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 year ended December 31, 2003

          |_| 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. ___

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes     No  |X|
    ---    -----

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 June 30, 2003 was $9,218,804.

The number of shares of common stock outstanding at March 11, 2004 was
3,542,736.


                       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 its
2003 Annual Meeting of Shareholders to be filed with the SEC or will be provided
in an amendment to this Form 10-K to be filed with the SEC no later than April
30, 2004.



<PAGE>

                                    FORM 10-K
                                TABLE OF CONTENTS
                                    CASTELLE
                                    FORM 10-K
                                                         TABLE OF CONTENTS


                                                                          PAGE



PART I........................................................................1

       ITEM 1.       BUSINESS.................................................1
       ITEM 2.       PROPERTIES..............................................12
       ITEM 3.       LEGAL PROCEEDINGS.......................................12
       ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS...12

PART II .....................................................................13

       ITEM 5.       MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
                     SHAREHOLDER MATTERS.....................................13
       ITEM 6.       SELECTED FINANCIAL DATA.................................14
       ITEM 7.       MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL
                     CONDITION AND RESULTS OF OPERATION......................16
       ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                     RISK....................................................32
       ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............32
       ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                     ACCOUNTING AND FINANCIAL DISCLOSURE.....................32
       ITEM 9A.      CONTROLS AND PROCEDURES.................................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
       ITEM 14.      PRINCIPAL AUDITOR FEES AND SERVICES.....................33

PART IV......................................................................34

       ITEM 15.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
                     FORM 8-K................................................34

SIGNATURES...................................................................36


FINANCIAL STATEMENTS........................................................F-2





<PAGE>



                   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. All of our forward-looking statements
involve risks and uncertainties. Our 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. Important factors that may cause
results to differ from expectations include those discussed in Risk Factors
beginning on page 24 in this document.

                                     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.


                                    OVERVIEW


         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. Our telephone number is (408)
852-8000. Castelle(R), LANpress(R) and JetPress(R) are registered trademarks of
the Company. FaxPressTM, FaxPress PremierTM and InfoPressTM are trademarks of
the Company. This Annual Report on Form 10-K includes trademarks and trade names
of other companies. Our common stock is listed on the Nasdaq SmallCap Market
under the symbol CSTL. We maintain a Website with the address www.castelle.com.
We are not including the information contained on its website as a part of, or
incorporating it by reference into, this Annual Report on Form 10-K. We make
available free of charge through our website our Annual Reports on Form 10-K and
Quarterly Reports on Form 10-Q as soon as reasonably practicable after we
electronically file such material with, or furnish such material to, the
Securities and Exchange Commission. In addition, we intend to disclose on our
website any amendments to, or waivers from, our code of business conduct and
ethics, that are required to be publicly disclosed pursuant to rules of the
Securities and Exchange Commission and the Nasdaq Stock Market.

          We develop, manufacture, market and support office automation systems
that allow organizations to implement faxing and printing over local area
networks and the Internet. A market leader in fax solutions for small to medium
sized workgroups, our FaxPress fax servers provide a simple way to integrate fax
with email, desktop and back-end applications. We also provides LANpress print
servers, which enable users to locate printers anywhere on the network, and the
InfoPress information-on-demand software suite. Our products are designed to be
easy to use and maintain, and provide an economical way for companies to share
resources over their networks.

         Our products have historically centered on fax and print servers and
related technologies. Beginning in 1997, our revenues 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.

                                       1
<PAGE>

As a result, we experienced annual operating losses during 1997 through 1999.
During the past five years, management has 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. Through the
introduction of enhanced fax automation products that generate higher gross
profits, restructuring and cost reductions, we were able to report operating
profits in the fourth quarter of 1999 and in each of the four quarters of 2000.
In 2000, we recorded a profit of $732,000 with sales at $14.8 million. We
incurred a loss of $591,000 in 2001 with sales of $9.4 million, resulting from a
decrease in demand for our products due in part to the slowness of the economy.
Our sales and profitability rebounded beginning in the third quarter of 2001,
and we recorded a profit of $659,000 in 2002 with sales at $9.8 million and a
profit of $1.6 million in 2003 with sales at $10.2 million. The pre-tax profit
for 2003 of $1.1 million is the highest since 1996.

Industry Background

         In the mid-1980s, organizations began to interconnect personal
computers into local area networks (known as "LANs") in order to allow
workgroups to share files, peripherals such as printers, and other specialized
applications. As LANs have proliferated throughout organizations and
client/server architectures have gained acceptance, they have become
increasingly complex and the applications operating on computer networks have
become more critical to the success of the business enterprise. The further
proliferation of the Internet and Intranets and popularity of electronic
communications expanded the role of LANs as a means to provide common access to
the Internet, email and other office automation applications. Installation,
maintenance and administration of LAN equipment required a staff of highly
skilled professionals. The costs associated with LANs and related equipment,
server-class hardware, specialized software, network integration and support
services are significant and typically affordable only by larger organizations.
Many businesses were not able to afford office automation applications beyond
basic email, such as integrating fax technology into the network. This has
created the opportunity for specialized networking equipment that would perform
a single application very well, known in the industry as a "server appliance."
It is similar to using a toaster instead of an oven, it does a specific job
better and it costs less. A server appliance is an integrated hardware and
software product designed to reduce the complexity and cost for a specific
server-based application. Internet routers, email servers, remote access
servers, communication servers, fax servers and print servers are examples of
server appliances used by businesses today.

         We are a pioneer in server appliances, establishing a benchmark for
"plug-and-play" and ease of use with our fax and print server product families.

         Fax Office Automation Products: Fax machines have become a basic method
of doing business worldwide. Fax is ubiquitous in business; many homes even have
fax machines. While computers have automated many business applications, faxing
remains as a basic method of business communication. We believe fax is here to
stay, just as the computer, in its quest for the paperless society, has not
replaced paper. Fax servers integrate legacy fax business methods into the
network to improve office productivity. Fax servers also provide the opportunity
for new business applications to be developed to take advantage of the inherent
strength and prevalence of fax machines. Virtually every business in the world
has a fax machine that can be used to receive information. Sending purchase
orders, invoices, order confirmations, etc. directly to a fax machine, as
compared to using the mail, is a growing segment of the fax server market.

         The increasing popularity of email and the Internet has provided a
boost to all types of electronic communications as many users and organizations
become more comfortable and accustomed to their use. To further simplify and
improve inter- and intra-organizational communications, corporate Management
Information Services departments are looking for ways to integrate different
types of messaging into a


                                       2
<PAGE>

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. A fax server can also be
used as an independent network shared system in environments that require high
volume incoming and outgoing faxes. Users are able to send and receive faxes
directly from their computers or workstations, eliminating the need to print a
document, take it to a stand-alone fax machine and wait for its transmission.
Fax servers can help reduce fax transmission costs by sending non-urgent faxes
at "off-peak" telephone rates and by utilizing fax over the Internet technology.

         Many fax servers are implemented using complex software that requires
the installation of a Windows or UNIX network operating system, a server-class
computer, and specialized expensive fax modems. Our fax servers, FaxPress and
FaxPress Premier, are self-contained units with all the necessary hardware and
software to integrate fax into network, desktop, email and back-end
applications. As server appliances, they are designed to be easy to use and
maintain and we believe that they are more economical than other solutions.

         Automated delivery of information is another popular application of 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.

         Print Servers: The sharing of printers, which is 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. In addition, print servers improve network performance by relieving
the burden on the file server. 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 and gained 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 smaller businesses. As professionals in enterprises and small organizations
alike continue to recognize the benefits of server appliances, such as remote
access, scanning, faxing, electronic mail and related functions, we believe that
the demand for such network systems will increase.


                                       3
<PAGE>

Our Strategy

         Our objective is to be a leading worldwide supplier of network server
appliances. We established a benchmark for "plug-and-play" and ease of use with
our fax and print server product families. Our products are installed in many
Fortune 1000 firms, small and medium sized businesses worldwide, integrating
desktop fax automation, email, Internet connectivity, print and other shared
services.

         Focus on Server Appliances: We focus exclusively on providing
innovative, reliable, easy-to-use network products. Since our inception, we have
focused on developing networking products that tightly integrate proprietary
hardware systems with standard computing platforms. As a result, we believe we
have developed a high level of expertise in networking, software development,
hardware design and telephony technology. We plan to capitalize on these
attributes by continuing to focus on providing network enhancement products that
enable users to communicate more effectively.

         Focus on Application Solutions and Communications: We focus on
developing application solutions for inter and intra-company communications. We
believe that our focus on application servers rather than on infrastructure
systems enables us to offer products that bring higher value services to
customers and provide a higher margin to us.

         Expand Product Line: We are leveraging our expertise in server
appliances to offer new easy-to-use, cost-effective solutions. We continue to
expand our fax server products and apply our proven technology to other areas.

         Focus on E-commerce and Other High Volume Distribution Channels: We
have established a two-tier domestic and international distribution network of
leading national and regional network product distributors and resellers
including Ingram Micro and Tech Data. Our products are well suited for sale by
e-commerce vendors and we have been successful working with leading resellers
such as CDW and Insight. We are focused on maintaining and strengthening our
current distribution network in North America, Europe and Pacific Rim.

         Leverage Strategic Relationships: We augment our product offerings by
establishing relationships with companies able to provide products in areas
outside of our core technical competencies or in instances where internal
development of such products is not cost-effective. We also establish
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

         We develop and market a range of server appliances that enhance network
 productivity, performance and functionality. Our current products are grouped
 into two areas: fax servers and print servers.

         Fax Server Products: We offer the FaxPress family of network fax
servers. We position FaxPress and FaxPress Premier as the easiest way to add
faxing to a company's network and integrate fax with email. FaxPress and
FaxPress Premier allow network users to send, receive, route, print, store, edit
and retrieve fax transmissions from their own personal computers on a network.
FaxPress and FaxPress Premier can be integrated into an email system creating a
unified fax/email environment. FaxPress and FaxPress Premier enable 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 such as, monitoring, logging or configuring
FaxPress and FaxPress Premier users. Our fax server products are designed to
comply with current regulatory standards in the United States, Europe and the

                                       4
<PAGE>

Pacific Rim. During 2003, 2002, and 2001, fax products represented 97%, 95%, and
91%, respectively, of total net sales.

         Key features of FaxPress and FaxPress Premier products (configured with
         its current software versions) include:

o                 Easy Installation and maintenance: FaxPress and FaxPress
                  Premier are network fax servers that include all the necessary
                  hardware and software. The hardware system is a box with an
                  integrated 10/100 Base-T Ethernet interface and one to
                  seventy-two fax channels. FaxPress and FaxPress Premier
                  include all required server and client software.

o                 Support for popular network operating environments: FaxPress
                  and FaxPress Premier operate in any local area network based
                  on Microsoft Windows 98, ME, 2000 and 2003; Windows NT/XP, and
                  NT Terminal Server; Novell NetWare; or Linux servers.

o                 Ability to create a unified fax/email messaging environment:
                  FaxPress and FaxPress Premier have the ability to integrate
                  fax into a corporate email system, allowing users to send and
                  receive faxes in the same manner as emails. FaxPress and
                  FaxPress Premier support Microsoft Exchange/Outlook, Lotus
                  Notes, Novell GroupWise, Netscape and other SMTP compatible
                  email systems. Our unique Outlook Direct interface offloads
                  fax processing from the Microsoft Exchange Server while
                  maintaining tight integration with the Outlook client.

o                 Integration with many popular accounting and Customer
                  Relationship Management applications: FaxPress and FaxPress
                  Premier are available with the Reform-for-FaxPress software
                  package 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.

o                 Ability to send faxes from many applications: Faxing from
                  within any Windows, Windows 95/98 and Windows NT/2000/XP
                  application such as Microsoft Office and Lotus Smart Suite.

o                 Electronic delivery of faxes to desktops: FaxPress and
                  FaxPress Premier support several methods to deliver incoming
                  faxes direct to the email or fax inbox of the intended
                  recipient. Such methods include Direct Inward Dialing, Dual
                  Tone Multifrequency, T.30 sub-addressing, and line routing.

o                 Internet faxing capabilities reduce transmission costs:
                  FaxPress and FaxPress Premier enable 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.

o                 Integration into custom applications: We provide a software
                  development kit that allows programmers to integrate fax
                  functions into their current applications or to create new
                  customized applications that use the FaxPress or FaxPress
                  Premier servers.

o                 Software Options: We offer a range of value-added software
                  options that increase the functionality of our FaxPress and
                  FaxPress Premier systems and enable the FaxPress and FaxPress
                  Premier to address specialized applications as mentioned
                  above. Software


                                       5
<PAGE>

                 upgrades and options are available to the installed base of
                 FaxPress and FaxPress Premier units at prices starting at $495.

         We offer a family of FaxPress and FaxPress Premier fax server systems
ranging from entry-level products targeted for small businesses with fewer than
50 users to high-end fax solutions capable of supporting enterprise-wide
installations. The suggested U.S. list prices for FaxPress and FaxPress Premier
fax servers range from $1,495 to $48,995. Server pricing is based on hardware
model, with no per-user costs. The FaxPress 2500, 5000 and 7000 families come
with the FaxPress 7.X network fax software that adds integration with popular
email packages, and many advanced fax management and integration features.
FaxPress 7.1.1 Email Integration is not included on FaxPress Small Business
Edition ("SBE"). The FaxPress Premier family comes with the FaxPress Premier 3.X
network fax software. The following table summarizes our FaxPress and FaxPress
Premier system products:
<TABLE>
<CAPTION>

                                                                            ---------------------------------------
                                                                            |           Network Environment       |
  -----------------------------------------------------------------------------------------------------------------
                                                                                NetWare
                                  Number of        Email         Network    3.x, 4.x, 5.x,
          Product Model           Channels      Integration     Topology     6.x (IPX,IP)  Windows NT/2000/XP/2003
  -----------------------------------------------------------------------------------------------------------------

<S>                              <C>           <C>              <C>             <C>                  <C>
  FaxPress SBE                        1        Not available    Ethernet          x                   x
  FaxPress 2500                       2              x          Ethernet          x                   x
  FaxPress 5000                   2, 4 or 8          x          Ethernet          x                   x
  FaxPress 7000                       8              x          Ethernet          x                   x
  FaxPress 7500                       8              x          Ethernet          x                   x
  FaxPress Premier Analog         8, 12, 16          x          Ethernet         n/a                  x
  FaxPress Premier Digital T1    24, 48, 72          x          Ethernet         n/a                  x
  FaxPress Premier ISDN           4, 8, 12           x          Ethernet         n/a                  x
  -----------------------------------------------------------------------------------------------------------------
</TABLE>




         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.


         Our InfoPress is a software product designed to operate on Microsoft
Windows NT/2000/XP platforms. 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.

o                 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.

o                 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

                                       6
<PAGE>

                  the ability to share the document library with fax-on-demand.

o                 Web Integration: InfoPress supports Web HTML documents in the
                  document library. The documents are automatically rendered
                  into a fax document when required.

         Print Servers: Printer sharing continues to be one of the important
benefits of computer networking. Print servers are the most efficient and
economical way to share printers on a network. While demand for print servers in
various sizes of businesses continues to grow, the market is very competitive.
We have been involved in the print server business for more than thirteen years.
After continuous improvements to the cost and feature set, our LANpress has
become a well-received print server product line. Our latest print server models
incorporate a RISC microprocessor, Fast Ethernet, Windows, Internet Printing and
many other attractive features. The suggested U.S. list price for LANpress print
servers ranges from $165 to $280. During 2003, 2002 and 2001, print server
products represented 3%, 5% and 9%, respectively, of total net sales.

