UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 
 Form 10-K/A
(Amendment No. 1)
    x
  ANNUAL
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For
  the year ended December 31, 2006Oro
  TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For
  the transition period from
          to          . Commission File Number 0-220-20 
  Castelle
 (Exact name of Registrant as
specified in its charter)
  California
  77-0164056(State of Incorporation)
  (IRS Employer Identification No.) 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 checkmark if the Registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o
No x Indicate by checkmark if the Registrant is not
required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o
No x 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 o Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of Registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x Indicate by check mark whether the Registrant is a
large accelerated filer, an accelerated filer or a non-accelerated filer (as
defined in Rule 12b-2 of the Act). Large accelerated filer o
Accelerated
filer o
Non-accelerated filer x Indicate by check mark whether the Registrant is a
shell company (as defined in Rule 12b-2 of the Act). Yeso
No xThe approximate aggregate market value of the
Registrants common stock held by non-affiliates of the Registrant, based upon
the last sale price of the common stock reported on the NASDAQ SmallCap Market
on March 30, 2007 was $11,650,622. The number of shares of Registrants common stock
outstanding at March 31, 2007 was 4,041,670. 1    CASTELLE

TABLE OF CONTENTS

Item
  
  
  PageExplanatory NotePART IIIItem 10
  Directors, Executive Officers and
  Corporate Governance
  
  4Item 11
  Executive Compensation
  
  8Item 12
  Security Ownership of Certain
  Beneficial Owners and Management and Related Stockholder Matters
  
  18Item 13
  Certain Relationships and Related
  Transactions, and Director Independence
  
  19Item 14
  Principal Accountant Fees and Services
  
  20PART IVItem 15
  Exhibits
  
  21Signatures
  
  
  232

CASTELLE

EXPLANATORY NOTE

We
are filing this Amendment No. 1 to our Annual Report on Form 10-K for the year
ended December 31, 2006 (this Amendment No. 1) to amend our Form 10-K for the
same period initially filed with the Securities and Exchange Commission (the
SEC) on March 30, 2007 (the Initially Filed Form 10-K). This Amendment No.
1 amends and restates the following items of the Initially Filed Form 10-K: (i)
Part III, Item 10  Directors, Executive Officers and Corporate Governance,
(ii) Part III, Item 11  Executive Compensation, (iii)
Part III, Item 12  Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters, (iv) Part III,
Item 13  Certain Relationships and Related Transactions, and Director Independence,
(v) Part III, Item 14  Principal Accountant Fees and Services,
and (vi) Part IV, Item 15  Exhibits and Financial Statement Schedules. The
disclosures set forth in those items in the Initially Filed Form 10-K that are
amended by this Amendment No. 1 include, without limitation, responses to
the items required by Part III, which were originally expected to be
incorporated by reference to our definitive Proxy Statement to be delivered to
our shareholders in connection with our 2007 Annual Meeting of Shareholders.
Inasmuch as the definitive Proxy Statement for our annual shareholders meeting
will not be filed with the SEC within 120 days after our fiscal year end, such
information may not be incorporated by reference and is instead included in this
Amendment No. 1. In addition, we are filing herewith
certain currently dated certifications pursuant to Rule 12b-15 of the
Securities and Exchange Act of 1934, as amended (the Securities Exchange
Act). No other information contained in the Initially Filed Form 10-K is being
amended hereby and such information is not reproduced in this Amendment No. 1. All
information in the Initially Filed Form 10-K, as amended by this Amendment
No. 1, speaks as of the date of the original filing of the Initially Filed
Form 10-K and does not reflect any subsequent information or events, except as
presented in this Amendment No. 1 and except for Exhibits 31.01, 31.02,
32.01, and 32.02.

All
information contained in this Amendment No. 1 is subject to updating and supplementing
as provided in our reports filed with the SEC subsequent to the date of the
filing of the Initially Filed Form 10-K.

3

PART III

Item 10.Directors, Executive Officers and Corporate
Governance

Directors

Our
Board of Directors currently consists of five directors. Each director holds
office until the next annual meeting of shareholders and until his or her
successor is elected and qualified, or until such directors earlier death,
resignation or removal.

The
table and biographies below present information about each of our directors as
of March 31, 2007:

Name of Director
  
  Age
  
  Principal Occupation
  
  Director
  SinceDonald L.
  Rich(3)
  
  65
  
  Chairman of
  our Board of Directors
  
  1999Scott C.
  McDonald(3)
  
  53
  
  President,
  Chief Executive Officer and Director of Castelle
  
  1999Peter R.
  Tierney(1)(2)(4)
  
  62
  
  Director,
  President and Chief Executive Officer of Finaplex, Inc.
  
  1999Robert H.
  Hambrecht(1)(2)(3)(4)
  
  40
  
  Managing
  Director of Corporate Finance, W.R. Hambrecht + Company
  
  1998Robert O.
  Smith(1)
  
  62
  
  Former
  President and Chief Executive Officer of Digital Power Corporation
  
  2004(1)
  Member of
  the Audit Committee.(2)
  Member of
  the Compensation Committee.(3)
  Member of
  the Executive Committee.(4)
  Member of
  the Nominating Committee.Donald L. Rich

Mr. Rich
joined Castelle in November 1998 and served as our Chief Executive Officer and
President from November 1998 to April 2002. Mr. Rich became Chairman of
our Board of Directors in May 1999, and has continued in that role since
retiring as our Chief Executive Officer and President in April 2002.
Mr. Rich served as our Chief Financial Officer from April 1999 to
March 2001 and as our Secretary from February 2000 to
March 2001. From 1997 until November 1998, Mr. Rich was self-employed
as a consultant. From 1993 through 1997, Mr. Rich was Chief Executive
Officer and President of Talarian Corporation, a provider of real-time
infrastructure software for the enterprise and the Internet. Prior to that, he
held various sales and marketing management positions at Integrated Systems,
Inc. and International Business Machines Corporation. Mr. Rich holds a BS
degree in Mechanical Engineering from Purdue University and an MBA from the
Stanford Graduate School of Business.

Scott C. McDonald

Mr. McDonald
has served as a director of Castelle since April 1999. Since April 2002,
Mr. McDonald has been our President and Chief Executive Officer. From May
2001 to the first quarter of 2002, Mr. McDonald served on the boards of
directors of Octant Technologies and Digital Power Corporation, and provided
consulting services. From December 1999 to April 2001, Mr. McDonald served
as the Chief Financial and Administrative Officer at Conxion Corporation, a network
and internet services company. From 1997 to 1999, Mr. McDonald served on
the boards of directors of CIDCO Incorporated, Octant Technologies Inc. and
Digital Power Corporation, in addition to providing consulting services to
CIDCO Incorporated. 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.

Peter R. Tierney

Mr. Tierney
has served as a director of Castelle since April 1999. He currently serves as
President and Chief Executive Officer of Finaplex, Inc., a software company
delivering the next generation of wealth management and brokerage processing
platforms. From May 2002 through December 2003 Mr. Tierney was President
and CEO of Sawyer Media Systems, a privately held business focused on
delivering next generation media. Previously, Mr. Tierney spent four years
as President and Chief Executive Officer of MarketFirst Software Corporation, a
company that specializes in streamlining and maximizing the effectiveness of
marketing programs. From 1991 to 1997, Mr. Tierney served as Chairman,
President and CEO of Inference Corporation, a leading provider of self-service
and knowledge management tools for the customer service and help desk
industries. Prior to Inference, as Senior Vice President of Oracle

4

Corporation,
Tierney was responsible for worldwide marketing and served as a member of the
Oracle Management Committee. Earlier in his career, Mr. Tierney served as
Vice President of Marketing and Sales for Relational Technology (Ingres)
Corporation and was Director of Marketing for the IBM Northwestern Region.
Mr. Tierney also currently serves on the board of advisors of the privately-held
company, ChannelNet Corporation. Mr. Tierney holds a BA/BS in management
and economics from Northeastern University.

