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

                                   FORM 10-KSB

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

                   For the fiscal year ended December 31, 1996

                         Commission File Number 0-220-20

                                    CASTELLE
                 (Name of small business issuer in its charter)
                         -------------------------------

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

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

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

        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
                                (Title of Class)


Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 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

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B not contained in this form, and no disclosure  will be contained,
to the best of  registrant's  knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. [ ]

The Company's revenues for its most recent fiscal year were $32,725,000.

The approximate aggregate market value of the voting stock held by nonaffiliates
of the  Registrant  as of February 28, 1997,  based upon the last trade price of
the Common Stock  reported on the Nasdaq  National  Market on February 28, 1997,
was $21,694,157.  Excludes an aggregate of 1,393,045 shares of Common Stock held
by Directors, Officers and other affiliates at February 28, 1997.

The number of shares of Common  Stock  outstanding  as of February  28, 1997 was
4,437,839.



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                                     PART I


ITEM 1.  BUSINESS

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

     Except for the  historical  information  contained  herein,  the  following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  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  in  this  section  under
"Introduction"   and  "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, FactsLine fax-on-demand software and LANpress print
servers.  The Company  entered the Small  Office/Branch  Office  ("SOBO") market
through a joint  marketing  arrangement  with 3Com  Corporation  ("3Com") as the
supplier of print and fax servers for 3Com's stackable network systems products.

     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 graphical
intensity  of files  being  communicated  have  increased  and the  applications
operating  on the LAN have  become more  mission-critical.  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 cost-effectively convert single-user resources such
as  stand-alone  printers and  telephone  lines into shared LAN  resources.  The
Company has developed its line of network enhancement  products to address these
needs.

     "Fax-on-demand"  is the ability to use a touch-tone phone and a fax machine
to request and receive information 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.

     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;  further
penetrating the growing SOBO market;  strengthening and growing its domestic and
international  distribution   network;  and  expanding  existing   relationships

                                       1.                           Page 2 of 83

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and  fostering  new  alliances to augment the  Company's  product  offerings and
enable the Company to respond quickly to technological changes.

     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,  retailers and other resellers. The Company's
major domestic  distributors  include Ingram Micro, Inc. ("Ingram Micro"),  Tech
Data Corporation and Merisel, Inc. The Company's primary distributor in Japan is
Macnica  Corporation  ("Macnica").  The  Company  also  has  relationships  with
selected  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 in a transaction accounted for as a pooling of interests. 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.

     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 in 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 in "Risk Factors" 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,  the  introduction  of new  products  by the  Company or its
competitors,   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


                                       2.                           Page 3 of 83
<PAGE>


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.  See  "Management's  Discussion  and  Analysis of Financial
Condition and Results of Operations."

     The Company's  quarterly operating results may continue to fluctuate due to
numerous  other  factors.  Some of these  factors  include  the  demand  for the
Company's products, seasonality, 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, including the effects of filling
the distribution  channels  following such introductions and of potential delays
in  availability  of announced or  anticipated  products,  price  changes by the
Company or its  competitors,  product  sales mix, the mix of license and service
revenue,  commencement  or  conclusion  of  significant  development  contracts,
changes  in  foreign  currency  exchange  rates,   timing  of  acquisitions  and
associated costs, and timing of significant marketing and sales promotions.

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. 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 World Wide
Web (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.  The Company began shipping the OfficeConnect  product line, which
includes a Fax server, a Print server and CD-ROM in 1996.  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 any such errors in the future will not result in adverse  product
reviews and a loss of, or delay in market acceptance.

     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
development  budgets or that new products  will achieve  market  acceptance  and
generate sales sufficient to offset development costs. In addition,  programs as
complex  as those  offered by the  Company  may  contain a number of  undetected
errors or bugs when they are first  introduced  or as new versions are released.
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 negatively  affect market  acceptance of these
products.

                                       3.                           Page 4 of 83

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

Recent Acquisition

     In November 1996, the Company acquired Ibex. Management of the Company will
be required to devote  substantial  time and attention for an extended period of
time  to  the  completion  of the  acquisition  and  the  integration  of  these
businesses.  The integration of recently merged companies is expensive,  complex
and  time-consuming  and subject to a number of inherent risks.  There can be no
assurance that the Company will not experience operational or financial problems
as a result of the  merger.  Should the  Company  not be able to  integrate  the
businesses in a timely and  coordinated  fashion,  it could result in a material
adverse  effect on the  Company's  business,  operating  results  and  financial
condition.  The  Company's  management  group has little  experience in business
combinations of this size. Realization of the anticipated benefits of the merger
will continue to depend in part upon the successful  combination and integration
of Castelle  and Ibex's  management.  The  inability to  successfully  integrate
management  or the loss of the services of one or more of these key person could
have a material  adverse  effect on the Company.  The  management of the Company
also must continue to attract and retain key  managerial,  technical,  sales and
marketing   personnel   and   continue  to  motivate   employees   in  light  of
organizational  changes resulting from the merger.  In addition,  the merger may
continue to cause uncertainties,  hesitation and possible  dissatisfaction among
customers  and  potential  customers  of  the  Company.   The  requirement  that
management  devote  substantial time and resources to the process of integrating
the two companies and the  occurrence of any material  operational  or financial
problems as a result of the merger could have a material  adverse  effect on the
Company's business, operating results and financial condition.

International Sales

     Sales to customers  located outside Canada and the United States  accounted
for  approximately  49% and 48% of the  Company's  net  sales in 1996 and  1995,
respectively.  The Company  sells its products in 39 foreign  countries  through
approximately  70  international  distributors.  A total of 12  distributors  in
Germany,   Japan,   the  Netherlands  and  the  United  Kingdom   accounted  for
approximately 41% and 39% of the Company's international sales in 1996 and 1995,
respectively.  Macnica, the Company's principal Japanese distributor,  accounted
for  approximately  30% and 26% of the  Company's  net  sales in 1996 and  1995,
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. 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.  See also  "Dependence  on  Proprietary
Rights; Uncertainty of Obtaining Licenses." 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."

                                       4.                           Page 5 of 83

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History of Losses; Accumulated Deficit

     The  Company  has  experienced  significant  operating  losses  and,  as of
December 31, 1996, had an accumulated  deficit of $6.7 million.  The development
and  marketing  by  the  Company  of  new  products  will  continue  to  require
substantial product development and other expenditures. Although the Company has
recently been profitable,  there can be no assurance that growth in net sales or
profitability  will be sustained.  See "Management's  Discussion and Analysis of
Financial Condition and Results of Operations."

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.  See "Directors,  Executive
Officers, Promoters and Control Persons."

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  may  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 may
experience  increasing   competition  from  companies  such  as  Symantec  Corp.
("Symantec")   and   Computer   Associates   International,    Inc.   ("Computer
Associates").  There can be no assurance  that  competitors  will not  introduce
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


                                       5.                           Page 6 of 83
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"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations" and "Business -- Competition."

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  value-added  resellers  ("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  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 63% of its net sales in 1996 and 62% of the Company's net sales in
1995.  Macnica,  the Company's principal Japanese  distributor,  and Ingram, the
Company's largest domestic distributor,  accounted for approximately 30% and 14%
of its net  sales in 1996,  respectively,  and 26% and 16% of net sales in 1995.
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  which 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 "Management's
Discussion and Analysis of Financial  Condition and Results of  Operations"  and
"Business -- Sales, Marketing and Distribution."

                                       6.                           Page 7 of 83

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Lack of Product Revenue Diversification

     The Company derives  substantially all of its sales from the Fax Server and
Print  Server line of  products.  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 Token Ring interface modules from Silcom Manufacturing Technology Inc.
("Silcom"),   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
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.  The Company  anticipates  that
such  products  will  constitute  an  increasing  percentage of net sales in the
future. 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 the agreement require the consent of both the Company
and its supplier.  Although,  to date,  the Company has not  experienced  supply
problems that were material to the Company's business, 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."

                                       7.                           Page 8 of 83

<PAGE>



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,  could
adversely affect the Company's business and operating results.  In addition,  if
the  Company  were unable to obtain  regulatory  approvals  within a  reasonable
period of time, the Company's operating results could be adversely affected. 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  materially  and  adversely  affect the  Company's  operating
results.

Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses

     The Company's  success  depends to a certain extent upon its  technological
expertise  and  proprietary  software  technology.  The  Company  relies  upon a
combination of contractual rights and copyright, trademark and trade secret laws
to establish and protect its technologies.  Despite the precautions taken by the
Company, it may be possible for unauthorized third parties to copy the Company's
products or to reverse  engineer or obtain and use information  that the Company
regards as proprietary.  In addition,  the laws of some foreign countries either
do  not  protect  the  Company's   proprietary  rights  or  offer  only  limited
protection.  Given  the rapid  evolution  of  technology  and  uncertainties  in
intellectual property law in the United States and internationally, there can be
no assurance that the Company's  current or future  products will not be subject
to third-party claims of infringement.  Any litigation to determine the validity
of any third-party claims could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel,  whether
or not such litigation is determined in favor of the Company. In the event of an
adverse result in any such  litigation,  the Company could be required to expend
significant resources to develop non-infringing technology or to obtain licenses
to the  technology  which 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 - -  Proprietary  Rights" and "-- Research
and Development."

     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

                                       8.                           Page 9 of 83

<PAGE>

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 --
Proprietary Rights" and "-- Research and Development."

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 common stock, or the perception that such sales
could occur,  could  adversely  affect  prevailing  market prices for the common
stock.  The management of the Company  believes that such past  fluctuations may
have been caused by 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 Common Stock.  Stock markets have  experienced  extreme price  volatility in
recent years. This volatility has had a substantial  effect on the market prices
of securities issued by the Company and other high technology  companies,  often
for reasons  unrelated to the operating  performance of the specific  companies.
The Company anticipates that prices for Castelle Common Stock may continue to be
volatile.  Such future  stock price  volatility  for  Castelle  Common Stock may
provoke the  initiation of securities  litigation  which may divert  substantial
management  resources  and have an  adverse  effect on the  Company's  business,
operating results and financial condition.

Future Capital Requirements

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

Voting Control by Officers, Directors and Affiliates

     At February 28,  1997,  the  Company's  officers  and  directors  and their
affiliates  beneficially owned  approximately 14.5% 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 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,


                                       9.                          Page 10 of 83
<PAGE>

and as a result,  the issuance  thereof could have a material  adverse effect on
the market value of the Common Stock.


                              BUSINESS DESCRIPTION

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.  The  Company  entered the SOBO
market through a joint marketing  arrangement with 3Com as the supplier of print
and fax servers for 3Com's  stackable  network systems  products.  See "Products
Under Development."

     In November  1996 Ibex  merged  with and into the Company in a  transaction
accounted for as a pooling of interests. 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. See "Risk-Factors-Recent Acquisition."

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 graphical intensity of files
being  transmitted has increased and the applications  operating on the LAN have
become more  mission-critical.  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
cost-effectively  convert single-user resources such as stand-alone printers and
telephone lines into shared LAN resources. 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


                                      10.                          Page 11 of 83

<PAGE>

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  information 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.

     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 paradigm continues to gain
acceptance  and  mission-critical   applications  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.

     The growth of the  Internet  has  impacted  the way  businesses  manage and
distribute  information.  With the increased use of the Web, many  companies are
now looking at using both fax-on-demand and the Web for information  access. The
Web is used for  information  retrieval  by those with  Internet  access,  while
fax-on-demand is used by the large percentage of the population that do not have
Web access but do have access to a phone and a fax machine.

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

                                      11.                          Page 12 of 83
<PAGE>

continuing to focus on providing network enhancement products which 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 and billing/analysis and other management utility
software.  Utilizing  an  extensive  internal  database of over 4,000  corporate
end-users,   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.  In addition to its recent efforts in the
SOBO  market and  products  acquired  as a result of the merger  with Ibex,  the
Company continues to expand both its fax server and print server product lines.

     Penetrate  the  Small  Office/Branch  Office  Market.  As the  productivity
benefits of networks have been demonstrated,  small offices and businesses which
previously   have  used   stand-alone   personal   computers   are  now  seeking
cost-effective devices which provide basic printing and faxing functionality and
are easy to use,  install  and  maintain.  Castelle  is  addressing  this market
through its licensing and joint marketing  agreement with 3Com in which Castelle
provides print, fax workgroup and CD-ROM server modules for 3Com's OfficeConnect
product line.

     Strengthen and Expand 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 Ricoh  Corporation  ("Ricoh")  and  Fujitsu  Ltd.
("Fujitsu"). The Company is expanding its distribution network in North America,
Europe, the Asia-Pacific and Latin America regions and other markets in order to
capitalize on the rapid growth in LANs in these regions.

     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  and
FactsLine  fax-on-demand  software and a range of software  enhancements for its
fax and print server product lines.  In 1996,  Castelle  entered the SOBO market
through its licensing and joint  marketing  agreement  with 3Com which  provides
print and fax workgroup server modules for 3Com's OfficeConnect product family.

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

                                      12.                          Page 13 of 83

<PAGE>

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,  Singapore,  Switzerland and the United  Kingdom.  The
Company is seeking regulatory  clearance in a number of other countries.  During
1996 and 1995, fax servers represented 42% and 38%,  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, Windows NT and DOS  application  and certain
          electronic mail applications.  The Company expects to introduce client
          software for the Macintosh in the second quarter of 1997.

     o    Electronic  routing of faxes:  Electronic  routing  of faxes  enhances
          efficiency and  confidentiality  through electronic delivery direct to
          the electronic mailbox 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 $5,795.  The following table summarizes the Company's FaxPress system product
line:

                                       13.                         Page 14 of 83

<PAGE>
<TABLE>
<CAPTION>




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

                                                                                                       NetWorking
                                                                                                       Environment
                          Number        Number                                                  ------------------------
                            of        of Micro-         Memory                                   NetWare,       Windows     TCP/IP
    Product Model         Modems      processors     (Megabytes)     Network 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/Token Ring            x                         x
FaxPress 3500             2 or 4         2-3              8          Ethernet/Token Ring            x              x          x
------------------------------------------------------------------------------------------------------------------------------------

</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,  available for both Windows and DOS environments,  which
          reside on the LAN user's personal computer and are included as part of
          the  Company's  FaxPress  products.  For  the  user  who  has  already
          installed  other  third-party fax  application  software,  the Company
          offers  software that enables the user to access the  capabilities  of
          the Company's FaxPress products through such third-party  software. In
          addition,  the  Company  is  developing  an  interface  which  enables
          Macintosh  clients to send and receive faxes through FaxPress systems.
          The  Company has also  developed  utilities  that  permit  network and
          systems  administrators  to monitor  and  control  the  routing of fax
          files.

     o    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 $199 to
          $995. The following table describes the available software options:

--------------------------------------------------------------------------------
Software Option                               Description
--------------------------------------------------------------------------------
Lotus cc:Mail Gateway            Integrates   the  FaxPress   into   the cc:Mail
                                 environment, enabling users to send and receive
                                 faxes within cc:Mail.



Novell MHS Mail Gateway          Integrates  the FaxPress  into any Novell MHS-
                                 compatible    electronic    mail   application,
                                 enabling users to send and receive faxes within
                                 the electronic mail package.



Novell GroupWise Gateway         Integrates   the   FaxPress   into   Groupwise,
                                 enabling  users to  send and receive faxes from
                                 GroupWise 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 into an
Image Enhancement                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.
--------------------------------------------------------------------------------

                                       14.                         Page 15 of 83

<PAGE>

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 1996 and 1995, print servers  represented
44% 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.

     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 network (100 Base-T or
          10 Base-T) and Token Ring network.

     LANpress Product Line. 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 64 print queues on up to 16 file servers.  The suggested  U.S. list price for
LANpress print servers ranges from $379 to $719.

                                       15.                         Page 16 of 83

<PAGE>



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

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


                                 Network Topology                           Networking Environment
                           ------------------------  -----------------------------------------------------------------       Flash
         Product                             Token          NetWare          UNIX         Windows NT         Apple          Upgrade
    Configuration (1)         Ethernet        Ring       2.x, 3.x, 4.x      TCP/IP        Windows 95       Ethertalk      Capability
------------------------------------------------------------------------------------------------------------------------------------
<S>                             <C>           <C>             <C>            <C>             <C>              <C>            <C>
OfficeConnect Print (1)          x                             x              x               x                               x
LANpress 3P/100 (4)              x                             x              x               x                x              x
LANpress Jr. MP (2)              x                             x              x               x                x              x
LANpress 1P MP (3)               x                             x              x               x                x              x
LANpress 2+1 MP (4)              x             x               x              x               x                x              x
LANpress 3+1 MP (4)              x                             x              x               x                x              x
------------------------------------------------------------------------------------------------------------------------------------




(1)      2 Centronics parallel ports
(2)      Connects directly to port on Printer
(3)      1 Centronics parallel port
(4)      Numbers refer to the number of parallel and serial port connections, respectively.
</TABLE>


Fax-On-Demand

     Castelle's  fax-on-demand  product suite  consists of its flagship  system,
FactsLine  for windows,  along with  optional  advanced  modules;  FactsLine for
Windows NT; RightFAX Edition and Fax-It-Back.

