UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

            |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997

            | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                        Commission File Number: 0-220-20

                                    CASTELLE
             (Exact name of Registrant as specified in its charter)

             California                             77-0164056
   (State or other jurisdiction of        (IRS Employer Identification No.)
    incorporation or organization)

                 3255-3 Scott Boulevard, Santa Clara, California
                 95054 (Address of principal executive offices,
                               including zip code)

                                 (408) 496-0474
              (Registrant's telephone number, including area code)

        Securities registered pursuant to Section 12(b) of the Act: NONE

           Securities registered pursuant to Section 12(g) of the Act:
                           COMMON STOCK, NO PAR VALUE

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes |X| No __

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of Registrant's knowledge, in any amendment to this Form 10-K. 

The  approximate  aggregate  market  value of the voting  common  equity held by
non-affiliates  of the Registrant,  based upon the last sale price of the Common
Stock reported on the Nasdaq  National  Market was $6,822,000 as of February 20,
1998.

The number of shares of Common  Stock  outstanding  as of February  20, 1998 was
4,490,047.


                       DOCUMENTS INCORPORATED BY REFERENCE

Certain exhibits filed with the Registrant's Registration Statement on Form SB-2
(Registration  No.  33-99628-LA-),   as  amended,  are  incorporated  herein  by
reference into Part IV of this Report and portions of the proxy  statement to be
filed in  connection  with the  annual  meeting  to be held  April 29,  1998 are
incorporated herein by reference into Part III of this Report.



<PAGE>

                                     PART I

ITEM 1.       BUSINESS

         The  following  summary  should  be read in  conjunction  with,  and is
qualified in its entirety by, the more  detailed  information  and  Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Report.

         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  Castelle's  actual  results could differ  materially  from those
discussed  here.  Factors  that could cause or  contribute  to such  differences
include,  but are not limited to, those discussed herein under "Risk Factors" as
well  as in the  section  entitled  "Management's  Discussion  and  Analysis  of
Financial Condition and Results of Operations."

                                  INTRODUCTION

         Castelle  (the  "Company")  designs,  develops,  markets  and  supports
network  enhancement  products,  both  software and  hardware,  that improve the
productivity,  performance and functionality of local area networks ("LANs") and
enhance the LAN user's ability to communicate.  The Company's  current  products
include  FaxPress  fax server  systems,  LANpress  print  servers and  InfoPress
fax-on-demand software.

         In  recent  years,   organizations  have  increasingly   interconnected
personal  computers into LANs.  Originally,  these LANs consisted of a dedicated
personal  computer,  called a file server, on which the network operating system
was installed, and multiple personal computers on which the users of the LAN ran
their applications. The network operating system on the file server provided the
server  administration  and  basic  file and print  sharing.  As  networks  have
proliferated  throughout  organizations  and  client/server  architectures  have
gained  acceptance,   LANs  have  become  increasingly  complex,  the  size  and
multimedia  intensity  of  files  being  communicated  have  increased  and  the
applications  operating  on the LAN have become more  critical to the success of
the business  enterprise.  These factors have caused network  administrators  to
seek network enhancement products which can improve network performance, enhance
the  functionality of the current installed base of network hardware and convert
single-user  resources  such as  stand-alone  printers and telephone  lines into
shared LAN resources in a cost-effective  manner.  The Company has developed its
line of network enhancement products to address these needs.

         The  Company's  objective  is to be a  leading  worldwide  supplier  of
network enhancement solutions. Key elements of the Company's strategy to achieve
this objective include: maintaining market focus in order to provide the Company
with a competitive edge in innovation and time-to-market  relative to its larger
competitors; broadening its software offerings to leverage its installed base of
fax,  fax-on-demand  and print servers;  continuing to develop products that are
widely  compatible  with leading  network  operating  systems and adapting those
products for remote access and Internet connectivity capabilities; strengthening
and  maintaining  its  domestic  and  international  distribution  network;  and
expanding  existing  relationships  and  fostering  new alliances to augment the
Company's  product  offerings  that  enable the  Company  to respond  quickly to
technological changes.

         The Company has adapted its  products  for use with the Internet and on
the World Wide Web (the  "Web"),  and will  continue  to focus on the effect the
Internet has had on network productivity. For example, the Company has developed
Internet fax capability with its FaxPress fax server,  Internet print capability
with its LANpress print servers, and Web-to-fax  capabilities with its InfoPress
fax-on-demand server.
                                       1.
<PAGE>


         The Company  distributes  its  products  primarily  through a two-tier,
domestic and international  distribution  network, with its distributors selling
Castelle's  products to  value-added  resellers  ("VARs"),  retailers  and other
resellers. The Company's three major domestic distributors include Ingram Micro,
Inc.   ("Ingram"),   Tech  Data  Corporation  ("Tech  Data")  and  Merisel,  Inc
("Merisel").  The Company's two major international distributors include Macnica
Corporation  ("Macnica")  in Japan and Azlan Group PLC  ("Azlan")  in the United
Kingdom.  The Company also has  relationships  with certain  original  equipment
manufacturers and sells software and upgrades directly to end users.

         In November 1996 Ibex Technologies,  Inc. ("Ibex") merged with and into
the Company. Ibex designed,  developed and marketed fax-on-demand,  fax-gateway,
fax broadcast  and Web/fax  applications  sold directly and through  value-added
resellers.  "Fax-on-Demand"  is the ability to use a touch-tone  phone and a fax
machine to request and  receive  hard copies of  documents  on demand.  Although
there  are a wide  variety  of  applications  installed,  the  two  most  common
applications are customer support and literature fulfillment applications.

         The Company was  incorporated  in California in 1987, and its principal
offices are located at 3255-3 Scott Boulevard,  Santa Clara,  California  95054.
The Company's telephone number is (408) 496-0474.  Castelle(R),  LANpress(R) and
JetPress(R)  are  registered  trademarks  and  FaxPressTM  is a trademark of the
Company. This Report includes trademarks and trade names of other companies.

                                  RISK FACTORS

         Shareholders  or  investors  considering  the purchase of shares of the
Company's Common Stock should carefully consider the following risk factors,  in
addition to other information in this Report.

         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  The Company's actual results could differ  materially from those
discussed  here.  Factors  that could cause or  contribute  to such  differences
include,  but are not  limited  to,  those  discussed  herein  as well as in the
section entitled  "Management's  Discussion and Analysis of Financial  Condition
and Results of Operations."

Fluctuations in Operating Results

         The Company's revenue and operating results have fluctuated in the past
and the Company's  future revenues and operating  results are likely to do so in
the future, particularly on a quarterly basis.

         The Company's  operating results may vary significantly from quarter to
quarter due to a variety of factors,  including changes in the Company's product
and customer mix,  constraints  in the Company's  manufacturing  and  assembling
operations,   shortages  or  increases  in  the  prices  of  raw  materials  and
components,  changes in pricing  policy by the  Company  or its  competitors,  a
slowdown  in the  growth  of  the  networking  market,  seasonality,  timing  of
expenditures and economic conditions in the United States,  Europe and Asia. The
Company's  backlog at any given  time is not  necessarily  indicative  of actual
sales for any succeeding  period.  The Company's sales will often reflect orders
shipped  in the  same  quarter  in which  they  are  received.  In  addition,  a
significant  portion of the Company's  expenses are relatively  fixed in nature,
and planned expenditures are based primarily on sales forecasts.  Therefore,  if
the Company  inaccurately  forecasts demand for its products,  the impact on net
income may be magnified by the Company's  inability to adjust  spending  quickly
enough  to  compensate  for the  net  sales  shortfall.  Future  demand  for the
Company's products may be stronger during the last quarter of each year than the
first  quarter of the  succeeding  year as the sales  personnel of the Company's
distributors seek to meet their annual sales quotas.  The Company's  performance
in  any  quarter  is  not  necessarily  indicative  of  its  performance  in any
subsequent quarter.
                                       2.
<PAGE>

         Other factors  contributing to fluctuations in the Company's  quarterly
operating  results  include  changes in the demand for the  Company's  products,
customer  order  deferrals  in  anticipation  of new  versions of the  Company's
products,  the  introduction  of new  products and product  enhancements  by the
Company or its  competitors,  the effects of filling the  distribution  channels
following such introductions,  potential delays in the availability of announced
or  anticipated   products,   the  mix  of  license  and  service  revenue,  the
commencement  or conclusion of  significant  development  contracts,  changes in
foreign  currency  exchange  rates,  the timing of  acquisitions  and associated
costs,  and the  timing  of  significant  marketing  and sales  promotions.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations."

History of Losses; Accumulated Deficit

         The Company has  experienced  significant  operating  losses and, as of
December 31, 1997, had an accumulated deficit of $13.8 million.  The development
and  marketing  by  the  Company  of  new  products  will  continue  to  require
substantial product development and other expenditures. Although the Company had
been profitable in 1996 and 1995, the Company sustained a loss in 1997 and there
can be no assurance that growth in net sales or  profitability  will be achieved
or sustained  in future  years.  See  "Management's  Discussion  and Analysis of
Financial Condition and Results of Operations."

Rapid Technological Change; Risks Associated with New Products

          The market for the Company's  products is affected by rapidly changing
networking technology and evolving industry standards. The Company believes that
its future success will depend upon its ability to enhance its existing products
and to develop and introduce new products  which conform to or support  emerging
network  telecommunications  standards,  are compatible  with a growing array of
computer and peripheral devices,  support popular computer and network operating
systems and  applications,  meet a wide range of evolving user needs and achieve
market acceptance. There can be no assurance that the Company will be successful
in these efforts. The Company has incurred,  and the Company expects to continue
to incur, substantial expenses associated with the introduction and promotion of
new  products.  There can be no assurance  that the expenses  incurred  will not
exceed research and development budgets or that new products will achieve market
acceptance and generate sales sufficient to offset  development  costs. In order
to develop  new  products  successfully,  the Company is  dependent  upon timely
access to information about new technological  developments and standards. There
can be no  assurance  that the Company  will have such access or that it will be
able  to  develop  new  products   successfully   and  respond   effectively  to
technological change or new product  announcements by others.  Furthermore,  the
Company  expects  that  printer  and  other  peripheral  manufacturers  will add
features to their  products  that make them more network  accessible,  which may
reduce demand for the Company's  network  enhancement  devices.  There can be no
assurance that products or technologies  developed by others will not render the
Company's  products  non-competitive  or obsolete.  The fax-on-demand  market in
general has been negatively  affected by the growth of the Web and the Internet.
Although the Company has new web/fax/email products in development, there can be
no assurance these products will compete successfully.  Complex products such as
those  offered by the Company  may contain  undetected  or  unresolved  hardware
defects or software errors when they are first introduced or as new versions are
released.  Changes in the Company's or its suppliers' manufacturing processes or
the  inadvertent  use of defective  components  by the Company or its  suppliers
could adversely affect the Company's ability to achieve acceptable manufacturing
yields and product reliability.  The Company has in the past discovered hardware
defects and  software  errors in certain of its new  products  and  enhancements
after their  introduction.  Although  the Company has not  experienced  material
adverse  effects  resulting  from  any such  errors  to  date,  there  can be no
assurance  that despite  testing by the Company and by  third-party  test sites,
errors will not be found in future  releases of the  Company's  products,  which
would result in adverse product reviews and negatively  affect market acceptance
of these products.
                                       3.
<PAGE>

         The  introduction of new or enhanced  products  requires the Company to
manage the transition from older  products.  The Company must manage new product
introductions so as to minimize disruption in customer ordering patterns,  avoid
excessive levels of older product  inventories and ensure that adequate supplies
of new products can be delivered to meet customer demands.  The Company has from
time to time experienced delays in the shipment of new products. There can be no
assurance that future product  transitions  will be managed  successfully by the
Company. See "Business -- Products," "-- Research and Product  Development," and
"-- Sales, Marketing and Distribution."

Key Personnel

         The Company' success depends to a significant degree upon the continued
contributions of the Company's key management,  marketing,  product  development
and  operational  personnel.  The success of the Company  will depend to a large
extent  upon its  ability  to retain and  continue  to  attract  highly  skilled
personnel.  Competition for employees in the computer  industry is intense,  and
there can be no  assurance  that the Company  will be able to attract and retain
enough qualified employees.  If the business of the Company grows, it may become
increasingly  difficult for it to hire,  train and  assimilate the new employees
needed. The Company's inability to retain and attract key employees could have a
material  adverse  effect  on  the  Company's  product  development,   business,
operating results and financial condition. The Company does not carry key person
life insurance with respect to any of its personnel.

Competition and Price Erosion

         The network  enhancement  products  and computer  software  markets are
highly  competitive,  and  the  Company  believes  that  such  competition  will
intensify in the future.  The competition is  characterized  by rapid change and
improvements in technology  along with constant  pressure to reduce prices.  The
Company currently  competes  principally in the market for network print servers
and  network  fax servers and  fax-on-demand  software.  Increased  competition,
direct and indirect, could adversely affect the Company's business and operating
results through  pricing  pressure,  loss of market share and other factors.  In
particular,  the Company expects that, over time, average-selling prices for its
print server  products will decline,  as the market for these  products  becomes
increasingly  competitive.  Any material reduction in the average selling prices
of the  Company's  products  would require the Company to increase unit sales in
order to avoid a  reduction  in net  sales  and  would  adversely  affect  gross
margins.  There can be no  assurance  the Company  will be able to maintain  the
current average selling prices of its products or the related gross margins.

         The  principal   competitive  factors  affecting  the  market  for  the
Company's  products  include  product   functionality,   performance,   quality,
reliability,  ease of use,  quality  of  customer  training  and  support,  name
recognition,  price, and compatibility  and conformance with industry  standards
and changing  operating system  environments.  Several of the Company's existing
and   potential   competitors,   most   notably  the   Hewlett-Packard   Company
("Hewlett-Packard") and Intel Corporation ("Intel"),  have substantially greater
financial,  engineering,  manufacturing  and marketing  resources  than does the
Company.  The  Company  also  experiences  competition  from a  number  of other
companies.  In  addition  to its  current  competitors,  the  Company  may  face
substantial  competition from new entrants into the network  enhancement market,
including    established   and   emerging   computer,    computer   peripherals,
communications  and software  companies.  As the Company develops and introduces
more fax server software  products,  it is experiencing  increasing  competition
from companies such as Applied Voice Technology, Inc. ("Applied Voice"), Omtool,
Ltd.   ("Omtool")  and  Computer  Associates   International,   Inc.  ("Computer
Associates").  There can be no assurance  that  competitors  will not  introduce

                                       4.
<PAGE>
products  incorporating  technology  more advanced than that of the Company.  In
addition,  certain competing  methods of communications  such as the Internet or
electronic mail could adversely  affect the market for fax products.  Certain of
the Company's  existing and potential  competitors are manufacturers of printers
and  other  peripherals,  and  these  competitors  may  develop  closed  systems
accessible only through their own proprietary servers. There can be no assurance
that the Company will be able to compete  successfully or that  competition will
not have a material adverse effect on the Company's business,  operating results
and financial condition.  See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

International Sales

         Sales  to  customers  located  outside  Canada  and the  United  States
accounted for  approximately  47% and 53% of the Company's net sales in 1997 and
1996,  respectively.  The Company  sells its  products  in 44 foreign  countries
through  approximately 89  international  distributors.  Macnica,  the Company's
principal  Japanese  distributor,  and Azlan,  the  Company's  principal  United
Kingdom  distributor,  accounted for  approximately 68% and 11% of the Company's
international  sales in  1997,  respectively,  and 63% and 11% of the  Company's
international   sales  in  1996,   respectively.   The  Company   expects   that
international  sales will  continue to  represent a  significant  portion of the
Company's  product  revenues  and that the Company will be subject to the normal
risks of international sales, such as export laws, currency fluctuations, longer
payment cycles,  greater difficulties in accounts receivable collections and the
requirement  of  complying  with  a wide  variety  of  foreign  laws.  See  also
"Dependence on Proprietary Rights;  Uncertainty of Obtaining Licenses." Although
the Company has not previously experienced any difficulties under foreign law in
exporting its products to other  countries,  there can be no assurance  that the
Company  will not  experience  such  difficulties  in foreign  countries  in the
future.  In addition,  because the Company  invoices  its foreign  sales in U.S.
dollars,  fluctuations  in exchange  rates could affect demand for the Company's
products  by causing  its prices to be out of line with  products  priced in the
local  currency.  Additionally,  any such  difficulties  would  have a  material
adverse  effect on the Company's  international  sales and a resulting  material
adverse  effect on the  Company's  business,  operating  results  and  financial
condition.  The  Company may  experience  fluctuations  in  European  sales on a
quarterly  basis because  European  sales may be weaker during the third quarter
than the second  quarter due to extended  holiday  shutdowns in July and August.
See "Business -- Sales, Marketing and Distribution."

Product Transition; Risk of Product Returns and Inventory Obsolescence

         From time to time,  the  Company may  announce  new  products,  product
versions,  capabilities  or  technologies  that have the potential to replace or
shorten the life cycles of  existing  products.  The release of a new product or
product  version may result in the  write-down  of product in  inventory if such
inventory  becomes obsolete.  The Company has in the past experienced  increased
returns of a particular  product version following the announcement of a planned
release of a new  version of that  product.  Although  the  Company  provides an
allowance for anticipated  returns,  and believes its existing policy results in
the  establishment of an allowance that is currently  adequate,  there can be no
assurance that product  returns will not exceed such allowance in the future and
will not have a material  adverse  effect on the Company's  business,  operating
results and financial condition.

Concentration of Distributors; Distribution Risks

         The Company sells its products  primarily  through a two-tier  domestic
and international  distribution network, with the Company's distributors selling
the  Company's  products to VARs,  retailers and other  resellers.  The personal
computer and networking products distribution industry has been characterized by
rapid change,  including  consolidations  due to the financial  difficulties  of
                                       5.
<PAGE>

distributors  and  the  emergence  of  alternative   distribution  channels.  In
addition,  an  increasing  number of companies are competing for access to these
channels.  The Company's five largest distributors  accounted for 68% of its net
sales in 1997 and 70% of the Company's net sales in 1996. Macnica, the Company's
principal  Japanese  distributor,  and Ingram,  the Company's  largest  domestic
distributor,  accounted for approximately 32% and 14% of the Company's net sales
in 1997,  respectively,  and 33% and 15% of the Company's net sales in 1996. The
Company's   distributors  typically  represent  other  product  lines  that  are
complementary  to, or compete  with,  those of the  Company.  While the  Company
attempts  to  encourage  its  distributors  to  focus  on its  products  through
marketing and support programs,  these  distributors may give higher priority to
products of other suppliers, thereby reducing the efforts they devote to selling
the Company's  products.  In particular,  certain of its competitors,  including
Hewlett-Packard  and Intel,  sell a substantially  higher total dollar volume of
products through several of the Company's large United States  distributors and,
as a result,  the Company  believes such  distributors  give higher  priority to
products  offered  by  such  competitors.  The  Company's  distributors  are not
contractually  committed to future purchases of the Company's products and could
discontinue  carrying  the  Company's  products at any time for any  reason.  In
addition, because the Company is dependent on a small number of distributors for
a  significant  portion  of the  sales of its  products,  the loss of any of the
Company's  major  distributors  or their  inability  to  satisfy  their  payment
obligations  to the  Company  could  have a  significant  adverse  effect on the
Company's business, operating results and financial condition. The Company has a
stock  rotation  policy  with  certain of its  distributors  that allows them to
return marketable inventory against offsetting orders. Should the Company reduce
its prices,  the Company credits certain of its  distributors for the difference
between the  purchase  price of products  remaining in their  inventory  and the
Company's  reduced  price  for  such  products.  In  addition,  due to  industry
conditions  or the actions of  competitors,  inventory  levels of the  Company's
products  held by  distributors  could  become  excessive  resulting  in product
returns and inventory write-downs.  There can be no assurance that in the future
returns  and price  protection  will not have a material  adverse  effect on the
Company's business,  operating results and financial condition. See "Business --
Sales, Marketing and Distribution" and "Management's  Discussion and Analysis of
Financial Condition and Results of Operations."