         The following table summarizes our line of LANpress external print
servers:
<TABLE>
<CAPTION>

                                            -------------------------------------------------
                                            |             Network Environment               |
----------------------------------------------------------------------------------------------------------------------

                                            NetWare
                                  Ethernet  3.x,                       Windows                     Flash       Internet
                                  Network   4.x,                       95/ 98/        Apple        Upgrade     Printing
     Product Configuration       Interface  5.x, 6.x  UNIX TCP/IP  NT/2000/2003/XP  Ethertalk    Capability    Protocol
----------------------------------------------------------------------------------------------------------------------

<S>                               <C>           <C>        <C>            <C>           <C>           <C>       <C>
LANpress 2000 1P Direct           10/100        x          x              x             x             x           x
LANpress 3P/100                   10/100        x          x              x             x             x          N/a
LANpress 2000 USB                 10/100        x          x              x             x             x           x

----------------------------------------------------------------------------------------------------------------------
</TABLE>




Research and Product Development

         We have invested substantially in research and product development
since inception. We believe our future performance will depend in large part on
our ability to enhance our current products, to expand our product offerings, to
maintain technological competitiveness and meet an expanding range of customer
requirements. We spent $1.6 million, $1.4 million and $1.8 million in research
and product development activities in 2003, 2002 and 2001, respectively.

         We continue to invest in enhancing our 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. Our development
efforts are focusing on high value applications, while relying on our partners
to provide basic functionality for some of our product lines.

         In 2003, we developed and released version 7.1.1 of our FaxPress
software and version 3.0 of our FaxPress Premier software. The new releases of
FaxPress 7.1.1 and FaxPress Premier 3.0 Network Fax Software offer a new level
of email integration, expanded operating environments and fax automation. It

                                       7
<PAGE>

includes a new gateway for IBM Lotus Notes email integration, improved
integration with Microsoft Exchange, enhanced Windows XP and Citrix MetaFrame XP
support, improved Novell client support, production faxing and fax automation
made easy.

          The current FaxPress and FaxPress Premier fax server product lines are
continuously being enhanced to offer greater integration into corporate
networking environments.

Sales, Marketing and Distribution

         We sell our products through multiple channels, determined by the
product, market and customer need. We have an established two-tier domestic and
international distribution network of leading national and regional network
product distributors and resellers. Software enhancements and options that
complement the FaxPress products are primarily marketed directly by us to
registered end users. The direct sales group works closely with distributors and
value-added resellers ("VARs") in qualifying sales opportunities for the fax and
print server products. We also sell some products through the on-line store on
our Web site. Demand for our 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 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. We increase awareness of our
products by Internet marketing via targeted e-advertising, publishing and
sponsoring email newsletters, enhancing our Web presence, print advertising,
conducting direct mail campaigns, offering seminars, trade shows and
conferences, and other forms of public relations efforts. Our Web site has been
updated and designed to assist customers in obtaining information about our
products and contacting our sales personnel, and offers selected products and
services through our on-line store.

          Our products are well suited for sale by e-commerce vendors, and we
have experienced success working with leading resellers such as CDW and Insight.

         In 2003, Ingram Micro and Tech Data individually accounted for more
than 10% of our sales and collectively represented approximately 50% of our net
sales. In 2002 and 2001, the same distributors accounted for approximately 48%
and 46% of our net sales, respectively. Total sales to customers located in the
Pacific Rim, Europe and rest of Americas comprised approximately 19%, 21% and
25% of our net sales in 2003, 2002 and 2001, respectively.

Customer Service and Support

         We provide customers with support services, which are available to
assist customers with installation, use and operation issues in an effort to
ensure smooth and reliable operation of our products. Our 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 our global partner program, VARs have access to
"priority technical support" via a special toll-free number that provides
immediate access to our network engineers. Support is provided under warranty
terms as well as through extended warranty agreements sold directly to the
customer by us. We also provide other customer support through our Web site. We
have an automated call management distribution system that provides improved
levels of support to help resolve customer issues.

Manufacturing

         Our current in-house manufacturing operations consist primarily of
material planning, assembly, final testing, quality control and service repair.
Certain of our products are manufactured by third-party


                                       8
<PAGE>

manufacturers  that  provide  customized,   integrated  manufacturing  services,
including procurement,  manufacturing,  printed circuit board assembly and final
testing.  We also rely on SerComm  to  manufacture  certain of our print  server
products. These arrangements enable us to shift certain costs to such providers,
thereby allowing us to focus resources on our product development  efforts.  The
failure of such manufacturers, to meet their contractual commitments to us could
cause delays in product shipments,  thereby potentially  adversely affecting our
business, operating results and financial condition.

         We do not currently have any material long-term supply contracts with
any of our manufacturing subcontractors or component suppliers. We purchase
finished products and components on a purchase order basis. We own all
engineering, sourcing documentation, functional test equipment and tooling used
in manufacturing our products and believes that it could shift product assembly
to alternate suppliers if necessary. Certain key components of our products,
including a modem chip set from Conexant, microprocessors from Motorola,
integrated circuits from Intel and Kendin, are currently available from single
sources. Other components of our products are currently available from only a
limited number of sources. In addition, certain manufacturers have announced the
end-of-life of certain standard off-the-shelf components which are being used by
us in the making of our FaxPress Products. However, we have purchased at least
two years worth of supplies of these end-of-life components in an effort to
guarantee an uninterrupted supply of FaxPress Products to our customers for the
next two years, while we decide whether to re-engineer our Products with the
manufacturers' suggested replacement parts, or develop new replacement products.

Competition

         The network enhancement products and computer software markets are
highly competitive, and we believe 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. We
currently compete principally in the market for network fax servers, network
print servers and fax-on-demand software.

         The principal competitive factors affecting the market for our 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 our existing and potential competitors, have
substantially greater financial, engineering, manufacturing and marketing
resources than us. We also experience competition from a number of other
software, hardware and service companies. In addition to our current
competitors, we may face substantial competition from new entrants into the
network enhancement market, including established and emerging computer,
computer peripheral, communications and software companies. In the fax server
market we compete with companies such as Captaris, Inc., Omtool, Ltd. and Esker
Software. In addition, certain competing methods of communications such as the
Internet or electronic mail could adversely affect the market for fax products.
Certain of our 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.

Proprietary Rights

         Our success depends to a certain extent upon our technological
expertise and proprietary software technology. We rely upon a combination of
contractual rights and copyright, trademark and trade secret laws to establish
and protect our technologies. Additionally, we generally enter into
confidentiality agreements with those employees, distributors, customers and
suppliers who have access to sensitive information and limits access to and
distribution of our software documentation and other proprietary information.
Because of the rapid pace of technological change in the LAN product industry,
we believe


                                       9
<PAGE>

that patent  protection for our products is less significant to our success than
the  knowledge,   ability  and   experience  of  our  employees,   the  frequent
introduction and market acceptance of new products and product enhancements, and
the timeliness and quality of our support services. We may not be able to obtain
the  necessary  intellectual  property  rights and other parties may contest our
intellectual property rights.

Government Regulation

         Certain aspects of the networking industry in which we compete 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 could have a
material, adverse effect on our business, operating results and financial
condition. Additionally, our products must comply with a variety of equipment,
interface and installation standards promulgated by communications regulatory
authorities in different countries.

Employees

         As of March 1, 2004, we employed a total of 43 full-time equivalent
personnel, 10 in operations, 11 in sales and marketing, 8 in engineering, 8 in
customer service and 6 in finance and administration. We have not experienced a
work stoppage, no employees are represented by a labor organization and we
consider our employee relations to be good.

Executive Officers

         The names and ages of our executive officers as of February 28, 2004
are set forth below:

       Name                       Age                Position
Scott C. McDonald                  50   President, Chief Executive Officer
Eric Chen                          51   Senior Vice President, Engineering and
                                        Business Development
Paul Cheng                         55   Vice President, Finance and Adminis-
                                        tration, Chief Financial Officer and
                                        Secretary
Richard Fernandez                  44   Vice President, Operations
Edward J. Heinze                   58   Vice President, Sales, U.S.
Michael Petrovich                  42   Vice President, Sales, International


Scott C. McDonald

         Mr. McDonald has served as our President and Chief Executive Officer
     since April 2002. Mr. McDonald has served as director of since April 1999.
     From May 2001 to the first quarter of 2002, Mr. McDonald served on the
     board of directors for Octant Technologies and Digital Power Corporation
     and provided consulting services. Mr. McDonald served as the Chief
     Financial and Administrative Officer at Conxion Corporation, a network and
     Internet services company, from December 1999 to April 2001. From 1997 to
     1999, Mr. McDonald served on the board of directors for CIDCO, Inc, Octant
     Technologies Inc. and Digital Power Corporation; in addition to providing
     consulting services to CIDCO, Inc. Mr. McDonald currently serves on the
     board of directors of privately held Octant Technologies, Inc. Mr. McDonald
     holds a BS in Accounting from the University of Akron and an MBA from
     Golden Gate University.


                                       10
<PAGE>

Eric Chen

         Mr. Chen has served as our Senior Vice President, Engineering and
     Business Development since May 2002. From May 2000 to May 2002, Mr. Chen
     served as our Vice President, Engineering. Upon joining us in 1989, 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 served as
     the Director of Print Server Product Marketing and Business Unit and has
     managed the engineering development and manufacturing business
     relationships with our partners. Before joining our company, 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.

Paul Cheng

         Mr. Cheng has served as our Vice President, Finance and Administration
     since April 2000. 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 career that was launched in Hong Kong where he was the
     Plant Controller of Fairchild Semiconductor Hong Kong Ltd. Before joining
     our company, 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 Vice President of Finance at Quintus Corporation, a developer of
     customer relations management software from 1993 to 1995 and Corporate
     Controller at Power Integration, Inc., a semiconductor manufacturer from
     1995 to 1997. Mr. Cheng is a member of the Chartered Certified Accountants
     and holds a BS in Accounting from Hong Kong.

Richard Fernandez

         Mr. Fernandez has served as our Vice President of Operations since
     December 2002. From June 2002 to December 2002, Mr. Fernandez served as our
     Director of Operations. Mr. Fernandez has more than 22 years of
     manufacturing and materials planning experience prior to joining the
     Company. Prior to joining our company, Mr. Fernandez managed the
     acquisition of servers and storage devices for Conxion Corporation from
     June 2000 to May 2002. Prior to joining Conxion, Mr. Fernandez was Director
     of Operations with CIDCO, Inc. since March 1994. In addition, Mr. Fernandez
     has held various management positions with Computer Products Inc., MAD
     Intelligent Systems and Sperry Univac.

Edward J. Heinze

         Mr. Heinze has served as our Vice President, Sales, U.S. since January
     2000. From 1994 to January 2000, Mr. Heinze served in several capacities
     including Product Manager of the Fax Product Line, and Regional Sales
     Manager. Before joining our company, 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 has served as our Vice President, Sales, International
     since October 2000 and has been with us since 1992. Mr. Petrovich
     concentrates on developing the sales channels for all sales outside of the
     Americas, including Asia, the Asia Pacific and Europe. Prior to joining us,
     Mr. Petrovich was the marketing communications manager for Novell's
     National Reseller Organization, a software company.


                                       11
<PAGE>

     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. Mr.
     Petrovich holds a BA in Behavioral Sciences from San Jose State University.


ITEM 2.       PROPERTIES

         Our headquarters, including our 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. We occupy this facility
under a lease, the term of which expires in December 2005 with one conditional
three-year option, which if exercised, would extend the lease to December 2008.
We also rent office space for sales and customer support in Illinois. We believe
our existing facilities will be adequate to meet our requirements for the
foreseeable future.


ITEM 3.       LEGAL PROCEEDINGS

         From time to time and in the ordinary course of business, we are
involved in various legal proceedings and third party assertions of patent or
trademark infringement claims against us in the form of letters and other forms
of communication. We are not currently involved in any litigation which, in our
opinion, would have a material adverse effect on our business, operating
results, cash flows or financial condition; however, there can be no assurance
that any such proceeding will not escalate or otherwise become material to our
business in the future.


ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

         Subsequent to our Annual Meeting of Shareholders held on May 29, 2003,
there were no matters submitted to a vote of securities holders in the remainder
of 2003.

                                       12
<PAGE>


                                     PART II


ITEM 5.     MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS

         Our 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 closing high and low sale
prices per share of our common stock as reported on the Nasdaq SmallCap Market.
Such quotations do not include retail markups, markdowns or commissions.

2002                            HIGH                 LOW
     First Quarter                  $1.01               $0.64
     Second Quarter                 $0.80               $0.57
     Third Quarter                  $0.85               $0.50
     Fourth Quarter                 $1.15               $0.47

2003                            HIGH                 LOW
     First Quarter                  $2.91               $1.03
     Second Quarter                 $3.86               $1.95
     Third Quarter                  $4.90               $3.01
     Fourth Quarter                 $3.50               $2.61


         The market price of our common stock has been volatile. See "Risk
Factors - Our stock price has been volatile, and is likely to continue to be
volatile in the future."

         As of March 3, 2004 there were 1,081 holders of record of our common
stock. On March 3, 2004 the last sale price reported on the Nasdaq SmallCap
Market for our common stock was $5.46 per share.

Stock Buyback

         In the fourth quarter of 2002, our Board of Directors authorized us,
from time to time, to repurchase at market prices, up to $2.25 million of our
common stock for cash in open market, negotiated or block transactions. The
timing of these transactions will depend on market conditions, other corporate
strategies and will be at the discretion of management. No time limit was set
for the completion of this program. At the time of the approval by the Board of
Directors, we had approximately 4.8 million shares of common stock outstanding
and as of the end of the third quarter 2002, cash and cash equivalents were
approximately $4.8 million. During the fourth quarter of 2002, we repurchased
from open market and negotiated transactions a total of 1.62 million shares for
$1.8 million, at an average per share price of $1.10. During the first quarter
of 2003, we repurchased from open market transactions a total of 46,500 shares
for $48,000, at an average per share price of $1.04. We performed no stock
repurchases during the rest of 2003. However, we may continue to execute our
buyback program as we deem necessary.

Dividend Policy

         We have not paid cash dividends on our common stock. The Board of
Directors currently intends to retain any and all earnings for use in our
business and we do not anticipate paying cash dividends in the foreseeable
future.

Equity Compensation Plan Information

         The following table sets forth a summary of our equity compensation
plans as of December 31, 2003. Details of the plans are discussed in Note 6 to
the Consolidated Financial Statements.

                                       13
<PAGE>
<TABLE>
<CAPTION>


                                           Number of securities to        Weighted average
                                           be issued upon exercise        exercise price of           Number of
                                           of outstanding options,      outstanding options,     securities remaining
                                             warrants and rights         warrants and rights          for future
                                                                                                      issuance
<C>                                                        <C>                            <C>                 <C>
1988 Equity compensation plan approved                         7,000                      $2.38                   -0-
by security holders
1998 (1988) Equity compensation plan
(As Amended) approved by security                          1,279,706                      $1.01                   -0-
holders
2002 Equity compensation plan approved                       303,500                      $2.94               546,500
by security holders
Equity compensation plans not approved                           -0-                        n/a                   -0-
by security holders
                                          --------------------------- -------------------------- ---------------------
         Total                                             1,590,206                      $1.38               546,500
</TABLE>



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.
<TABLE>
<CAPTION>

                                                                       Years ended December 31,
                                               ...................................................................
                                                   2003            2002           2001           2000            1999
                                               --------------  -------------  --------------  ------------   ------------
                                                                (in thousands, except per share amounts)
INCOME STATEMENT DATA:
<S>                                               <C>             <C>             <C>           <C>           <C>
        Net Sales                                 $10,214         $9,759          $9,354        $14,832       $16,116

        Gross Profit                               $7,729         $6,923          $6,265         $9,380       $ 8,404
        Gross Profit as a % of Net Sales              76%            71%             67%            63%           52%

        Net income/(loss)                          $1,633(1)        $659           ($591)(3)       $732       ($3,555)(3)
        Net income/(loss) as a % of Net Sales         16%(1)          7%             (6%)            5%          (22%)

        Net income/(loss) per share - diluted       $0.39(1)       $0.14          ($0.12)         $0.14        ($0.78)

   BALANCE SHEET DATA:
        Cash and Cash Equivalents                  $4,614         $3,460(2)       $4,568         $3,893        $4,714
        Working Capital                            $4,180         $2,434          $3,560         $3,969        $3,555
        Total Assets                               $7,803         $5,635          $7,010         $8,543        $8,502
        Long-term Liabilities                         $29            $44             $64            $63          --
        Shareholders' Equity                       $4,776         $2,923(2)       $4,202         $4,776        $4,020
</TABLE>

     (1) In the fourth quarter of 2003, we recorded a non-cash tax benefit
of $526,000, or $0.12 per diluted share, resulting from the release of a portion
of our tax valuation allowance. Prior to the fourth quarter, we had not reported
significant income tax expenses because we had utilized available Net Operating
Loss ("NOL") and tax credit carryforwards. These NOLs were fully reserved by a
valuation allowance due to uncertainly surrounding the likelihood of their
realization. Due to our continued profitability over the past ten quarters and a
determination that it is more likely than not that certain future tax benefits
will be realized, a portion of the deferred tax assets were recognized in the
fourth quarter.