     FactsLine for Windows.  Castelle's  Windows-based,  fax-on-demand  software
enables the access of  information  via a phone and a fax machine and allows the
dissemination  of information  via  "broadcasting"  to a select  database of fax
numbers. With the addition of a number of optional advanced modules and features
-- the management and  capabilities  of the FactsLine for Windows systems can be
further optimized. Key optional advanced modules and features include:

     o    Intelligent  Menus:  expands the  branching  technique of FactsLine to
          include powerful logic and analysis capability.

     o    Credit Card: allows FactsLine to verify, authorize and charge caller's
          credit cards.

     o    Application Programming Interface (API): enables FactsLine to retrieve
          information  from  another  computer and then fax or read back dynamic
          information to a caller.

     o    Aspect  Integration:  integrates  FactsLine  with  Aspect  to  provide
          powerful caller queuing,  intelligent  call routing and convenient fax
          retrieval functions.

     o    FactsLine for Notes:  merges  FactsLine  with the document  management
          capabilities of Lotus Notes.

     o    Transaction  Manager:  provides  sophisticated  management features to
          achieve  the  ultimate  performance  from  a  FactsLine  fax-on-demand
          system.

                                       16.                         Page 17 of 83

<PAGE>



     o    Fax  Description  Language:  provides a scripting  language  that adds
          graphical interest to your faxable documents.

     o    FactsLine  for the Web: an add-on to Web servers,  which allows native
          Web documents to be used as fax-on-demand documents.

     o    OpenFax:   allows  native  Windows  applications  files  on  FactsLine
          fax-on-demand systems.

     o    Fax Gateway:  allows third party programs to send fax transactions via
          the intelligent Ibex fax engine.

     InfoPress Product Family.  Castelle is developing support for the Microsoft
Windows  NT  operating  system  under  the new  InfoPress  product  family.  The
InfoPress  Fax-On-Demand module will eventually replace FactsLine for Windows as
the flagship  fax-on-demand  solution.  Since the FactsLine for Windows  product
line consists of numerous modules and added-cost  options,  complete support for
NT across the entire product line will not occur until late in 1997.

     New  Product  Line.  Infopress  will allow  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
     o    Web Delivery

     Users can update one document,  and the information  will  automatically be
available via the Web, via fax- on-demand,  or via an enhanced  auto-reply email
feature called Email-on-Demand. Web coding using HTML, Java, or CGI scripting is
not required.  Similarly, there is no fax-on-demand or mail-server configuration
needed when documents are added or deleted.

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

     The InfoPress  publishes  documents  automatically.  All document catalogs,
whether  they be an  interactive  Web page,  a  fax-on-demand  index or an email
index, 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 the Web

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

                                      17.                          Page 18 of 83
<PAGE>

     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 or two lines)  system sturdy enough
for production fax-on-demand, yet affordable and easy for non-technical staff to
use.

Small Office/Branch Office Market: The OfficeConnect Family of Products

     Castelle  has  partnered  with 3Com to develop  the  OfficeConnect  product
family  to  target  the  SOBO  marketplace.  Under  the  agreement  between  the
companies,  each party maintains proprietary rights to the products it develops.
Castelle has been  responsible  for developing the fax and print server modules,
while 3Com has been responsible for the hub unit and Integrated Services Digital
Network  ("ISDN")  dial-up  router.  Castelle  and 3Com  have  engaged  in joint
marketing activities to promote the products.  The sales and marketing personnel
of each company  have been  provided  with  technical  training and  promotional
literature by the other company and the companies have cooperated in trade shows
and other promotional  activities such as advertising and direct mail marketing.
Both the fax server and print server  modules have the same look and feel as the
3Com  OfficeConnect  products.  Castelle's  fax  server  module  is a  low-cost,
single-line,  workgroup-based fax sharing device. Castelle's print server module
has two  parallel  ports and is software  upgradeable  using flash  memory.  The
network  operating  systems  supported  by the fax server  include  NetWare  and
Windows  NT. The print  servers  also  provide  support  for UNIX and  Microsoft
peer-to-peer.

     OfficeConnect  CD-ROM  Server.  Castelle  introduced  another member to the
OfficeConnect  family.  The  OfficeConnect  CD-ROM Server began  shipping in the
fourth quarter of 1996. The CD-ROM Server is a multi-  protocol unit designed to
provide  simultaneous  network access for up to seven attached CD-ROM drives. It
offers many of the key benefits that differentiate the OfficeConnect family from
the competition,  including easy installation,  easy manageability,  reliability
and advanced  technology.  Castelle has licensed certain CD-ROM  technology from
Compact  Devices,   Inc.,  an  acknowledged   technology  leader  in  CD  Server
technology,  in order to address  key  time-to-market  objectives  with this new
product.

Products Under Development

     Hewlett-Packard Scanner Integration. In April 1996, Castelle entered into a
joint  marketing and development  relationship  with  Hewlett-Packard's  Scanner
division to integrate its FaxPress product line with Hewlett  Packard's  ScanJet
product family.  This integration allows users on a network to instantly scan in
documents,  edit  them,  and fax  them out  without  the use of  standalone  fax
machines or scanners.  This partnership is designed to provide users the benefit
of increased speed and higher quality.

                                       18.                         Page 19 of 83

<PAGE>




     FaxPress Systems. Castelle is continuing to expand and enhance its FaxPress
product line.  Ongoing  projects  include the  development of a new  intelligent
modem board that will  support up to four  33,600 bps modems.  This new board is
being  designed  to comply with the latest fax  standards  and to allow a single
FaxPress unit to support up to eight telephone lines.

     FaxPress  Software.  Castelle is currently  developing a number of software
enhancements  for  its  FaxPress  product  line  including   Microsoft  Exchange
compatibility,  an Internet  browser gateway and an improved user interface,  as
described below:

     o    Microsoft Exchange  Compatibility.  Microsoft  Exchange  compatibility
          will enable  Microsoft  Exchange users to send and receive faxes using
          the  FaxPress.  In  addition,  this  gateway  will enable  binary file
          transfer  from a  FaxPress  client to  another  FaxPress  client or an
          Exchange client.

     o    Internet  Browser  Gateway.  The  Castelle  Internet  Browser  Gateway
          software will allow the FaxPress server to respond to Hypertext Markup
          Language ("HTML")  requests.  HTML is the predominant  language of the
          World  Wide Web.  With this  server  software,  any LAN user,  whether
          connected   to  a  LAN  locally  or  as  a  mobile   user   through  a
          communications  gateway, will be able to use a World Wide Web browser,
          to access  the  FaxPress  server  "home  page fax  director"  and view
          incoming faxes or to send a fax. This gateway  capability  allows UNIX
          users  to send  and  receive  faxes,  even  though  FaxPress  does not
          presently support the UNIX operating system.

     o    User  Interface.  Castelle  continues to improve its user interface by
          adding  new  functionalities  such  as  a  more  advanced  phone  book
          structure,  the use of additional  cover pages,  greater facility when
          attaching documents for transmission and a new look and feel for wider
          user acceptance.


     InfoPress  Web  Delivery.  The  InfoPress  will  automatically  create  and
maintain Web sites for users. Navigation pages with hot links, and content pages
with the actual information content will be automatically created. The InfoPress
brings document management, version control and other management features to Web
site management.

     The Web site that this  product  creates is  intended  for  automatic  high
volume  management  and  delivery  of  documents  such  as  support  or  product
information.  It is not designed to create highly  graphical and interactive Web
pages,  although  the  automatically  created  pages can easily be linked to the
custom created pages.

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

     o    Download documents on Word Wide Web direct to Web browser

     o    Select  documents  on Web, but choose to fax them (or forward them via
          fax)

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

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

     o    Select  documents  via  telephone  keypad,  to  be  returned  via  fax
          (fax-on-demand)

Research and Development

     The  Company  was an early  entrant  into the fax server  and print  server
markets and has made substantial  investments in research and development.  Most
of the Company's early product development  initiatives was directed towards fax
server products although much of the resultant technology has application to the
further  development  of the  Company's  print  server  products.  Currently,  a

                                      19.                          Page 20 of 83
<PAGE>


significant  percentage of the Company's  research and development  expenses are
related to software development. The Company believes that its continued success
will depend in part upon its ability to enhance its existing products, introduce
new  products on a timely  basis,  maintain  compatibility  with new releases of
network  operating  systems and other relevant  software and continue to develop
technology  that can be incorporated  into products that meet changing  end-user
requirements.  The Company  intends to leverage its  proprietary  technology and
industry  expertise  into new product  offerings  that it believes  will further
enhance  network  users'  productivity.  In  addition,  the  Company  intends to
continue  to  expand  the   software   component  of  its  products  to  enhance
functionality and improve performance.

     To  facilitate  product  development,  the Company  works  closely with its
end-users,  VARs,  distributors and strategic  partners to identify market needs
and define product  specifications early in the development process. In order to
develop  products  successfully,  the Company is dependent  on timely  access to
information about new developments in the marketplace. 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 competitors.

Sales, Marketing and Distribution

     Castelle  sells its products  through  multiple  channels  depending on 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 Ricoh and  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 expanding its distribution network in
North America,  Europe,  the  Asia-Pacific  and Latin America  regions and other
markets  in order  to  capitalize  on the  anticipated  growth  in LANs in these
regions.  The Company's European  headquarters in the Netherlands provides sales
and support services to a distributor  network covering most European countries,
with a primary emphasis on Germany and 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 63% of
the Company's net sales in 1996 and 62% of its net sales in 1995.  Macnica,  the
Company's  principal  Japanese  distributor,  and Ingram  Micro,  the  Company's
largest  domestic   distributor,   accounted  for  approximately  30%  and  14%,
respectively,  of the Company's net sales in 1996 and 26% and 16%, respectively,
of its net sales in 1995.  Sales to  customers  located in the  Pacific  Rim and
Europe made up approximately  49% and 48% of the Company's net sales in 1996 and
1995, respectively.  The Pacific Rim has been the fastest growing sector for the
Company  primarily due to strong market growth and a relationship  with Macnica.
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

                                      20.                          Page 21 of 83
<PAGE>

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  which 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.

Customer Service and Support

     The Company's customers require 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  pertinent  facts.  The Company is also  implementing  other  customer
support activities,  including a World Wide Web site as well as an internal help
desk  system.  The  Company's  technical  support  is  also  accessible  through
CompuServe.

Competition

     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  may  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 Hewlett-Packard and 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 may experience increasing competition from
companies  such as Symantec and Computer  Associates.  There can be no assurance
that  competitors  will not introduce  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

                                      21.                          Page 22 of 83
<PAGE>

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" and "Business -- Competition."

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   and  sourcing
documentation  and 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  Token
Ring  interface  modules  from  Silcom,  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.  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.

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

                                      22.                          Page 23 of 83
<PAGE>

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  which 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 and operating results.

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,  could
adversely affect the Company's business and operating results.  In addition,  if
the  Company  were unable to obtain  regulatory  approvals  within a  reasonable
period of time, the Company's operating results could be adversely affected. 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  materially  and  adversely  affect the  Company's  operating
results.

Employees

     As of December  31,  1996,  the Company  employed a total of 122  full-time
equivalent  personnel,  28 in  manufacturing,  34 in sales and marketing,  30 in
engineering,  15 in customer  service and 15 in finance and  administration.  In
addition,  the Company  employs  people on a part-time  or contract  basis.  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

                                      23.                          Page 24 of 83
<PAGE>

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.

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 which
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,
Germany 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 SECURITY HOLDERS

     A special meeting of shareholders was held November 19,1996.

     A proposal to approve and adopt the  Agreement  and Plan of  Reorganization
dated as of August 22, 1996 (the "Merger Agreement"),  among Castelle,  Ibex and
certain  shareholders  of Ibex,  and to approve  the merger  (the  "Merger")  of
Castelle with and into Ibex pursuant to the Merger Agreement and the issuance of
Common  Stock in the Merger was  approved  by the  shareholders.  This  proposal
received the following votes:

                  For:             2,264,277
                  Against:               318
                  Abstain:                 0

     As a result of the Merger,  Ibex  shareholders  received 4.029796 shares of
Castelle Common Stock for each share of Ibex Common Stock and Ibex  shareholders
received  5.029796  shares  of  Castelle  Common  Stock  for each  share of Ibex
preferred stock, and Ibex merged into Castelle.

     The  stockholders  elected the Board's  nominees as  directors by the votes
indicated:

         Nominee                  Votes in Favor             Votes Withheld

         Arthur H. Bruno            2,264,580                      15
         John Freidenrich           2,264,580                      15
         Alan Kessman               2,264,580                      15
         Kanwal S. Rekhi            2,264,580                      15
         Delbert W. Yocam           2,264,580                      15

     The  selection of Coopers & Lybrand  L.L.P.  as the  Company's  independent
auditors  was  ratified  with  2,264,595   votes  in  favor,  0  against  and  0
abstentions.

                                       24.                         Page 25 of 83

<PAGE>



                                     PART II


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

     The  Company's  Common Stock  (Nasdaq  symbol  "CSTL") began trading on the
over-the-counter market through the Nasdaq National Market on December 20, 1995.
The  following  table  presents  information  during  fiscal 1996 and the fourth
quarter  of  fiscal  1995 on the  price  range of the  Company's  Common  Stock,
indicating  the high and the low sale  prices  reported  by the Nasdaq  National
Market. These prices do not include retail markups, markdowns or commissions.

FISCAL 1995                       HIGH                  LOW
Fourth Quarter                   $7-3/4              $6-15/16

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


     As of December 31,  1996,  there were 139 holders of the  Company's  Common
Stock,  which  does not  include  those who held in street or nominee  name.  On
February 28, 1997,  the last sale price reported on the Nasdaq  National  Market
for the Company's Common Stock was $7-1/8 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.

ITEM 6.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
             RESULTS OF OPERATIONS

     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 in this section as well as in
the section entitled "Business - Risk Factors."

Results of Operations

     Net sales  increased  16% to $32.7  million in 1996 from  $28.2  million in
1995.  The  increase in net sales  resulted  primarily  from higher sales of the
Company's fax server  products.  Fax server  product  sales  increased by 28% to
$13.8 million in 1996 from $10.8 million during 1995. Net sales increased 27% in
1995 to $28.2 million from $22.2 million in 1994.  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 $15.9 million, $13.5 million and $8.3 million in
1996, 1995 and 1994, respectively,  representing 49%, 48% and 37%, respectively,
of net sales in 1996, 1995 and 1994.  These increases are due primarily to sales
growth in the Pacific Rim region.  Although all of the  Company's  international
sales  to date  have  been  determined  in U.S.  dollars,  such  sales  could be
adversely  affected by changes in demand resulting from fluctuations in currency
exchange rates.

                                       25.                         Page 26 of 83

<PAGE>

     Cost of sales includes cost of materials,  including  components,  manuals,
diskettes and their duplication,  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 $15.6 million,  $14.3 million and $12.2 million in
1996, 1995 and 1994, respectively, and represented 48%, 51% and 55% of net sales
for those years.  Cost of sales has increased in absolute  dollars but decreased
as a  percentage  of net sales from 1994 to 1996.  This  percentage  decrease is
primarily  attributable to changes in product mix towards a higher proportion of
net  sales  derived  from  fax  server  products  as well as  manufacturing  and
purchasing efficiencies realized from higher volume operations.

     Research and development expenses were $3.0 million,  $2.7 million and $2.6
million in 1996,  1995 and 1994,  respectively.  Most of the  Company's  product
development  efforts  during these periods were focused on fax server  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  development   expenses  is  related  to  software
development.  The Company  anticipates  that the dollar  amount of research  and
development  expenses will increase in the future as a result of its  continuing
commitment to the development of new products.