Lack of Product Revenue Diversification

         The  Company  derives  substantially  all of its sales from its fax and
print server product lines. During 1997 and 1996, both product lines represented
94% and 95%,  respectively,  of total net sales.  The Company expects that these
hardware and software  products  will  continue to account for a majority of the
Company's  sales in the  future.  A decline  in demand for these  products  as a
result of  competition,  technological  change  or other  factors  would  have a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial condition.

Dependence on Suppliers and Subcontractors

         The   Company's   products   incorporate   or  require   components  or
sub-assemblies procured from third-party suppliers.  Certain of these components
or  sub-assemblies  are  available  only from a single  source,  and  others are
available  only from limited  sources.  Certain key  components of the Company's
products,  including a modem chip set from  Rockwell  International  Corporation
("Rockwell")  and  a  microprocessor  from  Motorola,  Inc.  ("Motorola"),   are
currently available from only single sources.  Other components of the Company's
products  are  currently  available  from only a limited  number of sources.  In
addition, the Company subcontracts a substantial portion of its manufacturing to
third parties,  and there can be no assurance that these  subcontractors will be
able to support the manufacturing  requirements of the Company. The Company does
not have material  long-term  supply  contracts  with these or any other sole or
limited source vendors and  subcontractors  other than an agreement with SerComm
Corporation ("SerComm"), and otherwise purchases components or sub-assemblies on
a purchase  order basis.  The Company's  ability to obtain these  components and
sub-assemblies  is dependent  upon its ability to accurately  forecast  customer
                                       6.
<PAGE>

demand for its products and to  anticipate  shortages of critical  components or
sub-assemblies created by competing demands upon suppliers.  If the Company were
unable  to  obtain  a   sufficient   supply  of   high-quality   components   or
sub-assemblies from its current sources,  the Company could experience delays in
obtaining such components or sub-assemblies from other sources. Resulting delays
or  reductions  in  product  shipments  could  adversely  affect  the  Company's
business,   operating  results  and  financial  condition  and  damage  customer
relationships.  Furthermore,  a significant increase in the price of one or more
of these  components  or  sub-assemblies  or the  Company's  inability  to lower
component or  sub-assembly  prices in response to competitive  price  reductions
could adversely affect the Company's  business,  operating results and financial
condition.

         The Company  augments  its product  offerings  by  obtaining  access to
third-party  products and technologies in areas outside of its core competencies
or where the Company believes internal  development of products and technologies
is not cost-effective. The Company's third-party product supplier is SerComm for
certain of the Company's print server  products.  There can be no assurance that
these  products will produce gross margins  comparable to those of the Company's
internally  generated  products.  The Company's  agreement with its  third-party
product supplier has a limited term of two years, subject to earlier termination
upon the occurrence of certain events. Extensions of the terms of this agreement
require  the  consent  of  both  the  Company  and  its  supplier.  The  Company
experienced  a  supply  shortage  during  the  fourth  quarter  of  1997  for  a
proprietary  chip. This shortage  reduced the Company's sales for the quarter by
approximately $800,000, as a result of the Company's inability to fulfill orders
in backlog for several  print  server  products.  Although the chip again became
available in sufficient quantities during the first quarter of 1998, the Company
has also taken action to reduce its risk by engineering this chip out of new and
future  versions of these  products.  There can be no assurance that the parties
with which the Company  contracts  will continue to provide the  quantities  and
quality of products needed by the Company or they will upgrade their  respective
products on a timely basis. The termination of the Company's  relationships with
third-party product suppliers and with SerComm,  in particular,  could result in
delays or reductions in product  shipments,  which could have a material adverse
effect on the Company's business, operating results and financial condition. See
"Business -- Manufacturing."

Government Regulation

         Certain  aspects  of the  networking  industry  in  which  the  Company
competes  are  regulated  both in the United  States  and in foreign  countries.
Imposition of public carrier tariffs,  taxation of  telecommunications  services
and the necessity of incurring  substantial  costs and expenditure of managerial
resources to obtain  regulatory  approvals,  particularly  in foreign  countries
where  telecommunications  standards differ from those in the United States,  or
the inability to obtain regulatory approvals within a reasonable period of time,
could have a  material,  adverse  effect on the  Company's  business,  operating
results and  financial  condition.  The  Company's  products  must comply with a
variety of  equipment,  interface  and  installation  standards  promulgated  by
communications  regulatory  authorities  in  different  countries.   Changes  in
government  policies,  regulations  and  interface  standards  could require the
redesign of products  and result in product  shipment  delays which could have a
material,  adverse  impact on the  Company's  business,  operating  results  and
financial condition.

Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses

         The   Company's   success   depends  to  a  certain   extent  upon  its
technological expertise and proprietary software technology.  The Company relies
upon a combination  of  contractual  rights and  copyright,  trademark and trade
secret laws to establish and protect its  technologies.  Despite the precautions
taken by the Company,  it may be possible for unauthorized third parties to copy
the Company's products or to reverse engineer or obtain and use information that
the  Company  regards as  proprietary.  In  addition,  the laws of some  foreign
                                       7.
<PAGE>
countries either do not protect the Company's  proprietary  rights or offer only
limited protection. Given the rapid evolution of technology and uncertainties in
intellectual property law in the United States and internationally, there can be
no assurance that the Company's  current or future  products will not be subject
to third-party claims of infringement.  Any litigation to determine the validity
of any third-party claims could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel,  whether
or not such litigation is determined in favor of the Company. In the event of an
adverse result in any such  litigation,  the Company could be required to expend
significant resources to develop non-infringing technology or to obtain licenses
to the  technology  that  is the  subject  of the  litigation.  There  can be no
assurance  that the Company would be successful in such  development or that any
such licenses would be available. The Company also relies on technology licenses
from third parties.  There can be no assurance that these licenses will continue
to be available to the Company upon reasonable  terms, if at all. Any impairment
or termination of the Company's  relationship  with third-party  licensors could
have a material adverse effect on the Company's business,  operating results and
financial  condition.  There can be no assurance that the Company's  precautions
will be adequate to deter  misappropriation  or  infringement of its proprietary
technologies.  Furthermore,  while the Company has obtained federal registration
for many of its trademarks in the United States,  certain of its trademarks have
not been registered in the United States, and the Company has not registered any
of its trademarks in foreign  jurisdictions.  There can be no assurance that the
Company's  use of such  registered  trademarks  will not be  contested  by third
parties in the  future.  See  "Business-Research  and Product  Development"  and
"-Proprietary Rights."

         The Company has received, and may receive in the future, communications
asserting that its products infringe the proprietary  rights of third parties or
seeking indemnification against such infringement. The Company is not aware that
any of its  products,  trademarks,  or other  proprietary  rights  infringe  the
property rights of third parties.  However, there can be no assurance that third
parties will not assert  infringement  claims  against the Company in the future
with respect to current or future  products or that any such  assertion  may not
require  the  Company to enter  into  royalty  arrangements  or result in costly
litigation. As the number of software products in the industry increases and the
functionality  of these  products  further  overlap,  the Company  believes that
software developers may become  increasingly  subject to infringement clams. Any
such claims,  with or without  merit,  can be time  consuming  and  expensive to
defend. There can be no assurance that any such intellectual property litigation
that may be brought in the future will not have a material adverse effect on the
Company's business,  operating results and financial  condition.  As a result of
such claims or  litigation,  it may become  necessary or desirable in the future
for the Company to obtain  licenses  relating to one or more of its  products or
relating to current or future  technologies,  and there can be no assurance that
it   would   be  able  to  do  so  on   commercially   reasonable   terms.   See
"Business-Research and Product Development" and "-Proprietary Rights."

Possible Volatility of the Company's Common Stock Price

         The price of the Company's  Common Stock has  fluctuated  widely in the
past.  Sales of  substantial  amounts  of the  Company's  Common  Stock,  or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Company's  Common Stock.  The management of the Company  believes
that such past fluctuations may have been caused by the factors identified above
as well as announcements of new products,  quarterly fluctuations in the results
of  operations  and other  factors,  including  changes in the  condition of the
personal computer industry in general.  These  fluctuations,  as well as general
economic,  political and market conditions,  such as recessions or international
currency  fluctuations,  may adversely  affect the market price of the Company's
Common Stock. Stock markets have experienced  extreme price volatility in recent
years.  This  volatility  has had a  substantial  effect on the market prices of
securities issued by the Company and other high technology companies,  often for
reasons unrelated to the operating  performance of the specific  companies.  The
Company  anticipates  that prices for  Castelle  Common Stock may continue to be
volatile.  Such future  stock price  volatility  for  Castelle  Common Stock may
provoke the  initiation of securities  litigation  which may divert  substantial
management  resources  and have an  adverse  effect on the  Company's  business,
operating results and financial condition.
                                       8.
<PAGE>
Future Capital Requirements

         Although  the Company  believes  that its existing  capital  resources,
expected  cash flows  from  operations  and  available  lines of credit  will be
sufficient to meet its  anticipated  capital  requirements  at least through the
next 12 months,  the Company may be required to seek  additional  equity or debt
financing.  The  timing  and  amount  of such  capital  requirements  cannot  be
determined at this time and will depend on a number of factors, including demand
for the  Company's  existing and new products and changes in  technology  in the
networking  industry.  There can be no assurance that such additional  financing
will  be  available  on  satisfactory   terms  when  needed,   if  at  all.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations --Liquidity and Capital Resources."

Voting Control by Officers, Directors and Affiliates
         At February 20, 1998,  the  Company's  officers and directors and their
affiliates  beneficially  owned  approximately 49% of the outstanding  shares of
Common  Stock.  Accordingly,  together  they had the  ability  to  significantly
influence the election of the Company's  directors and other  corporate  actions
requiring  shareholder  approval.  Such  concentration of ownership may have the
effect of delaying, deferring or preventing a change in control of the Company.

Certain Charter Provisions

         The Company's Board of Directors has authority to issue up to 2,000,000
shares of Preferred  Stock and to fix the rights,  preferences,  privileges  and
restrictions,  including voting rights, of these shares without any further vote
or action by the shareholders. The rights of the holders of the Company's Common
Stock will be subject to, and may be  adversely  affected  by, the rights of the
holders of any Preferred Stock that may be issued in the future. The issuance of
Preferred  Stock,  while  providing  desirable  flexibility  in connection  with
possible  acquisitions  and other corporate  purposes,  could have the effect of
making  it more  difficult  for a third  party  to  acquire  a  majority  of the
outstanding  voting  stock  of  the  Company,  thereby  delaying,  deferring  or
preventing a change in control of the Company. Furthermore, such Preferred Stock
may have other rights,  including  economic rights,  senior to the Common Stock,
and as a result,  the issuance  thereof could have a material  adverse effect on
the market value of the Company's Common Stock.

                                    BUSINESS

General

         Castelle designs,  develops,  markets and supports network  enhancement
products, both software and hardware, that improve the productivity, performance
and functionality of LANs and enhance the LAN user's ability to communicate. The
Company's  current products include FaxPress fax server systems,  LANpress print
servers  and  FactsLine   fax-on-demand  software.  See  "Research  and  Product
Development."

         In November 1996 Ibex merged with and into the Company.  As a result of
the  transaction,  790,617  shares of the Company's  Common Stock were issued in
exchange for all of the  outstanding  Ibex common stock and preferred  stock and
59,345  shares of the  Company's  Common Stock were  reserved for issuance  upon
exercise of  outstanding  options to purchase  Ibex common stock  assumed by the
Company  in  connection  with the  transaction.  Ibex  designed,  developed  and
marketed fax-on-demand, fax-gateway, fax broadcast and Web/fax applications sold
directly and through value-added resellers.
                                       9.
<PAGE>

Industry Background

         In  the  mid-1980s,   organizations  began  to  interconnect   personal
computers into LANs in order to allow work groups to share files and peripherals
such as  printers.  Originally,  these LANs  consisted  of a dedicated  personal
computer,  called a file  server,  on which the  network  operating  system  was
installed,  and multiple personal  computers on which users of the LAN ran their
applications.  The  network  operating  system on the file server  provided  the
server  administration  and  basic  file and print  sharing.  As  networks  have
proliferated  throughout  organizations  and  client/server  architectures  have
gained  acceptance,   LANs  have  become  increasingly  complex,  the  size  and
multimedia   intensity  of  files  being   transmitted  has  increased  and  the
applications  operating  on the LAN have become more  critical to the success of
the business  enterprise.  These factors have caused network  administrators  to
seek network enhancement products which can improve network performance, enhance
the  functionality of the current installed base of network hardware and convert
single-user  resources  such as  stand-alone  printers and telephone  lines into
shared LAN resources in a cost-effective  manner.  Fax servers and print servers
are two of the  primary  network  enhancement  solutions  that have  emerged  to
provide cost-effective improvements in network performance and functionality.

         Fax Servers:  Fax machines typically used in business  environments are
         characterized  by  relatively  low  quality  transmissions,   low  data
         transmission  rates  and  the  inability  to  send  and  receive  faxes
         simultaneously.  Fax  machines  also require  labor-intensive  sorting,
         copying and routing of faxes in paper form. Alternatively,  a dedicated
         personal computer with a fax modem,  while able to store incoming faxes
         electronically  and improve fax  quality,  is not  economical  in a LAN
         environment  because  each  user must have his or her own fax modem and
         dedicated  telephone  line.  Fax servers have emerged as an  economical
         alternative for providing high performance faxing capability to network
         users.  A fax  server  connects a LAN to one or more  telephone  lines,
         enabling a large number of users to share  dedicated  telephone  lines.
         Users  are  able  to  send  faxes  directly  from  their  computers  or
         workstations,  eliminating  the need to print a document,  take it to a
         stand-alone fax machine and wait for its transmission.  In addition,  a
         fax server can sort incoming  faxes and route them  electronically  and
         confidentially  directly to the  electronic  mailboxes  of the intended
         recipients   and  store   non-urgent   outgoing   faxes  for  automatic
         transmission at an "off-peak" time when telephone rates are lower.

         Print Servers:  The sharing of printers,  a basic benefit of a LAN, has
         traditionally been provided by connecting a printer either to a network
         file  server  or to a  dedicated  personal  computer  on  the  network.
         However,   direct   connection   to  the  file   server   has   several
         disadvantages, including the risk of the file server being overburdened
         by the processing required to print large or graphically complex files,
         lower print  transfer  speeds and  location  inflexibility.  Similarly,
         printer connection to a dedicated  personal  computer,  while providing
         better location  flexibility,  is more costly and offers  substantially
         lower  print file  transfer  speed than a  dedicated  print  server can
         provide.  A print server  directly  connects one or more  printers to a
         LAN, providing a cost-effective,  high-speed solution to the demand for
         shared  print  resources  on a LAN. In addition to  providing  location
         flexibility and convenience,  print servers improve network performance
         by relieving the burden on the file server. Furthermore,  print servers
         enable users to access  essential  information  about the status of the
         printer  and their  print  files and to select  their  desired  printer
         configuration.

         Fax-On-Demand:  Fax-on-Demand  is the ability to use a touch-tone phone
         and a fax machine to request and receive  hard copies of  documents  on
         demand.  Although there are a wide variety of  applications  installed,
         the two most common  applications  are customer  support and literature
         fulfillment  applications.  The largest industry using fax-on-demand is
         the high-technology sector, with applications also installed in travel,
         government,  newspapers,  manufacturing  and non-profit  organizations.
         Essentially,  any company with information to disseminate publicly is a
         potential fax-on-demand customer.
                                      10.
<PAGE>

         Network enhancement  solutions,  such as fax servers and print servers,
have  emerged to gain  significant  market  acceptance  due to their  ability to
improve  network   performance  and  personal   productivity,   enhance  network
functionality  and preserve the  investment  many companies have made in network
hardware.  The  Company  believes  that  as the  client/server  computing  model
continues to gain acceptance and applications which are critical to the business
enterprise  continue to be ported from  mainframes  and  minicomputers  to LANs,
corporate  processes will become more  dependent on the LAN and the  performance
enhancement  that can be achieved on the corporate LAN will more directly impact
overall  productivity.  As LAN users and network managers  continue to recognize
the  benefits  of  network  enhancement  products,  and  as  additional  network
functionality  such as  facsimile/document  communication  across the  Internet,
remote access, scanning,  electronic mail and multimedia communications continue
to emerge,  the Company  believes  that the demand for such network  enhancement
products will increase.

Castelle Strategy

         Castelle's  objective is to be a leading worldwide  supplier of network
enhancement  solutions.  The Company  intends to continue to provide  innovative
products  focused on  enhancing  the LAN  user's  ability  to  communicate.  Key
elements of the Company's strategy include:

         Focus on Network Enhancement Products - The Company focuses exclusively
         on providing  innovative,  reliable,  easy-to-use  network  enhancement
         products.  Since its  inception,  the Company has focused on developing
         networking products that utilize advanced software to tightly integrate
         proprietary  hardware systems with standard computing  platforms.  As a
         result, the Company believes it has developed a high level of expertise
         in  networking,  software  development,  hardware  design and telephony
         technology.  The Company  plans to  capitalize  on these  attributes by
         continuing  to focus on providing  network  enhancement  products  that
         enable users to communicate more effectively.

         Broaden  Software  Offerings  - In order to  leverage  its  significant
         installed  base of fax and print  servers,  the Company is developing a
         range of value-added  software options which increase the functionality
         of  Castelle's   products  and  enable  them  to  address   specialized
         applications.  Examples of  applications  currently  available  include
         electronic   mail   gateways,   optical   character   recognition/image
         enhancement  software and billing/analysis and other management utility
         software.  Utilizing  an  extensive  internal  database  of over  6,000
         corporate  end-users  of Castelle  products,  the Company is  marketing
         these products through a direct telemarketing team.

         Expand  Product  Line - The  Company is  leveraging  its  expertise  in
         easy-to-use,  cost-effective enhancement solutions to offer new network
         and  communications  enhancement  products.  The Company  continues  to
         expand both its fax server and print server product lines.

         Strengthen  and  Maintain  Distribution  Channels  -  The  Company  has
         established a two-tier domestic and international  distribution network
         of leading  national  and regional  network  product  distributors  and
         resellers.  The Company also sells  through OEM vendors such as Fujitsu
         Ltd.   ("Fujitsu").   The  Company  is  focused  on   maintaining   and
         strengthening  its  current  distribution  network  in  North  America,
         Europe, the Asia-Pacific and Latin America regions.
                                      11.
<PAGE>

         Leverage  Strategic  Relationships  - The Company  augments its product
         offering by establishing  relationships  with companies able to provide
         products in areas outside of the Company's core technical  competencies
         or in instances  where  internal  development  of such  products is not
         cost-effective.   The  Company  also  establishes   relationships  with
         numerous  leaders in hardware and software  technology  to enable it to
         keep abreast of, and respond quickly to, technological changes that may
         affect the network enhancement market.