Robert H. Hambrecht

Mr. Hambrecht
has served as a director of Castelle since March 1998. Mr. Hambrecht was a
founding partner of W.R. Hambrecht + Co., an investment banking firm,
founded in January 1998, and is presently Managing Director of Corporate
Finance at W.R. Hambrecht + Co. From 1996 through January 1998,
Mr. Hambrecht was Vice President of H&Q Venture Partners, a venture
capital firm. From 1994 to 1996, Mr. Hambrecht was employed by Unterberg
Harris, an investment banking firm. Mr. Hambrecht also serves on the
boards of directors of five privately-held companies. Mr. Hambrecht holds
a BA/BS in history from the University of California at Berkeley, and a MA/MS
in public administration from Columbia University.

Robert O. Smith

Mr. Smith
has served as a director of Castelle since March 2004. Mr. Smith currently
serves as a consultant to Digital Power Corporation, makers of switching power
supplies. From 1990 to 2004 he served primarily as Chairman, President and
Chief Executive Officer of Digital Power Corporation. Prior to that, he held
various senior-level management positions at Computer Products Inc., Harris
Computer Systems, the J.M. Smucker Company and Ametek/Lamb Electric.
Mr. Smith holds a BA/BS in business administration from Ohio University.

Executive Officers

The
following table presents the names, offices, and positions of each of our
executive officers as of March 31, 2007:



Name
  
  Age
  
  PositionScott C.
  McDonald
  
  53
  
  President
  and Chief Executive OfficerEric Chen
  
  54
  
  Senior Vice
  President, Engineering and Business DevelopmentPaul Cheng
  
  58
  
  Vice
  President, Finance and Administration, Chief Financial Officer and SecretaryRichard
  Fernandez
  
  47
  
  Vice
  President, OperationsEdward J.
  Heinze
  
  61
  
  Vice
  President, Sales, U.S.Michael
  Petrovich
  
  46
  
  Vice
  President, Sales, InternationalScott C. McDonald

Mr. McDonald has served as our President and Chief
Executive Officer since April 2002 and has served as a director of Castelle
since April 1999. From May 2001 to the first quarter of 2002, Mr. McDonald
served on the boards of directors of 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 boards of directors of 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.

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 development of the first FaxPress
e-mail gateways, porting of FaxPress to non-Novell platforms, and the first menu-driven
installation and configuration programs for both FaxPress and LANpress.
Successive to that, 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.

5

Paul Cheng

Mr.
Cheng has served as our Vice President, Finance and Administration since April
2000. In March 2001, Mr. Cheng was also 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 Senior Vice President, Sales since July 2006. From
January 2000 to July 2006, Mr. Heinze served as our Vice President, Sales, U.S.
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, North American Sales since July
2006. From October 2000 to July 2006, Mr. Petrovich served as our Vice
President, Sales, International and has been with us since 1992. Prior to
joining us, Mr. Petrovich was the marketing communications manager for Novells
National Reseller Organization, a software company. In this role Mr. Petrovich
focused on business strategies and development of Novells direct reseller
sales channel. Before joining Novell, Mr. Petrovich held sales and marketing
positions at Excelan, a LAN manufacturer, and International Microcircuits
Incorporated, a semiconductor company. Mr. Petrovich holds a BA in Behavioral
Sciences from San Jose State University.

Section 16(a) Beneficial Ownership Reporting
Compliance

Section
16(a) of the Securities Exchange Act requires our directors and executive
officers, and persons who own more than 10% of the outstanding shares of our
common stock to file with the SEC initial reports of ownership and to file
reports of changes in ownership of our common stock. Officers, directors and
greater than 10% shareholders are required to furnish us with copies of all
Section 16(a) forms they file.

To
our knowledge, based solely on a review of the copies of such reports furnished
to us and on written representations that no other reports were required,
during the year ended December 31, 2006 all Section 16(a) filing requirements
applicable to our officers, directors and greater than 10% beneficial owners
were complied with.

Code of Conduct and Ethics

We
have adopted a Code of Conduct and Ethics that applies to all our officers,
directors and employees. Our Code of Conduct and Ethics is posted on our
website at http://www.castelle.com/corporate/investorrelations/governance.htm.
Please note that information on our web site is not incorporated by reference
into this Annual Report on Form 10-K. We intend to disclose any amendments or
waivers to our Code of Conduct and Ethics on our internet website that would
otherwise be required to be disclosed in Form 8-K.

Shareholder Director Nominations

On August 4, 2006, our Board of
Directors amended and restated our Amended and Restated Bylaws in order to
require that advance written notice be received by us not less than one hundred
twenty (120) days prior to an annual meeting of shareholders of

6

any
shareholder proposal to be brought before such annual meeting of shareholders
or any nomination by a shareholder of a person for election as a director at
such annual meeting of shareholders.

Except
as described above, there have been no material changes to the procedures by
which shareholders may recommend nominees to our Board of Directors.
Shareholders can recommend qualified candidates for our Board of Directors by
providing written notice to the Corporate Secretary at our principal executive
offices located at 855 Jarvis Drive, Suite 100, Morgan Hill, CA 95037 by the
time of the deadline described above. Any such notice should clearly indicate
that it is a recommendation of a director candidate by a shareholder and must
set forth (i) the name, age, business address and residence address of the
recommended candidate, (ii) the principal occupation or employment of such
recommended candidate, (iii) the class and number of shares of the corporation
which are beneficially owned by such recommended candidate, (iv) a description
of all understandings or arrangements between the shareholder and the
recommended candidate and any other person or persons pursuant to which the
recommendations are to be made by the shareholder and (v) any other information
relating to such recommended candidate that is required to be disclosed in solicitations
of proxies for the election of directors. In addition, such notice must contain
(i) a representation that the shareholder is a holder of record of our stock
entitled to vote at such meeting, (ii) the name and address, as they appear on
our books, of the shareholder proposing such nomination, (iii) the class and
number of shares of our common stock that are beneficially owned by such
shareholder, (iv) any material interest of the shareholder in such
recommendation and (v) any other information that is required to be provided by
the shareholder pursuant to Regulation 14A under the Securities Exchange Act,
in such shareholders capacity as proponent of a shareholder proposal. Properly
submitted recommendations will be forwarded to the Nominating Committee for
review and consideration. Assuming that a shareholder recommendation complies
with the above process and contains the information required above, the
Nominating Committee will evaluate a candidate recommended by a shareholder
according to its processes and criteria established in its sole discretion.