                                       14
<PAGE>

         (2) In 2002, cash and cash equivalents and shareholders' equity reflect
the use of $2 million of cash for the repurchase of 1.62 million shares of our
common stock and the associated expenses.
         (3) Net loss for 2001 and 1999 includes net charges for restructuring
and other non-recurring items of $239,000 and $400,000, respectively.


Quarterly Results of Operations


         The following table sets forth certain consolidated quarterly financial
data for the eight quarters ended December 31, 2003. This information is
unaudited, but in our opinion, has been prepared 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,
have been included in the amounts stated below to present fairly the unaudited
interim results. The results of operations for any quarter are not necessarily
indicative of the results of operations for any future period.


Selected Quarterly Data (unaudited)
<TABLE>
<CAPTION>

                                                 Year 2003, Quarter Ended
                                 ---------------------------------------------------------
                                        Mar  31        Jun  30      Sep  30       Dec  31
                                 ---------------------------------------------------------
                                          (in thousands, except per share data)
<S>                                      <C>            <C>        <C>          <C>
Net sales                                $2,500         $2,511     $2,566       $2,637
Gross profit                              1,803          1,938      2,011        1,977
Operating  income                           256            240        241          369
Net income                                  243            228        241          921(1)
Net income per share, basic                0.08           0.07       0.07         0.27(1)
Net income per share, diluted              0.06           0.06       0.06         0.21(1)
</TABLE>

(1) Includes a non-cash tax benefit of $526,000, or $0.16 per basic share, and
$0.12 per diluted share, resulting from the release of a portion of our tax
valuation allowance.
<TABLE>
<CAPTION>

                                             Year 2002, Quarter Ended
                              --------------------------------------------------------
                                     Mar  31       Jun  30       Sep  30      Dec  31
                              ----------------------------- --------------------------
                                       (in thousands, except per share data)
<S>                                   <C>           <C>           <C>          <C>
Net sales                             $2,368        $2,261        $2,543       $2,587
Gross profit                           1,591         1,592         1,808        1,932
Operating income                          11            53           222          335
Net income                                32            62           228          337
Net income per share, basic             0.01          0.01          0.05         0.09
Net income per share, diluted           0.01          0.01          0.05         0.08
</TABLE>


                                       15
<PAGE>







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

         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 in 1997 through 1999. We 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 and the FaxPress 7500 in September 2000. In
September 2003, we launched our newest enterprise level fax servers, the
FaxPress Premier Analog and FaxPress Premier Digital, which can provide up to 16
analog fax channels and 71 T1 fax channels, respectively. In support of our
hardware, we introduced a major release of our FaxPress software, FaxPress 7.0,
in November 2002 and FaxPress Premier 3.0, in September 2003. Through mainly the
release of these enhanced products in the fax messaging family and continuous
efforts in product cost reductions, our gross profit margins improved from 52%
in 1999 to 76% in 2003.

         Additionally, improved cash management and operating results resulted
in positive operating cash flows in 2001, 2002 and 2003. Cash balances increased
to $4.6 million at December 31, 2003 from $3.5 million at December 31, 2002.

         From time to time, component manufacturers announce the end of life of
certain of their products and at the same time introduce replacement components
which are usually more efficient or cost effective. We have been informed by
several of our component suppliers that new components are available to replace
certain of their end-of-life components currently used in our FaxPress products.
We have purchased approximately two years worth of these end-of-life components
in an effort to guarantee a smooth supply of our FaxPress Products to our
customers. We believe this will give us ample time to decide whether to
re-engineer our Products with the manufacturers' suggested replacement parts, or
develop new replacement products. Even though we believe we have secured enough
components for the next two years, there is no assurance that we will be able to
secure additional components in the future, or be able to redesign new products
in a timely manner.

Critical Accounting Policies

         We have identified the policies below as critical to our business
operations and to the understanding of our results of operations. We have
defined a critical accounting policy as one that is both important to the
portrayal of our financial condition and results of operations and requires our
management to make difficult, subjective or complex judgments. The impact of
risks associated with these policies on our business operations is discussed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations. For a detailed discussion on the application of these and other
accounting policies, see Note 2 in the Notes to the Consolidated Financial
Statements of this Annual Report on Form 10-K, beginning on page F-6. Note that
preparation of this Annual Report on Form 10-K requires us to make estimates and
assumptions that affect the reported amount of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of our financial
statements, and reported amounts of revenue and expenses during the reporting
period. Estimates about future events and their effects


                                       16
<PAGE>

cannot be made with certainty.  We based our estimates on historical  experience
and on various other  assumptions  that are believed to be reasonable  under the
circumstances,  the results of which form the basis for making judgments.  These
estimates may change as new events  occur,  as more  experience is acquired,  as
additional information is obtained and as our operating environment changes.

Revenue recognition

         We recognize  revenue based on the provisions of Staff Accounting
Bulletin ("SAB") No. 104 "Revenue  Recognition"  and  Statement  of Financial
Accounting Standards ("SFAS") No. 48 "Revenue Recognition When Right of Return
Exists."

         Product revenue is recognized upon shipment if a signed contract or
purchase order exists, the fee is fixed or determinable, collection of the
resulting receivable is probable and product returns are reasonably estimable.
Shipment generally occurs and title is transferred when product is delivered to
a common carrier.

         We enter into agreements with some of our 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. End-user customers who purchase our products directly from us also
have limited return rights, which expire 30 days from product shipment. Revenues
subject to stock rotation or other return rights are reduced by our estimates of
anticipated exchanges and returns. We establish our reserve for sales returns
for distributors and direct end-user customers based on historic return rates.
If the historical data used by the Company to calculate these estimates does not
properly reflect future returns, these estimates could be revised.

         Pursuant to our agreements with distributors, we also protect our
distributors' exposure related to the impact of price reductions. Price
adjustments are recorded at the time price reductions are communicated to our
distributors.

         Revenue for transactions that include multiple elements such as
hardware and post-contract customer support is allocated to each element based
on its relative fair value and recognized for each element when the revenue
recognition criteria have been met for such element. Fair value is generally
determined based on the price charged when the element is sold separately.

         We recognize revenue from the sale of extended warranty contracts
ratably over the period of the contracts.

         We recognize royalty income on the sale of LANpress products by a
Japanese distributor. Royalties are not recognized as revenue until the products
are sold by the distributor.

Distributor Programs and Incentives

         We record estimated reductions to revenues for distributor programs and
incentive offerings including special pricing agreements, trade-in credits,
promotions and other volume-based incentives. If market conditions were to
change, we may take actions to increase distributor incentive offerings possibly
resulting in an incremental reduction of revenues at the time the incentive is
offered.



                                       17
<PAGE>



Warranty

         Provisions for estimated warranty costs are recorded at the time
products are shipped as a charge to cost of sales. While we engage in extensive
product quality programs and processes, our warranty obligation is affected by
product failure rates, material usage and service delivery costs incurred in
correcting a product failure. Should product failure rates, material usage or
service delivery cost differ from our estimates, revision to the estimated
warranty liability would be required, which could affect the amount of gross
profit reported.

Credit, collection and allowance for doubtful accounts

         We perform ongoing customer credit evaluations based on a number of
factors, including past transaction history with the customer and the
credit-worthiness of the customer. When credit criteria are not met, we require
cash-on-delivery or payment by credit card before products are shipped. On a
quarterly basis, we specifically analyze accounts receivable, historical bad
debts, customer concentration, and changes in our customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts. Such losses have
generally been within our expectations. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required. Three customers accounted
for 69% and 68% of accounts receivable at December 31, 2003 and 2002,
respectively.

Inventories and related write-downs for excess and obsolete inventory

         Inventories are stated at the lower of standard cost (which
approximates cost on a first-in, first-out basis) or market. Inventories are
reduced for excess and obsolete inventories. These write-downs are based on
management's review of inventories on hand on a quarterly basis, compared to
management's assumptions about future demand, market conditions and anticipated
timing of the release of product upgrades or next generation products. If actual
market conditions for future demand are less favorable than those projected by
us or if product upgrades or next generation products are released earlier than
anticipated, additional inventory write-downs may be required.

Income taxes

       We account for income taxes in accordance with the liability method.
Under the liability method, deferred assets and liabilities are recognized based
upon anticipated future tax consequences attributable to differences between
financial statement carrying amounts of assets and liabilities and their
respective tax bases. The provision for income taxes is comprised of the current
tax liability and the change in deferred tax assets and liabilities. We assess
the likelihood that our deferred tax assets will be recovered from future
taxable income and to the extent we believe that recovery is not likely, we must
establish a valuation allowance against these tax assets. Significant management
judgment is required in determining the provision for income taxes and any
valuation allowance recorded against our deferred tax assets. The establishment
or reversal of any valuation allowance is based in large part on projected
future taxable income.


Results of Operations

     Comparison of Years Ended December 31, 2003 and 2002

       Net Sales

                  Net sales increased 5% to $10.2 million in 2003 from $9.8
         million in 2002. The increase of $455,000 resulted primarily from sales
         of our enterprise level FaxPress Premier fax server products, which
         were launched in September 2003.

                                       18
<PAGE>

                  Domestic sales were $8.3 million in 2003 as compared to $7.7
         million in 2002, representing 81% and 79%, respectively, of total net
         sales. The increase in sales was mostly attributable to the
         introduction of the new FaxPress Premier fax server products.

                  International sales (excluding sales to the rest of the
         Americas) were $1.6 million in 2003 as compared to $1.7 million in
         2002, representing 16% and 18%, respectively, of total net sales.
         International sales were lower largely due to lower sales of our
         FaxPress server products to Europe. Most of our international sales are
         denominated in U.S. dollars and thus could be adversely affected by
         changes in demand resulting from fluctuations in currency exchange
         rates.

                  Sales to the rest of the Americas, excluding the United
         States, were $371,000 in 2003, as compared to $347,000 in 2002,
         representing 4% and 3% of total net sales in both 2003 and 2002,
         respectively.

                  In 2003, Ingram Micro, Tech Data and Macnica, our top three
         customers accounted for approximately 57% of our net sales. In 2002,
         the same three distributors accounted for 56% of net sales.


       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 and shipping. Cost of sales also
         includes compensation costs and overhead related to our manufacturing
         operations, inventory obsolescence and warranty expenses. Gross profit
         was $7.7 million, or 76% of net sales, in 2003, compared to $6.9
         million, or 71% of net sales, in 2002. Sales growth, continuous product
         cost reductions in 2003, increased outsourcing of manufacturing and
         higher sales of our fax server products, which have better gross profit
         relative to our print server products contributed to the improvement in
         gross profit in 2003.

       Research and Development

                  Research and development expenses represent costs associated
         with the development of new products and consist primarily of
         employee-related expenses, material costs and allocated facility costs.
         Research and product development expenses were $1.6 million in 2003,
         compared to $1.4 million in 2002, and represented 16% and 14% of net
         sales for those periods, respectively. The higher research and
         development expenses in 2003 were mostly due to additional material
         costs of $106,000 used in the development of our FaxPress Premier
         server products that were launched in September 2003, and higher
         compensation expense of $82,000 due to increased headcount. Research
         and development spending has supported both existing products and the
         development of new server appliances. We remain committed to the
         development of highly competitive new products and services through the
         efficient utilization of our engineering resources.

       Sales and Marketing

                  Sales and marketing expenses consist primarily of
         employee-related expenses, commissions to sales representatives,
         product promotion expenses, and allocated facilities expenses,
         including expenses associated with our regional sales and support
         offices. Sales and marketing expenses were $3.1 million and $3.0
         million for 2003 and 2002, respectively, and represented 31% of net
         sales for both periods. The slight increase in sales and marketing
         expenses was largely due to increased promotional and travel related
         expenses of $235,000 and higher compensation expenses of $76,000 due to
         increased headcount, offset in part by lower consulting expenses of
         $173,000.

                                       19
<PAGE>

       General and 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 accounting expenses, and allocated facilities expenses. General and
         administrative expenses were $1.9 million in both 2003 and 2002, and
         represented 19% and 20% of net sales for those periods. The slightly
         lower expenses in 2003 as compared to 2002 were mainly attributable to
         lower consulting expenses of $180,000 and legal and accounting fees of
         $166,000, offset partially by higher compensation expenses of $151,000
         and investor relation expenses of $86,000. General and administrative
         expenses in 2002 included legal expenses of $128,000 and outside
         consulting expenses of $209,000, which were chiefly attributable to our
         stock repurchase and Nasdaq listing issues.

       Interest and other income

                  Interest and other income consist primarily of interest income
         earned from our invested cash balances, interest expense on capital
         leases, bank service fees, and miscellaneous income and expenses.
         Interest and other expenses for 2003 were $10,000 as compared to income
         of $44,000 in 2002. The decrease in interest and other income was
         chiefly due to a $29,000 reduction in interest income due to lower
         interest rates and decreased miscellaneous income of $26,000.

       Provision for Income Tax

                  In the fourth quarter of 2003, we recorded a non-cash tax
         benefit of $526,000, resulting from the release of a portion of our tax
         valuation allowance. Prior to the fourth quarter, we had not reported
         significant income tax expenses because we had utilized available Net
         Operating Loss ("NOL") and tax credit carryforwards. These NOLs were
         fully reserved by a valuation allowance due to uncertainly surrounding
         the likelihood of their realization. Due to our continued profitability
         over the past ten quarters and a determination that it is more likely
         than not that certain future tax benefits will be realized, a portion
         of the deferred tax assets were recognized in the fourth quarter.


                  In 2002, our provision for income taxes was $6,000,
         representing state income taxes. The tax provision for federal income
         taxes was offset by utilization of our net operating loss
         carryforwards.

     Comparison of Years Ended December 31, 2002 and 2001

       Net Sales

                  Net sales increased 4% to $9.8 million in 2002 from $9.4
         million in 2001. The increase of $405,000 in net sales resulted
         primarily from an increase in sales of our FaxPress fax server products
         to the domestic channels of $763,000, offset partially by a decrease in
         our print server product sales to international markets of $358,000.

                  Domestic sales were $7.7 million in 2002 as compared to $7.0
         million in 2001, representing 79% and 75%, respectively, of total net
         sales. The increase was mostly attributable to higher sales of our
         FaxPress fax server products.

                  International sales (excluding sales to the rest of the
         Americas) were $1.7 million in 2002 as compared to $2.0 million in
         2001, representing 18% and 21%, respectively, of total net sales. Lower
         international sales were largely due to reduced demand for our print
         server products in the


                                       20
<PAGE>

         Asia Pacific region. Most of our international
         sales are denominated in U.S. dollars and thus could be adversely
         affected by changes in demand resulting from fluctuations in currency
         exchange rates.

                  Sales to the rest of the Americas, excluding the United
         States, were $347,000 in 2002, as compared to $321,000 in 2001,
         representing 3% and 4% of total net sales in 2002 and 2001,
         respectively.

                  In 2002, Ingram Micro, Tech Data and Macnica, our top three
         customers accounted for approximately 56% of our net sales. In 2001,
         the same three distributors accounted for 55% of net sales.

       Cost of Sales; Gross profit

                  Gross profit was $6.9 million, or 71% of net sales, in 2002,
         compared to $6.3 million, or 67% of net sales, in 2001. Efficiencies
         realized from the restructuring in 2001, continuous product cost
         reductions in 2002, increased outsourcing of manufacturing and an
         increase in the mix of sales of our fax server products, which have
         higher gross profit relative to our print server products, contributed
         to the improvement in gross profit in 2002.

       Research and Development

                  Research and product development expenses were $1.4 million in
         2002, compared to $1.8 million in 2001, and represented 14% and 19% of
         net sales for those periods, respectively. The lower research and
         development expenses in 2002 were mostly due to lower support costs of
         $213,000 and reduced use of outside consulting, resulting in a savings
         of $244,000.