Products

         The Company develops and markets a broad range of products that enhance
network  productivity,  performance  and  functionality.  The Company's  current
products include FaxPress fax server systems, LANpress print servers,  InfoPress
fax-on-demand  software  and a range of  software  enhancements  for its fax and
print server product lines.


         Fax Servers

                  The  Company's fax server  product line includes  FaxPress fax
         server  systems as well as FaxPress  software.  The  Company's  line of
         FaxPress software  includes client  applications and interfaces for use
         with the FaxPress  system and software  enhancements  and options.  The
         Company's fax server  products  allow  network users to send,  receive,
         route, print, store, edit and retrieve fax transmissions from their own
         personal  computers  on a LAN.  These fax  server  products  enable all
         network  users  to  access  fax  services  without  requiring  a  large
         investment in stand-alone fax machines,  fax modem boards or additional
         telephone lines. Network-based fax capability is a logical extension of
         network  printing  capability,  enabling  users to  transmit  documents
         directly to a fax device as easily as if they were  printing to a laser
         printer or sending an  electronic  mail  message.  Network  fax servers
         redirect fax output from applications  running on a LAN user's personal
         computer or  workstation  to a fax queue.  The fax server then converts
         the file to fax format and sends the fax to the intended recipient. The
         Company's  FaxPress  products  are  designed to comply with  regulatory
         standards in the United States as well as Australia,  Canada,  Germany,
         Hong Kong, Japan, Korea, the Netherlands,  Denmark, Finland, Singapore,
         Switzerland and the United Kingdom.  The Company is seeking  regulatory
         clearance  in a number of other  countries.  During 1997 and 1996,  fax
         servers represented 52% and 47%, respectively, of total net sales.

                  FaxPress Systems - Castelle's  FaxPress fax server systems are
                  high-performance  network-based  fax solutions.  FaxPress is a
                  compact, self-contained fax server that connects directly to a
                  LAN and is  accompanied by software that is installed from any
                  personal  computer or workstation on the LAN.  FaxPress system
                  products are available in configurations that support one, two
                  or four  dedicated  telephone  lines.  In  addition,  FaxPress
                  system products can function as parallel and serial port print
                  servers. Key features of the FaxPress product line (configured
                  with its current software versions) include:

                      o   Ability  to send faxes  from many  applications:  Easy
                          faxing from within any Windows, Windows 95 and Windows
                          NT   application    and   certain    electronic   mail
                          applications.    The    server    supports    multiple
                          simultaneous clients on the network.

                      o   Broad networking support: FaxPress servers install and
                          operate   in   both   TCP/IP   and   SPX/IPX   network
                          environments.  FaxPress also support file servers with
                          Windows NT and Novell NetWare operating systems.
                                      12.
<PAGE>

                      o   Electronic  routing  of faxes:  Electronic  routing of
                          faxes enhances efficiency and confidentiality  through
                          electronic  delivery  direct  to the fax  inbox of the
                          intended recipient.

                      o   Retention  of document  formatting:  Retention  of all
                          text,  fonts and  graphics  generated by PCL and other
                          leading document format  languages.  Any document that
                          can be printed to a Hewlett-Packard  laser printer can
                          be faxed using the FaxPress system.

                      o   Ability to use fax  servers in  tandem:  Load  sharing
                          between fax servers  provides the  capability to stack
                          up to five fax server  units and share up to 20 modems
                          for outbound faxing.

                      o   No waiting for  document  conversion:  Internal  image
                          processing by the FaxPress provides high image quality
                          and  frees  the   personal   computer   for   end-user
                          applications.  The  user  does  not have to wait for a
                          document to be  converted  to a fax image before using
                          the personal computer for other tasks.

                      o   Group   broadcasts/scheduled   transmission:   Delayed
                          sending  feature  allows  users to send  faxes  during
                          "off-peak" hours, facilitating low-cost communications
                          for group broadcast and other uses.

                           The Company  offers a family of  FaxPress  fax server
                  systems  ranging  from  entry-level  products to high-end  fax
                  solutions  capable of supporting over 500 users. The suggested
                  U.S. list prices for FaxPress fax servers range from $1,695 to
                  $6,395.  The following table summarizes the Company's FaxPress
                  system product line:
<TABLE>
<CAPTION>

  ---------------------------------------------------------------------------------------------------------------- 
                                                                                  Network Environment                       
                                                                              ------------------------
                        Number      Number of
                         of          Micro-         Memory       Network        NetWare     Windows     TCP/IP
     Product Model      Modems     Processors    (Megabytes)     Topology       3.x, 4.x      NT        Support

  ----------------------------------------------------------------------------------------------------------------
  <S>                     <C>          <C>            <C>        <C>              <C>         <C>         <C>             
  OfficeConnect Fax        1            1              4          Ethernet        |X|         |X|         |X|
  FaxPress 1500         1 or 2          1              4          Ethernet        |X|                     |X|
  FaxPress 1500-N       1 or 2          1              8          Ethernet        |X|         |X|         |X|
  FaxPress 3000         2 or 4         2-3             4         Ethernet /       |X|                     |X|
                                                                 Token Ring
  FaxPress 3500         2 or 4         2-3             8         Ethernet /       |X|         |X|         |X|
                                                                 Token Ring
  ----------------------------------------------------------------------------------------------------------------

</TABLE>

                  FaxPress  Software - The Company's  line of FaxPress  software
                  includes  client  applications  and  interfaces  for use  with
                  FaxPress systems and software enhancements and options.

                      o   Client  Applications  and Interfaces:  The Company has
                          developed  fax  applications  which  reside on the LAN
                          user's  personal  computer and are included as part of
                          the   Company's   FaxPress   products.    The   client
                          application  allows a user to send and receive  faxes,
                          includes support for user  authentication,  as well as
                          personal and corporate cover pages and phone books.

                                      13.
<PAGE>
                            Software  Enhancements  and  Upgrades:  The  Company
                           offers a range of value-added  software options which
                           increase the  functionality  of  Castelle's  FaxPress
                           systems   and   enable   the   FaxPress   to  address
                           specialized   applications.   Software  upgrades  and
                           options  are  available  to  the  installed  base  of
                           FaxPress  units at prices  ranging  from $99 to $995.
                           The following table describes the available  software
                           options:



     ---------------------------------------------------------------------------
     Software Option                  Description
     ---------------------------------------------------------------------------
     Castelle Internet Faxing         Castelle   Internet  Faxing  provides  the
                                      ability  to send  faxes to other  FaxPress
                                      units via the Internet.
                                    
     Third Party Internet Faxing      Provides  the ability to deliver  faxes to
                                      select third party  carriers of faxes over
                                      the Internet.   
                                      
     Microsoft Exchange Gateway       Integrates  the  FaxPress  into  Microsoft
                                      Exchange,   enabling  users  to  send  and
                                      receive faxes from Exchange in addition to
                                      sending  documents in native format as fax
                                      attachments.      
                                     
     Lotus Notes Gateway              Integrates  the FaxPress into Lotus Notes,
                                      enabling  users to send and receive  faxes
                                      from Lotus Notes.  
                                     
     Embedded Codes Gateway           Enables  mainframe  computer users to send
                                      faxes using the FaxPress server.   
                                   
     Optical Character Recognition/   Enables an  incoming  fax to be  converted
     Image Enhancement                into an editable format. Image enhancement
                                      capability  enables the electronic editing
                                      of a fax image to correct visual defects.
                                      
     Billing and Analysis Software    Analyzes and  allocates  cost of faxing by
                                      user,  department  or customer and creates
                                      "ready to print" reports.
                                      
     FaxPress Print Server Software   Enables  the  FaxPress to act as a network
                                      print server.
                                      
     ---------------------------------------------------------------------------



         Print Servers

                  The Company's print server products  perform  network-printing
         services  otherwise  handled by a file server or a  dedicated  personal
         computer.  The Company offers a family of  multi-protocol  external and
         internal  print servers that enhance  overall  network  performance  by
         reducing  the  burden  on  the  file  server  or a  dedicated  personal
         computer.  During 1997 and 1996, print servers represented 42% and 48%,
         respectively, of total net sales.

                  The  Company  believes  its print  servers  provide a superior
         method  of  connecting  printers  to a LAN  for a  number  of  reasons,
         including:

                      o   Network performance  enhancement:  The Company's print
                          servers   enable   substantially   higher  print  file
                          transfer  speeds than file servers while  reducing the
                          data transfer and processing burden on file servers.

                      o   Plug-and-play  in a  multi-protocol  environment:  The
                          Company's  print servers offer easy  installation  and
                          configuration,  with  multiple  protocols  enabling  a
                          seamless integration into a mixed network environment.
                          This is not possible using either a dedicated personal
                          computer or a file server.
                                      14.
<PAGE>

                      o   Location flexibility:  The Company's print servers are
                          self-contained,  can be located  anywhere on a network
                          and can support  printer-clustering  as well as single
                          printer connectivity.

                      o   Cost-effectiveness:  The  Company's  print servers are
                          more  cost-effective than dedicated personal computers
                          or direct file server connections.

                      o   Compatibility:   The   Company's   print  servers  are
                          compatible  with  printers  from  virtually  all major
                          printer vendors and support leading network  operating
                          systems on both the Ethernet (100 Base-T or 10 Base-T)
                          and Token Ring networks.

                  LANpress  Products  -  The  Company's  LANpress  products  are
                  external  print  servers  that  are  independent  nodes  on  a
                  network.   They  represent   superior  methods  of  connecting
                  printers  to a LAN due to their  multi-protocol  capabilities.
                  With a variety of configurations for a single printer or up to
                  4 printers,  and support for NetWare (true NDS), UNIX, Windows
                  NT, Windows 95, Windows for Workgroups and AppleTalk, LANpress
                  is compatible  with printers with standard  parallel or serial
                  interfaces  and is  targeted  at the large  installed  base of
                  stand-alone  printers.  LANpress  has  remote  management  and
                  configuration  features enabling the network  administrator to
                  check for print queues and status,  locate sources of problems
                  and reconfigure  units within the network from anywhere on the
                  LAN. LANpress selectively routes to all networked printers and
                  thereby  improves the  productivity of all printers across the
                  network.  LANpress products can serve up to 56 print queues on
                  up to 16 file  servers.  LANpress  was  recently  enhanced  to
                  provide Internet printing  capability.  This allows the PCs to
                  submit emails and attachments to LANpress for printing via the
                  Internet.  The suggested  U.S.  list price for LANpress  print
                  servers ranges from $199 to $599.

         The following table summarizes the Company's line of LANpress  external
print servers:
<TABLE>
<CAPTION>

                                                 
                                             --------------------------------------------------
                                                            Network Environment
      ------------------------------------------------------------------------------------------------------------------   
                                  Ethernet                               Windows                     Flash
        Product Configuration      Network   NetWare 2.x,  UNIX TCP/IP    3.11 /       Apple        Upgrade     Internet
                                  Interface    3.x, 4.x                  95 / NT     Ethertalk    Capability    Printing
      ------------------------------------------------------------------------------------------------------------------
                                 
      <S>                            <C>          <C>          <C>         <C>          <C>           <C>          <C>      
      LANpress 1P/100 MP (1)         |X|          |X|          |X|         |X|          |X|           |X|          |X|
      LANpress 3P/100 (2)            |X|          |X|          |X|         |X|          |X|           |X|          |X|
      LANpress Jr. MP (3)            |X|          |X|          |X|         |X|          |X|           |X|          |X|
      LANpress 1P MP (1)             |X|          |X|          |X|         |X|          |X|           |X|          |X|
      LANpress 2+1 MP (4)            |X|          |X|          |X|         |X|          |X|           |X|          |X|
      LANpress 3+1 MP (2)            |X|          |X|          |X|         |X|          |X|           |X|          |X|
      OfficeConnect Print (5)        |X|          |X|          |X|         |X|                        |X|
      ------------------------------------------------------------------------------------------------------------------
</TABLE>
      --------------------
      (1)1 Centronics parallel port
      (2)Numbers  refer to the number of parallel  and serial port  connections,
         respectively.
      (3)Connects directly to port on Printer
      (4)Numbers  refer to the number of parallel  and serial port  connections,
         respectively.  The LANpress 2+1 MP also comes with a Token Ring network
         interface.
      (5)2 Centronics parallel ports

                                      15.
<PAGE>

         Fax-On-Demand

                  Castelle's  fax-on-demand  product  suite  consists of Windows
         NT-based  InfoPress,  as  well  as  the  low-cost  Fax-it-Back  product
         offering. Both InfoPress and Fax-it-Back  fax-on-demand software enable
         the access of  information  via a phone and a fax machine and allow the
         dissemination of information via "broadcasting" to a select database of
         fax numbers. InfoPress replaces an older Ibex product, FactsLine.

                  InfoPress  Product -  InfoPress  allows  companies  to use one
                  source of  documents  in a Castelle  document  library  and to
                  automatically   publish  the  documents  using  the  following
                  methods:

                      o   Fax-on-Demand.

                      o   Email-on-Demand.

                           Users  can  update  one  document,  and  the  updated
                  document will  automatically  be sent via facsimile  using the
                  Fax-on-Demand  product,  or via an enhanced  auto-reply  email
                  product called  Email-on-Demand to the intended recipient.  In
                  addition, Web delivery of the document is also possible. There
                  is no fax-on-demand or mail-server  configuration  needed when
                  documents are added or deleted.

                           The  InfoPress   product   provides   cost-effective,
                  automated and immediate information retrieval using tools that
                  everyone  understands.  Using the product, a technically savvy
                  consumer can access a document  using the Web.  Another person
                  can access the same  document  via email if he chooses.  Still
                  another person, perhaps not connected to the Internet, can use
                  his  touch-tone  phone to select the same document to be faxed
                  to his fax machine.

                           The    InfoPress    product    publishes    documents
                  automatically.  All document catalogs will be updated whenever
                  the user adds, changes, or deletes a document in the system.

                  Email-on-Demand - Email-on-Demand  is the ability to use email
                  (local or  Internet)  to request  and receive  information  on
                  demand.  Auto-reply  email  exists  today,  but is  limited to
                  receiving  one  document,  usually  in text  format.  The main
                  benefits of Email-on-Demand are:

                      o   Email via Internet is more prevalent than usage of the
                          Web

                      o   Email-on-demand  can be done on an  "off-line"  basis.
                          Users can order documents,  which will be delivered to
                          their email box. In other  words,  there is no waiting
                          to download  documents  on the Web and no "surfing" to
                          find documents.

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

                  Product  Benefits - InfoPress  also includes a  "fax-it-to-me"
                  feature for Web and email  users.  Thus,  users of the product
                  can access the same document source in the following ways:

                      o   Select documents on the Web to fax (or forward them to
                          others via fax)

                      o   Select  documents in an email message,  to be returned
                          via email

                      o   Select  documents in an email message,  to be returned
                          via fax
                                      16.
<PAGE>

                      o   Select  documents  via  a  telephone   keypad,  to  be
                          returned via fax (Fax-on-Demand)

                  Fax-It-Back - Castelle's  entry-level Windows 95 fax-on-demand
                  system  is  specifically   designed  for  small-  to  mid-size
                  organizations and departmental use and provides a professional
                  multi-line  (one to  four  lines)  system  sturdy  enough  for
                  production   fax-on-demand,   yet   affordable  and  easy  for
                  non-technical staff to use.

Research and Product Development

         The Company has made  substantial  investments  in research and product
development.  The Company  believes its future  performance will depend in large
part on its ability to enhance its current product line, maintain  technological
competitiveness and meet an expanding range of customer requirements.

         Castelle  continues to invest in enhancing the FaxPress product line by
developing new versions of client and server software and server  hardware.  The
product feature set is driven by the increasing complexity of user needs because
of proliferating  client and network  environments,  the continued importance of
Windows NT and the increasing importance of Internet faxing.

         New versions of the client software will have  enhancements in the user
interface,  improvements in ease of use and ease of localization,  be accessible
through a Web browser,  include improved integration with NT and Netware network
environments  and contain other  enhancements.  The  client-server  interface is
being enhanced to become an  object-oriented  model with Component  Object Model
(COM) support.  The server  software will have enhanced  performance,  including
support  for Simple  Network  Management  Protocol  (SNMP)  network  management.
Castelle  will continue to further its strategy of  supporting  Internet  Faxing
through its own FaxPress-to-FaxPress communication and interfaces to third party
Internet  Fax  providers.  Castelle  is  also  investing  in  developing  a  new
generation of the FaxPress hardware platform.

         In the print server market,  Castelle is developing a new  miniaturized
LANpress  print  server  product  targeted  at the  Pacific  Rim through OEM and
distribution  channels and upgrading  the hardware  design of prior print server
products.  The print  server  and fax server  products  will also share the same
hardware  architecture,  allowing  these products to share basic server code and
hardware components resulting in operating efficiencies and reduced costs.

         There  can be no  assurance  that the  Company  will be  successful  in
developing  and marketing the new software and hardware  product  versions or in
responding to other emerging technological  developments or that any development
will achieve commercial acceptance.  The Company is seeking and will continue to
seek to hire additional skilled development engineers. Such engineers are likely
to be in  short  supply,  and the  Company's  business,  operating  results  and
financial  condition  could be  adversely  affected if it  encounters  delays in
hiring or fails to retain the required skilled engineers. The Company's research
and product development expense for 1997 and 1996 was approximately $3.1 million
and $2.4 million, respectively, which was 12% and 8% of the Company's net sales.
The Company plans to continue to make  significant  investments  in research and
product development.
                                      17.
<PAGE>

Sales, Marketing and Distribution

         Castelle sells its products through multiple channels, the channel used
being  determined by the product,  market and customer  need. The Company has an
established two-tier domestic and international  distribution network of leading
national and regional network product  distributors  and resellers.  The Company
also sells  through  OEM  vendors  such as Fujitsu.  Software  enhancements  and
options  that  complement  the  FaxPress  product  line are  primarily  marketed
directly by the Company to  registered  end-users.  The direct sales group works
closely with the distributors and VARs in qualifying sales opportunities for the
fax server and print  server  product  lines.  The  Company is  maintaining  its
distribution  network  in North  America,  Europe,  the  Asia-Pacific  and Latin
America regions. The Company's European  headquarters provides sales and support
services to a  distributor  network  covering most  European  countries,  with a
primary emphasis on the United Kingdom.

         Demand for Castelle's  products is created through  targeted and active
participation in industry  networking and communication  trade shows, as well as
advertising in associated publications.  The Company also increases awareness of
Company  products  through  advertising,  generating  client leads,  instituting
direct mail campaigns,  sending Company  newsletters,  offering seminars,  trade
shows and conferences and other forms of public relations efforts. The Company's
sales and  marketing  efforts  are  enhanced by a specific  program  designed to
encourage VARs and other  resellers to promote and sell the Company's  products.
Such  promotion  is  encouraged  by providing  participants  in the program with
technical  support on a priority basis,  product  literature,  on-site sales and
support training,  sales leads, free software upgrades, and other forms of sales
promotions.  In addition to its other  activities,  Castelle's  marketing  staff
employs various research methods,  gathering  information from many sources such
as VARS and other resellers,  customers,  distribution  partners,  OEM partners,
strategic partners, and press/publication groups. Product development, sales and
client  services/support  personnel  benefit  from the  information  gathered in
planning future products.