Audit Committee of
our Board of Directors

We
have a separately designated standing Audit Committee of our Board of
Directors, established in accordance with Section 3(a)(58)(A) of the Securities
Exchange Act. The Audit Committee meets at least annually with our management
and independent auditors to review the results of the annual audit and discuss
the financial statements, recommends to our Board of Directors the independent
auditors to be retained, reviews, negotiates and approves audit fees, oversees
the independence of the independent auditors, evaluates the independent
auditors performance and receives and considers the independent auditors
comments as to controls, adequacy of staff and management performance and
procedures in connection with audit and financial controls. The Audit Committee
pre-approves all audit services to be performed by any accounting firm,
including our independent auditors, and all non-audit services to be provided
by our independent auditors, and provides our Board of Directors such
additional information and materials as it may deem necessary to make our Board
of Directors aware of significant financial, accounting, and internal control
matters that require the attention of our Board of Directors.

During
2006, the Audit Committee was composed of three non-employee directors:
Messrs. Hambrecht, Smith and Tierney. Mr. Hambrecht serves as
Chairman of the Audit Committee. Our Board of Directors has determined that
each of Messrs. Hambrecht, Smith and Tierney is independent for Audit
Committee purposes pursuant to the applicable Marketplace Rules of The NASDAQ
Stock Market and Rule 10A-3 under the Securities Exchange Act. Our Board of
Directors has determined that each member is qualified as an audit committee
financial expert pursuant to Item 401(h) of Regulation S-K and as a financially
sophisticated audit committee member under Rule 4350(d)(2)(A) of the
Marketplace Rules of The NASDAQ Stock Market.

The
Audit Committee acts pursuant to a written charter adopted by our Board of
Directors.

7

Item 11.Executive Compensation

Executive Compensation

Compensation Discussion and Analysis

Administration of Executive Compensation
Program

The
Compensation Committee makes decisions regarding executive compensation and
stock option grants to executives. The Compensation Committee determines base
salary levels and target bonuses for our executive officers. The Compensation
Committee also supervises the administration of our equity compensation plans.

The
members of the Compensation Committee throughout 2006 were Messrs. Hambrecht
and Tierney. Each of Messrs. Hambrecht and Tierney is a non-employee
director within the meaning of Section 16 of the Securities Exchange Act of
1934 and an outside director within the meaning of Section 162(m) of the
Internal Revenue Code. Although our Chief Executive Officer and Chief Financial
Officer attend portions of some of the meetings of the Compensation Committee,
they do not participate in deliberations that relate to their own compensation.

Compensation Committee Interlocks and Insider
Participation

None
of our executive officers currently serves or has served during the current
fiscal year or at any time during the last completed fiscal year as a
member of the board of directors or the compensation committee of another
entity whose executive officer(s) served on our Board of Directors or the
Compensation Committee.

General Compensation Policy and Philosophy

In
general, the Compensation Committee structures executive compensation packages
with two objectives:


to attract and retain, through a competitive compensation structure,
  those key executives critical to the long-term success of the company; and
to ensure that the compensation and incentives provided to the executive
  officers are closely aligned with our financial performance and shareholder
  value; andThe
Compensation Committees compensation philosophy for executive officers is to
relate compensation directly to corporate performance, while providing a total
compensation package that is competitive relative to our peers and enables us
to attract, motivate, reward and retain key executives and employees. Our
compensation policy, which applies to executive officers and our other key
employees, relates a portion of each individuals total compensation to our
revenue, profit and corporate objectives as well as individual objectives set
at the beginning of the year and each quarter. Consistent with this policy,
each executive officers compensation package may, in one or more years, be
comprised of the following three components: (i) base salary, (ii) options to
purchase shares of common stock, and (iii) quarterly incentives in the form of
cash bonuses.

The
market for talented individuals in the high technology arena is very
competitive, particularly in the San Francisco Bay Area. While we consider peer
groups and a variety of factors, no single factor is determinative in setting
compensation structure or allocating among elements of compensation. To ensure
that we are appropriately compensating our employees and that we have
appropriate human resources to execute on our business plans, our Compensation
Committee incorporates all available information and use their judgment in
making compensation decisions. The Compensation Committee does not retain
consultants in assisting it
with these decisions.

Elements of Compensation Package

We
generally provide three major categories of compensation: base salary, a
quarterly bonus and equity compensation, which has historically been in the
form of options. We also provide a comprehensive benefits package, including
health insurance, dental insurance, life insurance, disability insurance, and a
401(k) program.

8

Compensation Process

The
Compensation Committees current intent is to perform periodic strategic review
of our executive officers compensation levels to determine whether they
provide adequate incentives and motivation to our executive officers and
whether they adequately compensate our executive officers relative to
comparable officers in other companies with which we compete for executives. In
addition, the Compensation Committee reviews each executive officers
performance for the last year and objectives for the upcoming year, together
with the executive officers responsibility level and our fiscal performance,
as compared to the objectives for the last year and our performance targets for
the upcoming year. The Compensation Committees most recent review occurred in
December 2005. The last salary increase for any of our executive officers
occurred in 2003.

Accounting and Tax Considerations

We
account for equity compensation paid to our employees under the rules of SFAS
No. 123R, which requires us to estimate and record an expense over the
service period of the award. Accounting rules also require us to record cash
compensation as an expense at the time the obligation is accrued. We structure
cash bonus compensation so that it is taxable to our executives at the time it
becomes available to them. We currently intend that all cash compensation paid
will be tax deductible for us. However, with respect to equity compensation
awards, while any gain recognized by employees from nonqualified options should
be deductible, to the extent that an option constitutes an incentive stock
option gain recognized by the optionee will not be deductible if there is no
disqualifying disposition by the optionee. In addition, if we grant restricted
stock or restricted stock unit awards that are not subject to performance
vesting, they may not be fully deductible by us at the time the award is
otherwise taxable to the employee.

Under
Section 162(m) of the Internal Revenue Code, a limitation was placed on tax
deductions of any publicly-held corporation for individual compensation to
certain executives of such corporation exceeding $1,000,000 in any taxable
year, unless the compensation is performance-based. Stock option grants made
under our 2002 Equity Incentive Plan (the 2002 Option Plan) currently do not
meet the requirements for performance-based grants as defined in
Section 162(m) of the Internal Revenue Code, so they are not exempt from
the $1,000,000 deduction limitation. None of our executives were paid
non-performance based compensation in 2006 in excess of the Internal Revenue
Code Section 162(m) tax deduction limitation.

Base Salary and Cash Bonuses

The
first objective of our overall executive compensation policy is addressed by a
salary and bonus policy which is based on:


consideration
  of the salaries and total compensation of executive officers in similar
  positions with comparable companies in the industry;
the
  qualifications and experience of each executive officer;
the
  companys financial performance during the past year; and
each
  officers performance against objectives related to their areas of
  responsibility.The
Compensation Committee periodically reviews individual base salaries of
executive officers, and adjusts salaries based on individual job performance
and changes in the officers duties and responsibilities. In making salary
decisions, the Compensation Committee exercises its discretion and judgment
based on these factors. No specific formula is applied to determine the weight
of each factor, although the mix among the compensation elements of salary,
cash incentive and stock options are biased toward stock options to emphasize
the link between executive incentives and the creation of shareholder value as
measured by the equity markets. Consequently, salaries and cash incentives may
be in the low-range as compared to comparable companies in the industry while
stock options may be in the mid to high-range compared to comparable companies.
The Chief Executive Officer provides the Compensation Committee with
recommendations for individual executive officers based upon an evaluation of
their performance against objectives and responsibilities. The base salaries
paid to our executive officers were unchanged for 2006.