       Sales and Marketing

                  Sales and marketing expenses were $3.0 million and $3.6
         million for 2002 and 2001, respectively, and represented 31% and 38% of
         net sales for those periods. The reduction in sales and marketing
         expenses was largely due to a reduction in personnel related costs of
         $395,000, which was partly realized from the restructuring actions in
         2001 and lower product promotional expenses of $291,000, offset in part
         by higher support costs of $55,000.

       General and Administrative

                  General and administrative expenses were $1.9 million and $1.3
         million for 2002 and 2001, respectively, or 20% and 14% of net sales
         for those periods. The increase in expenses in 2002 was mostly due to
         higher legal expenses of $128,000 and outside consulting expenses of
         $209,000, which were chiefly attributable to our stock repurchase and
         Nasdaq listing issues. Increased accounting fees of $81,000,
         compensation to our board of directors of $49,000, investor relations
         expenses of $72,000 and the absence of benefit obtained from the
         collection of bad debts previously written-off in 2001 of $115,000 also
         contributed to the higher general and administrative expenses in 2002.

       Restructuring Expenses

                  In April 2001, we terminated 17 regular, temporary and
         contractor positions, which constituted approximately 25% of our
         workforce. This action resulted in a restructuring charge of $239,000
         in 2001. In the second quarter of 2002, a non-recurring benefit of
         $40,000 arising from the reversal of previously recorded restructuring
         charges was included in our results of operations, following the
         completion of our 2001 restructuring program for less than previously
         anticipated. The following table sets forth an analysis of the
         components of the reserve balance carried-forward from fiscal 2001 (in
         thousands of dollars):

                                       21
<PAGE>

<TABLE>
<CAPTION>


                                                                   Asset Write
                                    Employee Costs    Facilities      Down         Other        Total
                                    --------------------------------------------------------------------
<S>                                         <C>          <C>              <C>        <C>         <C>
 Balance as of December 31, 2001            $36          $28              $ -        $ 25        $ 89
 Cash payments                              (36)           -                -         (13)        (49)
 Reversal of excess accrual                   -          (28)               -         (12)        (40)
                                    --------------------------------------------------------------------
 Balance as of 12/31/2002                   $ -          $ -              $ -        $  -        $  -
</TABLE>


       Interest and other income


                  Interest and other income consist primarily of interest income
         earned from our invested cash balances, interest expense on capital
         leases, bank service fees, and miscellaneous income and expenses.
         Interest and other income was $44,000 and $111,000 in 2002 and 2001,
         respectively. The decrease in other income in 2002 when compared to
         2001 primarily reflected lower interest income of $52,000 due to the
         decline in interest rates during 2002 and miscellaneous income of
         $64,000, offset in part by lower bank fees of $51,000.

       Provision for Income Tax

                  In fiscal 2002, our provision for income taxes was $6,000,
         representing state income taxes. The tax provision for federal income
         taxes was offset by utilization of our net operating loss
         carryforwards.

                  In fiscal 2001, we incurred a loss and there were no
         substantial federal or state income taxes recognized.


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, 2003, we had $4.6 million
of cash and cash equivalents, an increase of $1.2 million from December 31,
2002. The increase in cash and cash equivalents was primarily attributable to
the increase in income before tax of $1.1 million and $268,000 in proceeds from
the exercise of stock options, offset in part by $164,000 of investment in new
computers and other production equipment.

         On March 12, 2002, we received a notice from the Nasdaq Stock Market
that our common stock had failed to maintain the minimum bid price of $1.00 per
share required for continued listing on the Nasdaq SmallCap Market. On November
18, 2002, we were granted a temporary exception to Nasdaq's minimum bid price
requirement, subject to us meeting certain conditions during the term of the
exception. On December 30, 2002, our common stock bid price closed at $1.00 per
share and since then the bid price has closed above $1.00. On January 16, 2003,
we received a letter from the Nasdaq stating that we have demonstrated full
compliance with the Nasdaq Qualifications Exception issued to us on November 18,
2002.

         In the fourth quarter of 2002, our Board of Directors authorized us,
from time to time, to repurchase at market prices, up to $2.25 million shares of
our common stock for cash in open market, negotiated or block transactions. The
timing of such transactions has depended and will depend on market conditions,
other corporate strategies and has been and will be at the discretion of our
management. No time limit was set for the completion of this program. As of
December 31, 2003, we have repurchased from open market and negotiated
transactions a total of 1.67 million shares for $1.8 million, at an average per
share price of $1.10.

                                       22
<PAGE>

         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 12.8% and is repayable by December
2006. As of December 31, 2003, the future minimum payments are $50,000.

         In April 2001, as a source of capital asset financing, we entered into
a loan and security agreement with a finance company for an amount of $25,000.
This loan is subject to interest of 12.5% and is repayable by April 2004. As of
December 31, 2003, the future minimum payments are $2,000.We have entered into a
noncancelable operating lease that expires in 2005 and other capital leases that
expire at various stages in 2006, and are responsible for certain maintenance
costs, taxes and insurance under the leases. We lease our headquarters in Morgan
Hill, California.. The lease 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.

         The following represents combined aggregate maturities for all our
financing and commitments as of December 31, 2003:
<TABLE>
<CAPTION>

                                                               Payments Due by Period
                                        ---------- ------------- --------------- ------------- ---------------
Contractual Obligations                   Total    Less Than 1    1 - 3 Years    3 - 5 Years    More than 5
                                                       Year                                        Years
                                        ---------- ------------- --------------- ------------- ---------------
<S>                                         <C>           <C>             <C>              <C>             <C>
Capital (Finance) Lease Obligations         $  53         $  20           $  33             -               -
Operating Lease Obligations                 $ 532         $ 269           $ 263             -               -
                                        ---------- ------------- --------------- ------------- ---------------
Total contractual cash obligations          $ 585         $ 289           $ 296             -               -
                                        ========== ============= =============== ============= ===============
</TABLE>


         In addition to the commitments shown above, we have a $3.0 million
secured revolving line of credit with a bank, which expires in March 2005,
pursuant to which we may borrow 100% against pledges of cash at the bank's prime
rate (4% at December 31, 2003). Borrowings under this line of credit agreement
are collateralized by all of our assets. Under the agreement, we must comply
with certain financial and other covenants. As of December 31, 2003, we have not
drawn down on the line of credit, were in compliance with these covenants and
have no borrowings outstanding under the line of credit.

         Net cash provided by operations in 2003 was $1.1 million as compared to
$882,000 in 2002. The increase was largely a result of sales increases, and
better gross profit arising from improved operational efficiencies and cost
reductions.

         Net cash used in financing activities of $2.0 million in 2002 was
largely for the repurchase of our stock and the professional fees associated
with such repurchase. In the first quarter of 2003, we repurchased $48,000 of
our stock from open market transactions. We acquired additional property and
equipment of $164,000, $34,000 and $105,000 in 2003, 2002 and 2001,
respectively.

         We believe that our existing cash balances, anticipated cash flows from
operations and available lines of credit will be sufficient to meet our
anticipated capital requirements for the next 12 months. If we have a need for
additional capital resources, we may be required to sell additional equity or
debt securities, secure additional lines of credit or obtain other third party
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 our existing and new products, if any, 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. Failure to raise
such additional financing, if needed, may result in our inability to achieve our
long-term business objectives. To the extent that additional capital is raised

                                       23
<PAGE>

through the sale of additional equity or convertible debt securities, the
issuance of such securities would result in additional dilution to our
shareholders.

         In addition, because of our dependency on a small number of
distributors for a significant portion of the sales of our products, the loss of
any of our major distributors or their inability to satisfy their payment
obligations to us could have a significant adverse effect on our business,
operating results and financial condition.


                                  RISK FACTORS

         Shareholders or investors considering the purchase of shares of the our
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 us or that we currently deem immaterial
also may impair our business operations.

Our revenue and operating results have fluctuated in the past and are likely to
fluctuate significantly in the future, particularly on a quarterly basis.

         Our operating results may vary significantly from quarter to quarter
due to many factors, some of which are outside our control. For example, the
following conditions could all affect our results:

O      changes in our product sales and customer mix;
O      constraints in our manufacturing and assembling operations;
O      shortages or increases in the prices of raw materials and components;
O      changes in pricing policy by us or our competitors;
O      a slowdown in the growth of the networking market;
O      seasonality;
O      timing of expenditures; and
O      economic conditions in the United States, Europe and Asia.

         Our sales often reflect orders shipped in the same quarter in which
they are received. In addition, significant portions of our expenses are
relatively fixed in nature, and planned expenditures are based primarily on
sales forecasts. Therefore, if we inaccurately forecast demand for our products,
the impact on net income may be magnified by our inability to adjust spending
quickly enough to compensate for the net sales shortfall.

         Other factors contributing to fluctuations in our quarterly operating
results include:

O     changes in the demand for our products;
O     customer order deferrals in anticipation of new versions of our products;
O     the introduction and acceptance of new products and product enhancements
      by us or our competitors;
O     the effects of filling the distribution channels following introductions
      of new products and product enhancements;
O     potential delays in the availability of announced or anticipated products;
O     the mix of product and service revenue,
O     the commencement or conclusion of significant development contracts;
O     changes in foreign currency exchange rates; and
O     the timing of significant marketing and sales promotions.

         Based on the foregoing, we believe that quarterly operating results are
likely to vary significantly in the future and that period-to-period comparisons
of our results of operations are not necessarily meaningful and should not be
viewed as indications of future performance.

                                       24
<PAGE>

We have a history of losses and may not be able to sustain profitability.

         We have experienced significant operating losses and, as of December
31, 2003, had an accumulated deficit of $22 million. Our development and
marketing of current and new products will continue to require substantial
expenditures. We incurred $591,000 of losses in 2001 due to a slowdown in demand
for our products due in part to industry-wide adverse economic conditions. We
were able to recover and have been profitable since the third quarter of 2001,
with total net income of $659,000 and $1.6 million in 2002 and 2003,
respectively. There can be no assurance that growth in net sales will be
achieved or profitability sustained in future years.

Our common stock is listed on the Nasdaq SmallCap Market, and we have had
difficulty satisfying the listing criteria to avoid the delisting of our common
stock

         Our common stock has been listed on the Nasdaq SmallCap Market since
April 1999. In order to maintain our listing on the Nasdaq SmallCap Market, we
must maintain total assets, capital and public float at specified levels, and
our common stock generally must maintain a minimum bid price of $1.00 per share.
If we fail to maintain the standards necessary to be quoted on the Nasdaq
SmallCap Market, our common stock could become subject to delisting. There can
be no assurance that we will be able to maintain the $1.00 minimum bid price per
share of our common stock and thus maintain our listing on the Nasdaq SmallCap
Market.

         If our common stock is delisted, trading in our 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 our common stock or to obtain accurate
quotations as to the price of our common stock. Lack of any active trading
market would have an adverse effect on a shareholder's ability to liquidate an
investment in our common stock easily and quickly at a reasonable price. It
might also contribute to volatility in the market price of our common stock and
could adversely affect our 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 our business, financial condition and results of
operations.

Substantially all of our revenue comes from the sale of fax server products, and
a decline in demand for those products would harm our business, operating
results and financial condition.

         We derive substantially all of our revenue from the sale of fax and
print server products, with fax server products accounting for 97% of total
sales in 2003. We expect that our current products will continue to account for
most of our sales in the near future. A decline in demand for our fax server
products as a result of competition, technological change, shortages of
components or other factors, or a delay in the development and market acceptance
of new features and products, would have a material adverse effect on our
business, operating results and financial condition.

We sell our products through a limited number of distributors, and any
deterioration in our relationship with those distributors would harm our
business, operating results and financial condition.

         We sell our products primarily through a two-tier domestic and
international distribution network. Our distributors sell our 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. An increasing number of
companies are competing for access to these channels. Our distributors typically
represent other products that are complementary to, or compete with, our
products. Our distributors are not contractually committed to future purchases
of our products and could discontinue carrying our products at any time for any
reason. In addition, because we are dependent on a small number of distributors
for a significant portion of the sales of our products, the loss of any of our

                                       25
<PAGE>

major distributors or their inability to satisfy their payment obligations to us
could have a significant adverse effect on our business, operating results and
financial condition. We have a stock rotation policy with certain of our
distributors that allows them to return marketable inventory against offsetting
orders. If we reduce our prices, we credit certain distributors for the
difference between the purchase price of products remaining in their inventory
and our reduced price for these products. In addition, inventory levels of our
products held by distributors could become excessive due to industry conditions
or the actions of competitors, resulting in product returns and inventory
write-downs.


The market for our products is affected by rapidly changing technology and if we
fail to predict and respond to customers' changing needs, our business,
operating results and financial condition may suffer.

         The market for our products is affected by rapidly changing networking
technology, evolving industry standards and the emergence of the Internet and
other new communication technologies. We believe that our future success will
depend upon our ability to enhance our existing products and to identify,
develop, manufacture and introduce new products which

O     conform to or support emerging network telecommunications standards;
O     are compatible with a growing array of computer and peripheral devices;
O     support popular computer and network operating systems and applications;
O     meet a wide range of evolving user needs; and
O     achieve market acceptance.

There can be no assurance that we will be successful in these efforts.

         We have incurred, and expect 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 products will achieve market acceptance and generate
sales sufficient to offset development costs. In order to develop new products
successfully, we are dependent upon timely access to information about new
technological developments and standards. There can be no assurance that we will
have such access or will be able to develop new products successfully and
respond effectively to technological change or new product announcements by
others.

         Complex products such as those offered by us may contain undetected or
unresolved hardware defects or software errors when they are first introduced or
as new versions are released. Changes in our or our suppliers' manufacturing
processes or the inadvertent use of defective components could adversely affect
our ability to achieve acceptable manufacturing yields and product reliability.
We have in the past discovered hardware defects and software errors in certain
of our new products and enhancements after their introduction. Replacement of
discontinued components used in our products could lead to further defects and
errors. There can be no assurance that despite testing by us and by third-party
test sites, errors and defects will not be found in future releases of our
products, which would result in adverse product reviews and negatively affect
market acceptance of these products.

         The introduction of new or enhanced products requires us to manage the
transition from the older products to the new or enhanced products or versions,
both internally and for customers. We 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. We have from time to time experienced
delays in the shipment of new products. There can be no assurance that we will
successfully manage future product transitions.


                                       26
<PAGE>


Our success depends upon the continued contributions of our key management,
marketing, product development and operational personnel.

         Our success will depend, to a large extent, upon our ability to retain
and continue to attract highly skilled personnel in management, marketing,
product development and operations. Competition for employees in the computer
and electronics industries is intense, and there can be no assurance that we
will be able to attract and retain enough qualified employees. Volatility or
lack of positive performance in our stock price may also adversely affect our
ability to retain and continue to attract key employees, many of whom have been
granted stock options. Our inability to retain and attract key employees could
have a material adverse effect on our product development, business, operating
results and financial condition. We do not carry key person life insurance with
respect to any of our personnel.

The markets for our products are highly competitive and may become more
competitive in the future.

         The network enhancement products and computer software markets are
highly competitive, and we believe that 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. We
currently compete principally in the market for network fax servers, network
print servers and fax-on-demand software. Both direct and indirect competition
could adversely affect our business and operating results through pricing
pressure, loss of market share and other factors. In particular, we expect that,
over time, average selling prices for our 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 our products would adversely
affect gross margins. There can be no assurance we will be able to maintain the
current average selling prices of our products or the related gross margins.

         The principal competitive factors affecting the market for our products
include:

o        product functionality;
o        performance;
o        quality;
o        reliability;
o        ease of use;
o        quality of customer training and support;
o        name recognition;
o        price; and
o        compatibility and conformance with industry standards and changing
         operating system environments.

         Several of our existing and potential competitors have substantially
greater financial, engineering, manufacturing and marketing resources than us.
We also experience competition from a number of other software, hardware and
service companies. In addition to our current competitors, we may face
substantial competition from new entrants into the network enhancement market,
including established and emerging computer, computer peripheral, communications
and software companies. In the fax server market we compete with companies such
as Captaris Inc., Omtool, Ltd. and Esker Software. There can be no assurance
that competitors will not introduce products incorporating technology more
advanced than the technology used by us in our 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 our 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 we will be able to compete successfully or that competition will not have a
material adverse effect on our business, operating results and financial
condition.