         The Company's five largest distributors accounted for approximately 68%
of the  Company's  net sales in 1997 and 70% of its net sales in 1996.  Macnica,
the Company's  principal Japanese  distributor,  and Ingram Micro, the Company's
largest  domestic   distributor,   accounted  for  approximately  32%  and  14%,
respectively,  of the Company's net sales in 1997 and 33% and 15%, respectively,
of its net sales in 1996.  Sales to  customers  located in the  Pacific  Rim and
Europe made up approximately  47% and 53% of the Company's net sales in 1997 and
1996, respectively. The Company's distributors typically represent other product
lines that are complementary to or compete with, those of the Company. While the
Company  attempts to encourage its distributors to focus on its products through
marketing and support programs,  these  distributors may give higher priority to
products of other suppliers, thereby reducing the efforts they devote to selling
the Company's  products.  In particular,  certain of its competitors,  including
Hewlett-Packard  and Intel,  sell a substantially  higher total dollar volume of
products through several of the Company's large United States  distributors and,
as a result,  the Company  believes such  distributors  give higher  priority to
products  offered  by  such  competitors.  The  Company's  distributors  are not
contractually  committed to future purchases of the Company's products and could
discontinue  carrying  the  Company's  products at any time for any  reason.  In
addition, because the Company is dependent on a small number of distributors for
a  significant  portion  of the  sales of its  products,  the loss of any of the
Company's  major  distributors  or their  inability  to  satisfy  their  payment
obligations  to the  Company  could  have a  significant  adverse  effect on the
Company's business, operating results and financial condition. The Company has a
stock  rotation  policy  with  certain of its  distributors  that allows them to
return marketable inventory against offsetting orders. Should the Company reduce
its prices,  the Company credits certain of its  distributors for the difference
between the  purchase  price of products  remaining in their  inventory  and the
Company's  reduced  price  for  such  products.  In  addition,  due to  industry
conditions  or the actions of  competitors,  inventory  levels of the  Company's
products  held by  distributors  could  become  excessive  resulting  in product
returns and inventory write downs.

                                      18.
<PAGE>
Customer Service and Support

         The Company provides customers with service support, which is available
at all times to assist customers with  installation,  use and operation  issues.
The Company has network  engineers at corporate  headquarters  as well as in the
field.  Support is provided under  warranty as well as with  different  extended
software and hardware  support  agreements  sold directly to the customer by the
Company.  An electronic bulletin board is available on a 24-hour basis to assist
customers in obtaining data about Company  products.  The Company also has other
customer  support  activities,  including a Web site as well as an internal help
desk system.  The Company has  established  a call  management,  automated  call
distribution  ("ACD")  system to  provide  improved  levels of  support  to help
resolve customer issues.

Competition

         See  "Business -- Risk Factors --  Competition  and Price  Erosion" and
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Results of Operations."

Manufacturing

         The  Company's  current  in-house   manufacturing   operations  consist
primarily of material  planning,  final test and assembly,  quality  control and
service repair. Certain of the Company's manufacturing  operations are performed
by third party manufacturers that provide customized,  integrated  manufacturing
services,  including  procurement,  manufacturing and associated printed circuit
board assembly. The Company also relies on SerComm to provide it with certain of
its print  server  products.  These  arrangements  enable  the  Company to shift
certain costs to such providers, thereby allowing the Company to focus resources
on  its  product  development   efforts.  The  failure  of  such  manufacturers,
particularly SerComm, to meet their contractual commitments to the Company could
cause delays in product shipments,  thereby potentially  adversely affecting the
Company's business, operating results and financial condition.

         The Company  does not  currently  have any  material  long-term  supply
contracts with any of its manufacturing  subcontractors  or component  suppliers
other than an  agreement  with  SerComm  relating  to the  manufacture  of print
servers.  Other  than its  relationship  with  SerComm,  the  Company  purchases
components on a purchase order basis. The Company owns all engineering, sourcing
documentation,  functional test equipment and tooling used in manufacturing  its
products,  except for the products  which are produced by SerComm,  and believes
that it could  shift  product  assembly to  alternate  suppliers  if  necessary.
Certain key  components  of the Company's  products,  including a modem chip set
from Rockwell,  and a microprocessor from Motorola, are currently available from
only single sources.  Other  components of the Company's  products are currently
available  from only a limited  number of  sources.  In  addition,  the  Company
subcontracts a substantial  portion of its  manufacturing to third parties,  and
there can be no assurance that these  subcontractors will be able to support the
manufacturing requirements of the Company. The Company's ability to obtain these
components  or  sub-assemblies  is  dependent  upon its  ability  to  accurately
forecast  customer  demand  for its  products  and to  anticipate  shortages  of
critical  components  or  sub-assemblies   created  by  competing  demands  upon
suppliers.  If the  Company  were  unable  to  obtain  a  sufficient  supply  of
high-quality  components or sub-assemblies from its current sources, the Company
could  experience  delays in obtaining such  components or  sub-assemblies  from
other  sources.  Resulting  delays or  reductions  in  product  shipments  could
adversely  affect  the  Company's  business,  operating  results  and  financial
condition  and damage  customer  relationships.  See "Business -- Risk Factors -
Dependence on Suppliers and Subcontractors." Furthermore, a significant increase
in the  price  of one or more  of  these  components  or  sub-assemblies  or the
Company's  inability to lower  component or  sub-assembly  prices in response to
competitive  price  reductions  could  adversely  affect the Company's  business
operating results and financial condition.

                                      19.
<PAGE>

Proprietary Rights

         The   Company's   success   depends  to  a  certain   extent  upon  its
technological expertise and proprietary software technology.  The Company relies
upon a combination  of  contractual  rights and  copyright,  trademark and trade
secret laws to establish and protect its technologies. Additionally, the Company
generally   enters  into   confidentiality   agreements  with  those  employees,
distributors,  customers and suppliers who have access to sensitive  information
and limits access to and  distribution of its software  documentation  and other
proprietary  information.  Because of the rapid pace of technological  change in
the LAN product  industry,  the Company believes that patent  protection for its
products is less  significant  to its success  than the  knowledge,  ability and
experience of its employees,  the frequent introduction and market acceptance of
new products and product enhancements, and the timeliness and quality of support
services provided by the Company.  See "Risk Factors --Dependence on Proprietary
Rights; Uncertainty of Obtaining Licenses."

         Despite the  precautions  taken by the Company,  it may be possible for
unauthorized third parties to copy certain portions of the Company's products or
to reverse  engineer or obtain and use  information  that the Company regards as
proprietary.  There can be no assurance that the Company's  precautions  will be
adequate  to  deter   misappropriation   or   infringement  of  its  proprietary
technologies.  Furthermore,  while the Company has obtained federal registration
for many of its trademarks in the United States,  certain of its trademarks have
not been  registered in the United States and the Company has not registered any
of its trademarks in foreign  jurisdictions.  There can be no assurance that the
Company's  use of such  unregistered  trademarks  will not be contested by third
parties in the future. In addition, the laws of some foreign countries either do
not protect the Company's  proprietary rights or offer only limited  protection.
Given the rapid  evolution  of  technology  and  uncertainties  in  intellectual
property law in the United States and internationally  there can be no assurance
that the Company's current or future products will not be subject to third-party
claims  of  infringement.  Any  litigation  to  determine  the  validity  of any
third-party claims could result in significant expense to the Company and divert
the efforts of the Company's technical and management personnel,  whether or not
such  litigation  is  determined  in favor of the  Company.  In the  event of an
adverse result in any such  litigation,  the Company could be required to expend
significant resources to develop non-infringing technology or to obtain licenses
to the  technology  that  is the  subject  of the  litigation.  There  can be no
assurance  that the Company would be successful in such  development or that any
such licenses would be available. The Company also relies on technology licenses
from third parties.  There can be no assurance that these licenses will continue
to be available to the Company upon reasonable  terms, if at all. Any impairment
or termination of the Company's  relationship  with third-party  licensors could
have a material adverse effect on the Company's business,  operating results and
financial condition.

Government Regulation

         See  "Business -- Risk Factors -- Government Regulations."

Employees

         As of December 31, 1997, the Company  employed a total of 102 full-time
equivalent  personnel,  24 in  manufacturing,  30 in sales and marketing,  21 in
engineering,  15 in customer service and 12 in finance and  administration.  The
Company intends to continue to hire additional  personnel in connection with the
expansion  of its  operations.  The  Company has never had a work  stoppage,  no
employees are represented by a labor  organization and the Company considers its
employee relations to be good.

         The  Company  has  entered  into  confidentiality  agreements  with its
employees  (including  its officers)  that prohibit  disclosure of  confidential
information  to anyone  outside of the  Company  both during and  subsequent  to
employment  and  require  disclosure  to the  Company of ideas,  discoveries  or
inventions relating to or resulting from the employee's work for the Company and
assignment to the Company of all proprietary  rights to such ideas,  discoveries
or inventions.
                                      20.
<PAGE>


                      EXECUTIVE OFFICERS OF THE REGISTRANT

Identification of Executive Officers

     The names of the  executive  officers  of the  Company and their ages as of
February 20, 1998 are set forth below:

                    Name        Age                  Position
       Arthur H. Bruno           64   Chairman of the Board and Chief Executive 
                                      Officer
       Jerome J. Burke           57   President and Chief Operating Officer
       Randall I. Bambrough      42   Chief Financial Officer, Vice President of
                                      Finance and Administration and Secretary
       Prasad Raje               32   Chief Technical Officer, Vice President of
                                      Engineering

Arthur H. Bruno

     Mr. Bruno served as the Company's Chairman of the Board since October 1993,
     as Chief  Executive  Officer from October 1993 through  April 1997 and from
     November  1997 to the present,  and as President  from October 1993 through
     April 1997. From February 1996 to the present he has served as the Chairman
     of the  Board  and as a  director  of  Ashlar,  a  privately-held  maker of
     computer-aided  design software.  From 1991 to 1993, he was Chairman of the
     Board and Chief  Executive  Officer of White Pine Software  Inc., a desktop
     connectivity  company.  From 1989 to 1991, he was the Chairman of the Board
     and Chief Executive Officer of Wellsley Medical Management  Corporation,  a
     primary  care  medical  service  provider.  From  1986 to 1989,  he was the
     Chairman  of the Board and Chief  Executive  Officer  of Visual  Technology
     Incorporated,  the  predecessor  to White Pine  Software Inc. Mr. Bruno has
     served as a director of White Pine  Software,  Inc. since February 1994 and
     is also a director of several privately held companies.

Jerome J. Burke

     Mr. Burke  joined the Company in December  1993 and has served as President
     and Chief Operating Officer from November 1997 to the present. He served as
     the Company's Executive Vice President from December 1993 to November 1997.
     From 1988 through  November 1993, Mr. Burke was Executive Vice President of
     Sales and Marketing of White Pine Software Inc. and its predecessor, Visual
     Technology Incorporated.

Randall I. Bambrough

     Mr.  Bambrough joined the Company in June 1992 and was named to his current
     positions in August 1995. From October 1990 until joining the Company,  Mr.
     Bambrough was a self-employed financial consultant. Prior to that time, Mr.
     Bambrough  was  employed  by Daisy  Systems,  Inc.,  an  electronic  design
     automation  software  company,   and  Iomega  Corporation,   a  disk  drive
     manufacturer, in various financial management positions.

Prasad Raje

     Dr. Raje joined the Company in May 1997 and was  appointed  to the position
     of Vice  President of Engineering  and Chief  Technical  Officer.  Prior to
     joining  the   Company,   Dr.  Raje  was  an   engineering   manager   with
     Hewlett-Packard  Company  from 1995 to 1997 and a member  of the  technical
     staff from 1991 to 1995.  Dr.  Raje was a founder of  Internet  Information
     Systems,  one of the early web-site  development  companies in 1994 and has
     served as its  President  from that date  through  the  present.  Dr.  Raje
     received his Ph.D.  and MS degree,  both in  Electrical  Engineering,  from
     Stanford University.
                                      21.
<PAGE>

Other Key Employees

         In addition to directors  and executive  officers,  the Company has the
following key employees:

         Ney Grant has served as the  President of the  Company's  Ibex division
since the  acquisition  of Ibex by the Company in November 1996. Mr. Grant was a
co-founder  of Ibex in 1989 and served as its  President  from 1990  through the
Company's  merger with and into Castelle in 1996.  From 1988 to 1989,  Mr. Grant
was a product marketing  manager at Genesis  Electronics Corp. a manufacturer of
voice mail systems.  From 1986 to 1988,  Mr. Grant served as general  manager at
Heuristics, Inc., an industrial software company. Mr. Grant holds an engineering
degree from the  University  of  California,  Santa  Barbara and an MBA from the
University of California, Davis.

         Donald  Masulis,  a founder of the  Company,  has served as Director of
Technology  since  October 1993.  Mr.  Masulis is  responsible  for the software
development  of various  versions of the  FaxPress  and  LANpress  products  and
directs the Company's  product quality  assurance  program.  Mr. Masulis holds a
Master of Science degree in Industrial  Engineering and Operations Research from
the  University of  California  at Berkeley and a Bachelor of Science  degree in
Information and Computer Science from the University of California at Irvine.

ITEM 2.       PROPERTIES

         The  Company's  headquarters,   including  its  executive  offices  and
corporate  administration,  development,  manufacturing,  marketing,  sales  and
technical  services/support  facilities,  are located in Santa Clara, California
with an  aggregate  of  approximately  21,400  square feet of floor  space.  The
Company  occupies  this  facility  under a lease,  the term of which  expires in
October 2000. The Company also occupies an additional 5,200 square feet of floor
space that is located in El Dorado Hills,  California.  This facility is under a
lease,  the term of which  expires in the year 2000.  In  addition,  the Company
rents office space for sales and customer support offices in Florida,  Illinois,
Pennsylvania,  the United Kingdom and the Netherlands.  The Company believes its
existing   facilities  will  be  adequate  to  meet  its  requirements  for  the
foreseeable future.

ITEM 3.       LEGAL PROCEEDINGS

         The Company is not a party to any material  litigation and is not aware
of any pending or  threatened  litigation  against the Company that could have a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial condition.

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

         Not applicable.
                                      22.
<PAGE>




                                     PART II



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

         The Company's  Common Stock (Nasdaq symbol "CSTL") began trading on the
Nasdaq National  Market on December 20, 1995.  Listed below are the high and low
sale  prices on the Nasdaq  National  Market  for the  periods  indicated.  Such
quotations do not include retail markups, markdowns or commissions.

FISCAL 1996                     HIGH                 LOW
     First Quarter             $9-1/4                $7
     Second Quarter            $9-3/4              $7-1/4
     Third Quarter               $8                $6-1/2
     Fourth Quarter            $6-7/8              $5-1/4

FISCAL 1997                     HIGH                 LOW
     First Quarter             $8-1/2              $5-1/4
     Second Quarter            $6-3/4              $3-7/8
     Third Quarter             $5-1/16             $3-1/2
     Fourth Quarter            $6-1/4              $1-5/8

         As of  December  31,  1997,  there  were 124  holders  of record of the
Company's  Common  Stock,  which  does not  include  those who held in street or
nominee name. On February 20, 1998,  the last sale price  reported on the Nasdaq
National Market for the Company's Common Stock was $3 per share.

Dividend Policy

         The Company has not paid cash  dividends  on its Common  Stock and does
not plan to pay cash dividends for the foreseeable future.

Use of Proceeds from Registered Securities

         On December 19, 1995, the Company's registration statement on Form SB-2
(Registration No. 33-99628-LA-) became effective.  The offering commenced on the
same date and terminated  upon the sale of the securities  offered for sale. The
managing  underwriters for the offering were Unterberg Harris and RvR Securities
Corp. One million one hundred fifty thousand shares of no par common stock, with
an aggregate  value of $8.1 million,  were  registered and sold on behalf of the
Company.  Expenses  incurred for the Company's  account in  connection  with the
offering included $564,000 in underwriting discounts and commissions, $15,000 in
underwriters' expenses and $609,000 in other expenses. The payments were made to
persons who were not officers,  directors and owners of 10% or more of any class
of equity  securities of the Company or affiliates.  Net proceeds to the Company
after  deducting  the expenses  identified  above were $6.9  million.  Since the
effective date of the registration statement,  the Company has utilized all $6.9
million of the net proceeds for the  following  purposes,  $1.5 million to repay
indebtedness,  $1.0 million for technology and other capital asset acquisitions,
$1.4 million for higher levels of research and development,  and $3.0 million to
expand sales and  marketing  activities  worldwide.  The  payments  were made to
persons who were not officers,  directors and owners of 10% or more of any class
of equity securities of the Company or affiliates.
                                      23.
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

         The following selected financial  information has been derived from the
audited Consolidated  Financial  Statements.  The information set forth below is
not necessarily  indicative of results of future operations,  and should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
Notes thereto included elsewhere in this Report. Information with respect to the
three years ended December 31, 1996,  1995 and 1994 has been restated to account
for Ibex as a purchase.  See "Management's  Discussion and Analysis of Financial
Condition  and Results of Operations --  Restatement  of Financial  Results" and
Notes  3 and  13 to  the  Consolidated  Financial  Statements  thereto  included
elsewhere in this Report.

<TABLE>
<CAPTION>
                                                              Fiscal Years ended December 31,
                                         -------------------------------------------------------------------------
                                            1997            1996           1995           1994            1993
                                         ------------ --------------  -------------  -------------  --------------
                                                         (in thousands, except per share amounts)
INCOME STATEMENT DATA:
  <S>                                    <C>             <C>            <C>            <C>             <C>    
  Net Sales                              $25,343         $29,461        $25,082        $19,486         $17,787

  Gross Profit                           $13,507         $14,468        $11,511         $7,983          $6,441
  Gross Profit as a % of Net Sales            53%             49%            46%            41%             36%
  
  Net Income/(Loss)                      ($6,895)         $5,724         $2,024          ($378)       ($4,795)
  Net Income/(Loss) as a % of Net Sales      (27%)            19%             8%            (2%)          (27%)


  Net Income/(Loss) per share - diluted   ($1.54)          $1.45          $0.78        ($0.16)        ($12.11)


BALANCE SHEET DATA:
  Cash and Cash Equivalents               $6,204          $8,161         $7,268           $907          $1,882
  Working Capital                         10,816          13,163          8,912            884           (765)
  Total Assets                            18,926          27,303         14,728          7,124           8,623
  Long-term Liabilities                       52              --             75            354           2,261
  Stockholders Equity                     14,855          21,616          9,289          1,355         (1,264)

</TABLE>

         Net income for 1997 and 1993 included net charges for restructuring and
other non-recurring items of $6.1 million and $615,000,  respectively, and a net
benefit of $2.5 million in 1996. For detailed  information on these transactions
see "Management's  Discussion and Analysis of Financial Condition and Results of
Operations  Restatement of Financial  Results - Restructuring  and Other Charges
and Amortization of Intangible Assets" and the Consolidated Financial Statements
and related  Notes  thereto  included  elsewhere in this Report.  Excluding  the
restructuring and other items referenced above, net income (loss) and net income
(loss) per share on a diluted basis would have been has follows:
<TABLE>
<CAPTION>

                                                    Fiscal Years ended December 31,
                               ---------------------------------------------------------------------------
                                   1997            1996           1995           1994            1993
                               -------------  --------------  -------------  -------------  --------------
                                                (in thousands, except per share amounts)
<S>                                <C>           <C>            <C>              <C>         <C>     
  Net Income/(Loss)
     excluding          
     restructuring and
     non-recurring items           ($829)        $3,215         $2,024           ($378)      ($4,180)

  Net Income/(Loss) per
     share, diluted,
     excluding          
     restructuring and
     non-recurring items          ($0.19)         $0.82          $0.78         ($0.16)       ($10.56)

</TABLE>

                                      24.
<PAGE>




ITEM 7.       MANAGEMENT'S  DISCUSSION  AND ANALYSIS OF FINANCIAL CONDITIONS AND
              RESULTS OF OPERATION

         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  Castelle's  actual  results could differ  materially  from those
discussed  herein.  Factors that could cause or contribute  to such  differences
include,  but are not limited to, those  discussed in this section as well as in
the section entitled  "Business - Risk Factors." All information with respect to
1996 and 1995 has been restated.  See  "Management's  Discussion and Analysis of
Financial  Condition  and Results of  Operations  --  Restatement  of  Financial
Results" and Notes 3 and 13 of the  Consolidated  Financial  Statements  thereto
included elsewhere in this Report.