The
Compensation Committee believes that another key element of executive
compensation should be the variable portion provided by cash incentive plans.
The Compensation Committee sets annual performance objectives for executives of
the company, which are administered quarterly by the Chief Executive Officer.
Our executive officer compensation plan is designed such that if we meet our
stated objectives, executive officers receive the cash incentive part of their
compensation. If we perform below our stated objectives, the cash incentive
portion of the executives compensation is significantly reduced, and may be
eliminated altogether if performance is below defined thresholds. A
substantially smaller portion of some executives incentive compensation is
based on performance against individual objectives. The actual cash bonus
earned in 2006 by executive officers depended upon the extent to which our
objectives were achieved. Because we obtained a certain percentage of such
quarterly performance objectives, cash bonuses ranging from $44,025 to $122,063
were paid to executive officers for services performed during 2006.

9

Our
Chief Executive Officer, Scott C. McDonald, is eligible to receive quarterly
performance bonuses, in a total amount of up to $150,000 per year. Payment of
$75,000 or 50% of such bonus is contingent upon the company remaining
profitable on an earnings per share basis. The remaining $75,000 or 50% of such
bonus shall be granted in proportion to the company meeting the profit
performance criteria set forth within the financial plans approved by the
Compensation Committee and our Board of Directors. In the event
Mr. McDonald exceeds the performance criteria established by the
Compensation Committee and our Board of Directors in a given year (as
determined by the Compensation Committee), Mr. McDonald will be eligible
to earn bonuses that exceed a total of $150,000 for the year. Mr. McDonald
earned cash bonuses totaling $124,500 in 2006.

For
executive officers other than our Chief Executive Officer, the Companys annual
financial plan (the Plan) is structured to enable review and analysis on a
quarter-by-quarter basis. The Plan is used as a guideline for establishing
performance expectations and determining potential ranges of bonus awards. The
Compensation Committee establishes a bonus target for executive officers
depending on their respective roles and responsibilities, based on the annual
and quarterly objectives. After the preliminary quarter end income statement is
prepared, the Chief Executive Officer and Chief Financial Officer prepare
financial results information for Audit Committee review, and to enable
finalization of the quarterly bonus for each executive officer. If our results,
excluding stock based compensation expense, meets or exceeds the targets, and
the individual objectives of each executive officer have been met at the
discretion of the Chief Executive Officer, then the target bonus is accrued
pending review and approval of the quarterly financial results by the Audit
Committee, with any variation based upon each officers performance against
objectives implemented at the discretion of the Chief Executive Officer. Upon
Audit Committee review and approval of the quarterly results, bonus awards are
paid matching the accruals for that particular quarter, in keeping with the
targets and guidance of the Compensation Committee. If at the end of each
quarter the income before taxes excluding stock based compensation do not meet
the targets, then depending upon the performance against objectives of each
individual executive officer at the discretion of Chief Executive Officer, the
bonus may either be paid according to the percentage of target achieved, or
withheld.

Stock Options

Stock
options are an essential element of our executive compensation philosophy and
package. In addressing the second objective of our overall executive
compensation policy, the Compensation Committee utilizes stock option grants to
executive officers to tie a portion of executive officer compensation directly
to our stock price performance. The Compensation Committee believes that the
grant of an equity interest in the company serves to link management interests
with shareholder interests and to motivate executive officers to make decisions
that are in the best interests of Castelle and its shareholders. Our Board of
Directors considers stock option grants to executive officers based on various
factors, including (i) each officers responsibilities, (ii) any changes in such
responsibilities, (iii) past option grants and each officers current equity
interest in the company and (iv) individual or corporation performance. The
stock options are granted at a price that is equal to 100% of the fair market
value of our common stock on the date of grant. The stock options typically
vest over a three-year period in equal monthly increments. In 2006, our
executive officers received no options to purchase common stock.

Severance and Change of Control Payments

We
have entered into a severance and transition benefit agreement with
Mr. McDonald, pursuant to which we agreed that if we terminate
Mr. McDonald without cause or if Mr. McDonald terminates his
employment voluntarily for good reason, we are required to pay him 100% of his
annualized salary and maintain his medical benefits for one year. In addition,
50% of Mr. McDonalds unvested options will become immediately vested. The
agreement allows Mr. McDonald to terminate his employment for good cause
if his responsibilities are materially diminished, his base pay is reduced or
potential bonus payments are materially reduced, we fail to continue any
benefit plan in which Mr. McDonald is participating without comparable
replacement, our corporate headquarters is relocated more than 20 miles from
its current location or we breach this agreement or Mr. McDonalds
employment agreement. No payment will be due if Mr. McDonald is dismissed
for cause, or if Mr. McDonald terminates his employment voluntarily
without good reason.

In the event of a change of
control of Castelle, Mr. McDonald is eligible for a lump sum payment equal
to six months of his base salary, in addition to any benefits that may be
conveyed to Mr. McDonald upon termination, if he remains with us at
least 90 days after a change in control and then voluntarily terminates his
employment without good reason or is terminated for cause. .After a change of
control, if Mr. McDonald is terminated without cause, or voluntary terminates
for good reason, the termination of employment will be a Covered Termination.
Under a Covered Termination, Mr. McDonald will be paid 100% of his annualized
salary if the termination occurs prior to 90 days following a change of
control, and 1.5 times his base salary for a termination occurring after 90
days following a change of control. Please see the table below for additional
information.

We
have entered into a severance plan with Michael Petrovich, pursuant to which
the shares subject to Mr. Petrovichs stock options will continue to vest for a
period of 6 months following his involuntary termination without cause.

10

In
addition, we have agreed to pay our other named executive officers a severance
payment ranging from three to six months of their compensation, subject to
standard payroll deductions and withholdings, if we terminate the officers
employment without cause at any time or if we terminate the officers
employment as a result of a change of control.

The
following table summarizes the potential payments and benefits payable to each
of our named executive officers upon termination of employment or a change in
our control under each situation listed below, assuming, in each situation,
that our named executive officers were terminated on December 31, 2006.

Not following a change of

Following a change ofVoluntarytermination

control

controlwithout good

Involuntary

Voluntary

Involuntary

VoluntaryExecutive benefits
and

reason or

termination

termination

termination

Terminationpayments
upon

termination

without

for good

without

for goodtermination:

for cause

cause

reason

cause

reasonScott C.
McDonald:Base salary


$




$
225,000



$
225,000



$
225,000
(1)


$
225,000
(1)Value of accelerated stock options








51,646




51,646




51,646




51,646Health care benefits for one (1) year








12,670




12,670




12,670




12,670Paul Cheng:Base salary








35,000









70,000




Eric Chen:Base salary








43,750









87,500




Edward J. Heinze:Base salary








22,500









45,000
(2)



Michael Petrovich:Base salary








55,000









55,000




Value of additional stock option vesting








1,938









1,938




(1)
The
  following further defines the change of control compensation for Mr. McDonald:If Mr.
  McDonald is terminated due to an involuntary termination without cause, or
  voluntary termination for good reason, and without regard to any change of
  control, the termination of employment will be a Covered Termination.Base salary to be paid from
0-89 days after
  change in control as a Covered Termination

$
225,000Base salary to be paid from
0-89 days after
  change in control not qualified as a Covered Termination

$
0Base salary to be paid 90 days
after change
  in control as a Covered Termination

$
225,000Base salary to be paid 90 days
after change
  in control not qualified as a Covered Termination

$
112,500Base salary to be paid after 90
days after
  change in control as a Covered Termination

$
337,500Base salary to be paid after 90
days after
  change in control not qualified as a Covered Termination

$
112,500(2)
Only within
  30 days of change of control. If Mr. Heinze is terminated without cause more
  than 30 days after a change of control, then he will be entitled to severance
  in the amount of $22,500.Other Benefits

Executive
officers are eligible to participate in all of our employee benefit plans, such
as medical, dental, vision, group life, disability, and accidental death and
dismemberment insurance and our 401(k) plan, in each case on the same basis as
other employees. There were no special benefits or perquisites provided to any
executive officer in 2006.