                                       27
<PAGE>

We depend on sales in foreign markets, and political or economic changes in
these markets could affect our business, operating results and financial
condition.

         Sales to customers located outside the United States accounted for
approximately 19%, 21% and 25% of our net sales in 2003, 2002 and 2001,
respectively. We sell our products in approximately 40 foreign countries through
approximately 50 international distributors. Our principal Japanese distributor
accounted for approximately 38%, 27% and 40% of our international sales in 2003,
2002 and 2001, respectively, and 7%, 6% and 10% of our total net sales in 2003,
2002 and 2001, respectively. We expect that international sales will continue to
represent a significant portion of our product revenues and that we 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. There can be no assurance that we will not experience difficulties
resulting from changes in foreign laws relating to the export of our products in
the future. In addition, because we primarily invoice foreign sales in U.S.
dollars, fluctuations in exchange rates could affect demand for our products by
causing prices to be out of line with products priced in the local currency.
Additionally, any such difficulties would have a material adverse effect on our
international sales and a resulting material adverse effect on our business,
operating results and financial condition. We 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. There can be no assurance that we will be able to maintain the
level of international sales in the future. Any fluctuations in international
sales will significantly affect our operating results and financial condition.

The introduction of new products may reduce the demand for our existing products
and increase returns of existing products.

         From time to time, we 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 this inventory
becomes obsolete. We have 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. There can be no assurance that product returns will
not exceed our allowance for these returns in the future and will not have a
material adverse effect on our business, operating results and financial
condition.

If we fail to obtain components of our products from third-party suppliers and
subcontractors, our business could suffer.

         Our products require components procured from third-party suppliers.
Some of these components are available only from a single source or from limited
sources. In addition, we subcontract a substantial portion of our manufacturing
to third parties, and there can be no assurance that these subcontractors will
be able to support our manufacturing requirements. We purchase components on a
purchase order basis, and generally have no long-term contracts for these
components. If we are unable to obtain a sufficient supply of high-quality
components from our current sources, we could experience delays or reductions in
product shipments. From time to time, component manufacturers announce the end
of life of certain of their products and may or may not have replacement
products. If we are unable to secure enough inventories of the end-of-life
components or their replacements, we might not be able to deliver our products
to our customers and could adversely affect our revenue and net income.
Furthermore, a significant increase in the price of one or more of these
components or our inability to lower component or sub-assembly prices in
response to competitive price reductions could adversely affect our gross
margin.

                                       28
<PAGE>


Government regulation could increase our costs of doing business and adversely
affect our gross margin.

         Certain aspects of the networking industry in which we compete 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, or the inability to obtain regulatory approvals
within a reasonable period of time, could have a material, adverse effect on our
business, operating results and financial condition. This is particularly true
in foreign countries where telecommunications standards differ from those in the
United States. Our 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 our business,
operating results and financial condition.

We depend on proprietary technology, and inability to develop and protect this
technology or license it from third parties could adversely affect our business,
operating results and financial condition.

         Our success depends to a certain extent upon our technological
expertise and proprietary software technology. We rely upon a combination of
contractual rights and copyright, trademark and trade secret laws to establish
and protect our technologies. Despite the precautions taken by us, it may be
possible for unauthorized third parties to copy our products or to reverse
engineer or obtain and use information that we regard as proprietary. In
addition, the laws of some foreign countries either do not protect our
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 our 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 and divert the efforts our technical and management
personnel, whether or not any litigation is determined in favor of us. In the
event of an adverse result in litigation, we 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 we would be successful in this development or that any such
licenses would be available on commercially reasonable terms. We also rely on
technology licensed from third parties. There can be no assurance that these
licenses will continue to be available upon reasonable terms, if at all. Any
impairment or termination of our relationship with third-party licensors could
have a material adverse effect on our business, operating results and financial
condition. There can be no assurance that our precautions will be adequate to
deter misappropriation or infringement of our proprietary technologies.

         We have received, and may receive in the future, communications
asserting that our products infringe the proprietary rights of third parties or
seeking indemnification against the alleged infringement. There can be no
assurance that third parties will not assert infringement claims against us with
respect to current or future products or that any assertion may not require us
to enter into royalty arrangements or result in costly litigation. Any claims,
with or without merit, can be time consuming and expensive to defend. There can
be no assurance that any intellectual property litigation will not have a
material adverse effect on our business, operating results and financial
condition.

Our stock price has been volatile, and is likely to continue to be volatile in
the future.

         The price of our common stock has fluctuated widely in the past. Sales
of substantial amounts of our common stock, or the perception that sales could
occur, could adversely affect prevailing market prices for our common stock. Our
management believes past fluctuations may have been caused by the factors
identified above, and that these factors may continue to affect the market price
of our common stock. Additionally, stock markets have experienced extreme price
volatility in recent years. This


                                       29
<PAGE>

volatility has had a substantial  effect on the market price of the common stock
of us and other  high  technology  companies,  often for  reasons  unrelated  to
operating  performance.  We  anticipate  that  prices for our  common  stock may
continue  to be  volatile.  Future  stock  price  volatility  may  result in the
initiation of  securities  litigation  against us, which may divert  substantial
management  and financial  resources and have an adverse effect on our business,
operating results and financial condition.

We may require additional capital in the future, and may be unable to obtain
this capital at all or on commercially reasonable terms.

         The development and marketing of products requires significant amounts
of capital. If we need additional capital resources, we may be required to sell
additional equity or debt securities, secure additional lines of credit or
obtain other third party 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 our existing and new products and changes in
technology in the networking industry. There can be no assurance that additional
financing will be available on satisfactory terms when needed, if at all.
Failure to raise such additional financing, if needed, may result in our
inability to achieve our long-term business objectives. The issuance of equity
or convertible debt securities to raise additional capital would result in
additional dilution to our shareholders.

Recent terrorist activity in the United States and the military action to
counter terrorism could adversely impact our business.

         Terrorist acts or acts of war (wherever located around the world) could
significantly impact our revenue, costs and expenses, and financial condition.
The terrorist attacks that took place in the United States on September 11, 2001
have created many economic and political uncertainties, some of which may
materially harm our business, operating results and financial condition. The
long-term effects on our business of the September 11, 2001 attacks and the
ensuing war on terror are unknown. The potential for future terrorist attacks,
the national and international responses to terrorist attacks or perceived
threats to national security, and other actual or potential conflicts, acts of
war or hostility, including the United States' activities in Iraq, have created
many economic and political uncertainties that could adversely affect our
business, operating results and financial condition in ways that cannot
presently be predicted.

The costs of compliance with recent developments in corporate governance
regulation may affect our business, operating results and financial condition in
ways that presently cannot be predicted.

         Beginning with the enactment of the Sarbanes-Oxley Act of 2002, a
significant number of new corporate governance requirements have been adopted or
proposed through legislation and regulation by the Securities and Exchange
Commission and Nasdaq National Stock Market. We may not be successful in
complying with these requirements at all times in the future. Additionally, we
expect these developments to increase our legal compliance and accounting costs,
and to make some activities more difficult, such as stockholder approval of new
stock option plans. We expect these developments to make it more difficult and
more expensive for us to obtain director and officer liability insurance, and we
may be required to accept reduced coverage or incur substantially higher costs
to obtain coverage. These developments could make it more difficult for us to
attract and retain qualified members of our board of directors, or qualified
executive officers. We are presently evaluating and monitoring regulatory
developments and cannot estimate the timing or magnitude of additional costs we
may incur as a result, or the effect that these increased costs may have on our
operating results.

Voting control by officers, directors and affiliates may delay, defer or
prevent a change of control.

         At February 29, 2004, our 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 our 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.

                                       30
<PAGE>

Provisions in our charter documents might deter a company from acquiring us,
which could inhibit your ability to receive an acquisition premium for your
shares.

         Our Board of Directors has authority to issue shares of preferred stock
and to fix the rights, including voting rights, of these shares without any
further vote or action by the shareholders. The rights of the holders of our
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 our
outstanding voting stock, thereby delaying, deferring or preventing a change in
control. 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.

RECENT ACCOUNTING PRONOUNCEMENTS

         In November 2002, the EITF reached a consensus on Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"). EITF 00-21
provides guidance on how to account for arrangements that involve the delivery
or performance of multiple products, services and/or rights to use assets. The
provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The adoption of this interpretation has
not had a material impact on our consolidated results of operations, financial
position or cash flows.

         In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. It clarifies when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The adoption of this
interpretation has not had a material impact on our consolidated results of
operations, financial position or cash flows.

         In May, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability or an asset in some circumstances. Many of those instruments were
previously classified as equity. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. It is to be implemented by reporting the cumulative effect of a change in
an accounting principle for financial instruments created before the issuance
date of SFAS No. 150 and still existing at the beginning of the interim period
of adoption. While the effective date of certain elements of SFAS No. 150 has
been deferred, we do not expect the adoption of SFAS No. 150 to have a material
impact upon our financial position, cash flows or results of operations.

         In December 2003, the FASB issued a revised FASB interpretation No. 46
(FIN 46R), "Consolidation for Variable Interest Entities, and interpretation of
ARB No. 51" The FASB published the revision to clarify and amend some of the
original provisions of FIN 46, which was issued in January 2003, and to exempt
certain entities from its requirements. A variable interest Entity ("VIE")
refers to an entity subject to consolidation according to the provisions of the
Interpretation. FIN 46R applies to entities whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support provided by any parties, including equity
holders, or where the equity investors (if any) do not have a controlling
financial interest. FIN 46R provides that if an entity is the primary
beneficiary of a VIE, the assets, liabilities, and results of operations of the
VIE should be consolidated in the entity's financial statements. In addition,
FIN 46R requires that both the primary


                                       31
<PAGE>

beneficiary and all other enterprises with a significant  variable interest in a
VIE provide additional disclosures.  The provisions of FIN 46R are effective for
our fiscal 2004 first  quarter.  The Company does not expect the adoption of FIN
46R to  have  a  material  impact  on  our  financial  position  or  results  of
operations.


ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We had no holdings of derivative financial or commodity instruments at
December 31, 2003. 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, certain spending is 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 accounts and related income would not be
significantly impacted by increases or decreases in interest rates due mainly to
the highly liquid nature of these investments. However, sharp declines in
interest rates could seriously harm interest earnings.


ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The consolidated financial statements and supplementary data required
by this Item are set forth at the pages indicated in Item 15 of this report.


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

         None

ITEM 9A. CONTROLS AND PROCEDURES

         Regulations under the Securities Exchange Act of 1934 require public
companies, including our company, to maintain "disclosure controls and
procedures," which are defined to mean a company's controls and other procedures
that are designed to ensure that information required to be disclosed in the
reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized, and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms. Our Chief Executive
Officer and our Chief Financial Officer, based on their evaluation of our
disclosure controls and procedures as of the end of the period covered by this
report, concluded that our disclosure controls and procedures were effective for
this purpose.

         Regulations under the Securities Exchange Act of 1934 require public
companies, including our company, to evaluate any change in our "internal
control over financial reporting," which is defined as a process to provide
reasonable assurance regarding the reliability of financial reporting and
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States. In connection
with their evaluation of our disclosure controls and procedures as of the end of
the period covered by this report, our Chief Executive Officer and Chief
Financial Officer did not identify any change in our internal control over
financial reporting during the three-month period ended December 31, 2003 that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.


                                       32
<PAGE>





                                    PART III

ITEM 10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Identification of Directors

         The information required by this Item concerning our directors is
incorporated by reference from the sections captioned "Proposal 1: Election of
Directors" contained in our definitive Proxy Statement (the "Proxy Statement"),
related to our 2003 Annual Meeting of Shareholders to be filed by us with the
Securities and Exchange Commission ("SEC") no later than April 30, 2004 or will
be provided in an amendment to this Form 10-K to be filed with the SEC no later
than April 30, 2004.

Identification of Executive Officers

         The information required by this Item concerning our executive officers
is set forth in Part I of this Report.

Section 16(a) Beneficial Ownership Reporting Compliance

         The information concerning compliance with Section 16(a) of the
Exchange Act required by this Item is incorporated by reference to the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" 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

     In October 2002, the Company engaged W.R. Hambrecht + Co. ("WRH + Co."), an
investment bank in which Mr. Hambrecht, a director of the Company, is a partner,
to manage our stock buyback  program  approved by the Board of Directors.  As of
March 10, 2004, WRH + Co. had received an  insignificant  amount of compensation
under this arrangement.

         Other information required by this Item is incorporated by reference
from the sections captioned "Certain Transactions" and "Executive Compensation"
contained in the Proxy Statement.


ITEM 14.      PRINCIPAL AUDITOR FEES AND SERVICES

         Information regarding principal auditor fees and service is set forth
under "Ratification of Selection of Independent Auditors" in the Proxy
Statement, which information is incorporated hererin by reference.

                                       33
<PAGE>




                                     PART IV


ITEM 15.      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)  Financial Statements
<TABLE>
<CAPTION>

                                                                                             Page in
                                                                                            Form 10-K

<S>                                                                                            <C>
             Report of Independent Auditors................................................    F-1
             Consolidated Balance Sheets as of December 31, 2003 and 2002..................    F-2
             Consolidated Statements of Operations for the years ended
                  December 31, 2003, 2002 and 2001.........................................    F-3
             Consolidated Statements of Shareholders' Equity for the years ended
                  December 31, 2003, 2002 and 2001.........................................    F-4
             Consolidated Statements of Cash Flows for the years ended
                  December 31, 2003, 2002 and 2001.........................................    F-5
             Notes to Consolidated Financial Statements....................................    F-6
</TABLE>

         2)  Financial Statement Schedules


             The following financial statement schedule of Castelle for the
             years ended December 31, 2003, 2002 and 2001 is filed as part of
             this Form 10-K and should be read in conjunction with the Company's
             Financial Statements.
<TABLE>
<CAPTION>

                                                                                              Page in
                                                                                             Form 10-K

<S>                                                                                            <C>
             Schedule II - Valuation and Qualifying Accounts...............................    F-23
</TABLE>

         3)  Additional Exhibits

             In accordance with SEC Release No. 33-8212, Exhibits 32.1
             and 32.2 are to be treated as "accompanying" this report
             rather than "filed" as part of the report.

             31.1  Certification pursuant to 18 U.S.C. Section 1350, as adopted
                   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,
                   executed by Scott C. McDonald, Chief Executive Officer and
                   President of Castelle

             31.2  Certification pursuant to 18 U.S.C. Section 1350, as adopted
                   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,
                   executed by Paul Cheng, Chief Financial Officer of Castelle

             32.1  Certification pursuant to 18 U.S.C Section 1350, as adopted
                   pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
                   executed by Scott C. McDonald, Chief Executive Officer of
                   Castelle

             32.2  Certification pursuant to 18 U.S.C Section 1350, as adopted
                   pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
                   executed by Paul Cheng, Chief Financial Officer of Castelle


         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.

                                       34
<PAGE>

     (b) Reports on Form 8-K

         During the fourth quarter of 2003, Castelle filed a Form 8-K
         on October 24, 2003. Furnished under Item 12, "Results of
         Operations and Financial Condition", Castelle filed a press
         release regarding its financial results for its fiscal quarter
         ended September 30, 2003.


