- ----------------
Raw material $ 335 $ 136
Work in process 201 300
Finished goods 827 975
---------------- ----------------
$ 1,363 $ 1,411
Total inventories
================ ================
F-9
Property and equipment:
December 31,
..................................
2000 1999
---------------- ----------------
Production, test and demonstration equipment $ 350 $ 281
Computer equipment 1,157 1,099
Office equipment 92 67
Leasehold improvements 395 118
---------------- ----------------
1,994 1,565
Less accumulated depreciation and amortization (1,226) (1,178)
---------------- ----------------
Total property and equipment $ 768 $ 387
================ ================
The Company recorded depreciation and amortization related to property and
equipment of $260,000 in 2000, $382,000 in 1999 and $491,000 in 1998. Castelle
follows the IRS recommendations regarding useful lives of the assets.
Accrued liabilities:
December 31,
..................................
2000 1999
---------------- ----------------
Accrued compensation $ 852 $ 990
Accrued sales and marketing 349 368
Accrued professional fees 416 404
Deferred revenue 486 451
Other 578 835
---------------- ----------------
$ 2,681 $ 3,048
Total accrued liabilities
================ ================
5. Commitments
The Company entered into noncancelable operating leases expiring in 2006, and is
responsible for certain maintenance costs, taxes and insurance under the leases.
The Company entered into a lease for a new facility in Morgan Hill, California,
in August 2000 and relocated its corporate headquarters in December 2000 after
the lease at the Santa Clara, California location expired at the same time. The
lease on the new facility has a term of 5 years, expiring in December 2005 with
one conditional three-year option, which, if exercised, would extend the lease
to December 2008 commencing with rent at ninety-five percent of fair market
value. Future minimum payments under noncancelable operating leases are as
follows (in thousands):
F-10
Year Ended December 31,
2001 $ 254
2002 260
2003 271
2004 282
2005 278
Thereafter 14
----------------
$ 1,359
================
Rent expense, including the facility lease and equipment rental, was $510,000,
$466,000, and $584,000 for 2000, 1999 and 1998, respectively.
6. Bank Borrowings
The Company has a $3.0 million collateralized revolving line of credit with a
bank, which expires in March 2001, pursuant to which the Company may borrow 100%
against pledges of cash at the bank's prime rate (9.50% at December 31, 2000).
Borrowings under this line of credit agreement are collateralized by all of the
assets of the Company. The Company was in compliance with the terms of the
agreement, and at December 31, 2000 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 an amount of $288,000. The amounts borrowed were subject to
interest of 10.11%, and were repaid in December 2000, and were partially
collateralized by a certificate of deposit of $125,000, which is included as
restricted cash on the accompanying balance sheet.
In December 2000, the Company entered into a loan and security agreement with a
finance company for an amount of $75,000. This loan is subject to interest of
12.82% and is repayable by December 2006. As of December 31, 2000, future
minimum lease payments are $103,000 as follows (in thousands):
Year Ended December 31,
2001 $ 18
2002 18
2003 18
2004 18
2005 17
Thereafter 14
----------------
Total minimum lease payments 103
Less amount representing interest (31)
----------------
Present value of capital lease obligations 72
Less current portion (9)
----------------
Long-term portion of capital lease obligations $ 63
================
F-11
8. Common Stock
In connection with the sale of common stock to two executives (153,000 shares at
$0.20 per share in October 1994 and 53,000 shares at $5.00 per share in April
1995), the Company had the right to repurchase the shares at cost in the event
of termination of service. These rights lapsed ratably through 1999. During
1999, the Company repurchased 53,000 shares from the executives at $5.00 per
share.
A deferred compensation expense of $93,000 was recognized in 1998 and 1999
related to a grant of stock options to a consultant. Deferred compensation of
$67,000 was written off in 2000 as the options were cancelled. In 2000, the
Company granted an additional 20,000 options to other consultants. These options
were recorded at fair value and will be amortized over their five year term.
There were 55,000, 160,000 and 152,000 of options to consultants outstanding at
December 31, 2000, 1999 and 1998, respectively, of which 35,000, 77,000 and
27,000 were exercisable at a weighted exercise price of $52,000, $117,000 and
$44,000 in 2000, 1999 and 1998, respectively.
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, 2000,
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):
Outstanding Options
..........................................................