11

Executive
Compensation Tables

Summary Compensation Table

The
following table provides information regarding all plan and non-plan
compensation in 2006 awarded to, earned by or paid to each person who served as
our principal executive officer, each person who served as our principal
financial officer and our three other most highly compensated executive
officers who served as such on December 31, 2006, in each case for all services
rendered in all capacities to us during 2006. We refer to the five executive
officers identified in this table as our named executive officers.

Name and
  Principal 
  Position

Year

Salary(1)

Option
  Awards

Non-Equity
  Incentive Plan 
  Compensation

All Other
  Compensation

TotalScott C. McDonaldPresident and
Chief Executive Officer


2006

$
234,531


$




$
124,500
(2)


$



$
359,031Paul ChengVice
President, Finance and Administration,
  Chief Financial Officer and Secretary


2006


147,335








45,000
(2)







192,335Eric ChenSenior Vice
President, Engineering and
  Business Development


2006


184,257








60,000
(2)







244,257Edward J. HeinzeSenior Vice
President, Sales, Worldwide


2006


99,504








96,455
(3)







195,959Michael PetrovichVice
President, Sales, U.S.


2006


118,733








65,568
(3)







184,301(1)
The amounts
  in this column include any salary contributed by the named executive officer
  to our 401(k) plan and payments in respect of accrued vacation, holidays and
  sick days.(2)
The amount
  represents total performance-based bonuses earned for services rendered
  during 2006. The bonuses earned in the first three quarters of 2006 were paid
  in 2006 and the bonus earned for the last quarter of 2006 was paid in the
  first quarter of 2007.(3)
The amount
  represents total performance-based commissions paid in 2006.12

2006
Grants of Plan-Based Awards

The
following table provides information with regard to cash bonuses and
commissions paid in 2006 under our performance based, non-equity incentive
plan, and with regard to each stock option granted to each named executive
officer during 2006.

Payouts
  Under
  Non-Equity Incentive Plan AwardsName

Grant
  Date

Threshold

Target

AwardsScott C. McDonald

4/26/2006


(1)

$
37,500

$
49,500
(2)7/27/2006


(1)


37,500


010/25/2006


(1)


37,500


37,500
(3)2/15/2007


(1)


37,500


37,500
(4)Paul Cheng

4/26/2006

$
15,000


15,000


15,000
(2)7/27/2006


15,000


15,000


010/25/2006


15,000


15,000


15,000
(3)2/15/2007


15,000


15,000


15,000
(4)Eric Chen

4/26/2006


20,000


20,000


20,000
(2)7/27/2006


20,000


20,000


010/25/2006


20,000


20,000


20,000
(3)2/15/2007


20,000


20,000


20,000
(4)Edward J. Heinze

1/6/2006


(5)


(5)


9,940
(6)2/7/2006


(5)


(5)


6,743
(6)3/7/2006


(5)


(5)


9,464
(6)4/7/2006


(5)


(5)


10,570
(6)5/5/2006


(5)


(5)


6,242
(6)6/7/2006


(5)


(5)


6,919
(6)7/7/2006


(5)


(5)


10,246
(6)8/7/2006


(5)


(5)


5,675
(6)9/7/2006


(5)


(5)


5,537
(6)10/6/2006


(5)


(5)


9,586
(6)11/7/2006


(5)


(5)


8,683
(6)12/7/2006


(5)


(5)


6,850
(6)Michael Petrovich

1/6/2006


(5)


(5)


7,927
(6)2/7/2006


(5)


(5)


3,593
(6)3/7/2006


(5)


(5)


4,225
(6)4/7/2006


(5)


(5)


7,274
(6)5/5/2006


(5)


(5)


1,824
(6)6/7/2006


(5)


(5)


4,484
(6)7/7/2006


(5)


(5)


5,693
(6)8/7/2006


(5)


(5)


4,729
(6)9/7/2006


(5)


(5)


4,886
(6)10/6/2006


(5)


(5)


7,988
(6)11/7/2006


(5)


(5)


7,236
(6)12/7/2006


(5)


(5)


5,709
(6)13

(1)
Mr. McDonald is entitled to earn bonuses of $150,000
  per year. Payment of 50% is contingent upon the Company remaining profitable
  on an earnings per share basis. The remaining 50% is granted in proportion to
  the Company meeting profit performance criteria set forth within the
  financial plan approved by the Compensation Committee.(2)
This amount represents the bonus earned by the
  officer in the first quarter of 2006 under our bonus plan.(3)
This amount represents the bonus earned by the
  officer in the third quarter of 2006 under our bonus plan.(4)
This amount represents the bonus earned by the
  officer in the fourth quarter of 2006 under our bonus plan.(5)
Commission earned is in proportion to the quarterly
  revenue target set forth by the Chief Executive Officer.(6)
This amount represents commissions paid to the
  officer in 2006 under our sales commission plan.14

Outstanding Equity Awards at
December 31, 2006

The
following table provides information regarding each unexercised stock option
held by each of our named executive officers as of December 31, 2006.

Number of
  Securities 
  Underlying Unexercised 
  Options

Option 
  Exercise 
  Price(2)

Option 
  Expiration 
  DateName

Exercisable

Unexercisable(1)Scott C.
  McDonald

10,000





$
1.9375


4/1/2010Scott C.
  McDonald

10,000






1.0630


4/1/2011Scott C.
  McDonald

3,751






0.79


4/1/2012Scott C.
  McDonald

19,999






0.68


4/22/2009Scott C.
  McDonald

100,000






0.70


5/28/2009Scott C.
  McDonald

71,454






2.75


6/23/2010Scott C.
  McDonald

78,546






2.75


6/23/2010Scott C.
  McDonald

16,680


33,320
(3)


3.10


12/19/2012Paul Cheng

45,000






1.1562


4/19/2007Paul Cheng

25,000






0.68


4/11/2008Paul Cheng

12,499


2,501



3.40


8/18/2010Paul Cheng

3,750


11,250



3.10


12/19/2012Eric Chen

30,000






1.2812


5/10/2007Eric Chen

5,000






0.68


4/11/2008Eric Chen

16,666


3,334



3.40


8/18/2010Eric Chen

15,624


9,376



3.03


6/16/2011Eric Chen

6,250


18,750



3.10


12/19/2012Edward J.
  Heinze

4,166


834



3.40


8/18/2010Edward J.
  Heinze

3,750


15,000



3.10


12/19/2012Michael
  Petrovich

4,166


834



3.40


8/18/2010(1)
Except as
  otherwise described in these footnotes, each of these options vests as to 1/4th
  of the shares underlying the option after 12 consecutive months following the
  date of grant, with 1/36th of the shares underlying the option
  grant vesting after each consecutive month thereafter. The vesting of certain
  of these options may also be accelerated under certain circumstances as
  described above in Severance and Change of Control Payments.(2)
Represents
  the market closing price on the respective grant dates.(3)
These
  options vest as to 1/36th of the shares underlying the option
  after each consecutive month following the date of grant. The vesting of
  these options may also be accelerated under certain circumstances as
  described above in Severance and Change of Control Payments.15

2006 Option Exercises

The
following table shows the number of shares acquired pursuant to the exercise of
options by each named executive officer during 2006 and the aggregate dollar
amount realized by the named executive officer upon exercise of the option,
based on the information available to us as of December 31, 2006.