     (c) Exhibits


<TABLE>
<CAPTION>
                                                                              Incorporated by Reference
Exhibit                                                                                             Date of     Exhibit   Filed
 Number                        Exhibit Description                       Form        File No.    First Filing   Number   Herewith
                                                                                     --------    ------------   ------    --------

<S>       <C>                                                          <C>        <C>            <C>            <C>          <C>
3.1       Registrant's Amended and Restated Articles of Incorporation. SB-2/A     33-99628-LA-   12/8/1995      3.3
3.2       Registrant's Amended and Restated Bylaws.                    10-K       000-22020      12/31/2000     3.2
4.1       Specimen Stock Certificate representing shares of            SB-2/A     33-99628-LA-   12/14/1995     4.1
          Registrant's Common Stock.
10.1*     1995 Non-Employee Directors' Stock Option Plan, as amended,  SB-2/A     111-22020      12/14/1995     10.2
          and form of Director Stock Option Agreement
10.2      Form of Indemnity Agreement between the Registrant and each  SB-2/A     33-99628-LA-   12/8/1995      10.4
          of its directors and executive officers.
10.3      OEM Purchase Agreement dated May 23, 1995, by and between    SB-2/A     33-99628-LA-   12/8/1995      10.7
          the Registrant and SerComm Corporation.
10.4      Distribution Agreement dated February 26, 1990, by and       SB-2/A     33-99628-LA-   12/8/1995      10.8
          between the Registrant and Ingram Micro D Inc.
10.5      Distributor Contract dated June 25, 1991, as amended June    SB-2/A     33-99628-LA-   12/8/1995      10.9
          25, 1991, by and between the Registrant and Tech Data
          Corporation.
10.6      International Distributor Agreement dated February 24, 1994, SB-2/A     33-99628-LA-   12/8/1995      10.12
          by and between the Registrant and Macnica.
10.7*     1988 Equity Incentive Plan, as amended, and form of option   S-8        333-75247      3/29/1999      99.1
          agreement
10.8      International Distributor Agreement dated April 24, 2001 by  10-K       000-22020      3/29/2002      10.11
          and between the Registrant and AMS Limited.
10.9      Commercial Tenant Lease Agreement dated August 16, 2000 by   10-K       000-22020      3/29/2002      10.12
          and among the Registrant and Kyung S. Lee and Ieesun Kim Lee.
10.10*    Summary of Severance Agreements with Named Executive         10-K       000-22020      3/29/2002      10.13
          Officers.
10.11     Employment agreement dated April 22, 2002 by and between the 10-K       000-22020      3/28/2003      10.16
          Registrant and Scott McDonald.
10.12     Form of Executive Severance and Transition Benefits          10-K       000-22020      3/28/2003      10.16
          Agreement dated April 22, 2002 by and between the Registrant
          and Scott McDonald.
10.13*    2002 Equity Incentive Plan.                                  10-K       000-22020      3/28/2003      10.16
10.14     Loan and Security Agreement dated March 18, 1999 by and      10-K       000-22020      3/28/2003      10.17
          between the Registrant and Silicon Valley Bank.
10.15     Loan Modification Agreement dated March 16, 2003 by and      10-K       000-22020      3/28/2003      10.18
          between the Registrant and Silicon Valley Bank.
10.16     Loan Modification Agreement dated March 15, 2004 by and                                                            X
          between the Registrant and Silicon Valley Bank.                 --           --             --         --
23.1      Consent of PricewaterhouseCoopers LLP, Independent Auditors.    --           --             --         --          X
</TABLE>



     *   Indicates management contracts or compensatory plans or arrangements
         filed pursuant to Item 601(b)(10) of Regulation S-K


                                       35
<PAGE>



                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, as 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 twenty-ninth day of March 2004.


                                    By:    /S/ SCOTT C. MCDONALD
                                    --------------------------------------------
                                           Scott C. McDonald
                                           Chief Executive Officer and President



         KNOW BY ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Scott C. McDonald, 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:
<TABLE>
<CAPTION>

Name                                                           Title                                   Date


<S>                                  <C>                                                       <C>
/S/ SCOTT C. MCDONALD                Chief Executive Officer, President                        March 29, 2004
---------------------                (principal executive officer), Director
Scott C. McDonald

/S/ PAUL CHENG                        Vice President, Finance and Administration,              March 29, 2004
--------------                        Chief Financial Officer (principal accounting officer),
Paul Cheng                            Secretary


/S/ DONALD L. RICH                    Chairman of the Board and Director                       March 29, 2004
------------------
Donald L. Rich

/S/ ROBERT H. HAMBRECHT               Director                                                 March 29, 2004
-----------------------
Robert H. Hambrecht

/S/ ROBERT O. SMITH                   Director                                                 March 29, 2004
-------------------
Robert O. Smith

/S/ PETER R. TIERNEY                  Director                                                 March 29, 2004
--------------------
Peter R. Tierney
</TABLE>


                                       36

<PAGE>

                         Report of Independent Auditors




To the Board of Directors and
Shareholders of Castelle

In our opinion, the consolidated financial statements listed in the index
appearing under Item 15 (a)(1) present fairly, in all material respects, the
financial position of Castelle and its subsidiary at December 31, 2003 and 2002,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 15(a)(2) presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule 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 our opinion.



PricewaterhouseCoopers LLP
San Jose, California
March 29, 2004



<PAGE>

<TABLE>
<CAPTION>

Castelle
Consolidated Balance Sheets
(in thousands)
-------------------------------------------------------------------------------------------------------------------

                                                                                           December 31,
                                                                                ....................................
                                                                                     2003                2002
                                                                                ----------------   -----------------
<S>                                                                                  <C>                 <C>
Assets
Current assets:
    Cash and cash equivalents                                                        $   4,614           $   3,460
    Accounts receivable, net                                                               873                 444
    Inventories                                                                          1,177               1,110
    Prepaid expenses and other current assets                                              134                  88
    Deferred taxes                                                                         380                   -
                                                                                ----------------   -----------------
           Total current assets                                                          7,178               5,102

Property and equipment, net                                                                376                 425
Other assets                                                                               103                 108
Deferred taxes                                                                             146                   -
                                                                                ----------------   -----------------

             Total assets                                                             $  7,803            $  5,635
                                                                                ================   =================

Liabilities and Shareholders' Equity
Current liabilities:
    Current portion of long-term debt                                                  $    16             $    21
    Accounts payable                                                                       314                 359
    Accrued liabilities                                                                  1,759               1,696
    Deferred Revenue                                                                       909                 592
                                                                                ----------------   -----------------
           Total current liabilities                                                     2,998               2,668

Long-term debt, net of current portion                                                      29                  44
                                                                                ----------------   -----------------
           Total liabilities                                                             3,027               2,712
                                                                                ----------------   -----------------

Commitments and contingencies (Note 4)

Shareholders' equity:
    Preferred stock, no par value:
      Authorized:  2,000 shares in 2003 and 2002
      Issued and outstanding:  none in 2003 and 2002                                         -                   -
    Common stock, no par value:
      Authorized:  25,000 shares
      Issued and outstanding: 3,425 shares at December 31, 2003
           and 3,187 shares at December 31, 2002                                        27,258              27,038
    Accumulated deficit                                                                (22,482)            (24,115)
                                                                                ----------------   -----------------
           Total shareholders' equity                                                    4,776               2,923
                                                                                ----------------   -----------------

             Total liabilities and shareholders' equity                               $  7,803            $  5,635
                                                                                ================   =================
</TABLE>




                                      F-2
   The accompanying notes are an integral part of these financial statements.
<PAGE>


<TABLE>
<CAPTION>

Castelle
Consolidated Statements of Operations
(in thousands, except per share data)
-------------------------------------------------------------------------------------------------------------------

                                                                               Year Ended December 31
                                                               ........................................................
                                                                     2003                2002               2001
                                                               -----------------   -----------------  -----------------

<S>                                                                  <C>                 <C>                 <C>
Net sales                                                            $  10,214           $   9,759           $  9,354
Cost of sales                                                            2,485               2,836              3,089
                                                               -----------------   -----------------  -----------------
        Gross profit                                                     7,729               6,923              6,265
                                                               -----------------   -----------------  -----------------

Operating expenses:
    Research and development                                             1,590               1,383              1,805
    Sales and marketing                                                  3,131               3,016              3,588
    General and administrative                                           1,902               1,943              1,335
    Restructuring charge/(recovery)                                          -                 (40)               239
                                                               -----------------   -----------------  -----------------
                                                                         6,623               6,302              6,967
                                                               -----------------   -----------------  -----------------

           Operating income/(loss)                                       1,106                621               (702)

Interest income, net                                                        16                 43                 94
Other income/(expense), net                                                (26)                 1                 17
                                                               -----------------   -----------------  -----------------

Income/(loss) before provision for/(benefit from)
    income taxes                                                         1,096                665               (591)
Provision (benefit) for income taxes                                      (537)                 6                  -
                                                               -----------------   -----------------  -----------------

           Net income/(loss)                                         $   1,633           $    659          $    (591)
                                                               =================   =================  =================

Net income/(loss) per common share - basic                           $    0.50           $   0.15          $   (0.12)
                                                               =================   =================  =================

Net income/(loss) per common share - diluted                         $    0.39           $   0.14          $   (0.12)
                                                               =================   =================  =================

Shares used in per share calculation - basic                             3,254              4,539              4,744
                                                               =================   =================  =================

Shares used in per share calculation - diluted                           4,186              4,586              4,744
                                                               =================   =================  =================
</TABLE>

                                      F-3
   The accompnaying notes are an integral part of these financial statements.
<PAGE>


<TABLE>
<CAPTION>

Castelle
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 2003, 2002 and 2001
(in thousands)
-------------------------------------------------------------------------------------------------------------------


                                                              Common Stock           Deferred    Accumulated
                                                        ..........................
                                                          Shares        Amount     Compensation    Deficit       Total
                                                        ------------  ------------ ------------- ------------ ------------
<S>                                                          <C>       <C>             <C>        <C>           <C>
Balances, December 31, 2000                                  4,741     $  28,976       $   (17)   $ (24,183)    $  4,776
    Issuance of common stock through
      exercise of stock options                                  4             1             -            -            1
    Deferred compensation related to options issued to           -             4            (4)           -            -
    consultant
    Revaluation of options issued to consultants                              (4)            4                         -
    Amortization of deferred compensation                        -             -            16            -           16
    Net loss                                                     -             -             -         (591)         591

                                                        ------------  ------------ ------------- ------------ ------------
Balances, December 31, 2001                                  4,745        28,977            (1)      (24,774)      4,202
                                                        ============  ============ ============= ============ ============

    Issuance of common stock through
      exercise of stock options                                 61            38             -            -           38
    Repurchase and cancellation of common stock             (1,619)       (1,977)                         -       (1,977)
    Amortization of deferred compensation                        -             -             1            -            1
    Net                                                          -             -             -           659         659
    income

                                                        ------------  ------------ ------------- ------------ ------------
Balances, December 31, 2002                                  3,187        27,038             -       (24,115)      2,923
                                                        ============  ============ ============= ============ ============
    Issuance of common stock through
      exercise of stock options                                285           268             -            -          268
    Repurchase and cancellation of common stock                (47)          (48)                         -          (48)
    Net                                                          -             -             -         1,633       1,633
    income

                                                        ------------  ------------ ------------- ------------ ------------
Balances, December 31, 2003                                  3,425     $  27,258        $    -    $ (22,482)    $  4,776
                                                        ============  ============ ============= ============ ============
</TABLE>


                                      F-4
   The accompanying notes are an integral part of these financial statements.
<PAGE>


<TABLE>
<CAPTION>

Castelle
Consolidated Statements of Cash Flows
Years Ended December 31,2003, 2002 and 2001
(in thousands)
----------------------------------------------------------------------------------------------------------------------


                                                                                 Year Ended December 31,
                                                                   ....................................................
                                                                        2003              2002              2001
                                                                   ----------------  ----------------  ----------------
<S>                                                                   <C>                 <C>             <C>
Cash flows from operating activities:
    Net income/(loss)                                                 $     1,633         $     659       $     (591)
    Adjustments to reconcile net income/(loss) to
      net cash provided by  operating activities:
        Depreciation and amortization                                         213               206              230
        Provision for doubtful accounts and sales returns                       5               (21)              59
        Write-downs of excess and obsolete inventory                         (167)             (105)             148
        Deferred taxes                                                       (526)                -                -
        Compensation expense related to grant of stock options                  -                 1               16
        Loss on disposal of fixed assets                                        -                 1               44
        Changes in assets and liabilities:
           Accounts receivable                                               (434)              257            1,344
           Inventories                                                        100               (79)             289
           Prepaid expenses and other current assets                          (41)               42               79
           Other assets                                                         -                 -               (6)
           Accounts payable                                                   (45)               79             (734)
           Accrued liabilities                                                 63              (306)            (193)
           Deferred revenue                                                   317               148              (42)
                                                                   ----------------  ----------------  ----------------
             Net cash provided by operating activities                      1,118               882              643
                                                                   ----------------  ----------------  ----------------

Cash flows from investing activities:
    Acquisition of property and equipment                                   ( 164)              (34)            (105)
                                                                   ----------------  ----------------  ----------------
             Net cash used in investing activities                           (164)              (34)            (105)
                                                                   ----------------  ----------------  ----------------

Cash flows from financing activities:
    Return of restricted cash                                                   -                 -               125
    Issuance/(repayment) of notes payable                                     (20)              (17)               11
    Repurchase of common stock                                                (48)           (1,977)                -
    Proceeds from issuance of common stock                                    268                38                 1
                                                                   ----------------  ----------------  ----------------
             Net cash provided by/(used in) financing activities              200            (1,956)              137
                                                                   ----------------  ----------------  ----------------

Net increase/(decrease) in cash and cash equivalents                        1,154            (1,108)              675

Cash and cash equivalents, beginning of period                              3,460             4,568             3,893
                                                                   ----------------  ----------------  ----------------
Cash and cash equivalents, end of period                               $    4,614        $    3,460         $   4,568
                                                                   ================  ================  ================

Supplemental information:
    Cash paid during the period for:
      Interest                                                          $       9          $     10          $     12
    Noncash investing and financing activities:
      Note payable for fixed asset acquisition                          $       -          $      -          $     25
</TABLE>



                                      F-5
   The accompanying notes are an integral part of these financial statements.
<PAGE>



Castelle
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

1.     Business and Organization of the Company

       Castelle develops, manufactures, markets and supports office automation
       systems that allow organizations to easily implement faxing and printing
       over local area networks and the Internet. Castelle's FaxPress and
       FaxPress Premier fax servers provide simple ways to integrate fax with
       email, desktop and back-end applications. The Company also provides
       LANpress print servers, which enable users to locate printers anywhere on
       the network, and the InfoPress information-on-demand software suite.

       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 manufacturers and sells software enhancements and
       upgrades directly to end-users.

       The Company believes that its existing cash balances and anticipated cash
       flows from operations will be sufficient to meet its anticipated capital
       requirements for the next 12 months. If the Company has a need for
       additional capital resources, it may be required to sell additional
       equity or debt securities, secure additional lines of credit or obtain
       other third party 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, if any, 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. Failure to raise
       such additional financing, if needed, may result in the Company not being
       able to achieve its long-term business objectives

       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's three largest distributors accounted for 57%,
       56% and 55% of the Company's sales in 2003, 2002 and 2001, respectively.

2.       Summary of Significant Accounting Policies

       Use of estimates in preparation of financial statements
       The preparation of financial statements in conformity with accounting
       principles generally accepted in the United States 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.

       Basis of presentation
       Certain reclassifications have been made to prior year balances in order
       to conform to the current year presentation.

                                      F-6
<PAGE>

       Principles of consolidation
       The consolidated financial statements include the accounts of Castelle
       and its wholly owned subsidiaries in the United States and the United
       Kingdom. All intercompany balances and transactions have been eliminated.

       Financial instruments
       Cash equivalents consist of highly liquid investments with original or
       remaining maturities of three months or less when purchased.

       Carrying amounts of financial instruments consisting of cash and cash
       equivalents, accounts receivable, accounts payable and accrued
       liabilities included in the Company's financial statements approximate
       fair value due to their short maturities.

       Concentrations of credit risk
       Financial instruments that potentially subject the Company to
       concentrations of credit risk consist principally of trade receivables
       and cash equivalents. With respect to trade receivables, the Company
       performs ongoing credit evaluations of its customers' financial
       condition. Additionally, the Company establishes an allowance for
       doubtful accounts based upon factors surrounding the credit risk of
       specific customers, historical trends and other available information.
       Three customers accounted for 69%, 68% and 72% of accounts receivable at
       December 31, 2003, 2002 and 2001, respectively. The same three customers
       accounted for 57%, 56% and 55% of the Company's total sales in 2003, 2002
       and 2001, respectively. Although the Company does not require collateral
       on certain accounts receivable on sales to large, well-established
       companies, it does require prepayments on certain sales to foreign and
       smaller companies.

       With respect to cash equivalents, the Company has cash investment
       policies that limit the amount of credit exposure to any one issuer and
       restrict placement of these investments to issuers evaluated as
       creditworthy.