Weighted
Average
Available Number Exercise Exercise
for Grant of Shares Price Total Price
------------- ------------- --------------- ------------- -------------
Balances, January 1, 1998 110 10 $6.12 - $8.00 $74 $7.20
Options granted (11) 11 $2.37 - $2.38 26 $2.38
Options cancelled - - - -
------------- ------------- ------------- -------------
Balances, December 31, 1998 99 21 $2.37 - $8.00 $100 $4.69
Options granted (26) 26 $0.34 - $0.56 $10 $0.39
Options cancelled 8 (8) $0.56 - $8.00 ($24) $3.00
------------- ------------- ------------- -------------
Balances, December 31, 1999 81 39 $0.34 - $8.00 $86 $2.20
Options granted (30) 30 $1.94 $58 $1.94
Options cancelled 10 (10) $0.56 - $8.00 ($60) $5.97
------------- ------------- ------------- -------------
Balances, December 31, 2000 61 59 $0.34-$2.38 $ 84 $1.42
============= ============= ============= =============
At December 31, 2000, 1999, and 1998 35,000, 24,000 and 27,000 options,
respectively, were exercisable at a weighted average exercise price of $43,000,
$79,000, and $44,000, respectively.
F-12
The options outstanding and currently exercisable by exercise price at December
31, 2000 are as follows (in thousands, except years and per share data):
Options Outstanding Options Exercisable
................................................................... .................................
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
---------------- ---------------- --------------- ---------------- ---------------- ----------------
$0.00-$0.50 20 8.3 $0.34 16 $0.34
$0.51-$0.75 2 8.2 $0.56 2 $0.56
$0.76-$2.00 30 9.2 $1.94 10 $1.94
$2.01-$3.00 7 7.2 $2.37 7 $2.37
---------------- ----------------
---------------- ----------------
59 8.6 $1.40 35 $1.21
================ ================
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, 2000, there
were no stock purchase rights outstanding, and no shares purchased
pursuant to stock purchase rights were subject to repurchase by the
Company.
F-13
Option activity under the 1988 Plan was as follows (in thousands):
Outstanding Options
..........................................................
Weighted
Average
Available Number Exercise Exercise
for Grant of Shares Price Total Price
------------- ------------- --------------- ------------- -------------
Balances, January 1, 1998 624 965 $0.20-$7.75 $ 4,381 $4.54
Options granted (1,466) 1,466 $1.00-$3.50 2,406 $1.64
Options cancelled 1,105 (1,105) $0.20-$7.75 (4,929) $4.46
Options exercised - (40) $0.20-$1.55 (12) $0.30
------------- ------------- ------------- -------------
Balances, December 31, 1998 263 1,286 $0.20-$7.75 $ 1,846 $1.43
Options granted (657) 657 $0.88-$1.03 604 $0.92
Options cancelled 617 (617) $0.20-$6.88 (962) $1.56
Options exercised - (17) $0.20-$1.56 (10) $0.62
------------- ------------- ------------- -------------
Balances, December 31, 1999 223 1,309 $0.20-$1.56 $ 1,477 $1.13
Options granted (256) 256 $0.88-$1.88 289 $1.13
Options cancelled 342 (342) $0.20-$1.56 (440) $1.29
Options exercised - (30) $0.20-$1.56 (24) $0.77
------------- ------------- ------------- -------------
Balances, December 31, 2000 309 1,193 $0.20-$1.56 $ 1,302 $1.09
============= ============= ============= =============
At December 31, 2000, 1999 and 1998 721,000, 644,000 and 508,000 options,
respectively, were exercisable at a weighted average exercise price of $812,000,
$761,000 and $1,023,000, respectively.
In August 1998, the company offered employees the right to cancel certain
outstanding stock options at original exercise prices and receive new options
with a new exercise price. The new exercise price was $1.56 per share, based on
the closing price of common stock on the date employees agreed to cancel their
original outstanding stock options. Options to purchase a total of 942,000
shares at original exercise prices ranging from $2.50 to $7.75 per share were
cancelled and new options were issued in August 1998. In return for the lower
exercise price, each optionee agreed that no portion of a repriced option would
be exercisable until six months after the effective date of the repricing.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation - an interpretation of APB Opinion
No.25" ("FIN 44"). This Interpretation clarifies (i) the definition of employee
for purposes of applying APB Opinion No. 25, (ii) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (iii) the accounting
consequence of various modifications to the terms of the previously fixed stock
option or award, and (iv) the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998, or January 12, 2000. To the extent that FIN 44 covers events
occurring during the period after December 15, 1998, or January 12, 2000, but
before the effective date of July 1, 2000, the effects of applying this
Interpretation are recognized on a prospective basis from July 1, 2000. The
Company adopted FIN 44 during the fiscal year 2000.