     Sales and  marketing  expenses  were $8.7  million,  $7.0  million and $5.4
million for 1996, 1995 and 1994, respectively,  and represented 27%, 25% and 24%
of net sales for those periods.  Sales and marketing  expenses have continued to
increase in  absolute  dollars,  as well as a  percentage  of net sales,  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 better support  customers  using the Company's
products.

     General  and  administrative  expenses  were  relatively  constant  at $1.9
million, $1.7 million and $1.7 million for 1996, 1995 and 1994, respectively, or
6%, 6% and 8% of net sales for those periods.

     During the year, the Company  incurred  expenses of $1.4 million to acquire
Ibex  Technologies,  Inc., a leading  supplier of  fax-on-demand  software.  For
further information, see the Company's Form S-4 (Registration No. 333-14815), as
filed with the Securities and Exchange Commission on October 24, 1996.

     Net  interest  income was $341,000 in 1996,  and net  interest  expense was
$304,000 and $481,000 in 1995 and 1994,  respectively.  The increase in interest
income in 1996 was due  primarily  to  interest  earned on  investment  balances
related to funds generated by the Company's  initial public offering in December
1995 and the decrease in interest expense  resulting from retiring the Company's
outstanding  debt during 1996. The decrease in interest expense in 1995 relative
to 1994 was due to reductions in the Company's debt.

     The Company  recorded a benefit  from income  taxes in 1996 of $3.4 million
and  provisions  for  income  tax in 1995  and  1994 of  $69,000  and  $121,000,
respectively.  In 1996, in  accordance  with  Statement of Financial  Accounting
Standard No. 109,  "Accounting for Income Taxes," the Company recorded an income
tax benefit of $4.2 million,  reflecting 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 8 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  issuances of capital  stock and bank
borrowings. Cash flows from operations were $398,000, $3.2 million and $3,000 in
1996,  1995 and 1994,  respectively.  Castelle  acquired  capital  equipment  of
$425,000, $241,000 and $446,000 in 1996, 1995 and 1994, respectively.

     As of December  31,  1996,  the  Company had $8.2  million of cash and cash
equivalents.  Working  capital  increased to $13.2  million at December 31, 1996
from $9.4 million at December 31, 1995.  The Company has a $6.0 million  secured
revolving  line of credit  with a bank which  expires in June 1997,  pursuant to
which the Company may borrow 75% of eligible domestic accounts receivable at the

                                       26.                         Page 27 of 83
<PAGE>

bank's  prime  rate.  As of December  31,  1996 the  Company had no  outstanding
borrowings  under this line of  credit.  In  addition,  the  Company  has a $3.0
million foreign  accounts  receivable and inventory line of credit which is part
of the overall $6.0 million  commitment.  The Company may borrow 90% of eligible
accounts  receivable  and 40% of  eligible  inventory.  Under  the  terms of the
agreement, the Company is required to comply with covenants, including a certain
minimum  quick ratio and  tangible  net worth and maximum  debt to tangible  net
worth,  is prohibited  from paying cash  dividends and is also  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 these covenants and at December 31, 1996 has no borrowings
under the line of credit.

     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.

ITEM 7.   FINANCIAL STATEMENTS

     The  following  financial  statements  of the Company and the report of the
Company's independent accountants are included in Item 13:

               Report  of  Coopers  & Lybrand  L.L.P.,  Independent  Accountants
               Consolidated Balance Sheets as of December 31, 1996 and 1995
               Consolidated   Statements  of  Operations  for  the  years  ended
               December  31,  1996,  1995  and 1994
               Consolidated  Statement of Shareholders' Equity  for the years
               ended  December  31,  1996,  1995 and 1994
               Consolidated  Statements  of  Cash  Flows  for  the  years  ended
               December 31, 1996, 1995 and 1994
               Notes to Consolidated  Financial Statements

ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

     Not applicable.


                                       27.                         Page 28 of 83

<PAGE>



                                    PART III


ITEM 9.      DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
             COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Identification of Directors and Executive Officers.

     The names of the directors  and  executive  officers and of the Company and
their ages as of February 28, 1997 are set forth below:

Name                      Age    Position
Arthur H. Bruno           63     Chairman of the Board, Chief Executive Officer,
                                 President and Director
Jerome J. Burke           56     Executive Vice President
Randall I. Bambrough      41     Chief Financial Officer, Vice President of
                                 Finance and Administration and Secretary
John Freidenrich (1)      59     Director
Alan Kessman (2)          50     Director
Kanwal S. Rekhi (1)       50     Director

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

(1)      Member of Compensation Committee of the Board of Directors.
(2)      Member of Audit Committee of the Board of Directors.

Arthur H. Bruno

     Mr. Bruno has served as the Company's Chairman, Chief Executive Officer and
President  since  October  1993.  From 1991 to 1993,  he was  Chairman and Chief
Executive Officer of White Pine Software Inc., a desktop  connectivity  company.
From 1989 to 1991, he was the Chairman and Chief  Executive  Officer of Wellsley
Medical Management  Corporation,  a primary care medical service provider.  From
1986 to  1989,  he was the  Chairman  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 and has served as the Company's Executive Vice
President  since December 1993.  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, in various financial management positions.

                                       28.                         Page 29 of 83

<PAGE>



John Freidenrich

     Mr. Freidenrich has served as a director of the Company since January 1994.
Since 1981, he has been a general partner of various entities established by Bay
Partners,  a venture  capital  group.  Currently,  Mr.  Freidenrich is a general
partner of Bay  Management  and Bay  Management  Company IV,  L.P.,  the general
partner of Bay Partners III, L.P. and Bay Partners IV, L.P.,  respectively.  Mr.
Freidenrich  was also a partner  in, or of  counsel  to, the law firms of Ware &
Freidenrich or Gray, Cary, Ware & Freidenrich from January 1987 through December
1991.

Alan Kessman

     Mr.  Kessman has served as a director of the Company  since April 1992.  He
has also served as Chairman of the Board, President, and Chief Executive Officer
of Executone  Information  Systems,  Inc., a telecommunications  company,  since
August 1983.

Kanwal S. Rekhi

     Mr.  Rekhi has  served as a  director  of the  Company  since  April  1995.
Currently retired,  Mr. Rekhi served as Executive Vice President of Novell, Inc.
from June 1989  through  January  1995.  Mr.  Rekhi also served as a director of
Novell,  Inc.  from  June 1989  through  August  1995,  as a  director  of Gupta
Corporation  from  June  1990  through  September  1996  and  as a  director  of
CyberMedia, Inc., since September 1995.

Other Key Employees

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

     Ariel  Bialik  joined the  Company in January  1990 as Manager of  Software
Engineering and has served since 1993 as Director of Software Development. While
at  Castelle,  Mr.  Bialik has  managed all  software  product  development  and
maintenance  activities and assisted in establishing the technology direction of
the Company. Prior to joining Castelle, Mr. Bialik was a member of the technical
staff at Daisy  Systems,  Inc.  Mr.  Bialik holds a B.Sc.  degree in  Electrical
Engineering from the Technion Israel Institute of Technology.

     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.

     Curtis Powell has served as Vice  President of Development of the Company's
Ibex division since the acquisition of Ibex by the Company in November 1996. Mr.
Powell was a  co-founder  of Ibex in 1989,  and served as its Vice  President of
Development  from 1990 through the  Company's  merger with and into  Castelle in
1996.  From  1987  to  1989,  Mr.  Powell  was a  Senior  Software  Engineer  at
Heuristics,  Inc.,  and from 1986 to 1987 was a system analyst at the University

                                      29.                          Page 30 of 83

<PAGE>

of  California,   Davis  and  specialized  in  process  control  and  industrial
automation.  Mr.  Powell  holds  a Ph.D  and  an  MBA  from  the  University  of
California, Davis.

Compliance with Section 16(a) of the Securities Exchange Act of 1934.

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file with the Commission
initial reports of ownership and reports of changes in ownership of Common Stock
and other equity securities of the Company. Officers, directors and greater than
ten percent  shareholders  are required by Commission  regulation to furnish the
Company with copies of all Section 16(a) forms they file.

     To the Company's knowledge,  based solely on a review of the copies of such
reports furnished to the Company and representations  that no other reports were
required,  during the fiscal year ended  December  31, 1996,  all Section  16(a)
filing requirements  applicable to its officers,  directors and greater than ten
percent beneficial owners were complied with.

ITEM 10.  EXECUTIVE COMPENSATION

Compensation of Directors

     Directors currently receive no cash compensation from the Company for their
services as members of the Board of Directors.  They are  reimbursed for certain
expenses in connection with attendance at Board and Committee meetings.

     The Company has adopted the 1995 Non-Employee  Directors' Stock Option Plan
(the  "Directors'  Plan") to  provide  for the  automatic  grant of  options  to
purchase  shares of  Common  Stock to  eligible  non-employee  directors  of the
Company and to each  eligible  director of the Company who joins the Board after
the date of the adoption of the Directors' Plan.

     On April 1, 1996,  pursuant to the Directors' Plan, John Freidenrich,  Alan
Kessman and Kanwal S. Rekhi were each granted an option to purchase 2,000 shares
of Common  Stock at an exercise  price of $8.00.  The options  will vest ratably
over two years.

                                       30.                         Page 31 of 83

<PAGE>



Compensation of Executive Officers

     Summary of Compensation

     The  following  table shows for the fiscal  years ended  December 31, 1996,
1995 and 1994,  compensation  awarded or paid to, or earned  by,  the  Company's
Chief  Executive  Officer and its other  executive  officers  whose total annual
salary and bonus exceeded $100,000 (the "Named Executive Officers"):

                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>

                                                                            Annual
                                                                         Compensation
                                             --------------------------------------------------------------------

                                                                                                Other
      Name and Principal                            Salary               Bonus                  Annual              Long-Term
           Position                  Year             ($)                 ($)               Compensation($)       Compensation
-------------------------------   -------      -----------------   -----------------        ---------------       ------------

<S>                                  <C>           <C>                  <C>                            <C>                   <C>
Arthur H. Bruno,                     1996          176,538              50,000                         --                    --
Chairman of the Board,               1995          180,000               7,500                         --                    --
President, Chief Executive           1994          180,000                 -0-                         --                    --
Officer and Director

Randall I. Bambrough                 1996          112,188              10,000                         --                    --
Chief Financial Officer,             1995           92,298                 581
Vice President of Finance            1994           81,988              14,654
and Administration and
Secretary

Jerome J. Burke                      1996          124,578          120,720(1)                         --                    --
Executive Vice President             1995          117,385              60,909                         --                    --
                                     1994          120,000           26,559(2)                         --                    --

</TABLE>

(1)  Represents  bonus and sales  commissions paid by the Company for sales made
     in 1996.
(2)  Represents  sales  commissions  paid by the Company for sales made in 1994.


     Stock Option Grants and Exercises

     The Company grants options to its executive  officers under its 1988 Equity
Incentive Plan (the "1988 Plan"). As of February 28, 1997, options to purchase a
total of 418,124  shares had been  granted and were  outstanding  under the 1988
Plan and 225,700 shares remained available for grant thereunder.

     There  were no stock  option  exercises  during  fiscal  1996 by any  Named
Executive Officer.

                                       31.                         Page 32 of 83

<PAGE>



     The  following  tables show for the fiscal year ended  December  31,  1996,
certain information regarding options granted to, exercised by, and held at year
end by the Named Executive Officers:

<TABLE>
<CAPTION>

                                              Option Grants In Last Fiscal Year


                                                      Individual Grants

                                                       %
                                 Number of         of Total
                                Securities          Options
                                Underlying          Granted         Exercise
                                  Options          in Fiscal          Price            Expiration
                Name              Granted           Year(1)       Per Share(2)            Date


<S>                                   <C>             <C>            <C>                 <C>

Arthur H. Bruno
  Chairman and Chief
  Executive Officer                   --               --             --                  --

Randall I. Bambrough
  Chief Financial Officer,
Vice
  President of Finance and
  Administration and
Secretary                           5,000             3.4%           $7.75            04/17/03

Jerome J. Burke
  Executive Vice President            --               --             --                 --

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

(1)  Based on an aggregate of 149,000 options granted to employees and directors
     of the Company in fiscal 1996 including the Named Executive  Officer as set
     forth in the "Summary  Compensation Table" above and directors set forth in
     "Director Compensation" above.

(2)  The exercise  price is equal to 100% of the fair market value of the Common
     Stock at the date of grant.


                                       32.                         Page 33 of 83

<PAGE>



ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth certain information  regarding the ownership
of the  Company's  Common Stock as of February  28, 1997 by: (i) each  director;
(ii) each executive officer named in the Summary  Compensation  Table; (iii) all
executive  officers and directors of the Company as a group;  and (iv) all those
known by the Company to be  beneficial  owners of more than five  percent of its
Common Stock.

Beneficial Owner                                     Beneficial Ownership (1)

                                                          Number        Percent
                                                        of Shares       of Total

Entities Affiliated with                                 959,348           20.8%
  Hambrecht & Quist Group (2)
  One Bush Street
  18th Floor
  San Francisco, CA 94104

Entities Affiliated with                                 386,454            8.7%
  Bay Partners (3)
  10600 North DeAnza Blvd.
  Suite 100
  Cupertino, CA 95014

Wellington Management Company, LLP                       237,000            5.3%
  75 State Street
  Boston, MA 02109

Arthur H. Bruno (4)                                      142,250            3.2%
  c/o Castelle
  3255-3 Scott Boulevard
  Santa Clara, CA 95054

Randall I. Bambrough (5)                                  12,741               *

Jerome J. Burke                                           73,565            1.7%

John Freidenrich (6)                                     397,453            9.0%

Alan Kessman (7)                                           5,558               *

Kanwal S. Rekhi (8)                                       14,948               *

All directors and executive officers as a group          646,515           14.5%
(6 persons) (3)(4)(5)(6)(7)(8)



* Less than one percent.

(1)  This table is based upon  information  supplied by officers,  directors and
     principal  shareholders and Schedules 13D and 13G filed with the Securities
     and Exchange  Commission  (the "SEC").  Unless  otherwise  indicated in the
     footnotes  to this  table and  subject  to  community  property  laws where
     applicable,  the Company  believes that each of the  shareholders  named in
     this table has sole voting and investment  power with respect to the shares
     indicated  as  beneficially  owned.  Applicable  percentages  are  based on
     4,437,839 shares outstanding on February 28, 1997,  adjusted as required by
     rules promulgated by the SEC.

(2)  Includes  60,835 shares held by each of H & Q Ventures  International  C.V.
     and H & Q Ventures IV, 338,480 shares (and warrants  exercisable  within 60
     days for 16,666 shares) held by H & Q London Ventures, 1,250 shares held by
     Hamquist,  832  shares  held by  Hambrecht  &  Quist  Venture  Partners,  a
     California  Limited  Partnership,  182,517  shares  held  by  Ivory  & Sime

                                      33.                          Page 34 of 83
<PAGE>

     Enterprise  Capital PLC, 85,536 shares (and warrants  exercisable within 60
     days for 16,666 shares) held by Hambrecht & Quist Group, 45,232 shares held
     by the  Hambrecht  1980  Revocable  Trust,  and 499 shares of Common  stock
     subject to  options  exercisable  within 60 days of  February  28,  1997 by
     William  Hambrecht,  warrants  exercisable within 60 days for 70,000 shares
     held by Hambrecht & Quist Liquidating Trust, warrants exercisable within 60
     days for 30,000  shares  held by  Guaranty  Finance  Management  Corp.  and
     warrants  exercisable  within  60  days  for  50,000  shares  held  by  RVR
     Securities.

(3)  Includes 15,453 shares held by California BPIV,  L.P.,  193,231 shares held
     by Bay  Partners  III and  177,770  shares  held by Bay  Partners  IV. John
     Freidenrich, a director of the Company, and John Bosch are general partners
     of California  BPIV,  L.P.,  and of Bay  Management  Company,  L.P. and Bay
     Management  Company IV, L.P., the general  partners of Bay Partners III and
     Bay Partners IV. Neal Dempsey is a general partner of California BPIV, L.P.
     and Bay  Management  Company IV, L.P. In such  capacities,  Messrs.  Bosch,
     Dempsey and Freidenrich have shared voting and investment power over shares
     of the Company's  Common Stock held by California BP IV, L.P., Bay Partners
     III and Bay Partners  IV. They  disclaim  beneficial  ownership as to these
     shares,  except  to the  extent  of their  respective  pecuniary  interests
     therein.

(4)  Includes 10,000 shares of Common Stock held by Mr. Bruno's wife.