       Inventories and related write-downs for excess and obsolete inventory
       Inventories are stated at the lower of standard cost (which approximates
       cost on a first-in, first-out basis) or market. Inventories have also
       been written down for excess and obsolete inventories. The write-downs
       are based on management's review of inventories on hand, compared to
       management's assumptions about future demand, market conditions and
       anticipated timing of the release of product upgrades or next generation
       products. If actual market conditions for future demand are less
       favorable than those projected by us or if product upgrades or next
       generation products are released earlier than anticipated, additional
       inventory write-downs may be required.

       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. Expenditures for replacements and betterments are
       capitalized, while expenditures for maintenance and repairs are charged
       against earnings as incurred.

                                      F-7
<PAGE>

       Accounting for long-lived assets
       The Company reviews long-lived 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 undiscounted 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.

     Revenue recognition
     Castelle  recognizes  revenue based on the  provisions of Staff  Accounting
     Bulletin  No.  104  "Revenue   Recognition"   and  Statement  of  Financial
     Accounting  Standards  ("SFAS") No. 48 "Revenue  Recognition  When Right of
     Return Exists."

       Product revenue is recognized upon shipment if a signed contract or
       purchase order exists, the fee is fixed or determinable, collection of
       the resulting receivable is probable and product returns are reasonably
       estimable. Shipment generally occurs and title and risk of loss is
       transferred when the product is delivered to a common carrier.

       The Company enters into agreements with some of its distributors that
       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. End-user customers who purchase
       products directly from Castelle also have limited return rights, which
       expire 30 days from product shipment. Revenues subject to stock rotation
       or other return rights are reduced by management's estimates of
       anticipated exchanges and returns. Castelle establishes its returns
       allowance for distributors and direct end-user customers based on
       historic return rates.

       Pursuant to the Company's agreements with distributors, the Company also
       protects its distributors' exposure related to the impact of price
       reductions. Price adjustments are recorded at the time price reductions
       are communicated to the Company's distributors.

       Revenue for transactions that include multiple elements such as hardware
       and post-contract customer support is allocated to each element based on
       its relative fair value and recognized for each element when the revenue
       recognition criteria have been met for such element. Fair value is
       generally determined based on the price charged when the element is sold
       separately.

       The Company recognizes revenue from support or maintenance contracts,
       including extended warranty and support programs, ratably over the period
       of the contract.

       Castelle recognizes royalty income on the sale of LANpress products by a
       Japanese distributor. Royalties are recognized when the products are sold
       by the distributor to its end customer.

       Shipping and handling
       Costs related to shipping and handling are included in cost of sales for
       all periods presented.

       Advertising costs
       Advertising costs, included in sales and marketing expenses, are expensed
       as incurred and were $345,000, $193,000 and $446,000 in 2003, 2002 and
       2001, respectively.


                                      F-8
<PAGE>



       Research and development expenses

       Costs related to the conceptual formulation and design of both hardware
       and 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.

       Income taxes

       The Company accounts for income taxes in accordance with the liability
       method. Under the liability method, deferred assets and liabilities are
       recognized based upon anticipated future tax consequences attributable to
       differences between financial statement carrying amounts of assets and
       liabilities and their respective tax bases. The provision for income
       taxes is comprised of the current tax liability and the change in
       deferred tax assets and liabilities. The company establishes a valuation
       allowance to the extent that all or some portion of the deferred tax
       assets more likely than not will not be recoverable against future
       taxable income.

       Foreign currency translation
       The functional currency of the Company's foreign subsidiary is the U.S.
       dollar. Accordingly, all assets and liabilities are translated into U.S.
       dollars at the current exchange rates as of the applicable balance sheet
       date. Revenues and expenses are translated at the average exchange rates
       prevailing during the period. Cumulative gains and losses from the
       translation of the foreign subsidiaries' financial statements have not
       been material to date. Foreign exchange gains and losses resulting from
       foreign currency transactions were not material in any of the periods
       presented.

       Net income/(loss) per share
       Basic net income/(loss) per share is computed by dividing net
       income/(loss) 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.



                                      F-9
<PAGE>



       Basic and diluted net income/(loss) per share are calculated as follows
       for 2003, 2002 and 2001 (in thousands except per share amounts):
<TABLE>
<CAPTION>

                                                                      2003              2002              2001
                                                                 ---------------   ----------------  ----------------
<S>                                                                  <C>                 <C>             <C>
       Basic:
          Weighted average shares                                       3,254              4,539              4,744
                                                                 ===============   ================  ================
          Net income/(loss)                                           $ 1,633            $   659          $    (591)
                                                                 ===============   ================  ================
          Net income/(loss) per share                                 $  0.50            $  0.15          $   (0.12)
                                                                 ===============   ================  ================

       Diluted:
          Weighted average shares                                       3,254              4,539              4,744
          Common equivalent shares from stock options                     932                 47                  -
                                                                 ---------------   ----------------  ----------------
          Shares used in per share calculation                          4,186              4,586              4,744
                                                                 ===============   ================  ================
          Net income/(loss)                                           $ 1,633            $    659         $    (591)
                                                                 ===============   ================  ================
          Net income/(loss) per share                                 $  0.39            $   0.14         $   (0.12)
                                                                 ===============   ================  ================
</TABLE>

       The calculation of diluted shares outstanding excludes 120,000, 1,153,000
       and 901,000 shares of common stock for the years ended December 31, 2003,
       2002, and 2001 respectively, as their effect was antidilutive in the
       period.

       Stock-Based Compensation
       The Company accounts for its stock-based compensation plans using the
       intrinsic value method prescribed in Accounting Principles Board Opinion
       No. 25, "Accounting for Stock Issued to Employees." Compensation cost for
       stock options, if any, is measured by the excess of the quoted market
       price of the Company's stock at the date of grant over the amount an
       employee must pay to acquire the stock. SFAS No. 123, "Accounting for
       Stock-Based Compensation," established accounting and disclosure
       requirements using a fair-value based method of accounting for
       stock-based employee compensation plans.


                                      F-10
<PAGE>



       Had compensation costs been determined consistent with SFAS No. 123, the
       Company's net income or loss would have been changed to the amounts
       indicated below for the years ended December 31 (in thousands, except per
       share data):
<TABLE>
<CAPTION>

                                                                         2003           2002           2001
                                                                    --------------- -------------- -------------

<S>                                                                      <C>             <C>          <C>
       Net income/(loss) - as reported                                   $  1,633        $   659      $  (591)
       Fair value of stock-based compensation                                (433)          (176)         (65)
                                                                    --------------- -------------- -------------
       Net income/(loss) - pro forma                                     $  1,200        $   483      $  (656)
                                                                    =============== ============== =============

       Net income/(loss) per share - basic - as reported                  $  0.50        $   0.15     $ (0.12)
       Net income/(loss) per share - diluted - as reported                $  0.39        $   0.14     $ (0.12)
       Net income/(loss) per share - basic - pro forma                    $  0.37        $   0.11     $ (0.14)
       Net income/(loss) per share - diluted - pro forma                  $  0.29        $   0.11     $ (0.14)
       Stock-based compensation included in net income/(loss), as
       reported                                                           $     -        $      1     $    16
</TABLE>

       The Company accounts for stock-based compensation arrangements with
       non-employees in accordance with Emerging Issues Task Force ("EITF")
       Abstract No. 96-18, Accounting for Equity Instruments That Are Issued to
       Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
       or Services. Accordingly, unvested options held by non-employees are
       subject to revaluation at each balance sheet date based on the then
       current fair market value.

       Comprehensive income
       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, and therefore, no
       separate statement of comprehensive income has been presented.

       Segment information
       The Company uses one measurement of profitability of its business for
       internal purposes and has determined that it operates in one business
       segment: server appliances. The Company's sales by geographic area are
       included in Note 9.

       Recent accounting pronouncements
       In November 2002, the EITF reached a consensus on Issue No. 00-21,
       "Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"). EITF
       00-21 provides guidance on how to account for arrangements that involve
       the delivery or performance of multiple products, services and/or rights
       to use assets. The provisions of EITF 00-21 apply to revenue arrangements
       entered into in fiscal periods beginning after June 15, 2003. The
       adoption of this interpretation has not had a material impact on the
       Company's consolidated results of operations, financial position or cash
       flows.

       In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
       on Derivative Instruments and Hedging Activities." SFAS No. 149 amends
       and clarifies accounting for derivative instruments, including certain
       derivative instruments embedded in other contracts, and for hedging
       activities under SFAS No. 133. It clarifies when a derivative contains a
       financing component that warrants special reporting in the statement of
       cash flows. SFAS No. 149 is


                                      F-11
<PAGE>

       effective for contracts entered into or
       modified after June 30, 2003 and for hedging relationships designated
       after June 30, 2003. The adoption of this interpretation has not had a
       material impact on the Company's consolidated results of operations,
       financial position or cash flows.

       In May, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
       Financial Instruments with Characteristics of both Liabilities and
       Equity." SFAS No. 150 establishes standards for how an issuer classifies
       and measures certain financial instruments with characteristics of both
       liabilities and equity. It requires that an issuer classify a financial
       instrument that is within its scope as a liability or an asset in some
       circumstances. Many of those instruments were previously classified as
       equity. SFAS No. 150 is effective for financial instruments entered into
       or modified after May 31, 2003, and otherwise is effective at the
       beginning of the first interim period beginning after June 15, 2003. It
       is to be implemented by reporting the cumulative effect of a change in an
       accounting principle for financial instruments created before the
       issuance date of SFAS No. 150 and still existing at the beginning of the
       interim period of adoption. While the effective date of certain elements
       of SFAS No. 150 has been deferred, the Company does not expect the
       adoption of SFAS No. 150 to have a material impact upon its financial
       position, cash flows or results of operations.

       In December 2003, the FASB issued a revised FASB interpretation No. 46
       (FIN 46R), "Consolidation for Variable Interest Entities, and
       interpretation of ARB No. 51" The FASB published the revision to clarify
       and amend some of the original provisions of FIN 46, which was issued in
       January 2003, and to exempt certain entities from its requirements. A
       variable interest Entity refers to an entity subject to consolidation
       according to the provisions of the Interpretation. FIN 46R applies to
       entities whose equity investment at risk is insufficient to finance that
       entity's activities without receiving additional subordinated financial
       support provided by any parties, including equity holders, or where the
       equity investors (if any) do not have a controlling financial interest.
       FIN 46R provides that if an entity is the primary beneficiary of a VIE,
       the assets, liabilities, and results of operations of the VIE should be
       consolidated in the entity's financial statements. In addition, FIN 46R
       requires that both the primary beneficiary and all other enterprises with
       a significant variable interest in a VIE provide additional disclosures.
       The provisions of FIN 46R are effective for the Company's fiscal 2004
       first quarter. The Company does not expect the adoption of FIN 46R to
       have a material impact on the Company's financial position or results of
       operations.


3.     Balance Sheet Detail (in thousands)

       Accounts Receivable, net:
<TABLE>
<CAPTION>

                                                                                  December 31,
                                                                        ..................................
                                                                             2003              2002
                                                                        ----------------  ----------------

<S>                                                                         <C>               <C>
              Accounts receivable                                           $  1,354          $   1,149
              Less: sales returns                                               (442)              (634)
              Less: allowance for doubtful accounts                              (39)               (71)
                                                                        ----------------  ----------------

                 Total accounts receivable, net                              $   873           $    444
                                                                        ================  ================
</TABLE>

                                      F-12
<PAGE>

       Inventories:
<TABLE>
<CAPTION>

                                                                                  December 31,
                                                                        ..................................
                                                                             2003              2002
                                                                        ----------------  ----------------

<S>                                                                         <C>               <C>
              Raw material                                                  $    610          $    493
              Work in process                                                      -               179
              Finished goods                                                     567               438
                                                                        ----------------  ----------------

                 Total inventories                                          $  1,177          $  1,110
                                                                        ================  ================
</TABLE>


       Property and equipment:
<TABLE>
<CAPTION>

                                                                                  December 31,
                                                                        ..................................
                                                                             2003              2002
                                                                        ----------------  ----------------

<S>                                                                          <C>               <C>
              Production, test and demonstration equipment                   $   420           $   353
              Computer equipment                                               1,175             1,112
              Office equipment                                                   100                82
              Leasehold improvements                                             442               436
                                                                        ----------------  ----------------
                                                                               2,137             1,983
              Less accumulated depreciation and amortization                  (1,761)           (1,558)
                                                                        ----------------  ----------------

                 Total property and equipment                                $   376           $   425
                                                                        ================  ================
</TABLE>


              The Company recorded depreciation and amortization related to
              property and equipment of $213,000, $206,000 and $230,000 in 2003,
              2002 and 2001, respectively.

              As of December 31, 2003 and 2002, the Company had $100,000 of
              equipment under capital leases. Accumulated depreciation and
              amortization associated with these capital leases was $65,000 and
              $42,000 at December 31, 2003 and 2002, respectively.

       Accrued liabilities:
<TABLE>
<CAPTION>

                                                                                  December 31,
                                                                        ..................................
                                                                             2003              2002
                                                                        ----------------  ----------------

<S>                                                                         <C>               <C>
              Accrued compensation                                          $    484          $    351
              Accrued sales and marketing                                        378               377
              Accrued professional fees                                          136               190
              Other accruals                                                     761               778
                                                                        ----------------  ----------------

                 Total accrued liabilities                                  $  1,759           $ 1,696
                                                                        ================  ================
</TABLE>

                                      F-13
<PAGE>

4.     Commitments and Contingencies

       Lease Commitments
       The Company has entered into a noncancelable operating lease that expires
       in 2005 and other capital leases that expire at various dates ending in
       2006, and is responsible for certain maintenance costs, taxes and
       insurance under the leases. The lease on the Company's headquarters
       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):
<TABLE>
<CAPTION>

              Year Ended December 31,
<S>                                                                                <C>
                    2004                                                           $   269
                    2005                                                               263
                                                                            ----------------
                                                                                   $   532
                                                                            ================
</TABLE>


       Rent expense, including the facility lease and equipment rental, was
       $288,000, $298,000, and $360,000 for 2003, 2002 and 2001, respectively.

       The Company leases certain of its equipment under various capital leases
       that expire at various dates through 2006. The lease agreements
       frequently include renewal and escalation clauses and purchase provisions
       and require the Company to pay taxes, insurance and maintenance costs. As
       of December 31, 2003, the Company had loan and security agreements for an
       aggregate value of $100,000, which are subject to interest rates of 12.5%
       to 12.8%. As of December 31, 2003, future minimum lease payments are as
       follows (in thousands):
<TABLE>
<CAPTION>

              Year Ended December 31,
<S>                                                                                <C>
                    2004                                                            $   20
                    2005                                                                18
                    2006                                                                15
                                                                            ----------------
                 Total minimum lease payments                                           53
              Less amount representing interest                                         (8)
                                                                            ----------------
                 Present value of capital lease obligations                             45
              Less current portion                                                     (16)
                                                                            ----------------
                 Long-term portion of capital lease obligations                     $   29
                                                                            ================
</TABLE>

       Product Warranties and Guarantor Arrangements
       The Company offers warranties on certain products and records a liability
       for the estimated future costs associated with warranty claims, which is
       based upon historical experience and an estimate of the level of future
       costs. Warranty costs are reflected in the statement of operations as a
       cost of sales. A reconciliation of the changes in the Company's warranty
       liability during 2003 is as follows (in thousands):



                                      F-14
<PAGE>




<TABLE>

<S>                                                                             <C>
              Warranty accrual at the beginning of the year                     $   34
              Accruals for warranties issued during the year                        15
              Settlements made in kind during the year                             (25)
                                                                        ----------------
              Warranty accrual at the end of the year                           $   24
                                                                        ================
</TABLE>


       As permitted under California law, the Company has agreements whereby the
       Company indemnifies its officers and directors for certain events or
       occurrences while the officer or director is, or was, serving at the
       Company's request in such capacity. The term of the indemnification
       period is for the officer's or director's lifetime. The maximum potential
       amount of future payments the Company could be required to make under
       these indemnification agreements is unlimited; however, the Company has a
       director and officer insurance policy that limits the Company's exposure
       and enables the Company to recover a portion of any future amounts paid.
       As a result of the Company's insurance policy coverage, the Company
       believes the estimated fair value of these indemnification agreements is
       minimal.