Results of Operations

         Overview

                  During the last six months of 1997, the Company  experienced a
         decrease  in net sales and units  shipped,  particularly  for its print
         server products, some of which was attributable to a component shortage
         experienced  in the fourth  quarter of 1997 and business  conditions in
         Asia. This overall decline in demand and the resulting losses,  coupled
         with intense competition throughout the industry, lead to the Company's
         decision to implement a  restructuring  of its  operations  intended to
         improve the Company's competitiveness and restore its profitability.

         Net Sales

                  Net sales  decreased  14% to $25.3  million in 1997 from $29.5
         million  in 1996.  The  decline of $4.2  million in net sales  resulted
         primarily  from lower sales of the  Company's  print  server  products,
         specifically in Japan due to increased local competition, price erosion
         and a component  shortage in the fourth  quarter of 1997 which impacted
         the  ability  of the  Company  to fill  orders  for print  servers  and
         increased  local  competition  in Europe.  Print server  product  sales
         declined 25% to $10.7 million in 1997 from $14.2  million  during 1996,
         approximately  $800,000 of the shortfall is attributed to the component
         shortage.

                  In 1996 net sales  increased  18% to $29.5  million from $25.1
         million in 1995.  This increase was  principally  due to an increase in
         sales of the FaxPress  product line,  principally the FaxPress 2000 and
         FaxPress 3000, and increased demand for print servers in Japan.

                  International  sales were $11.9  million,  $15.5  million  and
         $13.0 million in 1997, 1996 and 1995,  respectively,  representing 47%,
         53% and 52%,  respectively,  of net sales in 1997, 1996 and 1995. Lower
         international  sales  in 1997  was the  result  of a  combination  of a
         reduction in demand for the Company's  products in Asia,  the component
         shortage  identified  above and increased local  competition in Europe.
         Although  all of the  Company's  international  sales to date have been
         denominated in U.S. dollars,  such sales could be adversely affected by
         changes in demand  resulting  from  fluctuations  in currency  exchange
         rates.
                                      25.
<PAGE>


         Cost of Sales

                  Cost  of  sales   includes   cost  of   materials,   including
         components,  manuals,  diskettes,  packaging  materials,  assembly  and
         shipping,  as well as certain  royalties.  Cost of sales also  includes
         compensation costs and overhead related to the Company's  manufacturing
         operations  and warranty  expenses.  Cost of sales were $11.8  million,
         $15.0 million and $13.6 million in 1997,  1996 and 1995,  respectively,
         and  represented  47%, 51% and 54% of net sales for those  years.  Most
         significantly, cost of sales has decreased as a percentage of net sales
         each year resulting in improving gross margins. The decrease in cost of
         sales as a percentage of net sales is primarily attributable to changes
         in product mix  resulting in a higher  proportion  of net sales derived
         from higher  margin fax server  products.  Further,  in 1997,  sales of
         products acquired from Ibex, principally software,  helped to favorably
         impact  gross  margins.   This   improvement  was  somewhat  offset  by
         unfavorable overhead absorption, due to lower volumes.

         Research & Development

                  Research and product  development  expenses were $3.1 million,
         $2.4 million and $2.0 million in 1997, 1996 and 1995, respectively, and
         represented 12%, 8% and 8% of net sales for those periods.  Most of the
         Company's product development efforts during these periods were focused
         on fax-related products,  although much of the resultant technology has
         application to the further  development  of the Company's  print server
         products.  A  significant  percentage  of the  Company's  research  and
         product development expenses are related to software  development.  The
         increase in research and development expenses in 1997 was mainly due to
         the integration of Ibex development  efforts.  The Company  anticipates
         that the absolute  dollar  amount of research  and product  development
         expense will decrease slightly in 1998. However,  the Company continues
         to be committed to the  development of highly  competitive new products
         and  services  through the  efficient  utilization  of its  engineering
         resources.

         Sales & Marketing

                  Sales and marketing  expenses were $9.2 million,  $7.4 million
         and $5.6 million for 1997, 1996 and 1995, respectively, and represented
         36%, 25% and 23% of net sales for those  periods.  Sales and  marketing
         expenses  increased in 1997 compared to 1996 due to the  integration of
         the Ibex sales  organization and an increase in the number of sales and
         marketing  personnel.  However,  during  the third  quarter of 1997 the
         Company  determined that it was not receiving an appropriate  return in
         improved  sales  for the  investment  made.  As a result,  the  Company
         reorganized the sales and marketing activities, streamlining operations
         and reducing staff.

                  In 1996, the growth of sales and marketing  expenses  compared
         with  similar  expenses in 1995 was due to  increases  in the number of
         sales  and  marketing  personnel,   additional  sales  and  advertising
         promotional expenses and facilities-related  expenses needed to address
         sales opportunities and support customers using the Company's products.

         General & Administrative

                  General and  administrative  expenses were $2.3 million,  $1.6
         million and $1.4 million for 1997, 1996 and 1995, respectively,  or 9%,
         5% and 6% of net sales for those periods. The increase in 1997 expenses
         over 1996  expenses was due to increased  utilization  of  professional
         services and incorporating  Ibex-related  expenses.  As a result of the
         Company's restructuring, it anticipates that the absolute dollar amount
         of general and administrative expense will decrease slightly in 1998.

         Restructuring and Other Charges and Amortization of Intangible Assets

                  In the third  quarter of 1997,  the Company  restructured  its
         operations to streamline activities and focus on key products to reduce
         ongoing costs. As a result,  the Company recorded a $1.2 million charge
         to account for implementing and completing the restructuring plan. This
         was in  addition  to a  charge  of $5.0  million  associated  with  the
         write-off  of the Ibex  goodwill  and  related  intangibles.  The total
         restructuring  charge  of  $6.2  million  included  relocation  of  the
         Company's  European  office,  exit from certain  lines of  business,  a
         workforce  reduction,  the write-off of certain assets relating to Ibex
         and other  estimated  restructuring  costs.  In  addition,  charges  of
         $574,000  were related to the  amortization  of  intangible  assets and
         goodwill  associated  with  the  Company's  acquisition  of  Ibex.  See
         "Management's  Discussion  and  Analysis  of  Financial  Condition  and
         Results of Operations - Restatement  of Financial  Results" for further
         details concerning the Ibex asset write-off.
                                      26.
<PAGE>


                  In the  fourth  quarter  of 1996,  a total of $1.2  million in
         other  charges  was booked due to a $1.1  million  write-off  of Ibex's
         in-process  research and  development,  and $96,000 of amortization for
         the  intangible  assets  and  goodwill  associated  with the  Company's
         acquisition of Ibex in November 1996. See "Management's  Discussion and
         Analysis  of  Financial   Condition   and  Results  of   Operations  --
         Restatement of Financial Results" for further details.

         Interest Income/(Expense), net

                  Net interest  income was $288,000 in 1997,  down from $340,000
         in 1996,  due to a decrease  in cash  balances  as a result of the loss
         incurred in 1997. In 1995, net interest expense was $296,000 due to the
         interest expense  associated with the Company's  outstanding debt prior
         to the  Company's  initial  public  offering  in  December  1995.  Cash
         generated  from the public  offering  was used to retire the  Company's
         outstanding debt during 1995.

         Provision/Benefit from Taxes

                  The Company  recorded a net benefit  from income taxes in 1997
         and 1996 of $732,000  and $3.5  million,  respectively.  These  amounts
         reflect  the  recognition  of  various   deductible   deferred  assets,
         including prior years' net operating loss carry forwards,  business tax
         credits and various  temporary  accounting  differences.  See Note 9 of
         Notes to  Consolidated  Financial  Statements  for a discussion  of the
         Company's provision for income taxes.

Liquidity and Capital Resources

         Since  its  inception  in 1987,  Castelle  has  funded  its  operations
primarily through the issuance of capital stock and the assumption of bank debt.
As of  December  31,  1997,  the  Company  had  $6.2  million  of cash  and cash
equivalents, down from $8.2 million for the same period in 1996. Working capital
decreased to $10.8  million at December 31, 1997 from $13.2  million at December
31,  1996.  The  decrease  in cash,  cash  equivalents  and  working  capital is
primarily due to the operating loss incurred in 1997.

         The Company has a $3.0 million secured  revolving line of credit with a
bank, which expires in July 1998,  pursuant to which the Company may borrow 100%
against  pledges of cash at the bank's prime rate (8.50% at December 31,  1997).
Borrowings under this line of credit agreements are collateralized by all of the
assets of the  Company.  Under the terms of the loan  agreement,  the Company is
restricted  from  loaning  money or  assets  or  entering  into any  mergers  or
acquisitions  where the total  consideration  exceeds  $15,000,000,  without the
bank's  consent.  The Company is in compliance  with the terms of the agreement,
and at December 31, 1997 has no borrowings under the line of credit.

         In December 1997, as a source of capital asset  financing,  the Company
entered into a loan and security  agreement with a finance company for an amount
up to $288,000.  As of December 31, 1997, the Company had drawn $146,000 against
this amount.  The loan is subject to an interest rate of 10.11%, is repayable by
December 2000 and is collateralized by a certificate of deposit of $125,000.
                                      27.
<PAGE>


         As of December 31, 1997,  net accounts  receivable  were $3.3  million,
down from $5.8  million for the same period in 1996.  The  reduction in accounts
receivable is mainly attributed to lower sales in the fourth quarter of 1997 and
to a lesser degree,  an improvement in days sales outstanding  ("DSO").  In 1997
the average DSO improved 14% to 55, from 64 at the end of 1996.

         Net inventories as of December 31, 1997 were $3.8 million, up from $2.8
million in 1996.  The  increase  was  primarily  the result of lower actual unit
shipments  than  forecasted  coupled  with  a  component  shortage  that  caused
work-in-process  and other raw material levels to increase.  The  aforementioned
factors  can also be seen in the  lower  level  of  inventory  turnover  in 1997
compared to 1996.  Inventory turnover for the year-ended 1997 was 2.8, down from
5.1 in 1996.  The  components  causing the shortage  again  became  available in
sufficient quantities in the first quarter of 1998.

         In connection with the purchase of the ACD system and an upgrade to the
Company's internal network infrastructure,  Castelle acquired additional capital
equipment of $732,000 in 1997. Capital equipment spending in 1996 and 1995 were,
$364,000 and $195,000, respectively.

         Although  the Company  believes  that its existing  capital  resources,
expected  cash flows  from  operations  and  available  lines of credit  will be
sufficient to meet its  anticipated  capital  requirements  at least through the
next 12 months,  the Company may be required to seek  additional  equity or debt
financing.  The  timing  and  amount  of such  capital  requirements  cannot  be
determined at this time and will depend on a number of factors, including demand
for the  Company's  existing and new products and changes in  technology  in the
networking  industry.  There can be no assurance that such additional  financing
will be available on satisfactory terms when needed, if at all.

Restatement of Financial Results

         Following  discussions  with the  Securities  and  Exchange  Commission
("SEC"), the Company has restated prior reported financial results for the first
three  quarters  of 1997 and for 1996,  1995 and 1994 to reflect a change in the
method  of  accounting  for  the  acquisition  of  Ibex in  November  1996  from
pooling-of-interests  accounting to purchase accounting. The SEC has advised the
Company   that   in  its   view   the   acquisition   did  not   qualify   as  a
pooling-of-interests  for  technical  reasons  and  must be  accounted  for as a
purchase.  This conclusion was reached following initial questions raised by the
SEC after a review of the Company's  financial  statements in the fourth quarter
of 1997 and  extensive  subsequent  discussions  between the Company and the SEC
which continued through February 1998. Due to the SEC's conclusions, the Company
has now restated its financial statements for the years 1994, 1995 and 1996 as a
whole and for the first three  quarters of 1997 to account for the November 1996
Ibex acquisition using the purchase method of accounting as follows:
<TABLE>
<CAPTION>

                                                     
                                                                     
                                                                                                            First
                                  Prior Years                          Three Quarters Of 1997                Nine                   
                     ----------------------------------------  -----------------------------------------    Months
                         1994           1995         1996        1st Qtr        2nd Qtr       3rd Qtr       Of 1997
                     -------------  ------------  -----------  ------------   ------------  ------------  ------------
                                                     (in thousands, except per share amounts)
 Net Sales:
<S>                      <C>           <C>          <C>            <C>            <C>           <C>          <C>     
    As reported          $ 22,194      $ 28,173     $ 32,725       $ 6,419        $ 7,002       $ 6,597      $ 20,018

    As restated          $ 19,486      $ 25,082     $ 29,461       $ 6,419        $ 7,002       $ 6,597      $ 20,018

 Net Income (loss):
    As reported           $ (166)       $ 2,083      $ 5,643         $ 367           $ 74     $ (1,490)     $ (1,049)

    As restated           $ (378)       $ 2,024      $ 5,724          $ 80        $ (213)     $ (5,832)     $ (5,965)

 Net Income (loss) per share:
    As reported          $ (0.17)        $ 0.59       $ 1.20        $ 0.08         $ 0.02      $ (0.33)      $ (0.24)

    As restated          $ (0.16)        $ 0.78       $ 1.45        $ 0.02       $ (0.05)      $ (1.30)      $ (1.34)

</TABLE>
                                       28.
<PAGE>
         In  connection  with  the  restatement  of the Ibex  acquisition  using
purchase  accounting  instead of  pooling-of-interests  accounting,  the Company
recorded  in the fourth  quarter  of 1996 net  tangible  assets  and  identified
intangible  assets acquired from Ibex at their fair market value at that time of
$142,000 and $2.7 million,  respectively, and recorded goodwill in the amount of
$3.0  million.  In  addition,  a charge  of $1.1  million  was taken in the same
quarter to reflect a write-off of Ibex's in-process research and development.  A
charge of $1.4 million  relating to the  acquisition  costs of Ibex,  originally
booked in the fourth  quarter of 1996,  was reversed and included as part of the
purchase  price.  Net sales for 1996,  with related  expenses  and income,  were
reduced to reflect  only one month of Ibex  revenues  rather  than the 12 months
previously recorded.  1994 and 1995 net sales, with related income and expenses,
for Ibex were  removed.  Amortization  charges  with  respect  to the assets and
goodwill  acquired  from Ibex were  recorded in December  1996 and the first and
second  quarters of 1997,  resulting in  decreases in the net income  previously
reported  in the  amounts  of  $96,000,  $287,000  and  $287,000,  respectively.
Subsequently, the balance of the goodwill, $2.6 million, and the remaining value
of intangible assets,  $2.4 million,  were entirely written off during the third
quarter of 1997. This was done when the Company suffered  significant  losses on
its current Ibex  products due to  increasing  competition  from  Internet-based
applications  and determined that the primary product under  development by Ibex
was not economically  feasible.  As a result, a restructuring  charge previously
taken in the third  quarter  of 1997 was  increased  from $1.2  million  to $6.2
million.  Further,  as a  result  of the  restructuring  write-off  for the Ibex
intangible  assets and  goodwill,  the  Company  booked a benefit  from taxes of
$732,000 in the third quarter of 1997.

         Because the intangible  assets and goodwill recorded in connection with
the Ibex  acquisition  as restated were entirely  written-off  by the end of the
third quarter of 1997, the  restatement  had no impact on the financial  results
for the fourth  quarter  of 1997 and will not have any  impact on the  Company's
financial results for 1998 or subsequent years. Furthermore, the restatement had
no impact on cash or cash  equivalent  balances  during the  previous  reporting
periods nor will it have any impact on cash flow for future periods.

Year 2000 Issue

         The Company is in the process of conducting a  comprehensive  review of
its computer  systems to identify those that could be adversely  affected by the
Year 2000 issue and is developing an implementation plan to resolve any problem.
The Year 2000 issue refers to the inability of many computer  systems to process
accurately  dates later than December 31, 1999.  Date codes in many programs are
abbreviated to allow only two digits for the year,  e.g. "98" for the year 1998.
Unless these programs are modified to handle the century date change,  they will
likely  interpret the year "00",  that is, the year 2000, as the year 1900.  The
Year 2000 issue creates risk for the Company from unforeseen problems in its own
computer  systems as well as in computer  systems of third parties with whom the
Company does business worldwide, including banks and credit processing entities,
factories and others. The Company presently believes that, with modifications to
existing  software and  conversions  to new software  that the Company  plans to
implement  over the next year,  the Year 2000  issue  will not pose  significant
operational  problems for the Company's own computer  systems as so modified and
converted.  However,  if such  modifications  and  conversions are not completed
timely, the Year 2000 issue may have a material adverse impact on the operations
of the Company. In addition, the Company cannot give assurance the third parties
with  whom it does  business  will  address  any Year  2000  issues in their own
systems  on a timely  basis.  Their  failure to do so could also have a material
adverse impact on the Company.
                                      29.
<PAGE>


         The Company has completed a comprehensive review of its products,  both
firmware and  software,  to insure that they are Year 2000  compliant.  This was
done to insure  that the  Company's  products  are free of any Year 2000  issues
discussed  above.  The Company  believes  that the more  recent  versions of its
products are Year 2000 compliant,  meaning that users of its products should not
experience  performance  difficulties  as a result of the need to process  dates
later than December 31, 1999. In order to avoid difficulties, users will need to
install the versions of the Company's  software  which are Year 2000  compliant.
For example,  FaxPress  systems  require a software  and firmware  release of at
least  version  3.7.3  and  InfoPress  requires  that at  least  version  2.0 be
installed  for  compliance  with Year 2000  requirements.  The Company  provides
upgrade  kits to allow  customers  to  install  these  versions.  The  Company's
products  work in  conjunction  with  network  operating  systems such as Novell
NetWare and Microsoft  Windows 95/NT, and while these products appear to be Year
2000  compliant,  the  Company  does not  accept  responsibility  for Year  2000
compliance of any network  operating  system.  If modifications  and upgrades to
these network operating  systems are not completed  timely,  the Year 2000 issue
may have a material adverse impact on the Company's business,  operating results
and financial condition.



ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable.


ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The following financial statements of the Company and the report of the
Company's independent accountants are included in Item 14:

                  Report  of  Coopers  & Lybrand  LLP,  Independent  Accountants
                  Consolidated Balance Sheets as of December 31, 1997 and 1996
                  Consolidated  Statements  of  Operations  for the years  ended
                    December 31,  1997,  1996 and 1995  
                  Consolidated  Statement of Shareholders'  Equity for the years
                    ended  December  31,  1997,   1996  and  1995   Consolidated
                    Statements  of Cash Flows for the years ended  December  31,
                    1997, 1996 and 1995
                  Notes to Consolidated Financial Statements


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

         Not applicable.