F-14
The Company has adopted the disclosure-only provisions of 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 since January 1, 1995 consistent with the provisions
of SFAS No. 123, the Company's net income (loss) and net income (loss) per share
for 2000, 1999 and 1998 would have been reduced to the pro forma amounts
indicated below (in thousands):
2000 1999 1998
--------------- ---------------- ----------------
Net income - as reported $ 732 $ (3,555) $ (7,534)
Net income - pro forma 589 (3,834) (8,690)
Net income per share - basic - as reported 0.16 (0.78) (1.67)
Net income per share - basic - pro forma 0.13 (0.84) (1.93)
Net income per share - diluted - as reported 0.14 (0.78) (1.67)
Net income per share - diluted - pro forma 0.12 (0.84) (1.93)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes model with the following assumptions for 2000, 1999 and 1998:
2000 1999 1998
--------------- ---------------- ----------------
Risk-free interest rate 5.85%-6.44% 5.08%-5.98% 5.20%
Expected life 6.71 years 5.62 years 4.4 years
Expected dividends - - -
Volatility 163% 143% 79%
The weighted average fair value of options granted in 2000, 1999 and 1998 was
$1.21, $0.85 and $1.05 per share, respectively
F-15
The options outstanding and currently exercisable by exercise price at December
31, 2000, including those issued to Directors and outsiders, are as follows (in
thousands, except years and per share data):
Options Outstanding Options Exercisable
................................................................... .................................
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
---------------- ---------------- --------------- ---------------- ---------------- ----------------
$0.00-$0.20 13 6.9 $0.20 13 $0.20
$0.21-$0.50 20 8.3 $0.34 17 $0.34
$0.51-$0.75 2 8.2 $0.56 2 $0.56
$0.76-$1.00 744 5.6 $0.93 48 $0.94
$1.01-$1.25 171 5.9 $1.09 34 $1.03
$1.26-$1.50 91 6.0 $1.32 10 $1.47
$1.51-$1.75 236 3.5 $1.57 210 $1.57
$1.76-$2.00 31 9.1 $1.94 10 $1.94
$2.01-$2.50 7 7.2 $2.37 7 $2.37
---------------- ----------------
1,315 5.4 $1.11 787 $1.12
================ ================
Warrants
The Company had 233,000 outstanding fully exercisable warrants at December 31,
1999 at a price range from $1.00 to $8.40.
The warrant holders have certain demand and registration rights as specified in
the warrant agreement. In March 2000, warrants to purchase 133,000 shares of
common stock were exercised whereby the holders of these warrants, received, in
a "cash-less" exchange, 70,000 shares of common stock. The other warrants to
purchase 100,000 shares of common stock outstanding, which had a strike price of
$8.40, expired in December 2000 without being exercised.
Notes receivable
At December 31, 1998, the Company held notes receivable of $274,000, which bear
interest between 6.3% and 7.05% per annum, from two executive officers, issued
in connection with the purchase of common stock under restricted stock purchase
agreements. In 1999, the Company repurchased 53,000 shares of the Company's
common stock from the executive officers upon their termination of service and
cancelled the notes receivable of $263,000 with the remaining balance paid in
cash.
F-16
9. Income Taxes
The Company's provision for income taxes consists of the following (in
thousands):
Year Ended December 31,
....................................................
2000 1999 1998
--------------- ---------------- ----------------
Current:
Federal $ - $ - $ -
State 6 4 -
Foreign - - 1
--------------- ---------------- ----------------
6 4 1
--------------- ---------------- ----------------
Deferred:
Federal $ - $ - 3,495
State - - 469
--------------- ---------------- ----------------
- - 3,964
--------------- ---------------- ----------------
$ 6 $ 4 $ 3,965
=============== ================ ================
Current federal tax provision is net of the benefit of the utilization of
brought forward losses of $378,000 (none in 1999 and 1998). Current state tax
provision is net of the benefit of the utilization of brought forward losses of
$393,000 (none in 1999 and 1998).
The Company's tax provision differs from the provision computed using statutory
income tax rates as follows (in thousands):
2000 1999 1998
---------------- ---------------- ----------------
Federal tax (benefit) at statutory rate $ 210 $ (1,135) $ (754)
Permanent difference due to
non-deductible expenses 36 19 21
State taxes (benefit), net of federal benefit 4 (98) (173)
Change in valuation allowance (190) 1,332 5,001
General business credits (54) (114) (131)
Other - - 1
---------------- ---------------- ----------------
$ 6 $ 4 $ 3,965
================ ================ ================
F-17
The components of the net deferred tax assets are as follows (in thousands):
December 31,
...................................