       The Company enters into standard indemnification agreements in the
       ordinary course of business. Pursuant to these agreements, the Company
       indemnifies, holds harmless, and agrees to reimburse the indemnified
       party for losses suffered or incurred by the indemnified party, generally
       the Company's business partners or customers, in connection with any U.S.
       patent, or any copyright or other intellectual property infringement
       claim by any third party with respect to the Company's products. The term
       of these indemnification agreements is generally perpetual following
       execution of the agreement. The maximum potential amount of future
       payments the Company could be required to make under these
       indemnification agreements is unlimited; however, the Company has never
       incurred costs to defend lawsuits or settle claims related to these
       indemnification agreements.


5.     Bank Borrowings

       The Company has a $3.0 million collateralized revolving line of credit
       with a bank, which expires in March 2005, pursuant to which the Company
       may borrow 100% against pledges of cash at the bank's prime rate (4% at
       December 31, 2003). Borrowings under this line of credit agreement are
       collateralized by all of the assets of the Company. Under the agreement,
       the Company must comply with certain financial and other covenants. As of
       December 31, 2003, the Company has not drawn down on the line of credit,
       was in compliance with these covenants and has no borrowings outstanding
       under the line of credit.

6.       Common Stock

       Stock Repurchase Program
       In the fourth quarter of 2002, the Company's Board of Directors
       authorized the Company, from time to time, to repurchase at market
       prices, up to $2.25 million of its common stock for cash in open market,
       negotiated or block transactions. The timing of such transactions will
       depend on market conditions, other corporate strategies and will be at
       the discretion of the management of the Company. No time limit was set
       for the completion of this program. At the time of the approval by the
       Board of Directors, the Company had approximately 4.8 million shares of

                                      F-15
<PAGE>

       common stock outstanding. During the fourth quarter of 2002, the Company
       repurchased from open market and negotiated transactions a total of
       approximately 1.62 million shares for approximately $1.8 million, at an
       average per share price of $1.10. During the first quarter of 2003, the
       Company repurchased from open market transactions a total of 46,500
       shares for $48,000, at an average per share price of $1.04. The Company
       did not repurchase any of its common stock during the rest of 2003. The
       Company intends to continue to execute its buyback program as it deems
       necessary.

       2002 Equity Incentive Plan
       In December 2002, the shareholders of the Company approved the adoption
       of the 2002 Equity Incentive Plan ("2002 Plan"). A total of 850,000
       shares of common stock have been reserved for issuance under the 2002
       Plan. The 2002 Plan provides for awards to employees, directors,
       consultants and independent advisors. The adoption of the 2002 Plan was
       necessitated by the use or expiration of all but an insignificant amount
       of authorized shares under the prior option plans, (the 1995 Non-employee
       Directors' Stock Option Plan ("Directors Plan") and the 1988 Incentive
       Stock Plan ("1988 Plan")). Under the 2002 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 at the date of grant for non-qualified options and
       purchase rights. Options granted under the 2002 Plan as well as those
       granted under the prior option plans generally become exercisable, and
       the Company's right to repurchase shares issued and sold pursuant to
       stock purchase rights generally 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.
       Awards under the 2002 Plan and the prior option plans generally expire
       seven years from the date of grant. No additional option grants will be
       made under any prior option plan. As of December 31, 2003, 305,000
       options have been granted under the 2002 Plan, while 1.3 million options
       are outstanding under the prior plans.



                                      F-16
<PAGE>



       The following table summarizes option activity under the Company's stock
       option plans (in thousands):
<TABLE>
<CAPTION>

                                                   Outstanding Options
                                                                                            Weighted
                                                                                             Average
                                                     Available           Number             Exercise
                                                     for Grant         Outstanding            Price
                                                 ------------------ ------------------  ------------------

<S>                                                          <C>              <C>             <C>
                Balances, January 1, 2001                     370             1,313           $1.11
                Options granted                              (156)              156           $0.79
                Options cancelled                              61               (61)          $1.11
                Options exercised                               -                (4)          $0.20
                                                 ------------------ ------------------  ------------------

                Balances, December 31, 2001                   275             1,404           $1.08
                Options granted                              (405)              405           $0.71
                Options cancelled                             151              (175)          $1.08
                Options expired                               (21)                -
                Options exercised                               -               (61)          $0.63
                                                 ------------------ ------------------  ------------------

                Balances, December 31, 2002                     -             1,573           $1.00
                Additional shares reserved                    850                 -
                Options granted                              (305)              305           $2.94
                Options cancelled                               1                (3)          $2.05
                Options exercised                               -              (285)          $0.94
                                                 ------------------ ------------------  ------------------

                Balances, December 31, 2003                   546             1,590           $1.38
                                                 ================== ==================  ==================
</TABLE>


       At December 31, 2003, 2002 and 2001, 1,078,000, 1,087,000 and 1,035,000
       options, respectively, were exercisable at a weighted average exercise
       price of $1.15, $1.10 and $1.12, respectively.



                                      F-17
<PAGE>



       Options to purchase common stock outstanding and currently exercisable by
       exercise price at December 31, 2003, are as follows (in thousands, except
       years and per share data):
<TABLE>
<CAPTION>

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

<S>      <C>                      <C>           <C>             <C>                   <C>          <C>
         $0.00-$0.50                 10         5.3             $0.34                    10        $0.34
         $0.51-$0.75                287         5.1             $0.69                    86        $0.69
         $0.76-$1.00                635         2.7             $0.92                   598        $0.93
         $1.01-$1.25                 97         4.5             $1.12                    91        $1.12
         $1.26-$1.50                 72         3.0             $1.32                    65        $1.33
         $1.51-$2.00                178         1.8             $1.64                   178        $1.64
         $2.01-$2.50                 41         5.9             $2.38                     7        $2.37
         $2.51-$3.00                165         6.7             $2.77                    43        $2.80
         $3.01-$4.00                105         6.6             $3.40                     -          -
                         ----------------                                    ----------------
                                  1,590         3.9             $1.38                 1,078        $1.15
                         ================                                    ================
</TABLE>

       The fair value of each option grant is estimated on the date of grant
       using the Black-Scholes model with the following assumptions for 2003,
       2002 and 2001:
<TABLE>
<CAPTION>

                                                              2003                2002               2001
                                                       ------------------- ------------------- -----------------
<S>                                                       <C>                  <C>               <C>
       Risk-free interest rate                            3.32%-4.48%          3.86%-5.43%       4.22%-5.25%
       Expected life                                       4.1 years           6.9 years          7.0 years
       Expected dividends                                      -                   -                  -
       Volatility                                             201%                146%               355%

</TABLE>
       The weighted average fair value of options granted in 2003, 2002 and 2001
       was $2.95, $0.71 and $0.67 per share, respectively.

       Option Grants to Non-employees
       In addition to the options granted under the plans detailed above,
       Castelle has granted options to purchase common stock to consultants
       under special arrangements.

       During the year ended December 31, 2001, the Company granted 3,000
       options to non-employees. There were no grants to non-employees in 2002
       and 2003. Under EITF 96-18, the unvested options are revalued at each
       balance sheet date to reflect their current fair value. Compensation
       expense is reflected in results of operations over the vesting period. In
       connection with its grant of options to non-employees, the Company
       recorded charges of $1,000 and $16,000 in 2002 and 2001, respectively,
       and nothing in 2003.

       Options to purchase 27,000, 33,000 and 35,000 shares of common stock were
       held by non-employees at December 31, 2003, 2002 and 2001, respectively,
       of which 27,000, 33,000 and


                                      F-18
<PAGE>

       35,000 were exercisable for aggregate total
       exercise proceeds of $44,000, $50,000 and $52,000, respectively.

7.     Income Taxes

       The provision (benefit) for income taxes is as follows
      (amounts in thousands):
<TABLE>
<CAPTION>


                                                                             Years Ended December 31,
                                                                     2003              2002              2001

<S>                                                                    <C>              <C>                     <C>
             Current
                Federal                                                $     5                 -                -
                State                                                        1                 6                -
                                                                ----------------  ----------------  ---------------
                Total Current                                          $     6          $      6                -
             Deferred
                Federal                                                $ (464)                 -                -
                State                                                     (79)                 -                -
                                                                ----------------  ----------------  ---------------
                Total Deferred                                         $ (543)                 -                -

                                                                ----------------  ----------------  ---------------
             Total provision (benefit) for income taxes                $ (537)          $      6                -
                                                                ================  ================  ===============
</TABLE>


       The Company's tax provision (benefit) differs from the provision computed
       using statutory income tax rates as follows (in thousands):
<TABLE>
<CAPTION>

                                                                        2003            2002           2001
                                                                   ---------------- -------------- --------------

<S>                                                                   <C>             <C>            <C>
        Federal tax provision/(benefit) at statutory rate             $  386          $ 248          $ (201)
        Alternative minimum tax                                            5              -               -
        Permanent difference due to
           non-deductible expenses                                        12              7               8
        State taxes provision/(benefit), net of federal benefit            1              6              (7)
        Utilization of net operating loss carryovers                    (187)          (122)              -
        Change in valuation allowance                                   (694)           (65)            258
        General business credits                                         (60)           (68)            (58)
                                                                   ---------------- -------------- --------------
                                                                      $ (537)         $   6          $    -
                                                                   ================ ============== ==============
</TABLE>



                                      F-19
<PAGE>



       The components of the net deferred tax assets are as follows
(in thousands):
<TABLE>
<CAPTION>

                                                                                     December 31,
                                                                          ...................................
                                                                               2003               2002
                                                                          ----------------  -----------------

<S>                                                                               <C>                <C>
               Inventory allowances and adjustments                               $   77             $  131
               Accounts receivable allowances                                         16                 28
               Other liabilities and allowances                                      526                567
               Net operating loss carryforwards                                    4,584              4,727
               Tax credit carryforwards                                            1,615              1,825
               Depreciation and amortization                                         396                411
               Valuation allowance                                                (6,688)            (7,689)
                                                                          ----------------  -----------------

                    Total net deferred tax assets                                 $  526              $   -
                                                                          ================  =================
</TABLE>

       Significant management judgment is required in determining the provision
       for income taxes, and in particular, any valuation allowance recorded
       against the Company's deferred tax assets. During 2003, the Company
       recorded a tax benefit of $537,000, which included a $526,000 reduction
       in the valuation allowance. This portion of the valuation allowance was
       reversed because the Company determined that it is more likely than not
       that certain future tax benefits will be realized as a result of
       projected future income. This determination was principally based on
       cumulative profitability of the Company over the past 10 quarters and
       projected future taxable income expected to be generated by the Company.

       At December 31, 2003, the Company had net operating loss carryforwards of
       approximately $12,868,000 and $3,583,000 available to offset future
       federal and California taxable income, respectively. These loss
       carryforwards will expire in varying amounts beginning in 2004 through
       2021. In addition, at December 31, 2003, the Company had Federal and
       California Research and Development credit carryforwards of approximately
       $1,125,000 and $734,000, respectively. These credits expire in varying
       amounts beginning in 2007.

       For federal and state income tax purposes, the amount of benefit from the
       Company's net operating loss and credit carryforwards may be impaired or
       limited if the Company incurs a cumulative ownership change of more than
       50%, as defined, over a three year period.

       The Company's profit (loss) before provision for income taxes for all
       periods presented was derived substantially from domestic operations.


8.     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 2003, 2002 and 2001, the Company made no
       contributions to the plan.


                                      F-20
<PAGE>

9.     Major Customers and Segment Information

       Revenues by geographic area are determined by the location of the
       customer and are summarized as follows (in thousands):
<TABLE>
<CAPTION>

                                                                             Years Ended December 31,
                                                                ...................................................
                                                                     2003              2002              2001
                                                                ----------------  ----------------  ---------------

<S>                                                                   <C>               <C>              <C>
             United States                                            $  8,256          $  7,699         $  7,047
             Europe                                                        704               826              960
             Pacific Rim                                                   883               887            1,026
             Rest of Americas, excluding United States                     371               347              321
                                                                ----------------  ----------------  ---------------

                Total revenues                                       $  10,214          $  9,759         $  9,354
                                                                ================  ================  ===============
</TABLE>


       Customers that individually accounted for greater than 10% of net sales
are as follows (in thousands):
<TABLE>
<CAPTION>

                                                            Years Ended December 31,
                          ..............................................................................................
                                      2003                             2002                            2001
           Customer          Amount        Percentage         Amount        Percentage         Amount       Percentage
       -----------------  -------------- ---------------  --------------- ---------------  --------------- -------------

<S>                           <C>             <C>              <C>             <C>              <C>            <C>
              A               $  2,200        22%              $  2,657        26%              $  2,591       28%
              B               $  2,899        28%              $  2,257        22%              $  1,635       18%
              C                      *          *                     *         *               $    915       10%
</TABLE>

*In 2003 and 2002, this customer was responsible for less than 10% of net sales


10.    Restructuring

       In April 2001, in response to the continuing economic slowdown and
       decrease in demand for the Company's products, the Company terminated 17
       regular, temporary and contractor positions, which constituted
       approximately 25% of the Company's workforce. The restructuring included
       an asset write-off and other direct expenses associated with the
       consolidation of operations in the United Kingdom and El Dorado Hills,
       California.

       In the second quarter of 2002, a non-recurring benefit of $40,000 arising
       from the reversal of a portion of the previously recorded restructuring
       charge was included in the results of operations, following the
       completion of the Company's 2001 restructuring program for less than
       previously anticipated. The following table sets forth an analysis of the
       components of the restructuring charge, and subsequent activity (in
       thousands):

                                      F-21
<PAGE>

<TABLE>
<CAPTION>

                                                 Employee                    Asset Write
                                                   Costs      Facilities         Down         Other        Total
<S>                                                 <C>           <C>             <C>          <C>         <C>
          Provision for restructuring               $ 98          $64             $ 26         $ 51        $ 239
          Non-cash items                               -            -              (26)           -          (26)
          Cash payments                              (62)         (36)               -          (26)        (124)
                                             --------------------------------------------------------------------
             Balance as of December 31, 2001          36           28                -          25            89
          Cash payments                              (36)            -               -         (13)          (49)
          Reversal of excess accrual                   -          (28)               -         (12)          (40)
                                             --------------------------------------------------------------------
             Balance as of December 31, 2002        $  -          $ -             $  -        $  -         $   -
</TABLE>

11.    Litigation

        From time to time and in the ordinary course of business, the Company is
       involved in various legal proceedings and third party assertions of
       patent or trademark infringement claims against the Company in the form
       of letters and other forms of communication. The Company is not currently
       involved in any litigation which, in management's opinion, would have a
       material adverse effect on its business, operating results, cash flows or
       financial condition; however, there can be no assurance that any such
       proceeding will not escalate or otherwise become material to the
       Company's business in the future.


                                      F-22
<PAGE>
<TABLE>
<CAPTION>

Castelle                                                             Schedule II
Valuation and Qualifying Accounts
(in thousands)
-------------------------------------------------------------------------------------------------------------------

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

<S>                                                             <C>                <C>             <C>                <C>
Year Ended December 31, 2001:
Deducted from asset accounts:
    Allowance for doubtful accounts                             $   175            $   59          $  (138)           $    96
    Write-downs for excess and obsolete inventory               $   366            $  148          $     4            $   518
    Valuation allowance for deferred tax asset                  $ 7,717            $  229          $     -            $ 7,946

Year Ended December 31, 2002:
Deducted from asset accounts:
    Allowance for doubtful accounts                             $    96            $  (21)          $   (5)           $    70
    Write-downs for excess and obsolete inventory               $   518            $    -           $ (202)           $   316
    Valuation allowance for deferred tax asset                  $ 7,946            $    -           $ (257)           $ 7,689

Year Ended December 31, 2003:
Deducted from asset accounts:
    Allowance for doubtful accounts                             $    70            $    5          $   (36)           $    39
    Write-downs for excess and obsolete inventory               $   316            $   66          $  (186)           $   196
    Valuation allowance for deferred tax asset                  $ 7,689            $    -          $(1,001)           $ 6,688
</TABLE>


                                      F-23
<PAGE>



Castelle

--------------------------------------------------------------------------------
  Exhibit
   Number       Description
     10.16      Loan Modification Agreement with Silicon Valley Bank
     23.1       Consent of Independent Auditors



                                      F-24