                                      30.
<PAGE>


                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Certain  information with respect to executive officers is set forth in
Part  I of  this  Report.  Additional  information  required  by  this  Item  is
incorporated  herein by  reference  to the  sections  entitled  "Directors"  and
"Compliance  with Section 16(a) of the  Securities  and Exchange Act of 1934" of
the Proxy Statement related to the Company's 1998 Annual Meeting of Stockholders
to be filed by the Company  with the  Securities  and Exchange  Commission  (the
"Definitive Proxy Statement").


ITEM 11. EXECUTIVE COMPENSATION

         The  information  required  by this  Item  is  incorporated  herein  by
reference  to  the  sections  entitled  "Executive  Compensation"  and  "Certain
Transactions" of the Company's Definitive Proxy Statement.

ITEM 12.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The  information  required  by this  Item  is  incorporated  herein  by
reference to the sections  entitled  "Security  Ownership of Certain  Beneficial
Owners and Management" of the Company's Definitive Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The  information  required  by this  Item  is  incorporated  herein  by
reference to the sections  entitled  "Certain  Transactions"  and  "Compensation
Committee  Interlocks  and Insider  Participation"  of the Company's  Definitive
Proxy Statement.


                                      31.
<PAGE>


                                     PART IV

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

(a) Index to Financial Statements
                                                                       Page in
                                                                      Form 10-K
                                                                      ---------
    Report of Independent Accountants.................................... F-1
    Consolidated Balance Sheets as of December 31, 1997 and 1996......... F-2
    Consolidated  Statements  of  Operations  for the years ended
     December 31, 1997, 1996 and 1995.................................... F-3
    Consolidated  Statement of Shareholders' Equity for the years
     ended December 31, 1997, 1996 and 1995.............................. F-4
    Consolidated  Statements  of Cash  Flows for the years  ended
     December 31, 1997, 1996 and 1995.................................... F-5   
    Notes to Consolidated Financial Statements........................... F-6



             All schedules are omitted because they are not applicable,  or
    not required,  or because the required  information  is included in the
    financial statements or notes thereto.


(b) Exhibits

   2.1(1)   Agreement  and Plan of  Merger,  dated as of August  22,  1996 among
            Castelle,  Ibex Technologies,  Inc. and Certain Shareholders of Ibex
            Technologies, Inc.
   3.1(2)   Amended and Restated Articles of Incorporation of the Company.
   3.4(2)   Amended and Restated Bylaws of the Company.
   4.1      Reference is made to Exhibits 3.1 and 3.4.
   4.2      Fifth  Amended and  Restated  Registration  Rights  Agreement  dated
            November 20, 1996 by and among the Registrant and certain holders of
            the Company's Common Stock and Warrants to purchase Common Stock.
  10.2(2)*  1995 Outside  Directors'  Stock  Option  Plan,  and form of Director
            Stock Option Agreement.
  10.3(3)   Warrant for Common Stock issued to Unterberg Harris.
  10.4(2)*  Form of Indemnity  Agreement  between the Registrant and each of its
            directors and executive officers.
  10.5(2)   Form of Reseller and Development  Agreement dated September 8, 1995,
            by and between the Registrant and Tobit Software International GmbH.
  10.6(2)   License  Agreement dated June 9, 1995, by and between the Registrant
            and 3Com Limited.
  10.7(2)   OEM  Purchase  Agreement  dated May 23,  1995,  by and  between  the
            Registrant and SerComm Corporation.

     ------------------
     (1) Filed as an exhibit to the Company's Form 8-K dated August 22, 1996 and
         incorporated herein by reference. 
     (2) Filed as an Exhibit to the  Company's  Registration  Statement  on Form
         SB-2 (Reg. No.  33-99628-LA-)  or amendments  thereto and  incorporated
         herein by reference.
     (3) Filed  as an  exhibit  to the  Company's  Form  10-KSB  for the  fiscal
         year-ended December 31, 1995 and incorporated herein by reference.
     *   Indicates  management  contracts or compensatory  plans or arrangements
         filed pursuant to Item 601(b)(10) of Regulation S-K.

                                      32.
<PAGE>


  10.8(2)   Distribution  Agreement  dated February 26, 1990, by and between the
            Registrant and Ingram Micro D Inc.
  10.9(2)   Distributor  Contract dated June 25, 1991, as amended June 25, 1991,
            by and between the Registrant and Tech Data Corporation.
  10.10(2)  Distribution  Agreement  dated March 26, 1992,  as amended March 26,
            1992, by and between the Registrant and Merisel, Inc.
  10.11(2)  Distributor  Agreement  dated  October 1, 1990,  by and  between the
            Registrant and Vitek.
  10.12(2)  International  Distributor Agreement dated February 24, 1994, by and
            between the Registrant and Macnica.
  10.13(2)  International  Distributor  Agreement  dated July 13,  1992,  by and
            between the Registrant and Azlan Ltd.
  10.14(3)* 1988 Equity Incentive Plan, as amended.
  10.15(3)  Warrant for Common Stock issued to RvR Securities Corp.
  10.16(4)* Form  of  Executive  Severance  and  Transition  Benefits  Agreement
            between the Company and Messrs. R. Prasad, P. Raje, R. Singh and Ms.
            S. Anand.
  10.17(4)  Form  of  Executive  Severance  and  Transition  Benefits  Agreement
            between the Company and Messrs. R. Bambrough and J. Burke.
  10.18*    Letter  from the  Company  to Roy Prasad  dated  November  12,  1997
            concerning  modification  of severance  terms  (reference is made to
            page E-1).
  11.1      Computation  of Net Income  (Loss) Per Share.  Reference  is made to
            page F-22 of the Notes to Consolidated Financial Statements.
  24.1      Consent of Coopers & Lybrand LLP (reference is made to page E-2).
  25.1      Power of Attorney.  Reference is made to the signature  page.  (page
            34)
  27.1      Financial data schedule (reference is made to page E-3).

(c)  No reports on Form 8-K were filed for the quarter ended December 31, 1997.

     ------------------
     (1) Filed as an exhibit to the Company's Form 8-K dated August 22, 1996 and
         incorporated herein by reference.
     (2) Filed as an exhibit to the  Company's  Registration  Statement  on Form
         SB-2 (Reg. No.  33-99628-LA-)  or amendments  thereto and  incorporated
         herein by reference.
     (3) Filed  as an  exhibit  to the  Company's  Form  10-KSB  for the  fiscal
         year-ended December 31, 1996 and incorporated herein by reference.
     (4) Filed as an exhibit  to the  Company's  Form 10-Q for the period  ended
         September 26, 1997 and incorporated herein by reference.
     *   Indicates  management  contracts or compensatory  plans or arrangements
         filed pursuant to Item 601(b)(10) of Regulation S-K.



                                      33.
<PAGE>

                                   SIGNATURES

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


                                    By:    /S/ ARTHUR H. BRUNO
                                           Arthur H. Bruno
                                           Chief Executive Officer and President


                                                                  March 13, 1998

         KNOW BY ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Arthur H. Bruno and Randall I. Bambrough,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of  substitution  for him, and in his name in any and all  capacities,  to
sign any and all amendments to this Report,  and to file the same, with exhibits
thereto and other  documents in connection  therewith,  with the  Securities and
Exchange Commission,  granting unto said  attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite  and  necessary  to be done  therewith,  as fully to all  intents  and
purposes as he might or could do in person,  hereby ratifying and confirming all
that said  attorneys-in-fact  and agents,  and any of them, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  Report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>

         Signature                                Title                                Date


<S>                         <C>                                                <C> 
    /s/ ARTHUR H. BRUNO     Chairman of the Board, Chief Executive Officer,    March 13, 1998
    -------------------     President and Director (principal executive
      Arthur H. Bruno       officer)
                            

 /s/ RANDALL I. BAMBROUGH   Chief Financial Officer, Vice President, Finance   March 13, 1998
 ------------------------   and Administration and Secretary (principal
  Randall I. Bambrough      financial and accounting officer)


   /s/ JOHN FREIDENRICH     Director                                           March 13, 1998
   --------------------
    John Freidenrich


     /s/ ALAN KESSMAN       Director                                           March 13, 1998
     ----------------
       Alan Kessman
</TABLE>


                                      34.

<PAGE>




                                       


                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and
Shareholders of Castelle:

We have audited the  accompanying  consolidated  balance  sheets of Castelle and
subsidiaries  as of  December  31, 1997 and 1996,  and the related  consolidated
statements of  operations,  shareholders'  equity and cash flows for each of the
three years in the period ended December 31, 1997.  These  financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Castelle and  subsidiaries  as of December 31, 1997 and 1996, and the results of
their  operations and their cash flows for each of the three years in the period
ended  December 31, 1997,  in  conformity  with  generally  accepted  accounting
principles.

As discussed in Note 3, the Company has restated  the  financial  statements  to
reflect the  acquisition of Ibex as a purchase  transaction.  Previously  issued
financial  statements  reflected  that  acquisition  as a pooling  of  interests
transaction.




COOPERS & LYBRAND L.L.P.

San Jose, California
February 6, 1998

                                      F-1
<PAGE>






              
                            CASTELLE AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
                                      -----
<TABLE>
<CAPTION>

                                                                                              December 31,
                                                                                     -------------------------------
                                  ASSETS                                                 1997               1996
                                                                                     -------------     -------------

Current assets:                                                   
<S>                                                                                   <C>               <C>
   Cash and cash equivalents                                                          $    6,204        $    8,161
   Restricted cash                                                                           125
   Accounts receivable, net of allowance for doubtful accounts of $490
       in 1997 and $467 in 1996                                                            3,273             5,783             
   Inventories                                                                             3,786             2,841
   Prepaid expenses and other current assets                                                 573               626
   Deferred income taxes                                                                     874             1,439
                                                                                      -----------       -----------

           Total current assets                                                           14,835            18,850

Property and equipment, net                                                                  938               593
Goodwill, net                                                                                                2,955
Other, net                                                                                    93             2,777
Deferred income taxes                                                                      3,060             2,128
                                                                                      -----------       -----------

              Total assets                                                            $   18,926        $   27,303
                                                                                      ===========       ===========
                                                                                     

                               LIABILITIES

Current liabilities:
   Long-term debt, current portion                                                    $       87
   Accounts payable                                                                        1,312        $    1,862
   Accrued liabilities                                                                     2,620             3,825
                                                                                      -----------       -----------

           Total current liabilities                                                       4,019             5,687

Other long-term liabilities                                                                   52
                                                                                      -----------       -----------

           Total liabilities                                                               4,071             5,687
                                                                                      -----------       -----------

Commitments (Note 5)

                          SHAREHOLDERS' EQUITY

Preferred stock, no par value:
   Authorized:  2,000 shares in 1997 and 1996
   Issued and outstanding:  none in 1997 and 1996                                              -                 -

Common stock, no par value:
   Authorized:  25,000 shares
   Issued and outstanding: 4,490 shares in 1997 and 4,420 shares in 1996                  28,955            28,843

Notes receivable for purchase of common stock                                              (274)             (296)
Accumulated deficit                                                                     (13,826)           (6,931)
                                                                                      -----------       -----------

           Total shareholders' equity                                                     14,855            21,616
                                                                                      -----------       -----------

              Total liabilities and shareholders' equity                              $   18,926        $   27,303
                                                                                      ===========       ===========
                                                                                      


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

<PAGE>






                            CASTELLE AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
                                      -----




<TABLE>
<CAPTION>


                                                                        Years Ended December 31,
                                                                --------------------------------------
                                                                   1997         1996           1995
                                                                -----------  -----------   -----------

<S>                                                             <C>          <C>           <C>
Net sales                                                       $   25,343   $   29,461    $   25,082

Cost of sales                                                       11,836       14,993        13,571
                                                                -----------  -----------   -----------

        Gross profit                                                13,507       14,468        11,511
                                                                -----------  -----------   -----------

Operating expenses:

   Research and development                                          3,141        2,357         2,018

   Sales and marketing                                               9,180        7,357         5,641

   General and administrative                                        2,296        1,566         1,405

   Amortization of intangible assets                                   574           96

   Restructuring and other charges                                   6,224        1,079
                                                                -----------  -----------   -----------

                                                                    21,415       12,455         9,064
                                                                -----------  -----------   -----------

           Operating  income (loss)                                 (7,908)       2,013         2,447

Interest income (expense), net                                         288          340          (296)

Other income (expense), net                                             (7)        (157)          (53)
                                                                -----------  -----------   -----------

         Income (loss) before (benefit from) provision
            for income taxes                                        (7,627)       2,196         2,098  

(Benefit from) provision for income taxes                             (732)      (3,528)           74
                                                                -----------  -----------   -----------

              Net income (loss)                                 $   (6,895)   $   5,724    $    2,024
                                                                ===========  ===========   ===========
                                                                
Net income (loss) per common share - basic                      $    (1.54)   $    1.55    $     2.73
                                                                ===========  ===========   ===========

Shares used in per share calculation - basic                         4,470        3,701           742
                                                                ===========  ===========   ===========

Net income (loss) per common share - diluted                    $    (1.54)  $     1.45    $     0.78
                                                                ===========  ===========   ===========

Shares used in per share calculation - diluted                       4,470        3,942         2,599
                                                                ===========  ===========   ===========

</TABLE>
          The  accompanying  notes are an  integral  part of these  consolidated
          financial statements.
                                       F-3
<PAGE>



                            CASTELLE AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (in thousands)
                                      -----

<TABLE>
<CAPTION>

                                                                                       Notes
                                                                                     Receivable
                                                                                        for
                                           Preferred Stock       Common Stock       Purchase of
                                       --------------------   -------------------    Common       Accumulated
                                         Shares      Amount    Shares    Amount       Stock         Deficit        Total
                                       --------   ---------   -------  ----------    -------       ---------     ---------

<S>                                    <C>        <C>         <C>      <C>           <C>           <C>           <C> 
Balances, January 1, 1995, as
    previously reported                 22,349     $15,860     1,228       $ 660     $ (130)      $ (14,428)      $ 1,962
    Adjustment for change in 
      accounting for Ibex transaction 
     (Note 3)                                                   (788)       (356)                      (251)         (607)
                                       --------   ---------   -------  ----------    -------       ---------     ---------

Balances, January 1, 1995, as           22,349      15,860       440         304       (130)        (14,679)        1,355
    restated
   Issuance of common stock through:
      Exercise of stock options                                    2           1                                        1
      Exercise of purchase rights                                 52         263       (263)
      Initial public offering, net
        of issuance costs                                      1,000       5,886                                    5,886
      Exercise of warrants                                         7           7                                        7
      Conversion of preferred shares   (22,349)    (15,860)    1,970      15,860
   Other                                                                      17                                       17
   Repurchase of common stock                                    (15)        (15)        14                            (1)
   Net income                                                                                         2,024         2,024
                                       --------   ---------   -------  ----------    -------       ---------     ---------

Balances, December 31, 1995                  -           -     3,456      22,323       (379)        (12,655)        9,289
   Issuance of common stock through:
      Exercise of stock options                                   23          10                                       10
      Exercise of underwriter's
        overallotment option                                     150         976                                      976
   Issuance of common stock in
       connection with acquisition                               791       5,535                                    5,535
   Repurchase of common stock                                                 (1)                                      (1)
   Repayment of notes receivable                                                          83                           83
   Net income                                                                                         5,724         5,724
                                       --------   ---------   -------  ----------    --------      ---------     ---------

Balances, December 31, 1996                  -           -     4,420      28,843        (296)        (6,931)       21,616
   Issuance of common stock through
       exercise of stock options                                  70         112                                      112
   Repayment of notes receivable                                                          22                           22
   Net loss                                                                                          (6,895)       (6,895)
                                       --------   ---------   -------  ----------    --------      ---------     ---------

Balances, December 31, 1997                  -    $      -     4,490   $  28,955     $ (274)       $(13,826)     $ 14,855
                                       ========   =========   =======  ==========    ========      =========     =========
                                       
</TABLE>
          The  accompanying  notes are an  integral  part of these  consolidated
          financial statements.
                                       F-4

<PAGE>



                            CASTELLE AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                      -----
<TABLE>
<CAPTION>

                                                                                     Year Ended December 31,
                                                                             -------------------------------------
                                                                                1997         1996         1995
                                                                             ----------   ----------   -----------

Cash flows from operating activities:
<S>                                                                          <C>          <C>          <C>       
   Net income  (loss)                                                        $  (6,895)   $   5,724    $    2,024
   Adjustments to reconcile net income (loss) to net cash (used in)
       provided by operating activities:
      Depreciation and amortization                                                967          346           594
      Purchased in-process research and development                                           1,079
      Write-off of goodwill and other intangible assets                          5,074
      Provision for doubtful accounts and sales returns                            220          (11)           75
      Provision for excess and obsolete inventory                                  412           29           323
      Changes in assets and liabilities:
        Accounts receivable                                                      2,289       (2,280)       (1,039)
        Inventories                                                             (1,357)         795        (1,225)
        Prepaid expenses and other current assets                                   53          (19)         (174)
        Accounts payable                                                          (550)        (876)        1,626
        Accrued liabilities and other long-term liabilities                     (1,205)         311           800
        Deferred income taxes                                                     (367)      (3,567)
                                                                             ----------   ----------   -----------

           Net cash (used in) provided by operating activities                  (1,359)       1,531         3,004
                                                                             ----------   ----------   -----------

Cash flows from investing activities:
   Acquisition of property and equipment                                          (732)        (364)         (195)
   Cash portion of Ibex acquisition, net of cash acquired                                    (1,159)
   (Increase) decrease in other assets                                             (14)          41           (24)
                                                                             ----------   ----------   -----------

           Net cash used in investing activities                                  (746)      (1,482)         (219)
                                                                             ----------   ----------   -----------

Cash flows from financing activities:
   (Increase) decrease in restricted cash                                         (125)                       426
   Proceeds from notes payable                                                     146
   Repayment of notes payable                                                       (7)        (193)       (1,123)
   Proceeds from bank borrowings                                                                           18,933
   Repayment of bank borrowings                                                                           (20,509)
   Principal payments on capitalized leases                                                     (31)          (44)
   Proceeds from collection of note receivable for stock                            22           83
   Proceeds from issuance of common stock and warrants, net of
       repurchases                                                                 112          985         5,893
                                                                             ----------   ----------   -----------

           Net cash provided by financing activities                               148          844         3,576
                                                                             ----------   ----------   -----------

Net (decrease) increase in cash and cash equivalents                            (1,957)         893         6,361

Cash and cash equivalents, beginning of period                                   8,161        7,268           907
                                                                             ----------   ----------   -----------

Cash and cash equivalents, end of period                                     $   6,204    $   8,161    $    7,268
                                                                             ==========   ==========   ===========
                                                                             
Supplemental information:
   Cash paid during the period for:
      Interest                                                               $       3    $       6    $      217
      Income taxes                                                           $     123    $      86    $       57
   Noncash investing and financing activities:
      Issuance of common stock in exchange for notes receivable                                        $      263
      Repurchase of common stock in exchange for notes receivable                                      $       14
      Issuance of common stock on conversion of preferred stock                                        $   15,860
      Conversion of preferred stock to common stock in connection
         with merger                                                                      $     300
      Issuance of common stock for acquisition of Ibex                                    $   5,535

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





                            CASTELLE AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                      -----




 1.   Business and Organization of the Company:

      Castelle (the Company)  designs,  develops,  markets and supports  network
      enhancement  products,  both  software  and  hardware,  that  improve  the
      productivity,  performance and functionality of local area networks (LANs)
      and enhance the LAN user's ability to communicate.  The Company's  current
      products include  FaxPress fax server systems,  LANpress print servers and
      FactsLine  fax-on-demand  software.  The Company  distributes its products
      primarily  through a two-tier,  domestic  and  international  distribution
      network,  with its distributors selling Castelle's products to value-added
      resellers, system integrators, retailers and other resellers in the United
      States,  Europe and the Pacific Rim.  The Company  also has  relationships
      with  selected  original   equipment   manufacturers  and  sells  software
      enhancements and upgrades directly to end users.