Name

Number of
  Shares Acquired
  on Exercise

Value
  Realized
  on Exercise(1)Scott C.
  McDonald








Paul Cheng








Eric Chen








Edward J.
  Heinze








Michael
  Petrovich



30,000



$
58,725(1)
The aggregate dollar amount realized upon the exercise of an option
  represents the difference between the aggregate market price of the shares of
  our common stock underlying that option on the date of exercise and the
  aggregate exercise price of the option.Director
Compensation

Cash Compensation

In 2006,
each non-employee director received a quarterly retainer of $2,500 and a per
meeting fee of $1,000 for each quarterly meeting of our Board of Directors
attended. Non-employee directors are also reimbursed for their expenses
incurred in connection with attending meetings of our Board of Directors.

Equity Compensation

Non-employee
directors are eligible to participate in the 2002 Option Plan, which superseded
the 1995 Non-Employee Directors Stock Option Plan, as amended through February
2000, and the 1988 Equity Incentive Plan, as amended through 1998 (collectively
as the Prior Option Plan). In 2006, each non-employee director received
non-qualifying stock option grants under the 2002 Option Plan.

The 2002
Option Plan provides that each non-employee member of our Board of Directors,
upon initial election to our Board of Directors, is automatically granted an
option to purchase 10,000 shares of common stock at an exercise price equal to
the fair market value per share of our common stock on the date of grant. This
initial option grant vests monthly in 12 equal installments, beginning one
month after the date of grant provided that the optionee has continuously
served as a director. On April 1 of each year (or the next business day should
such date be a weekend or a legal holiday), each then-current member of our
Board of Directors who is eligible for participation in the 2002 Option Plan
and is a non-employee member of our Board of Directors is automatically granted
an option to purchase 5,000 shares of common stock at an exercise price equal
to the fair market value per share of our common stock on the date of grant,
without further action by us, our Board of Directors or our shareholders,
provided, that such director has served continuously as a member of our Board
of Directors for at least 12 months since the last option grant (whether an
initial option grant or an annual grant). If less than 12 months has passed,
then the number of shares subject to the annual grant will be pro-rated based
on the number of days passed since the last option grant to such director,
divided by 365 days. Each of these annual grants under the 2002 Option Plan
vests monthly in 12 equal installments beginning one month after the date of
grant. The term of options granted under the 2002 Option Plan may not be longer
than ten years.

In 2006, we
granted to each of Messrs. Hambrecht, Tierney, Rich and Smith an option to
purchase 5,000 shares at an exercise price of $3.10 per share under the 2002
Option Plan. The exercise prices were equal to the respective fair market
values of such common stock on the date of grant (based upon the closing sale
price reported on the NASDAQ SmallCap Market for the date of grant).

Options
which remain outstanding under the Prior Option Plan will accelerate under
certain circumstances. In the event of our merger with or into another
corporation or a consolidation, acquisition of assets or other
change-in-control transaction, vesting of

16

outstanding
option grants under the Prior Option Plan is accelerated and such options will
terminate if not exercised prior to the consummation of the transaction.

Director Compensation Table

Name

Fees
  Earned or 
  Paid in Cash(1)

Option 
  Awards(2)

Non-Equity
  
  Incentive Plan
  Compensation

All Other 
  Compensation

TotalDonald L.
  Rich

$
14,000

$
8,600(3)

$


$


$
22,600Peter R.
  Tierney


14,000


8,600(4)








22,600Robert H.
  Hambrecht


14,000


8,600(5)








22,600Robert O.
  Smith


14,000


8,600(6)








22,600(1)
All fees
  were both earned and paid during 2006.(2)
The amounts
  in this column represent the aggregate grant date fair value, computed in
  accordance with SFAS No. 123R, of all options granted to the named
  director in 2006.(3)
At December
  31, 2006, Mr. Rich held outstanding options to purchase an aggregate of
  220,000 shares of our common stock.(4)
At December
  31, 2006, Mr. Tierney held outstanding options to purchase an aggregate of
  40,000 shares of our common stock.(5)
At December
  31, 2006, Mr. Hambrecht held outstanding options to purchase an aggregate of
  47,000 shares of our common stock.(6)
At December
  31, 2006, Mr. Smith held outstanding options to purchase an aggregate of
  20,205 shares of our common stock.Compensation
Committee Report

The
Compensation Committee has reviewed and discussed the Compensation Discussion
and Analysis required by Item 402(b) of Regulation S-K with management,
and, based on such review and discussions, the Compensation Committee
recommended to our Board of Directors that the Compensation Discussion and
Analysis be included in this annual report on Form 10-K/A.

Compensation
  Committee Members:Robert H.
  Hambrecht 
  Peter R. Tierney17

Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters

The
following table presents information about the beneficial ownership of our
common stock as of March 31, 2007 by:


each person
  or entity known by us to be the beneficial owner of more than 5% of our
  common stock;
each
  director;
each of our
  named executive officers; and
all
  directors and executive officers as a group.The
percentage of beneficial ownership for the table is based on 4,041,670 shares
of our common stock outstanding as of March 31, 2007. The table is based upon
information supplied by officers, directors and principal shareholders and
Schedules 13D and 13G filed with the SEC. Unless otherwise indicated in the
footnotes to this table and subject to community property laws where
applicable, we believe that each shareholder named in the table has sole voting
and investment power with respect to the shares indicated as beneficially
owned. Unless otherwise indicated, each entity or person listed below maintains
a mailing address of c/o Castelle, 855 Jarvis Drive, Suite 100, Morgan Hill, CA
95037.

Beneficial
ownership is determined under the rules of the SEC and does not necessarily indicate
beneficial ownership for any other purpose. Under these rules, beneficial
ownership includes those shares of common stock over which the shareholder has
sole or shared voting or investment power. It also includes shares of common
stock that the shareholder has the right to acquire within 60 days after March
31, 2007, through the exercise of any option or warrant. However, the
percentage ownership of the common stock is based on the assumption, as
required by the rules of the SEC, that only the person or entity whose
ownership is being reported has converted options or warrants into shares of
our common stock.