2000 1999
---------------- -----------------
Inventory allowances and adjustments $ 149 $ 190
Accounts receivable allowances 70 105
Other liabilities and allowances 929 788
Net operating loss carryforwards 4,644 4,987
Tax credit carryforwards 1,271 796
Depreciation and amortization 654 706
Valuation allowance (7,717) (7,572)
---------------- -----------------
Total net deferred tax assets $ - $ -
================ =================
Due to the uncertainty surrounding the realization of favorable tax attributes
in future tax returns, the Company has placed a full valuation allowance against
its deferred tax asset balance.
At December 31, 2000, the Company had net operating loss carryforwards of
approximately $13,084,000 and $3,347,000 available to offset future federal and
California taxable income, respectively. These loss carryforwards expire from
2003 through 2019.
For federal and state income tax purposes, a portion of the Company's net
operating loss carryforward is subject to certain limitations on annual
utilization in case of changes in ownership, as defined by federal and state tax
laws.
The Company's loss 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 2000, 1999 and 1998, the Company made no contributions to the
plan.
F-18
11. Major Customers and Segment Information
Revenues by geographic area are determined by the location of the end user and
are summarized as follows (in thousands):
Years Ended December 31,
...................................................
2000 1999 1998
---------------- ---------------- ---------------
North America $ 11,260 $ 11,199 $ 13,442
Europe 853 1,605 2,148
Pacific Rim 2,719 3,312 6,156
---------------- ---------------- ---------------
$ 14,832 $ 16,116 $ 21,746
Total revenues
================ ================ ===============
Customers that individually accounted for greater than 10% of net sales are as
follows (in thousands):
Years Ended December 31,
..............................................................................................
2000 1999 1998
Customer Amount Percentage Amount Percentage Amount Percentage
----------------- -------------- --------------- --------------- --------------- --------------- -------------
A $ 2,485 17% $ 1,998 12% $ 3,752 17%
B 2,213 15% 518 3% - -%
C 2,183 15% 2,948 18% 5,569 26%
F-19
12. Computation of Net Income/(Loss) per Share
Basic and diluted earnings per share are calculated as follows for 2000, 1999
and 1998 (in thousands except per share amounts):
2000 1999 1998
--------------- ---------------- ----------------
Basic:
Weighted average shares 4,664 4,579 4,507
=============== ================ ================
Net income/(loss) $ 732 $ (3,555) $ (7,534)
=============== ================ ================
Net income/(loss) per share $ 0.16 $ (0.78) $ (1.67)
=============== ================ ================
Diluted:
Weighted average shares 4,664 4,579 4,507
Common equivalent shares from stock options 416 - -
--------------- ---------------- ----------------
Shares used in per share calculation 5,080 4,579 4,507
=============== ================ ================
Net income(loss) $ 732 $ (3,555) $ (7,534)
=============== ================ ================
Net income(loss) per share $ 0.14 $ (0.78) $ (1.67)
=============== ================ ================
Due to the losses in the periods, the calculation of diluted shares outstanding
for 1999 and 1998 excludes 1,508,000, and 1,540,000 stock options, respectively,
as their effect was antidilutive in the period. In 2000, no shares were
excluded.
F-20
Report of Independent Accountants on Financial Statement Schedule
To the Board of Directors of Castelle:
Our audits of the consolidated financial statements of Castelle and subsidiaries
referred to in our report dated February 14, 2001 appearing in this Form 10-K of
Castelle and Subsidiaries also included an audit of the financial statement
schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, the
financial statement schedule present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
San Jose, California
February 14, 2001
Castelle and Subsidiaries Schedule II
Valuation and Qualifying Accounts
(in thousands)
--------------------------------------------------------------------------------
Additional
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deductions Period
---------------- ---------------- ---------------- ----------------
Year Ended December 31, 1998:
Deducted from asset accounts:
Allowance for doubtful accounts $ 490 $ 257 $ 27 $ 720
Allowance for excess and obsolete inventory $ 395 $ 418 $ 22 $ 791
Year Ended December 31, 1999:
Deducted from asset accounts:
Allowance for doubtful accounts $ 720 $ - $ 227 $ 493
Allowance for excess and obsolete inventory $ 791 $ 1,579 $ 1,911 $ 459
Year Ended December 31, 2000:
Deducted from asset accounts:
Allowance for doubtful accounts $ 493 $ 257 $ 465 $ 285
Allowance for excess and obsolete inventory $ 459 $ 80 $ 173 $ 366
Castelle and Subsidiaries
Index To Exhibits
--------------------------------------------------------------------------------
EXHIBIT
NUMBER DESCRIPTION
--------------------------------------------------------------------------------
3.2 Amended and Restated Bylaws of Castelle.
23.1 Consent of PricewaterhouseCoopers LLP.
24.1 Power of Attorney. Reference is made to the signature page,
(page 36).