 2.    Summary of Significant Accounting Policies:

         Basis of Consolidation:

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

         Use of Estimates:

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

         Financial Instruments:

         Cash equivalents  consist of highly liquid investments with original or
         remaining maturities at the date of purchase of three months or less.

         Amounts reported for cash equivalents,  receivables and other financial
         instruments  are  considered  to  approximate  fair  values  based upon
         comparable market information available at the respective balance sheet
         dates.


                                    Continued
                                      F-6

<PAGE>




                            CASTELLE AND SUBSIDIARIES
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
                                      -----

 2.    Summary of Significant Accounting Policies, continued:

         Financial Instruments, continued:

         Financial   instruments  that   potentially   subject  the  Company  to
         concentrations  of credit  risks  consist  principally  of cash,  notes
         receivable and trade  accounts  receivable.  The Company  maintains its
         cash  balances  at a  variety  of  financial  institutions  and has not
         experienced  any losses  relating to any of its money  market  funds or
         bank deposits.

         Restricted Cash:

         The Company  considers cash equivalents used to collateralize  loans to
         be restricted. At December 31, 1997, long term restricted cash consists
         of a 30 day certificate of deposit which is used to  collateralize  one
         of the Company's notes.

         Certain Risks and Concentrations:

         Ongoing customer credit  evaluations are performed by the Company,  and
         collateral  is not  required.  The  Company  maintains  allowances  for
         potential  returns and credit losses,  and such returns and losses have
         generally  been  within  management's  expectations.   Three  customers
         accounted for 67% of accounts receivable at December 31, 1997 and three
         customers  accounted  for 54% of accounts  receivable  at December  31,
         1996.

         The   Company's   products   include   components   subject   to  rapid
         technological change.  Significant technological change could adversely
         affect the  Company's  operating  results  and  subject  the Company to
         returns of product and inventory losses.  While the Company has ongoing
         programs to minimize  the adverse  effect of such  changes and consider
         technological change in estimating its allowances, such estimates could
         change in the future.  In addition,  one of the Company's  print server
         products is currently manufactured by a single supplier and certain key
         components are currently available from only single sources.

         Inventories:

         Inventories   are  stated  at  the  lower  of   standard   cost  (which
         approximates cost on a first-in, first-out basis) or market.

                                   Continued
                                      F-7
<PAGE>
 2.    Summary of Significant Accounting Policies, continued:

         Property and Equipment:

         Property and equipment are stated at cost less accumulated depreciation
         and  amortization.  Depreciation  is provided  using the  straight-line
         method  over  the  estimated  useful  lives of the  respective  assets,
         generally three to seven years.  Amortization of leasehold improvements
         is provided on a straight-line basis over the life of the related asset
         or the lease term, if shorter. Gains and losses upon asset disposal are
         taken into income in the year of disposition.

         Software Production Costs:

         Costs  related to the  conceptual  formulation  and design of  software
         products are expensed as research and development  while costs incurred
         subsequent  to  establishing   technological  feasibility  of  software
         products  are  capitalized   until  general  release  of  the  product.
         Generally,  technological feasibility is established upon completion of
         a working  model.  No significant  costs  subsequent to such point have
         been incurred, and all such costs have been expensed.

         Revenue Recognition:

         Product  revenue is recognized  upon shipment  provided no  significant
         vendor obligations remain and collection of the resulting receivable is
         deemed probable by management.  The Company enters into agreements with
         certain of its distributors which permit limited stock rotation rights.
         These stock rotation  rights allow the  distributor to return  products
         for credit but require the  purchase  of  additional  products of equal
         value.  Revenues  subject  to stock  rotation  rights  are  reduced  by
         management's  estimates  of  anticipated   exchanges.   Provisions  for
         estimated   warranty  costs,   insignificant   vendor  obligations  and
         anticipated  retroactive  price  adjustments  are  recorded at the time
         products are shipped.

         Advertising Costs:

         Advertising  costs,  included  in sales  and  marketing  expenses,  are
         expensed as incurred and were  $2,471,000,  $2,304,000  and $914,000 in
         1997, 1996 and 1995, respectively.

         Foreign Currency Translation:

         The functional currency of the Company's foreign subsidiary is the U.S.
         dollar.  Foreign  currency  gains  and  losses,  which  have  not  been
         material, are reported in the statement of operations.

                                   Continued
                                      F-8
<PAGE>
 2.    Summary of Significant Accounting Policies, continued:

         Net Income (Loss) Per Share:

         The Company has adopted  Statement  of Financial  Accounting  Standards
         No.128 (SFAS 128),  "Earnings per Share," which  supersedes APB Opinion
         No. 15 (APB No. 15),  "Earnings  per Share," and which is effective for
         all periods  ending after  December 15,  1997.  SFAS 128 requires  dual
         presentation of basic and diluted  earnings per share (EPS) for complex
         capital  structures on the face of the Statements of Operations.  Basic
         EPS is computed by dividing net income by the  weighted-average  number
         of common shares  outstanding for the period.  Diluted EPS reflects the
         potential  dilution from the exercise or conversion of other securities
         into common stock. For the year ended December 31, 1997, the effects of
         the  exercise of  outstanding  stock  options  were  excluded  from the
         calculation of diluted EPS because their effect was antidilutive.

         Restructuring:

         In the quarter  ended  September  26, 1997,  the Company  announced and
         began to  implement  a  restructuring  plan.  The  Company  recorded  a
         $1,150,000  restructuring  charge to account for the estimated costs of
         implementing and completing the restructuring  plan. Such charge was in
         addition to the write-off of the Ibex goodwill and related  intangibles
         as  discussed  in Note 3. These costs  consist of $402,000 to exit from
         certain lines of business, $343,000 for the relocation of the Company's
         European  office,  $340,000 for estimated  employee  termination  costs
         associated  with  reductions  in the  workforce,  and $65,000 for other
         estimated restructuring costs. As of December 31, 1997, the Company had
         completed most of its restructuring  plan with actual costs incurred of
         $981,000.  The  remaining  balance of $169,000 will be used to complete
         the relocation of the Company's European office.

         Recent Accounting Pronouncements:

         In June 1997, the Financial Accounting Standards Board issued Statement
         of  Financial  Accounting  Standards  No.  130 (SFAS  130),  "Reporting
         Comprehensive  Income".  This statement  establishes  requirements  for
         disclosure  of  comprehensive  income  and  becomes  effective  for the
         Company for fiscal  years  beginning  after  December  15,  1997,  with
         reclassification  of  earlier  financial   statements  for  comparative
         purposes.  Comprehensive  income  generally  represents  all changes in
         shareholders'   equity  except  those  resulting  from  investments  or
         contributions  by shareholders.  The Company is evaluating  alternative
         formats  for  presenting  this  information,  but does not expect  this
         pronouncement to materially impact the Company's results of operations.

                                   Continued
                                      F-9
<PAGE>
 2.    Summary of Significant Accounting Policies, continued:

         Recent Accounting Pronouncements, continued:

         In June 1997, The Financial Accounting Standards Board issued Statement
         of  Financial  Accounting  Standards  No. 131 (SFAS 131),  "Disclosures
         about  Segments  of  an  Enterprise  and  Related  Information".   This
         statement establishes standards for disclosure about operating segments
         in annual  financial  statements  and selected  information  in interim
         financial   reports.   It  also   establishes   standards  for  related
         disclosures  about  products and services,  geographic  areas and major
         customers.  This statement supersedes Statement of Financial Accounting
         Standards  No. 14,  "Financial  Reporting  for  Segments  of a Business
         Enterprise."  The new  standard  becomes  effective  for  fiscal  years
         beginning  after  December 15,  1997,  and  requires  that  comparative
         information   from  earlier   years  be  restated  to  conform  to  the
         requirements   of  this   standard.   The  Company  is  evaluating  the
         requirements  of SFAS 131 and the  effects,  if any,  on the  Company's
         current reporting and disclosures.

         In October 1997, the Accounting  Standards  Executive  Committee issued
         Statement of Position 97-2 (SOP 97-2),  "Software Revenue Recognition,"
         which  delineates the accounting for software  product and  maintenance
         revenues.  SOP  97-2  supersedes  the  Accounting  Standards  Executive
         Committee Statement of Position 91-1,  "Software Revenue  Recognition,"
         and  is  effective  for  transactions  entered  into  in  fiscal  years
         beginning  after  December  15,  1997.  The Company is  evaluating  the
         requirements  of SOP  97-2  and the  effects,  if any on the  Company's
         current revenue recognition policies.

                                   Continued
                                      F-10


<PAGE>



 3. Acquisition of Ibex Technologies, Restatement and Related Charges:

      In November 1996, the Company acquired Ibex  Technologies,  Inc. (Ibex), a
      company which designed, developed and marketed fax-on-demand, fax-gateway,
      and fax broadcast  applications.  The Company issued 790,617 shares of its
      common stock in exchange for all of the  outstanding  common stock of Ibex
      and accounted for the transaction as a pooling of interests. In connection
      with the acquisition of Ibex by the Company, the holders of Ibex preferred
      stock  negotiated a  concession  with other Ibex  shareholders  to receive
      registration  rights which were  preferential to other Ibex  shareholders.
      Upon discussion with the staff of the Securities and Exchange  Commission,
      the Company has agreed that these  preferential  registration  rights were
      not  consistent  with  the   requirements  for  a  pooling  of  interests.
      Accordingly,  the  Company  has agreed to restate  its  previously  issued
      financial statements to reflect the acquisition of Ibex using the purchase
      method of  accounting.  The effect of changing the accounting for the Ibex
      transaction  on previously  reported net income was to increase net income
      in 1996 by $81,000  and to  decrease  net income in 1995 by  $59,000.  The
      effect on  previously  reported  diluted net income per share,  which also
      reflects a reduction in the weighted average number of shares  outstanding
      each year,  was an  increase  in net income per share of $0.25 in 1996 and
      $0.19 in 1995.  See  Note 13  for  discussion  of the  restatement  of the
      fiscal quarters in 1997.

      The total purchase price of Ibex, consisting of stock valued at $5,534,000
      (based  on the  closing  price at the  closing  date)  plus  direct  costs
      incurred of  $1,430,000,  was allocated to the net tangible and identified
      intangible  assets of Ibex, and to in-process  research and development in
      the amounts of $142,000,  $2,739,000,  and $1,079,000,  respectively.  The
      identified  intangible assets,  consisting  primarily of the fair value of
      current  technologies,  customer  lists,  and  the  workforce,  are  being
      amortized  on a  straight  line  basis  over 5 years.  The  excess  of the
      purchase  price  plus  direct  costs  incurred  over the fair value of the
      assets  acquired was  approximately  $3,004,000  and has been  recorded as
      goodwill, which was being amortized on a straight line basis over 5 years.
      The amount of the  purchase  price  allocated to  in-process  research and
      development  relates to products for which  technological  feasibility had
      not been  established  and for which there was no alternative  future use.
      Accordingly,  the in-process  research and  development was written off at
      the date of  the  acquisition  and  included  as  restructuring  and other
      charges on the accompanying statement of operations.

                                   Continued
                                      F-11


<PAGE>



3.    Acquisition of Ibex Technologies, Restatement and Related Charges, 
        continued:

      In 1997 Ibex suffered  significant  losses on its current  products due to
      increasing  competition  from internet based  applications  and determined
      that its primary product under development was not economically  feasible.
      As a result, management has determined that the value assigned to goodwill
      and other intangible assets is not currently recoverable and has therefore
      written off such assets. The expense incurred in 1997, included as part of
      the restructuring and other charges, was $5,073,000,  which amount was net
      of amortization recorded in 1997 of $574,000.


 4. Balance Sheet Detail (in thousands):

         Inventories:
<TABLE>
<CAPTION>

                                                            December 31,
                                                     -------------------------
                                                         1997          1996
                                                     -----------   -----------  
<S>                                                  <C>           <C>       
Raw material                                         $    1,544    $      878
Work in process                                             486           212
Finished goods                                            1,756         1,751
                                                     -----------   -----------

                                                     $    3,786    $    2,841
                                                     ===========   ===========
                                                    
         Property and Equipment:

                                                            December 31,
                                                     -------------------------
                                                         1997          1996
                                                     -----------   ----------- 

Production, test and demonstration equipment         $      746    $      637
Computer equipment                                        2,740         2,185
Office equipment                                            361           315
Leasehold improvements                                      127           109
                                                     -----------   -----------

                                                          3,974         3,246
Less accumulated depreciation and amortization           (3,036)       (2,653)
                                                     -----------   -----------

                                                     $      938    $      593
                                                     ===========   ===========
</TABLE>


                                   Continued
                                      F-12

<PAGE>



 4. Balance Sheet Detail (in thousands), continued:

         Property and Equipment, continued:

         Equipment  acquired  under  capital  leases  included in  property  and
         equipment above consist of:
<TABLE>
<CAPTION>

                                                    December 31,
                                               ---------------------
                                                 1997         1996
                                               ---------   ---------                                              
<S>                                            <C>         <C>     
Equipment                                      $    151    $    151
Less accumulated amortization                      (151)       (151)
                                               ---------   ---------

                                               $      -    $      -
                                               =========   ========= 
                                               
         Accrued Liabilities:

                                                 December 31,
                                          --------------------------
                                              1997         1996
                                          ------------  ------------                                                      
Accrued compensation                      $       870   $       893
Accrued sales and marketing                       444           743
Accrued professional fees                         126            58
Deferred revenue                                  252           239
Accrued income tax                                234           427
Accrued acquisition costs                                       292
Other                                             694         1,173
                                          ------------  ------------

                                          $     2,620   $     3,825
                                          ============  ============
</TABLE>
                                          



                                   Continued
                                      F-13

<PAGE>



 5.   Commitments:

      The Company leases its facilities  under a  noncancelable  operating lease
      that  expires in October  2000.  The  Company is  responsible  for certain
      maintenance  costs,  taxes and insurance  under the lease.  Future minimum
      payments  under   noncancelable   operating  leases  are  as  follows  (in
      thousands):

              1998                              $       300
              1999                                      310
              2000                                      268
                                                ------------
                                                $       878
                                                ============
                                                

     Rent  expense,  including  the facility  lease and  equipment  rental,  was
     $332,000, $374,000 and $367,000 for 1997, 1996 and 1995, respectively.

 6.   Bank Borrowings:

      The Company has a $3.0 million  revolving line of credit with a bank which
      expires in July  1998,  pursuant  to which the  Company  may  borrow  100%
      against  pledges of cash at the bank's  prime rate (8.50% at December  31,
      1997).  Borrowings under this line of credit agreement are  collateralized
      by all assets of the Company.  Under the terms of the loan agreement,  the
      Company is restricted from loaning money or assets or entering any mergers
      or acquisitions where the total annual  consideration  exceeds $15,000,000
      without the bank's approval.  The Company was in compliance with the terms
      of the agreement at December 31, 1997,  and at that date had no borrowings
      under the line of credit.


 7.   Long-Term Debt:

      In December 1997, the Company  entered into a loan and security  agreement
      with a finance  company for  amounts up to  $288,000.  As of December  31,
      1997, the Company had drawn $146,000  against this agreement.  The amounts
      borrowed  are  subject to interest of 10.11%,  are  repayable  by December
      2000, and are collateralized by a certificate of deposit of $125,000.



                                   Continued
                                      F-14
<PAGE>



 7.   Long-Term Debt, continued:

      At  December  31,  1997,  future  minimum  payments  are  as  follows  (in
      thousands):

                  Years Ending December 31,

                  1998                             $     87
                  1999                                   25
                  2000                                   27
                                                   ---------

                                                   $    139
                                                   =========
                                                 

 8.   Common Stock:

      In  connection  with the sale of common stock to two  executives  (152,815
      shares at $0.20 per share in October  1994 and 52,500  shares at $5.00 per
      share in April 1995),  the Company has the right to repurchase the 205,315
      shares at cost in the event of termination of service.  These rights lapse
      ratably through 1999. At December 31, 1997,  23,000 shares were subject to
      the Company's repurchase right.

         Non-Employee Directors' Stock Option Plan:

         In November  1995,  the Company's  Board of Directors  adopted the 1995
         Non-Employee  Directors'  Stock  Option Plan  (Directors  Plan).  As of
         December 31, 1997,  120,000  shares of the Company's  common stock have
         been reserved for issuance  under the Directors Plan and activity under
         the Plan is as follows (in thousands):
<TABLE>
<CAPTION>

                                                                                  Weighted     
                                                                                   Average                       
                                       Number          Exercise                   Exercise                                    
                                      of Shares         Price          Total        Price                                   
                                     ------------   ---------------  ----------   -------------                              
Balances, January 1, 1996
<S>                                  <C>            <C>              <C>          <C>  
   Options granted                           10         $8.00        $      80       $8.00
   Options canceled                          (3)        $8.00              (24)      $8.00
                                     ------------                    ----------   -------------

Balances, December 31, 1996                   7         $8.00               56       $8.00
   Options granted                            6         $6.12               37       $6.12
   Options canceled                          (3)     $6.12-$8.00           (21)      $7.00
                                     ------------                    ----------   -------------

Balances, December 31, 1997                  10      $6.12-$8.00     $      72       $7.20
                                     ============                    ==========   ============= 

</TABLE>
          At December 31, 1997 and 1996, 7,000 and 3,000 options,  respectively,
          were exercisable.  At December 31, 1997 and 1996,  110,000 and 113,000
          options, respectively, were available for grant under this plan.

                                    Continued
                                      F-15


<PAGE>
 8.    Common Stock, continued:

         1988 Incentive Stock Plan:

         Under the 1988 Incentive Stock Plan (1988 Plan), the Board of Directors
         may grant  either the right to  purchase  shares or options to purchase
         shares of the  Company's  common stock at prices not less than the fair
         market value at the date of grant for  incentive  stock options and 85%
         of the fair market value for non-qualified options and purchase rights.
         Options granted under the 1988 Plan generally become  exercisable,  and
         the Company's  right to  repurchase  shares issued and sold pursuant to
         stock purchase  rights  lapses,  at a rate of one-quarter of the shares
         under option or purchased under stock purchase rights at the end of the
         first  year  and  thereafter  ratably  over the next  three  years  and
         generally expire seven years from the date of grant. As of December 31,
         1997,  there were no stock purchase rights  outstanding,  and no shares
         purchased  pursuant to stock purchase rights were subject to repurchase
         by the Company.