(5)  Includes  12,041  shares of Common  Stock  subject to  options  exercisable
     within 60 days of February 28, 1997 and 200 shares held by Mr.  Bambrough's
     daughter.

(6)  Includes 15,453 shares held by California BP IV, L.P.,  193,231 shares held
     by Bay  Partners  III and  177,770  shares  held by Bay  Partners  IV. John
     Freidenrich,  a director of the Company,  and general partner of California
     BP IV, L.P. and of Bay Management Company,  L.P. and Bay Management Company
     IV, L.P., the general partners of Bay Partners III and Bay Partners IV. Mr.
     Freidenrich  disclaims beneficial  ownership as to these shares,  except to
     the extent of their respective  pecuniary interests therein.  Also includes
     10,000 shares held by the Freidenrich Family Trust and 999 shares of Common
     Stock subject to options exercisable within 60 days of February 28, 1997.

(7)  Includes 999 shares of Common Stock subject to options  exercisable  within
     60 days of February 28, 1997.

(8)  Includes  14,948  shares of Common  Stock  subject to  options  exercisable
     within 60 days of February 28, 1997.

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Executive Officer Stock Purchases and Option Grants

     Arthur H. Bruno, Chairman of the Board, Chief Executive Officer,  President
and a director of Castelle,  purchased 35,000 shares of Castelle's  Common Stock
at  $5.00  per  share  in April  1995.  The  shares  are  subject  to a right of
repurchase in favor of Castelle which expires  ratably over four years and which
are  exercisable  if Mr.  Bruno's  relationship  with  Castelle  terminates.  On
February 12, 1997,  the Company  granted Mr. Bruno an option to purchase  45,000
shares of the  Company's  Common Stock at an exercise  price of $5.75 per share.
The options will vest ratably over two years.

     Jerome J. Burke,  Executive  Vice President of Castelle,  purchased  17,500
shares at $5.00 per share in April  1995.  The shares are  subject to a right of
repurchase in favor of Castelle which expires  ratably over four years and which
are  exercisable  if Mr.  Burke's  relationship  with  Castelle  terminates.  On
February 12, 1997,  the Company  granted Mr. Burke an option to purchase  30,000
shares of the  Company's  Common Stock at an exercise  price of $5.75 per share.
The options will vest ratably over two years.

                                       34.                         Page 35 of 83

<PAGE>


<TABLE>
<CAPTION>
<S>                                                                                                                <C>

                                     PART IV

ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K

         (a)      Index to Financial Statements
                                                                                                                  Page in
                                                                                                                 Form 10-KSB

                  Report of Independent Accountants.............................................................    F-1
                  Consolidated Balance Sheets as of December 31, 1996 and 1995..................................    F-2
                  Consolidated Statements of Operations for the years ended
                       December 31, 1996, 1995 and 1994.........................................................    F-3
                  Consolidated Statement of Shareholders' Equity for the years ended
                       December 31, 1996, 1995 and 1994.........................................................    F-4
                  Consolidated Statements of Cash Flows for the years ended
                       December 31, 1996, 1995 and 1994.........................................................    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.
                   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.
------------------
</TABLE>

(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-B.

                                       35.                         Page 36 of 83

<PAGE>

<TABLE>
<CAPTION>

<S>                                                                                                  <C>
                  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.
                  11.1          Computation of Net Income (Loss) Per Share.
                  24.1          Consent of Coopers & Lybrand L.L.P. (reference is made to page 60).
                  25.1          Power of Attorney.  Reference is made to the signature page.

         (c)      The following reports on Form 8-K were filed for the quarter ended December 31, 1996:

                  The  Company  filed a Form 8-K dated  August 22, 1996 with the
         Securities  and  Exchange  Commission  and  reported  under  Item 5 the
         execution  of an  Agreement  and Plan of Merger  pursuant to which Ibex
         Technologies,  Inc.  would be  merged  with and into the  Company  (the
         "Agreement").  Under Item 7 of the Form 8-K the Company filed a copy of
         the Agreement and a copy of the press release announcing the merger.

                  The Company filed a Form 8-K dated  November 21, 1996 with the
         Securities  and  Exchange  Commission  and  reported  under  Item 2 the
         consummation of the merger of Ibex Technologies, Inc. with and into the
         Company  pursuant  to the  Agreement.  Under Item 7 of the Form 8-K the
         Company filed a copy of the press release announcing the merger and the
         consent  of the  Company's  auditors  to the  filing  of the  following
         audited financial statements of Ibex Technologies,  Inc.,  incorporated
         by reference to the Company's  Form S-4  (Registration  No.  333-14815)
         filed on October 24, 1996:

                         (i)        Balance Sheets at December 31, 1995 and December 31, 1994.

                        (ii)        Statement of Operations for the years ended December 31, 1995 and
                                    December 31, 1994.

                       (iii)        Statements of Changes in Shareholders' Equity for the years ended December 31,
                                    1995 and December 31, 1994.

                        (iv)        Statements of Cash Flows for the years ended December 31, 1995 and
                                    December 31, 1994.

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

(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.

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

                                       36.                         Page 37 of 83

<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, 1996 and 1995,  and the related  consolidated
statements of  operations,  shareholders'  equity and cash flows for each of the
three years in the period ended December 31, 1996.  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, 1996 and 1995, and the results of
their  operations and their cash flows for each of the three years in the period
ended  December 31, 1996,  in  conformity  with  generally  accepted  accounting
principles.



Coopers & Lybrand, L.L.P.


San Jose, California
February 9, 1997

                                      F-1                          Page 38 of 83

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

                                                                                                  December 31,
                                                                                        --------------------------------
                                  ASSETS                                                    1996               1995
                                                                                        -------------      -------------

   Current assets:
<S>                                                                                     <C>                 <C>
         Cash and cash equivalents                                                      $      8,161        $     7,406
         Accounts receivable, net of allowance for doubtful accounts
         of $467 in 1996 and $429 in 1995                                                      5,783              3,380
         Inventories                                                                           2,841              3,678
         Prepaid expenses and other current assets                                               626                550
         Deferred income taxes                                                                 1,439                 71
                                                                                        -------------      -------------
                                       Total current assets                                   18,850             15,085

   Property and equipment, net                                                                   593                448
   Other, net                                                                                     84                120
   Deferred income taxes                                                                       2,860                  -
                                                                                        -------------      -------------
                              Total assets                                              $     22,387        $    15,653
                                                                                        =============      =============

                               LIABILITIES

   Current liabilities:
                 Long-term debt, current portion                                        $          -        $       268
         Accounts payable                                                                      1,862              2,772
         Accrued liabilities                                                                   3,825              2,603
                                                                                        -------------      -------------
                                       Total current liabilities                               5,687              5,643

   Other long-term liabilities                                                                                       21
                                                                                        -------------      -------------
                                       Total liabilities                                       5,687              5,664
                                                                                        -------------      -------------

   Commitments (Note 4)

                           SHAREHOLDERS' EQUITY

   Preferred stock, no par value:
          Authorized:  2,000 shares in 1996 and 1995
          Issued and outstanding:  no shares in 1996 and 1995

   Common stock, no par value:
          Authorized:  25,000 shares
          Issued and outstanding: 4,440 shares in 1996 and 4,267 shares
          in 1995                                                                             23,698             22,713
   Notes receivable for purchase of common stock                                                (296)              (379)
   Accumulated deficit                                                                        (6,702)           (12,345)
                                                                                        -------------      -------------
                                       Total shareholders' equity                             16,700              9,989
                                                                                        -------------      -------------
                     Total liabilities and shareholders' equity                          $    22,387        $    15,653
                                                                                        =============      =============
</TABLE>
   The accompanying notes are an integral part of these financial statements.
                                      F-2                          Page 39 of 83

<PAGE>


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


<TABLE>
<CAPTION>


                                                                        Years Ended December 31,
                                                               ------------------------------------------
                                                                   1996           1995           1994
                                                               ------------   ------------   ------------

<S>                                                             <C>            <C>            <C>
   Net sales                                                    $    32,725    $    28,173    $    22,194
   Cost of sales                                                     15,609         14,303         12,194
                                                               ------------   ------------   ------------
                Gross profit                                         17,116         13,870         10,000
                                                               ------------   ------------   ------------

   Operating expenses:
       Research and development                                       2,986          2,666          2,611
       Sales and marketing                                            8,694          7,032          5,372
       General and administrative                                     1,930          1,667          1,702
       Acquisition costs                                              1,430
                                                               ------------   ------------   ------------
                                                                     15,040         11,365          9,685
                                                               ------------   ------------   ------------
                Operating  income                                     2,076          2,505            315

   Interest income (expense), net                                       341           (304)          (481)
   Other  income (expense), net                                        (130)           (49)           121
                                                               ------------   ------------   ------------

                Income (loss)  before (benefit from)
                provision for income taxes                            2,287          2,152            (45)

    (Benefit from) provision for income taxes                        (3,356)            69            121
                                                               ------------   ------------   ------------

                                                                $     5,643    $     2,083    $      (166)
   Net income (loss)
                                                               ============   ============   ============

   Net income (loss) per share                                  $      1.20    $      0.59    $     (0.17)
                                                               ============   ============   ============

   Shares used in per share calculation                               4,702          3,519            949
                                                               ============   ============   ============
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                      F-3                          Page 40 of 83
<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, 1994, as
 previously reported                     19,339     $ 12,911          312   $   237        $ (111)      $   (14,301)        $(1,264)
 Adjustments in connection with
 pooling of interests                                                 775       356                              39             395
 Balances, January 1, 1994, as restated  19,339       12,911        1,087       593          (111)          (14,262)           (869)
    Issuance of Series E preferred
    stock, net of issuance costs          3,010        2,949                                                                  2,949
    Issuance of common stock warrants                                            20                                              20
    Issuance of common stock
    through exercise of purchase rights                               154        31           (31)                                -
    Other                                                                        28                                              28
    Repurchase of common stock                                        (13)      (12)           12                                 -
    Net loss                                                                                                   (166)           (166)
                                         ------       ------       ------    ------        ------        ----------          ------
 Balances, December 31, 1994             22,349       15,860        1,228       660          (130)          (14,428)          1,962
    Issuance of common stock through:
       Exercise of stock options                                       25        35                                              35
       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                                                                                                2,083           2,083
                                         ------       ------       ------    ------        ------        ----------          ------
 Balances, December 31, 1995                  -            -        4,267    22,713          (379)          (12,345)          9,989
    Issuance of common stock through:
       Exercise of stock options                                       23        10                                              10
       Exercise of underwriter's
       overallotment option                                           150       976                                             976
    Repurchase of common stock                                                   (1)                                             (1)
    Repayment of notes receivable                                                              83                                83
    Net income                                                                                                5,643           5,643
                                         ------       ------       ------    ------        ------        ----------          ------
 Balances, December 31, 1996                  -     $      -        4,440  $ 23,698       $  (296)         $ (6,702)       $ 16,700
                                         ======       ======       ======    ======        ======        ==========          ======

</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                      F-4                          Page 41 of 83
<PAGE>
                            CASTELLE AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                      -----
<TABLE>
<CAPTION>

                                                                                         Year Ended December 31,
                                                                                ------------------------------------------
                                                                                   1996           1995            1994
                                                                                -----------   ------------   -------------
Cash flows from operating activities:
<S>                                                                              <C>           <C>             <C>
    Net income  (loss)                                                           $    5,643    $     2,083     $      (166)
    Adjustments to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
       Depreciation and amortization                                                    330            631             919
       Loss on disposition of property and equipment                                                    12
       Research and development expenses paid by issuance of
       stock and a note                                                                                178
       Provision for doubtful accounts                                                  171             53             259
       Provision for excess and obsolete inventory                                       29            323             279
       Changes in assets and liabilities:
          Accounts receivable                                                        (2,574)          (976)           (643)
          Inventories                                                                   808         (1,222)           (197)
          Prepaid expenses and other current assets                                      (5)          (227)            (13)
          Accounts payable                                                             (910)         1,636            (370)
          Accrued liabilities and other liabilities                                   1,205            704             (47)
          Deferred income taxes                                                      (4,299)             1             (18)
                                                                                -----------   ------------   -------------
             Net cash provided by operating activities                                  398          3,196               3
                                                                                -----------   ------------   -------------

Cash flows from investing activities:
    Acquisition of property and equipment                                              (425)         (241)            (446)
    Capitalization of software development costs                                                                       (12)
    Acquisition of intangible assets                                                    (14)                           (59)
    (Increase) decrease in other assets                                                               (24)              35
                                                                                -----------   ------------   -------------

             Net cash used in investing activities                                     (439)         (265)            (482)
                                                                                -----------   ------------   -------------

Cash flows from financing activities:
    (Increase) decrease in restricted cash                                                            426             (426)
    Repayment of notes payable                                                         (241)       (1,198)          (1,036)
    Proceeds from bank borrowings                                                                  19,035           15,784
    Repayment of bank borrowings                                                                  (20,639)         (17,292)
    Principal payments on capitalized leases                                            (31)          (44)             (47)
    Proceeds from issuance of preferred stock, net of issuance costs                                                 2,566
    Proceeds from collection of note receivable for stock                                83
    Proceeds from issuance of common stock and warrants, net of repurchases             985         5,899               20
                                                                                -----------   ------------   -------------

             Net cash provided by (used in) financing activities                        796         3,479             (431)
                                                                                -----------   ------------   -------------

Net increase (decrease) in cash and cash equivalents                                    755         6,410             (910)

Cash and cash equivalents at beginning of period                                      7,406           996            1,906
                                                                                -----------   ------------   -------------

Cash and cash equivalents at end of period                                      $     8,161   $     7,406    $         996
                                                                                ===========   ============   =============
Supplemental information:
    Cash paid during the period for:
       Interest                                                                 $         8   $       225     $        478
       Income taxes                                                             $        86   $       204     $         39
    Noncash investing and financing activities:
       Conversion of notes payable to shareholders to preferred stock                                         $        383
       Issuance of common stock in exchange for notes receivable                              $       263     $         31
       Repurchase of common stock in exchange for notes receivable                            $        14     $         12
       Cancellation of license prepayment and related accrued liability                                       $        500
       Issuance of common stock on conversion of preferred stock                              $    15,860
       Issuance of a note and common stock for purchase of
       development rights for a software product                                              $       178
       Sales of software products in exchange for computer
       software, marketing, advertising and telephone services                                $        59     $         24
       Conversion of preferred stock to common stock in
       connection with merger                                                   $       300
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                      F-5                          Page 42 of 83
<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,  FactsLine  fax-on-demand
     software and LANpress print servers.  The Company  distributes its products
     primarily  through a  two-tier,  domestic  and  international  distribution
     network,  with its distributors  selling Castelle's products to value-added
     resellers, system integrators,  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:

     Pooling of Interests:

     On November 20, 1996, the Company issued 790,617 shares of its common stock
     in exchange for all of the outstanding  common stock of Ibex  Technologies,
     Inc (Ibex). In addition, outstanding Ibex stock options were converted into
     options to purchase 59,345 shares of Castelle common stock. The transaction
     was accounted for as a pooling of interests  and  therefore,  all financial
     information  presented has been restated to reflect the combined operations
     of Castelle and Ibex.

                                   Continued
                                      F-6                          Page 43 of 83
<PAGE>
--------------------------------------------------------------------------------
                            CASTELLE AND SUBSIDIARIES
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     2. Summary of Significant Accounting Policies, continued:

     Pooling of Interests, continued:

     Separate net sales,  net income and related per share amounts of the merged
     entities are presented in the following table:
<TABLE>
<CAPTION>

                                              1996                 1995                1994
                                         --------------       --------------      --------------
                                                (in thousands, except per share amounts)

     Net sales:
<S>                                       <C>                  <C>                 <C>
       Castelle                           $      29,125        $      25,082       $      19,486
       Ibex Technologies, Inc.                    3,600                3,091               2,708
                                         --------------       --------------      --------------
            Combined                      $      32,725        $      28,173       $      22,194
                                         --------------       --------------      --------------

     Net income (loss):
       Castelle                           $       6,202        $       2,024       $       (378)
       Ibex Technologies, Inc.                     (559)                  59                212
                                         --------------       --------------      --------------
            Combined                      $       5,643        $       2,083       $       (166)
                                         --------------       --------------      --------------
</TABLE>


     Merger Costs and Expenses:

     In connection with the merger,  costs and expenses totaling $1,430,000 were
     incurred  and have been  charged to expense in the fourth  quarter of 1996.
     The merger costs and expenses consisted of merger related legal, accounting
     and investment banking fees.