Name of
  Beneficial Owner

Number of Shares
  of Common Stock
  Beneficially Owned

Percentage
  Beneficially
  Owned5%
Shareholders:Entities affiliated with Daniel
Zeff(1)


1,007,021


24.9
%Entities affiliated with
Barclays Bank Plc(2)


293,967


7.3Directors and Named
Executive Officers:Scott C.
McDonald(3)


517,630


11.9
%Donald L.
Rich(4)


221,916


5.2Eric
Chen(5)


140,831


3.4Paul
Cheng(6)


49,374


1.2Robert H.
Hambrecht(7)


61,426


1.5Peter R.
Tierney(8)


55,416


1.4Michael
Petrovich(9)


49,487


1.2Robert O.
Smith(10)


20,621


*Edward J.
Heinze(11)


12,499


*All executive officers and
directors as a
  group (10 persons)(12)


1,191,490


24.4
%* Less than 1%
  ownership.(1)
Daniel Zeff
  beneficially owns 1,007,021 shares of Common Stock, comprising 539,256 shares
  of Common Stock held by Zeff Capital Partners I, L.P and 467,765 shares of
  Common Stock held by Spectrum Galaxy Fund, Ltd. The address of Daniel Zeff is
  50 California Street, San Francisco, California 94111.(2)
Shares are
  held by Barclays Global Investors, NA. The address of Barclays Global
  Investors is 45 Fremont Street, San Francisco, California 94105.(3)
Includes
  317,380 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(4)
Includes
  220,416 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(5)
Includes
  80,831 shares that are subject to options exercisable within 60 days
  after March 31, 2007.18

(6)
Includes
  44,374 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(7)
Includes
  47,416 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(8)
Includes
  40,416 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(9)
Includes
  4,687 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(10)
Includes
  20,621 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(11)
Includes
  9,999 shares that are subject to options exercisable within 60 days
  after March 31, 2007.(12)
Consists of
  shares disclosed under footnotes 3-12. Of the number of shares that are
  beneficially owned by the directors and executive officers, 848,430 shares
  are subject to options exercisable within 60 days after March 31, 2007.Securities Authorized for Issuance under
Equity Compensation Plans

The
following table sets forth certain information, as of December 31, 2006,
concerning securities authorized for issuance under all Castelle equity
compensation plans:

Plan category

Number of securities to be
  issued upon exercise of
  outstanding options,
  warrants and rights
  (a)

Weighted-average exercise
  price of outstanding options,
  warrants and rights
  (b)

Number of securities
  remaining available for
  future issuance under equity
  compensation plans
  (excluding securities
  reflected in column (a)
  (c)Equity compensation plans
approved by
  security holders


1,039,147



$
1.83



214,995
(1)Equity compensation plans not
approved by
  security holders







n/a



Total


1,039,147



$
1.83



214,995(1)
Represents
  214,995 shares available for issuance under our 2002 Equity Incentive Plan.Item 13. Certain
Relationships and Related Transactions, and Director Independence

Policies and Procedures for Approving
Transactions with Related Persons

The
Audit Committee is responsible for reviewing and approving all related party
transactions, either in advance or when we become aware of a related person
transaction that was not approved in advance. Related parties include any of
our directors or executive officers, certain of our shareholders and their
immediate family members. To identify any related party transactions, each
year, we submit and require our directors and officers to complete director and
officer questionnaires identifying any transactions with us in which the
executive officer or director or their family members has an interest. In
addition, the Nominating Committee determines, on an annual basis, which
members of our Board of Directors meet the definition of independent director
as defined in the applicable Marketplace Rules of The NASDAQ Stock Market and
reviews and discusses any relationships with directors that would potentially interfere
with his exercise of independent judgment in carrying out the responsibilities
of a director.

Transactions with Related Persons

Other
than the compensation arrangements described in Director Compensation,
Executive Compensation and Employment Contracts, Termination of Employment
and Change in Control Arrangements and the transactions described below, since
January 1, 2006, there has not been nor is there currently proposed, any
transaction or series of similar transactions to which we were or will be a
party to which the amount involved exceeds $120,000 and in which any executive
officer, director or beneficial owner of more than 5% of our common stock had
or will have a direct or indirect material interest.

Our
Amended and Restated Bylaws provide that we will indemnify directors and
executive officers to the fullest extent permitted by California law. Under our
Amended and Restated Bylaws, indemnified parties are entitled to
indemnification for negligence, gross

19

negligence and
otherwise to the fullest extent permitted by law. Our Amended and Restated
Bylaws also require us to advance litigation expenses in the case of legal
proceedings, against an undertaking by the indemnified party to repay such
advances if it is ultimately determined that the indemnified party is not
entitled to indemnification.

Director Independence

Our
Board of Directors has determined that each of Messrs. Rich, Tierney, Hambrecht
and Smith, each a non-employee director of Castelle, is independent under the
applicable Marketplace Rules of The NASDAQ Stock Market. Mr. McDonald is not
independent based on his service as our President and Chief Executive Officer.
In making its independence determinations, our Board of Directors each year
reviews any transactions and relationships between the director, or any member
of his or her immediate family, and is based on information provided by the
director, company records and publicly available information during the year.
Specifically, our Board of Directors will consider the following types of
relationships and transactions: (i) principal employment of and other
public company directorships held by each non-employee director;
(ii) contracts or arrangements that are ongoing or which existed during
any of the past three fiscal years between our company and any entity for which
the non-employee director, or his or her immediate family member, is an
executive officer or greater-than-10% shareholder; and (iii) contracts or
arrangements that are ongoing or which existed during any of the past three
fiscal years between our company and any other public company for which the
non-employee director serves as a director. During 2006, there were no
relationships or transactions in these categories reviewed by our Board of
Directors, nor were there any other similar relationships or transactions that
our Board of Directors considered.

Item 14.Principal Accountant Fees and Services

The
aggregate fees billed by Grant Thornton LLP, our independent registered public
accounting firm, for professional services provided for fiscal years ended
December 31, 2006 and December 31, 2005, respectively, were as follows:

2006

2005Audit Fees

$
271,672

$
247,707
(1)Audit-Related
  Fees


2,808


Tax Fees





All Other
  Fees





2,400(1)
Excludes
  fees in the amount of $7,000 billed to us by our prior independent auditors,
  PricewaterhouseCoopers LLP.Audit
Fees. Consists of fees billed for professional services
rendered for the audit of our annual consolidated financial statements and the
review of our quarterly consolidated financial statements and services that are
normally provided by Grant Thornton LLP (and previously by
PricewaterhouseCoopers LLP) in connection with statutory and regulatory filings
or engagements.

Audit-Related
Fees. Consists
of fees billed for assurance and related services that are reasonably related
to the performance of the audit or review of our consolidated financial statements
and are not reported under Audit Fees. These services include accounting
consultations in connection with public offerings, internal control reviews,
and consultations concerning financial accounting and reporting standards.

Tax
Fees. Consists
of fees billed for professional services for tax compliance and tax advice.
These services consist of assistance regarding federal, state and international
tax compliance, assistance with the preparation of various tax returns,
research and design tax study and international compliance.

All
Other Fees. Consists of fees for products and services
other than the services reported above.

Pre-Approval of Audit and Non-Audit Services
of Independent Registered Public Accounting Firm

Section 10A(i)(1)
of the Securities Exchange Act requires that all audit and non-audit services
to be performed by our principal accountants be approved in advance by the
Audit Committee, subject to certain exceptions relating to non-audit services
accounting for less than 5% of the total fees paid to our principal accountants
that are subsequently ratified by the Audit Committee. Pursuant to
Section 10A(i)(1) of the Securities Exchange Act, the Audit Committees
policy is to pre-approve all audit and permissible non-audit services provided
by the independent auditor. These services may include audit services,
audit-related services, tax services and other services. Pre-approval is
generally provided for up to one year and any pre-approval is detailed as to the
particular service or category of services and is generally subject to a
specific budget. The independent auditor and management are required to
periodically report to the Audit Committee regarding the extent of services
provided by the independent auditor in accordance with this pre-approval, and
the fees for the services performed to date. The Audit Committee may also
pre-approve particular services on a case-by-case basis.

20

All
of the services described above respecting Audit-Related Fees, Tax Fees and All
Other Fees were pre-approved by the Audit Committee pursuant to the
pre-approval policy.