         Option activity under the 1988 Plan was as follows (in thousands):
<TABLE>
<CAPTION>

                                                                                  Weighted
                                                                                   Average                                        
                                       Number         Exercise                     Exercise            
                                      of Shares        Price           Total        Price              
                                      ----------   ---------------  -----------  ------------

<S>                                   <C>          <C>              <C>          <C>                    
Balances, January 1, 1995                   100     $.20-$25.00     $       43      $0.43
   Options granted                          184      $.20-$6.00            844      $4.58
   Options canceled                         (20)    $.20-$25.00            (29)     $1.45
   Options exercised                         (2)    $.20-$18.00             (1)     $0.57
                                      ----------                    -----------

Balances, December 31, 1995                 262      $.20-$6.00            857      $3.26
   Options granted                          197     $0.96-$7.75          1,075      $5.46
   Options canceled                         (65)     $.20-$7.75           (426)     $6.54
   Options exercised                         (9)     $.20-$1.55            (10)     $1.24
                                      ----------                    -----------

Balances, December 31, 1996                 387     $0.20-$7.75          1,496      $3.87
   Options granted                        1,184     $4.50-$5.75          5,476      $4.62
   Options canceled                        (112)    $0.20-$6.88         (5,677)     $5.09
   Options exercised                        (70)    $0.20-$5.00           (112)     $1.59
                                      ----------                    -----------

Balances, December 31, 1997               1,389     $0.20-$7.75     $    6,293      $4.53
                                      ==========                    ===========
</TABLE>

          At  December  31,  1997,  1996 and 1995,  694,000,  119,000 and 37,000
          options outstanding, respectively, were exercisable.

                                   Continued
                                      F-16

<PAGE>



 8.    Common Stock, continued:

         Stock Option Plans:

         The Company has adopted the disclosure-only  provisions of Statement of
         Financial Accounting Standards No. 123 (SFAS No. 123),  "Accounting for
         Stock-Based Compensation."  Accordingly,  no compensation cost has been
         recognized  for the  Non-Employee  Directors'  Stock Option Plan or the
         1988 Incentive Stock Plan.

         Had compensation cost for these Plans been determined based on the fair
         value at the grant  date for awards in 1997,  1996 and 1995  consistent
         with the  provisions  of SFAS No. 123, the Company's net income and net
         income per share for 1997, 1996 and 1995 would have been reduced to the
         pro forma amounts indicated below (in thousands):

<TABLE>
<CAPTION>

                                                              1997          1996          1995
                                                          -----------   -----------   -----------
<S>                                                       <C>           <C>           <C>       
Net income - as reported                                  $  (6,895)    $    5,724    $    2,024
                                                          ===========   ===========   ===========
Net income - pro forma                                    $  (8,093)    $    5,586    $    1,935
                                                          ===========   ===========   ===========
Net income per share - basic - as reported                $   (1.54)    $     1.55    $     2.73
                                                          ===========   ===========   ===========
Net income per share - basic - pro forma                  $   (1.81)    $     1.51    $     2.67
                                                          ===========   ===========   ===========
Net income per share - diluted - as reported              $   (1.54)    $     1.45    $     0.78
                                                          ===========   ===========   ===========
Net income per share - diluted - pro forma                $   (1.81)    $     1.42    $     0.76
                                                          ===========   ===========   ===========
</TABLE>

          The fair value of each option  grant is estimated on the date of grant
          using the  Black-Scholes  model with the  following  weighted  average
          assumptions for 1997, 1996 and 1995:
<TABLE>
<CAPTION>

                                                1997                1996                1995
                                         ------------------  ------------------  ------------------

<S>                                         <C>                 <C>                 <C>   
Risk-free interest rate                     4.88%-5.30%         5.38%-6.75%         5.38%-6.75%
Expected life                                5.6 years            3 years             3 years
Expected dividends                               -                   -                   -
Volatility                                     100%                 60%                 60%

</TABLE>


                                   Continued
                                      F-17
<PAGE>



 8.    Common Stock, continued:

         Stock Option Plans, continued:

         The options outstanding and currently  exercisable by exercise price at
         December  31, 1997 are as follows (in  thousands,  except years and per
         share data):
<TABLE>
<CAPTION>

                                                                        
                                                            
                                                                          Options  Currently
                    Options Outstanding                                      Exercisable                                          
-------------------------------------------------------------------    -------------------------
                                           Weighted
                                            Average      Weighted                     Weighted
                                           Remaining     Average                      Average
       Exercise          Number           Contractual    Exercise         Number       Exercise           
        Price            Outstanding         Life         Price        Exercisable      Price 
-----------------------  --------------  -------------  -----------    -----------  ------------
<S> <C>                  <C>             <C>            <C>             <C>         <C>  
        $0.20                      71      3.3 years       $0.20               62       $0.20
        $1.55                       5      1.7 years       $1.55                5       $1.55
    $3.41 - $5.75               1,215      3.9 years       $4.63              586       $4.61
    $6.00 - $8.00                 107      5.3 years       $6.68               48       $6.75
                           -----------                                  ----------

     $0.20-$8.00                1,398      4.0 years       $4.55              701       $4.34
                           ===========                                  ==========
</TABLE>

          The weighted  average fair value of options  granted in 1997, 1996 and
          1995 was $3.78, $3.41 and $1.98 per share, respectively.
          Warrants: 

          The Company has outstanding fully exercisable warrants at December 31,
          1997 as follows (in thousands except per share data):

                                   Stock Under      Exercise      Number
         Expiration Date           Warrant          Price        of Shares
         ---------------------    ---------------   -----------  ------------

         December 2000            Common              $8.40          100
         March 2000               Common              $1.00          133
         March 1999               Common              $3.00           15

          The warrant  holders have certain  demand and  registration  rights as
          specified in the warrant agreement.  No warrants were exercised during
          1997 and 1996. During 1995, 7,000 warrants were exercised.


                                   Continued
                                      F-18
<PAGE>



 8.    Common Stock, continued:

         Note Receivable:

         At December 31, 1997,  the Company held notes  receivable  of $274,000,
         which  bear  interest  between  6.3%  and  7.05%  per  annum,  from two
         executive officers or directors, issued in connection with the purchase
         of  common  stock  under  restricted  stock  purchase  agreements.  The
         principal and accrued  interest on these notes are due at various dates
         from October 1999 through September 2000.


 9.   Income Taxes:

          The Company's  (benefit  from)  provision for income taxes consists of
          the following (in thousands):

                                              Year Ended December 31,
                                        -------------------------------------
                                            1997          1996          1995
                                        ------------  ------------  ---------
          Current:
            Federal                     $         -   $       793   $     56
            State                                             130         18
            Foreign                                            20
                                        ------------  ------------  ---------
                                                  -           943         74
                                        ------------  ------------  ---------
          Deferred:
            Federal                            (732)       (4,062)
            State                                            (409)
                                        ------------  ------------  ---------
                                               (732)       (4,471)         -
                                        ------------  ------------  ---------

                                        $      (732)  $    (3,528)  $     74
                                        ============  ============  =========



                                   Continued
                                      F-19

<PAGE>



 9.   Income Taxes, continued:

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


                                                                       1997          1996         1995
                                                                   ------------  -----------   ---------
<S>                                                                <C>           <C>           <C>     
Federal tax (benefit) at statutory rate                             $   (2,975)   $     778    $    713
Permanent difference due to non-deductible expenses                      1,586          228          12
State taxes, net of federal benefit                                       (91)          251          98
Utilization of net operating loss carryforwards                                     (1,829)       (823)
Change in valuation allowance                                              834      (2,519)
General business credits                                                  (86)        (123)
Other                                                                                 (314)          74
                                                                   ------------  -----------   ---------

                                                                   $     (732)   $  (3,528)    $     74
                                                                   ------------  -----------   ---------
</TABLE>


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

                                                      December  31,
                                                -------------------------
                                                    1997          1996
                                                -----------   -----------

<S>                                             <C>           <C>       
Inventory allowances and adjustments            $      158    $      327
Accounts receivable allowances                         475           483
Other liabilities and allowances                       428           622
State income taxes                                                     7
Net operating loss carryforwards                     2,680         1,829
Ibex intangible assets                                              (732)
Tax credit carryforwards                             1,027           899
Depreciation                                                         132
Valuation allowance                                   (834)
                                                -----------   -----------
        Total deferred tax assets               $    3,934    $    3,567
                                                ===========   ===========
</TABLE>

          Due to the  uncertainty  of realizing the tax benefit of the Company's
          1997  net  operating  loss  carryforward,  the  Company  has  placed a
          valuation reserve against this deferred tax asset balance.


                                   Continued
                                      F-20
<PAGE>



 9.   Income Taxes, continued:

      At December 31, 1997, the Company had net operating loss  carryforwards of
      approximately $7,700,000 and $1,100,000 available to offset future federal
      and California  taxable  income,  respectively.  These loss  carryforwards
      expire from 2003 through 2013.

      The Tax Reform Act of 1986 substantially changed the rules relative to net
      operating loss  carryforwards  in the event of an "ownership  change" of a
      corporation.  Future changes in ownership may result in limitations on the
      annual utilization of net operating loss carryforwards.

      The  Company's income before provision for income  taxes  is substantially
      all from domestic operations.

10.   Retirement Plan:

      The  Company  has a  voluntary  401(k)  plan  covering  substantially  all
      employees.  The plan provides for employer contributions at the discretion
      of the Board of  Directors.  In 1997,  1996 and 1995,  the Company made no
      contributions to the plan.


11.   Major Customers and Segment Information:

      The Company  operates in one industry  segment and  develops,  markets and
      supports network enhancement products.

          The  Company's  export  revenues,  denominated  in U.S.  dollars,  are
          summarized as follows (in thousands):

                                         Years Ended December 31,
                                 -------------------------------------------
                                     1997           1996            1995
                                 -------------  -------------   ------------
      Europe                     $      3,000   $      4,800    $     4,700
      Pacific Rim                       8,900         10,700          8,300
                                 -------------  -------------   ------------

                                 $     11,900   $     15,500    $    13,000
                                 =============  =============   ============


                                   Continued
                                      F-21

<PAGE>



11.   Major Customers and Segment Information, continued:

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

                                              Years Ended December 31,
                ----------------------------------------------------------------------------------------
Customer                    1997                          1996                          1995
                -----------   --------------  -----------   --------------  ------------  --------------
                Amount         Percentage     Amount         Percentage     Amount         Percentage
                -----------   --------------  -----------   --------------  ------------  --------------
<S>             <C>                <C>        <C>                <C>        <C>                <C>
A               $    2,604         10%        $    3,833         13%        $     2,761        11%
B                    3,629         14%             4,419         15%              4,514        18%
C                    8,147         32%             9,711         33%              7,300        29%
</TABLE>

12. Computation of Net (Loss) Income per Share:

      Basic and diluted  earnings per share  are calculated as follows for 1997,
      1996 and 1995 (in thousands  except per share amounts):
<TABLE>
<CAPTION>


                                                    1997           1996           1995
                                                ------------   -------------  -------------
Basic:

<S>                                             <C>            <C>            <C>
   Weighted average shares                            4,470           3,701            742
                                                ============   =============  =============

   Net (loss) income                            $    (6,895)   $      5,724   $      2,024
                                                ============   =============  =============

   Net (loss) income per share                       $(1.54)          $1.55          $2.73
                                                ============   =============  =============

Diluted:

   Weighted average shares                            4,470           3,701            742

   Common equivalent shares from stock options                          241            133


   Assumed conversion of preferred stock                                             1,724
                                                ------------   -------------  -------------

   Shares used in per share calculation               4,470           3,942          2,599
                                                ============   =============  =============

   Net (loss) income                            $    (6,895)   $      5,724   $      2,024
                                                ============   =============  =============

   Net (loss) income per share                       $(1.54)          $1.45          $0.78
                                                ============   =============  =============
</TABLE>

          The  calculation  of  diluted  shares  outstanding  for 1997  excludes
          1,408,000  stock  options  as their  effect  was  antidilutive  in the
          period.


                                   Continued
                                      F-22
<PAGE>


                                

13. Restatement of Fiscal 1997 Quarters (unaudited):

      The financial  information as of and for the following fiscal quarters has
      been restated to reflect the acquisition of Ibex as a purchase transaction
      (in thousands, except per share data):
<TABLE>
<CAPTION>

                                                              
                                   March 28,     June 27,  September 26,  
                                      1997         1997         1997
                                   ----------   ----------  ------------
                                                (unaudited)
Total assets:
<S>                                <C>          <C>         <C>       
   As reported                     $   23,635   $  23,081   $   22,381
   As restated                     $   28,264   $  27,423   $   22,381

Total liabilities:
   As reported                     $    6,475   $   5,791   $    6,590
   As restated                     $    6,475   $   5,791   $    6,590

Total shareholders' equity:
   As reported                     $   17,160   $  17,290   $   15,791
   As restated                     $   21,789   $  21,632   $   15,791
 
Net sales:
   As reported                     $    6,419   $   7,002   $    6,597
   As restated                     $    6,419   $   7,002   $    6,597

Income (loss) before (benefit)
  provision for income taxes:
   As reported                     $      611   $     124   $   (1,490)
   As restated                     $      324   $    (163)  $   (6,564)

Net income (loss):
   As reported                     $      367   $      74   $   (1,490)
   As restated                     $       80   $    (213)  $   (5,832)

Net income (loss) per shares
  (diluted basis):
   As reported                          $0.08       $0.02       ($0.33)
   As restated                          $0.02      ($0.05)      ($1.30)

Shares used in per share calculations
  (diluted basis):
   As reported                          4,628       4,628        4,476
   As restated                          4,628       4,461        4,476

</TABLE>
                                   Continued
                                      F-23
<PAGE>





                                    





                        REPORT OF INDEPENDENT ACCOUNTANTS



Our report on the consolidated financial statements of Castelle and subsidiaries
is included at page F-1 of this Form 10-K. In connection with our audits of such
financial  statements,  we have also  audited  the related  financial  statement
schedule included at page F-25 of this Form 10-K.

In our  opinion,  the  financial  statement  schedule  referred  to above,  when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents  fairly,  in all  material  respects,  the  information  required to be
included therein.




COOPERS & LYBRAND L.L.P.

San Jose, California
February 6, 1998







                                      F-24

<PAGE>

                                     
                                                                   SCHEDULE II

                            CASTELLE AND SUBSIDIARIES
                        VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                              Additions     
                                                 Balance at   Charged to                Balance at
                                                  Beginning   Costs and                  End of
                                                  of Period   Expenses    Deduction      Period
                                                 ------------ ---------- ------------ -------------

Year Ended December 31, 1995:
   Deducted from asset accounts:
<S>                                               <C>         <C>          <C>          <C>     
   Allowance for doubtful accounts                $     428   $      75    $      74    $    429
   Allowance for excess and obsolete inventory    $     503   $     733    $     458    $    778


Year Ended December 31, 1996:
   Deducted from asset accounts:
   Allowance for doubtful accounts                 $    429   $     149   $      111    $    467
   Allowance for excess and obsolete inventory     $    778   $     443   $      414    $    807



Year Ended December 31, 1997:
   Deducted from asset accounts:
   Allowance for doubtful accounts                 $    467   $     107   $       84    $    490
   Allowance for excess and obsolete inventory     $    807   $     301   $      713    $    395



</TABLE>
                                      F-25
<PAGE>

                               INDEX TO EXHIBITS
  Exhibits
  Number    Description
  --------  --------------------------------------------------------------------
  10.18     Letter  from the  Company  to Roy Prasad  dated  November  12,  1997
            concerning  modification  of severance  terms  (reference is made to
            page E-1).
  11.1      Computation  of Net Income  (Loss) Per Share.  Reference  is made to
            page F-22 of the Notes to Consolidated Financial Statements.
  24.1      Consent of Coopers & Lybrand LLP (reference is made to page E-2).
  25.1      Power of Attorney.  Reference is made to the signature  page.  (page
            34)
  27.1      Financial data schedule (reference is made to page E-3).








<PAGE>
                                                                   Exhibit 10.18
November 12, 1997


Mr. Roy Prasad
15768 Kavin Lane
Los Gatos, CA
95030

Dear Roy:

This letter will confirm that you have  resigned your  employment  with Castelle
(the  "Company")  and your position as a Director of the Company  effective this
date  November  14,  1997 (the  "Effective  Date").  Pursuant  to the  Executive
Severance and  Transition  Benefits  Agreement  entered into between you and the
Company on September 22, 1997 (the  "Benefits  Agreement"),  you are entitled to
severance  benefits  pursuant to Section  2.1 of the  Benefits  Agreement.  Such
benefits are conditioned upon your execution of an effective  Employee Agreement
and Release, as required by Section 3.2 of the Benefits Agreement.

As of the  Effective  Date,  you hold two  options  to  purchase  shares  of the
Company's  common stock.  The first option (the "First  Option") is an incentive
stock option granted to you on August 18, 1997 at an exercise price of $4.50 per
share.  A total of 22,222  shares have vested  under the First  Option as of the
Effective Date. The second option (the "Second Option") is a nonstatutory  stock
option  granted  to you on August  18,  1997 at an  exercise  price of $4.50 per
share.  A total of 37,671  shares have vested under the Second  Option as of the
Effective  Date. You may exercise the First Option and/or the Second Option with
respect  to the  vested  shares  set forth  above at any time  prior to date the
option terminates (the "Termination  Date").  Notwithstanding  the provisions of
Section 5 of your option  agreements  evidencing the First Option and the Second
Option,  the  Termination  Date shall be the later of: (i) [twelve  (12)] months
from the  Effective  Date or (ii)  thirty  (30) days after the date on which you
would incur no liability under Section 16 of the Securities Exchange Act of 1934
resulting from the exercise of your option(s).  The vested portions of the First
Option and Second Option will  terminate and cease to remain  outstanding to the
extent not exercised prior to the Termination Date.  However, as a result of the
foregoing  amendment to your First Option, such option will no longer be treated
as an incentive stock option for tax purposes.

In addition,  should a transaction involving Network Technology PLC occur within
twelve (12) months  following the Effective  Date,  and should such  transaction
constitute  a Change in  Control  (as  defined in  Section  5.2 of the  Benefits
Agreement) then the unvested portions of the First Option and Second Option will
accelerate  and become  immediately  exercisable  for all such  unvested  option
shares.  This  will  provide  you with the  benefits  under  Section  2.2 of the
Benefits  Agreement as if you had remained  employed by the Company  through the
date of such Change in Control.

You acknowledge that, except as otherwise modified herein, you will remain bound
by all of the terms,  conditions and  limitations of your option  agreements and
the Company's 1988 Stock Option Plan to which your options are subject.

If you are in agreement with the terms of this letter, please sign and date both
copies that are  enclosed  and return one copy to me.  Please also sign and date
the enclosed copies of the Employee Agreement and Release and return one copy to
me.

Sincerely,


/s/ Arthur Bruno
--------------------------
ARTHUR BRUNO




Accepted and Agreed as of the 13th day of November, 1997

/s/ Roy Prasad
--------------------------
Roy Prasad




enclosures
                                      E-1
<PAGE>
                                                                    Exhibit 24.1



                      CONSENT OF COOPERS & LYBRAND L.L.P.,
                             INDEPENDENT ACCOUNTANTS



We consent to the  incorporation by reference in the  registration  statement of
Castelle and  subsidiaries on Form S-8 (File No. 333-06083) of our reports dated
February 6, 1998, on our audits of the  consolidated  financial  statements  and
financial  statement  schedule of Castelle and  subsidiaries  as of December 31,
1997 and 1996,  and for each of the three years in the period ended December 31,
1997, which reports are included in this Annual Report on Form 10-K.


COOPERS & LYBRAND L.L.P.


San Jose, California
March 13, 1998



                                      E-2
<PAGE>