     Basis of Consolidation:

     The  Company  has a wholly  owned  subsidiary  in the  State  of  Delaware,
     Castelle  International,  Inc.,  which has a wholly owned subsidiary in the
     Netherlands,  Castelle  Europe BV. The  consolidated  financial  statements
     include the accounts of these wholly owned  subsidiaries.  All intercompany
     balances and transactions have been eliminated.

                                   Continued
                                      F-7                          Page 44 of 83
<PAGE>

--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------
     2. Summary of Significant Accounting Policies, continued:

     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   comprise  highly  liquid   investments  with  original
     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.

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

     Certain Risks and Concentrations:

     Ongoing  customer  credit  evaluations  are  performed by the Company,  and
     collateral is not required.  The Company maintains allowances for potential
     returns and credit losses,  and such returns and losses have generally been
     within  management's  expectations.  Three  customers  accounted for 54% of
     accounts  receivable at December 31, 1996 and two  customers  accounted for
     34% of accounts receivable at December 31, 1995.

     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.

                                   Continued
                                      F-8                          Page 45 of 83
<PAGE>

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


   2.  Summary of Significant Accounting Policies, continued:

           Inventories:

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

           Property and Equipment:

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

           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.  Costs  incurred  subsequent to such
           point were not  significant in 1996 or 1995, 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 $2,304,000,  $1,138,000 and $901,000 in
           1996, 1995 and 1994, respectively.

                                   Continued
                                      F-9                          Page 46 of 83
<PAGE>

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


   2.  Summary of Significant Accounting Policies, continued:

           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.

           Net Income (Loss) Per Share:

           Net income (loss) per share is based upon the weighted average number
           of common and common equivalent shares outstanding. Common equivalent
           shares,   options  and   warrants  are  included  in  the  per  share
           calculations where the effect of their inclusion would be dilutive.

           Reclassifications:

           Certain  reclassifications  have been made to the 1994  statement  of
           cash flows presentation to conform with the 1995 presentation.



   3. Balance Sheet Detail, (in thousands):

           Inventories:

                                                     December 31,
                                             ----------------------------
                                                 1996           1995
                                             -------------  -------------

              Raw material                    $       878    $     2,361
              Work in process                         212            419
              Finished goods                        1,751            898
                                             -------------  -------------

                                             $      2,841    $     3,678
                                             =============  =============

                                   Continued
                                      F-10                         Page 47 of 83
                                     <PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

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

       Property and Equipment:
<TABLE>
<CAPTION>

                                                                         December 31,
                                                                  ----------------------------
                                                                      1996           1995
                                                                  ------------   -------------

<S>                                                                <C>            <C>
         Production, test and demonstration equipment              $      637     $       524
         Computer equipment                                             2,185           1,885
         Office equipment                                                 315             309
         Leasehold improvements                                           109             102
                                                                  ------------   -------------
                                                                        3,246           2,820
         Less accumulated depreciation and amortization                (2,653)         (2,372)
                                                                  ------------   -------------
                                                                   $      593     $       448
                                                                  ============   =============

</TABLE>

     Equipment  acquired under capital leases included in property and equipment
above comprise:

                                                     December 31,
                                                -----------------------
                                                   1996         1995
                                                ----------   ----------

          Equipment                              $    151     $    151
          Less accumulated amortization              (151)        (133)
                                                ----------   ----------

                                                 $      -     $     18
                                                ==========   ==========


           Accrued Liabilities:

                                                           December 31,
                                                    ----------------------------
                                                        1996           1995
                                                    -------------  -------------

           Accrued compensation                      $       893    $       664
           Accrued sales and marketing                       743            698
           Accrued professional fees                          58            332
           Deferred revenue                                  239            117
           Accrued income tax                                427            100
           Accrued acquisition costs                         292
           Other                                           1,173            692
                                                    -------------  -------------

                                                    $      3,825    $     2,603
                                                    =============  =============

                                   Continued
                                      F-11                         Page 48 of 83
                                     <PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------


     4. 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):

                      1997                         $        316
                      1998                                  300
                      1999                                  310
                      2000                                  268
                                                   -------------

                                                   $      1,194
                                                   =============



     Rent  expense,  including  the facility  lease and  equipment  rental,  was
     $374,000, $418,000 and $348,000 for 1996, 1995 and 1994, respectively.


     5. Bank Borrowings:

     The Company has a $6.0 million  revolving  line of credit with a bank which
     expires  in June  1997,  pursuant  to which the  Company  may borrow 75% of
     eligible domestic accounts receivable  ($2,007,000 at December 31, 1996) at
     the bank's prime rate (8.25% at December 31, 1996).  Borrowings  under this
     line of credit agreement are  collateralized  by all assets of the Company.
     In addition, the Company has a $3.0 million foreign accounts receivable and
     inventory  line which is part of the overall $6.0 million  commitment.  The
     Company may borrow 90% of eligible accounts  receivable and 40% of eligible
     inventory.  Under the terms of the  agreement,  the  Company is required to
     comply with covenants, including a certain minimum quick ratio and tangible
     net worth and maximum  debt to tangible net worth,  and is also  restricted
     from  entering  into any  mergers or  acquisitions  where the total  annual
     consideration exceeds $15,000,000 without the bank's approval.  The Company
     is in compliance with these covenants and at December 31, 1996, the line of
     credit had no outstanding balance. The line of credit prohibits the payment
     of cash  dividends  and  contains  certain  restrictions  on the  Company's
     ability to loan money or assets or  purchase  interests  in other  entities
     without the prior written consent of the lender.

                                   Continued
                                      F-12                         Page 49 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     6. Long-Term Debt:

                                                       December 31,
                                                ---------------------------
                                                     1996          1995
                                                --------------  -----------

          Bank note payable                                      $       7
          Vendor note payable                                          159
          Note payable                                                  75
          Capital lease obligations                                     31
                                                --------------  -----------

                                                $           -          272
          Less current maturities                                     (268)
                                                --------------  -----------

                                                $           -   $        4
                                                ==============  ===========


     The bank note payable bore  interest at 12% per annum and was  repayable in
     monthly installments of principal and interest. The note was subject to the
     same conditions as the Company's line of credit (see Note 5) and was repaid
     in full in January 1996.

     The vendor note payable balance  resulted from the conversion of $2,121,000
     of accounts  payable  due to a single  vendor at December  31,  1993,  bore
     interest at 7% per annum and was repaid in full in January 1996.

     In 1995, the Company purchased exclusive license and development rights for
     a software  product in exchange for 18,033 shares of its common stock at an
     estimated fair value of $27,969,  and a  non-interest  bearing note payable
     for  $150,000.  The note,  which was not  collateralized,  was  payable  in
     installments of $25,000,  with the first payment due on March 17, 1995, the
     second payment due July 1, 1995, and quarterly thereafter.


     7. Common Stock:

     In 1995,  the  Company's  Board of Directors  authorized  a  one-for-twenty
     reverse  stock  split  of  its  common  shares,  subject  to  shareholders'
     approval.  All  references  in  the  accompanying   consolidated  financial
     statements  to the number of common  shares and per share amounts have been
     retroactively restated to reflect the reverse stock split.

     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, 1996, 80,693 such shares were subject
     to the Company's repurchase right.

                                   Continued
                                      F-13                         Page 50 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------


     7. Common Stock, continued:

     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, 1996,  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):

                                                Stock Options Outstanding
                                          -------------------------------------
                                            Number      Exercise
                                          of Shares       Price       Total
                                          ----------   ----------  ------------

          Balances, January 1, 1996
                Options granted                  10      $8.00     $        80
                Options canceled                 (3)     $8.00             (22)
                                          ----------               ------------

          Balances, December 31, 1996             7                 $       58
                                          ==========               ============


     At December 31, 1996, 3,247 options were exercisable.

     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,  1996,  there  were no stock  purchase  rights
     outstanding,  and 4 shares purchased pursuant to stock purchase rights were
     subject to repurchase by the Company.


                                   Continued
                                      F-14                         Page 51 of 83

<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------




     7. Common Stock, continued:

          Stock Plans:

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

                                                                  Stock Options Outstanding              Weighted
                                                          -------------------------------------------    Average
                                                            Number         Exercise                      Exercise
                                                           of Shares          Price          Total        Price
                                                           -----------  ----------------  ------------   --------

                            <S>                                  <C>         <C>                 <C>        <C>
                     Balances, January 1, 1994                    57     $5.00-$25.00     $      649        $9.25
                           Options granted                       116        $.20                  24         $.20
                           Options canceled                      (73)    $.20-$20.00            (267)       $5.27
                                                          -----------                    ------------    --------

                     Balances, December 31, 1994                 100     $.20-$20.00             406         $.42
                           Options granted                       191      $.20-$6.00             853        $4.58
                           Options canceled                      (27)    $.20-$25.00            (133)       $1.45
                           Options exercised                      (2)    $.20-$18.00              (1)        $.57
                                                          -----------                    ------------    --------

                     Balances, December 31, 1995                 262      $.20-$6.00           1,125        $3.26
                           Options granted                       139     $6.00-$7.75             987        $7.18
                           Options canceled                      (64)     $.20-$7.75            (425)       $6.61
                           Options exercised                      (2)     $.20-$9.00              (7)        $.20
                                                          -----------                    ------------    --------

                     Balances, December 31, 1996                 335                      $    1,680
                                                          ===========                    ============

</TABLE>

     At December 31, 1996, 118,548 options outstanding were exercisable.

     In February 1995,  the Board of Directors gave certain  employees the right
     to cancel certain outstanding stock options and receive new options with an
     exercise price of $0.20 per share. Options for 6,635 shares of common stock
     at original  exercise  prices  ranging  from $5.00 to $25.00 per share were
     canceled, and new options for a like number of shares were issued in fiscal
     1995. The new options retained the vesting of the canceled options.

                                   Continued
                                      F-15                         Page 52 of 83

<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

   7.  Common Stock, continued:

     Stock Plans, continued:

     1992 Stock Option Plan:

     Under the 1992 Stock  Option Plan (1992 Plan),  the Board of Directors  may
     grant options to purchase  shares of the  Company's  common stock at prices
     not less than the fair market value at the date of grant.  Options  granted
     under the 1992 Plan generally become exercisable  ratably over a three year
     period.

     Option activity under the 1992 Plan is as follows (in thousands):
<TABLE>
<CAPTION>


                                                                       Stock Options Outstanding           Weighted
                                                                 --------------------------------------    Average
                                                                   Number      Exercise        Total       Exercise
                                                                  of Shares      Price                      Price
                                                                 ----------  -------------   ----------    --------

                   <S>                                                 <C>       <C>               <C>        <C>
                   Balances, January 1, 1994                            34    $0.96-$1.55     $     50        $1.07
                       Options granted                                  13      $1.55               20        $1.55
                                                                 ----------                  ----------    --------

                   Balances, December 31, 1994                          47    $0.96-$1.55           70        $1.25
                       Options granted                                  11    $1.55-$3.41           20        $1.81
                       Options exercised                                (5)     $3.41              (19)       $3.41
                                                                 ----------                  ----------    --------

                   Balances, December 31, 1995                          53    $0.96-$3.41           71        $1.34
                       Options granted                                   6      $3.41               21        $3.41
                       Options exercised                                (7)     $1.55              (10)       $1.55
                                                                 ----------                  ----------    --------

                   Balances, December 31, 1996                          52                    $     82
                                                                 ==========                  ==========

</TABLE>

     At December 31, 1996, 41,080 outstanding options were exercisable.

     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 1996 and 1995
     consistent  with the  provisions  of SFAS No. 123, the Company's net income
     and net income per share for the years  ended  December  31,  1996 and 1995
     would  have been  reduced  to the pro  forma  amounts  indicated  below (in
     thousands):

                                                   1996               1995
                                               ------------       -------------

         Net income - as reported               $    5,643         $     2,083
                                               ============       =============
         Net income - pro forma                 $    5,505         $     2,044
                                               ============       =============
         Net income per share - as reported     $     1.20         $      0.59
                                               ============       =============
         Net income per share - pro forma       $     1.17         $      0.58
                                               ============       =============

                                   Continued
                                      F-16                         Page 53 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
                  CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     7. Common Stock, continued:

     Stock Plans, continued:

     The fair value of each option grant is estimated on the date of grant using
     the Black-Scholes method with the following weighted average assumptions by
     subgroup:

                Risk-free interest rate                   5.38%-6.75%
                Expected life                               3 years
                Expected dividends                             -
                Volatility                                    60%



     The options  outstanding  and currently  exercisable  by exercise  price at
     December 31, 1996 are as follows (in thousands, except 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                      99         5.0          $0.20               63       $0.20
                $0.96 - $1.00                  22         2.0          $0.96               22       $0.96
                    $1.55                      22         5.0          $1.55               18       $1.55
                $3.41 - $5.00                 111         5.5          $4.91               40       $4.99
                $6.00 - $8.00                 140         6.5          $6.70               12       $6.74


</TABLE>
     The weighted  average fair value of those options  granted in 1996 and 1995
     was $3.41 and $1.98, respectively.

                                   Continued
                                      F-17                         Page 54 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     7. Common Stock, continued:

     Warrants:

     The Company has outstanding fully exercisable warrants at December 31, 1996
     as follows (in thousands):

                               Stock Under
                Expiration     Stock Under        Exercise     Number of
                    Date         Warrant           Price        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.  During  1995,  6,916  warrants  were
     exercised. No warrants were exercised during 1996.

     Notes Receivable:

     At December 31, 1996, the Company held notes receivable of $296,000,  which
     bear  interest  between  6.3% and 7.05% per  annum,  from  three  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 December 1996 through
     September 2000.

                                   Continued
                                      F-18                         Page 55 of 83

<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     8. Income Taxes:

     The provision for income taxes comprised (in thousands):

                                   Year Ended December 31,
                           ----------------------------------------
                               1996           1995         1994
                           -------------   -----------  -----------

         Current:
              Federal       $       793     $      52    $     109
              State                 130            16           30
              Foreign                20             -            -
                           -------------   -----------  -----------
                                    943            68          139
                           -------------   -----------  -----------
         Deferred:
              Federal            (3,890)            3          (13)
              State                (409)           (2)          (5)
              Foreign                 -             -            -
                           -------------   -----------  -----------
                                 (4,299)            1          (18)
                           -------------   -----------  -----------

                            $    (3,356)    $      69    $     121
                           =============   ===========  ===========

                                   Continued
                                      F-19                         Page 56 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     8. Income Taxes:

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


                                                                                   Year Ended December 31,
                                                                           ----------------------------------------
                                                                               1996           1995         1994
                                                                           -------------   -----------  -----------

<S>                                                                         <C>             <C>          <C>
         Federal tax at statutory rate                                      $       778     $     731    $     (16)
         Permanent difference due to non-deductible expenses                        228            17           (1)
         State taxes, net of federal benefit                                        251            95            8
         Utilization of net operating loss carryforwards                         (1,829)         (823)           -
         Net operating losses not benefited                                           -             -          146
         Release of valuation allowance                                          (2,347)            -            -
         General business credits                                                  (123)            -            -
         Other                                                                     (314)           49          (16)
                                                                           -------------   -----------  -----------

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

                                                                            $    (3,356)    $      69    $     121
                                                                           =============   ===========  ===========
</TABLE>


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

                                                         December 31,
                                                 ----------------------------
                                                     1996           1995
                                                 ------------   -------------

         Inventory allowances and adjustments    $       327     $       323
         Accounts receivable allowances                  483             530
         Other liabilities and allowances                622             133
         State income taxes                                7             260
         Net operating loss carryforwards              1,829           3,027
         Tax credit carryforwards                        899             538
         Depreciation                                    132               -
         Valuation allowance                               -          (4,740)
                                                 ------------   -------------
            Total deferred tax assets            $     4,299     $        71
                                                 ============   =============
         Depreciation                            $         -     $         7
                                                 ------------   -------------
            Total deferred tax liabilities       $         -     $         7
                                                 ============   =============

                                   Continued
                                      F-20                         Page 57 of 83
<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     8. Income Taxes, continued:

     At  December  31,  1996,   the  Company  had  federal  net  operating  loss
     carryforwards  of  approximately  $5,380,000  available  to  offset  future
     regular and alternative  minimum taxable income.  These loss  carryforwards
     expire in 2009.

     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 its domestic operations.


     9. 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 1996,  1995 and 1994,  the Company  made no
     contributions to the plan.