PART IV

Item 15. Exhibits and Financial Statement
Schedules

3.
Exhibits

The
following exhibits are filed herewith or incorporated by reference herein:

INCORPORATED BY
  REFERENCEExhibit
  Number

EXHIBIT DESCRIPTION

FORM

File No.

Date of
  First Filing

Exhibit
  Number

Filed
  Herewith3.1

Registrants Amended and Restated Articles of
  Incorporation.

SB-2/A

33-99628-LA-

12/8/1995

3.33.2

Registrants Amended and Restated Bylaws

8-K

000-22020

8/8/2006

3.014.1

Specimen Stock Certificate representing shares of
  Registrants Common Stock.

SB-2/A

33-99628-LA-

12/14/1995

4.110.1*

1995 Non-Employee Directors Stock Option Plan, as
  amended, and form of Director Stock Option Agreement

SB-2/A

111-22020

12/14/1995

10.210.2

Distribution Agreement dated February 26, 1990, by
  and between the Registrant and Ingram Micro D Inc.

SB-2/A

33-99628-LA-

12/8/1995

10.810.3*

1988 Equity Incentive Plan, as amended, and form of
  option agreement

S-8

333-75247

3/29/1999

99.110.4

International Distributor Agreement dated April 24,
  2001 by and between the Registrant and AMS Limited.

10-K

000-22020

3/29/2002

10.1110.5

Commercial Tenant Lease Agreement dated August 16,
  2000 by and among the Registrant and Kyung S. Lee and Ieesun Kim Lee.

10-K

000-22020

3/29/2002

10.1210.6

First Amendment to Lease Agreement dated June 1,
  2004 by and among the Registrant and by and between Kyung S. Lee and Ieesun
  Kim Lee.

10-Q

000-22020

8/11/2004

10.110.7*

Summary of Severance Agreements with Named Executive
  Officers.

10-K

000-22020

4/15/2005

10.1110.8

Employment agreement dated April 22, 2002 by and
  between the Registrant and Scott McDonald.

10-K

000-22020

3/28/2003

10.1610.9

Form of Executive Severance and Transition Benefits
  Agreement dated April 22, 2002 by and between the Registrant and Scott
  McDonald.

10-K

000-22020

3/28/2003

10.1610.10*

2002 Equity Incentive Plan.

10-K

000-22020

3/28/2003

10.1610.11

Loan and Security Agreement dated August 2, 2004 by
  and between the Registrant and Silicon Valley Bank.

10-Q

000-22020

8/11/2004

10.210.12

Loan
  Modification Agreement dated July 18, 2006 by and between the Registrant and
  Silicon Valley Bank.

10-Q

000-22020

11/13/2006

10.110.13

Addendum
  dated December 3, 1991 to Distributor Agreement dated February 26, 1990, by
  and between the Registrant and Ingram Micro Inc.

10-K

000-22020

3/30/2007

10.1310.14

Distributor
  Agreement dated September 29, 1997, by and between the Registrant and Tech
  Data Corporation

10-K

000-22020

3/30/2007

10.1410.15

International
  Distributor Agreement dated May 31, 2001, by and between the Registrant and
  Macnica, Inc.

10-K

000-22020

3/30/2007

10.1510.16

Amended
  and Restated International Distributor Agreement dated July 18, 2002, by and
  between the Registrant and AMS Limited.

10-K

000-22020

3/30/2007

10.1621

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









X31.2

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









X32.1**

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









X32.2**

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









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

** 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.

(b)
Exhibits

See
Item 15(3) above.

22

SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

CASTELLEBy:
/s/ SCOTT C. MCDONALDScott C. McDonaldPresident
  and Chief Executive OfficerDated: April 30, 2007

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

Signature

Title

Date/s/ Scott C. McDonald

President, Chief Executive Officer and Director

April 30, 2007[Principal Executive Officer]Scott C. McDonald*

Chief Financial Officer

April 30, 2007[Principal Financial Officer]Paul Cheng*

Chairman of the Board of Directors

April 30, 2007Donald L. Rich*

Director

April 30, 2007Robert H. Hambrecht*

Director

April 30, 2007Robert O. Smith*

Director

April 30, 2007Peter R. Tierney* By:
/s/ Scott C. McDonaldScott C. McDonaldAttorney-in-Fact23

EXHIBIT INDEX

INCORPORATED BY
  REFERENCEExhibit
  Number

EXHIBIT DESCRIPTION

FORM

File No.

Date of
  First Filing

Exhibit
  Number

Filed
  Herewith3.1

Registrants Amended and Restated Articles of
  Incorporation.

SB-2/A

33-99628-LA-

12/8/1995

3.33.2

Registrants Amended and Restated Bylaws

8-K

000-22020

8/8/2006

3.014.1

Specimen Stock Certificate representing shares of
  Registrants Common Stock.

SB-2/A

33-99628-LA-

12/14/1995

4.110.1*

1995 Non-Employee Directors Stock Option Plan, as
  amended, and form of Director Stock Option Agreement

SB-2/A

111-22020

12/14/1995

10.210.2

Distribution Agreement dated February 26, 1990, by
  and between the Registrant and Ingram Micro D Inc.

SB-2/A

33-99628-LA-

12/8/1995

10.810.3*

1988 Equity Incentive Plan, as amended, and form of
  option agreement

S-8

333-75247

3/29/1999

99.110.4

International Distributor Agreement dated April 24,
  2001 by and between the Registrant and AMS Limited.

10-K

000-22020

3/29/2002

10.1110.5

Commercial Tenant Lease Agreement dated August 16,
  2000 by and among the Registrant and Kyung S. Lee and Ieesun Kim Lee.

10-K

000-22020

3/29/2002

10.1210.6

First Amendment to Lease Agreement dated June 1,
  2004 by and among the Registrant and by and between Kyung S. Lee and Ieesun
  Kim Lee.

10-Q

000-22020

8/11/2004

10.110.7*

Summary of Severance Agreements with Named Executive
  Officers.

10-K

000-22020

4/15/2005

10.1110.8

Employment agreement dated April 22, 2002 by and
  between the Registrant and Scott McDonald.

10-K

000-22020

3/28/2003

10.1610.9

Form of Executive Severance and Transition Benefits
  Agreement dated April 22, 2002 by and between the Registrant and Scott
  McDonald.

10-K

000-22020

3/28/2003

10.1610.10*

2002 Equity Incentive Plan.

10-K

000-22020

3/28/2003

10.1610.11

Loan and Security Agreement dated August 2, 2004 by
  and between the Registrant and Silicon Valley Bank.

10-Q

000-22020

8/11/2004

10.210.12

Loan
  Modification Agreement dated July 18, 2006 by and between the Registrant and
  Silicon Valley Bank.

10-Q

000-22020

11/13/2006

10.110.13

Addendum
  dated December 3, 1991 to Distributor Agreement dated February 26, 1990, by
  and between the Registrant and Ingram Micro Inc.

10-K

000-22020

3/30/2007

10.1310.14

Distributor
  Agreement dated September 29, 1997, by and between the Registrant and Tech
  Data Corporation

10-K

000-22020

3/30/2007

10.1410.15

International
  Distributor Agreement dated May 31, 2001, by and between the Registrant and
  Macnica, Inc.

10-K

000-22020

3/30/2007

10.1510.16

Amended
  and Restated International Distributor Agreement dated July 18, 2002, by and
  between the Registrant and AMS Limited.

10-K

000-22020

3/30/2007

10.1631.1

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









X31.2

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









X24

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









X32.2**

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









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

** 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.

25