                                   Continued
                                      F-21                         Page 58 of 83

<PAGE>
--------------------------------------------------------------------------------
                           CASTELLE AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------------------------------------------------------------------

     10. 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 are all denominated in U.S. dollars,  and are
     summarized as follows (in thousands):

                                        Years Ended December 31,
                              ----------------------------------------------
                                   1996             1995            1994
                              --------------   --------------   ------------
               Europe          $      5,100     $      5,100     $    4,500
               Pacific Rim           10,800            8,400          3,800
                              --------------   --------------   ------------
                               $     15,900     $     13,500     $    8,300
                              ==============   ==============   ============


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

                                     Years Ended December 31,
                       --------------------------------------------------------
          Customer           1996                1995                1994
          --------     --------------     ---------------     -----------------
          A            $ 3,833    12%     $  2,761    10%     $  2,549      11%
          B              4,419    14%        4,514    16%        4,465      20%
          C              9,711    30%        7,300    26%        3,296      15%


                                      F-22                         Page 59 of 83
<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-KSB.  In  connection  with our audits of
such financial statements,  we have also audited the related financial statement
schedule included at page F-24 of this Form 10-KSB.

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  repects,  the  information  required  to be
included therein.



Coopers & Lybrand, L.L.P.


San Jose, California
February 9, 1997




                                      F-23                         Page 60 of 83

<PAGE>

                                                                     SCHEDULE II

                            CASTELLE AND SUBSIDIARIES
                        VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)


<TABLE>
<CAPTION>

   <S>                                                            <C>         <C>         <C>        <C>
   COLUMN A                                                     COLUMN B    COLUMN C    COLUMN D   COLUMN E

                                                                           Additions
                                                                            Charged
                                                               Balance at   to Costs                Balance
                                                                Beginning     and                  at End of
                                                                of Period   Expenses   Deductions   Period
                                                               ----------  ---------   ---------  ----------
       Year Ended December 31, 1994:
           Deducted from asset accounts:
           Allowance for doubtful accounts                     $   184     $   244     $     -    $   428
           Allowance for excess and obsolete inventory         $   788     $   279     $   564    $   503



       Year Ended December 31, 1995:
           Deducted from asset accounts:
           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



</TABLE>

                                      F-24                         Page 61 of 83
<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, in the City of Santa Clara, State
of California, on the 28th day of March, 1997.


                                      By:
                                         Arthur H. Bruno
                                         Chief Executive Officer and President

     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>
       <S>                                                            <C>                                 <C>


                    Signature                                         Title                           Date

       ___________________________________         Chairman of the Board, Chief Executive        March 28, 1997
                  Arthur H. Bruno                  Officer, President (principal executive
                                                   officer) and Director

       ___________________________________         Chief Financial Officer, Vice President,      March 28, 1997
               Randall I. Bambrough                Finance and Administration and
                                                   Secretary (principal financial and
                                                   accounting officer)

       ___________________________________         Director                                      March 28, 1997
                 John Freidenrich

       ___________________________________         Director                                      March 28, 1997
                   Alan Kessman

        ___________________________________         Director                                      March 28, 1997
                 Kanwal S. Rekhi


</TABLE>
                                                                   Page 62 of 83

<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,  in the City of Santa
Clara, State of California, on the 28th day of March, 1997.


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

     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>
                          <S>                                             <C>                             <C>

                      Signature                                           Title                          Date


                 /S/ ARTHUR H. BRUNO                  Chairman of the Board, Chief Executive         March 28, 1997
                   Arthur H. Bruno                    Officer, President (principal executive
                                                      officer) and Director


              /s/ RANDALL I. BAMBROUGH                Chief Financial Officer, Vice President,       March 28, 1997
                Randall I. Bambrough                  Finance and Administration and Secretary
                                                      (principal financial and accounting officer)


                /s/ JOHN FREIDENRICH                  Director                                       March 28, 1997
                  John Freidenrich


                  /s/ ALAN KESSMAN                    Director                                       March 28, 1997
                    Alan Kessman


                 /s/ KANWAL S. REKHI                  Director                                       March 28, 1997
                   Kanwal S. Rekhi


</TABLE>

                                                                   Page 63 of 83
<PAGE>
<TABLE>
<CAPTION>



                                  EXHIBIT INDEX

<S>                                                                                                    <C>

Exhibit                                                                                            Sequentially
Number        Description                                                                          Numbered Page


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.                                               65

11.1 Computation of Net Income (Loss) Per Share.                                                       81

24.1 Consent of Coopers & Lybrand L.L.P. (reference is made to page 60).                               60

25.1 Power of Attorney. Reference is made to the signature page.                                       63

27.1 Financial Data Schedule                                                                           83

</TABLE>

                                                                   Page 64 of 83
<PAGE>



                                   EXHIBIT 4.2



                                                                   Page 65 of 83
<PAGE>
                                    CASTELLE

                           FIFTH AMENDED AND RESTATED
                          REGISTRATION RIGHTS AGREEMENT


         THIS  AMENDED  AND  RESTATED   REGISTRATION   RIGHTS   AGREEMENT   (the
 "Agreement") is entered into as of the 20th day of November, 1996 by and among
CASTELLE, a California Corporation (the "Company"), and the persons and entities
listed on Exhibit A hereto.

                                    RECITALS

     WHEREAS,  the holders of the Company's Series A Preferred  Stock,  Series B
Preferred Stock,  Series C Preferred Stock,  Series D Preferred Stock,  Series E
Preferred  Stock,  1990 Common,  1992 Common,  1994  Warrants and  Underwriters'
Warrants,  and Eli  Schetrit,  Don  Masulis and Q. T. Wiles  (collectively,  the
"Prior Holders")  possess certain  registration  rights pursuant to that certain
Amended and  Restated  Registration  Rights  Agreement  dated as of February 25,
1991,  amended on February  12,  1992,  further  amended on February  24,  1992,
further  amended on February  24, 1994 and further  amended on December 26, 1995
(the "Prior Agreements"); and

     WHEREAS,  in  connection  with the  merger of Ibex  Technologies,  Inc.,  a
California  corporation ("Ibex"),  into the Company pursuant to an Agreement and
Plan of Reorganization  dated as of August 22, 1996 (the "Merger"),  the Company
has agreed to grant  certain  registration  rights to certain Ibex  shareholders
upon the receipt by them of Company Common Stock pursuant to the Merger; and

     WHEREAS,  since  the  effective  date of the  Third  Amended  and  Restated
Registration Rights Agreement, the Company has effected a 1-for-20 reverse split
of its Common Stock; and

     WHEREAS, the rights granted in this Agreement are intended to supersede and
replace those granted to the Prior Holders pursuant to the Prior Agreements.

     NOW,  THEREFORE,  in  consideration  of the  foregoing  and  of the  mutual
promises and covenants contained herein the parties hereby agree as follows:

     1.  Definitions.  As used  herein,  the  following  terms  shall  have  the
following respective meanings:

     (a)  "1994  Warrants"  means (i) the warrant issued to H&Q London  Ventures
          and initially exercisable for 1,000,000 shares of the Company's Common
          Stock, dated February 24, 1994, (ii) the warrant issued to Hambrecht &
          Quist Group and  initially  exercisable  for  1,000,000  shares of the
          Company's Common Stock, dated February 24, 1994, and (iii) the warrant

                                       1.                          Page 66 of 83
<PAGE>

          issued to Hambrecht & Quist Guaranty Finance and initially exercisable
          for 6,000,000 shares of the Company's Common Stock, dated February 24,
          1994.

     (b)  "Bank  Warrant"  shall mean the warrant  issued to Silicon Valley Bank
          exercisable  for 45,000  shares of the  Company's  Series E  Preferred
          Stock and dated March 1, 1994.

     (c)  "Commission" shall mean the Securities and Exchange  Commission or any
          other federal agency at the time administering the Securities Act.

     (d)  "Eligible  Holder" shall mean Holders,  Ibex Holders and Warrant Share
          Holders, collectively.

     (e)  "Holders"  shall  mean and  include  any  person  or  persons  to whom
          Registrable  Securities (as defined herein) were originally  issued or
          qualifying  transferees  under Section 11 hereof who hold  Registrable
          Securities.

     (f)  "Ibex  Holders"  shall mean and  include any person or persons to whom
          Ibex  Merger  Shares (as defined  herein)  were  originally  issued or
          qualifying  transferees  under  Section 11 hereof who hold Ibex Merger
          Shares.

     (g)  "Ibex Merger  Shares" shall mean those shares of Company  Common Stock
          issued pursuant to the Merger.

     (h)  "Initiating  Holders"  shall mean any Holders who in the aggregate own
          not less than 35% of the  Registrable  Securities  which have not been
          sold to the public.

     (i)  The  terms  "register,"  "registered"  and  "registration"  refer to a
          registration effected by preparing and filing a registration statement
          in compliance with the Securities Act, and the declaration or ordering
          of the effectiveness of such registration statement.

     (j)  "Registrable  Securities" means (i) 37,500 shares of Common Stock held
          by Eli Schetrit, 22,500 shares of Common Stock held by Don Masulis and
          10,312  shares  of  Common  Stock  held by Q. T.  Wiles  (collectively
          referred to as "Founders Stock"),  (ii) shares of the Company's Common
          Stock issued or issuable  pursuant to the  conversion  of the Series A
          Preferred Stock,  Series B Preferred Stock,  Series C Preferred Stock,
          Series D Preferred  Stock or Series E  Preferred  Stock which have not
          been sold to the public,  (iii) 7,494 shares of the  Company's  Common
          Stock issued  pursuant to  conversion  of warrants to purchase  Common
          Stock dated prior to November 14, 1990 (the "1990 Common"), (iv) 7,811
          shares of the  Company's  Common Stock issued by the Company in August
          1992 to the purchasers of Series D Preferred Stock (the "1992 Common")
          and (v) any Common Stock of the Company  issued or issuable in respect
          of the Series A Preferred Stock,  Series B Preferred  Stock,  Series C
          Preferred Stock, Series D Preferred Stock, Series E Preferred Stock or
          the Underwriters' Warrants or any shares of the Company's Common Stock
          or other securities  issued or issuable pursuant to the conversion of,
          or with respect to, the Series A Preferred  Stock,  Series B Preferred
          Stock,  Series C Preferred Stock, Series D Preferred Stock or Series E

                                       2.                          Page 67 of 83
<PAGE>

          Preferred  Stock and the Founder's  Stock,  the 1990 Common,  the 1992
          Common and the  Underwriters'  Warrants  upon any stock  split,  stock
          dividend,  recapitalization,  or similar event,  which shares have not
          been sold to the public.

     (k)  "Registration  Expenses"  shall  mean  all  expenses  incurred  by the
          Company  in  complying  with  Sections  2, 3 and 4 hereof,  including,
          without limitation,  all registration,  qualification and filing fees,
          printing expenses,  escrow fees, fees and disbursements of counsel for
          the Company,  fees and  disbursements  of one counsel for all Holders,
          blue sky fees and  expenses,  and the  expense of any  special  audits
          incident to or required by any such  registration  (but  excluding the
          compensation  of regular  employees of the Company which shall be paid
          in any event by the Company).

     (l)  "Securities Act" shall mean the Securities Act of 1933, as amended, or
          any  similar  federal  statute  and the rules and  regulations  of the
          Commission thereunder, all as the same shall be in effect at the time.

     (m)  "Securities" shall mean the shares of Series A Preferred Stock, Series
          B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock,
          Series E Preferred Stock, the 1990 Common,  the 1992 Common,  the Ibex
          Merger  Shares,   the  1994  Warrants,   the  Bank  Warrants  and  the
          Underwriters'  Warrants  (or any  shares  issued  upon  conversion  or
          exercise thereof).

     (n)  "Selling  Expenses"  shall  mean  all  underwriting  fees,  discounts,
          selling  commissions  and  stock  transfer  taxes  applicable  to  the
          securities registered by the Holders and all fees and disbursements of
          counsel for any Holder, other than are counsel acting on behalf of all
          Holders.

     (o)  "Special  Ibex Holder" shall mean and include  Tucha  Limited,  Newark
          Holding  S.A. and Teodoro  Ramos  Gimenez and any person or persons to
          whom Ibex Merger Shares held by those parties have been transferred in
          accordance with Section 11 hereof.

     (p)  "Underwriters'  Warrants"  shall  mean  those two  warrants  issued to
          Unterberg  Harris and RvR  Securities  Corp.  in  connection  with the
          Company's  initial public offering in December,  1995 for the purchase
          of 100,000 shares of Company Common Stock each.

     (q)  "Underwriters'  Warrants  Holders"  shall mean any  Holders who in the
          aggregate  own or would  own upon  exercise  not less  than 50% of the
          shares of the  Company's  Common Stock  underlying  the  Underwriters'
          Warrants.

     (r)  "Warrant  Shares"  shall mean  shares of the  Company's  Common  Stock
          issued or  issuable  pursuant to  exercise  of the 1994  Warrants  and
          shares  of  the  Company's   Common  Stock  issued  or  issuable  upon
          conversion  of the  Company's  Series  E  Preferred  Stock  issued  or
          issuable upon exercise of the Bank Warrant.

                                       3.                          Page 68 of 83

<PAGE>




     (s)  "Warrant  Share  Holder"  shall mean holders of shares of Common Stock
          issued or issuable  upon  exercise of the 1994  Warrants  and the Bank
          Warrant.

     2. Requested Registration.

     (a)  Request for  Registration.  In case the  Company  shall  receive  from
          Initiating Holders or Underwriters' Warrants Holders a written request
          that the Company effect any registration,  qualification or compliance
          and an  anticipated  aggregate  offering  price,  net of  underwriting
          discounts and commissions, that would exceed either $5,000,000 (in the
          case of a request by Initiating Holders) or $500,000 (in the case of a
          request by Underwriters' Warrants Holders), the Company will:

          (i)  promptly  give  written  notice  of  the  proposed  registration,
               qualification or compliance to all other Holders; and

          (ii) use  its   diligent   efforts   to  effect   such   registration,
               qualification  or compliance as soon as  practicable  (including,
               without  limitation,  the  execution  of an  undertaking  to file
               post-effective   amendments,   appropriate   qualification  under
               applicable   blue  sky  or  other  state   securities   laws  and
               appropriate  compliance with applicable  regulations issued under
               the Securities  Act and any other  governmental  requirements  or
               regulations)  as  may be so  requested  and as  would  permit  or
               facilitate  the sale and  distribution  of all or such portion of
               such  Registrable  Securities  as are  specified in such request,
               together with all or such portion of the  Registrable  Securities
               of any Holder or Holders joining in such request as are specified
               in a written request received by the Company within 15 days after
               receipt of such written notice from the Company;

     Provided,  however,  that the Company  shall not be  obligated  to take any
action to effect any such registration,  qualification or compliance pursuant to
this Section 2:

               (A)  In any particular jurisdiction in which the Company would be
                    required to execute a general  consent to service of process
                    in effecting such registration,  qualification or compliance
                    unless the  Company  is  already  subject to service in such
                    jurisdiction and except as may be required by the Securities
                    Act;

               (B)  Prior to January 1, 1996;

               (C)  Within six (6) months  immediately  following  the effective
                    date of any  registration  statement  pertaining to a firmly
                    underwritten  offering of  securities of the Company for its
                    own account; or

               (D)  Upon request from the Initiating Holders,  after the Company
                    has effected  one such  requested  registration  pursuant to
                    this  Agreement  upon request from the  Initiating  Holders,
                    such registration has been declared or ordered effective and
                    the securities  offered pursuant to such  registration  have
                    been sold.

                                       4.                          Page 69 of 83

<PAGE>

               (E)  Upon request from the Underwriters'  Warrants Holders, after
                    the Company has  effected  one such  requested  registration
                    pursuant   to  this   Agreement   upon   request   from  the
                    Underwriters'  Warrants Holders,  such registration has been
                    declared or ordered  effective  and the  securities  offered
                    pursuant to such registration have been sold.

     Subject to the foregoing  clauses (A) through (E), the Company shall file a
registration  statement  covering the Registrable  Securities so requested to be
registered  as  soon  as  practicable,  after  receipt  of  the  request  of the
Initiating Holders or Underwriters' Warrants Holders; provided, however, that if
the Company shall furnish to such Holders a certificate  signed by the President
of the Company stating that in the good faith judgment of the Board of Directors
of the  Company,  it would  be  seriously  detrimental  to the  Company  and its
shareholders for such  registration  statement to be filed on or before the date
filing would be required,  and it is therefore  essential to defer the filing of
such  registration  statement,  the  Company  shall have the right to defer such
filing for a period of not more than 90 days after receipt of the request of the
Initiating Holders or Underwriters'  Warrants Holders;  provided,  however, that
the  Company may not make such  certification  more than once in any twelve (12)
month period.

     (b)  Underwriting.

          (i)  The  distribution  of the Registrable  Securities  covered by the
               request of the Initiating Holders shall be effected by means of a
               firm commitment underwriting.  The right of any Initiating Holder
               to registration  pursuant to Section 2 shall be conditioned  upon
               such Initiating  Holder's  participation in such underwriting and
               the inclusion of such Initiating Holder's Registrable  Securities
               in the  underwriting to the extent  requested  (unless  otherwise
               mutually  agreed by a  majority  in  interest  of the  Initiating
               Holders  and  such  Initiating  Holder)  to the  extent  provided
               herein.

     The  Company  (together  with  all  Initiating  Holders  and  Underwriters'
Warrants  Holders   proposing  to  distribute  their  securities   through  such
underwriting) shall enter into an underwriting  agreement in customary form with
the  managing  underwriter  selected  for such  underwriting  by a  majority  in
interest of the Initiating Holders.  Notwithstanding any other provision of this
Section 2, if the managing  underwriter  advises the Initiating  Holders and the
Underwriters'  Warrants  Holders in writing  that  marketing  factors  require a
limitation  of the  number of shares to be  underwritten,  then,  subject to the
provisions  of this  Section  2(b),  the  Initiating  Holders and  Underwriters'
Warrants Holders shall so advise all holders of Registrable Securities,  and the
number  of  shares  of  Registrable  Securities  that  may  be  included  in the
registration  and underwriting  shall be allocated among all Initiating  Holders
and  Underwriters'  Warrants  Holders  thereof  in  proportion,   as  nearly  as
practicable,  to the respective  amounts of Registrable  Securities held by such
Initiating Holders and Underwriters'  Warrants Holders at the time of filing the
registration statement. No Registrable Securities excluded from the underwriting
by reason of the managing  underwriter's  marketing limitation shall be included
in such registration.

     If any Initiating  Holder or  Underwriters'  Warrants Holder of Registrable
Securities  disapproves of the terms of the underwriting,  such person may elect
to  withdraw   therefrom  by  written  notice  to  the  Company,   the  managing

                                       5.                          Page 70 of 83
<PAGE>

underwriter,  the Initiating  Holders and Underwriters'  Warrants  Holders.  The
Registrable  Securities  and/or  other  securities  so  withdrawn  shall also be
withdrawn from registration;  provided,  however,  that, if by the withdrawal of
such Registrable  Securities a greater number of Registrable  Securities held by
other Initiating  Holders or  Underwriters'  Warrants Holders may be included in
such  registration  (up  to  the  maximum  of  any  limitation  imposed  by  the
underwriters),  then the  Company  shall  offer to all  Initiating  Holders  and
Underwriters'  Warrants Holders who have included Registrable  Securities in the
registration the right to include additional  Registrable Securities in the same
proportion used in determining the underwriter limitation in this Section 2(b).

          (ii) Notwithstanding any terms in this Agreement to the contrary,  the
               distribution   of  the  shares  issuable  upon  exercise  of  the
               Underwriters' Warrants is not required to be effected by means of
               an underwriting.

     (c)  Inclusion of Shares by Company.  If the managing  underwriter  has not
          limited the number of Registrable  Securities to be underwritten,  the
          Company may include  securities for its own account or for the account
          of others in such  registration if the managing  underwriter so agrees
          and if the  number of  Registrable  Securities  held by  participating
          Holders which would otherwise have been included in such  registration
          and  underwriting  will not thereby be limited.  The inclusion of such
          shares shall be on the same terms as the  registration  of shares held
          by the Initiating Holders or Underwriters' Warrants Holders.

     3. Company Registration.

     (a)  Notice of  Registration  to Eligible  Holders.  If at any time or from
          time to time,  the Company  shall  determine  to  register  any of its
          securities,  either for its own  account or the  account of a security
          holder or holders,  other than (i) a registration  relating  solely to
          employee  benefit plans,  or (ii) a registration  relating solely to a
          Commission Rule 145 transaction, the Company will:

          (i)  promptly give to each Eligible Holder written notice thereof; and

          (ii) include in such registration (and any related qualification under
               blue  sky  laws or  other  compliance),  and in any  underwriting
               involved  therein,  all the Registrable  Securities,  Ibex Merger
               Shares  and  Warrant  Shares  specified  in a written  request or
               requests,  made  within 15 days  after  receipt  of such  written
               notice from the Company, by any Eligible Holder.

     (b)  Inclusion  of  Additional  Shares.  The  Company  may  include  in any
          registration  pursuant to this Section 3  securities  held by officers
          and  employees  of  the  Company,  in  amounts  as  determined  by the
          Company's Board of Directors;  provided,  however,  that the number of
          such shares included in such registration  shall not exceed 10% of the
          total  number  of  shares to be  included  on behalf of the  Company's
          security holders in such registration.

                                       6.                          Page 71 of 83

<PAGE>



     (c)  Underwriting. If the registration of which the Company gives notice is
          for a  registered  public  offering  involving  an  underwriting,  the
          Company shall so advise the Eligible  Holders as a part of the written
          notice given pursuant to Section  3(a)(i).  In such event the right of
          any Eligible Holder to  registration  pursuant to this Section 3 shall
          be  conditioned  upon such  Eligible  Holder's  participation  in such
          underwriting and the inclusion of such Eligible  Holder's  Registrable
          Securities,  Ibex Merger Shares and Warrant Shares in the underwriting
          to the extent  provided  herein.  All  Eligible  Holders  proposing to
          distribute their securities  through such underwriting shall (together
          with the Company and the other holders  distributing  their securities
          through such  underwriting)  enter into an  underwriting  agreement in
          customary  form  with  the  managing  underwriter  selected  for  such
          underwriting  by the Company.  Notwithstanding  any other provision of
          this Section 3, if the managing underwriter  determines that marketing
          factors   require  a  limitation   of  the  number  of  shares  to  be
          underwritten:  (i) if such  registration  is the first offering by the
          Company to the general  public of its  securities for its own account,
          the underwriter may exclude some or all Registrable  Securities,  Ibex
          Merger  Shares  and  Warrant   Shares  from  such   registration   and
          underwriting  (provided the securities of other  shareholders  are not
          included  therein),  and (ii) if such  registration  is other than the
          first  offering by the Company to the general public of its securities
          for its  own  account,  the  underwriter  may  limit  the  Registrable
          Securities,  Ibex Merger  Shares and  Warrant  Shares held by Eligible
          Holders and  securities to be included  pursuant to Section 3(b) to be
          included in such  registration and underwriting to an aggregate of not
          less than 25% of the total value of the  securities to be  distributed
          through  such  registration  and  underwriting.  The Company  shall so
          advise all Eligible Holders and the other holders  distributing  their
          securities  through  such  underwriting,  and the  number of shares of
          Registrable  Securities,  Ibex Merger Shares, Warrant Shares and other
          securities that may be included in the  registration  and underwriting
          shall be  allocated  among all  Eligible  Holders  and  other  holders
          thereof in  proportion,  as nearly as  practicable,  to the respective
          amounts of securities  entitled to inclusion in such registration held
          by all such  Eligible  Holders and other holders at the time of filing
          the registration statement,  except that Ibex Merger Shares includible
          in the registration shall first consist of those shares offered by any
          Special  Ibex Holder with the balance of the Ibex Merger  Shares to be
          included   being   allocated   among  the   remaining   Ibex   Holders
          participating  in  the  registration  in  proportion,   as  nearly  as
          practicable,  to the respective  amounts of Ibex Merger Shares held by
          such Ibex Holders which are  includible in such  registration.  If any
          Eligible  Holder or other holder  disapproves of the terms of any such
          underwriting,  he may elect to withdraw therefrom by written notice to
          the Company and the managing  underwriter.  Any securities excluded or
          withdrawn  from  such  underwriting   shall  be  withdrawn  from  such
          registration,  but if the  registration  is the first  offering by the
          Company to the general  public of its  securities for its own account,
          then the securities so excluded or withdrawn  shall not be transferred
          in a public distribution prior to 120 days after the effective date of
          the registration statement relating thereto.

     4. Registration on Form S-3.

     (a)  In  addition  to the rights set forth in Section 2, if Holders or Ibex
          Holders request that the Company file a registration statement on Form
          S-3 (or any successor to Form S-3) for a public  offering of shares of
          Registrable  Securities  and/or Ibex  Merger  Shares,  the  reasonably
          anticipated aggregate price to the public of which would either (i) be

                                       7.                          Page 72 of 83
<PAGE>

          at least  $1,000,000 or (ii) include at least  $500,000 of Registrable
          Securities issued upon exercise of the Underwriters' Warrants, and the
          Company  is a  registrant  entitled  to use Form S-3 to  register  the
          shares for such an offering, the Company shall use its best efforts to
          cause  such  shares  to be  registered  for  the  offering  as soon as
          practicable  on Form  S-3 (or any  successor  form to Form  S-3).  The
          number of shares of Registrable Securities that may be included on the
          Form S-3 shall be  allocated  among all  Holders  and Ibex  Holders in
          proportion to the  respective  amounts of  Registrable  Securities and
          Ibex Merger Shares  entitled to inclusion in such  registration at the
          time of filing the  registration  statement,  except  that Ibex Merger
          Shares  includible  in the  registration  shall first consist of those
          shares offered by any Special Ibex Holder with the balance of the Ibex
          Merger Shares to be included being  allocated among the remaining Ibex
          Holders participating in the registration in proportion,  as nearly as
          practicable,  to the respective  amounts of Ibex Merger Shares held by
          such Ibex Holders which are includible in such registration.

     (b)  Collectively,  the Ibex Special Holders shall have the right to make a
          single  request,  which  shall be  identified  as such  request in the
          notice to the Company, that the Company file a registration  statement
          on Form S-3 (or any  successor  to Form S-3) for a public  offering of
          Ibex Merger  Shares held by the Special Ibex Holders,  the  reasonably
          anticipated  aggregate  price to the public of which would be at least
          $1,000,000.  If Company is a  registrant  entitled  to use Form S-3 to
          register  the shares for such an offering,  the Company  shall use its
          best efforts to cause such shares to be registered for the offering as
          soon as  practicable  on Form S-3 (or any successor  form to Form S-3)
          and shall keep such registration effective and current for a period of
          30 days.  During such thirty day period,  the Company  shall not allow
          any other  registration  statement  filed  pursuant to Sections 2-4 to
          become effective.  The number of shares of Registrable Securities that
          may be included on the Form S-3 shall be  allocated  among all Special
          Ibex Holders in  proportion to the  respective  amounts of Ibex Merger
          Shares  entitled  to  inclusion  in such  registration  at the time of
          filing the registration statement. Should the Company not be obligated
          to take the action  requested in Section 4(b) due to the exceptions to
          such  obligation  identified in Section  4(c)(ii),  (iii) or (iv), the
          right to make a single  request for  registration  pursuant to Section
          4(b) shall be treated as  unexercised  until the Special  Ibex Holders
          make a subsequent request for registration.

     (c)  Notwithstanding  the foregoing,  the Company shall not be obligated to
          take any action  pursuant  to this  Section  4: (i) in any  particular
          jurisdiction  in which the  Company  would be  required  to  execute a
          general consent to service of process in effecting such  registration,
          qualification  or compliance  unless the Company is already subject to
          service  in such  jurisdiction  and except as may be  required  by the
          Securities  Act;  (ii) if the  Company,  within  ten (10)  days of the
          receipt of the request of the  Holders,  gives notice of its bona fide
          intention to effect the filing of a  registration  statement  with the
          Commission  within  forty-five  (45) days of receipt  of such  request
          (other than with  respect to a  registration  statement  relating to a
          Rule 145  transaction,  an offering  solely to  employees or any other
          registration   which  is  not  appropriate  for  the  registration  of
          Registrable Securities); (iii) except as noted in Section 4(b), during
          the period  starting  with the date of filing of, and ending on a date
          ninety  (90) days  following  the  effective  date of, a  registration

                                       8.                          Page 73 of 83
<PAGE>

          statement  described in (ii) above or pursuant to Section 2,  provided
          that the Company is actively  employing  in good faith all  reasonable
          efforts to cause such  registration  statement to become effective and
          further  provided  that no other  person or entity  could  require the
          Company to file a  registration  statement in such  period;  (iv) more
          than once in any twelve month period or (v) with regard to a Holder or
          Ibex Holder of less than one percent (1%) of the Company's outstanding
          Common  Stock  determined  in  accordance  with  Rule  144  under  the
          Securities Act.

     5.  Expenses  of  Registration.   All  Registration  Expenses,  other  than
underwriting  fees,  discounts or  commissions or fees of counsel other than one
counsel  for  all  selling   shareholders,   incurred  in  connection  with  any
registration, qualification or compliance pursuant to Sections 2, 3 and 4, shall
be borne by the Company.  Unless otherwise stated, all Selling Expenses relating
to securities  registered by the Holders or the Eligible  Holders shall be borne
by the holders of such  securities pro rata on the basis of the number of shares
so registered.

     6. Registration Procedures. In the case of each registration, qualification
or compliance  effected by the Company  pursuant to this Agreement,  the Company
will keep each  participating  Eligible  Holder  advised  in  writing  as to the
initiation of each  registration,  qualification  and  compliance  and as to the
completion thereof. At its expense the Company will:

     (a)  Except as noted in Section 4(b), keep such registration, qualification
          or  compliance  effective and current for a period of 90 days (or such
          longer  period  as may be  necessary  to  accommodate  the  filing  of
          amendments or supplements necessary to comply with the Securities Act)
          or until the participating  Eligible Holder or participating  Eligible
          Holders have completed the distribution  described in the registration
          statement relating thereto, whichever first occurs; and

     (b)  Furnish  such  number of  prospectuses  and other  documents  incident
          thereto  as a  participating  Eligible  Holder  from  time to time may
          reasonably request.

     (c)  Use its best efforts to register and qualify the securities covered by
          such  registration  statement under such other  securities or Blue Sky
          laws of such  jurisdictions  as shall be  reasonably  requested by the
          participating Eligible Holders, provided that the Company shall not be
          required in connection  therewith or as a condition thereto to qualify
          to do business  or to file a general  consent to service of process in
          any such states or jurisdiction.

     (d)  In the  event of any  underwritten  public  offering,  enter  into and
          perform its obligations under an underwriting  agreement, in usual and
          customary form, with the managing  underwriter of such offering.  Each
          Eligible Holder  participating in such  underwriting  shall also enter
          into and perform its obligations under such an agreement.

     (e)  Notify each  participating  Eligible Holder of Registrable  Securities
          and Warrant Shares covered by such registration statement, at any time
          when a  prospectus  relating  thereto  covered  by  such  registration
          statement is required to be delivered under the Securities Act, of the
          happening of any event as a result of which the prospectus included in
          such  registration  statement,  as then in effect,  includes an untrue
          statement  of a  material  fact or  omits  to  state a  material  fact

                                       9.                          Page 74 of 83
<PAGE>

          required  to be stated  therein or  necessary  to make the  statements
          therein  not  misleading  in  the  light  of  the  circumstances  then
          existing.

     7. Indemnification.

     (a)  The Company will indemnify each Eligible Holder, depending on the form
          of the  registration,  each of its officers and directors and partners
          and such Eligible Holder's legal counsel and independent  accountants,
          and each person  controlling  any such  persons  within the meaning of
          Section 15 of the Securities Act, with respect to which  registration,
          qualification  or  compliance  has  been  effected  pursuant  to  this
          Agreement, and each underwriter,  if any, and each person who controls
          any  underwriter  within the  meaning of Section 15 of the  Securities
          Act, against all expenses, claims, losses, damages and liabilities (or
          actions in respect thereof),  including any of the foregoing  incurred
          in settlement of any litigation,  commenced or threatened, arising out
          of or based on any untrue statement (or alleged untrue statement) of a
          material fact  contained in any  registration  statement,  prospectus,
          offering  circular or other  document,  or any amendment or supplement
          thereto,   incident  to  any  such   registration,   qualification  or
          compliance,  or based on any omission  (or alleged  omission) to state
          therein a material fact required to be stated  therein or necessary to
          make the statements therein,  not misleading,  or any violation by the
          Company of any rule or regulation promulgated under the Securities Act
          or any state securities laws applicable to the Company and relating to
          action or inaction required of the Company in connection with any such
          registration,  qualification  or  compliance,  and will reimburse each
          such  Eligible  Holder,  each of its officers and  directors  and such
          Eligible Holder's legal counsel and independent accountants,  and each
          person  controlling any such persons,  each such  underwriter and each
          person who controls any such underwriter,  for any legal and any other
          expenses   reasonably   incurred  in  connection  with  investigating,
          preparing  or defending  any such claim,  loss,  damage,  liability or
          action,  provided that the Company will not be liable in any such case
          to the extent that any such claim, loss, damage,  liability or expense
          arises  out of or is based on any  untrue  statement  or  omission  or
          alleged  untrue  statement or omission,  made in reliance  upon and in
          conformity  with  written  information  furnished to the Company by an
          instrument  duly executed by such Eligible  Holder or underwriter  and
          stated to be specifically for use therein.

     (b)  Each Eligible  Holder will, if Securities held by such Eligible Holder
          are  included  in  the  securities  as  to  which  such  registration,
          qualification or compliance is being effected,  indemnify the Company,
          each  of  its  directors  and  officers  and  its  legal  counsel  and
          independent  accountants,  each underwriter,  if any, of the Company's
          securities covered by such a registration  statement,  each person who
          controls the Company or such underwriter within the meaning of Section
          15 of the Securities Act, and each other such Eligible Holder, each of
          its officers and directors and each person  controlling  such Eligible
          Holder within the meaning of Section 15 of the Securities Act, against
          all claims,  losses,  damages and  liabilities  (or actions in respect
          thereof)  arising out of or based on any untrue  statement (or alleged
          untrue   statement)  of  a  material   fact   contained  in  any  such
          registration  statement,   prospectus,   offering  circular  or  other
          document,  or any  omission (or alleged  omission) to state  therein a
          material fact  required to be stated  therein or necessary to make the

                                      10.                          Page 75 of 83
<PAGE>

          statements  therein not  misleading,  and will  reimburse the Company,
          such  Eligible  Holders,  such  directors,  officers,  legal  counsel,
          independent accountants, underwriters or control persons for any legal
          or  any  other  expenses   reasonably   incurred  in  connection  with
          investigating or defending any such claim, loss, damage,  liability or
          action, in each case to the extent, but only to the extent,  that such
          untrue statement (or alleged untrue statement) or omission (or alleged
          omission) is made in such registration statement, prospectus, offering
          circular or other  document in reliance  upon and in  conformity  with
          written  information  furnished to the Company by an  instrument  duly
          executed by such Eligible Holder and stated to be specifically for use
          therein;  provided,  however,  that the  obligations  of such Eligible
          Holders  hereunder shall be limited to an amount equal to the proceeds
          to each such  Eligible  Holder of  Registrable  Securities  or Warrant
          Shares sold as contemplated herein.

     (c)  Each party  entitled  to  indemnification  under  this  Section 7 (the
          "Indemnified  Party")  shall  give  notice  to the party  required  to
          provide indemnification (the "Indemnifying Party") promptly after such
          Indemnified  Party  has  actual  knowledge  of any  claim  as to which
          indemnity may be sought,  and shall permit the  Indemnifying  Party to
          assume  the  defense  of any such  claim or any  litigation  resulting
          therefrom, provided that counsel for the Indemnifying Party, who shall
          conduct the defense of such claim or litigation,  shall be approved by
          the  Indemnified  Party  (whose  approval  shall not  unreasonably  be
          withheld).  The  Indemnified  Party may participate in such defense at
          such party's expense;  provided,  however, that the Indemnifying Party
          shall bear the  expense of such  defense of the  Indemnified  Party if
          representation   of  both  parties  by  the  same  counsel   would  be
          inappropriate  due to actual or potential  conflicts of interest.  The
          failure of any  Indemnified  Party to give notice as  provided  herein
          shall not relieve the Indemnifying Party of its obligations under this
          Agreement.  No Indemnifying Party, in the defense of any such claim or
          litigation,  shall, except with the consent of each Indemnified Party,
          consent to entry of any  judgment or enter into any  settlement  which
          does not include as an  unconditional  term  thereof the giving by the
          claimant or plaintiff to such Indemnified  Party of a release from all
          liability in respect to such claim or litigation.

     8. Lockup  Agreement.  In  consideration  for the  Company  agreeing to its
obligations under this Agreement, each Eligible Holder agrees in connection with
the first  registration of the Company's  securities whether for its own account
or under Section 2, upon the request of the Company or the underwriters managing
the  underwritten  offering of the Company's  securities,  not to sell, make any
short sale of, loan, grant any option for the purchase of, or otherwise  dispose
of any  Registrable  Securities or Warrant  Shares (other than those included in
the  registration)  without  the prior  written  consent of the  Company or such
underwriters,  as the case may be,  for such  period of time (not to exceed  120
days)  from  the  effective  date of such  registration  as the  Company  or the
underwriters may specify; provided, however, that (i) such Eligible Holder shall
have no  obligation  to enter into the  agreement  described  herein  unless all
executive  officers and directors of the Company  enter into similar  agreements
and (ii) nothing herein shall prevent any Eligible  Holder that is a partnership
from making a distribution  of  Registrable  Securities or Warrant Shares to the
partners  thereof that is otherwise in  compliance  with  applicable  securities
laws.

     9.  Information  by Eligible  Holder.  The  Eligible  Holder of  Securities
included  in any  registration  shall  furnish to the Company  such  information
regarding such Eligible Holder or Holders and the distribution  proposed by such

                                      11.                          Page 76 of 83
<PAGE>

Eligible Holder or Holders as the Company may request in writing and as shall be
required  in  connection  with any  registration,  qualification  or  compliance
referred to in this Agreement.

     10. Rule 144  Reporting.  With a view to making  available  the benefits of
certain rules and regulations of the Commission which may at any time permit the
sale of securities of the Company to the public without registration, after such
time as a public market exists for the Common Stock of the Company,  the Company
agrees to:

     (a)  Make  and keep  public  information  available,  as  those  terms  are
          understood  and defined in Rule 144 under the  Securities  Act, at all
          times after the  effective  date of the first  registration  under the
          Securities  Act filed by the Company for an offering of its securities
          to the general public;

     (b)  Use its best  efforts  to then  file with the  Commission  in a timely
          manner all reports and other  documents  required of the Company under
          the Securities Act and the Securities Exchange Act of 1934, as amended
          (at  any  time  after  it  has  become   subject  to  such   reporting
          requirements);

     (c)  So long as a Eligible  Holder  owns any  Securities  to furnish to the
          Eligible  Holder  forthwith  upon  request a written  statement by the
          Company as to its compliance  with the reporting  requirements of said
          Rule 144 (at any time  after 90 days after the  effective  date of the
          first  registration  statement filed by the Company for an offering of
          its securities to the general  public),  and of the Securities Act and
          the  Securities  Exchange Act of 1934 (at any time after it has become
          subject to such  reporting  requirements),  a copy of the most  recent
          annual or quarterly report of the Company,  and such other reports and
          documents of the Company as an Eligible Holder may reasonably  request
          in  availing  itself  of any  rule  or  regulation  of the  Commission
          allowing  an  Eligible  Holder  to sell  any such  securities  without
          registration.

     11.  Transfer of  Registration  Rights.  The rights to cause the Company to
register  securities  granted  Holders  under  Section 2 and to Holders and Ibex
Holders  under Section 4, and to Eligible  Holders under  Sections 3, may not be
assigned to a transferee or assignee  without the prior  written  consent of the
Company.  Notwithstanding the foregoing, rights to cause the Company to register
securities  may be assigned in  connection  with the transfer or  assignment  of
Securities,  without the Company's consent,  either during the Eligible Holder's
lifetime, or on death by will or intestacy, to his other ancestors,  descendants
or spouse,  or any  custodian  or trustee for the account of Eligible  Holder or
Holders'  ancestors,  descendants or spouse or to any constituent  partner of an
Eligible Holder,  where such Eligible Holder is a partnership,  or to any parent
or  subsidiary  corporation  or any officer,  director or principal  shareholder
thereof, where such Eligible Holder is a corporation.

     12. Termination of Registration Rights. The rights granted pursuant to this
Agreement  shall  terminate as to any Eligible Holder at the earlier of (i) five
years after the Company's  initial  public  offering or (ii) unless the Eligible
Holder is a holder of at least 1% of the  aggregate  of all  outstanding  Common
Stock of the Company,  at such time as such Eligible  Holder may sell under Rule

                                      12.                          Page 77 of 83
<PAGE>

144, or a successor  rule, in a three month period,  all Securities then held by
such Eligible Holder.

     13. Miscellaneous.

     (a)  Waivers and  Amendments.  With the written consent of the holders of a
          majority of the Securities (as then adjusted for any stock  dividends,
          stock splits,  recapitalizations or combinations),  the obligations of
          the  Company  and  the  rights  of the  Eligible  Holders  under  this
          Agreement may be waived (either generally or in a particular instance,
          either  retroactively  or  prospectively,  and either for a  specified
          period of time or indefinitely) or amended; provided, however, that no
          such waiver or amendment shall reduce the aforesaid  number of shares,
          the  holders  of which  are  required  to  consent  to any  waiver  or
          amendment, without the consent of the holders of all of the Securities
          and  provided  further  that no such  waiver  or  amendment  shall  be
          effective  as to the Special  Ibex  Holders or the Ibex Merger  Shares
          held by them without the written  consent of the Special Ibex Holders.
          Upon the  effectuation  of each such waiver or amendment,  the Company
          shall  promptly  give  written  notice  thereof to the  holders of the
          Securities who have not previously consented thereto in writing.

     (b)  Governing Law. This Agreement shall be governed by and construed under
          the laws of the  State of  California  as such  laws  are  applied  to
          contracts made and to be fully  performed  entirely  within that state
          between  residents  of that state.  All  disputes  arising out of this
          Agreement shall be subject to the exclusive  jurisdiction and venue of
          the California State courts of Santa Clara County,  California (or, if
          there is exclusive  federal  jurisdiction,  the United States District
          Court for the Northern District of California) and the parties consent
          to the personal and exclusive jurisdiction and venue of these courts.

     (c)  Successors and Assigns. Except as otherwise expressly provided herein,
          the  provisions  hereof  shall inure to the benefit of, and be binding
          upon, the successors,  assigns, heirs, executors and administrators of
          the parties hereto.

     (d)  Entire  Agreement.  This  Agreement  constitutes  the full and  entire
          understanding  and  agreement  between the parties  with regard to the
          subjects hereof and thereof.

     (e)  Notices.  All notices and other  communications  required or permitted
          hereunder  shall be in  writing  and shall be  mailed by first  class,
          postage  prepaid,  addressed  (a) if to an  Eligible  Holder,  at such
          Eligible  Holder's  address as  indicated  in the  Company's  transfer
          agent's records,  or (b) if to the Company, at 3255-3 Scott Boulevard,
          Santa Clara, California 95051, or at such other address as the Company
          shall have furnished to the Holders in writing.

     (f)  Separability.  In case  any  provision  of  this  Agreement  shall  be
          invalid,  illegal  or  unenforceable,   the  validity,   legality  and
          enforceability of the remaining provisions of this Agreement shall not
          in any way be affected or impaired thereby.

                                       13.                         Page 78 of 83

<PAGE>



     (g)  Titles and  Subtitles.  The titles of the sections and  subsections of
          this Agreement are for  conveniences  of reference only and are not to
          be considered in construing this Agreement.

     (h)  Counterparts.  This  Agreement  may  be  executed  in  any  number  of
          counterparts,  each of which  shall be an  original,  but all of which
          together constitute one instrument.

     The  foregoing  Agreement  is hereby  executed  as of the date first  above
written.

                        CASTELLE,
                        a California corporation



                         By:     /s/ Arthur Bruno
                                 ARTHUR BRUNO,
                                 President and Chief Executive Officer

                                       14.                         Page 79 of 83

<PAGE>


                         COUNTERPART SIGNATURE PAGE FOR
                           FIFTH AMENDED AND RESTATED
                          REGISTRATION RIGHTS AGREEMENT


     The  undersigned is executing this signature page for the Fifth Amended and
Restated  Registration  Rights  Agreement  with  respect to all  Securities  and
Registrable Securities held by the undersigned shareholder.

                                                              SHAREHOLDER:  *

                                                              Name:



                                                              Signature:

                                                              By:

                                                              Title:



* The persons and entities listed below are signatories to the Agreement:

Applied Systems Engineering, Inc.
Asset Management Associates 1984
Bay Partners III
Bay Partners IV
Henry S. Bienen
California BPIV, L.P. (formerly BP IV)
Daniel H. Case III
Marian H. Case
Eric Chen
Colleen E. Curry
Delaware Charter Guarantee & Trust Co.
Scott Edwards
Antonio J. Espinosa
Elizabeth Hambrecht Eu
Boyd W. Fellows
Dieter Folta
Peter S. Friedman
Golden Moon Ventures
The 1990 Grant Revocable Trust
Robert Ney Grant
Joseph A. Greco & Roslyn M. Greco
Guaranty Finance Management Corp.
H&Q Group
H&Q London Ventures
H&Q TV Management N.V. H&Q Ventures International C.V.
H&Q Ventures IV
Hambrecht & Quist Venture Partners
Hambrecht 1980 Revocable Trust
Amelia T. Hambrecht
Forrest Hambrecht
George N. Hambrecht
Robert H. Hambrecht
Susan L. Hambrecht
William R. Hambrecht
Hamco Capital Corporation
Hamquist
Donald E. Hansen & Sarah A. Blanchette
Hardie Honda
INL Ventures, Inc.
Ivory & Sime Enterprise Capital plc
   (formerly The Independent Investment
   Co. Plc)
Brian H. Jones
Alan Kessman
Robert F. Killion
Samuel D. Kingsland
Donald R. Klarich and Geraldine Klarich
Kulp 1983 Revocable Trust 04/01/83
Douglas Look
Edgar L. Lowe
Bruce M. Lupatkin
Gordon S. Macklin
Dean Witter Reynolds, Custodian for
   Bruce A. Mann Rollover dated 11/02/94
Clovis F. Mattos
Cristina M. Morgan
William R. Murray and Mary Patricia
   Murray, Trustees of the Murray
   Family Revocable Trust dtd 6/6/90
Randall A. Nishimi
Standish H. O'Grady
Paul F. Pelosi
Robert Place
Curtis R. Powell
Elizabeth Powell
John S. Powell
Hans-Peter Riecken
RvR Securities Corp.
Kevin R. Skaggs
J.F. Shea Company, Inc.
J.F. Shea Co., as Nominee 1989-15
John J.F. Sherrerd
Susan Sherrerd
Silicon Valley Bank
Sharon L. Smith
Prakash C. Sootarsing
Timothy M. Spicer
William R. Timken
Barry Traub
Tucha Limited
Unterberg Harris, L.P.
John C. Vlahoyiannis
Leonor Velasco
Dennis Walton
P. Stewart Ward
Lawrence P. Weiner
William Welty
Richard J. & Robin L. Wetmore
Susan Witter

                                                                   Page 80 of 83

<PAGE>

                                  EXHIBIT 11.1



                                                                   Page 81 of 83
<PAGE>





                                                                   EXHIBIT 11.1

                            CASTELLE AND SUBSIDIARIES
                        COMPUTATION OF NET LOSS PER SHARE
                    (in thousands, except per share amounts)






<TABLE>
<CAPTION>


                                                                    December 31,          December 31,      December 31,
                                                                       1996                  1995              1994
                                                                    ------------          ------------      ------------
Primary and fully diluted:
<S>                                                                       <C>                   <C>                 <C>
   Weighted average common shares outstanding for the period              4,461                 1,588               875
   Weighted average shares from assumed conversion of
   preferred stock                                                                              1,724
   Common equivalent shares pursuant to Staff Accounting
   Bulletin No. 83                                                                                 74                74
   Common equivalent shares assuming conversion of stock
   options under the treasury stock method                                  241                   133
                                                                    ------------          ------------      ------------
   Shares used in per share calculation                                   4,702                 3,519               949
                                                                    ============          ============      ============

   Net income                                                       $     5,643           $     2,032       $      (166)
   Income addback under modified treasury stock method                                             51
   Net income                                                       $     5,643           $     2,083       $      (166)
                                                                    ============          ============      ============
   Net income per share                                             $      1.20           $      0.59       $     (0.17)
                                                                    ============          ============      ============
                                                                   Page 82 of 83
</TABLE>
<PAGE>